Facing billions in debt, Detroit files for bankruptcy
DETROIT — Detroit filed Thursday afternoon for Chapter 9 bankruptcy protection in federal court, laying the groundwork for a historic effort to bail out a city that is sinking under billions of dollars in debt and decades of mismanagement, population flight and loss of tax revenue.
The filing begins a 30- to 90-day period that will determine whether the city is eligible for Chapter 9 protection, the court proceeding used by municipalities, and will define how many claimants might compete for the limited settlement resources that Detroit has to offer.
The bankruptcy petition seeks protection from creditors and unions that are renegotiating up to $20 billion in debt and other liabilities.
Detroit emergency manager Kevyn Orr, who in June released a plan to rem
structure the city’s debt and obligations that would leave many creditors with much less than they are owed, had warned consistently that if negotiations hit an impasse, he would move quickly to seek bankruptcy protection.
“Let me be blunt: Detroit’s broke,” said Michigan Gov. Rick Snyder, who signed off on the filing.
Snyder outlined the city’s failures Thursday, including failing public services: Detroit has been among the nation’s 10 most violent cities for 24 of the past 27 years. Average police response time is 58 minutes, compared with a national average of 11 minutes. Only 8.7 percent of criminal cases in the city are cleared.
The announcement came four months after Snyder named Orr as emergency financial manager to try to heave Detroit out of its fiscal morass. Orr at the time insisted that the city could “rise from the ashes.”
But Orr sent a letter to the governor earlier this week saying “Detroit today is a shell of the thriving metropolis that it once was,” and that he saw no alternative to filing for Chapter 9.
“Despite Mr. Orr’s best efforts, he has been unable to reach a restructuring plan with the city’s creditors,” the governor wrote Thursday in a letter approving the filing. “I therefore agree that the only feasible path to a stable and solid Detroit is to file for bankruptcy protection.”
This week, the city’s two pension funds, which have claims to $9.2 billion in unfunded pension and retiree health-care liabilities, filed suit in state court to prevent Orr from slashing retiree benefits as part of a bankruptcy restructuring.
Ambac Assurance Guaranty, which insures some of the city’s general-obligation bonds, has also objected to Orr’s plan to treat those bonds as “unsecured,” meaning they are not tied directly to a revenue stream and would receive pennies on the dollar of their value. Ambac and other creditors also have threatened to file suit.
Orr had reached a deal with some creditors, widely reported to be Bank of America Corp. and UBS AG, to pay a $344 million swap with a $255 million debtor-in-possession loan.
The deal gives the city access to $11 million a month in casino tax revenue that Orr has said is key to maintaining city services while negotiations, in or out of bankruptcy court, take their course with other creditors and unions.
On Monday, an Ingham County Circuit Court judge was scheduled to hold a hearing on the city workers’ and retirees’ bid to stop the city from filing bankruptcy.
The employee groups and pension funds had argued that the governor — who under Michigan law must authorize any bankruptcy filing — could not do so if the filing includes plans to reduce pension benefits, because the state’s constitution explicitly protects public pensions.
Michigan bankruptcy lawyer Doug Bernstein, who is not involved in the bankruptcy and is not representing any parties related to it, said preventing the court hearing Monday was likely a key part of the strategy behind the Chapter 9 filing, because a ruling in favor of the employees could put a halt, at least temporarily, to any moves by Orr and Snyder to proceed with a bankruptcy petition.
A bankruptcy filing immediately stays all such court proceedings.
“The stay kicks in as soon as the filing,” Bernstein said. “The key is taking advantage of the automatic stay. Because of the lawsuit filed by the pension funds and the hearings coming up Monday, it became a factor.”
Michael Sweet, a bankruptcy attorney in Fox-Rothschild’s San Francisco office, said the city would pay current employees, but “beyond that, all bets are off.”
“They don’t have to pay anyone they don’t want to,” Sweet said. “And no one can sue them.”
Orr said Thursday evening that Detroit would continue paying its bills and employees.
The 30- to 90-day eligibility fight could be prolonged beyond that time frame if creditors mount a significant challenge to Detroit’s eligibility for bankruptcy. In other communities that have filed for Chapter 9 protection, such fights have extended the process a year or more.
Detroit’s is by far the largest municipal bankruptcy in U.S. history, in terms of the city’s population and the amount of its debts and liabilities.
At its peak in the 1950s, Detroit was the nation’s fourth-largest city, with more than 1.8 million people. Population losses began in the 1960s with migration to the suburbs, picking up after a race riot in 1967. The exodus gained further momentum as the automobile industry shrank.
Now, Detroit has about 700,000 people and thousands of abandoned buildings with acres of neglected lots. Thirty-eight cents of every city dollar goes to debt repayment and unfunded liabilities, the governor said.
By 2017, Snyder said, that would jump to 65 cents per $1.
The city’s budget deficit is believed to be more than $380 million, and Orr has said long-term debt was more than $14 billion and could be as much as $20 billion.
“That’s not a sustainable situation,” said the governor, who called Chapter 9 “the opportunity for a fresh start,” not just for Detroit but for Michigan.
The debt in Detroit dwarfs that of Jefferson County, Ala., which had been the nation’s largest municipal bankruptcy, filed in 2011 with about $4 billion in debt. The population of Detroit, the largest city in Michigan, is more than twice that of Stockton, Calif., which filed for bankruptcy in 2012 and had been the nation’s most populous city to do so.
Other major cities, including New York and Cleveland in the 1970s and Philadelphia two decades later, have teetered near the edge of financial ruin but ultimately found solutions other than federal court. Detroit’s struggle, experts say, is particularly dire because it is not limited to a single event or one failed financial deal, like the troubled sewer system largely responsible for Jefferson County’s downfall.
The Detroit case is expected to have an impact on residents statewide, including the 30,000 current and retired city workers, and could affect the city’s ability to stay in business. It could also set an important trajectory for the way troubled cities nationwide settle their financial difficulties, experts said.
“If you end up with precedent that allows the restructuring of retirement benefits in bankruptcy court, that will make it an attractive option for cities,” said Karol Denniston, a bankruptcy lawyer who is advising a taxpayer group in Stockton. “Detroit is going to be a huge test kitchen.”
Recent memories of bankruptcies by Chrysler and General Motors — and the re-emergence of those companies — appeared to have calmed nerves for some residents and even for one of the automakers.
General Motors does not anticipate any effect on its daily operations, it said Thursday in a statement.
“GM is proud to call Detroit home and today’s bankruptcy declaration is a day that we and others hoped would not come,” the statement said. “We believe, however, that today also can mark a clean start for the city.
But experts say corporate bankruptcy procedures are significantly different from municipal bankruptcies.
In municipal bankruptcies, for instance, the ability of judges to intervene in how a city is run is sharply limited. Municipal bankruptcies are a form of debt adjustment, as opposed to liquidation or reorganization.
Residents are likely to see little immediate change from the way the city has been run since March, when Orr arrived to oversee major decisions. Orr, a bankruptcy lawyer who represented Chrysler during its successful restructuring, is widely expected to continue to run Detroit during a legal process.
For the time being, Mayor Dave Bing and Detroit’s elected City Council members are still paid to hold office and are permitted to make decisions about dayto-day operations, although Orr has the ability to remove those powers at any point.
Bing has announced that he will not seek re-election when his term expires at the end of the year.