State of the Law: Discussing Detroit and the Potential Ripple Effects in New York

The November 19, 2014, event “Discussing Detroit: The Potential Ripple Effects of the Largest Municipal Bankruptcy in U.S. History and What it Might Mean for New York,” primarily sponsored by Albany Law School’s Government Law Center, the Nelson A. Rockefeller Institute for Government and the Albany Law School/ University at Albany Institute for Financial Market Regulation, generated lively discussion about the causes and consequences of municipal fiscal distress.  The program consisted of a keynote address by former Lieutenant Governor Richard Ravitch, followed by a panel discussion featuring Albany Mayor Kathy Sheehan; Peter Kiernan (of counsel, Schiff Hardin LLP); Albany Law School Professor Christine Sgarlata Chung; Donald J. Boyd (Senior fellow, Rockefeller Institute); Richard Mulvaney (NYS Troopers Police Benevolent Association).  David Unkovic (Of Counsel, McNees, Wallace & Nurick, LLC, State-Appointed Receiver for the City of Harrisburg, PA) served as moderator.

In his keynote address, former Lieutenant Governor Richard Ravitch highlighted the most compelling reasons why Detroit entered bankruptcy and identified key agreements reached through mediation.  Mr. Ravitch focused on the legal issue of feasibility under Chapter 9.  For a Plan of Adjustment in a Chapter 9 (municipal) bankruptcy to be confirmed, the Bankruptcy Court must determine that the plan is feasible, i.e., that it can be implemented in a manner that does not lead to an “18” — a subsequent Chapter 9 filing.  Mr. Ravitch emphasized that the alternative to Detroit’s Plan would have been chaos, but also noted that there is no assurance the plan, while feasible in its construct, can be implemented successfully.  Chapter 9 filings are rare and remain a venture into the unknown.  Also unknown are many exogenous factors impacting Detroit’s finances, such as whether the federal government will reduce local government assistance to education and health care, whether infrastructure improvements will be able to be financed, whether Detroit’s bureaucracy will be able to respond effectively to changing governmental challenges, and whether Michigan will be proactive in its support of its largest city.  Detroit achieved debt relief and now has more borrowing capacity, but there is no evidence yet that it will have new, willing lenders, and its underlying problems of declining population, loss of industry, and an eroding tax base remain.

The Lieutenant Governor briefly contrasted Detroit’s circumstances with those of New York City in the mid-1970’s Fiscal Crisis.  Although insolvent, New York City did not file for bankruptcy.  Rather, the state provided substantial assistance to the City and supported an elaborate, politically accountable process that led to the implementation of many financial management reforms, including the requirement that the city maintain balanced budgets.

Following the Lieutenant Governor’s keynote, the panelists explored causes and responses to municipal financial distress. Many of the panel members agreed that the problems afflicting Detroit and Harrisburg also imperil many municipalities in New York State.  This was given substance by Kathy Sheehan, the Mayor of Albany and an Albany Law School alumna, who described Albany’s fiscal challenges in the face of tax saturation, high and increasing personnel costs, and limited resources.   As Mayor Sheehan and several of the panelists explained, municipalities face a fundamental structural challenge to fiscal health.  They must spend money on public services and infrastructure to meet public health and safety needs, but face severe revenue constraints due to population loss and industrial decline, and may have few opportunities for expense reduction or debt relief.  Especially during times of economic strain, this structural revenue challenge can make it difficult for municipalities to achieve and maintain fiscal health.

With respect to municipal bankruptcy, several of the panelists noted that New York is one of twenty-seven states that, with varying conditions, permit their municipalities to file for bankruptcy relief.  (Pursuant to the U.S. Constitution, a political subdivision must have its state’s permission to file; a state cannot file.)  To date, there have been no municipal bankruptcies of note in New York history.    Instead, as was seen during New York City’s fiscal crisis in the 1970s, and with several New York cities subsequently, New York State employs the “Financial Control Board” approach when a local government faces severe fiscal distress.  Such control boards provide a forum for negotiated solutions among certain stakeholders, including lenders, creditors, labor, government, and business.  In contrast, Michigan and a number of other states allow for the appointment of an emergency manager or receiver entrusted with authority to make certain financial decisions while the distressed municipality attempts to navigate through financial distress. In the case of Detroit, the emergency manager there ultimately sought permission to file a Chapter 9 bankruptcy petition on the City’s behalf.  One panelist expressed the view that the control board approach supports political processes, incentivizes local government to find solutions, and places a premium on political accountability, but acknowledged that control boards cannot generate revenue.  Other panelists questioned whether municipalities are disadvantaged when municipal bankruptcy is not an option, whether for legal or political reasons.

One issue that inevitably arises in the context of municipal financial distress is how a municipality will deal with the OPEB (other post-employment benefits) and pension benefits of current and former municipal employees.  New York has a State-administered pension system for all local governments except New York City.  Under the New York system, municipalities make an annual contribution to the Central Retirement Fund (“CRF”), in an amount as determined by the state comptroller.  Several of the panelists observed that the CRF system is in one respects similar to CALPERS (the California Public Employees Retirement System), and further observed that a California bankruptcy court judge recently suggested than an insolvent municipality might be able to sever its ties with CALPERS.  The panelists noted that no New York municipality has sought to sever its ties with the CRF, but further noted that the annual contribution to the CRF can be a significant line item in local government budgets.

Along with the costs and benefits associated with maintaining a viable public workforce during periods of fiscal distress, the panelists also discussed another issue surfaced by the Detroit bankruptcy – namely, whether promises to general obligation bondholders should be equated with or given primacy over promises to pension beneficiaries.  In 2009, Rhode Island, by statute, enacted primacy for full faith and credit bond holders while the bankruptcy courts in Stockton, San Bernardino, and Detroit have wrestled with the relative status of pensioners, bondholders, and secured and unsecured creditors.    Mr. Ravitch argued that a pension promise carries the same moral weight as does a bond promise.  Others suggested that the pension promise, which is deferred compensation, should have primacy. The panelists concluded by acknowledging that municipal financial distress surfaces a range of knotty issues and competing concerns.  The panelists look forward to a continuing conversation about how best to support and sustain local government fiscal stability and health.