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Detroit Bankruptcy Ruling May Reverberate

   Published on:  05 Dec, 2013

In a ruling with potential implications for California public sector unions, a federal bankruptcy judge in Michigan ruled this week that Detroit is eligible to declare bankruptcy and that Detroit’s pension obligations would be treated the same as any other contractual obligation for bankruptcy purposes. The Court found that public employee pensions are not protected in federal Chapter 9 bankruptcy proceedings, even though in this instance, the Michigan Constitution expressly protects them. Specifically, the judge stated, “Pension benefits are a contractual right and are not entitled to any heightened protection in a municipal bankruptcy.” Thus, the Court opened the door for Detroit to unilaterally decrease its pension obligations to current employees and current retirees as part of a Court-approved bankruptcy reorganization plan.

While this decision is concerning, we do not believe it will cause public entities in California to suddenly rush out and declare bankruptcy to avoid pension obligations. First, the judge made it clear that Detroit’s fiscal condition was extremely dire. The City is $18 billion in debt, has lost hundreds of thousands of residents, has only a third of its ambulances functioning, and its police department closes less than 9 percent of cases due to understaffing. We are not aware of any city in California that is in such dire financial straits, even among those (San Bernardino, Vallejo and Stockton) that have already declared bankruptcy. Second, it is unclear whether the Court ultimately will approve any decrease to current retirees’ pensions because Detroit is still obligated to pay everything that it can pay. Thus, the practical effect of this decision remains to be seen. Finally, whether the reasoning employed by the court would apply to a California public entity remains unclear. California, under Assembly Bill 506 (passed October 9, 2011), has strict procedural requirements public entities must adhere to before declaring bankruptcy, as well as decades of case law upholding the inviolability of public pensions. We expect to publish a more detailed analysis of this issue in the next Labor Beat.

If you have any questions, please contact Jennifer Stoughton at jennifer@majlabor.com.