Four months after being hired to help the city of Detroit find a way out from under its mountain of debt, Jones Day is now taking the lead advisory role on what is poised to become the largest municipal bankruptcy in U.S. history.
And though the Thursday filing in the U.S. Bankruptcy Court for the Eastern District of Michigan comes well ahead of the end of the $3.35 million, six-month contract under which Jones Day is serving as the city's restructuring counsel, Governor Rick Snyder said in a statement approving the voluntary Chapter 9 petition [PDF] that it was decades in the making. (The governor is required to approve any municipal bankruptcy filing under Michigan law.)
"I knew from the outset that it would be difficult to reverse 60 years of decline in which promises were made that did not reflect the reality of the ability to deliver on those promises," said Snyder, who cited a long-term debt load of $18 billion and the continuing deterioration of city services as factors in his decision. "We must face the fact that the city cannot and is not paying its debts as they become due, and is insolvent."
The blunt talk continued at an evening press conference held by city emergency financial manager Kevyn Orr, a former Jones Day partner installed in the job by Snyder. "Detroit has been working its way to a level of insolvency for decades," Orr said. "Even the casual observer has had to understand for some period of time now, Detroit was simply not on sustainable footing."
Snyder said in his statement that Orr had asked him to approve the Chapter 9 filing in a letter sent Tuesday. After reviewing the letter, as well as Orr's financial and operating plans and his report to the city's creditors, the governor said he determined "that the financial emergency in Detroit cannot be successfully addressed outside such a filing, and it is the only reasonable alternative that is available." Given the scope of its financial problems, the city is relying on a rarely used provision of bankruptcy law to enter what amounts to uncharted territory, according to lawyers who specialize in the field.
There have been just 302 Chapter 9 filings in the U.S. since 1954, according to James Spiotto of Chapman and Cutler, who tracks such data. Of those, Spiotto says, 62 involved cities, towns, villages, or counties. The rest were filed by special tax districts, utilities, hospitals, and school districts defined as local governments. (There has been an uptick in Chapter 9 cases since the collapse of the financial markets five years ago. While five municipalities apiece filed for bankruptcy in 2006 and 2007, 13 did so in 2011, and 12 went that route last year.)
Detroit's staggering debts make its filing by far the largest ever by a local government entity, Spiotto says. The previous record-holder, Jefferson County, Alabama, listed approximately $4.2 billion in debt when it sought Chapter 9 protection in 2011. Orange County, California's 1994 filing ($1.9 billion) and Stockton, California's last year ($1 billion) rank a distant third and fourth. "Clearly there has been a long series of problems in Detroit, so the initial reaction is why would anyone be surprised," Spiotto says. "But traditionally—when it comes to the largest cities in a state—this step isn't taken."
Orrick, Herrington & Sutcliffe partner Marc Levinson, who represents Stockton in its bankruptcy and represented Vallejo, California, in its Chapter 9 filing in 2008, agrees that Detroit's move is unprecedented. "There are no modern Chapter 9 filings of a large size," Levinson says. "There are a lot of filings, but they're just one-offs."
Orr said during his press conference that he decided to pursue bankruptcy now—less than a month after making a formal pitch to Detroit's creditors that they take pennies on the dollars they are owed to avoid such a filing—because he has only 15 months left in the emergency manager post and it is time to "make some difficult decisions." He said he hopes to complete the bankruptcy by next summer or fall, and attempted to reassure city residents that for the time being, "nothing changes from the standpoint of an ordinary citizen's perspective." (The Detroit Free Press has a useful primer on where the case is likely to go from here.)
As Levinson notes, a judge must now deem Detroit eligible for bankruptcy protection—a process that could drag on for some time. "Stockton has been in bankruptcy for a year and a month now, and it took us nine months to just get it declared eligible," he says, adding that given Detroit's various liabilities and labor unions, "Stockton is complex, and the complexity of Detroit is that times some very large number."
There is also the possibility that creditors could challenge Detroit's move into bankruptcy, as happened in Chapter 9 filings made by Jefferson County; San Bernardino, California; and Vallejo. "That seems to be the recent trend," Spiotto says.
