U.S. Workout/Insolvency Law Course University of Belgrade Faculty of Law FALL 2015 Select Issues With Respect to the Filing of Chapter 9 Bankruptcy by

U.S. Workout/Insolvency Law CourseUniversity of Belgrade Faculty of LawFALL 2015

Select Issues With Respect to the Filing of Chapter 9 Bankruptcy by the City of DetroitJ. Robert StollMayer Brown LLPVisiting ProfessorUniversity of Belgrade Faculty of Law

Aaron GavantMayer Brown LLP

I. Detroit declared in “financial emergency” under state law – March 1, 2013

II. Kevyn Orr appointed as Detroit’s emergency manager – March 14, 2013

III. Filing of Chapter 9 Petition – July 18, 2013

• Approximately 100,000 Creditors

• 20,000+ current and retired employees

IV. Plan of adjustment approved – November 7, 2014

Introduction

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Legal Challenges to Detroit’s Chapter 9 Petition

o Constitutionality under U.S. and Michigan State Constitutionso Does Chapter 9 of the Bankruptcy Code violate the U.S. constitutiono Can the Bankruptcy Court determine the constitutionality of the

Bankruptcy Codeo Michigan Public Act 436 (2012) violates the Michigan constitution (and

therefore Detroit is not validly authorized to file Chapter 9 bankruptcy case)

o Does the Bankruptcy Court have the authority/jurisdiction to determine constitutionality of Michigan Public Act 436

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• U.S. Constitutiono U.S. Constitution, Art. I, Sec. 8, Clause 2-- Power to establish bankruptcy

laws:

“The Congress shall have power to . . . establish . . . uniform Laws on the subject of Bankruptcies throughout the United States . . .”

o U.S. Constitution, Tenth Amendment – powers not given to federal government reserved for states:

“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.”

o U.S. Constitution, Art. VI, Clause 2 – “Supremacy clause”:

“The Laws of the United States . . . shall be the supreme Law of the Land.”

Legal Challenges -- Selected Applicable Bankruptcy Code and State Law Provisions

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• 11 U.S.C. § 903 – Reservation of State power to control municipalities:

This chapter does not limit or impair the power of a State to control, by legislation or otherwise, a municipality of or in such State in the exercise of the political or governmental powers of such municipality, including expenditures for such exercise, but –

(1) A State law prescribing a method of composition of indebtedness of such municipality may not bind any creditor that does not consent to such composition; and

(2) a judgment entered under such a law may not bind a creditor that does not consent to such composition.


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• 11 U.S.C. § 904 – Limitation on jurisdiction and powers of court:

Notwithstanding any power of the court, unless the debtor consents or the plan so provides, the court may not, by any stay, order, or decree, in the case or otherwise, 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 enjoyment of any income-producing property.


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o Eligibility o Detroit’s emergency manager was not an elected official and hence

did not have authority to file Chapter 9 petition

o Since Governor’s authorization to file Chapter 9 did not prohibit Detroit from impairing pension rights, authorization was not valid under the Michigan constitution and Section 109(c)(2) of the Bankruptcy Code.

o Because a Michigan state court had determined that the City was precluded from filing Chapter 9, later filing was invalid

Legal Challenges to Detroit’s Chapter 9 Petition

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• Michigan State Law

o Michigan Public Act 436 – Appointment of Emergency Manager

o Michigan Constitution Article IX, § 24 – Protection of Public Pension Benefits:

“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.”


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o City of Detroit was not insolvent – Section 109(c)(3), definition of insolvency – Section 101(32)(c)

o City of Detroit did not desire “to affect the plan to adjust such debts” (Section 109(c)(4))

o City of Detroit did not negotiate in good faith (Section 109(c)(5)(B)

o City of Detroit was not “unable to negotiate with creditors because such negotiation was impracticable” (Section 109(c)(5)(C))

o Chapter 9 Petition was filed in bad faith (Section 921(c))

Factual Challenges to Detroit's Chapter 9 Petition

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• 11 U.S.C. § 109(c) – eligibility to file under Chapter 9:

(c) An entity may be a debtor under chapter 9 of this title if and only if such entity –

(1) is a municipality;

(2) is 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;

(3) is insolvent;

(4) desires to effect a plan to adjust such debts; and

(5) (A) has obtained the agreement of creditors holding at least a majority in amount of the claims of each class that such entity intends to impair under a plan in a case under such chapter;

Factual Challenges -- Selected Applicable Bankruptcy Code and State Law Provisions

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• 11 U.S.C. § 109(c) cont.

