Detroit's Chapter 9 Bankruptcy and the Grinch Who Stole Their Pensions

JURIST Guest Columnist Charles Tabb of the University of Illinois College of Law argues that the Detroit bankruptcy ruling produces a catch-22 between the federal and state courts which may ultimately be decided by the US Supreme Court ...
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The first clause to the title of this comment is of course to some degree hyperbolic; nothing has happened (yet) to impair or diminish the public pensions enjoyed by Detroit pensioners. As was previously reported by JURIST, on December 3, Bankruptcy Judge Steven Rhodes held that the City of Detroit was eligible for bankruptcy under chapter 9 of the United States Bankruptcy Code. Two days later, he issued a 150-page opinion detailing his findings. On December 16, Judge Rhodes certified the case for direct appeal to the US Court of Appeals for the Sixth Circuit. It is not yet known whether the Sixth Circuit will hear the case on an expedited basis.

In the course of his opinion, Judge Rhodes made clear that Detroit's pension obligations could be impaired in the chapter 9 case, notwithstanding the roadblocks of either the Tenth Amendment (which preserves state sovereignty except as specifically given to the federal government in the US Constitution) or the provision in Article IX, section 24 of the Michigan Constitution that prohibits the impairment or diminishment of pension obligations. At this early stage, wherein only eligibility was on the table for decision, it was of course premature for Judge Rhodes to rule on any specific plan to cut pensions. Furthermore, he was careful to state that he "will not lightly or casually exercise the power under federal bankruptcy law to impair pensions," which I am fairly confident did not offer even the tiniest bit of comfort to Detroit's now-terrified pensioners, given Detroit's obvious and overwhelming insolvency and the reality that one of their largest debts is for pension obligations. To restructure, it would seem, Detroit would have to cut its pensions, and dramatically.

I think there is a substantial possibility that the case will ultimately be decided by the United States Supreme Court, given the overarching importance of the questions involved, and the festering tension between the Supremacy Clause and the Tenth Amendment. The only Supreme Court precedent on the constitutionality of municipal bankruptcies is now three-quarters of a century old, involving a pair of Depression-era cases sitting on each side of the 1937 divide (inspired by FDR's infamous court-packing plan) in the Supreme Court's war with FDR over the New Deal. The Court first held in Ashton v. Cameron County Water Improvement that the municipal bankruptcy law that Congress had enacted did violate State sovereignty under the Tenth Amendment. After Congress passed a minutely modified law, the Court then held that the law did not violate the Tenth Amendment in United States v. Bekins. Whether Bekins is still good law, especially after New York v. United States, and Printz v. United States, is at the very least a non-frivolous question, and especially given the current composition of the court. Time will tell.

The Detroit case is one of the most important bankruptcy cases in decades. It is the poster child for testing whether and in what circumstances financially distressed cities—which are legion—can restructure their debts under chapter 9 and, most particularly, whether and how they can restructure their pension obligations. While it is somewhat difficult to generalize as to the pension question, given the wide variety in the ways in which the states recognize, enforce, and protect public pension obligations, much can be learned from the Detroit case. Notably, Michigan (supposedly) has one of the strongest state laws for safeguarding pensions—it is written into the state constitution, as noted above, which provides: "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." Thus, in a nutshell, if Detroit's pensions can be modified in bankruptcy, then virtually no public municipal pensions are safe, no matter how structured. State pensions, though, are not affected, because there is no provision in the federal Bankruptcy Code for a state to file bankruptcy; rather, only subdivisions of states are eligible for bankruptcy relief, as a statutory matter.

One uninitiated in the mysterious sleight-of-hand of legal reasoning might be quite puzzled in trying to grasp how, exactly, it can be that pensions protected as sacrosanct by a state's constitution could be slashed in a bankruptcy case, especially with the Tenth Amendment lurking in the background. Perhaps to fully understand, one would need to be channeling Joseph Heller's Yossarian in Catch-22. Let me explain. For most types of debts, the constitutionality of impairing and restructuring debts in a case pursuant to a federal bankruptcy law is beyond contest, because of the specific authorization given to Congress in Article I, section 8, clause 4 of the US Constitution to enact "uniform laws on the subject of bankruptcies." And usually, because of the Supremacy Clause, federal law plainly trumps state law. However, that logic won't carry the day for the Detroit situation, because the US government cannot cut Michigan state pensions for Detroit workers in a bankruptcy without Michigan's consent, because that would violate the Tenth Amendment. That is, the Tenth Amendment trumps the Bankruptcy Clause. So, Congress cannot just pass a bankruptcy law that would include cutting state pensions; i.e., the feds don't have the power. Nor can the Michigan state government cut the pensions, because the state constitution won't let it. So, the state also doesn't have the power to cut the pensions. A sane person (who, as we saw in the book Catch-22, would be compelled to fly dangerous combat missions, because you can only be excused from flying missions if you are crazy, and if you don't want to fly the dangerous missions, you're obviously not crazy) might thus conclude that if the feds can't do it, and the state can't do it, well, then it can't be done. Who else is there? Never fear, legal legerdemain is here.

