The long, painful process for Detroit’s bankruptcy is under way. Among the first questions to be answered is whether Detroit is even eligible to do so.
Unlike corporations that file for Chapter 11 bankruptcy protection, municipalities and other governments seeking to file for Chapter 9 are required to prove that they are eligible. A trial to consider Detroit’s eligibility for bankruptcy is scheduled for Oct. 23, and parties had until Monday to file objections.
Section 109(c) of the Bankruptcy Code sets forth five distinct requirements for filing under Chapter 9. The objections that were filed as of Monday by parties including unions and retirees contested almost all of them.
I think everyone conceded that Detroit was a municipality as required by the statute. But the public employees union did argue that Chapter 9 itself is unconstitutional, despite the fact the Supreme Court upheld an earlier version of Chapter 9 in 1938. The Supreme Court, the union notes, has changed since then.
Still, Detroit has to convince Judge Steven W. Rhodes of Federal Bankruptcy Court that the city is indeed eligible to proceed. While Judge Rhodes ponders the objections - and objections to having a bankruptcy judge even hearing the case - it might be helpful to address two of the most common objections to Detroit’s case that have been raised in the news media.
First is the argument that Michigan’s Constitution prohibits modification of the pensions, and thus prohibits a Chapter 9 filing, where they might be modified.
What Michigan’s Constitution actually provides is that pension benefits “shall be a contractual obligation thereof which shall not be diminished or impaired thereby.†By calling the benefits a contract, the state’s Constitution invokes the federal Constitution, which has a Contracts Clause that prohibits the states from passing any law impairing contracts. The same kind of provision also appears in Article I, Section 10 of the Michigan Constitution.
But the Bankruptcy Code is federal, enacted under the Bankruptcy Clause of the Constitution, and not subject to the Contracts Clause. And, of course, the laws under the federal Constitution override conflicting state laws, including the state Constitution.
The other argument I want to dispatch is the idea that the city’s general obligation bonds are somehow secretly secured. One bond insurance company executive has argued for “legal and moral†priority to these bonds. A bond insurance company would say that, wouldn’t it?
On the moral front, I’m not quite sure what it means to say that this obligation is any more vital than Detroit’s obligation to provide museums, parks and basic services to its residents.
And a promise to raise taxes to support the debt strikes me as just one more promise that Detroit will not be keeping as it works it way through its problems.
Stephen J. Lubben is the Harvey Washington Wiley Chair in corporate governance and business ethics at Seton Hall Law School and an expert on bankruptcy.
