Zombieland/the Detroit Bankruptcy: Why Debts Associated with Pensions, Benefits, and Municipal Securities Never Die ... and How They Are Killing Cities like Detroit

By Chung, Christine Sgarlata | Fordham Urban Law Journal, March 2014 | Go to article overview

Zombieland/the Detroit Bankruptcy: Why Debts Associated with Pensions, Benefits, and Municipal Securities Never Die ... and How They Are Killing Cities like Detroit


Chung, Christine Sgarlata, Fordham Urban Law Journal


II. KEY LEGAL QUESTIONS: PENSIONER RIGHTS, BONDHOLDER RIGHTS, AND TAXPAYER RIGHTS

Against this backdrop of hard choices and competition for meager resources, Detroit's bankruptcy presents two key legal questions: 1) Can Detroit use Chapter 9 bankruptcy proceedings to reduce or restructure accrued pension benefits of retired city workers when the Michigan Constitution states that "[t]he 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" (207) and also states that "[n]o ... law impairing the obligations of contract shall be enacted?" (208) 2) How will debts associated with Detroit's municipal securities--and particularly its UTGO--be dealt with, when (i) Detroit is already levying taxes at or near statutory maximums; (ii) City residents cannot absorb taxes increases, and (ii) Detroit does not have (and will not have, without restructuring) sufficient funds to pay its debts?

In the following subpart, I discuss legal questions surrounding pension impairment in Part A, and issues relating to Detroit's UTGO bonds in Part B.

A. Can Detroit Use Chapter 9 Bankruptcy Proceedings to Reduce or Restructure Accrued Pension Rights of Retired City Workers, Given Michigan Constitution Pension Clause?

On December 5, 2013, Judge Steven Rhodes held that Detroit is eligible to be a Chapter 9 debtor despite the fact that neither the City nor the State explicitly carved out accrued pension benefits and protected them from adjustment. (209) Judge Rhodes also held that accrued pension benefits are subject to impairment in Chapter 9 proceedings, despite the Pension Clause. (210) In the following section, I discuss the debate surrounding pension impairment and Judge Rhodes's ruling.

1. The Emergency Manager Puts Pension Impairment on the Table.

Pension impairment has been a hot button issue in the Detroit bankruptcy ever since June 14, 2013, when the Office of the Emergency Manager published a proposal to the City's creditors which referenced adjusting pension obligations. (211) In his proposal, Orr outlined Detroit's dire financial condition and called for a "thorough overhaul and restructuring" of the City's obligations. (212) Among other initiatives, the June 14 proposal outlined the City's plans to invest $1.25 billion over ten years to improve basic and essential City services such as police, fire and EMS. (213) The June 14 proposal also outlined the City's intention to expand its income and property tax bases, rationalize and adjust income tax rates, and improve tax and fee collection efforts. (214)

With respect to creditor recoveries, Orr proposed the following: (i) "treatment of secured debt commensurate with the value of the collateral securing such debt, including the repayment or refinancing of the City's revenue bonds, secured unlimited and limited tax general obligation bonds, secured installment notes and liabilities arising in connection with swap obligations;" (215) (ii) "pro rata distribution of $2,000,000,000 in principal amount of interest-only limited recourse participation notes to holders of unsecured claims," including holders of unsecured limited and unlimited tax general obligation bonds, the service corporations (based on the COPs), the pension systems (based on pension underfunding), and retirees (based on OPEB); (216) and (iii) "[a] 'Dutch Auction' process for the City to purchase the notes." (217) Also at the meeting respecting the June 14 proposal, Orr announced his decision to not make the scheduled $39,700,000 in payments due on the COPs and swap transactions. (218)

With respect to claims for unfunded pension liabilities, Orr stated that "[b]ecause the amounts realized on the underfunding claims will be substantially less than the underfunding amount, there must be significant cuts in accrued, vested pension amounts for both active and currently retired persons. …

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