With Detroit's Chapter 9 Filing Approved, Some Firms Win Big
UPDATE: 12/5/13, 5:00 p.m. EST. Click here for a copy of Rhodes' 143-page eligibility ruling.
In a historic ruling handed down Tuesday, U.S. Bankruptcy Judge Steven Rhodes approved Detroit’s Chapter 9 petition and made the Motor City the largest U.S. municipality ever to declare itself legally insolvent.
The ruling—which Rhodes issued from the bench and will be memorialized at a later date in what the judge said will be a 140-page written decision—allows the city to slash its pension obligations and sell off municipal assets as it seeks to restructure roughly $18 billion in long-term debt to put itself on sounder financial footing.
“I think this is good news for the city of Detroit,” says David Warfield, a financial restructuring partner at Thompson Coburn in St. Louis who does not have a role in the case but has followed the city’s fiscal travails. “There are so many conflicting interests that there really is no alternative to bankruptcy—you need that central forum to resolve them.”
Vendors, pensioners, and bondholders and their insurers are among the creditors jockeying for supremacy in the bankruptcy proceedings, with each party hoping to recoup as much of what they are owed as they can. Warfield notes that in allowing the city to cut pension benefits during the Chapter 9 process, Rhodes rejected the argument that Michigan's constitution prohibits such a move.
How Rhodes—a tough judge known for running a strict courtroom—resolves the inevitable conflicts between state and federal law will be a key focus as the landmark case unfolds and growing armies of Am Law 200 lawyers do battle on behalf of dozens of clients.
Rhodes’ ruling came on the heels of a nine-day bankruptcy trial last month that saw some creditors accuse Detroit and emergency manager Kevyn Orr—a former Jones Day restructuring partner—of acting in bad faith before the city filed its Chapter 9 petition on July 18.
Jones Day’s retention as Detroit’s lead bankruptcy counsel in March, Orr’s appointment as emergency manager that same month and his subsequent comment to a city pensioner on June 10 that pensions are “sacrosanct” were seized upon by lawyers representing Detroit retirees and city workers during last month’s trial. (Orr, whose $275,000-per-year salary was also questioned, testified that he didn’t intend to mislead anyone.) On Tuesday, Orr welcomed Rhodes’ decision.
“We are pleased with Judge Rhodes’ decision today, and we will continue to press ahead with the ongoing revitalization of Detroit,” the emergency manager said in a statement. “We look forward to working with all our creditors—pension funds, unions and lenders—to achieve a consensual agreement on a restructuring plan that balances their financial recoveries with the very real needs of the 700,000 citizens of Detroit.”
Orr also said that in the weeks ahead Detroit intends to submit a “plan of adjustment” to the court that delineates how it hopes to settle its debts (in a Chapter 9 case, only a debtor may do so). The city also expects to file a disclosure statement by early next year that details its strategy for exiting bankruptcy by the end of September 2014. Among the steps the city has already taken to firm up its financial condition: moving to privatize sanitation services in a way that officials say will save about $6 million a year and arranging a controversial $350 million debtor-in-possession loan that has drawn objections from retirees and some European banks.
As Detroit’s Chapter 9 case proceeds, the city continues to rely on a team of financial, legal, public relations and restructuring advisers and consultants whose fees keep climbing. The Am Law Daily reported in October that Jones Day’s contract with the city is now capped at $18 million. The firm has already been paid about $11 million of that amount, according to our previous reports.