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What's Happening in Detroit

posted by Adam Levitin

Already the Detroit bankruptcy is producing a interesting bit of litigation about the interaction between state and federal law. Federal bankruptcy law sets up this problem because among the requirements for a municipality to file for Chapter 9 bankruptcy is that the municipality:

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.

Michigan law requires that the governor approve a municipal bankruptcy filing.  The governor of Michigan has approved Detroit's bankruptcy filing, but a Michigan state court found that his approval violated the Michigan state constitution, namely a provision that:

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.

Presumably the governor's authority is always bounded by the state constitution--to the extent he acts ultra vires, his actions are not valid, and given the pre-filing constitutional challenge, it's hard to claim any sort of apparent authority. Still, it's not clear to me why this provision would render the governor's approval of the bankruptcy filing unconstitutional, as bankruptcy law itself prohibits the violation of the Michigan constitution provision at issue, so by authorizing the bankruptcy filing, the governor cannot be approving the violation of the Michigan constitution.

Here's why I think the filing is authorized:  

(1) Chapter 9 requires that for a plan to be confirmed, the court must find that the "the debtor is not prohibited by law from taking any action necessary to carry out the plan". As this provision applies in addition to 11 USC 1129(a)(3) (via section 901), it must mean something more than 1129(a)(3). There's only one reported case on this provision, In re Sanitary & Improv. Dist. #7, 98 B.R. 970 (Bankr. D. Neb. 1989), which held that a plan that failed to comply with a state law priority system protecting bondholders could not be confirmed. To the extent that this is the proper reading of the provision, it means that in chapter 9, unlike in chapter 11, the Supremacy clause does not always hold sway. Given that federal law allows states to limit chapter 9 filings in the first place, such a reading makes sense. Down the road, section 943(b)(4) should protect unionized and non-unionized employees' accured pension benefits. And that means that the Michigan governor's authorization of the bankruptcy could not violate the state constitution because federal law prevents the very violation alleged. In other words, if the unions are protected by section 943(b)(4), they aren't protected against a bankruptcy filing.

(There is of course a possibility that the unions would be jurisdictionally whipsawed, with the Michigan courts approving the bankruptcy filing on the assumption that 943(b)(4) will protect accrued pension benefits, but with the bankruptcy court subsequently taking a different reading of 943(b)(4).)  

(2) Irrespective of how section 943(b)(4) is read, it's possible for a bankruptcy to leave untouched the accrued financial benefits of each pension plan.  Therefore, authorizing a bankruptcy filing does not necessarily violate the state constitution. What happens in bankruptcy after the governor authorizes the filing is out of his control and is guided by what federal law, rather than state law permits (other than when federal law defers to state law); the governor just starts the process. Given the cannon of constitutional avoidance, the possibility of a bankruptcy plan not violating the state constitution might be enough for the governor's approval to pass constitutional muster.

In any case, it's worth noting what the Michigan constitution does not do:  it provides no protection for non-accured pension benefits.  Current employees might find the terms of their pension plans changed going forward.  It's also not clear to me whether this provision extends to protect accrued retiree health benefits. 

So where we stand is that the Michigan courts have to sort out whether the bankruptcy filing would violate the Michigan constitution. 

Comments

Thank you for covering this, Professor Levitin. Seems to me you have situated the issues well and I hope you continue your coverage.

In Detroit's case, does Article 9, Section 24 make the city pensioners' "accrued financial benefits" a contractual obligation of the state? The city? The Gen'l Employees Retirement System and Police & Fire Retirement System, as applicable?

I'm having trouble figuring out who the thereof is, since that party is the thereby referant who can't diminish or impair the obligations.

Given the cannon of constitutional avoidance .. Is this a 2nd Amendment post?

I thought the point of bankruptcy was to break a set of contractual obligations in a way most acceptable to all parties as determined by the bankruptcy court. The court would decide how to balance various bad options.

The constitution can't specify logically impossible conditions.

And while all these lawyers get rich fighting about the wording or this convoluted set of laws, where is the City of Detroit going to get the money to keep paying those pensioners? No one is going to lend them the money, unless the Federal Reserve is leaned on to run the presses for a few extra minutes each day...

I think Meano Culpa has a good point. Who or what is the antecedent to "thereof"? The antecedent seems to me to be the pension plans and retirement systems. Thus it is the pension plans and retirement systems that are proscribed from diminishing or impairing obligations, not the City of Detroit.

I think the statute is pretty clear. The "thereof" and the "thereby" both refer to whichever state or political subdivision has the pension plan or retirement system at issue.

Sadly, had all levels of state government implemented the second sentence of sec. 24 of Art. IX of the Michigan Constitution, the first wouldn't be in play.

Let me dig out my fed courts hat here. (Rummaging). Ok, this state trial court proceeding is going nowhere, because it can't enjoin a federal proceeding.

But seems like the bankruptcy court could bounce things over to the Michigan Supreme Court to clear up the question Adam mentions.

Although some states limit the availability of certification (e.g., New York only allows certification from the federal courts of appeals, IIRC), it looks as though Michigan could accept a certification directly from the bankruptcy court. Mich. Sup. Ct. R. 7.305(B).

If the MSC were clever, couldn't it rule conditionally -- that is, state that if s. 943 has the meaning Adam suggests, the bankruptcy is permissible, and if not, it isn't? And at that point, I think, settlement happens pretty quickly, as it's clear the bondholders will be taking most of the lumps. So the MSC can really drive the whole bus if it wants to, right?

(From original post): "It's also not clear to me whether this provision extends to protect accrued retiree health benefits."

The Michigan Supreme Court addressed this directly in 2005 in Studier. I hate to summarize opinions, but this one was a pretty clear no (OPEB not protected).

The fallback position in Studier is whether specific public retiree healthcare benefits constitute a contractual obligation or merely a policy. There are different plans/terms of employment here, so the result might be different than in Studier as a threshold matter. Retirees would then make the same argument outlined above: even if a BK court can set aside the contract, the municipality is barred from asking that it be done.

http://publicdocs.courts.mi.gov:81/OPINIONS/FINAL/SCT/20050628_S125765_73_studier2jan05-op.pdf

First,I am not a attorney,just a taxpyer--What I would like to know is whether the State Constitutional provision was intended to keep politics out of retiree compensation,or strictly to guarantee these people get paid,"no matter what",as many of them seem to believe.The sad truth is that financial reality has finally caught up to the public irresponsibility,and what cannot be paid,will NOT be paid..

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