Michigan State Judge Rules Detroit Chapter 9 Unconstitutional; Ruling Being Appealed

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Less than twenty-four hours after we learned that the City of Detroit was filing a petition under Chapter 9 of the Bankruptcy Code, a Michigan state court Judge issued an order purporting to find the filing unconstitutional under state law and ordering it being withdrawn, but the matter is already being appealed:

An Ingham County judge says Thursday’s historic Detroit bankruptcy filing violates the Michigan Constitution and state law and must be withdrawn.

But Attorney General Bill Schuette said he will appeal Circuit Judge Rosemarie Aquilina’s Friday rulings and seek emergency consideration by the Michigan Court of Appeals. He wants her orders stayed pending the appeals, he said in a news release.

In a spate of orders today arising from three separate lawsuits, Aquilina said Gov. Rick Snyder and Detroit emergency manager Kevyn Orr must take no further actions that threaten to diminish the pension benefits of City of Detroit retirees.

“I have some very serious concerns because there was this rush to bankruptcy court that didn’t have to occur and shouldn’t have occurred,” Aquilina said.

“Plaintiffs shouldn’t have been blindsided,” and “this process shouldn’t have been ignored.

Lawyers representing pensioners and two city pension funds got an emergency hearing with Aquilina Thursday at which she said she planned to issue an order to block the bankruptcy filing. But lawyers and the judge learned Orr filed the Detroit bankruptcy petition in Detroit five minutes before the hearing began.

Aquilina said the Michigan Constitution prohibits actions that will lessen the pension benefits of public employees, including those in the City of Detroit. Snyder and Orr violated the constitution by going ahead with the bankruptcy filing, because they know reductions in those benefits will result, Aquilina said.

“We can’t speculate what the bankruptcy court might order,” said assistant Attorney General Brian Devlin, representing the governor and other state defendants.

“It’s a certainty, sir,” Aquilina replied. “That’s why you filed for bankruptcy.”

Devlin said Snyder has to follow both the Michigan Constitution and the U.S. Constitution.

Schuette’s office issued a statement saying an appeal has been filed on behalf of the governor in all three cases before Aquilina.

“In addition, the Attorney General filed motions to stay the trial court rulings and any future proceedings while the appeals proceed,” spokeswoman Joy Yearout said. “Later today, we expect to file additional motions seeking emergency consideration.”

Aquilina issued a declaratory judgment that says the bankruptcy filing violated the Michigan Constitution.

“In order to rectify his unauthorized and unconstitutional actions … the Governor must (1) direct the Emergency Manager to immediately withdraw the Chapter 9 petition filed on July 18, and (2) not authorize any further Chapter 9 filing which threatens to diminish or impair accrued pension benefits,” she said in her order.

John Canzano, a Southfield attorney representing retirees, cautioned there are no contempt implications for Snyder if he doesn’t follow the judge’s instructions. But he said he will likely return to court seeking further relief if Snyder doesn’t instruct Orr to withdraw the bankruptcy filing.

Asked what the judge could then do, Canzano said: “I will have to do my homework.”

Douglas Bernstein, a partner with Plunkett Cooney in Birmingham, said Aquilina’s ruling is surprising.

“This is generally how bankruptcies occur: You file bankruptcy when there is an impending crisis at the eleventh hour,” Bernstein said. “You file bankruptcies to stave off litigation.”

University of Michigan law professor John Pottow said the issue could travel up the court system, all the way to the Michigan Supreme Court. Or it could be answered decisively and quickly in bankruptcy court, he said.

“There’s nothing that precludes a federal judge from adjudicating the constitutionality of the Michigan statute,” Pottow said. “The bankruptcy judge can interpret Michigan law.”

