Many American cities are facing financial distress; some have yet to recover from the recession of 2008-2009, as foreclosures and depressed property values continue to erode property tax receipts and other revenues. Many of those cities also have substantial obligations for pensions and medical costs.1 As a result of the difficulty in restructuring benefit obligations out of court, many of which are protected by state law,2 some commentators suggested that municipal bankruptcies under Chapter 9 of the Bankruptcy Code might provide a means to achieve that goal.3 But in the recent bankruptcy of Detroit, Mich., it was financial creditorsand not employees and retireeswho were asked to bear the heaviest costs of restructuring. Detroit's pensions and benefits were largely protected. The result raises the issue of whether Detroit's restructuring is a long-term solution that will become a future model or a short-term fix with an uncertain shelf life. No large American city has suffered as badly as Detroit: Its job losses and population decline decimated its tax base, leading to years of budget deficits, which it plugged through borrowings and one-off financing transactions. Detroit's strained finances led to a cycle of deep service reductions, which contributed to extensive blight.4 Responding to these problems in 2012, the Michigan legislature enacted a law authorizing Michigan governor Rick Snyder to appoint an emergency manager, Kevyn Orr, who determined that a municipal bankruptcy was the only workable solution.5 But Detroit's financial problems are not unique. Such diverse cities as Boston, Chicago, Los Angeles, Philadelphia and San Francisco also have substantially underfunded municipal pension plans. Many cities have pension plans that are 20-30 percent underfunded, and a recent study estimated that cities have funded only 6 percent of their estimated retiree health care obligations.6 Detroit may have exhausted its financial resources sooner than other cities, but its problems cannot be dismissed as isolated. The lesson of Detroit is that it is difficult to achieve reductions of pensions and health benefits, even in Chapter 9.
Detroit's Chapter 9
When it filed its case in July 2013, Detroit's liabilities included $11.9 billion in unsecured obligations owed to bondholders and retirees and over $6.4 billion in revenue bonds, making it by far the largest municipal bankruptcy. In its filing, Detroit took the position that approximately $650 million of its general obligation bonds were unsecured.7 Detroit also said that pension and retiree health benefits represented $9.2-$9.9 billion of the unsecured claims, and that it intended to use the bankruptcy process to reduce and restructure those obligations.8 After approximately 16 months of intense litigation and mediation, on Nov. 7, 2014 Detroit's bankruptcy plan of adjustment (the Plan) was confirmed by Judge Steven W. Rhodes.9 The approval was expected because Detroit had settled with all of its principal adversaries, largely as a result of mediations between the city and its various creditors.10 An important driver to the various settlements was the high level of litigation risk faced by all parties. Because Chapter 9 cases remain rare, and many of the historic cases have involved small municipalities, the case law offers sparse guidance to litigants.11 While Detroit's focus on exiting Chapter 9 promptly is certainly commendable, at 16 months, the case was far shorter than many far smaller commercial Chapter 11 cases. But the nagging issue that was raised in the confirmation hearing was whether the Plan is a real solution. To assist...
