In re City of Detroit, Michigan – Part I

Detroit, one of my very favorite cities, has been on the news a lot in the last few days, and not for anything good. Nope – after more than a few generations of decline, the city has succumbed to its debts and filed for relief in the bankruptcy courts.

What does it all mean?

First of all, anyone who professes surprise at Detroit’s bankruptcy filing obviously has not been paying attention. Detroit has been on the wane, according to its own governor, for 60 years. The population has fled, many car companies have re-located to the union-free Southeast (particularly Tennessee, Alabama and South Carolina), and the Big Three (General Motors, Ford and Chrysler) have flirted with annihilation, to be saved only by the U.S. government (GM) and the Italians (Chrysler). Not to mention years of inept and corrupt local government (feel free to send former mayor Kwame Kilpatrick a flower arrangement in the federal pen). In fact, the local government has been so ineffective that Gov. Rick Snyder appointed an “emergency manager,” Kevyn Orr, to run the city, aka the governor fired both the mayor and the city council in one fell swoop. Detroit’s had it rough and, in light of these factors, plus many others, its Chapter 9 filing was expected and, perhaps, not unwelcome.

Second, as the old song goes, we’ve only just begun. The city, through its emergency manager, filed bankruptcy on Thursday. On Friday, a state court judge issued an order that the city manager must withdraw the bankruptcy petition.

What the what??

Allow me, dear readers, to put on my juris doctor cape and explain in non-legalese just what is happening.

As I understand it, the State of Michigan passed a law allowing the governor to appoint an “emergency manager” to run a distressed municipality in place of the mayor and city council. I don’t believe the law specifically addresses Detroit, but I have no doubt it was written and passed with Detroit in mind. Pursuant to that law, the governor then appointed Kevyn Orr as Detroit’s Emergency Manager this spring. Orr began negotiating with creditors (including the city retirement system), but was not able to reach agreement on how to handle Detroit’s billions in debts. Orr therefore recommended to Gov. Snyder that the city file bankruptcy (apparently, the same law that allows the emergency manager requires the governor’s authorization to initiate a bankruptcy).

Meanwhile, a group of city pensioners filed a declaratory judgment action in a Detroit state court. A dec action is different from a regular lawsuit because the people filing it are not necessarily suing someone for money; instead, they are asking the court to declare something (often what rights someone has under a contract or what a specific contractual provision means). The plaintiffs in this dec action asked the court to declare that the state law allowing the governor to authorize a city manager to file bankruptcy violates the state’s constitution because it would allow a city to pay its employees less in benefits than they are entitled to.

Detroit’s bankruptcy petition (available here), filed on Thursday, declared $1 billion+ in assets and $1 billion+ in liabilities, with over 100,000 creditors. The city filed under Chapter 9 (chapters refer to chapters within the Bankruptcy Code), which governs municipal bankruptcies. The end result of a Chapter 9 bankruptcy is a reorganization, not a liquidation.

On Friday, the judge in the declaratory judgment action issued an order declaring the law authorizing Detroit’s bankruptcy to be unconstitutional (referring to the Michigan state constitution, not the U.S. constitution). The judge ordered the City to withdraw its petition. You can see the full order here.

And that’s where we are. Clear as mud, no?

So what happens next? I really don’t see any scenario in which Detroit will have to withdraw its bankruptcy filing. The state will, of course, appeal the judge’s ruling, but the likeliest outcome is that all of this will be transferred to the bankruptcy proceeding itself, with the bankruptcy judge deciding the constitutional issues. Bankruptcy law is federal law (and bankruptcy judges are federal judges), which a state cannot limit. And once a bankruptcy is filed, an “automatic stay” takes effect. This covers all lawsuits, proceedings, collection actions, etc. So if this constitutional question even goes forward, it will likely not do so in a separate proceeding. It will just be added to the headache the bankruptcy judge already has.

I called this post “Part I,” since this saga is far from over. Questions, comments, opinions? Leave them in the comments below. I’ll keep tracking this story and post updates, corrections, etc. as this whole messy mess goes forward.

Class dismissed!

P.S. The photo, above left, is of the Guardian Building in downtown Detroit. Detroit has some amazing architecture, which I look forward to telling you more about soon. Bottom line – Detroit is much, much more than a city in decline.