Heard About Detroit? The First Word on Treatment of Public Employee Pension Benefits in Chapter 9 (And Absolutely Not the Last)

 by Ben Feder

The recent ruling by Judge Stephen Rhodes finding the City of Detroit eligible for protection under Chapter 9 of the U.S. Bankruptcy Code has rightly received considerable attention. The determination that Detroit has met the standards under Section 109(c) of the Bankruptcy Code to be a debtor under Chapter 9 was widely expected [an annotated version of this statute is available to lexis.com subscribers]. The surprising part of the opinion lies in Judge Rhodes’s express ruling that the pension rights of Detroit’s current and former public employees are simple contractual obligations that may be subject to impairment in bankruptcy. Uncertainty regarding the appropriate legal treatment of pension obligations, and the Tenth Amendment implications in connection therewith, has been a crucial overhanging issue in Chapter 9 municipal bankruptcy cases for several years, and Judge Rhodes’s opinion is the first opinion directly to address it.

In Judge Rhode’s view, Michigan’s public pension rights are not vested property interests, but instead are contractual rights.

The [Michigan] constitution could have given pensions protection from impairment in bankruptcy in several ways. It could have created a property interest that bankruptcy would be required to respect . . . Or, it could have established some sort of a secured interest in the municipality’s property. It could even have explicitly required the State to guaranty pension benefits. But it did none of these.

Instead, both the history . . . and the language of the pension provision . . . make it clear that the only remedy for impairment of pensions is a claim for breach of contract.

As such, Judge Rhodes held that public pension rights may be impaired in bankruptcy, similar to rights arising under any other contract. Judge Rhodes saw no abrogation of the Tenth Amendment, which reserves to states rights not granted to the federal government under the Constitution, because the State of Michigan had expressly authorized municipalities to seek protection under Chapter 9.

Impairing contracts is what the bankruptcy process does. . . For Tenth Amendment and state sovereignty purposes, nothing distinguishes pension debt in a municipal bankruptcy case from any other debt.

The importance of Judge Rhodes’s opinion should not be understated, but at the same time it should not be overstated. His analysis is detailed and well-reasoned. However, the extent to which it will affect or apply to pension obligations in other cities and states, particularly in the California cases where similar issues have been playing out, remains very much an uncertainty. Judge Rhodes’s opinion relied on a detailed parsing of the Michigan statutes and the provisions in the Michigan state constitution, which by itself could limit its applicability.

Other courts are going to weigh in, beginning with the U.S. Court of Appeals for the Sixth Circuit, which will probably hear a direct appeal of Judge Rhodes’s decision. It is likely that at least one court will come to a different conclusion, either due to different underlying facts or a good faith disagreement with Judge Rhodes’s analysis. It is a near certainty that this issue will ultimately wind up before the Supreme Court.

 Read more articles at Kelley Drye & Warren LLP’s Bankruptcy Law Insights blog.

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