Indeed, this is what I would normally expect to see happen. With the understanding that I am not familiar with those provisions of Michigan law upon which Judge Aquilina based her opinion, it strikes me as a tremendous legal stretch to say that Michigan state law would impose a per se bar on any filing of a petition under Chapter 9 of the Bankruptcy Code. Instead, a more reasonable view of the law would seem to be that Michigan law may give pension beneficiaries some set of rights in bankruptcy that would have an impact on how their claims against the city can properly be dealt with. As a general rule, though, the idea that state law can prevent any individual or entity, including a municipality, from exercising their rights under Federal Law seems to be way of the mark. I would expect to see this ruling set aside, either at the appellate level in Michigan, or in Bankruptcy Court itself.

Update: The Detroit News account of today’s hearing includes what I can only call some rather odd comments by the Judge:

Aquilina, who granted the restraining order, clearly was irked.

Prior to her ruling on Friday, she criticized the Snyder administration and Attorney General’s Office for what appeared to be hasty action to outflank pension board attorneys.

“It’s cheating, sir, and it’s cheating good people who work,” the judge told assistant Attorney General Brian Devlin. “It’s also not honoring the (United States) president, who took (Detroit’s auto companies) out of bankruptcy.”

Aquilina said she would make sure President Obama got a copy of her order.

“I know he’s watching this,” she said, predicting the president ultimately will have to take action to make sure existing pension commitments are honored.

Excuse me, Judge Aquilina? What, exactly are you insinuating here? That the Administration should be intervening in Court proceedings to favor one side over the other? And if that’s what she did here, regardless of the law, then it strikes me as highly improper.

Here are Judge Aquilina’s orders:

Webster et al v. Michigan et al by dmataconis

FILED UNDER: Economics and Business, Law and the Courts, Quick Takes, ,
Doug Mataconis
About Doug Mataconis
Doug holds a B.A. in Political Science from Rutgers University and J.D. from George Mason University School of Law. He joined the staff of OTB in May 2010. Before joining OTB, he wrote at Below The BeltwayThe Liberty Papers, and United Liberty Follow Doug on Twitter | Facebook

Comments

  1. Anderson says:

    As a general rule, though, the idea that state law can prevent any individual or entity, including a municipality, from exercising their rights under Federal Law seems to be way off the mark

    Yeah, I need that one explained to me as well.

  2. James Joyner says:

    I think you’re right on the merits. Not being a lawyer: Does a state court judge even consider Federal law implications? That is, is her jurisdiction limited to what the Michigan Constitution says?

    From a pure equity standpoint, I do think state employee pensions should be as close to sacrosanct as possible. Certainly, they should have higher protection than ordinary creditors given their powerlessness.

  3. James,

    A state court judge is as bound by Federal law as they are by state law to be honest. It appears though that this judge based her opinion entirely on her interpretation of the state Constitution. It’s obviously not going to end here and I really don’t expect her ruling to stand.

  4. @James Joyner:

    Certainly, they should have higher protection than ordinary creditors given their powerlessness.

    Just wait until you see what happens to the interest rates on municipal bonds if the court rules a city can underfund its pension and then use that as an excuse to stiff the bond holders.

  5. C. Clavin says:

    My understanding was that the bankruptcy meant everyone, pensioners and bond holders, were going to take a hair-cut…not just pensioners. For bond-holders to walk away clean and pensioners to take the entire hit wouldn’t be right. For the pensioners to try to put it all on the bond holders seems equally wrong.

  6. JohnMcC says:

    Legal question: Could a municipality (Detroit in this case) chose a friendly court in which to file bankruptcy? I see that the GM/Chrysler cases of ’08 were in Federal Court and those settlements had major effects on pensions and such. Why could not the Emergency Manager of Detroit simply file in the same courthouse?

  7. rudderpedals says:

    As to state trumping the fed, the Code would like the chapter 9 petitioner to have express state law authority to be a debtor in a case. http://www.law.cornell.edu/uscode/text/11/109

  8. I’ve read a few articles suggesting that liquidating the assets of the city owned Detroit Institute of Arts museum would likely provide enough money to cover pretty much all of the city’s creditors, pension and bondholders included.

