What is at stake for pensioners in municipal bankruptcy?

As the Detroit bankruptcy proceeds, a critical question is how much is at stake and what do Detroit pensioners stand to lose in the process?

In July of 2013, the city of Detroit filed the largest municipal bankruptcy case in history. In filing for bankruptcy, the city claimed that is would be unable to meet its financial obligations in full going forward. These obligations included vendor contracts, employee wages and salaries, debt payments and pension payments. One of the biggest challenges facing the city is the amount of unfunded pension obligations that the city owes according to a report filed by the Detroit Emergency Manager Kevyn Orr. The Orr report claims that city has an unfunded liability of nearly $3.5 billion for the two pension systems. Given this fiscal challenge, the city plan includes reducing pension benefits. Yet, there is vehement disagreement over the legality of reducing pension benefits.

Why is there so much disagreement about cutting the pension plans? The reason for the disagreement lies in the Michigan Constitution. The Michigan Constitution in Article 9, Section 24 states that “The accrued financial benefits of each pension plan and retirement system of the state and its political subdivisions shall be a contractual obligation thereof which shall not be diminished or impaired thereby”. The bottom line is that pensioners who work and earn a pension benefit cannot have that benefit taken away under Michigan law.

But the story does not end there. Federal law lays out the process for a municipal bankruptcy. In a bankruptcy trial, a federal judge has the power to approve the termination of ongoing contracts. The language in U.S. law is that “the trustee, subject to the court’s approval, may assume or reject any executory contract or unexpired lease of the debtor” (11 USC §365). Above, the Michigan Constitution defined a pension as a “contractual obligation” and therefore it may be subject to the trustee (Detroit Emergency Manager) and the federal judge’s approval to terminate or alter this contract.

But why can a federal court overrule the Michigan Constitution? In the U.S. Constitution in Article 6, Clause 2, there is a principle known as the supremacy clause. The Supremacy Clause reads “This Constitution, and the Laws of the United States which shall be made in pursuance thereof; and all treaties made, or which shall be made, under the authority of the United States, shall be the supreme law of the land; and the judges in every state shall be bound thereby, anything in the constitution or laws of any state to the contrary notwithstanding”. This clause can be interpreted as saying that a federal court has the power to supersede a state law or even a state constitutional provision.

In the Detroit bankruptcy case, these competing state and federal legal principles will clash and ultimately it will be up to the federal bankruptcy judge to decide whether he is willing to override the Michigan constitution and reduce city pensions. Based on current estimates, Detroit pensioners may see only cents on the dollar for what they were expecting. The representatives of the pensioners are demanding that the city be declared ineligible for bankruptcy protection. Their reasoning is that the Governor in approving a bankruptcy filing by the city violated the Michigan Constitution. The violation occurred because the pension representatives believe that the Governor approved a bankruptcy filing knowing the pensions would be a target for diminution. Regardless of the outcome, the Detroit case will set precedence for public pensioners around the county as municipalities continue to struggle with fiscal distress. For specific answers to public policy questions or the Detroit municipal bankruptcy, contact a Michigan State University Extension educator in your area.

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