Chapter 9 and public pensions

March 18, 2014

empty pockets image: bankruptcy or debt settlement?The filing in 2013 of a Chapter 9 Bankruptcy Proceeding by the City of Detroit highlights again the growing problem of cities not being able to pay for public pensions.

The Wall Street Journal recently published an Editorial Opinion about the “Public Pension Red Alert” (the “Opinion”).  The Opinion quotes Warren Buffett who warned, “local and state financial problems are accelerating because public entities promised pensions they couldn’t afford.” That pretty much says it all!

The Opinion reports Governor Christie’s comments that  pension benefits were increased in good economic times, probably for political support from public unions.  Of course, those who made these deals knew the “pay day” for the increased benefits would not arrive until long after they were out of office.

According to the Opinion, some of the amounts owed are staggering when you consider that we are talking here about unfunded pensions.  For example, take a look at the following chart:

NAME

UNFUNDED PENSION DEBT

DUE DATE

State of New Jersey

-0-

$4.8 Billion

2000

2018

City of Chicago

$1.07 Billion

on Total Pension Debt of $19.4 Billion

2015

California State Teachers’ Retirement System

$71 Billion

 

?

City of Detroit

$3.5 Billion

 

Chapter 9

 

In 2013, the Center for Retirement Research at Boston College estimated the liabilities for state and local pension systems have grown faster than assets resulting in a $2.7 Trillion shortfall as of the end of 2013.

Fortunately for the City of Detroit (and several other cities like Stockton and San Bernandino, California, that have already filed Chapter 9 Bankruptcy Proceedings), the authors of the United States Bankruptcy Code enacted by Congress in 1978 (the “Bankruptcy Code”), included a Chapter 9 called “Adjustment of Debts of a Municipality.”

Not many Chapter 9’s have been filed to date, but I expect  more will be filed in the years ahead because of the public pension time bomb.

The first section of Chapter 9 makes many basic provisions of the Bankruptcy Code applicable in a Chapter 9 Case.  In some ways, a Chapter 9 Case resembles a Chapter 11 Case, but there are a lot of distinct differences.

Section 903 of Chapter 9 (which is a carryover from the old Chapter IX of the Bankruptcy Act) acknowledges that a State, through its Constitution, laws and other powers, has authority over its municipalities.  It recognizes maximum flexibility is advisable for the States in solving the debt problems of their municipalities.

In addition, § 903(c) of the Bankruptcy Code includes a laundry list of requirements that a municipality must satisfy before it can file a Chapter 9, including:

  • Must be a municipality;
  • Must be authorized to file Chapter 9 either by state law, or by a state officer with the power to authorize the filing;
  • Must have negotiated in good faith with its creditors, or been unable to negotiate with its creditors because it is impracticable;
  • Must believe that some creditors will receive transfers that would otherwise be avoidable.

In the Chapter 9 Case of City of Detroit, Michigan , 504 B.R. 79 (Bankr.E.D.Mich. 2013), (the “Detroit Case”), one of the early attacks was on the Bankruptcy Court’s alleged lack of constitutional authority to determine Detroit’s eligibility to file Chapter 9.  However, the Court ruled against this argument.

Another attack was whether Detroit’s Chapter 9 petition was filed in “good faith.”  After a very lengthy opinion, the Bankruptcy Court concluded  Detroit’s Bankruptcy petition was filed in good faith, saying  Detroit’s financial problems, including over $18 Billion in escalating debts, were the kind of debts that Chapter 9 was designed to address.

We’ll keep a lookout for developments in Detroit’s Bankruptcy case.  I’m sure we will have an opportunity to learn more about Chapter 9’s.  And, it will be interesting to see how the Debtor, the Creditors and the Court resolve the entitlement issues on Detroit’s $3.5 Billion pension debt!