Doing the Right Thing in the Wrong Way in Detroit

19 Apr
April 19, 2014

As Detroit’s bankruptcy heads into the homestretch, with the big hearing on its proposed restructuring plan currently scheduled for mid-July, Detroit is increasingly using settlements with key constituencies to line up additional payments for its pension beneficiaries.  The most dramatic illustration of this is Detroit’s art-for-pensions deal.  Under the proposed deal, the Detroit Institute of Arts would sell its art for $816 million to a nonprofit organization that will commit to keep the art in Detroit.  The $816 million, which would come from a group of foundations, the state of Michigan, and others, would be used to fund a higher payout for Detroit’s pension beneficiaries than they would otherwise receive.  More recently, Detroit entered into a settlement with a small group of its bondholders who have argued that they have a lien and are entitled to highest priority.  Under the settlement, the bondholders would receive roughly two-thirds of what they are owed, and a large side payment would be made to Detroit’s pension beneficiaries.

These arrangements seem to me to be doing a good thing in a very dangerous way.  It’s right, in my view, for pension beneficiaries to receive somewhat more than other general creditors, and this can be justified under existing municipal bankruptcy law  (as I have argued elsewhere, for example, here).  But the new arrangements take money that might otherwise go to all general creditors, and give it to one group of these creditors—pension beneficiaries.  In a short new magazine article (here), I point out that the strategy used in the art-for-pension deal is remarkably similar to the most problematic features of the 2009 Chrysler bailout.

I can imagine several technical (but unpersuasive) arguments Detroit might use to try to justify the art-for-pension deal and the side payment to pensioners under the bond deal.  I will perhaps delve into the particulars in future posts.  But the bottom line is that the new settlements are deeply problematic from a rule of law perspective, and should be rejected by the bankruptcy judge.  It’s essential to minimize the hardship of Detroit’s bankruptcy on pensioners, but it’s also important not to run roughshod over the rule of law, at the expense of Detroit’s other creditors, along the way.

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