Select Issues With Respect to the Filing of
Chapter 9 Bankruptcy by the City of Detroit
J. Robert Stoll
Aaron Gavant
Mayer Brown LLP
Mayer Brown LLP
Visiting Professor
University of Belgrade Faculty of Law
U.S. Workout/Insolvency Law Course
University of Belgrade Faculty of Law
FALL 2015
Introduction
I.
Detroit declared in “financial emergency” under state law –
March 1, 2013
II.
Kevyn Orr appointed as Detroit’s emergency manager – March
14, 2013
III. Filing of Chapter 9 Petition – July 18, 2013
• Approximately 100,000 Creditors
• 20,000+ current and retired employees
IV. Plan of adjustment approved – November 7, 2014
1
Legal Challenges to Detroit’s Chapter 9 Petition
o Constitutionality under U.S. and Michigan State Constitutions
o Does Chapter 9 of the Bankruptcy Code violate the U.S. constitution
o Can the Bankruptcy Court determine the constitutionality of the
Bankruptcy Code
o Michigan Public Act 436 (2012) violates the Michigan constitution (and
therefore Detroit is not validly authorized to file Chapter 9 bankruptcy
case)
o Does the Bankruptcy Court have the authority/jurisdiction to determine
constitutionality of Michigan Public Act 436
2
Legal Challenges -- Selected Applicable
Bankruptcy Code and State Law Provisions
•
U.S. Constitution
o
U.S. Constitution, Art. I, Sec. 8, Clause 2-- Power to establish bankruptcy
laws:
“The Congress shall have power to . . . establish . . . uniform Laws on the
subject of Bankruptcies throughout the United States . . .”
o
U.S. Constitution, Tenth Amendment – powers not given to federal
government reserved for states:
“The powers not delegated to the United States by the Constitution, nor
prohibited by it to the states, are reserved to the states respectively, or
to the people.”
o
U.S. Constitution, Art. VI, Clause 2 – “Supremacy clause”:
“The Laws of the United States . . . shall be the supreme Law of the
Land.”
3
Legal Challenges -- Selected Applicable
Bankruptcy Code and State Law Provisions
•
11 U.S.C. § 903 – Reservation of State power to control municipalities:
This chapter does not limit or impair the power of a State to control, by
legislation or otherwise, a municipality of or in such State in the exercise of
the political or governmental powers of such municipality, including
expenditures for such exercise, but –
(1) A State law prescribing a method of composition of indebtedness of such
municipality may not bind any creditor that does not consent to such
composition; and
(2) a judgment entered under such a law may not bind a creditor that does
not consent to such composition.
4
Legal Challenges -- Selected Applicable
Bankruptcy Code and State Law Provisions
•
11 U.S.C. § 904 – Limitation on jurisdiction and powers of court:
Notwithstanding any power of the court, unless the debtor consents or the
plan so provides, the court may not, by any stay, order, or decree, in the case
or otherwise, interfere with—–
(1) any of the political or governmental powers of the debtor;
(2) any of the property or revenues of the debtor; or
(3) the debtor’s use or enjoyment of any income-producing property.
5
Legal Challenges to Detroit’s Chapter 9 Petition
o Eligibility
o
Detroit’s emergency manager was not an elected official and hence
did not have authority to file Chapter 9 petition
o
Since Governor’s authorization to file Chapter 9 did not prohibit
Detroit from impairing pension rights, authorization was not valid
under the Michigan constitution and Section 109(c)(2) of the
Bankruptcy Code.
o
Because a Michigan state court had determined that the City was
precluded from filing Chapter 9, later filing was invalid
6
Legal Challenges -- Selected Applicable
Bankruptcy Code and State Law Provisions
•
Michigan State Law
o
Michigan Public Act 436 – Appointment of Emergency Manager
o
Michigan Constitution Article IX, § 24 – Protection of Public Pension Benefits:
“The accrued financial benefits of each pension plan and retirement
system of the state and its political subdivisions shall be a contractual
obligation thereof which shall not be diminished or impaired thereby.”
