Detroitfs financial woes reveal tension between state pension laws, federal bankruptcy laws
By David A. Lieb, THE ASSOCIATED PRESS
July 24, 2013 - via The Montreal Gazette
As the once-proud city of Detroit humbles itself in bankruptcy court, its
financial future may hinge on this key question: Is the city obliged to its
past? Or can Detroit renege on its promises to thousands of retirees for the
sake of its present city services?
The legal question at the heart of
Detroit's bankruptcy filing has never definitively been answered by the nation's
highest courts. But it could become increasingly important as cities from coast
to coast are grappling with shortfalls in pension funds that left unchecked
could force cutbacks to police, firefighters and other essential city
services.
A federal judge overseeing Detroit's bankruptcy case is to hold
his first hearing Wednesday, as Detroit spars with its employees over whether
state lawsuits from pension beneficiaries can proceed.
Some cities, like
Detroit, are located in states where pension benefits are guaranteed in full
according to state constitutions, statutes or court precedent. Yet Detroit's
emergency manager is asserting that those guarantees go away in federal
bankruptcy court, leaving retirees in the same pool as numerous other creditors
who may get mere cents for each dollar they are owed.
"There's not a lot
of previous case law that tells us what's going to happen here," said Paul
Secunda, a Marquette University law professor who specializes in labour and
benefits issues.
"It's not just an issue of bankruptcy law and pension
law, it's also an issue of federalism," Secunda said. "Can a federal bankruptcy
court basically ignore a state constitutional provision and allow a city like
Detroit to ignore its previous promises concerning public employee
pensions?"
The question matters because pensions pose a major liability
for states, counties, cities, schools and other local governmental entities. A
report released earlier this year by the Pew Charitable Trusts found that the
nation's largest cities had a combined pension shortfall of almost $100 billion
and an even larger shortfall in retiree health-care benefits as the nation's
financial crisis peaked in the 2009 fiscal year.
Although municipal
finances generally have improved since then, many local retirement plans remain
on an unsustainable path, the Pew organization said.
Michigan Gov. Rick
Snyder and Detroit emergency manager Kevyn Orr contend that retiree benefits
should be able to be trimmed along with other debts to restore the city's
finances. Detroit has about 21,000 retired workers who are owed benefits, with
underfunded obligations of about $3.5 billion U.S. for pensions and $5.7 billion
for retiree health coverage.
"There have to be concessions," Orr said
earlier this week.
A similar situation is unfolding in Stockton, Calif.,
which entered bankruptcy in April after its property tax revenues were hit hard
by the housing crisis. Stockton owes the California Public Employees' Retirement
System about $900 million to cover pension promises, by far the city's largest
financial obligation. The city already has tried to save costs elsewhere by
slashing employment, cutting health benefits for current workers and limiting
its police force to responding only to emergencies in progress.
Bond
insurers contend that pension cuts should be part of Stockton's debt reduction
plan to be submitted to a bankruptcy judge in September. Attorneys for the
creditors argue that employees who benefited when economic times were good
should have to share the pain now that times are bad.
But union
representatives contend retiree benefits already have been earned and shouldn't
be part of the discussion in bankruptcy court.
"It's essentially similar
to salary — you just don't reach inside somebody's savings account and take
their pay back, nor should you reach inside their pension and deny them their
pension benefits," said Steve Kreisberg, director of collective bargaining and
pensions for the American Federation of State, County and Municipal
Employees.
The legal arguments could centre on two provisions of the U.S.
Constitution — Article 6, which declares U.S. laws to be supreme; and the 10th
Amendment, which reserves for states all powers not constitutionally delegated
to the federal government.
Laws governing local public employee pensions
are one of those areas left to state control.
Federal bankruptcy laws
also require states to grant permission before their local governments can file
Chapter 9 municipal bankruptcy cases. Only about half the states have authorized
municipal bankruptcy filings, and many of those have done so only in limited
circumstances.
The question for courts is whether a state's pension laws
take greater precedence because of their 10th Amendment powers, or whether
states have essentially waived that right by agreeing to let cities to
participate in federal bankruptcy proceedings.
"The cases in Stockton and
Detroit are similar in that they will answer the question on how far the U.S.
Bankruptcy Code goes and whether that trumps state law," said Karol Denniston, a
San Francisco attorney who specializes in municipal restructuring and monitors
bankruptcies across the nation. "There are a lot of cities watching how this
plays out."
Other recent municipal bankruptcies provide only limited
guidance.
Rhode Island lacked a pension-guarantee law similar to
Michigan's when the city of Central Falls filed for bankruptcy in 2011. Under a
settlement approved last year by a federal bankruptcy judge, some retired
Central Falls workers took pension cuts of more than 50 per cent. But the state
created a fund to help offset some of those lost benefits.
The city of
Vallejo, Calif., which filed for bankruptcy in 2008, had threatened to stop
paying pension benefits, but an out-of-court settlement was reached that set no
precedent on the issue.
If a federal bankruptcy judge in Detroit or
Stockton overrules state laws against pension reductions, "we would have a
constitutional crisis at that point," said Hank Kim, the executive director of
the National Conference on Public Employee Retirement Systems, a trade
association for public pension plans.
But it also could provide a path to
financial stability for other troubled cities.
"It could potentially have
a large impact in how these pension obligations get treated," Secunda
said.
© Copyright (c) The Montreal Gazette