Court Rules That Detroit Is Eligible For Chapter 9 And That Pensions May Be Impaired In Chapter 9

On December 5, 2013, the U.S. Bankruptcy Court for the Eastern District of Michigan released its 143 page decision upholding the City of Detroit's eligibility to be a debtor under chapter 9 of the United States Bankruptcy Code. In re City of Detroit, Michigan, Case No. 13-53846 (Bankr. E.D. Mich. Dec. 5, 2013).1 The Court's decision is the first ever to address the treatment of municipal pensions in bankruptcy, concluding that pension obligations may be adjusted in a chapter 9 case, notwithstanding protective provisions in the state constitution. A similar issue is pending, but not yet decided, in the Stockton and San Bernardino chapter 9 cases in California.

I. Constitutionality of Chapter 9 and the Ability to Impair Pensions

The Court rejected the objectors'2 arguments that chapter 9 violates the Tenth Amendment of the U.S. Constitution. The objectors argued that chapter 9 usurps state sovereignty by invalidating state law protections that are afforded to pensioners. The Court concluded that the issue of chapter 9's constitutionality was already decided in United States v. Bekins, 304 U.S. 27 (1938), where the U.S. Supreme Court upheld the constitutionality of the Municipal Bankruptcy Act of 1937. Further, the Court found that chapter 9 does not violate the Tenth Amendment because it specifically protects a state's right to consent. Here, eligibility for chapter 9 is expressly predicated on a state "specifically authorizing" a municipality to file for chapter 9 and thus chapter 9 is limited to voluntary proceedings.

The Court also rejected certain objections that chapter 9 is unconstitutional "as applied" in this case. The objectors argued that under the Pensions Clause of the Michigan Constitution,3 the pensioners have an absolute right to be protected from any impairment of their vested pension benefits, including in a chapter 9 case. The Court disagreed and found that the Pensions Clause does not afford an absolute prohibition against impairment of vested pension benefits. In analyzing applicable Michigan law, the Court found that the purpose of the Pensions Clause was not to create an absolute protection for pensioners. Rather, the Court found that the state legislature enacted the Pensions Clause to treat pensions as contractual obligations, as opposed to gifts.

Furthermore, the Court found that even though Michigan had a bankruptcy authorizing statute when the state legislature enacted the Pensions Clause in 1963, the state legislature did not take any measures to protect pensions from impairment in bankruptcy. According to the Court, the state legislature could "have given pensions protection from impairment in bankruptcy in several ways," including prohibiting municipalities from filing for bankruptcy, creating a property interest, creating a secured interest in the municipality's property, or explicitly requiring that the State guaranty pension benefits. The Court stated that the state legislature could have provided pensioners with more protections in a municipal bankruptcy, but it declined to do so. Therefore, the Court held that pensions are merely contractual obligations under Michigan law and they are subject to impairment in a federal bankruptcy proceeding.

Furthermore, the Court held that the Bankruptcy Code...