Municipal bankruptcy and public pensions: Detroit's eligibility for Chapter 9 relief and legal restraints on the city's actions as a debtor.

Author:Garvey, Jackson T.
 
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"I'm a proponent of cities going bankrupt. Bridgeport will show the way. It's the only way out." (1)

--Richard M. Daley, Former Mayor of Chicago

INTRODUCTION

On July 18, 2013, after decades of steady economic decline, the City of Detroit, Michigan filed for bankruptcy in the Eastern District of Michigan under Chapter 9 of the United States Bankruptcy Code. (2) For years, Detroit has served as a cautionary tale for single-industry-dominated cities. Detroit is both the most populous U.S. city to declare bankruptcy and the most indebted municipality to ever file for relief. (3) Its exact debts have not yet been determined, but early estimates put the number somewhere between eighteen and twenty billion dollars. (4)

The case presents complex legal and political problems, but one group of creditors has received the bulk of media attention in the city's bankruptcy: pensioners. Pension commitments to both current and future retirees represent a sizeable portion of the city's overall debts, and estimates by Detroit's state-appointed Emergency Manager Kevyn Orr and his team place the amount of underfunded pension obligations at $3.5 billion. (5) Because ERISA pension pre-funding requirements do not apply to governmental pension plans, (6) many public pension systems are paid directly out of the municipality's yearly budget instead of being pre-funded by employee earnings. (7) Many cities across the country face similarly burgeoning underfunded pension debt, (8) and some states (including Michigan) have passed statutory or constitutional protection for pension benefits once they have been earned or have vested. (9) A recent estimate from a 2010 study conducted by Northwestern University economists pegs the total deficit in public pension plans in the United States at $574 billion. (10) This means that pensioners and municipal administrators across the country will be watching Detroit's bankruptcy closely, since any legal precedent set by the case will have enormous influence on the future of municipal bankruptcy law and the retirement outcomes of many Americans.

This Note will seek to address the constitutional and statutory issues raised in the early stages of Detroit's bankruptcy. Part I will briefly address how Detroit reached the point where municipal bankruptcy became legally possible and politically attractive. It will examine population trends in the city, changes in the character of Detroit's major industries, and the deterioration of city services.

Part II will provide background information about the history of municipal bankruptcy in America and the constitutional challenges that it has faced. It will attempt to give a base from which to examine the major issues raised by Detroit's case and how they might fit into the history of municipal bankruptcy and America's system of federalism. Specifically, it will address the Supreme Court's decision in United States v. Bekins (11) and some of the cases that have followed.

Part III will dive into the issues raised by objectors to Detroit's filing. While the objectors have raised at least thirteen distinct objections to the filing, this Note will concentrate on three. First, an effort will be made to demonstrate that contrary to some of the objections raised in the Detroit case, Chapter 9 is facially constitutional. Next, it will examine Michigan's authorization of Detroit's bankruptcy petition in accordance with [section] 109(c) of the Bankruptcy Code. (12) It will argue that Public Act 436, (13) the Michigan law that authorizes municipal bankruptcy and sets out the procedures that must be followed to file under Chapter 9, is constitutional and that the filing in this case complied with both federal and state law. It will also argue that Chapter 9 is constitutional as applied to Detroit, and that the protections present in Chapter 9 do more than enough to overcome any potential Tenth Amendment issue in Detroit's filing. (14) Finally, it will argue that, due to the Bankruptcy Code's incorporation of state law property definitions, public sector pensions may not be reduced in Michigan by any means, including Chapter 9 bankruptcy.

  1. HOW DETROIT REACHED BANKRUPTCY

    Detroit was once the cradle of the world's automobile industry. It had a population of 1.85 million at its peak in 1952, (15) built half the world's cars in the early 1950s, (16) and experienced intense job-driven population growth for multiple decades. (17) However, the industry that spurred Detroit to become the fourth-largest city in America (18) would also prove to be the main driver of its decay. Shortly after the end of World War II, the auto industry started moving toward automated production processes, reducing the need for labor. (19) Not surprisingly, this shift led to rising unemployment in Detroit, as the number of manufacturing jobs fell by approximately 134,000 between 1947 and 1963. (20)

    The problem only worsened when foreign automakers began to gain market share both abroad and in America. Between 1955 and 1980, the "Detroit Three" (Ford, Chevrolet, and Chrysler) saw their American market share for new cars plummet from 95% to 75%. (21) Things did not improve with time, and in 2010, the American market share held by the "Detroit Three" had fallen to a previously unimaginable 45% combined. (22) While the troubled companies collectively saw a slight uptick in their market share between 2010 and 2011 (to 47%) following the bankruptcies of Chrysler and General Motors, (23) there are no indications of a coming turnaround.

