STEVEN RHODES, Bankruptcy Judge.
Table of Contents I Summary of Opinion ...........................................................110II. Introduction to the Eligibility Objections ...................................110 A. The Process..............................................................111 B. Objections Filed by Individuals Without an Attorney......................111 C. Objections That Raise Only Legal Issues..................................111 D. Objections That Require the Resolution of Genuine Issues of Material Fact...........................................................112III. Introduction to the Facts Leading up to the Bankruptcy Filing ................112 A. The City's Financial Distress............................................113 1. The City's Debt.....................................................113 2. Pension Liabilities.................................................114 3. OPEB Liabilities....................................................115 4. Legacy Expenditures — Pensions and OPEB ........................115 5. The Certificates of Participation...................................115 a. The COPs and Swaps Transaction .................................115 b. The Result......................................................116 c. The Collateral Agreement........................................116 d. The City`s Defaults Under the Collateral Agreement..............116 e. The Forbearance and Optional Termination Agreement..............117 f. The Resulting Litigation Involving Syncora......................117 g. The COPs Debt ..................................................118 6. Debt Service........................................................118 7. Revenues............................................................118 8. Operating Deficits..................................................118 9. Payment Deferrals ..................................................119 B. The Causes and Consequences of the City's Financial Distress.............119 1. Population Losses...................................................119 2. Employment Losses...................................................119 3. Credit Rating.......................................................119 4. The Water and Sewerage Department...................................119 5. The Crime Rate......................................................120 6. Streetlights........................................................120 7. Blight..............................................................120 8. The Police Department...............................................120 9. The Fire Department.................................................120 10. Parks and Recreation................................................120 11. Information Technology..............................................120 C. The City's Efforts to Address Its Financial Distress.....................121 D. A Brief History of Michigan's Emergency Manager Laws.....................121 E. The Events Leading to the Appointment of the City's Emergency Manager.................................................................122 1. The State Treasurer's Report of December 21, 2011...................122 2. The Financial Review Team's Report of March 26, 2012 ...............123 3. The Consent Agreement...............................................123 4. The State Treasurer's Report of December 14, 2012...................124 5. The Financial Review Team's Report of February 19, 2013.............124 6. The Appointment of an Emergency Manager for the City of Detroit............................................................125 F. The Emergency Manager's Activities.......................................126 1. The June 14, 2013 Meeting and Proposal to Creditors.................126 2. Subsequent Discussions with Creditor Representatives................127 H. The Bankruptcy Filing....................................................128 G. The Prepetition Litigation...............................................128
IV. The City Bears the Burden of Proof ...........................................128V. The Objections of the Individuals Who Filed Objections Without an Attorney ....................................................................129VI. The City of Detroit Is a "Municipality" Under 11 U.S.C. § 109(c)(1) .....129VII. The Bankruptcy Court Has the Authority to Determine the Constitutionality of Chapter 9 of the Bankruptcy Code and Public Act 436 ..............................................................129 A. The Parties' Objections to the Court's Authority Under Stern v. Marshall................................................................129 B. Stern, Waldman, and Global Technovations.................................130 C. Applying Stern, Waldman, and Global Technovations in This Case...........131 D. Applying Stern in Similar Procedural Contexts............................132 E. The Objectors Overstate the Scope of Stern..............................133 1. Stern Does Not Preclude This Court from Determining Constitutional Issues..............................................133 2. Federalism Issues Are Not Relevant to a Stern Analysis..............134 F. Conclusion Regarding the Stern Issue.....................................135VIII. Chapter 9 Does Not Violate the United States Constitution ....................136 A. Chapter 9 Does Not Violate the Uniformity Requirement of the Bankruptcy Clause of the United States Constitution.....................136 1. The Applicable Law .................................................136 2. Discussion..........................................................137 B. Chapter 9 Does Not Violate the Contracts Clause of the United States Constitution.....................................................137 C. Chapter 9 Does Not Violate the Tenth Amendment to the United States Constitution.....................................................138 1. The Tenth Amendment Challenges to Chapter 9 Are Ripe for Decision and the Objecting Parties Have Standing...................138 a. Standing .......................................................139 b. Ripeness .......................................................140 2. The Supreme Court Has Already Determined That Chapter 9 Is Constitutional .................................................141 3. Changes to Municipal Bankruptcy Law Since 1937 Do Not Undermine the Continuing Validity of Bekins........................143 a. The Contracts Clause of the United States Constitution Prohibits States from Enacting Municipal Bankruptcy Laws...........................................................144 b. Asbury Park Is Limited to Its Own Facts.........................144 4. Changes to the Supreme Court's Tenth Amendment Jurisprudence Do Not Undermine the Continuing Validity of Bekins................................................145 a. New York v. United States......................................145 b. Printz v. United States.........................................146 c. New York and Printz Do Not Undermine Bekins.....................147 d. Explaining Some Puzzling Language in New York...................148 5. Chapter 9 Is Constitutional As Applied in This Case.................149 a. When the State Consents to a Chapter 9 Bankruptcy, the Tent h Amendment Does Not Prohibit the Impairment of Contract Rights That Are Otherwise Protected by the State Constitution.............................................150 b. Under the Michigan Constitution, Pension Rights Are Contractual Rights.............................................150IX. Public Act 436 Does Not Violate the Michigan Constitution ....................154
A. The Michigan Case Law on Evaluating the Constitutionality of a State Statute...........................................................155 B. The Voters' Rejection of Public Act 4 Did Not Constitutionally Prohibit the Michigan Legislature from Enacting Public Act 436..........156 C. Even If the Michigan Legislature Did Include Appropriations Provisions in Public Act 436 to Evade the Constitutional Right of Referendum, It Is Not Unconstitutional.........................157 D. Public Act 436 Does Not Violate the Home Rule Provisions of the Michigan Constitution ..................................................158 E. Public Act 436 Does Not Violate the Pension Clause of the Michigan Constitution............................................................161 X. Detroit's Emergency Manager Had Valid Authority to File This Bankruptcy Case Even Though He Is Not an Elected Official ...................161XI. The Governor's Authorization to File This Bankruptcy Case Was Valid Under the Michigan Constitution Even Though the Authorization Did Not Prohibit the City from Impairing Pension Rights ..............................................................162XII. The Judgment in Webster v. Michigan Does Not Preclude the City from Asserting That the Governor's Authorization to File This Bankruptcy Case Was Valid ...................................................162 A. The Circumstances Leading to the Judgment................................162 B. The Judgment Is Void Because It Was Entered After the City Filed Its Petition............................................................165 C. The Judgment Is Also Void Because It Violated the Automatic Stay.........166 D. Other Issues ............................................................167XIII. The City Was "Insolvent" .....................................................168 A. The Applicable Law.......................................................168 B. Discussion ..............................................................168 1. The City Was "Generally Not Paying Its Debts As They Become Due"........................................................169 2. The City Is Also "Unable to Pay Its Debts As They Become Due."..............................................................169 3. The City's "Lay" Witnesses..........................................170 4. The City's Failure to Monetize Assets...............................170XIV. The City Desires to Effect a Plan to Adjust Its Debts ........................171 A. The Applicable Law.......................................................171 B. Discussion ..............................................................172XV. The City Did Not Negotiate with Its Creditors in Good Faith ..................172 A. The Applicable Law.......................................................172 B. Discussion ..............................................................174XVI. The City Was Unable to Negotiate with Creditors Because Such Negotiation Was Impracticable ...............................................176 A. The Applicable Law.......................................................176 B. Discussion ..............................................................177XVII. The City Filed Its Bankruptcy Petition in Good Faith .........................179 A. The Applicable Law.......................................................180 B. Discussion ..............................................................180 1. The Objectors' Theory of Bad Faith..................................181 2. The Court's Conclusions Regarding the Objectors' Theory of Bad Faith..........................................................183 3. The City Filed This Bankruptcy Case in Good Faith...................187
a. The City's Financial Problems Are of a Type Contemplated for Chapter 9 Relief..............................187 b. The City's Reasons for Filing Are Consistent with the Remedial Purpose of Chapter 9..................................187 c. The City Made Efforts to Improve the State of Its Finances Prior to Filing, to No Avail..........................188 d. The Residents of Detroit Will Be Severely Prejudiced If This Case Is Dismissed.........................................188 C. Conclusion Regarding the City's Good Faith...............................189 XVIII. Other Miscellaneous Arguments ................................................189 A. Midlantic Does Not Apply in This Case.....................................189 B. There Was No Gap in Mr. Orr's Service as Emergency Manager................190XIX. Conclusion: The City is Eligible and the Court Will Enter an Order for Relief ..................................................................190
For the reason stated herein, the Court finds that the City of Detroit has established that it meets the requirements of 11 U.S.C. § 109(c). Accordingly, the Court finds that the City may be a debtor under chapter 9 of the bankruptcy code. The Court will enter an order for relief under chapter 9.
Specifically, the Court finds that:
The Court further finds that the City filed the petition in good faith and that therefore the petition is not subject to dismissal under 11 U.S.C. § 921(c).
The Court concludes that it has jurisdiction over this matter under 28 U.S.C. § 1334(a), and that the matter is a core proceeding under 28 U.S.C. § 157(b)(2).
The matter is before the Court on the parties' objections to the eligibility of the City of Detroit to be a debtor in this chapter 9 case under 11 U.S.C. § 109(c).
By order dated August 2, 2013, the Court set a deadline of August 19, 2013 for parties to file objections to eligibility. (Dkt. # 280) That order also allowed the Official Committee of Retirees, then in formation, to file eligibility objections 14 days after it retained counsel.
One hundred nine parties filed timely objections to the City's eligibility to file this bankruptcy case under § 109 of the bankruptcy code. In addition, two individuals, Hassan Aleem and Carl Williams, filed an untimely joint objection, but upon motion, the Court determined that these objections should be considered timely. (Dkt. # 821, ¶ VIII, at 7) Accordingly, the total number of objections to be considered is 110.
In pursuing their eligibility objections, the parties represented by attorneys filed over 50 briefs through several rounds.
Also, because the constitutionality of a state statute was drawn into question, the Court certified the matter to the Michigan Attorney General under 28 U.S.C. § 2403(b), and permitted the State of Michigan to intervene. The Michigan Attorney General filed a "Statement Regarding The Michigan Constitution And The Bankruptcy Of The City Of Detroit." (Dkt. # 481) He also filed a brief regarding eligibility (Dkt. # 756) and a supplemental response (Dkt. # 1085).
In an effort to organize and expedite its consideration of these objections, the Court entered an "Order Regarding Eligibility Objections" on August 26, 2013 (Dkt. # 642) and a "First Amended Order Regarding Eligibility Objections" on September 12, 2013 (Dkt. #821). Those orders divided the objections into two groups — those filed by parties with an attorney, which were, generally, organized groups (group A), and those filed by individuals, mostly without an attorney (group B). Individuals without an attorney (group B) filed 93 objections. The remaining 17 objections were filed by parties with an attorney. The objections filed by attorneys were then further divided between objections raising only legal issues and objections that require the resolution of genuine issues of material fact.
The Second Amended Final Pre-Trial Order concisely identifies which parties assert which objections. (Dkt. # 1647 at 4-11) This opinion will not repeat that recitation.
On September 19, 2013, the Court held a hearing at which the individuals who filed timely objections without an attorney had an opportunity to address the Court. At that hearing, 45 individuals addressed the Court. These objections are discussed in Part V, below.
On October 15 and 16, 2013, the Court heard arguments on the objections that raised only legal issues. These objections are addressed in Parts VII-XII, below. Summarily stated, these objections are:
1. Chapter 9 of the bankruptcy code violates the United States Constitution.
2. The bankruptcy court does not have the authority to determine the constitutionality of chapter 9 of the bankruptcy code.
3. Public Act 436 of 2012 violates the Michigan Constitution and therefore the City was not validly authorized to file this bankruptcy case as required for eligibility by 11 U.S.C. § 109(c)(2).
4. The bankruptcy court does not have the authority to determine the constitutionality of P.A. 436.
5. Detroit's emergency manager is not an elected official and therefore did not
6. Because the governor's authorization to file this bankruptcy case did not prohibit the City from impairing the pension rights of its employees and retirees, the authorization was not valid under the Michigan Constitution, as required for eligibility by 11 U.S.C. § 109(c)(2).
7. Because of the proceedings and judgment in Webster v. The State of Michigan, Case No. 13-734-CZ (Ingham County Circuit Court), the City is precluded by law from claiming that the governor's authorization to file this bankruptcy case was valid, as required for eligibility by 11 U.S.C. § 109(c)(2).
Beginning on October 23, 2013, the Court conducted a trial on the objections filed by attorneys that require the resolution of genuine issues of material fact. These objections are addressed in Parts XIII-XVII, below. Summarily stated, these objections are:
8. The City was not "insolvent," as required for eligibility by 11 U.S.C. § 109(c)(3) and as defined in 11 U.S.C. § 101(32)(C).
9. The City does not desire "to effect a plan to adjust such debts," as required for eligibility by 11 U.S.C. § 109(c)(4).
10. The City did not negotiate in good faith with creditors, as required (in the alternative) for eligibility by 11 U.S.C. § 109(c)(5)(B).
11. The City was not "unable to negotiate with creditors because such negotiation [was] impracticable," as required (in the alternative) for eligibility by 11 U.S.C. § 109(c)(5)(C).
12. The City's bankruptcy petition should be dismissed under 11 U.S.C. § 921(c) because it was filed in bad faith.
In addition, in the course of the briefing, parties asserted certain new and untimely objections. These are addressed in Part XVIII, below.
The City of Detroit was once a hardworking, diverse, vital city, the home of the automobile industry, proud of its nickname — the "Motor City." It was rightfully known as the birthplace of the American automobile industry. In 1952, at the height of its prosperity and prestige, it had a population of approximately 1,850,000 residents. In 1950, Detroit was building half of the world's cars.
The evidence before the Court establishes that for decades, however, the City of Detroit has experienced dwindling population, employment, and revenues. This has led to decaying infrastructure, excessive borrowing, mounting crime rates, spreading blight, and a deteriorating quality of life.
The City no longer has the resources to provide its residents with the basic police, fire and emergency medical services that its residents need for their basic health and safety.
Moreover, the City's governmental operations are wasteful and inefficient. Its equipment, especially its streetlights and its technology, and much of its fire and police equipment, is obsolete.
To reverse this decline in basic services, to attract new residents and businesses, and to revitalize and reinvigorate itself, the City needs help.
The following sections of this Part of the opinion detail the basic facts regarding the City's fiscal decline, and the causes and
The evidence supporting these factual findings consists largely of the following admitted exhibits:
Exhibit 6 — the City's "Comprehensive Annual Financial Report" for the fiscal year ended June 30, 2012.
Exhibit 21 — "Preliminary Review of the City of Detroit," from Andy Dillon, State Treasurer, to Rick Snyder, Governor, December 21, 2011;
Exhibit 22 — "Report of the Detroit Financial Review Team," from the Detroit Financial Review Team to Governor Snyder, March 26, 2012;
Exhibit 24 — "Preliminary Review of the City of Detroit," from Andy Dillon, State Treasurer, to Rick Snyder, Governor, December 14, 2012;
Exhibit 25 — "Report of the Detroit Financial Review Team," from the Detroit Financial Review Team to Governor Snyder, February 19, 2013;
Exhibit 26 — Letter from Governor Rick Snyder to Mayor Dave Bing and Detroit City Council, March 1, 2013;
Exhibit 28 — Letter from Kevyn D. Orr, Emergency Manager, to Governor Richard Snyder and State Treasurer Andrew Dillon, July 16, 2013;
Exhibit 29 — "Authorization to Commence Chapter 9 Bankruptcy Proceeding," from Governor Richard Snyder to Emergency Manager Kevyn Orr and State Treasurer Andrew Dillon.
Exhibit 38 — Graph, "FY14 monthly cash forecast absent restructuring"
Exhibit 41 — "Financial and Operating Plan," Kevyn D. Orr, Emergency Manager, June 10, 2013;
Exhibit 43 — "Proposal for Creditors," City of Detroit, June 14, 2013;
Exhibit 44 — "Proposal for Creditors, Executive Summary," City of Detroit, June 14, 2013;
Exhibit 75 — "Financial and Operating Plan," Kevyn D. Orr, Emergency Manager, May 12, 2013;
Exhibit 414 — Declaration of Kevyn Orr in Support of Eligibility. (Dkt. # 11)
The Court notes that the objecting creditors offered no substantial evidence contradicting the facts found in this Part of the opinion, except as noted below relating to the City's unfunded pension liability.
The City estimates its debt to be $18,000,000,000. This consists of $11,900,000,000 in unsecured debt and $6,400,000,000 in secured debt. It has more than 100,000 creditors.
According to the City, the unsecured debt includes:
$5,700,000,000 for "OPEB" through June 2011, which is the most recent actuarial data available. "OPEB" is "other post-employment benefits," and refers to the Health and Life Insurance Benefit Plan and the Supplemental Death Benefit Plan for retirees;
$3,500,000,000 in unfunded pension obligations;
$651,000,000 in general obligation bonds;
$300,000,000 of other liabilities, including $101,200,000 in accrued compensated absences, including unpaid, accumulated vacation and sick leave balances; $86,500,000 in accrued workers' compensation for which the City is self-insured; $63,900,000 in claims and judgments, including lawsuits and claims other than workers' compensation claims; and $13,000,000 in capital leases and accrued pollution remediation.
As noted, the objecting parties do not seriously challenge the City's estimates of its debt, except for its estimates of its unfunded pension liability. The plans and others have suggested a much lower pension underfunding amount, perhaps even below $1,000,000,000. However, they submitted no proof of that. The Court concludes that it is unnecessary to resolve the issue at this time, because the City would be found eligible regardless of any specific finding on the pension liability that would be in the range between the parties' estimates. Otherwise, the Court is satisfied that the City's estimates of its other liabilities are accurate enough for purposes of determining eligibility, and so finds.
The City's General Retirement System ("GRS") administers the pension plan for its nonuniformed personnel. The average annual benefit received by retired pensioners or their beneficiaries is about $18,000. AFSCME Br. at 3 (citing June 30, 2012 General Retirement System of City of Detroit pension valuation report). (Dkt. # 505) Generally these retirees are eligible for Social Security retirement or disability benefits.
The City's Police and Fire Retirement System ("PFRS") administers the pension plan for its uniformed personnel. The average annual benefit received by retired pensioners or their beneficiaries is about $30,000. Generally, these retirees are not eligible for Social Security retirement or disability benefits. Retirement Systems Br. at 5 (citing 20 C.F.R. § 404.1206(a)(8), 20 C.F.R. § 404.1212). (Dkt. # 519)
The Pension Benefit Guaranty Corporation does not insure pension benefits under either plan.
For the five years ending with FY 2012, pension payments exceeded contributions and investment income by approximately $1,700,000,000 for the GRS and $1,600,000,000 for the PFRS. This resulted in the liquidation of pension trust principal.
As noted, the two pension plans and the City disagree about the level of underfunding in the plans. Gabriel Roeder Smith & Company is the funds' actuary. In its reports for the two pension plans as of June 30, 2012, it found an unfunded actuarial accrued liability ("UAAL") of $829,760,482 for the GRS. Ex. 69 at 3. It found UAAL of $147,216,398 for the PFRS. Ex. 70 at 3.
The City asserts that the actuarial assumptions underlying these estimates are aggressive. Most significantly, the City believes that the two plans project unrealistic annual rates of return on investments net of expenses — 7.9% by GRS and 8.0% by PFRS, and that therefore their estimates are substantially understated. As stated above, the City estimates the underfunding to be $3,500,000,000.
Using current actuarial assumptions, the City's required pension contributions, as a percentage of eligible payroll expenses, are projected to grow from 25% for GRS and 30% for PFRS in 2012 to 30% for GRS and 60% for PFRS by 2017. Changes in actuarial assumptions would result in further
The OPEB plans consist of the Health and Life Insurance Benefit Plan and the Supplemental Death Benefit Plan. The City's OPEB obligations arise under 22 different plans, including 15 different plans alone for medical and prescription drugs. These plans have varying structures and terms. The plan is a defined benefit plan providing hospitalization, dental care, vision care and life insurance to current employees and substantially all retirees. The City generally pays for 80% to 100% of health care coverage for eligible retirees. The Health and Life Insurance Plan is totally unfunded; it is financed entirely on a current basis.
