A warning Detroit emergency manager Kevyn Orr issued in March could
serve as an effective starting point for negotiations Friday with city
bondholders and creditors, who will be asked to accept far less than what is
owed to them.
"Don't make me go to the bankruptcy court," Orr said at his introductory news conference, adding a moment later: "I'm very comfortable in bankruptcy court."
Interviews with several bankruptcy attorneys and legal research suggest creditors, unions and bondholders should be worried.
Under a Chapter 9 bankruptcy, Orr becomes even more powerful. The 10th Amendment of the U.S. Constitution says the federal government can't interfere with states' rights -- so a federal bankruptcy judge might have to defer to Orr's recommendations on some issues. Judges in Chapter 11 bankruptcy -- the kind that helped revive General Motors and Chrysler -- have much more power.
"People say, 'Oh, well, I don't want to do what Kevyn Orr says, I'll take a risk with the bankruptcy judge,' " said Laura Beth Bartell, Wayne State University law professor. "The bankruptcy judge isn't making the decisions. It's either Kevyn Orr making the decisions out of bankruptcy, or Kevyn Orr making the decisions in bankruptcy."
Here are some answers to questions about how a Chapter 9 bankruptcy could unfold:
QUESTION: Can Orr -- who is set to offer fewer than 10 cents on the dollar to city creditors -- avert bankruptcy?
ANSWER: Experts said it's likely he's pursuing agreements from as many creditors as possible so that he can enter bankruptcy with concrete deals to hasten the process.
University of Michigan bankruptcy law professor John Pottow said the city's debt-to-revenue ratio of approximately 15-to-1 is "absurd," yet creditors may ignore intense pressure to cave outside bankruptcy.
"People are not going to be willing to give up 90 cents on the dollar outside of bankruptcy," he said.
What needs to happen before the city files for bankruptcy?
To file a Chapter 9 petition, the city must convince a judge that it's eligible to file by getting the state's approval, showing it's not paying its bills and proving it negotiated "in good faith" with its creditors.
"Creditors usually can find room to argue that the city has not done enough to avoid bankruptcy," said Patrick Darby, an attorney who is advising Jefferson County, Ala., in its Chapter 9 bankruptcy.
How long could the process take?
Douglas Bernstein, a bankruptcy attorney with Plunkett Cooney, said it could last years.
But Pottow said it may take "months, rather than years," if creditors agree to concessions ahead of time and the bankruptcy judge decides to expedite the case.
Who decides whether the city negotiated "in good faith" with its creditors?
Bankruptcy attorneys suggested that Orr's current talks with creditors reflect an attempt to prove to the bankruptcy court that the restructuring talks were fair. But disgruntled creditors can challenge the city's assertion that it negotiated in good faith, spawning a protracted legal fight. "That bogs the process down," Bartell said.
How does the bankruptcy judge get appointed, and where would the case be filed?
Alice Batchelder, the chief judge of the U.S. 6th Circuit Court of Appeals, would have the power to appoint a bankruptcy judge to handle Detroit's case.
The case would be filed in the U.S. Eastern District Court of Michigan, and hearings could take place in Detroit, or elsewhere in the district, which also includes Kentucky, Ohio and Tennessee.
Can the city be liquidated?
No. "You can't liquidate city hall," Pottow said.
Unlike in Chapter 11 corporate bankruptcy cases, municipalities cannot be forced to sell all their assets to pay off creditors.
However, the city may negotiate a plan that involves selling assets as part of a plan to stabilize the city's finances.
Under this scenario, for example, the city could try to sell city-owned artwork at the Detroit Institute of Arts to help reduce the city's debt, though the DIA would seek to block a sale and Orr has said he wants to avoid it. But creditors could pressure Orr to off-load some assets to reduce their own losses.
Can the city just wipe out all its debt in bankruptcy and start over?
No. Chapter 9 bankruptcy offers no swift solutions. However, it could provide the city with the power to negotiate a debt-reduction deal that could be forced upon bondholders and creditors that previously refused to accept concessions.
Can union contracts be abandoned?
Yes. In fact, Chapter 9 bankruptcy makes it even easier to slash labor deals than in Chapter 11 bankruptcy. In this scenario, Orr could impose new contracts. But the U.S. Supreme Court has ruled this must be a last resort.
Can city retirees lose their pensions?
Probably not. But there's a chance that their monthly pension payments could be reduced. This issue is among the most difficult and uncertain legal questions in Chapter 9 bankruptcy cases.
"You're talking about people who gave their lives to the city, and they're living on this thing. What's going to happen to them? This is a very serious emotional, political, moral issue," Bartell said.
Detroit city unions are arguing that public pensions are protected in bankruptcy because the Michigan Constitution says they "shall be a contractual obligation" that "shall not be diminished or impaired."
But lawyers questioned whether that legal protection would hold up in bankruptcy court. The U.S. Constitution dictates that federal law trumps state law, and federal law allows contracts to be severed in bankruptcy.
Can city retirees lose health care insurance?
Yes. Or benefits could be reduced. According to the U.S. court system website, cities that file for Chapter 9 can reject "retiree benefit plans without going through the usual procedures required in Chapter 11 cases."
What happens to general obligation bondholders?
They can expect a fraction in return for their original investments. In most cases, bond insurers incur these losses.
But they won't agree to a deal that favors other creditors, including union members. Bondholders could push for cuts to pensions.
How would the city's regular business be affected?
In bankruptcy, the city would still have the right to do business as usual. For example, the city could pay police officers and sweep the streets.
However, disruptions could occur if, for example, a city union authorized a strike in response to something that happens during the bankruptcy proceedings, Pottow said.
But if the city dramatically reduces its liabilities during bankruptcy, it could free up cash flow to increase spending on public safety.
Do any city assets get special treatment in bankruptcy?
Yes. Any bonds that are secured by special taxes, such as water and sewer bonds, cannot be stripped of their revenue streams. These bondholders may be protected from cuts.
How would the city pay for bankruptcy proceedings and how much would it cost?
This is still unclear, but the numerous consultants and attorneys involved in the Chapter 9 bankruptcy process could be paid out of the city's general revenue stream. Federal law allows cities to borrow money during bankruptcy, meaning the city could hunt for lenders to help finance its bankruptcy case.
How would the city exit bankruptcy?
The city would propose a reorganization plan that must be approved by more than half of the creditors in each creditor class and by creditors representing at least two-thirds of the total claims. This would likely involve major debt reduction, new union deals and potentially the sale of some assets.
What powers does the bankruptcy judge have?
Although the bankruptcy judge must defer to the debtor on many issues, the judge still maintains the power to approve the reorganization plan, set deadlines during the case and determine how seriously to consider various legal challenges during the case.
How long would the Chapter 9 process take?
Opinions vary widely. Estimates range from anywhere from six months to several years. By all accounts, some creditors will try to slow the process with legal challenges. But if Orr can line up enough support ahead of time, he could convince the judge to expedite the process.
"How long it would take?" Bartell said. "That depends on how much people fight."
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