  9. Dave Schuler says:

    It looks as though there’s a conflict in state law. On the one hand, cities may file for protection from creditors but on the other public employee pensions are protected. To my layman’s ear that doesn’t sound as though it should bar the Chapter 9 proceedings from going forward but it may influence the shape of the final resolution.

    The appeals are obvious and it will be ironed out in the courts.

  10. rudderpedals says:

    @JohnMcC: Under the venue statute in title 28 it has to be filed in Detroit’s actual geographic federal district. The local rules probably pin it down into specific division.

  11. Dave Schuler says:

    @Stormy Dragon:

    I’d certainly like to see a reference on that. I have no doubt that Detroit could raise some money by selling off the collection. But the city’s liability has been quoted as being around $18 billion. That would have to be some collection.

  12. legion says:

    @C. Clavin: I think you’re right, and that also sounds like why the bankruptcy was turned back by the judge… while pensioners are unlikely to walk away at full value, their interests should be superior to banks’ & other creditors’. As James points out, even in a class-action setting, they have next to no ability to fight for their own interests, as every dime they spend on legal fees comes, quite literally, off their own plates.

  13. legion says:

    @Stormy Dragon: It would be a start, but the collection is only worth maybe $1-2 billion these days. Not nearly enough to clear the debt in any meaningful way on its own.

  14. Electroman says:

    @Dave Schuler: The DIA collection was valued at “more than $1 billion” in 2004. It’s not likely to be near $18b now.

    http://www.crainsdetroit.com/article/20120112/STAFFBLOG04/120119939/in-a-detroit-fire-sale-assets-might-not-prove-worth-much

  15. Sorry, the articles I was thinking of were comparing the value of the art to the city’s current budget deficit rather than to its long term liabilities.

  16. JKB says:

    Well, if this should make things interesting. As it stands, only a fool buys bonds, municipal or corporate, in any entity governed by Michigan law or with a large union influence. Or at least you don’t buy them thinking the bonds are not subordinate to other debt holders.

    Not really an issue with bankrupt Detroit but if it turns out pensioners have a superior claim in bankruptcy, i’d expect a lot of lawsuits against Michigan government entities claiming fraud since it appears such claims weren’t revealed in the bond prospectus.

    I see so many wanting to stick it to the banks and investors. But you might realize that many holders of municipal bonds are pension funds, life insurance companies, etc. The kind who will now have to dump the bonds since a slip in the bankruptcy hierarchy is sure to affect the credit rating for all municipal bonds.

  17. Gromitt Gunn says:

    It seems to me that if any party should be subordinate, it should be the bondholders. No one forced them to buy what is clearly non-investment grade debt. On the other hand, the deferred compensation of the employees was a condition of employment – there’s no way to opt out of pension plan participation.

  18. @JKB:

    The kind who will now have to dump the bonds since a slip in the bankruptcy hierarchy is sure to affect the credit rating for all municipal bonds.

    I’m pretty sure that if you’re in bankruptcy, your credit rating is by definition as low as it can get regardless of the payout order.

  19. @Gromitt Gunn:

    No one forced them to buy what is clearly non-investment grade debt.

    Precisely the problem for the cities: if the bond investors decide that being subordinate to underfunded public pensions is too much of a risk, no one is going to force them to buy what is clearly non-investment grade debt.

    How many cities are going to be able to function if they have to finance their debt at 15-20% interest?

  20. PD Shaw says:

    States can prohibit their municipalities from filing Chapter 9, or as I think many do, require the municipalities to first obtain state approval. I think the U.S. Supreme Court has required the bankruptcy courts to recognize these statutory limitations as Constitutionally protected interests in state sovereignty.

    But the judge does not appear to be citing any statutory law that expressly prohibits the filing or requires procedural pre-conditions to be performed. She is claiming implications of future uncertainties. Seems completely off to me.

  21. PD Shaw says:

    The real question is:

    Does Detroit have enough money to pay its pension obligations without future borrowing?