As of June 30, 2011, 19,389 retirees were eligible to receive benefits under the City's OPEB plans. The number of retirees receiving benefits from the City is expected to increase over time.
The Supplemental Death Benefit Plan is a pre-funded single-employer defined benefit plan providing death benefits based upon years of creditable service. It has $34,564,960 in actuarially accrued liabilities as of June 30, 2011 and is 74.3% funded with UAAL of $8,900,000.
Of the City's $5,700,000,000 OPEB liability, 99.6% is unfunded.
During 2012, 38.6% of the City's revenue was consumed servicing legacy liabilities. The forecasts for subsequent years, assuming no restructuring, are 42.5% for 2013, 54.3% for 2014, 59.5% for 2015, 63% for 2016, and 64.5% for 2017.
The transactions described here are complex and confusing. The resulting litigation is as well. Nevertheless, a fairly complete explanation of them is necessary to an understanding of the City's severe financial distress.
In 2005 and 2006, the City set out to raise $1.4 billion for its underfunded pension funds, the GRS and PFRS. The City created a non-profit Service Corporation for each of the two pension funds, to act as an intermediary in the financing. The City then entered into Service Contracts with each of the Service Corporations. The City would make payments to the Service Corporations, which had created Funding Trusts and assigned their rights to those Funding Trusts. The Funding Trusts issued debt obligations to investors called "Pension Obligation Certificates of Participation. ("COPs").
The City arranged for the purchase of insurance from two monoline insurers to protect against defaults by the funding trusts that would result if the City failed to make payments to the Service Corporations under the Service Contracts. This was intended to make the investments more attractive to potential investors. One insurer was XL Capital Assurance, Inc., now known as Syncora. The other was the Financial Guaranty Insurance Company.
Some of the COPs paid a floating interest rate. To protect the Service Corporations from the risk of increasing interest rates, they entered into hedge arrangements
Under the swaps, the City was also at risk if there was an "event of default" or a "termination event." In such an event, the Swap Counterparties could terminate the swaps and demand a potentially enormous termination payment.
The Swap Counterparties also obtained protection against the risk that the Service Corporations would default on their quarterly swap payments. The parties purchased additional insurance against that risk from Syncora and the Financial Guaranty Insurance Company. Syncora's liability for swap defaults is capped at $50,000,000, even though the Swap Counterparties' claims may be significantly greater. This insurance is separate from the insurance purchased to protect against a default under the COPs.
In 2008, interest rates dropped dramatically. As a result, the City lost on the swaps bet. Actually, it lost catastrophically on the swaps bet. The bet could cost the City hundreds of millions of dollars. The City estimates that the damage will be approximately $45,000,000 per year for the next ten years.
As the City's financial condition worsened, the City, the Service Corporations and the Swap Counterparties sought to restructure the swap contracts. In June 2009, they negotiated and entered into a Collateral Agreement that amended the swap agreements. The Collateral Agreement eliminated the "Additional Termination Event" and the potential for an immediate demand for a termination payment. The City agreed to make the swap payments through a "lockbox" arrangement and to pledge certain gaming tax revenues as collateral. The City also agreed to increase the interest rate of the swap agreements by 10 basis points effective July 1, 2010. It also agreed to new termination events, including any downgrading of the credit ratings for the COPs.
Two accounts were set up: 1) a "Holdback Account" and 2) a "General Receipts Subaccount." U.S. Bank was appointed custodian of the accounts. The casinos would pay developer payments and gaming tax payments to the General Receipts Subaccount daily. The City would make monthly deposits into the Holdback Account equal to one-third of the quarterly payment that the Service Corporations owed to the Swap Counterparties. When the City made that monthly payment, U.S. Bank would release to the City the accumulated funds in the General Receipts Subaccount. If the City defaulted, the Swap Counterparties could serve notice on U.S. Bank, which would then hold or "trap" the money in the General Receipts Subaccount and not disburse it to the City.
Syncora was not a party to the Collateral Agreement.
In March, 2012, the COPs were downgraded, which triggered a termination
In March, 2013, the appointment of the emergency manager for the City was another event of default. Again however, the Swap Counterparties did not declare a default.
As of June 28, 2013, the City estimated that if an event of default were declared and the Swap Counterparties chose to exercise their right to terminate, it faced a termination obligation to the Swap Counterparties of $296,500,000. This was the approximate negative fair value of the swaps at that time.
On June 14, 2013, the City failed to make a required payment of approximately $40,000,000 on the COPs. This default triggered Syncora's liability as insurer on the COPs and it has apparently made the required payments. However, the City has made all of its required payments to the Swap Counterparties through the Holdback Account. The City contends that as a result, Syncora has no liability to the Swap Counterparties on its guaranty to them.
Following the City's defaults on the Collateral Agreement, the parties negotiated. On July 15, 2013 (three days before this bankruptcy filing), the City and the Swap Counterparties entered into a "Forbearance and Optional Termination Agreement." Under this agreement, the Swap Counterparties would forebear from terminating the swaps and from instructing U.S. Bank to trap the funds in the General Receipts Subaccount. The City may buy out the swaps at an 18-25% discount, depending on when the payment is made. That buy-out would terminate the pledge of the gaming revenues. Syncora was not a party to this agreement.
When the City filed this bankruptcy case, it also filed a motion to assume the "Forbearance and Optional Termination Agreement." (Dkt. # 17) Syncora and many other parties have filed objections to the City's motion. However, because there are serious and substantial defenses to the claims made against the City under the COPs, these objections assert that the agreement should not be approved. After several adjournments, it is scheduled for hearing on December 17, 2013.
Meanwhile, back on June 17, 2013, Syncora sent a letter to U.S. Bank declaring an event of default, triggering U.S. Bank's obligation to trap all of the money in the General Receipts Subaccount. The City responded, taking the position that because it had not defaulted in its swap payments and because Syncora has no rights under the Collateral Agreement, Syncora had no right to instruct U.S. Bank to trap the funds.
U.S. Bank did trap approximately $15,000,000. This represented a significant percentage of the City's monthly revenue.
As a result, on July 5, 2013, the City filed a lawsuit against Syncora in the Wayne County Circuit Court. It sought and obtained a temporary restraining order that resulted in U.S. Bank's release of the trapped funds to the City. On July 11, 2013, Syncora removed the action to the district court in Detroit and filed a motion to dissolve the temporary restraining order. On July 31, 2013, Syncora filed a motion to dismiss the complaint. On August 9, 2013, the district referred the matter to this Court. It is now Adversary Proceeding #13-04942. On August 28, 2013, this Court ruled that the gaming revenues are property of the City and therefore protected by the automatic stay.
Adding to this drama, on July 24, 2013, Syncora filed a lawsuit against the Swap Counterparties in a state court in New York, seeking an injunction to prevent the Swap Counterparties from performing their obligations under the Forbearance and Optional Termination Agreement. The Swap Counterparties then removed the action to the United States District Court for the Southern District of New York. That court, at the request of the Swap Counterparties, transferred the case to the federal district court in Detroit, which then referred it to this Court. It is Adversary Proceeding No. 13-05395.
Returning, finally, to the underlying obligations — the COPS, the City estimates that as of June 30, 2013, the following amounts were outstanding:
Debt service from the City's general fund related to limited tax and unlimited tax GO debt and the COPs was $225,300,000 for 2012, and is projected to exceed $247,000,000 in 2013.
Income tax revenues have decreased by $91,000,000 since 2002(30%) and by $44,000,000 (15%) since 2008. Municipal income tax revenue was $276,500,000 in 2008 and $233,000,000 in 2012.
Property tax revenues for 2013 were $135,000,000. This is a reduction of $13,000,000 (10%) from 2012.
Revenues from the City's utility users' tax have declined from approximately $55,300,000 in 2003 to approximately $39,800,000 in 2012(28%).
Wagering taxes receipts are about $170-$180,000,000 annually. However, the City projects that these receipts will decrease through 2015 due to the expected loss of gaming revenue to casinos opening in nearby Toledo, Ohio.
State revenue sharing has decreased by $161,000,000 since 2002(48%) and by $76,000,000 (30.6%) since 2008, due to the City's declining population and significant reductions in statutory revenue sharing by the State.
The City has experienced operating deficits for each of the past seven years. Through 2013, it has had an accumulated general fund deficit of $237,000,000. However, this includes the effect of recent debt issuances — $75,000,000 in 2008; $250,000,000 in 2010; and $129,500,000 in 2013. If these debt issuances are excluded, the City's accumulated general fund
In 2012, the City had a negative cash flow of $115,500,000, excluding the impact of proceeds from short-term borrowings. In March 2012, to avoid running out of cash, the City borrowed $80,000,000 on a secured basis. The City spent $50,000,000 of that borrowing in 2012.
In 2013, the City deferred payments on certain of its obligations, totaling approximately $120,000,000. As set forth in the next section, these deferrals were for current and prior year pension contributions and other payments. With those deferrals, the City projects a positive cash flow of $4,000,000 for 2013.
If the City had not deferred these payments, it would have run out of cash by June 30, 2013.
Absent restructuring, the City projects that it will have negative cash flows of $190,500,000 for 2014; $260,400,000 for 2015; $314,100,000 for 2016; and $346,000,000 for 2017. The City further estimates that by 2017, its accumulated deficit could grow to approximately $1,350,000,000.
The City is not making its pension contributions as they come due. It has deferred payment of its year-end Police and Fire Retirement System contributions. As of May 2013, the City had deferred approximately $54,000,000 in pension contributions related to current and prior periods and approximately $50,000,000 on June 30, 2013 for current year PFRS pension contributions. Therefore, the City will have deferred $104,000,000 of pension contributions.
Also, the City did not make the scheduled $39,700,000 payments on its COPs that were due on June 14, 2013.
A full discussion of the causes and consequences of the City's financial distress is well beyond the scope of this opinion. Still, the evidence presented at the eligibility trial did shed some important and relevant light on the issues that are before the Court. These "causes" and "consequences" are addressed together here because it is often difficult to distinguish one from the other.
Detroit's population declined to just over 1,000,000 as of June 1990. In December 2012, the population was 684,799. This is a 63% decline in population from its peak in 1950.
From 1972 to 2007, the City lost approximately 80% of its manufacturing establishments and 78% of its retail establishments. The number of jobs in Detroit declined from 735,104 in 1970 to 346,545 in 2012.
Detroit's unemployment rate was 6.3% in June 2000; 23.4% in June 2010; and 18.3% in June 2012. The number of employed Detroit residents fell from approximately 353,000 in 2000 to 279,960 in 2012.
The City's credit ratings are below investment grade. As of June 17, 2013, S & P and Moody's had lowered Detroit's credit ratings to CC and Caa3, respectively. Ex. 75 at 3.
The Detroit Water and Sewerage Department ("DWSD") provides water and wastewater services to the City and many suburban communities in an eight-county area, covering 1,079 square miles. DWSD's cost of capital is inflated due to
During calendar year 2011, 136,000 crimes were reported in the City. Of these, 15,245 were violent crimes. In 2012, the City's violent crime rate was five times the national average and the highest of any city with a population in excess of 200,000.
The City's case clearance rate for violent crimes is 18.6%. The clearance rate for all crimes is 8.7%. These rates are substantially below those of comparable municipalities nationally and surrounding local municipalities.
As of April 2013, about 40% of the approximately 88,000 streetlights operated and maintained by the City's Public Lighting Department were not working.
There are approximately 78,000 abandoned and blighted structures in the City. Of these, 38,000 are considered dangerous buildings. The City has experienced 11,000 — 12,000 fires each year for the past decade. Approximately 60% of these occur in blighted or unoccupied buildings.
The average cost to demolish a residential structure is approximately $8,500.
The City also has 66,000 blighted vacant lots.
In 2012, the average priority one response time for the police department was 30 minutes. In 2013, it was 58 minutes. The national average is 11 minutes.
The department's manpower has been reduced by approximately 40% over the last 10 years.
The department has not invested in or maintained its facility infrastructure for many years, and has closed or consolidated many precincts.
The department operates with a fleet of 1,291 vehicles, most of which have reached the replacement age of three years and lack modern information technology.
The average age of the City's 35 fire stations is 80 years, and maintenance costs often exceed $1,000,000 annually. The fire department's fleet has many mechanical issues, contains no reserve vehicles and lacks equipment ordinarily considered standard. The department's apparatus division now has 26 employees, resulting in a mechanic to vehicle ratio of 1 to 39 and an inability to complete preventative maintenance on schedule.
In February 2013, Detroit Fire Commissioner Donald Austin ordered firefighters not to use hydraulic ladders on ladder trucks except in cases involving an "immediate threat to life" because the ladders had not received safety inspections "for years."
During the first quarter of 2013, frequently only 10 to 14 of the City's 36 ambulances were in service. Some of the City's EMS vehicles have been driven 250,000 to 300,000 miles and break down frequently.
The City closed 210 parks during fiscal year 2009, reducing its total from 317 to 107(66%). It has also announced that 50 of its remaining 107 parks would be closed and that another 38 would be provided with limited maintenance.
The City's information technology infrastructure and software is obsolete and is not integrated between departments, or even within departments. Its information
The City has reduced the number of its employees by about 2,700 since 2011. As of May 31, 2013, it had approximately 9,560 employees.
The City's unionized employees are represented by 47 discrete bargaining units.
The City has implemented revised employment terms, called "City Employment Terms" ("CET"), for nonunionized employees and for unionized employees under expired collective bargaining agreements. It has also increased revenues and reduced expenses in other ways. It estimates that these measures have resulted in annual savings of $200,000,000.
The City cannot legally increase its tax revenues. Nor can it reduce its employee expenses without further endangering public health and safety.
Before reviewing the events leading to the appointment of the City's emergency manager, a brief review of the winding history of the Michigan statutes on point is necessary.
In 1990, the Michigan Legislature enacted Public Act 72 of 1990, the "Local Government Fiscal Responsibility Act." ("P.A. 72") This Act empowered the State to intervene with respect to municipalities facing financial crisis through the appointment of an emergency financial manager who would assume many of the powers ordinarily held by local elected officials.
Effective March 16, 2011, P.A. 72 was repealed and replaced with Public Act 4 of
On November 5, 2012, Michigan voters rejected P.A. 4 by referendum. This rejection revived P.A. 72. See Order, Davis v. Roberts, No. 313297 (Mich.Ct.App. Nov. 16, 2012):
See also Davis v. Weatherspoon, 2013 WL 2076478, at *2 (E.D.Mich. May 15, 2013); Mich. Op. Att'y Gen No. 7267 (Aug. 6, 2012), 2012 WL 3544658.
P.A. 72 remained in effect until March 28, 2013, when the "Local Financial Stability and Choice Act," Public Act 436 of 2012, became effective. ("P.A. 436") That Legislature enacted that law on December 13, 2012, and the governor signed it on December 26, 2012.
The following subsections review the events leading to the appointment of the City's emergency manager.
On December 6, 2011, the Michigan Department of the Treasury began a preliminary review of the City's financial condition pursuant to P.A. 4.
On December 21, 2011, Andy Dillon, the state treasurer, reported to the governor that "probable financial stress" existed in Detroit and recommended the appointment of a "financial review team" pursuant to P.A. 4. Ex. 503 at 3. (Dkt. #11-3) In making this finding, Dillon's report cited:
Under P.A. 4, upon a finding of "probable financial stress," the governor was required to appoint a financial review team to undertake a more extensive financial management review of the City. On December 27, 2011, the governor announced the appointment of a ten member Financial Review Team. The Financial Review Team was then required to report its findings to the governor within 60-90 days.
On March 26, 2012, the Financial Review Team submitted its report to the governor. This report found that "the City of Detroit is in a condition of severe financial stress[.]" Ex. 22. This finding of "severe financial stress" was based upon the following considerations:
In early 2012, the City and the State of Michigan negotiated a 47 page "Financial Stability Agreement," more commonly called the "Consent Agreement." Ex. 23. The Consent Agreement states that its purpose is to achieve financial stability for the City and a stable platform for the
The Consent Agreement created a "Financial Advisory Board" ("FAB") of nine members selected by the governor, the treasurer, the mayor and the city council. The Consent Agreement granted the FAB an oversight role and limited powers over certain City reform and budget activities. The FAB has held, and continues to hold, regular public meetings and to exercise its oversight functions set forth in the Consent Agreement.
On December 11, 2012, the Department of Treasury commenced a preliminary review of the City's financial condition under P.A. 72. On December 14, 2012, Andy Dillon, State Treasurer sent to Rick Snyder, Governor a memorandum entitled "Preliminary Review of the City of Detroit." Ex. 24. This was after the voters had rejected P.A. 4 and P.A. 72 was revived.
Treasurer Dillon reported to the governor that, based on his preliminary review, a "serious financial problem" existed within the City. Ex. 24 at 1. This conclusion was based on many of the same findings as his earlier report of December 21, 2011. Ex. 21. In addition he reported that:
Upon receipt of Treasurer Dillon's report, the governor appointed another Financial Review Team to review the City's financial condition on December 18, 2012. This was also done under P.A. 72.
On February 19, 2013, the Financial Review Team submitted its report to the governor, concluding, "in accordance with [P.A. 72], that a local government financial emergency exists within the City of Detroit because no satisfactory plan exists to resolve a serious financial problem."
On March 1, 2013, after receiving the Financial Review Team Report of February 19, 2013, the governor announced his determination under P.A. 72 that a "financial emergency" existed within the City. Ex. 26. By that point, P.A. 436 had been enacted but it was not yet effective.
On March 12, 2013, the governor conducted a public hearing to consider the city council's appeal of his determination.
On March 14, 2013, the governor confirmed his determination of a "financial emergency" within the City and requested that the Local Emergency Financial Assistance Loan Board ("LEFALB") appoint an emergency financial manager under P.A. 72.
On March 15, 2013, the LEFALB appointed Kevyn Orr as the emergency financial manager for the City of Detroit. Second Amended Final Pre-Trial Order, ¶ 42 at 11. (Dkt. #1647)
On March 25, 2013, Mr. Orr formally took office. Second Amended Final Pre-Trial Order, ¶ 43 at 11. (Dkt. #1647)
On March 28, 2013, the effective date of P.A. 436, P.A. 72 was repealed, and Mr. Orr became the emergency manager of the City under §§ 2(e) and 31 of P.A. 436. M.C.L. §§ 141.1542(e) and 141.1571.
The emergency manager acts "for and in the place and stead of the governing body and the office of chief administrative officer of the local government." M.C.L. § 141.1549(2). He has "broad powers in receivership to rectify the financial emergency and to assure the fiscal accountability of the local government and the local government's capacity to provide or cause to be provided necessary governmental services essential to the public health,
On June 14, 2013, Mr. Orr organized a meeting with approximately 150 representatives of the City's creditors, including representatives of: (a) the City's debt holders; (b) the insurers of this debt; (c) the City's unions; (d) certain retiree associations; (e) the Pension Systems; and (f) many individual bondholders. At the meeting, Mr. Orr presented the June 14 Creditor Proposal, Ex. 43, and answered questions. At the conclusion of the meeting, Mr. Orr invited creditor representatives to meet and engage in a dialogue with City representatives regarding the proposal.
This proposal described the economic circumstances that resulted in Detroit's financial condition. It also offered a thorough overhaul and restructuring of the City's operations, finances and capital structure, as well as proposed recoveries for each creditor group. More specifically, the June 14, 2013 Creditor Proposal set forth:
Regarding creditor recoveries, the City proposed:
At this meeting, Mr. Orr also announced his decision not to make the scheduled $39,700,000 payments due on the COPs and swaps transactions and to impose a moratorium on principal and interest payments related to unsecured debt.
Following the June 14, 2013 meeting at which the proposal to creditors was presented. Mr. Orr and his staff had several other meetings.
On June 20, 2013, Mr. Orr's advisors met with representatives of the City's unions and four retiree associations. In the morning they met with representatives of "non-uniformed" employees and retirees. In the afternoon they met with "uniformed" employees and retirees. In these meetings, his advisors discussed retiree health and pension obligations. Approximately 100 union and retiree representatives attended the two-hour morning session. It included time for questions and answers. Approximately 35 union and retiree representatives attended the afternoon session, which lasted approximately 90 minutes.
