CLS Blue Sky Blog

The Detroit Bankruptcy Blueprint

Melissa B. Jacoby is a Professor of Law at UNC Chapel Hill. Melissa B. Jacoby studies and teaches bankruptcy and commercial law and participates in law reform activities in these areas. Photographed by Steve Exum on September3, 2014.

What unites Atlantic City, the Chicago Public School System, and Puerto Rico’s electric company? They are financially distressed government entities facing various legal and political barriers to using the United States bankruptcy system. Negotiations over those barriers are, in part, a referendum on the historic Detroit chapter 9 case – not just the substantive outcome, but the procedural pathway constructed by the court from the case’s inception to the finish line.

Detroit was a game changer in understanding the federal court’s influence through management decisions rather than landmark rulings after trials. According to the conventional wisdom, judges perform primarily gatekeeping roles in chapter 9, ruling on eligibility and plan confirmation after trials. Otherwise, court oversight is thought to be highly restricted. Section 904 of the Bankruptcy Code prohibits the court from using a stay, order, or decree to interfere in municipal decision making, expenditures, asset deployment, and the like, without municipal consent. Most commentators ground that provision in the Tenth Amendment or federalism principles more generally.

As demonstrated in my forthcoming article, the court in Detroit’s bankruptcy formally followed the language of section 904. But functionally, the court and a host of court adjuncts exercised considerable influence over Detroit’s restructuring, operating through channels familiar to civil procedure and federal courts scholars but absent from discussions of municipal bankruptcy. Although several published decisions emerged from the case, including on eligibility and plan confirmation, the vast majority of issues were settled in court-ordered mediation in relatively short order; notwithstanding the level of discord at the case’s outset, even the most hotly contested questions generated no circuit case law, let alone Supreme Court precedent.

A transparency-promoting initiative of the U.S. Bankruptcy Court for the Eastern District of Michigan facilitated my study of Detroit’s bankruptcy: as in other (but by no means all) federal districts, the court digitally recorded hearings and status conferences and posted the audio files on the public court docket. That initiative enabled me to listen to those proceedings in nearly real-time throughout the life of the case. The twist is that close study of these hearings and other sources reveals just how much judicial influence was exercised beyond the courtroom, often behind closed doors. Nonetheless, key channels producing “The Detroit Blueprint” emerged.

The backdrop to The Detroit Blueprint was the special judicial selection rule for municipal bankruptcy cases. Departing from the random assignment norm, section 921(b) of the Bankruptcy Code requires that the chief judge of the court of appeals select a judge to preside. This mandate created the opportunity for an off-the-record conversation between the circuit, district, and bankruptcy courts about the oversight of Detroit’s case.

The selected judge, Hon. Steven Rhodes, who delayed his retirement to preside over the case, planted the additional seeds of oversight and influence in the earliest days of the bankruptcy. He drew on tools and techniques used for decades in other kinds of complex litigation. Upon establishing an optimistic and detailed timeline, Judge Rhodes managed the case on micro and macro levels, using inquisitorial techniques to accomplish indirectly what could not be done directly. Information flowed between the court and parties in the full range of hearings and status conferences, educating the judge about important facts and conveying to the parties the judge’s beliefs and preferences.

Issues at the core of the debt restructuring and the city’s reform were negotiated in confidential sessions heavily supervised by the Chief District Judge of the Eastern District of Michigan, Hon. Gerald Rosen and others he selected (mostly other federal judges). The process was labeled mediation but the activities went far beyond conventional definitions of that term. In crafting and pushing for the central settlement in the case, the “Grand Bargain”, Chief Judge Rosen met and worked with politicians, raised hundreds of millions of dollars from foundations, and became an outspoken advocate for the resulting restructuring plan in written statements and verbal comments at press conferences. In the meantime, the typical appellate pipeline for bankruptcy court orders was all but suspended, in anticipation that settlement would moot the appeals.

Judge Rhodes’s enlistment of additional assistance further increased federal court involvement with state and local affairs. The professionals appointed to evaluate and advise the court on the restructuring plan’s feasibility engaged in considerable contact with city officials and other parties, generating close collaboration and even the provision of direct policy and personnel advice from the court’s non-testifying consultant to Detroit’s mayor.

Back at the courthouse, Judge Rhodes created an inclusive process to bolster the public credibility of Detroit’s restructuring process by extending to citizens and individual retirees the right to participate in certain hearings. The information generated through that process led, perhaps inevitably, to the court’s conveyance of opinions on policy and personnel at times when they were likely to influence the city’s decisionmaking.

The result, as my article documents, was a federal court’s active engagement with and involvement in a city’s restructuring and reform, clashing with the professional and academic literature on chapter 9. Whatever one thinks of the results, they show the impotence of Congressional restrictions on judicial involvement, and cast doubt on the durability of the federalist structure of municipal bankruptcy.

As noted at the outset, deliberations over whether other municipalities should even have access to chapter 9 are in some respects referenda over the court’s management of the Detroit bankruptcy. Part IV of my article identifies two variables key to the portability, or lack thereof, of The Detroit Blueprint for other cases: inter-court coordination, and state municipal takeover law, although more work must be done to convert those factors into testable predictions of legal risk associated with specific geographic locations. Notwithstanding the case’s relatively quick timeline and the restructuring plan’s status as largely consensual under bankruptcy law, elements of The Detroit Blueprint are, and should be, controversial. Operating within an intense judge-supervised negotiation process, all classes of financial creditors eventually fell in line and settled, but some grumble that The Detroit Blueprint did not leave them free to litigate their entitlements. The source of disappointment is not only the payout, but the lack of party control over the process by which their rights were determined. The consequences of this latter risk are particularly difficult to predict, contributing significantly to current opposition to other municipalities seeking chapter 9 relief.

The preceding post comes to us from Melissa B. Jacoby, the Graham Kenan Professor of Law at the University of North Carolina at Chapel Hill. The post is based on her article, which is entitled “Federalism Form and Function in the Detroit Bankruptcy” and available here.

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