Judge Says Detroit Bankruptcy Unconstitutional

July 19, 2013 — -- A judge ruled Detroit's bankruptcy filing violates the Michigan Constitution, though the state attorney general said he will appeal the decision.

Detroit became the biggest American city to file for bankruptcy after its emergency manager filed for Chapter 9 protection on Thursday with more than $18 billion in accrued obligations. In the filing with the U.S. Bankruptcy Court in the Eastern District of Michigan, state-appointed emergency manager Kevyn Orr indicated that the city's estimated number of creditors was "over 100,000."

If the bankruptcy filing is approved, Detroit's assets could be liquidated to meet creditor payments.

But circuit judge Rosemarie Aquilina said the bankruptcy filing violated the state constitution by threatening the pension benefits for the city's retirees.

Lawyers representing pensioners and two city pension funds got an emergency hearing with Aquilina Thursday, but attorneys and the judge learned Orr filed the Detroit bankruptcy petition in Detroit five minutes before the hearing began, the Detroit Free Press reported.

Attorney General Bill Schuette said in a statement that he was appealing Aquilina's ruling on behalf of the governor's office.

Randye Soref, an attorney with law firm Polsinelli, said the chances of the bankruptcy not moving forward and being declared unconstitutional "are slim to none."

Soref said that the state constitution includes a prohibition against taking any action that would modify pensions.

"In Chapter 9, however, the municipality has the absolute right to modify pensions, reject collective bargaining agreements -- without meeting any protections that would arise in Chapter 11 -- and wage and severance claims are afforded no priority," she said. "I think the bankruptcy code as a federal statute will trump the state statute. The whole rationale behind Chapter 9 and the limits on court involvement that a debtor has in Chapter 11 is to allow the sovereign the breathing room it needs to rearrange and adjust its debts, thereby allowing it to govern."

Michael S. Leib, attorney with Maddin, Hauser, Wartell, Roth & Heller, P.C. in Southfield, Mich., said the decision as to whether the bankruptcy filing was proper should be determined by the U.S. bankruptcy judge appointed to hear the case.

"There are complicated issues of preemption and constitutional questions regarding the eligibility of the city to file the Chapter 9 petition. It would appear Congress placed that decision in the hands of the U.S. Bankruptcy Court," Leib said.

David Duffus, a partner with ParenteBeard, said there is a precedent for an attempted municipal bankruptcy to be derailed, as shown in the example of Harrisburg, Pa., which declared bankruptcy in 2011.

When the Harrisburg City Council attempted to file for bankruptcy, the petition was denied by Judge Mary D. France on the basis that the filing was illegal because Pennsylvania state law prohibited the city from filing, Duffus said. That council needed the mayor to back its filing. The issue was appealed to the Third Circuit, where the appeals court confirmed Judge France's decision. That ruling then cleared the way for the state takeover of Harrisburg.

Orr, who was hired in March to assist with the city's budget, had tried to convince creditors to accept pennies on the dollar to deal with its financial problems.

Included in the bankruptcy filing is a four-page letter signed by Michigan Gov. Snyder and dated July 18 in which he wrote that a "vital point" made by Orr was that, "Detroit tax rates are at their current legal limits, and that even if the city was legally able to raise taxes, its residents cannot afford to pay additional taxes."

Jefferson County, Ala., previously held the title of largest municipal bankruptcy. Attorneys for Jefferson County have submitted plans to exit its historic $4.23 billion bankruptcy.

In a statement, Detroit Mayor Dave Bing said, "Today's bankruptcy filing is an unfortunate event in our city's history. While it has never been my desire that the city file for bankruptcy, I understand why Kevyn found it necessary to do so."