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Bankruptcy Ruling Puts Union Pensions at Risk

January 17, 2014

By John R. Bielski

A recent bankruptcy decision involving the City of Detroit places at risk the pension rights of both retired and active municipal employees. After extensive briefing on a host of legal issues, a federal bankruptcy judge found that the city was eligible for municipal bankruptcy protection under Chapter 9 of the Bankruptcy Code—the section permitting municipalities to file for bankruptcy protection. In reaching its conclusion, the bankruptcy court made clear that its ruling could result in a reduction in pension benefits when the city presents and the court approves a reorganization plan. Thus, Detroit’s municipal employees may see the loss of hard-won pension and other health and welfare rights.

The bankruptcy court gave a long rendition of the history leading to the city filing for bankruptcy protection, including a list of the municipality’s various unfunded liabilities. In total, the city estimated that its debt was about $18 billion which is owed to approximately 100,000 creditors. Included in those obligations were approximately $3 billion in unfunded pension obligations.

Under Section 9 of the Bankruptcy Code, a municipality may file for bankruptcy protection. However, under Chapter 9, a state retains the power to prohibit its various municipalities from filing for bankruptcy protection. Some states have exercised their right to bar some or all of their municipalities from filing for bankruptcy protection.

Other states, like Michigan, have allowed some or all of their municipalities to file for bankruptcy protection. The Michigan legislature passed Public Act 436 of 2012, the Local Financial Stability and Choice Act, authorizing the appointment of an emergency manager for fiscally distressed municipalities. The emergency manager acts “for and in the place and stead of the governing body and the office of chief administrative officer of the local government.” Public Act 436 also permits the emergency manager to file for bankruptcy protection under Chapter 9 if, in his or her judgment, “no reasonable alternative to rectifying the financial emergency of the local government which is in receivership exists.” The statute allows the governor to place a contingency on the filing of a bankruptcy petition, prohibiting certain debts from being discharged in bankruptcy.

Pursuant to Michigan law, the governor selected an emergency manager for the city, who later recommended that the city file for bankruptcy protection under Chapter 9. On July 18, 2013, the emergency manager filed a bankruptcy petition on behalf of the city. The governor placed no contingency on the filing of the bankruptcy petition, leaving the pension rights of municipal employees at the mercy of any reorganization plan approved by the bankruptcy court.

Several creditors, including public sector unions, raised federal and state constitutional challenges. The unions alleged that Chapter 9 violates the federal constitution’s requirement that bankruptcy laws be uniform, that states may not impair the obligation of contracts, known as the Contract Clause, and that the federal government may not impinge on a state’s sovereign rights to manage the fiscal affairs of their municipalities, protected under the Tenth Amendment.

The bankruptcy court rejected all of these challenges. Of particular note to unions is the bankruptcy court’s rejection of the alleged Tenth Amendment violation. In reaching the conclusion that Chapter 9 does not violate this provision, the bankruptcy court found that the Tenth Amendment offers no protection for pension rights in Chapter 9 bankruptcy reorganization if the state consents to allow a municipality to file such a petition. Further, the bankruptcy court found that the Michigan Constitution does not confer greater protection to pension rights beyond any other contractual obligations. Thus, Chapter 9 does not prevent a bankruptcy court from approving decreases in pension obligations as part of its reorganization plan.

In light of this ruling, Detroit’s municipal employees face the prospect of having their pension benefits significantly reduced. Such a result may lead to other fiscally distressed municipalities filing for Chapter 9 bankruptcy in an effort to decrease pension obligations for their workers. Of course, such a possibility may only occur in states that currently allow their municipalities to file for bankruptcy or in those in which the state legislature authorizes such filings.

If you have any questions about the ruling in the Detroit bankruptcy case, please call the lawyers at Willig, Williams & Davidson.

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