Columns



Lawrence M. Glazer

Trick Question for Detroit

February 17, 2012

The state’s largest municipality is in deep fiscal trouble. It can’t pay its bills. Its former leader is in prison for corruption. The governor’s office has been evaluating the situation and trying to negotiate a resolution, but the municipality’s legislative body and employee unions have been unable to give enough ground.

Time has run out. Only one, drastic solution remains. Nobody wants it, but there is no other choice now. So the step is taken.

An emergency manager for Detroit?

No. Bankruptcy for Jefferson County, Alabama.

Jefferson is the state’s most populous county (it contains within its boundaries the state’s largest city, Birmingham). Alabama has no emergency manager statute. So Jefferson county filed for bankruptcy in November.

Much has been written about Michigan’s 2011 Public Act 4 and the draconian powers it grants to a state-appointed emergency manager to run a local municipality or school district. Little has been written about the alternative, a municipal bankruptcy under Chapter 9 of the U.S. Bankruptcy Code.

If Michigan did not have PA 4, then Detroit might well be facing the prospect of filing for bankruptcy under Chapter 9.

Detroit’s fiscal situation appears to qualify it to apply for bankruptcy protection under the federal law. It is “unable to pay its debts as they become due,” according to media reports. This meets the federal definition of municipal insolvency.

Municipal bankruptcies have been relatively rare. Only 44 have been filed by cities or counties in the last 32 years. The reasons for this are not hard to discern. No political leader wants his or her name associated with the bankruptcy of the government he or she led. In fact, when the Harrisburg, Pennsylvania, city council petitioned for bankruptcy in 2011, it was over the vociferous objections of the mayor, who argued that only he — not the council — had authority to file (and the federal court agreed with him, dismissing the council’s petition).

The prospect of a major municipal bankruptcy also makes the state’s governor and treasurer very nervous, fearing that the bond market may react by making it more expensive for other nearby cities and counties, and possibly even the state, to borrow. A bankruptcy is, after all, a court-approved default on debts.

The largest municipal bankruptcy was Orange County, California, filed in 1994. The county’s treasurer had lost $1.7 billion of taxpayer funds by investing them in risky derivatives he did not fully understand.

The City of Vallejo, California, filed in May 2008. Its insolvency was mainly the product of unsustainable retiree pensions. Vallejo emerged from bankruptcy at the end of 2011, having spent some $11 million in legal fees, much of it fighting police and firefighter unions over whether the City met the legal requirements for bankruptcy.

One notable result of the Vallejo bankruptcy was a ruling by the court that federal bankruptcy law could trump state labor law under some circumstances, and that the court could therefore reject an existing collective bargaining agreement. This decision has provoked much comment in law journals. However, the ruling only applies to the Vallejo case; it is not a precedent that other courts must follow.

Although federal law provides for municipal access to the bankruptcy courts, there is a major qualification: the state must first grant its permission. This is so because cities, counties and other local governments are creations of the state. They are enabled to exist solely by virtue of state laws. Nothing in the U.S. Constitution requires their existence. But the U.S. Constitution does recognize the existence and powers of the states, and prohibits federal government interference with state laws except under certain specified circumstances.

So, many states have enacted laws governing that permission. According to the National Association of State Budget Officers, 26 states expressly authorize it by law (12 of these impose no restrictions, while 14 require approval from a state authority before filing). Georgia law prohibits any municipality from filing, and the remaining 23 states have not enacted any laws on the subject.

Michigan is one of the 14 states that require state permission. The small city of Hamtramck sought the state’s permission in 2010 and was denied.

Comparisons between bankruptcy and an emergency financial manager takeover are instructive. Each is a form of receivership, but they are different in fundamental ways.

A municipality initiates a bankruptcy itself, with the state’s permission. An emergency managership is initiated by the state, which does not need the municipality’s permission.

The primary focus of a bankruptcy is debts, and the bankruptcy judge has the power to amend or cancel any debts, including bonds. The emergency manager has no power to amend undisputed debts.

An emergency manager can literally run the municipality without consulting the local elected officials. In fact, the emergency manager can fire the local officials. A bankruptcy judge cannot interfere with the local elected officials’ ongoing exercise of their powers.

The Michigan statute authorizes an emergency manager to unilaterally modify collective bargaining contracts between the municipality and its unionized employees. The law is not yet clear whether a bankruptcy judge can do this.

Then there is the matter of due process — the right to be heard before an authority makes a decision affecting one’s rights. Since bankruptcy is, by definition, available only from a court, it is no surprise that nearly every affected party has a right to a hearing at nearly every stage of the process — one reason it can take so long and cost so much.

Public Act 4, on the other hand, provides only one opportunity for a hearing. If the governor determines that a local financial emergency exists, the municipality has seven days to request a hearing. After the hearing the governor makes a final determination based on the record made at the hearing. If the final determination is to appoint an emergency manager, the decision is appealable to the Ingham County Circuit Court. That’s it.

The Snyder administration is currently in the early stages of determining whether a financial emergency exists in Detroit. Coming back to where we started, what would happen if Detroit were to file for bankruptcy?

Well, we probably would be treated to several years of expensive litigation over such issues as whether the court can modify the city’s existing labor agreements, and how large a bath Detroit’s creditors would take. And at the end of the process the city would have some breathing space, though its long-term fiscal future might not be all that much brighter (by most accounts, Vallejo’s isn’t).

But the chances of Detroit filing for bankruptcy on its own initiative are nil, because under current Michigan law it must first obtain the permission of a specific state official: the emergency manager. Yes, you read that right. Before Detroit can file for bankruptcy, it must first be taken over by the state, which under Public Act 4 can run the city a lot more efficiently than a federal judge, who is tied down by all that pesky due process.

Finally, a couple of potential monkey wrenches are dangling ever closer to the whole emergency manager works.

A group of activists has filed suit in Ingham County attacking the constitutionality of the statute. Gov. Snyder has requested that the Michigan Supreme Court fast-track the case to itself, but the Court has not yet made a decision.

Another group is gathering voter signatures on a referendum petition to put repeal of Public Act 4 on the November ballot, and would also suspend the law pending that election.

If either of these attacks succeeds, then bankruptcy could become Detroit’s only alternative. Unless, of course, Mayor Dave Bing’s ongoing negotiations with multiple parties avoid the financial emergency in the first place.

Lawrence M. Glazer is the author of Wounded Warrior, a recently published biography of former governor and Supreme Court justice John Swainson. He is also a retired Ingham County Circuit Court Judge and former legal advisor to Gov. James J. Blanchard.