On June 25, 2013, Mr. Orr's advisors and his senior advisor staff members held meetings in New York for representatives and advisors with all six of the insurers of the City's funded bond debt; the pension systems; and U.S. Bank, the trustee or paying agent on all of the City's bond issuances. Approximately 70 individuals attended this meeting. At this five-hour meeting, the City's advisors discussed the 10-year financial projections and cash flows presented in the June 14 Creditor Proposal, together with the assumptions and detail underlying those projections and cash flows; the City's contemplated reinvestment initiatives and related costs; and the retiree benefit and pension information and proposals that had been presented to the City's unions and pension representatives on June 20, 2013.
Also on June 25, 2013, the City's advisors held a separate meeting with U.S. Bank and its advisors to discuss the City's intentions with respect to the DWSD, and the special revenue bond debt related thereto; the City's proposed treatment of its general obligation debt, including the COPs; and various other issues raised by U.S. Bank.
On June 26 and 27, 2013, Mr. Orr's advisors held individual follow-up meetings with each of several bond insurers. On June 26, 2013, the City team met with business people, lawyers and financial advisors from NPFGC in a two-hour meeting and Ambac Assurance Corporation in a 90-minute meeting. Financial Guaranty Insurance Corporation had originally requested a meeting for June 26, 2013 but
On July 10, 2013, the City and certain of its advisors held meetings with representatives and advisors of the GRS, as well as representatives and counsel for certain non-uniformed unions and retiree associations and representatives and advisors of the PFRS, as well as representatives and counsel for certain uniformed unions and retiree associations. Each meeting lasted approximately two hours. The purposes of each meeting were to provide additional information on the City's pension restructuring proposal and to discuss a process for reaching a consensual agreement on pension underfunding issues and the treatment of any related claims.
On July 11, 2013, the City and its advisors held separate follow-up meetings with representatives and advisors for select non-uniform unions and retiree associations, the GRS, certain uniformed unions and retiree associations, and the PFRS to discuss retiree health issues.
On July 3, 2013, two lawsuits were filed against the governor and the treasurer in the Ingham County Circuit Court. These suits sought a declaratory judgment that P.A. 436 violated the Michigan Constitution to the extent that it purported to authorize chapter 9 proceedings in which vested pension benefits might be impaired. They also sought an injunction preventing the defendants from authorizing any chapter 9 proceeding for the City in which vested pension benefits might be impaired. Flowers v. Snyder, No. 13-729-CZ July 3, 2013; Webster v. Snyder, No. 13-734-CZ July 3, 2013.
On July 17, 2013, the Pension Systems commenced a similar lawsuit. General Retirement System of the City of Detroit v. Orr, No. 13-768-CZ July 17, 2013.
On July 16, 2013, Mr. Orr recommended to the governor and the treasurer in writing that the City file for chapter 9 relief. Ex. 28. (Dkt. #11-10) An emergency manager may recommend a chapter 9 filing if, in his judgment, "no reasonable alternative to rectifying the financial emergency of the local government which is in receivership exists." M.C.L. § 141.1566(1).
On July 18, 2013, Governor Snyder authorized the City of Detroit to file a chapter 9 bankruptcy case. Ex. 29. (Dkt. # 11-11) M.C.L. § 141.1558(1) permits the governor to "place contingencies on a local government in order to proceed under chapter 9." However, the governor's authorization letter stated, "I am choosing not to impose any such contingencies today. Federal law already contains the most important contingency — a requirement that the plan be legally executable, 11 USC 943(b)(4)." Ex. 29. at 4. Accordingly, his authorization did not include a condition prohibiting the City from seeking to impair pensions in a plan.
At 4:06 p.m. on July 18, 2013, the City filed this chapter 9 bankruptcy case.
Before turning to the filed objections, it is necessary to point out that the City bears the burden to establish by a preponderance of the evidence each of the elements of eligibility under 11 U.S.C.
As the Court commented at the conclusion of the hearing on September 19, 2013, the individuals' presentations were moving, passionate, thoughtful, compelling and well-articulated. These presentations demonstrated an extraordinary depth of concern for the City of Detroit, for the inadequate level of services that their city government provides and the personal hardships that creates, and, most clearly, for the pensions of City retirees and employees. These individuals expressed another deeply held concern, and even anger, that became a major theme of the hearing — the concern and anger that the State's appointment of an emergency manager over the City of Detroit violated their fundamental democratic right to self-governance.
The Court's role here is to evaluate how these concerns might impact the City's eligibility for bankruptcy. In making that evaluation, the Court can only consider the specific requirements of applicable law — 11 U.S.C. §§ 109(c) and 921(c). It is not the Court's role to examine this bankruptcy or these objections to this bankruptcy from any other perspective or on any other basis. For example, neither the popularity of the decision to appoint an emergency manager nor the popularity of the decision to file this bankruptcy case are matters of eligibility under the federal bankruptcy laws.
To the extent that individual objections raised arguments that do raise eligibility concerns, they are addressed through this opinion. It appears to the Court that these individuals' concerns should mostly be addressed in the context of whether the case was filed in good faith, as 11 U.S.C. § 921(c) requires. To a lesser extent, they should also be considered in the context of the specific requirement that the City was "insolvent." 11 U.S.C. § 109(c)(3). Accordingly, the Court will address these concerns in those Parts of this opinion. See Part XIII (insolvency) and Part XVII (good faith), below.
With its petition, the City filed a "Memorandum in Support of Statement of Qualifications Pursuant to Section 109(c) of the Bankruptcy Code," asserting that the City is a "municipality" as defined in 11 U.S.C. § 101(40) and as required by 11 U.S.C. § 109(c)(1). (Dkt. # 14 at 8-9) In the "Second Amended Final Pre-Trial Order," the parties so stipulated. (Dkt. # 1647 at 11) Accordingly, the Court finds that the City has established this element of eligibility and will not discuss it further.
Several objecting parties challenge the constitutionality of chapter 9 of the bankruptcy code under the United States Constitution. Citing the Supreme Court's decision in Stern v. Marshall, ___ U.S. ___, 131 S.Ct. 2594, 180 L.Ed.2d 475 (2011), these parties also assert that this Court does not have the authority to determine the constitutionality of chapter 9.
The Official Committee of Retirees filed a motion to withdraw the reference on the grounds that this Court does not have the authority to determine the constitutionality of chapter 9 or P.A. 436. It also filed a motion for stay of the eligibility proceedings pending the district court's resolution of that motion. In this Court's denial of the stay motion, it concluded that the Committee was unlikely to succeed on its arguments regarding this Court's lack of authority under Stern. In re City of Detroit, Mich., 498 B.R. 776, 781-87 (Bankr. E.D.Mich.2013). The following discussion is taken from that decision.
In Stern v. Marshall, the Supreme Court held that the "judicial power of the United States" can only be exercised by an Article III court and "that in general, Congress may not withdraw from judicial cognizance any matter which, from its nature, is the subject of a suit at the common law, or in equity, or admiralty." 131 S.Ct. at 2608-12. The Supreme Court held that a bankruptcy court therefore lacks the constitutional authority to enter a final judgment on a debtor's counterclaim that is based on a private right when resolution of the counterclaim is not necessary to fix the creditor's claim. 131 S.Ct. at 2611-19. The Court described the issue before it as "narrow."
The Sixth Circuit has adhered to a narrow reading of Stern in the two cases that have addressed the issue: Onkyo Europe Elect. GMBH v. Global Technovations Inc. (In re Global Technovations Inc.), 694 F.3d 705 (6th Cir.2012), and Waldman v. Stone, 698 F.3d 910 (6th Cir.2012).
In Global Technovations, the Sixth Circuit summarized Stern as follows:
694 F.3d at 722. Based on this view of Stern, the Global Technovations court held that the bankruptcy court did have the authority to rule on the debtor's fraudulent transfer counterclaim against a creditor that had filed a proof of claim. Id.
In Waldman, the Sixth Circuit summarized the holding of Stern as follows:
698 F.3d at 919. Based on this view of Stern, the Waldman court held that the bankruptcy court lacked authority to enter a final judgment on the debtor's prepetition fraud claim against a creditor that was not necessary to resolve in adjudicating the creditor's claim against the debtor.
These cases recognize the crucial difference to which Stern adhered. A bankruptcy court may determine matters that arise directly under the bankruptcy code, such as fixing a creditor's claim in the claims allowance process. However, a bankruptcy court may not determine more tangential matters, such as a state law claim for relief asserted by a debtor or the estate that arises outside of the bankruptcy process, unless it is necessary to resolve that claim as part of the claims allowance process. See City of Cent. Falls, R.I. v. Central Falls Teachers' Union (In re City of Cent. Falls), R.I., 468 B.R. 36, 52 (Bankr.D.R.I.2012) ("[A]lthough the counterclaim at issue in Stern arose under state law, the determinative feature of that counterclaim was that it did not arise under the Bankruptcy Code.").
The issue presently before the Court is the debtor's eligibility to file this chapter 9 case. A debtor's eligibility to file bankruptcy stems directly from rights established by the bankruptcy code. As quoted above, Waldman expressly held, "When a debtor pleads an action under federal bankruptcy law," the bankruptcy court's authority is constitutional. 698 F.3d at 919. In this case, the debtor has done precisely that. In seeking relief under chapter 9, it has pled "an action under federal bankruptcy law."
The parties' federal and state constitutional challenges are simply legal arguments in support of their objection to the City's request for bankruptcy relief. Nothing in Stern, Waldman, or Global Technovations suggests any limitation on the authority of a bankruptcy court to consider and decide any and all of the legal arguments that the parties present concerning an issue that is otherwise properly before it.
More specifically, those cases explicitly state that a bankruptcy court can constitutionally determine all of the issues that are raised in the context of resolving an objection to a proof of claim, even those involving state law.
No cases address Stern in the context of eligibility for bankruptcy. Nevertheless, several cases do address Stern in the context of similar contested matters — conversion and dismissal of a case. Each case readily concludes that Stern's limitation on the authority of a bankruptcy court is inapplicable. For example, in In re USA Baby, Inc., 674 F.3d 882, 884 (7th Cir. 2012), the Seventh Circuit held that nothing in Stern precludes a bankruptcy court from converting a chapter 11 case to chapter 7, stating, "we cannot fathom what bearing that principle might have on the present case."
Implicitly recognizing how far its objection to this Court's authority stretches Stern, the objectors argue that two aspects of their objection alter the analysis of Stern and its application here. The first is that their objections raise important issues under both the United States Constitution and the Michigan Constitution. The second is that strong federalism considerations warrant resolution of its objection by an Article III court. Neither consideration, however, is sufficient to justify the expansion of Stern that the objectors argue.
First, since Stern was decided, non-Article III courts have considered constitutional issues, always without objection.
Both bankruptcy courts and bankruptcy appellate panels have done so.
In addition, the Tax Court, a non-Article III court, has also examined constitutional issues, without objection.
Stern does not change this status quo, and nothing about the constitutional dimension of the objectors' eligibility objections warrants the expansion of Stern that they assert. As Stern itself reaffirmed, "We do not think the removal of counterclaims such as [the debtor's] from core bankruptcy jurisdiction meaningfully changes the division of labor in the current statute[.]" 131 S.Ct. at 2620. Expanding Stern to the point where it would prohibit bankruptcy courts from considering issues of state or federal constitutional law would certainly significantly change the division of labor between the bankruptcy courts and the district courts.
The objectors' federalism argument is even more perplexing and troubling. Certainly the objectors are correct that a ruling on whether the City was properly authorized to file this bankruptcy case, as required for eligibility under 11 U.S.C. § 109(c)(2), will require the interpretation of state law, including the Michigan Constitution.
However, ruling on state law issues is required in addressing many issues in bankruptcy cases. As the Supreme Court has observed, "[B]ankruptcy courts [] consult state law in determining the validity of most claims." Travelers Cas. & Sur. Co. of Am. v. Pacific Gas & Elec. Co., 549 U.S. 443, 444, 127 S.Ct. 1199, 1201, 167 L.Ed.2d
The distinction is clear. While in some narrow circumstances Stern prohibits a non-Article III court from adjudicating a state law claim for relief, a non-Article III court may consider and apply state law as necessary to resolve claims over which it does have authority under Stern. The mere fact that state law must be applied does not by itself mean that Stern prohibits a non-Article III court from determining the matter.
Moreover, nothing about a chapter 9 case suggests a different result. In City of Cent. Falls, R.I., 468 B.R. at 52, the court stated, "Nor did [Stern] address concerns of federalism; although the counterclaim at issue in Stern arose under state law, the determinative feature of that counterclaim was that it did not arise under the Bankruptcy Code. The operative dichotomy was not federal versus state, but bankruptcy versus nonbankruptcy."
The troubling aspect of the objectors' federalism argument is that it does not attempt to define, even vaguely, what interest of federalism is at stake here.
In Arizona v. United States, ___ U.S. ___, 132 S.Ct. 2492, 2500, 183 L.Ed.2d 351 (2012), the Supreme Court stated, "Federalism, central to the constitutional design, adopts the principle that both the National and State Governments have elements of sovereignty the other is bound to respect." Accordingly, federalism is about the federal and state governments respecting each other's sovereignty. It has nothing to do with the requirements of Article III or, to use the phraseology of Stern with the "division of labor" between the district courts and the bankruptcy courts.
For these reasons, the Court concludes that it does have the authority to determine the constitutionality of chapter 9 under the United States Constitution and the constitutionality of P.A. 436 under the Michigan Constitution.
The objecting parties argue that chapter 9 of the bankruptcy code violates several provisions of the United States Constitution, both on its face and as applied in this case. The Court will first address the arguments that chapter 9 is facially unconstitutional under the Bankruptcy Clause of Article I, Section 8, and the Contracts Clause of Article I, Section 10 of the United States Constitution. The Court will then address the argument that chapter 9, on its face and as applied, violates the Tenth Amendment to the United States Constitution and the principles of federalism embodied therein.
Article I, Section 8 of the United States Constitution provides: "The Congress shall have Power To ... establish... uniform Laws on the subject of Bankruptcies throughout the United States."
The objecting parties, principally AFSCME, assert chapter 9 violates the uniformity requirement of the United States Constitution because chapter 9 "ced[es] to each state the ability to define its own qualifications for a municipality to declare bankruptcy, chapter 9 permits the promulgation of non-uniform bankruptcies within states." AFSCME's Corrected Objection to Eligibility, ¶ 58 at 25 (citing M.C.L. § 141.1558). (Dkt. #505) AFSCME argues that this is particularly so in Michigan, where P.A. 436 allows the governor to exercise discretion when determining whether to authorize a municipality to seek chapter 9 relief, and also allows the governor to "attach whichever contingencies he wishes." Id.
The Supreme Court has addressed the uniformity requirement in several cases. In Hanover Nat'l Bank v. Moyses, 186 U.S. 181, 22 S.Ct. 857, 46 L.Ed. 1113 (1902), the Court held that the incorporation into the bankruptcy law of state laws relating to exemptions did not violate the uniformity requirement of the United States Constitution. The Court stated, "The general operation of the law is uniform although it may result in certain particulars differently in different states." Id. at 190, 22 S.Ct. 857.
In Stellwagen v. Clum, 245 U.S. 605, 38 S.Ct. 215, 62 L.Ed. 507 (1918), the Court upheld the Bankruptcy Act's incorporation of varying state fraudulent conveyance statutes, despite the fact that the laws "may lead to different results in different states." Id. at 613, 38 S.Ct. 215.
In Blanchette v. Connecticut General Ins. Corps., 419 U.S. 102, 159, 95 S.Ct. 335, 42 L.Ed.2d 320 (1974), the Court held, "The uniformity provision does not deny Congress power to take into account differences that exist between different parts of the country, and to fashion legislation to resolve geographically isolated problems."
The Supreme Court has struck down a bankruptcy statute as non-uniform only once. In Railway Labor Executives' Ass'n v. Gibbons, 455 U.S. 457, 102 S.Ct. 1169, 71 L.Ed.2d 335 (1982), the Court struck down a private bankruptcy law that affected only the employees of a single company. The Court concluded, "The uniformity requirement, however, prohibits Congress from enacting a bankruptcy law that, by definition, applies only to one regional debtor. To survive scrutiny under the Bankruptcy Clause, a law must at least apply uniformly to a defined class of debtors." Id. at 473, 102 S.Ct. 1169.
In Richardson v. Schafer (In re Schafer), 689 F.3d 601 (6th Cir.2012), the court stated, "the Bankruptcy Clause shall act as `no limitation upon congress as to the classification of persons who are to be affected by such laws, provided only the laws shall have uniform operation throughout the United States.'" Id. at 611 (quoting Leidigh Carriage Co. v. Stengel, 95 F. 637, 646 (6th Cir.1899)). It added, "Schultz clarified that it is not the outcome that determines the uniformity, but the uniform process by which creditors and debtors in a certain place are treated." Id.
Chapter 9 does exactly what these cases require to meet the uniformity requirement of the Bankruptcy Clause of the United States Constitution. The "defined class of debtors" to which chapter 9 applies is the class of entities that meet the eligibility requirements of 11 U.S.C. § 109(c). One such qualification is that the entity is "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[.]" § 109(c)(2). As Moyses and Stellwagen specifically held, it is of no consequence in the uniformity analysis that this requirement of state authorization to file a chapter 9 case may lead to different results in different states.
It appears that AFSCME objects to the lack of uniformity that may arise from the differing circumstances of municipalities that the governor might authorize to file a chapter 9 petition. That it not the test. Rather, the test is whether chapter 9 applies uniformly to all chapter 9 debtors. It does.
Accordingly, the Court concludes that chapter 9 satisfies the uniformity requirement of the Bankruptcy Clause of the United States Constitution.
The Contracts Clause of the United States Constitution, which is Article I, Section 10, provides, "No State shall ... pass any ... Law impairing the Obligation of Contracts, ..." AFSCME argues that chapter 9 violates the Contracts Clause. This argument is frivolous. Chapter 9 is a federal law. Article I, Section 10 does not prohibit Congress from enacting a "Law impairing the Obligation of Contracts." Id.
As the court stated in In re Sanitary & Imp. Dist., No. 7, 98 B.R. 970 (Bankr. D.Neb.1989):
Id. at 973.
Or, more succinctly stated, "The Bankruptcy Clause necessarily authorizes Congress to make laws that would impair contracts. It long has been understood that bankruptcy law entails impairment of contracts." Stockton, 478 B.R. at 15 (citing Sturges v. Crowninshield, 17 U.S. 122, 191, 4 Wheat. 122, 4 L.Ed. 529 (1819)).
The Tenth Amendment provides, "The powers not delegated to the United States by the Constitution, nor prohibited by it to the States, are reserved to the States respectively, or to the people."
This Amendment reflects the concept that the United States Constitution "created a Federal Government of limited powers." Gregory v. Ashcroft, 501 U.S. 452, 457, 111 S.Ct. 2395, 115 L.Ed.2d 410 (1991); see also United States v. Darby, 312 U.S. 100, 124, 61 S.Ct. 451, 85 L.Ed. 609 (1941) (The Tenth Amendment "states but a truism that all is retained which has not been surrendered.").
The Supreme Court's "consistent understanding" of the Tenth Amendment has been that "[t]he States unquestionably do retain a significant measure of sovereign authority ... to the extent that the Constitution has not divested them of their original powers and transferred those powers to the Federal Government." New York v. United States, 505 U.S. 144, 156, 112 S.Ct. 2408, 120 L.Ed.2d 120 (1992) (quoting Garcia v. San Antonio Metropolitan Transit Authority, 469 U.S. 528, 549, 105 S.Ct. 1005, 83 L.Ed.2d 1016 (1985)) (quotation marks omitted); see also South Carolina v. Baker, 485 U.S. 505, 511 n. 5, 108 S.Ct. 1355, 99 L.Ed.2d 592 (1988) ("We use `the Tenth Amendment' to encompass any implied constitutional limitation on Congress' authority to regulate state activities, whether grounded in the Tenth Amendment itself or in principles of federalism derived generally from the Constitution."); United States v. Sprague, 282 U.S. 716, 733, 51 S.Ct. 220, 75 L.Ed. 640 (1931) ("The Tenth Amendment was intended to confirm the understanding of the people at the time the Constitution was adopted, that powers not granted to the United States were reserved to the states or to the people.").
