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Detroit bankruptcy’s messy start

In filing the largest municipal bankruptcy case in U.S. history, the City of Detroit is already off to a messy start.

Emergency Manager Kevyn Orr issued a restructuring plan for the financially strapped city in June. While a Chapter 9 filing was likely inevitable, Orr had begun negotiations with retirees, unions, bondholders and their insurers, and other creditors with the stated aim of settling as many of their financial disputes as possible to make for a quicker and smoother proceeding in the U.S. Bankruptcy Court for the Eastern District of Michigan in Detroit.

With the city’s pensions underfunded and pension benefit cuts on the table, a major issue is that the Michigan Constitution protects public employee pension benefits. Article IX, Section 24 states, “The accrued financial benefits of each pension plan and retirement system of the state and its political subdivisions shall be a contractual obligation thereof which shall not be diminished or impaired thereby.” It is unclear whether federal bankruptcy law trumps this constitutional provision.

The Police and Fire Retirement System and the General Retirement System, representing about 20,000 city retirees, filed a lawsuit against Orr and Gov. Rick Snyder in Ingham County Circuit Court seeking to block a bankruptcy filing in order to protect pension benefits. A hearing on a temporary restraining order to prevent the filing was scheduled for 4 p.m. last Thursday before Judge Rosemarie Aquilina, who was ready to issue such an order.

But in a sneaky and underhanded move, lawyers representing Orr and Snyder asked for a five-minute delay in the hearing, to which the pension board attorneys agreed. During this five-minute delay, lawyers for Orr filed the bankruptcy petition with Snyder’s authorization. On the following day, the bankruptcy case was assigned to Judge Steven Rhodes.

At the Thursday hearing after the bankruptcy filing, Aquilina issued a temporary restraining order preventing pension benefit cuts. Ordinarily, a bankruptcy filing would put all lawsuits against the city on hold. But the case before Aquilina had been filed against Orr and Snyder, not the city, and on Friday, she ruled that the bankruptcy filing violated the state constitution, ordering Snyder to order Orr to withdraw the bankruptcy case. Attorney General Bill Schuette, representing Snyder, appealed Aquilina’s order to the Michigan Court of Appeals.

To add to the legal mess, Rhodes declared today that his court has jurisdiction over the lawsuit before Aquilina. He set a hearing for Wednesday to sort out the dispute between the city and its pension funds. Rhodes scheduled a second hearing for Aug. 2 to consider a series of other motions, including the city’s requests for a 32-day deadline for creditors to file objections to its eligibility for Chapter 9 bankruptcy protection, creation of a committee to represent retirees, and putting all lawsuits filed against it on hold.

Meanwhile, Aquilina scheduled a hearing for July 29 over whether the bankruptcy filing violated the state constitution, reiterating that the case should remain a state issue. In regards to the state constitution’s protection of pension benefits, she remarked, “I don’t think the constitution should be made of Swiss cheese. Once we erode it with one hole, there will be others.”

These legal maneuvers are just the start of what looks like a long, drawn-out and expensive process that could drag on for years. There will be questions as to whether Detroit is really insolvent and therefore eligible for Chapter 9 protection, as well as whether Orr negotiated in good faith or filed prematurely. The outcome is uncertain, and it is doubtful that Orr will still be emergency manager whenever a final resolution is reached. Whether Detroit residents will have a functioning city government delivering decent services at that point remains to be seen. Orr and Snyder may have opened up a Pandora’s box by using a dirty trick to file for bankruptcy.

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