Detroit Bankruptcy Plan Advances

Municipal Union Appeals the Ruling, Which Says Pensions Can Be Cut.

Detroit, the fallen capital of U.S. industrial might, was declared eligible Tuesday for the largest-ever municipal bankruptcy, clearing an important hurdle for the cash-poor city to restructure billions of dollars in debt.

Five months after the city filed for Chapter 9 protection, U.S. Bankruptcy Judge Steven Rhodes said Detroit was entitled to reorganize under bankruptcy law, describing his ruling as a potential “fresh start” for the city. The move was opposed by labor unions and civil rights advocates, among others.

Most of the judge’s findings were little surprise: that a city whose fortunes rose and fell with the U.S. auto industry was insolvent, swamped by more than 100,000 creditors and legally authorized to file for bankruptcy.

Judge Rhodes chided the city for giving creditors little time to negotiate, but concluded that such negotiations outside of court would have been impractical. He also found that the state properly used its controversial emergency-manager law to push the city into a filing.

In the most watched part of the case for other struggling cities and states, the judge said Detroit’s public pension holders aren’t entitled to special protection from potential cuts—despite a Michigan state constitutional provision aimed at shielding pensions. Unions and pension funds argued the pensions essentially were untouchable.

The city’s emergency manager unveiled a proposal over the summer calling for only a fraction of the $3.5 billion owed to pension funds to be paid.

“Pension rights are contract rights under the Michigan constitution” and contracts are at risk for cuts under federal bankruptcy law, Judge Rhodes said during his 90-minute presentation outlining his ruling Tuesday.

Michigan is one of only seven states to enshrine protections for government-worker pensions in its constitution, according to the Center for Retirement Research at Boston College. But Judge Rhodes ruled the power of the federal court essentially superseded that state provision.

Public pensions have been a thorny legal issue across the country. In Central Falls, R.I., pensions were reduced by as much as 50%, while retirees in Prichard, Ala., also were hit with large cuts. Illinois lawmakers voted Tuesday to trim state-worker pensions to close a nearly $100 billion shortfall.

The Detroit case also is being closely watched by art lovers, who fear the city might be forced to sell its rich collection at the Detroit Institute of Arts to help pay creditors. Judge Rhodes said Detroit had no obligation to sell assets before filing for bankruptcy and should proceed now with extreme care.

“It was a devastating opinion,” said Sharon Levine, a partner at Lowenstein Sandler LLP who represents the American Federation of State, County and Municipal Employees in the case.

But Ms. Levine said she was encouraged by the judge’s indication that he wouldn’t look kindly at a bid by Detroit to make severe cuts to the city’s unfunded pension obligations. The judge will review any debt-cutting plan offered by the city after its creditors first consider its merits.

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