(B) has negotiated in good faith with creditors and has failed to obtain the agreement of creditors holding at least a majority in amount of the claims of each class that such entity intends to impair under a plan in a case under such chapter;

(C) is unable to negotiate with creditors because such negotiation is impracticable; or

(D) reasonably believes that a creditor may attempt to obtain a transfer that is avoidable under section 547 of this title.”


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• 11 U.S.C. § 101(32)(C) - definition of “insolvency” with respect to a municipality:

(C) With reference to a municipality, 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) unable to pay its debts as they become due.


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o Allows City to cut $7 billion of unsecured liabilitieso Retiree pensions cut by 4.5% with majority of retirees not to

receive annual cost of living adjustmentso Denial of appeal by dissenting retirees – arguments not directly addressed

(ruled equitably moot)

o Retiree health benefits cut by 90%

o Bondholders and bond insurers recover at very low rate (e.g., Syncora, as bond insurer, accepting $0.14 on the dollar)

o City’s contribution to pension plans based on expected rate of return of 6.75% on pension investmentso Debate on whether rate is reasonable

Plan of Adjustment

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o “Grand Bargain”o Detroit Institute of Art collection valued at

approximately $4 - 4.5 billion o Collection not sold so long as museum contributed

at least $500 million toward paying off city’s debto Museum raised $800 million, including $330 million

from philanthropic organizations and $200 million from the state of Michigan

Plan of Adjustment

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• Section § 943(b) – Chapter 9 Confirmation requirements:

(b) The court shall confirm the plan if –

(1) the plan complies with the provisions of this title made applicable by sections 103(e) and 901 of this title;

(2) the plan complies with the provisions of this chapter;

(3) all amounts to be paid by the debtor or by any person for services or expenses in the case or incident to the plan have been fully disclosed and are reasonable;

(4) the debtor is not prohibited by law from taking any action necessary to carry out the plan;

(5) except to the extent that the holder of a particular claim has agreed to a different treatment of such claim, the plan provides that on the effective date of the plan each holder of a claim of a kind specified in section 507(a)(2) of this title will receive on account of such claim cash equal to the allowed amount of such claim;

Plan of Adjustment -- Selected Applicable Bankruptcy Code and State Law Provisions

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• Section § 943(b) cont.

(6) any regulatory or electoral approval necessary under applicable nonbankruptcy law in order to carry out any provision of the plan has been obtained, or such provision is expressly conditioned on such approval; and

(7) the plan is in the best interests of creditors and is feasible.

Plan of Adjustment -- Selected Applicable Bankruptcy Code and State Law Provisions

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o State law restrictions on application of tax revenues remain enforceable in bankruptcy.

o Bondholders entitled to specific pledge of tax obligations should demand the benefit of these pledges and expect recoveries greater than general unsecured creditors.

o Detroit case confirms unique character of lien on pledged, special revenues in Chapter 9.

o While pensions not sacrosanct, given political considerations surround pensions, reasonable to expect Detroit example to be followed elsewhere.

o Creditor should push municipalities to creatively monetize unencumbered municipal assets in Chapter 9.

Lessons Learned

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o Chapter 9 outcomes much more likely to be negotiated then litigated – creditors should therefore aggressively engage in mediation, when available, from the outset.

o Fee examiners likely to become a fixture in Chapter 9 cases.

o Creditors should be prepared to use debtor’s timetable to their advantage.

o In addition to legal realities, creditors and other stakeholders should approach Chapter 9 process with political realties in mind and not be surprised if such realities lead to plan treating situated creditors differently

Lessons Learned

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Documents

U.S. Workout/Insolvency Law Course University of Belgrade Faculty of Law FALL 2015 Select Issues With Respect to the Filing of Chapter 9 Bankruptcy by