The trick is, basically, for each side (the feds and the state) to pass the buck back to the other. That way neither side appears to be authorizing the actual pension-cutting, but viewed from each side, it looks like the other is doing it. Confused? You should be. But so far, it works. Specifically, the Tenth Amendment dodge for municipal bankruptcies approved long ago by the court in is that all is copacetic if the use of federal bankruptcy for a state's municipality is specifically authorized by the state. In short, the feds aren't making the state go through a bankruptcy restructuring. It's the state's choice to do it. So no Tenth Amendment problem. Fine.

But if that is so, then surely, sane person (e.g., unexcused combat pilot) might protest, the state is on the hook, and (as applied to the Detroit case), Michigan is violating its own state constitution if it authorizes Detroit to file a federal bankruptcy case under chapter 9 in which Detroit pensions will be slashed. To be eligible for chapter 9 bankruptcy, the federal Bankruptcy Code requires in section 109(c)(2) that the municipal debtor be "specifically authorized ... to be a debtor under such chapter by state law, or by a governmental officer or organization empowered by State law to authorize such entity to be a debtor under such chapter." And Michigan did so authorize, in Public Act 436 (which had just become effective in March 2013). In the Detroit case, the emergency manager, Kevyn Orr, exercised his authority under that law to recommend a bankruptcy filing and request the governor's approval for Detroit to file bankruptcy, which Governor Snyder did on July 18, 2013, without imposing any contingencies. So, that must mean, our sad sane person would reason, that the State of Michigan then is effecting the pension slash, and that must violate the pension clause in the state constitution, right? No, no, how silly, the judge would (and did) respond: the state isn't doing the cutting; that is being done under the auspices of the feds, who have the power under the Bankruptcy Clause and the Supremacy Clause to impair contractual debts. Indeed, the judge said, once the state has consented to federal bankruptcy, it cannot (because of the Supremacy Clause) tell the feds which debts are and which are not susceptible to being modified. Perhaps that is true. But the reality is that (because of the Tenth Amendment) the federal bankruptcy law, in all its apparently immutable and unchangeable glory, could only be triggered in Detroit's case if the state of Michigan gave the green light. And it is that green light signal, I submit, which then must violate the Michigan constitution. Logically, even Yossarian would complain that either the feds are violating the Tenth Amendment or the state is violating the state constitution.

This would all make for a fun and fascinating mind game, but for the cruel reality that the lives of many thousands of human beings, who labored dutifully in the Motor City for decades, comfortable, at least, in the belief that their constitutionally guaranteed pension would be there when they retired, are being ruined. These are not really "consensual" creditors. They trusted the state of Michigan, which supposedly guaranteed their pensions. And the feds cannot, because of the Tenth Amendment, make Michigan renege on that promise. But if Judge Rhodes' ruling stands (which I suspect it will, unless the Supreme Court has a change of heart about the continued legitimacy of its reasoning in Bekins), those pensioners will lose. This is a human tragedy, and it is wrong. Not only that, but if the Detroit reasoning stands, then we can expect a flood of municipal bankruptcy cases across the country, gleefully seeking to eviscerate pension rights of people who no longer can do anything about it. However you look at it, that should not happen.

Charles Tabb is the Mildred Van Voorhis Jones Chair in Law at the University of Illinois College of Law. Prior to joining the faculty there, he practiced bankruptcy and commercial law in Dallas.

Suggested Citation: Charles Tabb, Detroit's Chapter 9 Bankruptcy and the Grinch Who Stole Their Pensions, JURIST - Forum, Dec. 23, 2013, http://jurist.org/forum/2013/12/charles-tabb-detroit-bankruptcy.php


This article was prepared for publication by Brent Nesbitt, assistant editor for JURIST's academic commentary service. Please direct any questions or comments to him at academiccommentary@jurist.org

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