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Judge to Detroit Pensioners: “Impairing contracts is what the bankruptcy process does”

In an opinion filed December 5, Bankruptcy Judge Steven W. Rhodes ruled that the city of Detroit is eligible to file for bankruptcy. Perhaps more importantly for the 110 parties that unsuccessfully filed objections, Rhodes also ruled that “[p]ension benefits are a contractual obligation of a municipality and not entitled to any heightened protection in bankruptcy.” Such a ruling could have devastating consequences for the thousands of public employees promised benefits in return for years of loyal service.

Detroit owes $18,000,000,000 to over 100,000 creditors. From 2007- 2012, pension payments exceeded contributions and investment income by approximately $1,700,000,000 for the General Retirement System (GRS) and $1,600,000,000 for the Police and Fire Retirement System (PFRS). Absent restructuring, Detroit will have negative cash flows of $190,500,000 for 2014; $260,400,000 for 2015; $314,100,000 for 2016; and $346,000,000 for 2017. The City estimates that by 2017, its accumulated deficit could grow to $1,350,000,000. The average annual benefit received by retired pensioners is about $18,000 for GRS and $30,000 for PFRS.

At common law, pensions were conceived of as a gratuitous benefit and could be revoked at will. However, a clause in the 1963 Michigan Constitution significantly enhanced pension protection: “The accrued financial benefits of each pension plan and retirement system of the state and its political subdivisions shall be a contractual obligation thereof which shall not be diminished or impaired thereby.” Objectors of the bankruptcy such as the Retiree Committee argue that because of this anti-impairment clause, the bankruptcy should be ruled unconstitutional. The issue, as it turns out, hinges in part on a thesaurus. Judge Rhodes suggested that if the Michigan Constitution was drafted to make pension rights inviolable, it “would not have referred to pension benefits as a ‘contractual obligation.’ It also would not have been constructed by simply copying the verb from the contracts clause – ‘impair’ – and then adding a lesser verb –‘diminish’ in the disjunctive ‘Diminish’ adds nothing material to ‘impair.’ All ‘diminishment’ is ‘impairment.’ And, ‘impair’ includes ‘diminish.’”

To further frame the bankruptcy as in accord with the 10th Amendment of the U.S. Constitution, which protects against derogation of states’ rights, Judge Rhodes noted that while the federal government cannot force a state to require a municipal bankruptcy, it may authorize a state to do so. On July 16, 2013, the governor did just that when he approved a recommendation made by emergency manager Kevyn Orr. Ultimately, Rhodes held that the Bankruptcy Clause of the United States Constitution pre-empts the language in the Michigan Constitution and “empower[s] the bankruptcy court to impair contracts and to impair contractual rights relating to accrued vested pension benefits. Impairing contracts is what the bankruptcy process does.”

For pensioners fearing the worst, Rhodes did offer a few conciliatory words. “No one should interpret this holding that pension rights are subject to impairment in this bankruptcy case to mean that the Court will necessarily confirm any plan of adjustment that impairs pensions. The Court emphasizes that it will not lightly or casually exercise the power under federal bankruptcy law to impair pensions.” Emergency Manager Orr said he will submit a plan of adjustment in coming weeks and seek to exit Chapter 9 protection by the end of September. Michigan Council 25 of AFSCME, the city’s largest employee union, filed an appeal to the U.S. District Court for the Eastern District of Michigan and will ask that the case to be sent directly to the 6th Circuit Court of Appeals. Those interested can follow the entire saga on the official court website.

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