What Happens to Detroit’s Pensions in Bankruptcy?

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The General Retirement System of Detroit and the Police and Fire Retirement System of Detroit recently filed a suit attempting to enjoin Governor Richard Snyder and Emergency City Manager Kevyn Orr from, among other things, “any action that causes the City’s pension debts to be subject to impairment under Chapter 9 of the United States Bankruptcy Code.”  In other words, declare bankruptcy if you want, but don’t touch our pensions.

The legal argument of the retirement systems goes something like this:

  • Governor Snyder and Emergency Manager Orr swore oaths to uphold the Michigan Constitution.  
  • Under Article IX, Section 24 of the Michigan Constitution, “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.”
  • The city owes the retirement systems and pensioners accrued financial benefits, which under the Michigan Constitution are contractual obligations.
  • By seeking to impair the accrued benefits by way of a bankruptcy proceeding, the Governor and Emergency Manager are violating the state constitution and breaking their oaths.

OK, but Detroit is broke and broken.  Something has to give.  Or perhaps it is better to say that everything and everyone has to give, including pensioners.  And in such cases, the law seems to me to be on the side of Governor Snyder and Kevyn Orr.  As Amy Monahan has argued in a piece I referenced earlier:

[I]t is well established that the [Constitutional] prohibition against the impairment of contracts “must be accommodated to the inherent police power of the State ‘to safeguard the vital interests of its people.’” . . . Courts undertake a three-part analysis to determine whether state actions that potentially affect contracts are unconstitutional under the Contract Clause. The first step is to determine whether a contractual relationship exists. Where the statute at issue is ambiguous, the court looks to whether “the language and circumstances evince a legislative intent to create private rights of a contractual nature enforceable against the State.”

The second step in a contract clause analysis is to determine whether the state action constitutes a substantial impairment of a contractual relationship. An impairment occurs if it alters the contractual relationship between the parties and is substantial—for example, “where the right abridged was one that induced the parties to contract in the first place, or where the impaired right was one on which there had been reasonable and especial reliance.”  

. . . Finally, if a substantial impairment is found, a court may nevertheless  find the change to the relevant contract constitutional if it is justified by an  important public purpose and if the action undertaken to advance the public interest is “reasonable and necessary.” In determining whether the action is aimed at an important public purpose, courts look to see whether there is a “significant and legitimate public purpose behind the regulation, such as the remedying of a broad and general social or economic problem.” Doing this ensures that the state is actually acting under its police power and not “providing a benefit to special interests.”  . . . In addition, in determining reasonableness the court takes into account the degree of impairment. The state’s action is considered to be necessary when (1) no other, less drastic modification could have been implemented, and (2) the state could not have achieved its goals without the modification.

Let’s stipulate the first part of the test has been met in favor of the retirement systems: there is an unambiguous provision in the Michigan Constitution stating that there is a contract here.  Let’s also stipulate that the city’s bankruptcy would result in a substantial impairment to their benefits.  It is not clear yet how much of an impairment the bankruptcy will bring, but no doubt it is going to be painful.

The last part of the test is where the case should be decided (by whichever court rules on the matter–and it may not be the state court, since the federal court handling the bankruptcy filing can adjudicate the state claim as well).  Is the bankruptcy action “justified by an important public purpose and the action undertaken to advance the public interest ‘reasonable and necessary’”?  It seems so to me.  If this isn’t a broad social and economic problem, I don’t know what you’d call it.  And Detroit’s pension obligations form a huge part of its debt burden– Detroit has $3.5 billion in unfunded liabilities–and no real solution to the problem seems possible without some (more) sacrifice by the pensions.  And certainly the pensions know that, and this case 1) simply demonstrates that the trustees of the pension funds are going to do their best to fight the good fight for the pensioners, and 2) serves as a bargaining chip to extract some concessions from the city (subject to court approval) in a bankruptcy proceeding.

 The pension funds think Orr is playing hardball by filing for bankruptcy.  I don’t think he had any other realistic choice, and he seems to be negotiating in good faith.  Don’t forget that Kevyn Orr knows how to manage such negotiations, having represented Chrysler in its bankruptcy. 

 

[Image: Time.com]

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