Detroit bankruptcy’s effects will be felt across entire state of Michigan

Detroit bankruptcy’s effects will be felt across entire state of Michigan

Detroit Bankruptcy

Detroit’s Chapter 9 bankruptcy filing not only will impact residents of the Motor City, but it also will affect citizens across Michigan. And because the filing is historic, some unique constitutional questions will have to be answered by the U.S. Bankruptcy Court, practitioners tell Michigan Lawyers Weekly.

“You’re definitely going to see a trickle-down effect because there’s a whole restructuring of the city happening,” said attorney Caralyce M. Lassner. “Not to downplay it, but there are only 20,000 pensioners whose benefits may be affected. There are over 700,000 residents who will be impacted.”

Bloomfield Hills lawyer David J. Montera said that, as long as Detroit remains in bankruptcy, the citizens of Detroit in particular, and Michigan citizens and entities in general, will be affected on an ongoing basis.

For example, he said companies that rely on Detroit for their revenue are now waiting to get their money; property taxes and tax appeals are in limbo; fire and police response times may increase due to less funding and decreased staffing; the ability of people to borrow money could be affected; and basic services such as water and sewer may be impacted.

“It is difficult to say what the effect will be when you don’t know what the issues will actually be,” Montera said. “However, it is possible that city of Detroit residents will have to pay more for water and sewer if the water department is spun off as a separate identity.

“It is possible for a city to survive and thrive without a zoo or art museum. Will the city’s cultural identity be adversely impacted without these institutions? Yes. But at this point, the issue is whether the city can financially continue without them, not if it will be culturally deprived without them.”

The Chapter 9 filing also could have constitutional implications. “Another issue that is going to have to be determined is if the pensions and health and welfare funds are exempt from the bankruptcy based on specific provisions of the state constitution,” Montera said.

But a larger question is what the final result will be, because the city is not a corporation that can liquidate if the reorganization doesn’t work.

“The city, as a municipal corporation and a home rule city, will continue as an entity after the bankruptcy,” Montera said. “Will the city council and mayor make better decisions financially for the city? Will the people who vote install a different kind of councilperson who will put the city’s financial well-being ahead of everything else?”

According to Montera, if the problems with Detroit’s financial situation are resolved favorably but the direction and emphasis of the city’s leadership and the voters do not also change, the bankruptcy will be for naught.

Trickle down effects

Southfield bankruptcy lawyer Tadd R. Klimmek said the bankruptcy will have a varying trickle-down effect.

In his opinion, Klimmek said one of the most important impacts will be better services. “Once the city starts diverting money previously used to pay debt to services, the services should get better. Services like safety and lights need help and the money used previously to pay back debt can now be used to make these services better.”

Montera, a private practitioner, said another effect is that companies relying on Detroit for the bulk of their revenue are now left waiting, probably for a long time, to recover the money owed to them.

“The newspapers are replete with instances where certain vendors of the city that have not been paid for a number of months are either closing their doors or have laid off a significant number of employees because the money that was owed at the time of the filing was unsecured debt, and may receive only pennies on the dollar, if they receive anything at all.”

Montera further said that some Michigan municipalities are having problems selling bonds in the wake of the Chapter 9 filing. However, he noted there are conflicting stories about this issue, pointing to an Aug. 8 article in Business Week that indicated the city’s bankruptcy actually has not affected the municipal bond market.

In addition, property tax assessment appeals are being delayed. “Those administrative hearings were initially subject to the automatic stay, and so were not able to proceed,” Montera said. “We have heard that the attorneys representing the city have been agreeing to lift of the stay. Many of the attorneys that represent individuals in Chapter 13 bankruptcy have had to address that issue.”

Citizens could also see an impact on things like police and fire response times. “This will be dependent on what the resolution of funding and staffing issues will be for these two public safety departments,” Montera stated.

And the Detroit Water and Sewer Department is also in limbo. Montera said it’s uncertain what the department will look like after the bankruptcy. “Will the city be required to liquidate its interests in the water department and, if so, who will take it over?”

He said that, right now, users who live in the suburbs pay a higher price for water and sewer, and the question remains whether users will be affected if the department is sold to operate independently of the city.

Similar issues will need to be addressed when it comes to The Detroit Zoo, the Detroit Institute of Arts and Belle Isle. “All of these are, or could be, revenue generators,” Montera said. “How will the operation of these be resolved in the bankruptcy?”

He said it will be argued that institutions like these need to survive to allow Detroit to remain a vital, cultural entity.

“The question will be whether the city can continue to afford to spend revenues on these institutions if they are not self-sustaining as operated,” Montera said.

“The way they are operated can be changed, the way they are owned can also be changed and the institutions can remain in Detroit. It will be argued that the citizens should not have to continue to pay for these revenue-negative operations.”

Existing Chapter 13s and borrowing

Lassner, a private practitioner in Utica, said that she has filed an appearance in the Detroit bankruptcy because she represents a debtor who works for the city. She said the bankruptcy could impact her client, who’s in a Chapter 13 plan of reorganization.

“If she no longer has income, we must review whether she can continue with her Chapter 13,” Lassner said. “Anything that impacts her income will have to be reviewed under the Chapter 13 reorganization.”