The objecting parties argue that chapter 9 violates these principles of federalism because, in the words of AFSCME, it "allows Congress to set the rules controlling State fiscal self-management — an area of exclusive state sovereignty." AFSCME's Corrected Objection to Eligibility, ¶ 40 at 15-16. (Dkt. # 505) The Court interprets this argument as a facial challenge to the constitutionality of chapter 9. The as-applied challenge, as stated by the Retiree Committee and other objecting parties, is that if the State of Michigan can properly authorize the City of Detroit to file for chapter 9 relief without the explicit protection of accrued pension rights for individual retired city employees, then chapter 9 "must be found to be unconstitutional as permitting acts in derogation of Michigan's sovereignty." Retiree Committee Objection to Eligibility, ¶ 3 at 1-2. (Dkt. # 805)
Before addressing the merits of these arguments, however, the Court must first address two preliminary issues that the United States raised in its "Memorandum in Support of Constitutionality of Chapter 9 of Title 11 of the United States Code" — standing and ripeness. (Dkt. # 1149)
The United States argues that the creditors who assert that chapter 9 violates the
"As a rule, a party must have a `personal stake in the outcome of the controversy' to satisfy Article III." Stevenson v. J.C. Bradford & Co. (In re Cannon), 277 F.3d 838, 852 (6th Cir.2002) (citing Warth v. Seldin, 422 U.S. 490, 498, 95 S.Ct. 2197, 45 L.Ed.2d 343 (1975), quoting Baker v. Carr, 369 U.S. 186, 204, 82 S.Ct. 691, 703, 7 L.Ed.2d 663 (1962)).
In a bankruptcy case, the standing of a party requesting to be heard turns on whether the party is a "party in interest." See In re Global Indus. Techs., Inc., 645 F.3d 201, 210 (3rd Cir.2011). A party in interest is one who "has a sufficient stake in the proceeding so as to require representation." In re Amatex Corp., 755 F.2d 1034, 1042 (3d Cir.1985).
11 U.S.C. § 1109(b), provides, "A party in interest, including ... a creditor ... may raise and may appear and be heard on any issue in a case under this chapter." 11 U.S.C. § 901(a) makes this provision applicable in a chapter 9 case.
In the chapter 9 case of In re Barnwell County Hosp., 459 B.R. 903, 906 (Bankr. D.S.C.2011), the court stated, "`Party in interest' is a term of art in bankruptcy. Although not defined in the Bankruptcy Code, it reflects the unique nature of a bankruptcy case, where the global financial circumstances of a debtor are resolved with respect to all of debtor's creditors and other affected parties."
In a chapter 9 case on point, In re Suffolk Regional Off-Track Betting Corp., 462 B.R. 397, 403 (Bankr.E.D.N.Y.2011), the court held that a party to an executory contract with a municipal debtor has standing to object to the debtor's eligibility.
Similarly, in In re Wolf Creek Valley Metro. Dist. No. IV, 138 B.R. 610 (D.Colo. 1992), also a chapter 9 case, the court stated, "[M]any courts have concluded that the party requesting standing must either be a creditor of a debtor ... or be able to assert an equitable claim against the estate." Id. at 616 (citation and quotation marks omitted). See also In re Addison Community Hospital Authority, 175 B.R. 646 (Bankr.E.D.Mich.1994) (holding that creditors are parties in interest and have standing to be heard).
Under 11 U.S.C. § 1109(b) and these cases, it is abundantly clear that the objecting parties, who are creditors with pension claims against the City, have standing to assert their constitutional claim as part of their challenge to this bankruptcy case.
Nevertheless, the United States asserts that Lujan v. Defenders of Wildlife, 504 U.S. 555, 112 S.Ct. 2130, 119 L.Ed.2d 351 (1992), precludes standing here. In that case, the Supreme Court adopted this test to determine whether a party has standing under Article III of the constitution:
Id. at 560-61, 112 S.Ct. 2130 (internal citations omitted). The United States asserts that the objecting parties do not meet this standard because their injury is not "imminent" at this stage of the proceedings.
The Court concludes that the contours of standing under 11 U.S.C. § 1109(b) are entirely consistent with the constitutional test for standing that the Supreme Court adopted in Lujan. A creditor has a direct, personal stake in the outcome of a bankruptcy case and thus has standing to challenge the bankruptcy filing. Accordingly, the Court concludes that every creditor of the City of Detroit has standing to object to its eligibility to be a debtor under chapter 9.
The United States argues that the issue of whether chapter 9 is constitutional as applied in this case is not ripe for determination at this time. The City joins in this argument. City's Reply to Retiree Committee's Objection to Eligibility at 3-5. (Dkt. # 918)
The premise of the argument is that the filing of the case did not result in the impairment of any pension claims. Thus the United States argues that this issue will be ripe only when the City proposes a plan that would impair pensions if confirmed. Until then, it argues, their injury is speculative.
In Miles Christi Religious Order v. Township of Northville, 629 F.3d 533 (6th Cir.2010), the Sixth Circuit summarized the case law on the ripeness doctrine:
Id. at 537.
Although the argument of the United States has some appeal,
The Court further concludes that as a matter of judicial prudence, resolving this issue now will likely expedite the resolution of this bankruptcy case. The Court notes that the parties have fully briefed and argued the merits. Further, if the Tenth Amendment challenge to chapter 9 is resolved now, the parties and the Court can then focus on whether the City's plan (to be filed shortly, it states) meets the confirmation requirements of the bankruptcy code.
Accordingly, the Court concludes that the objecting parties' challenge to chapter 9 of the bankruptcy code as applied in this case is ripe for determination at this time.
The question of whether a federal municipal bankruptcy act can be administered consistent with the principles of federalism reflected in the Tenth Amendment has already been decided. In United States v. Bekins, 304 U.S. 27, 58 S.Ct. 811, 82 L.Ed. 1137 (1938), the United States Supreme Court specifically upheld the Municipal Corporation Bankruptcy Act, 50 Stat. 653 (1937), over objections that the statute violated the Tenth Amendment. Bekins, 304 U.S. at 53-54, 58 S.Ct. 811.
In upholding the 1937 Act, the Bekins court found:
Bekins, 304 U.S. at 51-2, 58 S.Ct. 811.
The Court further noted that two years earlier, it had struck down a previous version of the federal municipal bankruptcy law for violating the Tenth Amendment. Ashton v. Cameron County Water Improvement Dist. No. 1, 298 U.S. 513, 56 S.Ct. 892, 80 L.Ed. 1309 (1936).
Id. at 51, 58 S.Ct. 811 (quotation marks omitted).
Bekins thus squarely rejects the challenges that the objecting parties assert to chapter 9 in this case and it has not been overruled.
Nevertheless, the objecting parties assert that subsequent amendments to the municipal bankruptcy statute and subsequent Supreme Court decisions regarding the Tenth Amendment compel the conclusion that Bekins is no longer good law, or at least that it is inapplicable in this case. Specifically, in its objection, AFSCME argues that since Bekins was decided, "intervening Supreme Court precedent holds that states can fashion their own municipal reorganization statutes, but cannot consent to any derogation of their sovereign powers." AFSCME's Corrected Objection to Eligibility, ¶ 44 at 17. (Dkt. #505) Although the Court concludes that Bekins remains good law and is controlling here, the Court will address these arguments.
The only relevant change to municipal bankruptcy law that AFSCME identifies is the addition of § 903 to the bankruptcy code, the substance of which was added in 1946 as § 83(i) of the 1937 Act. That section provided, "[N]o State law prescribing a method of composition of indebtedness of such agencies shall be binding upon any creditor who does not consent to such composition, and no judgment shall be entered under such State law which would bind a creditor to such composition without his consent."
In slightly different form, § 903 of the bankruptcy code now provides:
11 U.S.C. § 903.
AFSCME argues that this provision created a new exclusivity in chapter 9 that forces the states to adopt the federal scheme for adjusting municipal debts. This exclusivity, the argument goes, deprives the states of the ability to enact state legislation providing for municipal debt adjustment, which is inconsistent with the principles of federalism set forth in New York v. United States, 505 U.S. 144, 112 S.Ct. 2408, 120 L.Ed.2d 120 (1992), and Printz v. United States, 521 U.S. 898, 117 S.Ct. 2365, 138 L.Ed.2d 914 (1997).
This argument fails on two levels. First, other than in one limited instance, Faitoute Iron & Steel Co. v. City of Asbury Park, N.J., 316 U.S. 502, 62 S.Ct. 1129, 86 L.Ed. 1629 (1942), courts have always interpreted the Contracts Clause of the United States Constitution to prohibit the states from enacting legislation providing for municipal bankruptcies. The 1946
Second, neither New York nor Printz undermine Bekins. As developed above, at its core, Bekins rests on state consent. As will be developed below, like Bekins, both New York and Printz are also built on the concept of state consent. Indeed, it was the lack of state consent to the federal programs in those cases that caused the Supreme Court to find them unconstitutional.
The Contracts Clause of the United States Constitution, Article I, Section 10, states, "No State shall ... pass any ... Law impairing the Obligation of Contracts[.]"
Applying this clause, the Supreme Court has stated, "When a State itself enters into a contract, it cannot simply walk away from its financial obligations." Energy Reserves Grp., Inc. v. Kansas Power & Light Co., 459 U.S. 400, 412 n. 14, 103 S.Ct. 697, 74 L.Ed.2d 569 (1983). "It long has been established that the Contracts Clause limits the power of the States to modify their own contracts as well as to regulate those between private parties." U.S. Trust Co. of New York v. New Jersey, 431 U.S. 1, 17, 97 S.Ct. 1505, 52 L.Ed.2d 92 (1977) (citing Dartmough College v. Woodward, 17 U.S. 518, 4 Wheat. 518, 4 L.Ed. 629 (1819); Fletcher v. Peck, 10 U.S. 87, 6 Cranch 87, 3 L.Ed. 162 (1810)). Section 903 simply restates this principle.
Moreover, contrary to AFSCME's assertion, it is clear that Bekins fully considered this issue. It found, "The natural and reasonable remedy through [bankruptcy] was not available under state law by reason of the restriction imposed by the Federal Constitution upon the impairment of contracts by state legislation." Bekins, 304 U.S. at 54, 58 S.Ct. 811.
As noted above, only one case, Asbury Park, is to the contrary. The Court concludes, however, that this case represents a very narrow departure from these principles and its holding is limited to the unique facts of that case. Indeed, the Court itself stated, "We do not go beyond the case before us." 316 U.S. at 516, 62 S.Ct. 1129.
The adjustment plan at issue in Asbury Park was "authorized" by the New Jersey state court on July 21, 1937. This was after the federal municipal bankruptcy law was struck down in Ashton and before the enactment of the municipal bankruptcy act that Bekins approved. Moreover, in Asbury Park, the bonds affected by the plan of adjustment, which the Court found were worthless prior to the adjustment, were reissued without a reduction in the principal obligation and became significantly more valuable as a result of the adjustment. Asbury Park, 316 U.S. at 507-08, 512-13, 62 S.Ct. 1129.
The limited application of Asbury Park to its own facts has been repeatedly recognized. The cases now firmly establish that the Contracts Clause of the United States Constitution bars a state from enacting municipal bankruptcy legislation. In U.S. Trust Co. of New York v. New Jersey, 431 U.S. 1, 27, 97 S.Ct. 1505, 52 L.Ed.2d 92 (1977), the Supreme Court observed, "The only time in this century that alteration of a municipal bond contract has been sustained by this Court was in [Asbury Park]."
Accordingly, the Court concludes that the addition of § 903 to our municipal bankruptcy law does not undermine the continuing validity of Bekins.
In New York v. United States, 505 U.S. 144, 112 S.Ct. 2408, 120 L.Ed.2d 120 (1992), the Supreme Court considered a Tenth Amendment objection to the Low-Level Radioactive Waste Policy Amendments Act of 1985, 42 U.S.C. § 2021b, et seq. Congress enacted that law to address the problem of identifying storage sites for low-level radioactive waste. 505 U.S. at 152-54, 112 S.Ct. 2408. The Act provided three different incentives for each state to take responsibility over the nuclear waste generated within its borders. Id.
The first was a monetary incentive to share in the proceeds of a surcharge on radioactive waste received from other states, based on a series of milestones. 505 U.S. at 171, 112 S.Ct. 2408. The Court found this program constitutional because it was, in fact, nothing more than an incentive to the state to regulate. Congress had "placed conditions — the achievement of the milestones — on the receipt of federal funds." Id. at 171, 112 S.Ct. 2408. The states could choose to achieve these milestones, and receive the federal funds, or not. Id. at 173, 112 S.Ct. 2408. "[T]he location of such choice in the States is an inherent element in any conditional exercise of Congress' spending power." Id.
The Court then stated, "In the second set of incentives, Congress has authorized States and regional compacts with disposal sites gradually to increase the cost of access to the sites, and then to deny access altogether, to radioactive waste generated in States that do not meet federal deadlines." Id. The Court held that this provision was also constitutional, again because the states retained the choice to participate in the federal program or not.
The Court explained, "Where federal regulation of private activity is within the scope of the Commerce Clause, we have recognized the ability of Congress to offer States the choice of regulating that activity according to federal standards or having state law pre-empted by federal regulation." Id. at 173-74, 112 S.Ct. 2408 (emphasis added). "[T]he choice remains at all times with the residents of the State,
These two provisions of the Act passed constitutional muster precisely because states could consent to participation in the federal program or withhold their consent as they saw fit. The Court held that these two programs:
Id. at 185, 112 S.Ct. 2408.
In contrast, the third of these provisions — the "take title" provision" — forced the states to choose between either regulating the disposal of radioactive waste according to Congress's standards or "taking title" to that waste, thereby assuming all the liabilities of its producers. Id. at 174-75, 112 S.Ct. 2408. The Court held that this provision violated the Tenth Amendment, because it offered the states no choice but to do the bidding of the federal government. This provision, the Court determined, did not ask for state "consent" but instead "commandeered" the states.
The Court's precedent is clear that the federal government may not require the states to regulate according to federal terms. "[T]he Constitution has never been understood to confer upon Congress the ability to require the States to govern according to Congress' instructions." Id. at 162, 112 S.Ct. 2408. "Congress may not simply `commandee[r] the legislative processes of the States by directly compelling them to enact and enforce a federal regulatory program.'" Id. at 161, 112 S.Ct. 2408 (quoting Hodel v. Virginia Surface Mining & Reclamation Assn., Inc., 452 U.S. 264, 288, 101 S.Ct. 2352, 69 L.Ed.2d 1 (1981)).
The "take title" provision did just that. Although guised as a "so-called incentive" scheme, the Court found that the "take title" provisions offered the states no real choice at all.
Id. at 176, 112 S.Ct. 2408. The "take title" provisions did not give the states what the Court deemed the constitutionally "critical alternative[.]" Id. at 176, 112 S.Ct. 2408. "A State may not decline to administer the federal program. No matter which path the State chooses, it must follow the direction of Congress." Id. at 177, 112 S.Ct. 2408.
The cornerstone of New York v. United States, then, is state consent. The federal government may constitutionally encourage, incentivize, or even entice, states to do the federal government's bidding. It may not command them to do so.
The Supreme Court reiterated these principles in Printz v. United States, 521 U.S. 898, 117 S.Ct. 2365, 138 L.Ed.2d 914 (1997), and extended them to Congressional efforts to compel state officers to act.
The Court concluded that while state and local governments remained free to voluntarily participate in the background check program, the "mandatory obligation imposed on [law enforcement officers] to perform background checks on prospective handgun purchasers plainly runs afoul [of the Constitution]." Id. at 933, 117 S.Ct. 2365. Again, the stumbling block was a lack of state consent:
521 U.S. at 935, 117 S.Ct. 2365.
Printz acknowledged that states could volunteer to carry out federal law. Id. at 910-11, 916-17, 117 S.Ct. 2365 (describing the history of state officers carrying out federal law as involving "voluntary" action on the part of the states). Concurring, Justice O'Connor added, "Our holding, of course, does not spell the end of the objectives of the Brady Act. States and chief law enforcement officers may voluntarily continue to participate in the federal program." Id. at 936, 117 S.Ct. 2365.
By the same token, New York acknowledged that states can and do enter into voluntary contracts with the federal government whereby states agree to legislate according to federal terms in exchange for some federal benefit or forbearance. New York, 505 U.S. at 166-67, 112 S.Ct. 2408.
What makes those federal programs constitutionally permissible, and the commandeering at issue in New York and Printz impermissible, is consent, and nothing more. If the state is acting voluntarily, it is free to engage with the federal government across a broad range of subject areas. The Tenth Amendment to the United States Constitution is violated only when the state does not consent.
Chapter 9 simply does not implicate the concerns of New York and Printz. As Bekins emphasized, chapter 9 "is limited to voluntary proceedings for the composition of debts." Bekins, 304 U.S. at 47, 58 S.Ct. 811 (emphasis added). The Bekins Court explained:
Id., 304 U.S. at 54, 58 S.Ct. 811.
The federal government cannot and does not compel states to authorize municipalities to file for chapter 9 relief, and municipalities are not permitted to seek chapter 9 relief without specific state authorization. 11 U.S.C. § 109(c)(2). There is simply no "commandeering" involved. New York, 505 U.S. at 161, 112 S.Ct. 2408. Chapter 9 does not compel a state to enact a specific regulatory program, as in New York. Nor does chapter 9 press state officers into federal service, as in Printz. Instead, as Bekins held, valid state authorization is required for a municipality to proceed in chapter 9.
Moreover, during the pendency of the chapter 9 case, § 904 of the bankruptcy code mandates that the bankruptcy court "may not ... interfere with (1) any of the political or governmental powers of the debtor; (2) any of the property or revenues of the debtor; or (3) the debtor's use or employment of any income-producing property." 11 U.S.C. § 904. At the same time, bankruptcy code § 903 mandates, "This chapter does not limit or impair the power of a State to control ... a municipality of or in such State in the exercise of the political or governmental powers of such municipality[.]"
Because the state and local officials must authorize the filing of a chapter 9 petition, 11 U.S.C. § 109(c)(2), and because they retain control over "the political or governmental powers" of the municipality, these state officials remain fully politically accountable to the citizens of the state and municipality. See New York, 505 U.S. at 186, 112 S.Ct. 2408 ("The States thereby retain the ability to set their legislative agendas; state government officials remain accountable to the local electorate.").
To be sure, some language in New York (not repeated in Printz) lends support to the argument that state consent cannot cure a federal law that would otherwise violate the Tenth Amendment. In New York, Justice O'Connor's opinion for the Court explained that federalism does not exist for the benefit of states, as such, but rather is a part of the constitutional structure whose purpose is to benefit individuals. 505 U.S. at 182, 112 S.Ct. 2408. Justice O'Connor continued:
Id.
Some of the parties in this case have seized upon this language to argue that "the Supreme Court has weakened if not rejected Bekins' foundation — that a State's consent can remedy any violation of the Tenth Amendment and principles of federalism as they affect individual citizens." Retiree Committee Objection to Eligibility, ¶ 37 at 19. (Dkt. #805)
The difficulty with this argument is that it proves too much. If this language from New York has the sweeping force that the objecting parties ascribe to it, then a state's consent could never "cure" what would otherwise be a Tenth Amendment violation. The two incentives in New York that were constitutionally sustained would instead have been struck down like the "take title" provision. As the Court emphasized in New York, "even where Congress has the authority under the Constitution
Yet, despite Congress' inability to compel states to regulate according to federal standards, it may unquestionably invite, encourage, or entice the states to do so. New York specifically held that Congress may "encourage a State to regulate in a particular way," or "hold out incentives to the States as a method of influencing a State's policy choices." Id. The key is consent. New York further held, "Our cases have identified a variety of methods, short of outright coercion, by which Congress may urge a State to adopt a legislative program consistent with federal interests." Id. Consent to what would otherwise be an unlawful commandeering of state governments was the very basis for upholding two of the regulatory programs at issue in New York. Id. at 173-74, 112 S.Ct. 2408.
It is not entirely clear, therefore, what Justice O'Connor meant when she wrote that states "cannot consent to the enlargement of the powers of Congress beyond those enumerated in the Constitution." Id. at 182, 112 S.Ct. 2408. In a very real sense, the holding of New York rests on the premise that states can do just that. Congress cannot require the states to legislate with respect to the problem of radioactive waste, but it can unquestionably hold out incentives that induce the states to consent to do so. More broadly put, states can "consent to the enlargement of the powers of Congress beyond those enumerated in the Constitution." Id.
