The Detroit bankruptcy, pre-eligibility.

• Author: Jacoby, Melissa B.

Introduction I. The First Main Event: Eligibility II. Before the Main Event: Detroit's Bankruptcy, Pre Eligibility A. Dispute Resolution 1. The Automatic Stay and an Additional Injunction 2. Establishing a Retiree Committee 3. Access to Casino Revenues 4. Discovery Generally 5. Pre-Trial Eligibility Matters B. Other Elements 1. Litigation Avoidance 2. Team-Building 3. Keep Things Moving 4. Interactivity 5. Procedural Justice Conclusion INTRODUCTION

On July 18, 2013, the City of Detroit, Michigan filed the largest municipal bankruptcy in history. (1) The filing fueled a national conversation about ailing governmental units and the gap between pension promises and financial realities. Eyes were trained primarily on one major court decision: after a trial, the judge would determine whether Detroit met the statutory eligibility requirements for Chapter 9 bankruptcy. If the City jumped that hurdle, then parties would resume negotiations over a plan of adjustment, which would require court review and approval to be effective.

Fast-forward several months, and the script already diverged from expectations. As predicted, the City of Detroit has been deemed eligible for bankruptcy. (2) Not as predicted, the court's lengthy eligibility decision tackled, head-on, the issue of pension obligations. The court held that the Michigan Constitution made pension entitlements contractual obligations that could be modified and impaired in a Chapter 9 plan of adjustment. (3) Whether a proposed plan could and would satisfy the legal requirements remained to be seen.

As the rest of the world looks ahead, however, this brief commentary looks back. Specifically, it examines Detroit's bankruptcy from its commencement through the eve of the eligibility trial. I draw significantly on a review of primary source documents on the court's docket and digital audio recordings of every court hearing through that time. This analysis sets a foundation to examine the interaction between federal courts, a major metropolitan city in serious financial distress, and its creditors and stakeholders.

Part I lays the groundwork by briefly discussing eligibility, the front-end flashpoint in Chapter 9 bankruptcies. Part II examines activity in Detroit's bankruptcy in the pre-eligibility-trial period that history otherwise might omit. Representative and relevant judicial acts of this period are divided into two groups. Part II.A reviews the court's dispute resolution activity. The willingness to rule quickly and either from the bench or quickly thereafter has been essential to the progress of the case. Part II.B identifies other elements to watch in this case beyond traditional dispute resolution.

1. THE FIRST MAIN EVENT: ELIGIBILITY

   The Chapter 9 eligibility requirement for municipalities is not merely a pro forma hurdle. (4) A debtor municipality bears the burden of proof on each element of the Chapter 9 eligibility test by a preponderance of the evidence. (5) This routine expectation of front-end judicial gatekeeping has no analogue in voluntary Chapter 11 cases. (6) Creditors sometimes allege that a Chapter 11 case should be dismissed because the debtor lacks good faith. (7) But judges rarely preside over trials about the entitlement of businesses to file bankruptcy.

   In a voluntary Chapter 11, the entry of an order for relief occurs simultaneously with the filing of the petition. (8) In a Chapter 9, the court does not enter the order for relief until it makes the eligibility finding. (9) The order for relief rather than the petition date is the trigger for some Bankruptcy Code provisions. (10) The cloud of potential ineligibility can stall negotiations with creditors and make it impossible to complete some transactions." After all, a finding of ineligibility will generate case dismissal--back to the world of state law and races to the courthouse. (12)

   The eligibility test for Chapter 9 has five components. (13) First, the Chapter 9 debtor must actually be a municipality. (14) Second, applicable state law must authorize the municipality to file for Chapter 9 bankruptcy. (15) Third, the municipality must be insolvent. (16) The fourth and rather subjective requirement is that the municipality "desires to affect a plan to adjust such debts;" no specific metric measures this prong's satisfaction. (17) Fifth, the municipality must meet one of four alternative tests relating to good faith pre-filing negotiations. The municipality need not have successfully negotiated a prepackaged plan with the requisite proportion of creditors; this used to be the law and was considered unworkable. (18) One possible fulfillment is to show the impracticability of negotiating with all creditors, a fact-sensitive inquiry that arises if a delay would put the assets at risk, or under other such circumstances. (19) The eligibility test is amplified by 11 U.S.C. [section] 921(c), which provides that a court may dismiss a Chapter 9 petition if the debtor did not file the petition in good faith or meet other requirements of Title 11. (20) The failure to exhaust "every possible option" before filing a petition is generally not perceived as lack of good faith in modern cases. (21)

