As many of you are aware, the City of Detroit filed for bankruptcy under the federal bankruptcy law; it is Chapter 9 under that law. That was in July 2013. The case has been before Judge Steven Rhodes. The filing is not official until the Judge agrees in a ruling, because a municipal government must show that it meets certain conditions before it is allowed to proceed under the terms of the law. That ruling came on 3rd December 2013. Judge Rhodes agreed that the City of Detroit is ‘insolvent’. As a result, he declared that the City of Detroit is eligible for a bankruptcy proceeding under the federal bankruptcy law. That was the main decision to be made by the judge at this stage of financial difficulties facing the city.
The Judge, however, went further and made a statement that will affect many municipal governments all over the country. He did so in a methodical way. First, he claimed jurisdiction. He explained why the federal bankruptcy court was ‘empowered’ to determine the meaning of the bankruptcy law and the Michigan State law (Act 436) that authorised the appointment of an emergency manager for the City of Detroit. Then, he proceeded to explain that the Chapter 9 provisions do not violate the United States Constitution. (This is important because the Constitution prohibits the States from ‘impairing contracts’.) Moreover, once a state allows for the filing of a bankruptcy petition by a local government, the bankruptcy law does not violate state constitutional provisions that prohibit the impairment of state constitutional contractual rights. He held that the pension rights of public employees are contractual rights under the Michigan Constitution; he discusses Michigan court interpretation of the state constitution to support his argument.
The key point here is that the federal bankruptcy law exists to ‘impair’ contracts. After all, that is precisely what happens in bankruptcy proceedings. The judge made it clear that Congress is not bound by state constitutions with regard to contracts in bankruptcy cases. As one municipal bankruptcy specialist said “no bankruptcy court had ruled that before. It will be instructive”.
What does this ruling mean, apart from the City of Detroit? The California courts have held that public pensions cannot be impaired under the California Constitution. Local governments in California have an express right given by the State to file petitions for bankruptcy. So, now these local governments can press public employees on their pension rights. That is an even bigger problem for CALPers (the state agency that administers health and pension services for local, school, county and state employers in California). In fact, CALPers issued a statement after the judge’s ruling calling it “short-sighted” and attempted to distinguish California public pensions from those of Detroit. It is likely that this tussle between pension rights and the impairment of contracts in Chapter 9 bankruptcies is going to be resolved by the United States Supreme Court.