The Court can only conclude that Justice O'Connor meant something else — that a state cannot consent to be compelled. As the Court saw the "choice" in New York, it was a choice between two unconstitutional alternatives — regulating according to federal standards or taking title to all of the low level radioactive waste produced by private parties in the state. Justice O'Connor likely concluded that the latter alternative was so unpalatable that it was really no choice at all. After all, here is where the Court found that "Congress had crossed the line distinguishing encouragement from coercion." Id. at 175, 112 S.Ct. 2408. Understood this way, Justice O'Connor may have been saying nothing more than that one cannot consent to have a gun held to one's head. The idea of "consent" in such a scenario is meaningless.
If this understanding is correct, it would be incumbent upon the objecting parties to identify some way in which federal authority has compelled state action here. They have not.
Whatever the intended meaning of this language, it cannot be that state consent can never "cure" what would otherwise violate the Tenth Amendment. That meaning would sweep aside the holding of New York itself. Nor does this language undo the holding in Bekins, which, as stated before, this Court must apply until the Supreme Court overrules it.
Accordingly, the Court concludes that chapter 9 is not facially unconstitutional under the Tenth Amendment.
Several of the objecting parties also raise "as-applied" challenges to the constitutionality of chapter 9 under the Tenth Amendment to United States Constitution. Although variously cast, the primary thrust of these arguments is that if chapter 9 permits the State of Michigan to authorize a city to file a petition for chapter 9 relief without explicitly providing for
The Court concludes that these arguments must be rejected.
The basis for this result begins with the recognition that the State of Michigan cannot legally provide for the adjustment of the pension debts of the City of Detroit. This is a direct result of the prohibition against the State of Michigan impairing contracts in both the United States Constitution and Michigan Constitution, as well as the prohibition against impairing the contractual obligations relating to accrued pension benefits in the Michigan Constitution.
The federal bankruptcy court, however, is not so constrained. As noted in Part VIII B, above, "The Bankruptcy Clause necessarily authorizes Congress to make laws that would impair contracts. It long has been understood that bankruptcy law entails impairment of contracts." Stockton, 478 B.R. at 15 (citing Sturges v. Crowninshield, 17 U.S. 122, 191, 4 Wheat. 122, 4 L.Ed. 529 (1819)).
The state constitutional provisions prohibiting the impairment of contracts and pensions impose no constraint on the bankruptcy process. The Bankruptcy Clause of the United States Constitution, and the bankruptcy code enacted pursuant thereto, explicitly empower the bankruptcy court to impair contracts and to impair contractual rights relating to accrued vested pension benefits. Impairing contracts is what the bankruptcy process does.
The constitutional foundation for municipal bankruptcy was well-articulated in Stockton:
478 B.R. at 16.
For Tenth Amendment and state sovereignty purposes, nothing distinguishes pension debt in a municipal bankruptcy case from any other debt. If the Tenth Amendment prohibits the impairment of pension benefits in this case, then it would also prohibit the adjustment any other debt in this case. Bekins makes it clear, however, that with state consent, the adjustment of municipal debts does not impermissibly intrude on state sovereignty. Bekins, 304 U.S. at 52, 58 S.Ct. 811. This Court is bound to follow that holding.
The Plans seek escape from this result by asserting that under the Michigan Constitution, pension debt has greater protection than ordinary contract debt.
There are several reasons why the slight difference between the language that protects contracts (no "impairment") and the language that protects pensions (no "impairment" or "diminishment") does not demonstrate that pensions were given any extraordinary protection.
Before reviewing those reasons, however, a brief review of the history of the legal status of pension benefits in Michigan is necessary.
At common law, before the adoption of the Michigan Constitution in 1963, public pensions in Michigan were viewed as gratuitous allowances that could be revoked at will, because a retiree lacked any vested right in their continuation. In Brown v. Highland Park, 320 Mich. 108, 114, 30 N.W.2d 798, 800 (Mich.1948), the Michigan Supreme Court stated:
Similarly, in Kosa v. Treasurer of State of Mich., 408 Mich. 356, 368-69, 292 N.W.2d 452, 459 (1980), the court observed this about the status of pension benefits before the 1963 Constitution was adopted:
Id. (footnote omitted).
In the 1963 Constitution, this provision enhancing the protection for pensions was included: "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." Mich. Const. art. IX, § 24.
In Kosa, 408 Mich. at 370 n. 21, 292 N.W.2d at 459, the Michigan Supreme Court quoted the following history from the constitutional convention regarding article 9, section 24:
Id. (emphasis added).
Kosa also offered an explanation for the origin of the provision. "To gain protection of their pension rights, Michigan teachers effectively lobbied for a constitutional amendment granting contractual status to retirement benefits." 408 Mich. at 360, 292 N.W.2d at 455 (emphasis added).
The Kosa court summarized the provision, again using contract language, as follows:
Id., 408 Mich. at 373, 292 N.W.2d at 461 (emphasis added).
Id., 408 Mich. at 382, 292 N.W.2d at 465 (emphasis added).
More recently, in In re Constitutionality of 2011 Pa. 38, 490 Mich. 295, 806 N.W.2d 683 (2011), the Michigan Supreme Court unequivocally stated, "The obvious intent of § 24, however, was to ensure that public pensions be treated as contractual obligations that, once earned, could not be diminished." Id. at 311, 806 N.W.2d at 693 (emphasis added).
That historical review begins to demonstrate the several reasons why the slight difference in the language that protects contracts and the language that protects pensions does not suggest that pensions were given any extraordinary protection:
Under Meridian Mut. Ins. Co. v. Kellman, 197 F.3d 1178, 1181 (6th Cir.1999), discussed in more detail in Part IX A, below, this Court is bound by these commands of statutory interpretation that the Michigan Supreme Court embraced in Koontz. But if this Court gives these terms — "diminish" and "impair" — their plain and ordinary meanings, as Koontz requires, those meanings would not be substantively different from each other. The terms are not synonyms, but they cannot honestly be given meanings so different as to compel the result that the Plans now seek. "Diminish" adds nothing material to "impair." All "diminishment" is "impairment." And, "impair" includes "diminish."
It was within that framework of rights, expectations, scenarios and possibilities that the newly negotiated, proposed and ratified Michigan Constitution of 1963 explicitly gave accrued pension benefits the status of contractual obligations. That new constitution could have given pensions protection from impairment in bankruptcy in several ways. It could have simply prohibited Michigan municipalities from filing bankruptcy. It could have somehow created a property interest that bankruptcy would be required to respect under Butner v. United States, 440 U.S. 48, 99 S.Ct. 914, 59 L.Ed.2d 136 (1979) (holding that property issues in bankruptcy are determined according to state law). Or, it could have established some sort of a secured interest in the municipality's property. It could even have explicitly required the State to guaranty pension benefits. But it did none of those.
Instead, both the history from the constitutional convention, quoted above, and the language of the pension provision itself, make it clear that the only remedy for
Because under the Michigan Constitution, pension rights are contractual rights, they are subject to impairment in a federal bankruptcy proceeding. Moreover, when, as here, the state consents, that impairment does not violate the Tenth Amendment. Therefore, as applied in this case, chapter 9 is not unconstitutional.
Nevertheless, the Court is compelled to comment. No one should interpret this holding that pension rights are subject to impairment in this bankruptcy case to mean that the Court will necessarily confirm any plan of adjustment that impairs pensions. The Court emphasizes that it will not lightly or casually exercise the power under federal bankruptcy law to impair pensions. Before the Court confirms any plan that the City submits, the Court must find that the plan fully meets the requirements of 11 U.S.C. § 943(b) and the other applicable provisions of the bankruptcy code. Together, these provisions of law demand this Court's judicious legal and equitable consideration of the interests of the City and all of its creditors, as well as the laws of the State of Michigan.
Section 109(c)(2) of the bankruptcy code requires that a municipality be "specifically authorized, in its capacity as a municipality or by name, 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." 11 U.S.C. § 109(c)(2). The evidence establishes that the City was authorized to file this case. The issue is whether that authorization was proper under the Michigan Constitution.
Section 18 of P.A. 436, M.C.L. § 141.1558, establishes the process for authorizing a municipality to file a case under chapter 9 of the bankruptcy code:
M.C.L. § 141.1558(1).
On July 16, 2013, Mr. Orr gave the governor and the treasurer his written recommendation that the City be authorized to file for chapter 9 relief. Ex. 28. On July 18, 2013, the governor approved this recommendation in writing. Ex. 29. Later that day, Mr. Orr issued a written order directing the City to file this chapter 9 case. Ex. 30. Thus the City of Detroit's bankruptcy filing was authorized under state law.
First, several objectors argue that the authorization is not valid because P.A. 436, the statute establishing the underlying procedure for a municipality to obtain authority for filing, is unconstitutional. Broadly stated, these are the challenges to P.A. 436:
The Retired Detroit Police Members Association ("RDPMA") challenges the constitutionality of P.A. 436 on the grounds that it was enacted immediately after the referendum rejection of a similar statute, P.A. 4.
The RDPMA also asserts that P.A. 436 is unconstitutional on the grounds that the Michigan Legislature added an appropriation provision for the purpose of evading the peoples' constitutional right to referendum.
Several objectors argue that P.A. 436 is unconstitutional because it fails to protect pensions from impairment in bankruptcy.
AFSCME asserts that P.A. 436 is unconstitutional because it violates the "Strong Home Rule" provisions in the Michigan Constitution.
The validity of P.A. 436 under the Michigan Constitution is a question of state law. Determining the several constitutional challenges to P.A. 436 requires this Court to apply state law. In Meridian Mut. Ins. Co. v. Kellman, 197 F.3d 1178, 1181 (6th Cir.1999), the Sixth Circuit provided this guidance on determining state law:
Similarly, in Demczyk v. Mut. Life Ins. Co. of N.Y. (In re Graham Square, Inc.), 126 F.3d 823, 827 (6th Cir.1997), the court stated, "Where the relevant state law is unsettled, we determine how we think the highest state court would rule if faced with the same case."
The Michigan Supreme Court has not ruled directly on the validity P.A. 436. As a result, this Court must attempt to ascertain how that court would rule if it were faced with the issue.
In In re Request for Advisory Opinion Regarding Constitutionality of 2011 Pa. 38, 490 Mich. 295, 307-8, 806 N.W.2d 683, 692 (2011), the Michigan Supreme Court summarized its decisions on evaluating a constitutional challenge to a state law:
This guidance, as well as the decisions of the Michigan Supreme Court on issues relating to the right to referendum, home rule, and the pension clause, will inform this Court's determinations on the objectors' challenges to P.A. 436.
On March 16, 2011, the governor signed P.A. 4 into law. P.A. 4 repealed P.A. 72. However, the voters rejected P.A. 4 by referendum in the November 6, 2012 election. Shortly after that election, on December 26, 2012, the governor signed P.A. 436 into law. It took effect on March 28, 2013.
The RDPMA argues that P.A. 436 is unconstitutional because it is essentially a reenactment of P.A. 4. The City and the State of Michigan assert that there are several differences between P.A. 436 and P.A. 4, such that they are not the same law.
The right of referendum is established in article 2, section 9 of the Michigan Constitution, which provides:
Mich. Const. art. II, § 9.
In Reynolds v. Bureau of State Lottery, 240 Mich.App. 84, 610 N.W.2d 597 (2000), the Michigan Court of Appeals considered the power of the legislature to reenact a law while a referendum process regarding that law was pending. The court explained:
Reynolds, 240 Mich.App. at 97, 610 N.W.2d at 604-05.
This Michigan Court of Appeals decision strongly suggests that the referendum rejection of P.A. 4 did not prohibit the Michigan legislature from enacting P.A. 436, even though P.A. 436 addressed the same subject matter as P.A. 4 and contained very few changes.
As noted above, the Sixth Circuit has instructed, "A federal court should not disregard the decisions of intermediate appellate state courts unless it is convinced by other persuasive data that the highest court of the state would decide otherwise." Meridian Mut. Ins. Co., 197 F.3d at 1181. No data, let alone any persuasive data, suggests that the Michigan Supreme Court would decide this issue otherwise. Accordingly, the RDPMA's challenge on this ground must be rejected.
The RDPMA also contends that P.A. 436 is unconstitutional because the Michigan legislature included appropriations provisions in P.A. 436 for the sole purpose of shielding the Act from referendum. Section 34 of P.A. 436 appropriates $780,000 for 2013 to pay the salaries of emergency managers. Section 35 of P.A. 436 appropriates $5,000,000 for 2013 to pay professionals hired to assist emergency managers.
There certainly was some credible evidence in support of the RDPMA's assertion that the appropriations provisions in P.A. 436 were motivated by a desire to immunize it from referendum. For example, Howard Ryan testified in his deposition on October 14, 2013:
Howard Dep. Tr. 46:1-23, Oct. 14, 2013.
Other evidence in support includes: a January 31, 2013 e-mail addressed from
There are, however, several difficulties with the RDPMA's argument.
The Court must conclude that the Michigan Supreme Court would not, if faced with this issue, hold that P.A. 436 is unconstitutional. In Michigan United Conservation Clubs v. Secretary of State, 464 Mich. 359, 367, 630 N.W.2d 297, 298 (2001), that court concisely held that a public act with an appropriations provision is not subject to referendum, regardless of motive. Concurring, Chief Justice Corrigan added that even if the motive of a legislative body could be discerned as opposed to the motives of individual legislators, "This Court has repeatedly held that courts must not be concerned with the alleged motives of a legislative body in enacting a law, but only with the end result — the actual language of the legislation." Id. at 367, 630 N.W.2d 297.
Similarly, in Houston v. Governor, 491 Mich. 876, 877, 810 N.W.2d 255, 256 (2012), the Michigan Supreme Court stated, "[T]his Court possesses no special capacity, and there are no legal standards, by which to assess the political propriety of actions undertaken by the legislative branch. Instead, it is the responsibility of the democratic, and representative, processes of government to check what the people may view as political or partisan excess by their Legislature."
In People v. Gibbs, 186 Mich. 127, 134-35, 152 N.W. 1053, 1055 (1915), the Michigan Supreme Court stated, "Courts are not concerned with the motives which actuate the members of the legislative body in enacting a law, but in the results of their action. Bad motives might inspire a law which appeared on its face and proved valid and beneficial, while a bad and invalid law might be, and sometimes is, passed with good intent and the best of motives." See also Kuhn v. Dep't of Treasury, 384 Mich. 378, 383-84, 183 N.W.2d 796, 799 (1971).
Finally, it must also be noted that on November 8, 2013, the Sixth Circuit vacated pending rehearing en banc the decision on which the RDPMA heavily relies. City of Pontiac Retired Employees Assoc. v. Schimmel, 726 F.3d 767 (6th Cir.2013).
Accordingly, the Court concludes that P.A. 436 is not unconstitutional as a violation of the right to referendum in article II, section 9 of the Michigan Constitution.
Certain objectors argue that P.A. 436 violates Article VII, Section 22 of the Michigan Constitution, which states:
The argument is that the appointment of an emergency manager for a municipality under P.A. 436 is inconsistent with the right of the electors to adopt and amend the City charter and the city's right to adopt ordinances. AFSCME asserts that "Michigan is strongly committed to the concept of home rule[.]" AFSCME Amended Objection at 75-91. (Dkt. # 1156) "This `strong home rule' regime reflects a bedrock principle of state law,... all officers of cities are to `be elected by the electors thereof, or appointed by such authorities thereof' not by the central State Government." Id. (citing Brouwer v. Bronkema, 377 Mich. 616, 141 N.W.2d 98 (1966)). AFSCME further asserts that in authorizing the appointment of an emergency manager with broad powers that usurp the powers of elected officials, "P.A. 436 offends the `strong home rule' of Detroit and that the Emergency Manager is not lawfully authorized to file for bankruptcy on behalf of the City or to act as its representative during chapter 9 proceedings." AFSCME Amended Objection at 75-91. (Dkt. # 1156)
AFSCME's argument fails for the simple reason that the broad authority the Michigan Constitution grants to municipalities is subject to constitutional and statutory limits. This constitutional provision itself embodies that principle. It states, "Each such city and village shall have power to adopt resolutions and ordinances relating to its municipal concerns, property and government, subject to the constitution and law." Mich. Const. art. VII, § 22 (emphasis added).
State law recognizes the same limitation on local government authority:
M.C.L. § 117.4j(3) (emphasis added).
Similarly, M.C.L. § 117.36, states, "No provision of any city charter shall conflict with or contravene the provisions of any general law of the state."
Indeed, § 1-102 of the Charter of the City of Detroit states: "The City has the comprehensive home rule power conferred upon it by the Michigan Constitution, subject only to the limitations on the exercise of that power contained in the Constitution or this Charter or imposed by statute." Id. (emphasis added). See Detroit City Council v. Mayor of Detroit, 283 Mich.App. 442, 453, 770 N.W.2d 117, 124 (Mich.Ct.App.2009) ("The charter itself thus recognizes that it is subject to limitations imposed by statute.").
"Municipal corporations have no inherent power. They are created by the state and derive their authority from the state." Bivens v. Grand Rapids, 443 Mich. 391, 397, 505 N.W.2d 239, 241 (1993).
The Michigan case law establishes that the powers granted to municipalities
City of Hazel Park v. Mun. Fin. Comm'n, 317 Mich. 582, 599-600, 27 N.W.2d 106, 113-14 (1947).
Local Union No. 876, Int'l Bhd. of Elec. Workers v. State of Mich. Labor Mediation Bd., 294 Mich. 629, 635-36, 293 N.W. 809, 811 (1940) (emphasis added). See also Mack v. City of Detroit, 467 Mich. 186, 194, 649 N.W.2d 47, 52 (2002); American Axle & Mfg., Inc. v. City of Hamtramck, 461 Mich. 352, 377, 604 N.W.2d 330, 342 (2000) (In Harsha [v. City of Detroit, 261 Mich. 586, 246 N.W. 849 (1933)] we held that "the legislature might modify the charters of municipal corporations at will and that the State still retained authority to amend charters and enlarge and diminish their powers."); Board of Trustees of Policemen & Firemen Retirement System v. City of Detroit, 143 Mich.App. 651, 655, 373 N.W.2d 173, 175 (Mich.Ct.App.1985) ("Where a city charter provision conflicts with general statutory law, the statute controls in all matters which are not of purely local character."); Oakland Cnty. Board of Cnty. Road Commis. v. Mich. Prop. & Cas. Guar. Ass'n, 456 Mich. 590, 609, 575 N.W.2d 751, 760 (1998) ("Like a municipal corporation, the road commission's existence is entirely dependent on the legislation that created it, and the Legislature that may also destroy it.").
AFSCME asserts that P.A. 436 is a "local law" because it gives the emergency manager broad authority to pass local legislation, and that therefore it violates article IV, section 29 of the Michigan Constitution. That section provides, in pertinent part, "The legislature shall pass no local or special act in any case where a general act can be made applicable[.]"
One plain difficulty with this argument is that this provision of the Michigan Constitution constrains the Michigan Legislature, not the emergency manager.
In defining a general law, the Michigan Supreme Court has stated, "`A general law is one which includes all persons, classes and property similarly situated and which come within its limitations.'" Am. Axle & Mfg., Inc. v. City of Hamtramck, 461 Mich. 352, 359 n. 5, 604 N.W.2d 330, 334 (2000) (citing Tribbett v. Village of Marcellus, 294 Mich. 607, 618, 293 N.W. 872 (1940), quoting Punke v. Village of Elliott, 364 Ill. 604, 608-9, 5 N.E.2d 389, 393 (1936)).
Clearly, P.A. 436 is a general law, potentially applicable to all municipalities similarly
Accordingly, the Court finds that P.A. 436 does not violate the home rule provisions of the Michigan Constitution.
Many objectors argue that the bankruptcy authorization section of P.A. 436, M.C.L. § 141.1558, does not conform to the requirements of the pension clause of the Michigan Constitution and is therefore unconstitutional. Accordingly, the objectors argue that P.A. 436 cannot provide the basis for authorization as required by 11 U.S.C. § 109(c)(2).
As noted, the premise of this argument is that under the Michigan constitution, pension benefits are entitled to greater protection than contract claims. That premise, however, is, the same as the premise of the argument that chapter 9 is unconstitutional as applied in this case.
In Part VIII C 5 b, above, the Court rejected this argument, concluding that pension benefits are a contractual obligation of the municipality.