7
Factual Challenges to Detroit's Chapter 9 Petition
o City of Detroit was not insolvent – Section 109(c)(3), definition
of insolvency – Section 101(32)(c)
o City of Detroit did not desire “to affect the plan to adjust such
debts” (Section 109(c)(4))
o City of Detroit did not negotiate in good faith (Section
109(c)(5)(B)
o City of Detroit was not “unable to negotiate with creditors
because such negotiation was impracticable” (Section
109(c)(5)(C))
o Chapter 9 Petition was filed in bad faith (Section 921(c))
8
Factual Challenges -- Selected Applicable
Bankruptcy Code and State Law Provisions
•
11 U.S.C. § 109(c) – eligibility to file under Chapter 9:
(c) An entity may be a debtor under chapter 9 of this title if and only if such
entity –
(1) is a municipality;
(2) is specifically authorized, in its capacity as a municipality or by name, to
be a debtor under such chapter by State law, or by a governmental officer or
organization empowered by State law to authorize such entity to be a
debtor under such chapter;
(3) is insolvent;
(4) desires to effect a plan to adjust such debts; and
(5) (A) has obtained the agreement of creditors holding at least a majority in
amount of the claims of each class that such entity intends to impair under
a plan in a case under such chapter;
9
Factual Challenges -- Selected Applicable
Bankruptcy Code and State Law Provisions
•
11 U.S.C. § 109(c) cont.
(B) has negotiated in good faith with creditors and has failed to obtain the
agreement of creditors holding at least a majority in amount of the claims of
each class that such entity intends to impair under a plan in a case under
such chapter;
(C) is unable to negotiate with creditors because such negotiation is
impracticable; or
(D) reasonably believes that a creditor may attempt to obtain a transfer that
is avoidable under section 547 of this title.”
10
Factual Challenges -- Selected Applicable
Bankruptcy Code and State Law Provisions
•
11 U.S.C. § 101(32)(C) - definition of “insolvency” with respect to a
municipality:
(C) With reference to a municipality, financial condition such that the
municipality is—
(i) generally not paying its debts as they become due unless such debts are
the subject of a bona fide dispute; or
(ii) unable to pay its debts as they become due.
11
Plan of Adjustment
o Allows City to cut $7 billion of unsecured liabilities
o Retiree pensions cut by 4.5% with majority of retirees not
to receive annual cost of living adjustments
o Denial of appeal by dissenting retirees – arguments not directly
addressed (ruled equitably moot)
o Retiree health benefits cut by 90%
o Bondholders and bond insurers recover at very low rate
(e.g., Syncora, as bond insurer, accepting $0.14 on the
dollar)
o City’s contribution to pension plans based on expected
rate of return of 6.75% on pension investments
o Debate on whether rate is reasonable
12
Plan of Adjustment
o “Grand Bargain”
o Detroit Institute of Art collection valued at
approximately $4 - 4.5 billion
o Collection not sold so long as museum contributed
at least $500 million toward paying off city’s debt
o Museum raised $800 million, including $330
million from philanthropic organizations and $200
million from the state of Michigan
13
Plan of Adjustment -- Selected Applicable
Bankruptcy Code and State Law Provisions
•
Section § 943(b) – Chapter 9 Confirmation requirements:
(b) The court shall confirm the plan if –
(1) the plan complies with the provisions of this title made applicable by
sections 103(e) and 901 of this title;
(2) the plan complies with the provisions of this chapter;
(3) all amounts to be paid by the debtor or by any person for services or
expenses in the case or incident to the plan have been fully disclosed and
are reasonable;
(4) the debtor is not prohibited by law from taking any action necessary to
carry out the plan;
(5) except to the extent that the holder of a particular claim has agreed to a
different treatment of such claim, the plan provides that on the effective
date of the plan each holder of a claim of a kind specified in section
507(a)(2) of this title will receive on account of such claim cash equal to the
allowed amount of such claim;
14
Plan of Adjustment -- Selected Applicable
Bankruptcy Code and State Law Provisions
•
Section § 943(b) cont.
(6) any regulatory or electoral approval necessary under applicable
nonbankruptcy law in order to carry out any provision of the plan has been
obtained, or such provision is expressly conditioned on such approval; and
(7) the plan is in the best interests of creditors and is feasible.
15
Lessons Learned
o State law restrictions on application of tax revenues remain
enforceable in bankruptcy.
o Bondholders entitled to specific pledge of tax obligations should
demand the benefit of these pledges and expect recoveries
greater than general unsecured creditors.
o Detroit case confirms unique character of lien on pledged,
special revenues in Chapter 9.
o While pensions not sacrosanct, given political considerations
surround pensions, reasonable to expect Detroit example to be
followed elsewhere.
o Creditor should push municipalities to creatively monetize
unencumbered municipal assets in Chapter 9.
16
Lessons Learned
o Chapter 9 outcomes much more likely to be negotiated then
litigated – creditors should therefore aggressively engage in
mediation, when available, from the outset.
o Fee examiners likely to become a fixture in Chapter 9 cases.
o Creditors should be prepared to use debtor’s timetable to their
advantage.
o In addition to legal realities, creditors and other stakeholders
should approach Chapter 9 process with political realties in mind
and not be surprised if such realities lead to plan treating
situated creditors differently
17