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Sep 27, 2013

Joseph Rothberg’s Article “Beyond Thunderdome: Ch. 9 And Saving The Blighted City” Appears in Law360

Joseph Rothberg’s Article “Beyond Thunderdome: Ch. 9 And Saving The Blighted City” appeared in leading national legal publication Law360’s September 20, 2013 issue.

New York (September 20, 2013, 10:13 AM ET) –

It’s an American city and symbol of an entire industry that experiences an average of 14 arson incidents a day. That alone may sound shocking, but in this city, if you happen to witness an arson and call to report the arson, it takes an average of 58 minutes for the police to arrive. The entire city barely functions on an antiquated infrastructural system, where million-dollar checks can go missing in desk drawers. Welcome to Detroit in 2013.

The images read as if written for a “Mad Max” movie. An American metonym for the manufacturing and innovation that brought the world the mass-produced automobile, Detroit now is plagued by problems of which no other American city of its size, history and prestige can even have nightmares.

As if the years of horror stories finally reached a breaking point, the City of Detroit finally filed for bankruptcy protection under what once was the exceptional Chapter 9 of the Bankruptcy Code on July 18, 2013.

Chapter 9 of the Bankruptcy Code allows insolvent municipalities to file for bankruptcy, and to use bankruptcy procedure to solve their fiscal problems. Bankruptcy provides a financially distressed municipality with protection from its creditors, and enables it to negotiate a plan for readjusting its debts. Through bankruptcy, the locality is able to decrease its debt burden, and to enjoy a fresh start that will hopefully increase its productivity and boost economic development. (See Omer Kimhi, Chapter 9 of the Bankruptcy Code: A Solution in Search of A Problem, 27 Yale J. on Reg. 351, 352-53 (2010)).

It has become well known that the pace of Chapter 9 bankruptcy fillings has increased tremendously in recent years; since 2010 there have been 36 such filings. Should the Chapter 9 process function successfully in Detroit, given the city’s size and notoriety, it may only prove to quicken the pace.

While there remains no guarantee that Detroit’s proposed bankruptcy will be allowed to proceed, or even if it will have the desired effect of turning the economic and fiscal woes of the city around, the Chapter 9 process may be just what the doctor ordered — very, very tough medicine.

The bankruptcy process is not likely to involve making easy choices. Emerging through the Chapter 9 bankruptcy is going to be a process in which the hard choices are finally going to have to be made, such as reneging on long-standing contracts, or laying off thousands of workers in one department in order to hire more police and firefighters. Prioritization of the debts that the city of Detroit has accrued is going to be the painful medicine needed to cure the ailments surrounding that metropolis.

With so many creditors of the city, negotiation of debts with creditors through the bankruptcy process may help the city re-prioritize its services. For example, while extremely painful, politically dodgy and perhaps even patently unfair, the bankruptcy process may aid the City of Detroit with renegotiating debts owed to former city employees due to accrued pensions. Further, under Chapter 9 protection, contracts can be rejected if they are deemed to be so burdensome that they would result in the inability of the debtor to adjust its debt absent rejection. Recently, a California bankruptcy judge has ruled that cities may apply this reasoning to renegotiation of unsustainable pension or other benefits packages.

With the tax base of the city ever decreasing due to depopulation, supporting these pensions may be simply impracticable when faced with the prospect of further reducing city emergency services, which are already abysmal. Furthermore, there is always the fear that, after a Chapter 9 is filed, the city will experience a further exodus of citizens wary of the decrease in certain services and the increase in taxes. Signaling a willingness to reprioritize and modernize city services while simultaneously throwing nonessential contracts to the wayside will be key to battling against further population exodus.

While Judge Steven Rhodes has been expediting the process to determine whether Detroit is even eligible for Chapter 9 bankruptcy, these very real infrastructural problems, that hundreds of thousands of citizens of the City of Detroit are effected by, persist. It seems that bankruptcy and the renegotiation and prioritization of debts and services may be the one thing left that can save Detroit.

While Chapter 9 bankruptcies remain rare, Brutzkus Gubner LLP attorneys Larry Gabriel and Steve Gubner in Los Angeles both have had experience in Chapter 9 cases. Gabriel represented the Orange County Sherriff’s Union in the Chapter 9 bankruptcy, which at the time was the largest municipal bankruptcy in United States history. When the county attempted to terminate the collective bargaining agreement on their own, Gabriel was able to have the court enjoin the termination through a temporary restraining order and a preliminary injunction.

Gabriel notes the complexities and difficulties of large municipal bankruptcies, due to the immense amount of service and union contracts that a typical municipal bankruptcy will have to unravel.

However, Gabriel also notes differences between the Orange County bankruptcy and that of Detroit. While the “big play” in the Orange County Chapter 9 was the suit against the county’s security dealers who had been investing the county’s money, this is a very different problem compared with the underlying issues that brought Detroit the courthouse steps — with the long-term population and structural issues.

This illustrates how the rare and large Chapter 9 bankruptcies are all so unique — no two municipalities will present the exact same issues to resolve.

Should Detroit’s Chapter 9 prove effective at turning the city’s fortunes around, it may serve as a sort of “tipping point” for municipal bankruptcy in the United States. This may be especially true of smaller municipalities within a large region such as Los Angeles which would have more difficulty expanding their tax base to provide cover for debts. Business with extensive municipal contracts and public employee unions thus has every reason to closely monitor the situation in Motor City.

—By Joseph M. Rothberg, Brutzkus Gubner LLP

Joe Rothberg is an associate in Brutzkus Gubner’s Los Angeles office.

Brutzkus Gubner attorneys represented the Orange County Sherriff’s Union in the Chapter 9 bankruptcy mentioned in this article.

The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.

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