It follows that if a state consents to a municipal bankruptcy, no state law can protect contractual pension rights from impairment in bankruptcy, just as no law could protect any other types of contract rights. Accordingly, the failure of P.A. 436 to protect pension rights in a municipal bankruptcy does not make that law inconsistent with the pension clause of the Michigan Constitution any more than the failure of P.A. 436 to protect, for example, bond debt in bankruptcy is inconsistent with the contracts clause of the Michigan Constitution. For this purpose, the parallel is perfect.
Stated another way, state law cannot reorder the distributional priorities of the bankruptcy code. If the state consents to a municipal bankruptcy, it consents to the application of chapter 9 of the bankruptcy code. This point was driven home in the Stockton case:
478 B.R. at 16-17 (emphasis added).
For these reasons, the Court concludes that P.A. 436 does not violate the pension clause of the Michigan Constitution.
AFSCME and most of the individual objectors argue that the emergency manager
Accordingly, for the reasons stated in that Part, AFSCME's argument on this point is rejected. The Court concludes that the emergency manager's authorization to file this bankruptcy case under P.A. 436 was valid under the Michigan Constitution, even though he was not an elected official.
P.A. 436 permits the governor to "place contingencies on a local government in order to proceed under chapter 9." M.C.L. § 141.1558(1). The governor did not place any contingencies on the bankruptcy filing in this case. Ex. 29 at 4. The governor's letter did, however, state "Federal law already contains the most important contingency — a requirement that the plan be legally executable." Ex. 29 at 4.
Several of the objectors argue that the pension clause of the Michigan Constitution, article IX, section 24, obligated the governor to include a condition in his authorization that would prohibit the City from impairing pension benefits in this bankruptcy case.
In Part IX E, above, the Court concluded that any such contingency in the law itself would be ineffective and potentially invalid. For the same reason, any such contingency in the governor's authorization letter would have been invalid, and may have rendered the authorization itself invalid under 11 U.S.C. § 109(c).
Accordingly, this objection is overruled. The Court concludes that the governor's authorization to file this bankruptcy case under P.A. 436 was valid under the Michigan Constitution.
On July 3, 2013, Gracie Webster and Veronica Thomas filed a complaint against the State of Michigan, Governor Snyder and Treasurer Dillon in the Ingham County Circuit Court. They sought a declaratory judgment that P.A. 436 is unconstitutional because it permits accrued pension benefits to be diminished or impaired in violation of article IX, section 24 of the Michigan Constitution. (Dkt. # 1219) The complaint also sought a preliminary and permanent injunction enjoining Governor Snyder and State Treasurer Dillon from authorizing the Detroit emergency manager to commence proceedings under chapter 9 of the bankruptcy code.
On Thursday, July 18, 2013, the state court held a hearing, apparently jointly on a similar complaint filed by the General Retirement System of the City of Detroit. According to the transcript of the hearing, it began at 4:15 p.m. Case No. 13-734-CZ, Hrg Tr. 4:2, July 18, 2013. (Dkt. # 1219-9) Almost immediately, counsel for the plaintiffs advised the court that the City had already filed its bankruptcy case. Hrg Tr. 6:2-9. (It was filed at 4:06 p.m. on that day.) As a result, counsel asked for an expedited process. Hrg Tr. 7:8-18. The court responded, "I plan on making a ruling Monday. I could make a ruling
The plaintiff's attorneys then asked that the hearing on their request for a preliminary injunction be advanced from the following Monday, which is when it had been set. Hrg Tr. 8:13-22. Counsel observed that it had been briefed by both sides. Hrg Tr. 9:1-10. After the Court confirmed through its law clerk that in fact the bankruptcy case had been filed, Hrg Tr. 10:9-10, counsel asked to amend its requested relief so that the governor and the emergency manager would be enjoined from taking any further action in the bankruptcy proceeding. Hrg Tr. 10:11-17. The court responded, "Granted, as to all your requests. How soon are you going to present me with an order?" Case No.13-734-CZ, Hrg Tr. 11:1-4, July 18, 2013. (Dkt. # 1219-9).
At this point, it must be observed that the judge granted this extraordinary relief with no findings and without giving the state's representative any opportunity to be heard.
In any event, the plaintiffs' counsel then used a previously prepared proposed order in the case that the General Retirement System filed and modified it extensively in handwriting, most of which was legible, to change the parties, the case number, and the ordering provisions. Case No.13-734-CZ, Hrg Tr.15:7-15, July 18, 2013. (Dkt. # 1219-9) It states that it was signed at 4:25 p.m., which was 10 minutes after the hearing began. Case No.13-734-CZ, Hrg Tr. 17:4-5, July 18, 2013. (Dkt. # 1219-9)
A further hearing was held the next day, beginning at 11:25 a.m., on the plaintiffs' request to amend the order of the previous afternoon. Case No.13-734-CZ, Hrg Tr. 4:2, July 19, 2013. (Dkt. # 1219-10) The plaintiffs' counsel had also filed a motion that morning for a declaratory judgment and asked the court to consider it. Hrg Tr.8:2-13 The state's attorney then agreed to allow the court to consider it. Hrg Tr. 8:24-25. The judge then addressed the parties. This portion of the transcript is quoted at length here because it is necessary to demonstrate an important point in section B, below, concerning Congress' purpose in granting exclusive jurisdiction to the bankruptcy court over all issues that concern the validity of a bankruptcy filing:
The attorneys then agreed and argued the merits. The judge then stated her decision to grant the declaratory relief that the plaintiffs requested. Case No.13-734-CZ, Hrg Tr.33:18-35:19, July 19, 2013. (Dkt. # 1219-10)
Later that day, the court entered an "Order of Declaratory Relief." This is the judgment on which the objecting parties rely in asserting their preclusion argument. The judgment is quoted at length here to demonstrate both its scope and its intended impact on this bankruptcy case:
Order of Declaratory Judgment, Webster v. State of Michigan, No. 13-734-CZ (July 19, 2013). (Dkt. # 1219-8)
In their eligibility objections in this case, several of the objectors assert that this judgment is binding upon the City under the principles of res judicata or collateral estoppel. Specifically, they contend that this judgment precludes the City from asserting that P.A. 436 is constitutional and that the governor properly authorized this bankruptcy filing. In the alternative, these parties assert that the judgment is at least a persuasive indication of what the
The Court concludes that it is neither.
There is a fundamental reason to deny the declaratory judgment any preclusive effect in this bankruptcy case.
Upon the City's bankruptcy filing, federal law — specifically, 28 U.S.C. § 1334(a) — gave this Court exclusive jurisdiction to determine all issues relating to the City's eligibility to be a chapter 9 debtor. That provision states, "[T]he district courts shall have original and exclusive jurisdiction of all cases under title 11." 28 U.S.C. § 1334(a). The Sixth Circuit has explained:
Pertuso v. Ford Motor Credit Co., 233 F.3d 417, 425 (6th Cir.2000). The court went on to quote this from MSR Exploration, Ltd. v. Meridian Oil, Inc., 74 F.3d 910, 914 (9th Cir.1996):
Pertuso, 233 F.3d at 417.
The wisdom of this grant of exclusive jurisdiction lies in the absolute necessity that any bankruptcy petition be filed, considered, and adjudicated in one court. Foreclosing the opportunity for parties to litigate a bankruptcy petition in multiple courts eliminates the likely consequence of a confused and chaotic race to judgment, and of the associated multiplication of expenses. It also eliminates the potential for inconsistent outcomes.
Indeed, the necessity to prohibit such collateral attacks on a bankruptcy petition is grounded in the uniformity requirement of Article 1, Section 8 of the United States Constitution, as the Ninth Circuit has observed:
Gonzales v. Parks, 830 F.2d 1033, 1035 (9th Cir.1987) (emphasis added). The Ninth Circuit continued, "A Congressional grant of exclusive jurisdiction to the federal courts includes the implied power to protect that grant." Id. at 1036. "A state
The Court recognizes that Congress has granted to other courts concurrent jurisdiction over certain proceedings related to the bankruptcy case. 28 U.S.C. § 1334(b) provides, "[T]he district courts shall have original but not exclusive jurisdiction of all civil proceedings arising under title 11, or arising in or related to cases under title 11." However, it is not argued that this subsection applies here, and for good reason. It does not. Referring to 28 U.S.C. § 1334(b), the Ninth Circuit stated in Gruntz v. Cnty. of Los Angeles (In re Gruntz), 202 F.3d 1074, 1083 (9th Cir. 2000) (en banc), "[N]othing in that section vests the states with any jurisdiction over a core bankruptcy proceeding[.]"
Indeed, 28 U.S.C. § 1334(b) only demonstrates that Congress knew precisely how to draw the line between those matters that should be within the exclusive jurisdiction of the federal bankruptcy court and those matters over which the jurisdiction could be shared. By denying effect to the Ingham County Circuit Court judgment in this case, this Court is enforcing that line.
The Court therefore concludes that upon the filing of this case at 4:06 p.m. on July 18, 2013, the Ingham County Circuit Court lost the jurisdiction to enter any order or to determine any issue pertaining to the City's eligibility to be a chapter 9 debtor.
The Sixth Circuit has held that a state court judgment entered without jurisdiction is void ab initio. Twin City Fire Ins. Co. v. Adkins, 400 F.3d 293, 299 (6th Cir.2005) ("Where a federal court finds that a state-court decision was rendered in the absence of subject matter jurisdiction or tainted by due process violations, it may declare the state court's judgment void ab initio and refuse to give the decision effect in the federal proceeding.")
Accordingly, the state court's "Order of Declaratory Judgment" on which the objectors rely here is therefore void and of no effect, and does not preclude the City from asserting its eligibility in this Court in this case.
11 U.S.C. § 362(a)(3) provides that "a petition filed under section 301 ... operates as a stay, applicable to all entities, of ... any act ... to exercise control over property of the estate[.]" 11 U.S.C. § 902(1) states, "In this chapter `property of the estate', when used in a section that is made applicable in a case under this chapter by section 103(e) or 901 of this title, means property of the debtor[.]"
The Sixth Circuit has held, "[A]n action taken against a nondebtor which would inevitably have an adverse impact upon the property of the estate must be barred by the [§ 362(a)(3)] automatic stay provision." Amedisys, Inc. v. Nat'l Century Fin. Enters., Inc. (In re Nat'l Century Fin. Enters., Inc.), 423 F.3d 567, 578 (6th Cir.2005) (quoting Licensing by Paolo, Inc. v. Sinatra (In re Gucci), 126 F.3d 380, 392 (2d Cir.1997)). See also Patton v. Bearden, 8 F.3d 343, 349 (6th Cir.1993).
The thrust of the plaintiffs' case in Webster v. Michigan was to protect the plaintiffs' pension rights by prohibiting a bankruptcy case which might allow the City to use its property in a way that might impair pensions. It does not matter that neither the City nor its officers were defendants. The suit was clearly an act to exercise control over the City's property. Accordingly, it was stayed under 11 U.S.C.
In Easley v. Pettibone Mich. Corp., 990 F.2d 905, 911 (6th Cir.1993), the court stated, "In summary, we hold that actions taken in violation of the stay are invalid and voidable and shall be voided absent limited equitable circumstances."
In this case, no equitable circumstances suggest any reason to find that the state court's order should not be voided. Instead, equitable circumstances suggest that it should be voided. When the plaintiffs' counsel appeared in the state court on July 18 and 19, 2013, they knew that the City had filed its bankruptcy petition, as did the judge. The record of those proceedings establishes beyond doubt that the proceedings were rushed in order to achieve a prompt dismissal of the bankruptcy case. The protection that the stay of 11 U.S.C. § 362(a) affords is for the benefit of both the debtor and all creditors. St. Paul Fire & Marine Ins. Co. v. Labuzan, 579 F.3d 533, 541 (5th Cir.2009); Johnson v. Smith (In re Johnson), 575 F.3d 1079, 1083 (10th Cir.2009). Condoning the actions that the plaintiffs took in this case would open the floodgates to similar actions by creditors in other bankruptcy cases and thereby vitiate that important protection.
Accordingly, the Court concludes that the judgment in Webster is void because its entry violated the automatic stay of 11 U.S.C. § 362(a)(3) and no equitable circumstances suggest that it should not be voided. For this additional reason, that judgment does not preclude the City from asserting its eligibility in this Court in this case.
The City disputes the application of res judicata and collateral estoppel on several other grounds. Specifically, it contends that the two hearings that resulted in the Webster judgment were confused and hurried. It also disputes whether the State was given a full and fair opportunity to be heard, and whether the judgment is binding on it, as it was not a party to the suit.
The Court concludes that in light of its conclusions that the state court lacked jurisdiction and that its judgment is void, it is unnecessary to decide these issues.
Nevertheless, the Court does comment that the transcripts of the two post-petition state court hearings on July 18 and 19, 2013 reflect a very chaotic and disorderly "race to judgment." (Dkt. # 1219-9; Dkt. # 1219-10) Those proceedings are perfect examples of the very kind of litigation the Congressional grant of exclusive jurisdiction in bankruptcy to one court was designed to control and eliminate. Moreover, respect for the extraordinary gravity
Finally, for the reasons stated in Part IX, above, the reasoning in the Webster declaratory judgment is neither persuasive nor at all indicative of how the Michigan Supreme Court would rule.
This objection to the City's eligibility is rejected.
To be eligible for relief under chapter 9, the City must establish that it is "insolvent." 11 U.SC. § 109(c)(3). Several individual objectors and AFSCME challenge the City's assertion that it is insolvent.
For a municipality, the bankruptcy code defines "insolvent" as a "financial condition such that the municipality is — (i) generally not paying its debts as they become due unless such debts are the subject of a bona fide dispute; or (ii) is unable to pay its debts as they become due." 11 U.S.C. § 101(32)(C).
The test under the first prong "looks to current, general non-payment." The test under the second prong "is an equitable, prospective test looking to future inability to pay." Hamilton Creek Metro. Dist. v. Bondholders Colo. Bondshares (In re Hamilton Creek Metro. Dist.), 143 F.3d 1381, 1384 (10th Cir.1998); see also In re City of Stockton, 493 B.R. 772, 788 (Bankr.E.D.Cal.2013) ("Statutory construction rules likewise point to a temporal aspect as the § 101(32)(C)(ii) phrase `as they become due' must mean something different than its § 101(32)(C)(i) partner `generally not paying its debts.'").
A payment is "due" under the first prong if it is "presently, unconditionally owing and presently enforceable." Hamilton Creek, 143 F.3d at 1385. When a municipality is unable to meet its presently enforceable debts, it is said to be "cash insolvent." See Stockton, 493 B.R. at 789.
When considering the second prong, courts take into account broader concerns, such as longer term budget imbalances and whether the City has sufficient resources to maintain services for the health, safety, and welfare of the community. Id.; see also In re Boise Cnty., 465 B.R. 156, 172 (Bankr.D.Idaho 2011) ("The test under § 101(32)(C)(ii) is a prospective one, which requires the petitioner to prove as of the petition date an inability to pay its debts as they become due in its current fiscal year, or, based on an adopted budget, in its next fiscal year.")
Although each test focuses on the City's ability to meet its financial obligations at different points in time, both are to be applied as of the time of the chapter 9 filing. Hamilton Creek, 143 F.3d at 1384-85 (citing In re Town of Westlake, 211 B.R. 860, 866 (Bankr.N.D.Tex.1997)).
Finally, the Court notes that "the theme underlying the two alternative definitions of municipal insolvency in § 101(32)(C) is that a municipality must be in bona fide financial distress that is not likely to be resolved without use of the federal exclusive bankruptcy power to impair contracts." Stockton, 493 B.R. at 788.
The Court finds that the City of Detroit was, and is, insolvent under both definitions in 11 U.S.C. § 101(32)(C). The Court has already detailed the enormous financial distress that the City faced as of
Specifically, in May 2013, the City deferred payment on approximately $54,000,000 in pension contributions. On June 30, 2013, it deferred an additional $5,000,000 fiscal year-end payment. Ex. 43 at 8. The City also did not make a scheduled $39,700,000 payment on its COPs on June 14, 2013. Ex. 43 at 8. It was also spending much more money than it was receiving, and only making up the difference through expensive and even catastrophic borrowings. See Part III A 5, 8 and 9, above.
These facts establish that the City was "generally not paying its debts as they become due," as of the time of the filing. 11 U.S.C. § 101(32)(C)(i).
AFSCME asserts that this was "[t]he purposeful refusal to make a few payments comprising a relatively small part of the City's budget." AFSCME Pre-Trial Br. at 51. (Dkt. # 1227)
The Court must reject this assertion. The evidence established that the nearly $40,000,000 pension-related COPs default was particularly serious because it put in jeopardy the City's access to its casino tax revenue, which was one of the City's few reliable sources of income. Eligibility Trial Tr. 185:16-186:23, Oct. 24, 2013. (Dkt. # 1490)
Moreover, the City was operating on a "razor's edge" for several months prior to June 2013. Eligibility Trial Tr. 189:9-10, Oct. 24, 2013. (Dkt. # 1490)
As of May 2013, the City stopped paying its trade creditors to avoid running out of cash. Eligibility Trial Tr. 189:14-15, Oct. 24, 2013. (Dkt. # 1490) But for these and other deferments, the City would have completely run out of cash by the end of 2013. Ex. 75 at 2.
The evidence was overwhelming that the City is unable to pay its debts as they become due.
The evidence established that there are many, many services in the City which do not function properly as a result of the City's financial state. The facts found in Parts III B 6-12, above, further firmly support this conclusion.
Most powerfully, however, the testimony of Chief Craig established that the City was in a state of "service delivery insolvency" as of July 18, 2013, and will continue to be for the foreseeable future. He testified that the conditions in the local precincts were "deplorable." Eligibility Trial Tr. 189:4-6, Oct. 25, 2013. (Dkt. # 1501) "If I just might summarize it in a very short way, that everything is broken, deplorable conditions, crime is extremely high, morale is low, the absence of leadership." Tr. 188:5-7 He described the City as "extremely violent," based on the high rate of violent crime and the low rate of "clearance" of violent crimes. Tr. 190:11-191:25. He stated that the officers' low morale is due, at least in part, to "the fact that they had lost ten percent pay; that they were forced into a 12-hour work schedule," and because there was an inadequate number of patrolling officers, and their facilities, equipment and vehicles were in various states of disrepair and obsolescence. Eligibility Trial Tr. 192:20-193:3, 197:21-23, 198:10-199:18, Oct. 25, 2013. (Dkt. # 1501)
In Stockton, the Court observed:
478 B.R. at 789.
Service delivery insolvency "focuses on the municipality's ability to pay for all costs of providing services at the level and quality that are required for the health, safety, and welfare of the community." Id. at 789. Indeed, while the City's tumbling credit rating, its utter lack of liquidity, and the disastrous COPs and swaps deal might more neatly establish the City's "insolvency" under 11 U.S.C. § 101(32)(C), it is the City's service delivery insolvency that the Court finds most strikingly disturbing in this case.
The objecting parties argue the City failed to establish its insolvency because it failed to present expert proof on this issue. See AFSCME Pre-Trial Br. at 52. (Dkt. # 1227) ("Courts in the non-chapter 9 context note that `it is generally accepted that whenever possible, a determination of insolvency should be based on ... expert testimony ...'") (citing Brandt v. Samuel, Son & Co., Ltd. (In re Longview Aluminum, L.L.C.), No. 03B 12184, 2005 WL 3021173, at *6 (Bankr.N.D.Ill. July 14, 2005)). This argument arises from the fact that the City mysteriously declined to qualify its financial analysts as expert witnesses.
At trial, upon the request of the City, the Court determined that under Rule 701, F.R.E., these witnesses — Charles Moore, Ken Buckfire and Gaurav Malhotra — could testify as lay witnesses regarding the City's finances and their projections of the City's finances in the future. Eligibility Trial Tr. 39:20-49:8, Oct. 25, 2013. (Dkt. # 1501) The Court also admitted extensive documentary evidence of the analysts' observations and projections. Tr. 49:5-8. These determinations were based upon the Court's finding that the financial consultants "had extensive personal knowledge of the City's affairs that they acquired during ... the course of their consulting work with the city." Eligibility Trial Tr. 48:14-19, Oct. 25, 2013. (Dkt. # 1501); see, e.g., JGR, Inc. v. Thomasville Furniture Indus., Inc., 370 F.3d 519, 525-26 (6th Cir.2004); DIJO, Inc. v. Hilton Hotels Corp., 351 F.3d 679, 685-87 (5th Cir.2003) (discussing In re Merritt Logan, Inc., 901 F.2d 349 (3rd Cir.1990) and Teen-Ed, Inc. v. Kimball Int'l, Inc., 620 F.2d 399 (3rd Cir.1980)). While the Court questions the City's strategy here, it is clear from these cases that there is nothing improper about the City's decision not to qualify these witnesses as experts, even though it likely could have.
