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.
Other firms retained by the city in connection with the bankruptcy include Pepper Hamilton, whose deal as conflicts and special litigation counsel is capped at $850,000, and Ann Arbor, Mich.–based employee benefits shop Stevenson Keppelman Associates, which is set to receive up to $100,000. Miller, Canfield, Paddock and Stone has two contracts totaling nearly $2 million, although the firm is awaiting a ruling by Rhodes this week on whether it has a conflict advising Detroit in its Chapter 9 case.
The Detroit Free Press reported Tuesday that attorneys from Arnold & Porter and Detroit-based Clark Hill are expected to appeal Rhodes’ ruling on behalf of the city’s pension systems within the next few days. The Am Law Daily reported this summer on Clark Hill’s decision to terminate its lobbying relationship with Detroit in order to represent the Detroit General Retirement System, whose members have reportedly seen their pensions padded with added benefits. (Clark Hill partner Joseph Turner was elected in June to serve as interim general counsel of The Police and Fire Retirement System of Detroit.)
Attorneys from Dentons, Lowenstein Sandler and New York’s Cohen, Weiss and Simon are representing an official committee of retirees, the American Federation of State, County and Municipal Employees and the UAW union, respectively, in the case. (Lowenstein filed a notice of appeal on behalf of its client immediately after Rhodes issued his ruling.)
A 2012 tax filing by the Detroit-based UAW—whose general counsel, Michael Nicholson, testified during the city’s bankruptcy trial—shows that it paid $704,031 to Southfield, Mich.–based McKnight, McClow, Canzano, Smith & Radtke and $747,224 to Washington, D.C.’s Bredhoff & Kaiser. The latter firm also received $680,347 for legal services from the AFSCME in 2011, according to a tax filing by the D.C.–based trade union. Bredhoff & Kaiser worked with both Lowenstein and Cohen Weiss in the bankruptcy of Hostess Brands last year.
Lawyers for union workers and retirees, meanwhile, have urged emergency manager Orr to consider liquidating certain municipal assets—including artworks owned by The Detroit Institute of Arts (DIA) that have been evaluated by Christie’s auction house—to help pay off some of its debts. While Orr hasn’t ruled out selling some of the DIA’s collection, he says its net worth is less than $2 billion and therefore won’t go very far toward solving the city’s pension crisis.
Cravath, Swaine & Moore restructuring chair Richard Levin, who joined the firm in a rare lateral move in 2007 and was hired three years ago to provide pro bono restructuring counsel to Harrisburg, Pa., is advising the DIA in connection with the Chapter 9 case along with local counsel Honigman Miller Schwartz and Cohn. (A 2012 tax filing by the DIA shows it paid $189,507 to Honigman for legal services last year.)
Levin declined to comment Tuesday on the ramifications of Rhodes’ ruling, although he did participate in a public panel discussion in New York on Halloween put on by the International Foundation for Art Research in which he discussed the DIA’s potential liabilities in Detroit’s Chapter 9 case.
The DIA issued a statement Tuesday calling on Orr to “recognize the city’s fiduciary duty to protect the museum art collection for future generations” and abide by an opinion from Michigan’s attorney general that “the art collection is a trust and cannot be used to satisfy [Detroit’s] obligations.”
Thompson Coburn’s Warfield says that despite the significance of Tuesday’s ruling, it is worth remembering that Chapter 9 cases remain relatively rare. Citing historical data compiled by Chicago-based Chapman and Cutler, which has put forth a plan to help cities deal with mounting pension obligations, Warfield notes that there have been less than 700 municipal bankruptcy filings in the U.S. since 1937.
Other U.S. municipalities that have filed for Chapter 9 in recent years include Central Falls, R.I., Jefferson County, Ala., San Bernardino, Calif., Stockton, Calif., and Vallejo, Calif. Harrisburg, barred by state law from entering Chapter 9, is currently in a receivership that was recently extended for two years.
Jefferson County, which until Detroit’s filing was the largest Chapter 9 case in U.S. history, took a step toward concluding its bankruptcy proceedings last month as several hedge fund creditors contributed to a $1.8 billion finance plan that could be a template for future Chapter 9 cases, according to The New York Times’ DealBook.
Warfield says many Chapter 9 cases are resolved after local citizens agree to tax increases to fund an exit plan. He says it is possible that Michigan taxpayers—and perhaps even the federal government—could be called on to help fund a restructuring plan to help bail out the city. Warfield adds that the debt drama could spur other ailing municipalities to consider Chapter 9.
“I think we will certainly see more [Chapter 9 cases] due to the distress in the municipal finance market,” Warfield says. “I think the Detroit case can clearly serve as a template to inform how those municipalities deal with their own situations of financial distress.”
Bruce Bennett, a Jones Day restructuring partner in Los Angeles who joined the firm last year from Dewey & LeBoeuf (the now-defunct firm he joined in 2011), did not respond to a request for comment Tuesday on Rhodes’ ruling. Bennett, who is working with Jones Day bankruptcy partners Heather Lennox and David Heiman on the Detroit matter, helped steer Orange County, Calif., through one of the largest municipal bankruptcies in U.S. history nearly two decades ago.
In October, CBS newsmagazine “60 Minutes” examined Detroit’s fiscal woes and plan to reinvent itself as a prominent U.S. city. The story focused on Detroit native and Quicken Loans billionaire Daniel Gilbert, who panned the piece as “ ruin porn.”
As it happens, Gilbert—an attorney who made this year’s Forbes 400 list of wealthiest Americans and owner of the National Basketball Association’s Cleveland Cavaliers—has ties to some of the key players in the Detroit bankruptcy that go beyond the city’s efforts to rebuild. Three years ago this month he reportedly hired a top Am Law 100 firm to probe the circumstances surrounding the departure of former Cavs star LeBron James.
The firm Gilbert hired? Jones Day.