    While the decline of the American auto industry's impact on Detroit's economic fall is hard to overstate, it should not be considered the only important factor. Several other shifts contributed to the city's economic collapse. Other manufacturing-based industries declined over the same period, and between 1972 and 2007 the city saw around 80% of its manufacturing plants and 78% of its retail establishments close their doors. (24) This general economic downturn led to a colossal contraction of Detroit's labor market, and the unemployment rate rose to a much higher figure than the national average. (25)

    The lack of job opportunities in Detroit likely led to another major driver of its current problems: a shrinking population. Detroit's population fell from 1.85 million in the 1950s to a little over 1 million in 1990. (26) The 2010 census revealed that Detroit's population had fallen again to 713,777 people, and the Census Bureau estimated that by 2012 only 701,475 people remained. (27) These figures reflect the stark reality that many of those with the means to leave Detroit have chosen to move rather than deal with the seemingly unstoppable contraction of jobs, population, and city services.

    As a result of this economic and population contraction, Detroit has seen the bottom fall out of its tax base. Detroit's collection of municipal income tax receipts has fallen by more than $95 million since 2002 and by over $34 million since 20 08. (28) The reduction is driven both by the shrinking population base and a decline in per capita income. Between 2008 and 2012, the median household income in Detroit was $26,955. (29) Over the same period of time, an estimated 38.1% of residents were below the poverty line. (30) During that period, the similar national figures were $53,046 and 14.9%, respectively. (31) Absent a significant change in the city's economic and demographic trends, Detroit's tax base is unlikely to improve any time soon, as both population and incomes shrink.

    City services have been hit hard by the decline. About 40% of the city's streetlights don't work. (32) Half the city's parks have closed since 2008. (33) Almost 80,000 buildings are considered blighted or have been abandoned, (34) and police response times, even for emergency calls, are currently at nearly an hour. (35) This lack of services most certainly makes building Detroit's tax base back up a much harder task, since people with options of where to live are unlikely to choose to live in a place where they cannot take their families to the park or count on the police to protect them. However, returning these municipal services to acceptable levels undoubtedly will be expensive, and in Detroit's current financial situation, the city can't afford to invest the necessary funds into services and infrastructure.

    Detroit's situation is undeniably bleak, and more than six decades of decline convinced the governor, with the City Council's approval, to appoint Jones Day restructuring attorney Kevyn Orr as the city's Emergency Manager on March 14, 2013. (36) Mr. Orr, in his role as Emergency Manager, was granted "sweeping powers" to make decisions concerning the city's finances, many of which "trump" the will of the city's elected officials. (37) The City Council approved Governor Rick Snyder's decision to appoint an emergency manager by a close vote, and at the time of Mr. Orr's appointment, many city officials expressed a willingness to work with him to solve Detroit's problems. (38) At the time of his appointment, Mr. Orr made public statements about his desire to avoid guiding the city to file for relief. (39)

    Mr. Orr and his team held negotiation sessions over the course of a few weeks with certain groups of creditors of the city, at which they proposed a plan to restructure the city's debt consensually. (40) At these meetings, the Emergency Manager and his team presented a plan for the reorganization of Detroit's debts, answered questions, and invited feedback and counter-proposals from each of the creditor constituencies that the Emergency Manager and his team met with. (41) While the meetings were ongoing, creditors of the city filed a state court action seeking declaratory judgment of the unconstitutionality of PA 436, (42) the Michigan law that allows appointment of an Emergency Manager and provides the procedure by which the State of Michigan can authorize a filing for municipal bankruptcy. (43)...

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