The biggest municipal bankruptcy proceeding in U.S. history is less than a week old but it’s already promising to generate enough legal controversy to gainfully employ the platoons of lawyers vying for a role in the Chapter 9 case. A state court judge in Lansing, Michigan, has teed up a fight over Michigan Governor Richard Snyder’s right to authorize Detroit’s petition for Chapter 9 protection. That’s a novel procedural question, as I’ll explain below. I don’t think doubts about Snyder’s authorization will stop U.S. Bankruptcy Judge Steven Rhodes from pushing Detroit’s Chapter 9 proceeding forward – but they may well impact Rhodes’s eventual determination of the city’s eligibility for Chapter 9 protection.
The issue, as in the bankruptcies of the California cities of Stockton and San Bernardino, is state constitutional safeguards for the pension benefits of municipal workers. Anticipating that the city would try to cut retirement benefits, two sets of pension beneficiaries, as well as Detroit’s two retirement systems, sued in Ingham County Circuit Court before Detroit entered Chapter 9, in an attempt to block the city’s bankruptcy. Their argument, in a nutshell, is that Michigan’s governor is bound to uphold the state constitution, which includes a provision barring the impairment of pension rights for state workers, so he cannot authorize a bankruptcy filing that contemplates any pension reductions. Detroit’s emergency manager, Kevyn Orr of Jones Day, filed for Chapter 9 before any ruling in the three state-court pension suits. But last week, after the Chapter 9 petition, the pensioners returned to court to argue that because the petition was filed under improperly granted gubernatorial authority, it must be withdrawn.
On Friday, Ingham County Judge Rosemarie Aquilina agreed. Aquilina, who sits in the state capital of Lansing, ruled that Governor Snyder’s authorization of a Chapter 9 petition that “threatens to diminish or impair accrued pension benefits” was a violation of the state constitution. She ordered Snyder to instruct Orr to withdraw the petition and barred him from granting Orr permission to file any other Chapter 9 petition that didn’t safeguard pension rights.
Over the weekend, Detroit’s lawyers at Jones Day responded with a motion in federal bankruptcy court to extend Chapter 9′s automatic stay of litigation to suits against the governor, Michigan Treasurer Andy Dillon, and other city and state officials – including a stay of the pension suits before Judge Aquilina. The state attorney general, Bill Schuette, also filed a state court appeal of Aquilina’s rulings.
From developments on Monday, it seems like Rhodes, the federal bankruptcy judge, will have the next word on whether the Chapter 9 goes forward. He ordered a hearing Wednesday on Detroit’s motion to extend the stay of litigation, which is opposed by the city pension funds’ counsel at Clark Hill. Judge Aquilina, meanwhile, adjourned a hearing in one of the pension challenges to the Chapter 9 filing. The Michigan appeals court, according to Reuters, has not acted on the AG’s filing.