The witnesses testified reliably and credibly regarding their personal knowledge of the City's finances and the basis for their knowledge. In these circumstances, the Court must reject AFSCME's argument that expert testimony is essential for a finding of insolvency under 11 U.S.C. §§ 109(c)(3) and 101(32)(C).
Finally, the objecting parties assert that the City could have, and should have, monetized a number of its assets in order to make up for its severe cash flow insolvency. See e.g., AFSCME Pre-Trial Br. at 53. (Dkt. # 1227)
However, Malhotra credibly established that sales of City assets would not address the operational, structural financial imbalance facing the City. Eligibility Trial Tr. 85:2-86:12, Oct. 25, 2013. (Dkt. # 1501)
When the expenses of an enterprise exceed its revenue, a one-time infusion of cash, whether from an asset sale or a borrowing, only delays the inevitable failure, unless in the meantime the enterprise sufficiently reduces its expenses and enhances its income. The City of Detroit has proven this reality many times.
In any event, when considering selling an asset, the enterprise must take extreme care that the asset is truly unnecessary in enhancing its operational revenue.
For these reasons, the Court finds that the City has established that it is insolvent as 11 U.S.C. § 109(c)(3) requires and as 11 U.S.C. § 101(32)(C) defines that term.
To establish its eligibility for relief under chapter 9, the City must establish that it desires to effect a plan to adjust its debts. 11 U.S.C. § 109(c)(4).
In Int'l Ass'n of Firefighters, Local 1186 v. City of Vallejo (In re City of Vallejo), 408 B.R. 280 (9th Cir. BAP 2009), the Bankruptcy Appellate Panel surveyed the case law under § 109(c)(4):
Local 1186, 408 B.R. at 295.
In Stockton, the court expanded:
493 B.R. at 791. See also City of San Bernardino, Cal., 499 B.R. 776, 786-90 (Bankr.C.D.Cal.2013); In re Boise County,
"Since that `plan' is to be effected by an entity seeking relief under Chapter 9, it is logical to conclude that the `plan' referred to in section 109(c)(4) is a `plan for adjustment of the debtor's debts' within the meaning of section 941 of the Bankruptcy Code." In re Cottonwood Water and Sanitation Dist., Douglas County, Colo., 138 B.R. 973, 975 (Bankr.D.Colo.1992).
Several objectors asserted that the City does not desire to effect a plan to adjust its debts.
The Court concludes that the evidence overwhelmingly established that the City does desire to effectuate a plan in this case. Mr. Orr so testified. Eligibility Trial Tr. 43:1-47:13, October 28, 2013. (Dkt. # 1502) More importantly, before filing this case, Mr. Orr did submit to creditors a plan to adjust the City's debts. Ex. 43. Plainly, that plan was not acceptable to any of the City's creditors. It may not have been confirmable under 11 U.S.C. § 943, although it is not necessary to resolve that question at this time. Still, it was evidence of the City's desire and intent to effect a plan. There is simply no evidence that the City has an ulterior motive in pursuing chapter 9, such as to buy time or to evade creditors.
Indeed, the objecting creditors do not contend that there was any such ulterior motive. They assert no desire on the part of the City or its emergency manager to buy time or evade creditors. Rather, their argument is that the plan that the emergency manager has stated he intends to propose in this case is not a confirmable plan. It is not confirmable, they argue, because it will impair pensions in violation of the Michigan Constitution.
Certainly the evidence does establish that the emergency manager intends to propose a plan that impairs pensions. The Court has already so found. See Part VIII C 1, above. Nevertheless, the objectors' argument must be rejected. As established in Part VIII C 5, above, a chapter 9 plan may impair pension rights. The emergency manager's stated intent to propose a plan that impairs pensions is therefore not inconsistent with a desire to effect a plan.
Accordingly, the Court finds that the City does desire to effect a plan, as 11 U.S.C. § 109(c)(4) requires.
The fifth requirement for eligibility is found in § 109(c)(5).
11 U.S.C. § 109(c)(5).
This section was enacted because Congress recognized that municipal bankruptcy is a drastic step and should only be taken as a last resort. In re Sullivan Cnty. Reg'l Refuse Disposal Dist., 165 B.R. 60, 78 (Bankr.D.N.H.1994); 5 Norton Bankr.L. & Prac.3d § 90:25 ("It is the policy of the Bankruptcy Code that a Chapter 9 filing should be considered only as a last resort, after an out-of-court attempt to avoid bankruptcy has failed.") Therefore, it added a requirement for pre-bankruptcy negotiation to attempt to resolve disputes.
In re Valley Health Sys., 383 B.R. 156, 162-63 (Bankr.C.D.Cal.2008).
The City of Detroit asserts that it has met the requirements of § 109(c)(5)(B) or, in the alternative, § 109(c)(5)(C). City's Reply to Objections at 45-49; (Dkt. # 765) City's Pre-trial Br. at 49-67. (Dkt. # 1240)
The Court finds the recent case, In re Mendocino Coast Recreation & Park Dist., 12-CV-02591-JST, 2013 WL 5423788 (N.D.Cal. Sept. 27, 2013), persuasive on this issue. In that case, the district court for the Northern District of California noted:
Mendocino Coast, 2013 WL 5423788, at *2. After a thorough analysis of the legislative history of § 109(c)(5)(B), the court was "persuaded by the Cottonwood view that Section 109(c)(5)(B) requires municipalities not just to negotiate generally in good faith with their creditors, but also to negotiate in good faith with creditors over a proposed plan, at least in concept, for bankruptcy under Chapter 9." Mendocino Coast, 2013 WL 5423788, at *5. This Court is also persuaded by that analysis.
Mendocino Coast also considered how the § 109(c)(5)(B) process compares to analogous provisions in other chapters of the bankruptcy code. The court looked to 11 U.S.C. §§ 1113(b) & (c) and 1114(f)(1), which require debtors to negotiate regarding the post-petition rejection of collective bargaining agreements and pension plans in chapter 11 proceedings. The court stated:
Mendocino Coast, 2013 WL 5423788, at *7. The Court reached two conclusions regarding § 109(c)(5)(B):
Mendocino Coast, 2013 WL 5423788, at *7.
Mendocino Coast recognized that its case did not present the issue "of what must occur in a negotiation that satisfies 109(c)(5)(B). It presents the issue of what information, if missing from the debtor's first attempt to negotiate, bars a municipality from filing Chapter 9 even if a creditor rejects the overture and declines to negotiate." Id. at *8.
This Court faces the same question, and therefore finds Mendocino Coast's analysis very useful, although on the facts of this case the Court ultimately reaches the opposite conclusion.
While recognizing that a determination of what qualifies as a good-faith effort to begin negotiation can depend on several factors, Mendocino Coast was able to make its determination upon consideration of three factors.
Mendocino Coast, 2013 WL 5423788, at *8-9.
In the present case, the City of Detroit argues that the June 14, 2013 proposal to creditors, along with its follow up meetings, was a good-faith effort to begin negotiations, and that the creditors refused to respond. It asserts, therefore, it has satisfied 11 U.S.C. § 109(c)(5)(B).
The Court concludes, however, that the June 14 Proposal to Creditors and the follow up meetings were not sufficient to satisfy the requirements of 11 U.S.C. § 109(c)(5)(B). The first and third factors cited by Mendocino Coast weigh heavily against finding that the City's initial efforts satisfied the requirement of good faith negotiation. The Proposal to Creditors did not provide creditors with sufficient information to make meaningful counter-proposals, especially in the very short amount of time that the City allowed for the "discussion" period.
The City's proposal to creditors is a 128 page document. Ex. 43. The City invited many creditors or "stakeholders" to the meeting on June 14, 2013, when it presented the proposal. Its presentation was a 120 deck powerpoint presentation, providing information regarding the financial condition of the City and proposing across the board reductions in creditor obligations.
The restructuring proposal began on page 101. Addressed on page 109 are the proposed treatment of the unsecured general obligation bonds, the claims of service corporations on account of the COPs, the claims for unfunded OPEB liabilities, the claims for unfunded pension liabilities and the claims on account of other liabilities. Ex. 43. Charitably stated, the proposal is very summary in nature.
For example, the proposed treatment for underfunded pension liabilities is three bullet points in length. The first bullet point states that the underfunding is approximately $3.5B. The second bullet point states, "Claims for the underfunding will be exchanged for a pro rata (relative to all unsecured claims) principal amount of new Notes." The third bullet point states, "Because the amounts realized on the underfunding claims will be substantially less than the underfunding amount, there must be significant cuts in accrued, vested pension amounts for both active and currently retired persons." Ex. 43 at 109.
This is simply not enough information for creditors to start meaningful negotiations. Brad Robins, of Greenhill & Co. LLC, financial advisor to the Retirement Systems, testified, "The note, itself, I thought was not really a serious proposal but maybe a place holder, [because it had] no maturity, no obligation for the City to pay." Eligibility Trial Tr. 129:1-11, Nov. 7, 2013. (Dkt. # 1681)
The City asserts that it provided supporting data in an "electronic data room." However, several witnesses testified that the data room did not contain all the necessary data to make a meaningful evaluation of the proposal to creditors. Brad Robins testified that the data room was missing "lots of information: value of assets, different projections and build-ups." Eligibility Trial Tr. 133:7-10, Nov. 7, 2013. (Dkt. # 1681) He felt that prior to the filing date, Greenhill was not given complete information to fully evaluate what was laid out in the June 14, 2013 proposal. Eligibility Trial Tr. 135:17-20, Nov. 7, 2013. (Dkt. # 1681) Mark Diaz testified that he made a request to the City for additional information and did not receive a response. Eligibility Trial Tr. 192:1-5, Nov. 7, 2013. (Dkt. # 1681)
Moreover, the City conditioned access to the data room on the signing of a confidentiality and release agreement. This created an unnecessary hurdle for creditors.
The creditors simply cannot be faulted for failing to offer counter-proposals when they did not have the necessary information to evaluate the City's vague initial proposal.
The City filed its bankruptcy on July 18, 2013, the day before the end of the evaluation period. Although the objecting creditors argue that in hindsight the bankruptcy filing was a forgone conclusion, they argue that the initial proposal did not make clear the City's intention to file. Regardless, the time available for creditor negotiations was approximately thirty days. Given the extraordinary complexities of the case, that amount of time is simply far too short to conclude that such a vague proposal to creditors rises to the level required to shift the burden to objectors to make counter-proposals.
In addition to the lack of detail in the initial proposal and the short response time, the Court notes that two additional factors support its conclusion.
First, the City affirmatively stated that the meetings were not negotiations. Eligibility Trial Tr. 188:22-24, 189:1-3, Nov. 7, 2013; (Dkt. # 1681) Orr Dep. Tr. 129:14-18, 262:1-25, Sept. 16, 2013. The City asserts this was to clarify that the City was not waiving the suspension of collective bargaining under P.A. 436. Orr Dep. Tr. 264:23-265:7, Sept. 16, 2013 (Dkt. # 1159-B); Orr Dep. Tr. 63:21-64.20, Oct. 28, 2013. (Dkt. # 1502) This explanation is inadequate, bordering on disingenuous. The City simply cannot announce to creditors that meetings are not negotiations and then assert to the Court that those same meetings amounted to good faith negotiations.
Second, the format of the meetings was primarily presentational, to different groups of creditors with different issues, and gave little opportunity for creditor input or substantive discussion. Eligibility Trial Tr. 145:7-146:3, Nov. 4, 2013. (Dkt. # 1683) For example, at the end of the June 14, 2013 meeting, creditors were permitted to submit questions via notecard. Shirley Lightsey attended the June 20, 2013, July 10, 2013 and July 11, 2013 meetings and testified that there was no opportunity to meet in smaller groups to discuss retiree-specific issues. Eligibility Trial Tr.108:19-20, 109:22-23, 111:1-3, Nov. 4, 2013. (Dkt. # 1683) Mark Diaz, President of the Detroit Police Officers Association, testified there was no back and forth discussion. Eligibility Trial Tr. 187:22-25, 189:1-3, Nov. 7, 2013. (Dkt. # 1681)
The City argues that these meetings were intended to start negotiations and that they expected counter-proposals from the creditors. Even as a first step, these meetings failed to reach a level that would justify a finding that negotiations had occurred, let alone good faith negotiations. Moreover, the Court finds that the lack of negotiations were not due to creditor recalcitrance. Accordingly, the Court concludes that the City has not established by a preponderance of the evidence that it has satisfied the requirement of 11 U.S.C. § 109(c)(5)(B).
Nevertheless, the Court finds that negotiations were in fact, impracticable, even if the City had attempted good faith negotiations. "[I]mpracticability of negotiations is a fact-sensitive inquiry that `depends
In re Valley Health Sys., 383 B.R. at 163.
Congress adopted § 109(c)(5)(C) specifically "to cover situations in which a very large body of creditors would render prefiling negotiations impracticable." In re Cnty. of Orange, 183 B.R. 594, 607 (Bankr.C.D.Cal.1995) (quoting In re Sullivan County Reg'l Refuse Disposal Dist., 165 B.R. at 79 n. 55.) See also In re New York City Off-Track Betting Corp., 427 B.R. at 276-77; 2 Collier on Bankruptcy ¶ 109.04[3][e][iii]. "The impracticality requirement may be satisfied based on the sheer number of creditors involved." Cnty. of Orange, 183 B.R. at 607. See In re Villages at Castle Rock Metro. Dist. No. 4, 145 B.R. 76, 85 (Bankr.D.Colo.1990) ("It certainly was impracticable for [debtor] to have included several hundred Series D Bondholders in these conceptual discussions."); Valley Health Sys., 383 B.R. at 165 (finding that the requirement of § 109(c)(5)(C) was met where the debtor's petition disclosed not more than 5,000 creditors holding claims in excess of $100,000,000); In re Pierce Cnty. Hous. Auth., 414 B.R. 702, 714 (Bankr. W.D.Wash.2009) (over 7,000 creditors and parties in interest were set forth on the mailing matrix).
The list of creditors for the City of Detroit is over 3500 pages. Ex. 64 (Dkt. # 1059) It lists over 100,000 creditors. It is divided into fifteen schedules including the following classifications: Long-Term Debt; Trade Debt, Employee Benefits; Pension Obligations, Non-Pension Retiree Obligations; Active Employee Obligations; Workers' Compensation; Litigation and Similar Claims; Real Estate Lease Obligations; Deposits; Grants; Pass-Through Obligations, Obligations to Component Units of the City; Property Tax-Related Obligations; Income Tax-Related Obligations. Ex. 64 at 2-3. (Dkt. # 1059) The summary of schedules provided with the list estimates the amount of claims and percent total for each schedule where sufficient information is available to determine those amounts. (Dkt. # 1059-1) Some schedules such as Workers' Compensation and Litigation and Similar Claims do not have amounts listed because they are unliquidated, contingent and often disputed claims.
Long term debt, including bonds, notes and loans, capital lease, and obligations arising under the COPs and swaps, is listed
As noted above, pension obligations are estimated at almost $3,500,000,000 or 19.33% of the City's total debt. The City estimates over 20,000 individual retirees are owed pension funds. Ex. 28 at 9. OPEB amounts are estimated at approximately $5,700,000,000 or 31.81% of the City's total debt.
The Court is satisfied that when Congress enacted the impracticability section, it foresaw precisely the situation facing the City of Detroit. It has been widely reported that Detroit is the largest municipality ever to file bankruptcy. Indeed, one of the objectors stated that it is "by far the largest and most economically significant city ever to file for chapter 9 bankruptcy." AFSCME's Supplemental Br. on Good Faith Negotiations at 7. (Dkt. # 1695) The sheer size of the debt and number of individual creditors made pre-bankruptcy negotiation impracticable — impossible, really.
There are, however, several other circumstances that also support a finding of impracticability.
First, although several unions have now come forward to argue that they are the "natural representatives of the retirees," those same unions asserted in response to the City's pre-filing inquires that they did not represent retirees. Ex. 32. For example, in a May 22, 2013 letter, Robyn Brooks, the President of UAW Local 2211, stated, "This union does not, however, represent current retirees and has no authority to negotiate on their behalf." John Cunningham sent the same response on behalf of UAW Locals 412 and 212. In a May 27, 2013 letter, Delia Enright, President of AFSCME Local 1023, stated, "Please be advised that in accordance with Michigan law, I have no authority in which to renegotiate the Pension or Medical Benefits that retired members of our union currently receive." Several other union representatives sent similar responses.
These responses sent a clear message to the City that the unions would not negotiate on behalf of the retirees. See Stockton, 493 B.R. at 794 ("it is impracticable to negotiate with 2,400 retirees for whom there is no natural representative capable of bargaining on their behalf.").
Several voluntary associations, including the RDPMA, the Detroit Retired City Employees ("DRCEA"), and the Retired Detroit Police and Fire Fighters Association ("RDPFFA"), assert that they are the natural representatives of retirees. However, none assert that they can bind individual retirees absent some sort of complex class action litigation. Ex. 301 at ¶ 6; (Dkt. # 497-2) Eligibility Trial Tr. 115:15-22, Nov. 4, 2013; (Dkt. # 1683) Ex. 302 at ¶ 6; (Dkt. # 497-3) Eligibility Trial Tr.164:1-8, Nov. 4, 2013. (Dkt. # 1683) Ultimately "it would be up to the individual members of the association to decide if they would accept or reject" an offer. Eligibility Trial Tr. 157:1-4, Nov. 4, 2013. (Dkt. # 1683)
Further, several witnesses who testified on behalf of the retiree associations made it clear that they would not have negotiated a reduction in accrued pension benefits because they consider them to be fully protected by state law. As Shirley Lightsey testified, "The DRCEA would not take any action to solicit authority from its membership to reduce pension benefits because they're protected by the Michigan Constitution." Eligibility Trial Tr. 125:3-7, Nov. 4, 2013. (Dkt. # 1683)
The answers to interrogatories from both organizations reveal a similar inflexibility.
Indeed, as noted above, within two weeks of the June 14, 2013 meeting, some retirees had filed lawsuits attempting to block this bankruptcy based on their state law position. (Flowers v. Synder, No. 13-729-CZ July 3, 2013; Webster v. Synder No. 13-734-CZ July 3, 2013)
It is impracticable to negotiate with a group that asserts that their position is immutable. See Stockton, 493 B.R. at 794 (Bankr.E.D.Cal.2013) ("it is impracticable to negotiate with a stone wall.").
The Court concludes that the position of the several retiree associations that they would never negotiate a reduction in accrued pension benefits made negotiations with them impracticable.
Finally, the City has sufficiently demonstrated that time was quickly running out on its liquidity. Ex. 9. (Dkt. # 12) The Court therefore rejects the objectors' assertions that the City manufactured any time constraints in an attempt to create impracticability. Throughout the pertinent time periods, the City was in a financial emergency.
In re New York City Off-Track Betting Corp., 427 B.R. at 276-77.
The majority of the City's debt is bond debt and legacy debt. Neither the pension debt nor the bond debt are adjustable except through consent or bankruptcy. Negotiations with retirees and bondholders were impracticable due to the sheer number of creditors, and because many of the retirees and bondholders have no formal representatives who could bind them, or even truly negotiate on their behalf. Additionally, the Court finds that the City's fiscal crisis was not self-imposed and also made negotiations impracticable.
Accordingly, the Court finds that prefiling negotiations were impracticable. The City has established by a preponderance of the evidence that it meets the requirements of 11 U.S.C. § 109(c)(5)(C).
The last requirement for eligibility is set forth in 11 U.S.C. § 921(c), which provides, "After any objection to the petition, the court, after notice and a hearing, may dismiss the petition if the debtor did not file the petition in good faith or if the petition does not meet the requirements of this title."
