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Detroit's Chapter 9 Bankruptcy

The City of Detroit has just filed for Chapter 9 Bankruptcy under the Federal Bankruptcy Code. Chapter 9 is Federal legislation enacted in 1934 during the Great Depression to allow municipalities to reorganize and discharge debts under the U.S. Bankruptcy Court’s supervision. It is interesting to note that according to the Court, in the more than 60 years since Congress established a federal mechanism for the resolution of municipal debts, there have been fewer than 500 municipal bankruptcy petitions filed.

Detroit Chapter 9 Bankruptcy - Legal Opinion

The purpose of Chapter 9 is to provide a financially-distressed municipality with protection from its creditors while it develops and negotiates a plan for adjusting its debts. Reorganization of the debts of a municipality is typically accomplished either by extending debt maturities, reducing the amount of principal or interest, or refinancing the debt by obtaining a new loan.

One significant difference between Chapter 9 cases and cases filed under other chapters is that the Clerk of Court does not assign the case to a sitting judge at Bankruptcy Court. Rather, the chief judge for the 6th Circuit of the US Court of Appeals in Cincinnati will appoint a judge who is deemed to have the time and capability to handle a case of this magnitude. This provision was designed to remove politics from the issue.

The City of Detroit will have broad powers to use its property, raise taxes, and make expenditures as it sees fit. It is also permitted to adjust burdensome non-debt contractual relationships under the power to reject executory contracts and unexpired leases, subject to court approval. But more significantly, the City of Detroit will be able to reject collective bargaining agreements and retiree benefit plans without going through the usual procedures required in Chapter 11 cases. This is crucial given the recent lawsuit filed against the City of Detroit by the retirees of Detroit’s General Retirement System, the Detroit Police and Fire Retirement System, and other pension funds attempting to get the State court to rule the Emergency Manager may not modify or renegotiate pension benefits.

Although similar to other chapters in some respects, Chapter 9 is significantly different in that there is no provision in the law for liquidation of the assets of the municipality and distribution of the proceeds to creditors. The Bankruptcy Court generally is not as active in managing a municipal bankruptcy case as it is in corporate reorganizations under Chapter 11. The functions of the bankruptcy court in Chapter 9 cases are generally limited to approving the petition (if the City is eligible), confirming a plan of debt adjustment, and ensuring implementation of the plan.

What is going to be interesting in the process is what role the Emergency Manager will play. The Chapter 9 Trustee will take over the role that Kevyn Orr was assigned as the appointed Emergency Financial Manager. His role will likely be advisory but the scope of his involvement in the process will depend on the Trustee’s determination for the need and level of Orr’s involvement.

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