Detroit Allowed to File Chapter 9 Bankruptcy and Can Impair its Pension Liability

Detroit Allowed to File Chapter 9 Bankruptcy and Can Impair its Pension Liability

| Dec 10, 2013 | Bankruptcy |


The United States Bankruptcy Court Judge Rhodes ruled last week that Detroit was eligible to file bankruptcy. In municipal cases, it is not a matter of Schedules I and J showing no disposable income, as in individual cases. Municipalities do not need to present a balance sheet, instead, the city must show that it is not able to pay its debts as they become due. It should also show that it tried in good faith to negotiate with its creditors or that it is unable to negotiate with them because such negotiation is impracticable. Judge Rhodes held that because of the size of Detroit’s debts and problems, it was impracticable to negotiate concessions from creditors. Further complicating the matter was the city’s unions insistence that its rights were guaranteed by the state constitution and could not be altered. Given these difficulties, the Judge determined that Detroit met the criteria for being eligible to file for bankruptcy protection from its creditors.

Regarding the issue of the city’s pension obligations, Judge Rhodes held that Detroit could impair its pension obligations. That means it can shed or reduce its obligations as part of its bankruptcy process. Needless to say, the retirees from city or municipal governments across the country are concerned with this ruling. If Detroit can rid itself of its large pension liability, why not other cities that are also facing large unfunded liabilities? In Chapter 9 cases, section 1123(b) of the Bankruptcy Code authorizes a bankruptcy plan to “impair or leave unimpaired any class of claims … notwithstanding any otherwise applicable non-bankruptcy law.” Judge Rhodes found that pension benefits are contractual rights and are not entitled to any higher degree of protection in municipal bankruptcy.

The question on appeal will be what effect does the state constitution have in federal bankruptcy law? On the one hand, the Supremacy Clause of the federal Constitution provides that to the extent state law conflicts with federal, it must yield. On the other hand, Chapter 9, municipal bankruptcies, may be considered the result of negotiations between the state of federal governments as co-equals, in which case the Supremacy Clause may not apply. It will be interesting to see how the appeals court rules on this issue.

Laura J. Margulies is a principal in the firm of Laura Margulies & Associates, LLC. We represent consumers in bankruptcy and litigation matters in Maryland and the District of Columbia. To learn more about our firm visit our web site at www.law-margulies.com