Unlike the eligibility requirements in § 109(c), "the court's power to dismiss a petition under § 921(c) is permissive, not mandatory." In re Pierce Cnty. Hous. Auth., 414 B.R. 702, 714 (Bankr. W.D.Wash.2009) (citing 6 Collier on Bankruptcy ¶ 921.04[4], at 921-7); In re Cnty. of Orange, 183 B.R. 594, 608 (Bankr. C.D.Cal.1995) (citing In re Sullivan Cnty.
The City's alleged bad faith in filing its chapter 9 petition was a central issue in the eligibility trial. Indeed, in one form or another, all of the objecting parties have taken the position that the City did not file its chapter 9 petition in good faith and that this Court should exercise its discretion under 11 U.S.C. § 921(c) to dismiss the case.
"Good faith in the chapter 9 context is not defined in the Code and the legislative history of [section] 921(c) sheds no light on Congress' intent behind the requirement." In re New York City Off-Track Betting Corp., 427 B.R. 256, 278-79 (Bankr. S.D.N.Y.2010) (quoting In re Cnty. of Orange, 183 B.R. at 608) (quotation marks omitted).
In Stockton, the Court found:
Stockton, 493 B.R. at 794.
Similarly, the court in New York City Off-Track Betting Corp., 427 B.R. at 279 (quoting 6 Collier on Bankruptcy ¶ 921.04[2]), stated:
The essence of this good faith requirement is to prevent abuse of the bankruptcy process. In re Villages at Castle Rock Metro. Dist. No. 4, 145 B.R. at 81.
In conducting its good faith analysis, the Court must consider the broad remedial purpose of the bankruptcy code. See, e.g., Stockton, 493 B.R. at 794; see also In re Mount Carbon Metro. Dist., 242 B.R. 18, 32 (Bankr.D.Colo.1999) ("The purpose of reorganization under Chapter 9 is to allow municipalities created by state law to adjust their debts through a plan voted on by creditors and approved by the bankruptcy court.").
Indeed, "if all of the eligibility criteria set forth in § 109(c) as described above are satisfied, it follows that there should be a strong presumption in favor of chapter 9 relief." Stockton, 493 B.R. at 794. This Court agrees with the analysis set forth in the Stockton case on the issue of good faith under § 921(c):
Stockton, 493 B.R. at 795.
As explained below, the Court finds that the totality of the circumstances,
In section 3, below, the Court will review the factors upon which it relies in finding that the City filed this case in good faith. First, however, it is crucial to this process for the Court to give voice to what it understands is the narrative giving rise to the objecting parties' argument that the City of Detroit did not file this case in good faith. The Court will then, in section 2, explain that there is some support in the record for that narrative.
It must be recognized that the narrative that the Court describes here is a composite of the objecting parties' positions and presentations on this issue. No single objecting party neatly laid out this precise version with all of the features described here. Moreover, it includes the perceptions of the objecting parties whose objections were filed by attorneys, as well as the many objecting parties who filed their objections without counsel. Naturally, these views on this subject were numerous, diverse, and at times inconsistent.
The Court will use an italics font for its description of this narrative, not to give it emphasis, but as a reminder that these are
The Court will now turn to its evaluation of this narrative of bad faith on the City's part in filing this case.
The Court acknowledges that many people in Detroit hold to this narrative, or at least to substantial parts of it.
The Court further recognizes, on the other hand, that State and City officials vehemently deny any such improper motives or tactics as this theory attributed to them. They contend that the case was filed for the proper desired and necessary purpose of restructuring the City's debt, including its pension debt, through a plan of adjustment. Indeed, in Part XIV, above, the Court has already found that the City does desire to effect a plan of adjustment.
The Court finds, however, that in some particulars, the record does support the objectors' view of the reality that led to this bankruptcy filing. It is, however, not nearly supported in enough particulars for the Court to find that the filing was in bad faith.
The evidence in support of the objectors' theory is as follows:
The issue that this evidence presents is how to evaluate it in the context of the good faith requirement. For example, during the orchestrated lead-up to the filing, was the City of Detroit's bankruptcy filing a "foregone conclusion" as the objecting parties assert? Of course it was, and for a long time.
Even if it was a foregone conclusion, however, experience with both individuals and businesses in financial distress establishes that they often wait longer to file bankruptcy than is in their interests. Detroit was no exception. Its financial crisis has been worsening for decades and it could have, and probably should have, filed for bankruptcy relief long before it did, perhaps even years before. At what point in Detroit's financial slide did it lose the ability, without bankruptcy help, to restructure its debt in a way that would firmly ground its economic and social revitalization? Was it after the disastrous COPs and swaps deal in 2005? Or even sometime before?
The record here does not permit an answer to that question. Whatever the answer, however, the Court must conclude that Detroit's bankruptcy filing was certainly a "foregone conclusion" during all of 2013.
For purposes of determining the City's good faith, however, it hardly matters. As noted, many in financial difficulty, Detroit included, wait too long to file bankruptcy.
Then the issue becomes what impact does it have on the good faith analysis that Detroit probably waited too long. Perhaps it would have been more consistent with our democratic ideals and with the economic and social needs of the City if its officials and State officials had openly and forthrightly recognized the need for filing bankruptcy when that need first arose. It is, after all, not bad faith to file bankruptcy when it is needed.
City officials also could have avoided the appearance of pretext negotiations, and the resulting mistrust, by simply announcing honestly that because negotiating with so many diverse creditors was impracticable, negotiations would not even be attempted. The law clearly permits that, and for good reason. It avoids the very
The Court must acknowledge some substantial truth in the factual basis for the objectors' claim that this case was not filed in good faith. Nevertheless, for the strong reasons stated in the next section, the Court finds that this case was filed in good faith and should not be dismissed.
Based on Stockton and New York City Off-Track Betting Corp., reviewed above, the Court concludes that the following factors are most relevant in establishing the City's good faith:
The Court's analysis of this factor is based on its findings that the City is "insolvent" in Part XIII, above, and that the City was "unable to negotiate with creditors because such negotiation [was] impracticable" in Part XVI, above. 11 U.S.C. §§ 109(c)(3) and 109(c)(5)(C).
The City has over $18,000,000,000 in debt and it is increasing. In the months before the filing, it was consistently at risk of running out of cash. It has over 100,000 creditors.
"Profound" is the best way to describe the City's insolvency, and it simply could not negotiate with its numerous and varied creditors. See In re Town of Westlake, Tex., 211 B.R. 860, 868 (Bankr.N.D.Tex. 1997) (finding the debtor filed in good faith because it faced "frozen funds, multiple litigation, and the disannexation of a substantial portion of its tax base").
It is true that the City does not have a clear picture of its assets, income, cash flow, and liabilities, likely because its bookkeeping and accounting systems are obsolete. But this only suggests the need for relief. It does not suggest bad faith. Moreover, as the City's financial analysts' subsequent months of work have sharpened the focus on the City's finances, the resulting picture has only become worse. Eligibility Trial Tr. 118:4-119:5, Nov. 5, 2013. (Dkt. # 1584)
The Court finds that this factor weighs in favor of finding good faith.
One of the purposes of chapter 9 is to give the debtor a "breathing spell" so that it may establish a plan of adjustment. In re Cnty. of Orange, 183 B.R. 594, 607 (Bankr.C.D.Cal.1995).
The Court's analysis on this factor is based on its finding that the City "desires to effect a plan to adjust such debts." 11 U.S.C. § 109(c)(4). To show good faith on this factor, "the evidence must demonstrate that `the purpose of the filing of the chapter 9 petition [was] not simply ... to buy time or evade creditors.'" In re New York City Off-Track Betting Corp., 427 B.R. at 272 (quoting In re City of Vallejo, 408 B.R. at 295). Notably, this argument was not raised by the objectors in any pleadings or at trial, nor was any evidence presented to support it.
The objectors do assert that the City filed the petition to avoid "a bad state court ruling" in the Webster litigation.
The objectors also argue that the City filed the petition so that its pension obligations could be impaired and that this is inconsistent with the remedial purpose of bankruptcy. See, e.g., Second Amended Final Pre-Trial Order, ¶ 86 at 24. (Dkt. # 1647) Again, discharging debt is the primary motive behind the filing of most bankruptcy petitions. That motivation does not suggest any bad faith. That the City "chose to avail itself of a legal remedy afforded it by federal law is not proof of bad faith." In re Chilhowee R-IV School Dist., 145 B.R. 981, 983 (Bankr.W.D.Mo. 1992). This is especially true here. The evidence demonstrated that attempting to negotiate a voluntary impairment of pensions would have been futile.
Accordingly, the Court finds that this factor also weighs in favor of finding good faith.
Although the Court finds that the City did not engage in good faith negotiations with its creditors, Part XV, above, the Court does find the City did make some efforts to improve its financial condition before filing its chapter 9 petition. See Part III C, above.
The City's efforts are detailed in Mr. Orr's declaration filed in support of the petition. Ex. 414 at 36-49. (Dkt. # 11) Those efforts include reducing the number of City employees, reducing labor costs through implementation of the City Employment Terms, increasing the City's corporate tax rate, working to improve the City's ability to collect taxes, increasing lighting rates, deferring capital expenditures, reducing vendor costs, and reducing subsidies to the Detroit Department of Transportation. Ex. 414 at 36-49. (Dkt. # 11); Eligibility Trial Tr. 231:15-233:7, October 28, 2013. (Dkt. # 1502) Despite those efforts, the City remains insolvent.
The fact that the City did not seriously consider any alternatives to chapter 9 in the period leading up to the filing of the petition does not indicate bad faith. By this time, all of the measures described in Mr. Orr's declaration had largely failed to resolve the problem of the City's cash flow insolvency. Ex. 414 at 36-49. (Dkt. # 11); Eligibility Trial Tr. 231:15-233:7, October 28, 2013. (Dkt. # 1502). In In re City of San Bernardino, Cal., 499 B.R. 776, 791 (Bankr.C.D.Cal. 2013), the Court observed:
The Court finds this factor also weighs in favor of finding good faith.
The Court concludes that this factor is of paramount importance in this case. The City's debt and cash flow insolvency is
Over 38% of the City's revenues were consumed by servicing debt in 2012, and that figure is projected to increase to nearly 65% of the budget by 2017 if the debt is not restructured. Ex. 414 at 39 (Dkt. # 11) Without revitalization, revenues will continue to plummet as residents leave Detroit for municipalities with lower tax rates and acceptable services.
Without the protection of chapter 9, the City will be forced to continue on the path that it was on until it filed this case. In order to free up cash for day-to-day operations, the City would continue to borrow money, defer capital investments, and shrink its workforce. This solution has proven unworkable. It is also dangerous for its residents.
If the City were to continue to default on its financial obligations, as it would outside of bankruptcy, creditor lawsuits would further deplete the City's resources. On the other hand, in seeking chapter 9 relief, the City not only reorganizes its debt and enhances City services, but it also creates an opportunity for investments in its revitalization efforts for the good of the residents of Detroit. Ex. 43 at 61.
This factor weighs heavily in favor of finding good faith.
While acknowledging some merit to the objectors' serious concerns about how City and State officials managed the lead-up to this filing, the Court finds that the factors relevant to the good faith issue weigh strongly in favor of finding good faith. Accordingly, the Court concludes the City's petition was filed in good faith and that the petition is not subject to dismissal under 11 U.S.C. § 921(c).
The objections addressed here were asserted in briefs after the deadline to object had passed. Accordingly, these objections are untimely and denied on that ground. In the interest of justice, however, the Court will briefly address their merits.
In its supplemental brief filed October 30, 2013, AFSCME asserts, "The rights created by the Pensions Clause should survive bankruptcy because the Pensions Clause is an exercise of the right to enact `state or local laws designed to protect public health or safety' which cannot be disregarded by the debtor." AFSCME's Supplemental Br. at 3-4. (Dkt. # 1467) In support of this argument, AFSCME relies on the United States Supreme Court decision in Midlantic Nat'l Bank v. New Jersey Dep't of Env. Protection, 474 U.S. 494, 106 S.Ct. 755, 88 L.Ed.2d 859 (1986).
In Midlantic, the Supreme Court held that "a trustee in bankruptcy does not have the power to authorize an abandonment without formulating conditions that will adequately protect the public's health and safety." 474 U.S. at 507, 106 S.Ct at 762. At issue in that case was whether a trustee in bankruptcy could abandon real property pursuant to 11 U.S.C. § 544(a),
The case is simply not applicable on AFSCME's point. The City has not "abandoned" its property. Moreover, AFSCME has failed to identify how the pensions clause is a "state or local law designed to protect public health or safety." Id. at 502, 106 S.Ct. at 760.
Accordingly, this objection is overruled.
In an objection filed on October 17, 2013 (Dkt. # 1222), Krystal Crittendon asserted that Mr. Orr was not validly appointed because the rejection of P.A. 4 did not revive P.A. 72. This argument is rejected for the reasons stated in Part III D, above.
In this objection, Crittendon also contended that Mr. Orr was not validly appointed because his initial emergency manager contract expired before P.A. 436 took effect.
P.A. 436 contains a grandfathering provision which states:
M.C.L. § 141.1571.
Mr. Orr's initial emergency manager contract under P.A. 72 stated that it "shall terminate at midnight on Wednesday, March 27, 2013." Crittendon contends that therefore the contract terminated the morning of Wednesday, March 27, and that therefore he was not in office on that day. She asserts that because Mr. Orr's current emergency manager contract became effective on Thursday, March 28, 2013, there was no emergency manager serving immediately prior to the March 28 effective date of P.A. 436, and the grandfathering clause does not apply.
The City contends that the parties intended for Mr. Orr's initial contract to expire at the end of the day on March 27th and that there was no gap in his service.
In Hallock v. Income Guar. Co., 270 Mich. 448, 452, 259 N.W. 133, 134 (1935), the court assumed "midnight" meant the end of the day. Courts in other jurisdictions, however, have found that the term is ambiguous. See Amer. Transit Ins. Co. v. Wilfred, 745 N.Y.S.2d 171, 172, 296 A.D.2d 360, 361 (N.Y.A.D.2002); Mumuni v. Eagle Ins. Co., 668 N.Y.S.2d 464, 247 A.D.2d 315 (N.Y.A.D.1998).
In Klapp v. United Insurance Group Agency, Inc., 468 Mich. 459, 663 N.W.2d 447 (2003), the Michigan Supreme Court noted, "`The law is clear that where the language of the contract is ambiguous, the court can look to such extrinsic evidence as the parties' conduct, the statements of its representatives, and past practice to aid in interpretation.'" Id. at 470, 663 N.W.2d at 454 (quoting Penzien v. Dielectric Prod. Engineering Co., Inc., 374 Mich. 444, 449, 132 N.W.2d 130, 132 (1965)).
The Court finds that the parties to the contracts clearly intended that there would be no gap in Mr. Orr's contracts or in his appointment. Accordingly, Mr. Orr was validly appointed under M.C.L. § 141.1572. The objection is rejected.
The Court concludes that under 11 U.S.C. § 109(c), the City of Detroit may be a debtor under chapter 9 of the bankruptcy code. The Court will enter an order for
The Court reminds all interested parties that this eligibility determination is merely a preliminary matter in this bankruptcy case. The City's ultimate objective is confirmation of a plan of adjustment. It has stated on the record its intent to achieve that objective with all deliberate speed and to file its plan shortly. Accordingly, the Court strongly encourages the parties to begin to negotiate, or if they have already begun, to continue to negotiate, with a view toward a consensual plan.
No court has ever held otherwise. On the contrary, the cases have uniformly concluded that the public rights doctrine is the basis of a bankruptcy court's authority to adjudicate issues that arise under the bankruptcy code. For example, in Carpenters Pension Trust Fund for Northern California v. Moxley, 734 F.3d 864, 868 (9th Cir.2013), the Ninth Circuit held:
Similarly, in CoreStates Bank, N.A. v. Huls Am., Inc., 176 F.3d 187, 196 n. 11 (3d Cir. 1999), the Third Circuit held, "The protections afforded a debtor under the Bankruptcy Code are congressionally created public rights."
In Kirschner v. Agoglia, 476 B.R. 75, 79 (S.D.N.Y.2012), the court stated, "[After Stern,] bankruptcy courts still have the ability to finally decide so-called `public rights' claims that assert rights derived from a federal regulatory scheme and are therefore not the `stuff of traditional actions,' as well as claims that are necessarily resolved in ruling on a creditor's proof of claim (e.g., a voidable preference claim)[.]"
Other cases also conclude that various matters arising within a bankruptcy case are within the public rights doctrine. See., e.g., In re Bataa/Kierland LLC, 496 B.R. 183, 188 (D.Ariz.2013) (scope of Chapter 11 debtor's rights under easement); Hamilton v. Try Us, LLC, 491 B.R. 561 (W.D.Mo.2013) (validity and amount of common law claim against Chapter 7 debtor); In re Prosser, 2013 WL 996367 (D.Vi.2013) (trustee's claim for turnover of property); White v. Kubotek Corp., 487 B.R. 1 (D.Mass.2012) (creditor's successor liability claim against purchaser of assets from bankruptcy estate); United States v. Bond, 486 B.R. 9 (E.D.N.Y.2012) (trustee's claims for tax refund); Turner v. First Cmty. Credit Union (In re Turner), 462 B.R. 214 (Bankr.S.D.Tex. 2011) (violation of the automatic stay); In re Whitley, 2011 WL 5855242 (Bankr.S.D.Tex. Nov. 21, 2011) (reasonableness of fees of debtor's attorney); In re Carlew, 469 B.R. 666 (Bankr.S.D.Tex.2012) (homestead exemption objection); West v. Freedom Med., Inc. (In re Apex Long Term Acute Care-Katy, L.P.), 465 B.R. 452, 458 (Bankr.S.D.Tex.2011) (addressing preference actions, stating, "This Court concludes that the resolution of certain fundamental bankruptcy issues falls within the public rights doctrine."); Sigillito v. Hollander (In re Hollander), 2011 WL 6819022 (Bankr. E.D.La. Dec. 28, 2011) (nondischargeability for fraud).
In light of the unanimous holdings of these cases, the Court must conclude that its determination regarding the City's eligibility is within the public rights doctrine and therefore that the Court does have the authority to decide the issue, including all of the arguments that the objectors make in their objections.
This single sentence cannot be given much weight. First, it is only dicta. Second, it is against the manifest weight of the case authorities. Third, the quote assumes, without analysis, that the litigants do have an interest in having Article III courts interpret the Constitution, and thus bootstraps its own conclusion. Fourth, nothing in the Flinn Investments case states or even suggests that Stern itself prohibits a bankruptcy court from ruling on a constitutional issue where it otherwise has the authority to rule on the claim before it. Finally, the district court that issued Flinn Investments has now entered an amended standing order of reference in bankruptcy cases to provide that its bankruptcy court should first consider objections to its authority that parties raise under Stern v. Marshall. Apparently, that district court's position now is that Stern does not preclude the bankruptcy court from determining constitutional issues, including the constitutional issue of its own authority. The order is available at http:// www.nysd.uscourts.gov/rules/StandingOrder_ OrderReference_12mc32.pdf.
Two other cases are cited in support of the position that only an Article III court can determine a constitutional issue: TTOD Liquidation, Inc. v. Lim (In re Dott Acquisition, LLC), 2012 WL 3257882 (E.D.Mich. July 25, 2012), and Picard v. Schneiderman (In re Madoff Secs.), 492 B.R. 133 (S.D.N.Y.2013). Both are irrelevant to the issue. Dott Acquisition did discuss Stern but only in the unremarkable context of withdrawing the reference on a fraudulent transfer action. Schneiderman did not address a Stern issue at all, or even cite the case.
298 U.S. at 541, 56 S.Ct. 892 (emphasis added). He then made this argument regarding the constitutional foundation for municipal bankruptcy law, which, arguably, the Court in Bekins adopted:
Id. at 541-42, 56 S.Ct. 892 (citations omitted) (emphasis added).
That order, however, did not preclude the City from arguing later that the stay of 11 U.S.C. § 362(a)(3) applied as of the bankruptcy filing. Indeed, at the hearing on the motions that resulted in these orders, the Court expressly stated: "The Court is not ruling on whether any orders entered by the state court after this bankruptcy case was filed violated the automatic stay." Hrg. Tr. 84:10-16, July 24, 2013. (Dkt. # 188)
That issue is now squarely before the Court. For the reasons stated in the text, the Court concludes that the automatic stay of § 362(a)(3) was applicable to the Flowers, Webster and General Retirement Systems state court cases from the moment the City filed its bankruptcy petition.
