On July 18, 2013, the city of Detroit filed the largest Chapter 9 municipal bankruptcy in the history of the United States. Bankruptcy Judge Steven Rhodes of the United States Bankruptcy Court for the Eastern District of Michigan will preside over the case.
On July 19, 2013, a state court judge ruled that the bankruptcy filing was unconstitutional and must be withdrawn. It is clear from the start that this bankruptcy will be extremely litigious and that various creditors intend to challenge the City's eligibility to file bankruptcy under Chapter 9.
On July 24, 2013, the Bankruptcy Court held the first hearings in the case and ruled that no one may commence or continue any legal action against various local and state governmental employees and representatives that will have an adverse effect on the City. Additional hearings governing certain general procedures for the case and scheduling the timeframe for litigating the eligibility determination will be heard on August 2, 2013.
Overview of Chapter 9-Differences from Other Chapters
Chapter 9 is unlike any other chapter of the Bankruptcy Code, and the power of the bankruptcy court is limited. For example, in a Chapter 9 case, the bankruptcy court cannot dictate the manner in which a municipal debtor operates and cannot force the liquidation of a municipal debtor's assets. Likewise, the creditors of such a debtor are unable to use the powers of the bankruptcy court to reach a municipality's assets during the case.
In a Chapter 9 case the court's primary focus is determining the debtor's eligibility for bankruptcy (which, if contested, may take months to decide); overseeing the assumption and rejection of certain types of contracts and leases; deciding preference and other forms of bankruptcy litigation; and confirming (or declining to confirm) a plan of readjustment.
Post-Bankruptcy Dealings with the City
Even before Detroit's eligibility to be a Chapter 9 debtor is determined, Detroit will enjoy the benefit of the automatic stay. As with any other bankruptcy case, most lawsuits against the city of Detroit will be stopped by operation of law. Creditors will not be able to take any action to collect pre-bankruptcy debts owed by the City. The stay even bars the sending of collection letters regarding pre-bankruptcy debt. Much later in the bankruptcy case, creditors will have the opportunity to file a "proof of claim" which will establish their pro-rata share of payments made by Detroit under a confirmed plan.
Trade vendors will be able to continue to do business with the City during the Chapter 9 case and receive payment in the ordinary course for services rendered and goods provided. To the extent they do not receive prompt payment, vendors may be eligible to receive priority treatment under a confirmed plan. Neither priority treatment nor approval of a Chapter 9 plan is a certainty; therefore, creditors should be extremely cautious in dealing with the City during the bankruptcy. These creditors should seek to negotiate additional protections to ensure payment for post-petition services and goods, including appropriate documentation (with the City in its capacity as a debtor) and, if possible, pre-payment or cash on delivery. Creditors must be particularly careful to avoid any action that could be interpreted as an attempt to collect a pre-bankruptcy debt because that would violate bankruptcy's automatic stay. Creditors should seek assistance of counsel in navigating these difficult issues.
During the case, Detroit will be able to "assume" favorable executory contracts and unexpired leases and "reject" the burdensome ones. To assume such contracts, the City may be required to cure all monetary defaults and provide adequate assurance of future performance. This is what bankruptcy law provides; however, creditors are free to accept less favorable treatment to avoid "rejection" of their ongoing agreements with the City. Creditors faced with this dilemma should contact bankruptcy counsel immediately to help them assess their options and negotiate the best possible treatment under all the circumstances.
If the City rejects an executory contract or unexpired lease, the creditor may be able to assert a claim against Detroit for damages. The extent and validity of that claim will be subject to further determination by the bankruptcy court.
Collective bargaining agreements may be assumed or rejected as well; however, there is likely to be a higher standard associated with their rejection than the standard that applies to other executory contracts. This is expected to be a hotly disputed issue in the case and the outcome of that dispute will be important to the City's plan.
The End-Game: Confirmation of a Plan of Readjustment
The goal of a Chapter 9 is the negotiation, proposal and eventual confirmation of a plan. A "plan of readjustment" is a new contract with a municipal debtor's creditors that establishes how pre-bankruptcy debts and debts incurred during the case will be treated and the terms under which they will be paid over time. While the bankruptcy court's ability to coerce the debtor is more limited in Chapter 9 than in other types of bankruptcies, the bankruptcy court has the broad power to approve the plan over the objection of dissenting creditors and enforce the terms of the plan against them (irrespective of whether they supported the plan). In order to confirm a plan, the City must demonstrate that it satisfies each of several technical requirements, including approval from a sufficient number of stakeholders and proof that Detroit will be able to perform under the plan.