Kenneth Klee of Klee, Tuchin, Bogdanoff & Stern—who represents Jefferson County in its bankruptcy, advised Orange County in its Chapter 9 case, and bid unsuccessfully for the Detroit contract—says the timing of the city's filing strikes him as "panicked." The move, Klee says, may be an attempt to preempt a lawsuit [PDF] filed Wednesday in which pension boards for local firefighters and police officers are seeking to bar Orr and Snyder from taking any action—including a bankruptcy filing—that would lead to a reduction in pension benefits the plaintiffs claim are protected by the state constitution. Detroit-based Clark Hill is representing the pension boards. (Bloomberg reported late Thursday that a state court judge had temporarily barred Snyder and Orr from taking any action that would allow cuts to pension benefits for city retirees, while allowing the bankruptcy to proceed.)
Speculation about a potential Chapter 9 filing mounted in March when Snyder appointed Orr as emergency manager. At the time, Orr, whose previous experience included working on the bankruptcy of Auburn Hill, Michigan–based Chrysler, said the Detroit assignment represented the "Olympics of restructuring."
Orr took on the herculean task less than a week after city officials tapped his former firm as lead outside counsel following a bidding process that saw Jones Day compete with 13 other firms, including eight members of The Am Law 200, to land a $3.35 million contract that runs until September 15. As The Am Law Daily recently reported, Jones Day has already billed the city $1.37 million for the first six weeks of work.
Detroit's Chapter 9 petition lists Jones Day partners David Heiman and Heather Lennox in Cleveland and Bruce Bennett in Los Angeles alongside Miller, Canfield, Paddock & Stone partners Jonathan Green and Stephen LaPlante as the city's lawyers. Heiman, who did not immediately respond to a request for comment Thursday, told The Am Law Daily earlier this year that the assignment "was viewed by us as a critically important project, not only for Detroit but as a representation or microcosm of some of the ills of American cities." (Bennett, who represented both Orange County and Major League Baseball in their bankruptcies, joined Jones Day with a team of bankruptcy specialists from the now-defunct Dewey & LeBoeuf. He did not immediately respond to a request for comment Thursday.)
Detroit-based Miller Canfield has close ties to the city and has long served as its bond counsel. Despite initial concerns that Miller Canfield might have a conflict of interest, the Detroit city council approved a $300,000 legal services contract in December under which the firm is to provide legal advice and litigation representation pertaining to implementing "the cty's ongoing restructuring." The firm's bills have not yet been made available by the city. Neither LaPlante nor Green, who heads Miller Canfield's bankruptcy and restructuring group, responded to requests for comment about Thursday's bankruptcy filing.
Jones Day's existing contract with the city calls for the firm's fees for "core restructuring work" to be capped at $475,000 a month—a limit the contract states becomes void in the event the city files for bankruptcy. One type of work that the contract describes as falling outside the core restructuring area is Chapter 9 contingency planning, a category that occupied just 13.5 hours of the Jones Day team's time worth $9,925 in the first half of March. By April, contingency planning had ratcheted up to 175 hours racked up by 12 lawyers, for a total of $112,081.
Jones Day's hiring initially raised the hackles of some Detroit politicians and citizens who accused the firm of having a conflict of interest given that Orr had only recently resigned from his position as a partner in the firm's Washington, D.C., office to take the emergency manager job. According to our previous reports, Orr came to Snyder's attention in January when Jones Day first made its pitch for the restructuring work to city and state officials. Snyder then requested permission to approach Orr about the Detroit job, which the former Jones Day partner moved into on March 25. Ethics experts told The Am Law Daily that they saw nothing unethical about the hiring.
Predictably for such a mammoth case, several other large law firms had already entered appearances in connection with Detroit’s Chapter 9 petition. Court filings show that Bingham McCutchen and Cadwalader, Wickersham & Taft, respectively, are advising creditors UBS and Bank of America, which in their capacity as the city's top creditors have reportedly negotiated a deal with Orr to provide $255 million in debtor-in-possession financing to help keep municipal services functioning.
Mark Ellenberg, cochair of Cadwalader’s financial restructuring department, did not immediately return a request for comment. Nor did Michael Reilly and Jeffrey Sabin, coheads of Bingham’s global financial restructuring group.
Bankruptcy court filings show that Sidley Austin and Michigan’s Jaffe, Raitt, Heuer & Weiss are representing the National Public Finance Corporation, while Tennessee’s Waller Lansden Dortch & Davis is advising the U.S. National Bank Association, indentured trustee for the City of Detroit and the Detroit Water and Sewerage Department. Maxwell Dunn has filed an appearance for Hercules & Hercules, a Detroit-based supplier of janitorial and maintenance services.
Am Law Daily reporters Brian Baxter and Sara Randazzo contributed to this story.