Detroit Not Eligible for Bankruptcy, Expert Says

Eric Scorsone, MSU State and City Financial ExpertNo city ever tripped and fell into bankruptcy; especially not any city in Michigan over the past year.

One municipal finance expert described city bankruptcy like an expensive club with spilling lines and an exclusive guest list.

According to Eric Scorsone, extension specialist in State and Local Government at Michigan State University, municipal bankruptcy is something a city has to file for, fight for, and prove. It is expensive, time taking, and choc-full of lawsuits—certainly, no picnic—but it has its perks, too: Like not having to pay bondholders, get sued for mandating wage cuts, or be forced to sell any city assets.

Still, contrary to what Detroit City Council members and Mayor Dave Bing have often implied, bankruptcy is not currently an option for Detroit.

“Detroit can’t get into bankruptcy. Detroit is not eligible,” said Scorsone. “You have to have an emergency manager first. In Michigan, that’s the only route to bankruptcy under Public Act 4.”

“I’ve heard that talk from the City Council,” Scorsone said. “It’s just not accurate. Unless they have an Emergency Manager, they are not going to get into bankruptcy.”

He added that it’s not clear what could happen if PA4 is repealed.

In a way, being getting and emergency manager is a form of bankruptcy, Scorsone said. So why are some officials pushing an EM over filing for broke? One reason is the price ticket.

“Bankruptcy costs a lot of money, ironically,” Scorsone said, noting that the city of Vallejo, California spent over $10 million on bankruptcy lawsuits in 2008. “If you can get the same outcome at a cheaper price, you do that.”

If a city can’t afford it, taxpayers may have to fork over the difference. “If a city owes creditors money, the creditors can go to a judge and argue to put a millage, say, five mils on the ballot. The theory is that you give the city breathing room to get organized.”

But the key difference between bankruptcy the consent agreement (or EM) is that under the consent agreement, the state has more power over city affairs.

“A bankruptcy judge is really almost more of an arbitrator or an administrator than anything else,” Scorsone said. “An EM is kind of in the driver’s seat.”

Still, Scorsone maintains that bankruptcy has plenty of drawbacks.

“When you file, the first thing that happens is the creditors are going to sue to say you are not eligible. This can take a long time and it’s very expensive,” he said. “You have to prove that you can’t pay bills. The judge would have to agree to this.”

Municipal bankruptcy is starkly different from business going bankrupt. “Creditors can force a corporation into bankruptcy but they cannot force a city into bankruptcy,” Scorsone said. Instead of forcing a city to file for bankruptcy, they do the opposite. “Creditors going to make all these arguments that the city’s not insolvent.”

Aside from being cheaper than bankruptcy, the consent agreement could have another silver lining. Because a bankruptcy judge takes a more hands-off approach, he or she is not going to fiddle with any  structures of city government. that may have landed the it in a financial bind in the first place.

“A bankruptcy judge is not gong to fix try to the city’s economy,” Scorsone said. ”Bankruptcy is temporary. It’s not a fix all by any means. It’s a fix of current problem. There are cities that have gone in and out of bankruptcy a number of times.”

Why is the state pushing so hard to avoid bankruptcy? There’s a lot at stake, and not just for Detroit: when it comes to regional governments, every thing’s connected. If the state’s largest city, Detroit, files for bankruptcy, the whole of Michigan will suffer a ripple effect in the form of steeper lending rates and the overall economy would wobble at a time when recovery is paramount.

What the Financial Advisory Board is doing now with union contracts is something that would be done under bankruptcy, too. Under bankruptcy law, it could not be disputed. But the new PA4 law has not been thoroughly litigated.

“The collective bargaining laws that apply have been essentially suspended in the City of Detroit,” Scorsone said of the consent agreement. “To be quite frank this is clearly going to be legally challenged.”

He said he was not sure about the outcome of these lawsuits because rulings in similar cases have gone both ways due to a contract clause in the U.S. constitution. “Contracts are broken all the time and the Supreme Court has interpreted that very differently.”

Some contracts can be broken by declaring a fiscal emergency: that’s the catch. Despite urgent deadlines from the mayor and state officials warning of “payless paydays” have come and gone with no fallout. So it’s not certain if the city is quite yet in a fiscal emergency. Scorsone says there is no clarity on the city’s financial problems but to say the city is out of cash is “probably not an unfair statement.”

“A bankruptcy judge cannot force the City of Detroit to sell Belle Isle,” Scorsone said. “That’s just not accurate.”

Another twist to the bankruptcy option is the logistics: There’s no judge in this circuit that has ever dealt with a municipal bankruptcy.

So the whole affair could turn into a bigger mess under a judge without municipal bankruptcy experience.

If the city files for bankruptcy and gets it, the city can’t its debt wiped out like a person or business can. In fact, it has to pay back everything owed.

“It’s unlikely that bond holders or banks get zero,” Scorsone said. “You can liquidate a corporation but you can’t liquidate a city.” 

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