   Given the multiple prongs and thin case law, the eligibility-plus-good-faith hurdle gives judges considerable discretion over continuation of the bankruptcy--whether or not judges are eager for it. (22) The time period before the eligibility determination can be lengthy for a variety of reasons, including the demands of objectors for sufficient discovery to prepare adequately for a trial. In Detroit's bankruptcy, objectors filed 109 timely objections to eligibility. (23) The written decision finding Detroit eligible for Chapter 9 responded to a remarkable number of objections in detail. (24)

2. BEFORE THE MAIN EVENT: DETROIT'S BANKRUPTCY, PRE ELIGIBILITY

   Although the bankruptcy case itself is in limbo until an eligibility finding, a Chapter 9 municipal debtor has far more freedom than a Chapter 11 debtor to continue to operate and make decisions. The distinction stems in part from the Tenth Amendment to the United States Constitution, which reserves for states and the people any powers not expressly delegated to the federal government. (25) Congress put constraints on federal courts more explicitly and affirmatively through Sections 903 and 904 of the Bankruptcy Code. Section 903 provides that Chapter 9 does not limit a state's power to control a municipality. (26) Section 904 prohibits a federal court from interfering, absent debtor consent, with the debtor's political powers, the debtor's property or revenues, or the debtor's use of income-producing property. (27) The judge presiding over the bankruptcy is not authorized to be a gatekeeper of municipal expenditures or deployment of assets. This restriction holds even with respect to unusual projects or when the city wants to hire expensive professionals. For these reasons, scholars almost universally observe that, whether before or after an eligibility finding, federal courts have limited control over municipalities in bankruptcy. (28) Detroit's case illustrates, however, the significance of the debtor consent caveat and other potential strategies.

   The Emergency Manager for the City of Detroit filed a bankruptcy petition on July 18, 2013. (29) For every Chapter 9 that is filed, the chief judge of the applicable court of appeals hand-picks a judge. (30) The Chief Judge of the Sixth Circuit, the Honorable Alice M. Batchelder, selected Judge Steven W. Rhodes, based in part on the strong endorsement of the Chief District Judge of the Eastern District of Michigan, Gerald E. Rosen. (31)

   Had Detroit been a corporation, its lawyers would have immediately rushed to bankruptcy court with a sky-high stack of first-day motions to authorize expenditures and acts. Instead, Detroit's first court hearing was six days into the case, with a more limited amount of in-court business to conduct. (32)

   1. Dispute Resolution

      In the early days of Detroit's case, requests by the debtor frequently prompted multiple objections, putting various matters into a traditional adversarial posture. The pre-eligibility phase of Detroit's bankruptcy presented an array of disputes between the City and various other creditors and parties. This subpart offers examples of those disputes. Had Judge Rhodes not been so efficient in his resolution, the case would have bogged down quickly.

      1. The Automatic Stay and an Additional Injunction

         The day after the bankruptcy was filed, the City sought a clarification of the scope of the existing automatic stay under Sections 362 and 922 of the Bankruptcy Code (which extend the stay to officers and inhabitants of the debtor), as well as a supplemental injunction to enjoin a range of actions against the City and related actors. (33) Creditors filed objections, particularly because they had already commenced litigation in other fora and wanted those matters to ride their course. (34)

         At the first hearing in Detroit's bankruptcy, the court ruled in favor of the debtor after argument, counterargument, and rebuttal on these motions. (35) Two written orders were entered the following day. (36) The orders channeled creditors to the bankruptcy court to seek permission before they pursued relief elsewhere. Such motions were filed and contested with regularity, and usually resolved quite expeditiously. (37)

      2. Establishing a Retiree Committee

         Immediately after the Chapter 9 filing, the City of Detroit requested the creation of a retiree committee. (38) The City also offered to pay the committee's professional expenses. (39) Retiree committees have been appointed in some other contemporary Chapter 9 cases, but usually at the request of unions or retiree associations. (40)

         Others raised a variety of questions and concerns about the details, including whether it was even permissible to authorize and appoint a committee before a finding of eligibility. (41) Although...