Chapter 9 bankruptcy puts Detroit in driver's seat of its restructuring

Thu Jul 18, 2013 8:26pm EDT

A large ''Opportunity Made In Detroit'' banner is seen on the side of a building in downtown Detroit, Michigan in this January 30, 2013 file photo. REUTERS/Rebecca Cook/Files

A large ''Opportunity Made In Detroit'' banner is seen on the side of a building in downtown Detroit, Michigan in this January 30, 2013 file photo.

Credit: Reuters/Rebecca Cook/Files

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(Reuters) - Detroit on Thursday filed the largest-ever municipal bankruptcy in the United States, with an estimated $18.5 billion in debt. Kevyn Orr, the city's emergency manager, referred to Chapter 9 - the bankruptcy statute governing municipal filings - as a "powerful" tool to right Detroit's ship.

A comparison with Chapter 11, the statute for corporate bankruptcy, shows just how much power a Chapter 9 debtor has.

Unlike in Chapter 11, judges in municipal bankruptcies cannot tell a debtor what to do with its money. While judges can order bankrupt companies to liquidate assets or force a debtor to sell a home, they have no power to tell a city to sell property or hike taxes to satisfy debts.

Creditors of bankrupt municipalities cannot submit restructuring plans. That right belongs exclusively to the municipality, unlike in Chapter 11, where creditors can propose competing plans after 180 days.

Provisions halting litigation against a bankrupt entity are broader in Chapter 9 than in Chapter 11, and it is not as easy to remove an elected official as it is to oust an executive of a bankrupt corporation.

In a distinction that could prove key in Detroit's heavily labor-driven insolvency, Chapter 9 allows a debtor to abrogate its pension and labor terms if good faith negotiations fail. In Chapter 11, a company can only walk away from labor contracts if it can convince a judge the cuts are absolutely necessary.

"It kind of goes to the role of the sovereign," said Randye Soref, a bankruptcy expert at law firm Polsinelli. "The rationale is that no one should interfere with the sovereign's ability to govern."

Chapter 9 is rare, but has produced a number of high-profile cases of late, including three in California last year. Alabama's Jefferson County filed for bankruptcy in 2011 with $4.2 billion in debt, while Central Falls, Rhode Island, filed the same year to address an $80 million unfunded pension liability.

While the Chapter 9 statute keeps Orr in the driver's seat of Detroit's restructuring, it also has its limitations. From a practical standpoint, the statute is little more than a glorified bargaining tool, because courts have little power to force compromise that parties do not hash out on their own.

So, while Orr could take drastic steps like crush Detroit's labor contingent, it would behoove him to compromise.

"It's a political process," said Bill Brandt, a restructuring expert at Development Specialists Inc.

Lawyers and other professionals looking to make money from Detroit's collapse should take note of one other crucial difference: unlike in Chapter 11, which puts a premium on transparency, professionals in Chapter 9 are not required to publicize or get court approval of fee payments.

In Chapter 11, creditors, judges and regulators from the Department of Justice pore over every detail of a professional's bill, raising objections to items they deem overpriced or unnecessary. In Chapter 9, bills can stay between a law firm and its client.

It's akin to the "Wild West," said one bankruptcy lawyer who refused to be named.

"You're used to being in a world where you have to explain yourself," the lawyer said, "and suddenly you don't anymore."

(Reporting by Nick Brown in New York; Editing by Lisa Shumaker)

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