Just a handful of modern big-city bankruptcies have revealed foundational questions about chapter 9's fit within federal courts and constitutional jurisprudence. Given that chapter 9 no longer is simply an adjustment of bond debt, bankrupt cities restructure a wide range of claims in their plans, including those arising from long-lingering disputes; to this point, a Ninth Circuit panel just heard oral argument on a dispute from Stockton's exercise of its eminent domain power twelve years before Stockton filed its chapter 9 petition, only to put the case on hold pending rehearing en banc of a chapter 11 equitable mootness dispute. But my commentary today focuses on the impact of events and decisions during a bankruptcy case. If cases no longer must be prepackaged, a city's decisionmakers have a longer period of automatic stay protection during which to act in ways that might generate controversy, causes of action, or both.
Recall, for example, Detroit's headline-making residential water shutoff policies and practices. The bankruptcy court used informal control to coax the city into increasing protections for low-income residents. In response to an adversary proceeding requesting more formal intervention, the bankruptcy court held it did not have the power to enter an order enjoining the policy or directing changes. But Judge Rhodes' analysis included a significant caveat: in a follow-up written ruling, Judge Rhodes held that section 904 of the Bankruptcy Code does not shield a municipal debtor from injunctions of ongoing constitutional violations:
The Court concludes that § 904 does not protect the City from the bankruptcy court's jurisdiction over the plaintiffs' constitutional claims because the City does not have the "governmental power" to violate the due process and equal protection mandates of the Constitution [citations omitted]. The City must comply with those constitutional mandates [citation omitted]. Accordingly, the Court concludes that those claims, unlike the plaintiffs' other claims, do survive the City's § 904 challenge.
Lyda v. City of Detroit, 2014 WL 6474081 at *5 (Bankr. E.D. Mich., Nov. 19, 2014). That holding did not get the Lyda plaintiffs far because, according to the court, the allegations failed to state a constitutional claim on which relief could be granted. The adversary proceeding was dismissed. Judge Rhodes' decision rightly signaled, though, that a municipal bankruptcy petition is not a license to engage in constitutional violations without consequence. The district court had affirmed the ruling. Lyda v. City of Detroit, 2015 WL 5461463 (E.D. Mich. Sept. 16, 2015).
Last week, the Sixth Circuit reversed the portion of the bankruptcy court's decision on the relationship between section 904 and alleged ongoing constitutional harms. The reversal did not change the outcome for the parties, but generates a troubling question: can municipal bankruptcy allow a city to continue to violate constitutional rights with no redress? Surely the answer must be "no"?