  22. Gustopher says:

    @Stormy Dragon: that’s a feature, not a bug. Cities should be funding their pensions, and the ones that do will be able to borrow for other reasons cheaper.

  23. Gromitt Gunn says:

    @Stormy Dragon: That seems like a feature, not a bug, to me. There’s no way that every General Obligation municipal issues deserves a rating somewhere in the investment-grade range from Moody’s and Fitch, but the ratings agencies act as though they are actually engaging in true due diligence.

    Investors don’t have a right to risk-free return on non-investment grade instruments, but they act as though they do when they’re building their portfolios. If fund managers have to put in more work beyond plugging data sets into their proprietary quantitative models, and then justify the results after the fact when they screw up, I think that is a good thing.

  24. @Gustopher:
    @Gromitt Gunn:

    Oh I agree that should be our goal, but that’s not the present state. Pretty much all municipalities are running deficits and nearly all have underfunded pensions. I don’t think the solution is to create a situation where the municipal bond market more or less disappears and these cities are unexpectedly required to balance their budgets RIGHT NOW.

  25. JKB says:

    @Stormy Dragon: I’m pretty sure that if you’re in bankruptcy, your credit rating is by definition as low as it can get regardless of the payout order.

    True, but if the judges determination of Michigan law stands, that pension obligations can’t be reduced in bankruptcy, then all municipalities in Michigan who have pension obligations are suddenly not going to get good rates on bonds.

  26. Kenny says:

    Curious. The following graph has been removed from that second story. Can’t imagine why …

    “I know he’s watching this,” she said, predicting the president ultimately will have to take action to make sure existing pension commitments are honored.

  27. JohnMcC says:

    @rudderpedals: Thank you, my kayaking friend, for the heads-up regarding Title 28. Playing with that clue on the inter-webs led me to several interesting and informative sites the best of which (or at least the clearest writing for non-lawyers) was ‘Commercial Bankruptcy Alternatives’ which recently (April of ’13) summarized the pertinant section of Title 28 (section 1408) as saying that bankruptcy may be filed in any court if the following qualifications are met: location (where it was ‘domiciled’), residency, location of principal source of business, or had it’s headquarters, or where an affiliate has also filed for bankruptcy.

    Which taken together brings me back to my question: If the rights of pension funds under Michigan law are a problem for the continuance of the proceedings, why is the City not filing in Federal Court where pension funds (as at GM & Chrysler) have taken their ‘white-side-wall’ haircuts. There does not seem to be a Title 28 problem with that. And I doubt that the Emergency Manager, Mr Orr, has such tender feelings for the pensioners of the City of Detroit that he filed in Michigan State Courts for the sole purpose of guaranteeing their pensions.

    The possibility that this was poor planning on his (or ‘their’ — considering he reports to the Governor Mr Snyder) … seems doubtful. This has been forseen for at least months.

  28. rudderpedals says:

    @JohnMcC:

    The bankruptcy court is administratively a piece of the district court but at the end of the day a district court Article III judge gets the final say. As you point out it wasn’t any secret that a filing was coming.

    The people you mentioned were openly threatening this for some time as the city manager was outwardly trying to work something out with its creditors but apparently could not. The city will need to prove deadlocked negotiations and express state law authority to overcome the looming motions to dismiss. The Anna Nicole Smith case teaches that the second question is a question Michigan courts get to answer. I expect to wait.

    For city retirees, general obligation bondholders, vendors and other unsecured creditors, they’re equally toasted in chapter 9. They’re at the end of the line.

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  30. JohnMcC says:

    @rudderpedals: Truly an “OMG” situation, sir. According to USA Today of yesterday (Legal Battle Brews Over Detroit Bankruptcy Filing, 7/19/13), “…the order from Ingham County Circuit Court Judge Rosemarie Aquilina ultimately could have little effect because the bankruptcy case already was filed in federal court….The city is asking US District Judge Stephen Rhodes to hold a hearing on Tuesday, or earlier….”

    But thank you for the assistance as I sneaked around the legal sites on the internet.

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