Klimmek, who is with Klimmek and Roose PLC, agreed. “In particular, if Judge [Steven] Rhodes determines the pensions can be reduced, those particular debtors who are in a Chapter 13 would therefore need to amend their plan if possible, because of their reduction in income,” he said. “I see no possible effect of for Chapter 7 clients. Income reduction is only an issue in existing Chapter 13 plans.”

Lassner, Montera and Klimmek all said the bankruptcy could affect overall borrowing, although Montera said any impact is difficult to ascertain right now.

“Loaning to an individual is based on many factors, including income, credit history and location,” Montera explained. “Location often comes into play when the security for the loan is real estate. There are federal laws in place to help protect borrowers for being discriminated against based on where they live.”

However, when the collateral is in the city of Detroit and the city services are in disarray, the risk on loans increases, resulting in higher interest rates, Montera pointed out. “Citizens may also see insurance rates increase, again due to a change in the risk right now based on the local services.”

Klimmek said he doesn’t see a large effect on everyday borrowing for individuals. “The creditors who will be affected by the city’s filing are not standard consumer creditors,” he said. “Using the same rationale for when GM filed bankruptcy, there were no large changes to everyday individuals. People could still get credit and buy cars. In the same way, people will still get credit despite the city’s filing.”

Constitutional concerns

Several constitutional issues may also arise during the Detroit bankruptcy, Montera said. “It is important to note that Chapter 9 is not a well-used section of the Bankruptcy Code,” he said, pointing to an article in the Wall Street Journal that said 261 municipalities have filed Chapter 9 and 82 of those cases have been dismissed.

“If it is determined that the emergency manager statute does not give the Governor and emergency manager authority to file the bankruptcy — the issue that was being raised by the pension funds in the Ingham County Circuit Court — then the pension and health and welfare funds may be excluded from the bankruptcy,” Montera said.

If that happens, “as those entities hold approximately 50 percent of the unsecured debt, or more depending on what figures you use, the efficacy of a Chapter 9 filing is called into question,” Montera stated. “That is, if half or more of the debt cannot be addressed in the bankruptcy, is there any reason to continue the bankruptcy?”

Another issue that will have to be determined, Montera said, is whether the pensions and health and welfare funds are exempt from the bankruptcy based on specific provisions of the Michigan Constitution.

He said it is being claimed the pension and health and welfare funds are not covered under the Employee Retirement Income Security Act.

“If that is the case, the provisions in ERISA do not control and so state law would apply,” he said. “The unions are alleging that the state constitution prohibits the modification of the pensions even in a bankruptcy. So the court may be asked to determine if the state constitution trumps the federal law.”

Montera said it will be interesting to see how Rhodes decides these issues, but that it may become a moot point, as in other Chapter 9 filings when the unions and municipalities negotiated a resolution, thereby avoiding a court determination of the issue.

Doing what’s necessary

Montera said that, while the bankruptcy will have impacts in the long run, he doesn’t believe it will have an immediate impact on Detroit residents or Michiganders in general. “The bankruptcy is in its preliminary stages. As such, I do not expect to see any reduction in work force immediately.”

Detroit needs to get past the preliminary motions before it actually starts taking steps to get its finances under control by way of cost reductions, Montera said. “It appears that the bankruptcy judge has appointed [Chief] Judge [Gerald] Rosen of the U.S. District Court for the Eastern District of Michigan to act as the mediator in the case. I would expect that, when the city determines it needs to renegotiate the contracts, if it can do so and determines it is necessary to do so, it will have to work through Judge Rosen’s office. That will be a long process, not an overnight thing.”

As for the city’s historic decision to file Chapter 9, Montera said it did what was necessary from a financial standpoint. “Perhaps for the first time in a long time, someone looked at the finances of the city and reached a logical conclusion that things could not continue the way they have been going. The debt was accumulating, the expenses were continuing and the revenue was not meeting the expenses anymore.”

Lassner said she is pleased the city filed Chapter 9. “It really is like fingernails on a chalkboard when people complain,” she said. Not only will the bankruptcy allow basic, everyday services to be restored, “we’re all learning a lot about Chapter 9 as we go along,” she noted.

Klimmek agreed that public education is an important part of the city’s historic bankruptcy. “One other effect that I have personally seen is a greater understanding of debt and bankruptcy,” he said. “I find it much easier to explain the concept of bankruptcy to existing and potential clients because they have learned much more from all the media coverage.”

For Montera, the real issue is whether the bankruptcy, assuming it is allowed to continue, will actually change anything in the long run. “Like a business in a Chapter 11 filing, there will be a reorganization of the debt, and a ‘fresh start’ financially,” he said. “However, unlike a corporation, the city of Detroit is a municipal corporation and its leadership is elected by the residents of the city. The Bankruptcy Court cannot change that process.”

In the end, it will be up to Detroit residents to elect future representatives who will work to ensure the city does not again end up in the same troubled financial state that it’s in right now, Montera said.

POSTED: August 26, 2013
BY: Douglas Levy

If you would like to comment on this story, email Traci R. Gentilozzi at traci.gentilozzi@mi.lawyersweekly.com.

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