Background

Last summer, Detroit filed for bankruptcy under chapter 9 of bankruptcy code.  This seldom-used provision offers federal ground rules for the City to restructure its $18 billion debt.  Detroit hopes to exit chapter 9 by getting judicial approval of a plan of debt adjustment.  Using a plan of adjustment, a municipal debtor can shed some of its obligations and provide a blueprint for managing its debt going forward. 

On February 21, Detroit presented a plan of debt adjustment to U.S. Bankruptcy Judge Steven Rhodes.  A plan of adjustment must meet several criteria to be approved.  For instance, Detroit’s plan must be approved by one half in number and two thirds in dollar amount of each impaired class of its more than 100,000 creditors.  If Detroit fails to get the votes, it has another option at its disposal.  It can submit a plan that can be crammed down on dissenting creditors.  If Detroit submits a plan that satisfies every statutory criterion but winning creditor approval, then Judge Rhodes must approve the plan so long as three conditions are met: (1) one class of impaired claims has accepted the plan, (2) the plan is fair and equitable and (3) the plan doesn’t discriminate unfairly among creditors.  ‘Fair and equitable’ and ‘unfair discrimination’ are bankruptcy terms of art.  They’re simply requirements that senior debt is paid in full before junior debt gets a dime, and that claims of identical seniority get the same treatment.  In conjunction with its plan of adjustment, Detroit filed a disclosure statement: a road map outlining how the City plans to restore itself to health. 

After outlining the pension cuts that city employees face under the plan, this post will explain how the City intends to deal with labor costs when it emerges from chapter 9.

City Employees Face Substantial Pension Cuts

Detroit has two pension funds, the $2.77 billion Detroit General Retirement System and $3.4 billion Detroit Police & Fire Retirement System.  The City’s plan proposes cuts aimed at reining in Detroit’s pension obligations while ensuring retirees can meet their needs.  Specifically, the plan calls for a 34% cut to the pensions of non-uniformed City employees, and a 10% reduction for police and fire.  These figures would drop to 26% and 4%, however, if the boards that oversee the respective pensions support the City’s plan.  The plan also does away with cost-of-living adjustments for pensioners.   

Throughout the bankruptcy, various creditors have taken steps to pressure the City to auction the Detroit Institute of Arts’ world-class collection.  The proceeds from such a sale could be used to limit both pension cuts and haircuts for other creditors.  Rather than auction off the art, Detroit has lined up hundreds of millions of dollars in funding from philanthropic foundations and the State of Michigan.  The plan allocates the funding to protect workers and retirees from pension cuts steeper than those already discussed.  Importantly, the funding is conditioned on the art staying put and pension creditors supporting the plan.

Union reactions to the plan have been negative.  Al Garrett, president of the AFSCME Council 25—the City’s largest union—described the plan as “a gut punch” to City employees and retirees.  Lee Saunders, president of AFSCME also had harsh words.   On Saunders’ account “[t]he proposal effectively devastates retirement security for the hard-working city employees and retirees of Detroit.”  While these criticisms may have merit, it bears noting that the City’s other unsecured creditors face far more severe haircuts.  Indeed, such creditors will only get 20 cents on the dollar under the plan. 

Some advisors to financial creditors have critiqued the plan on the grounds that it favors workers over financial creditors for political reasons.  There is, however, a more charitable explanation.  If all of the City’s creditors were treated equally, workers would bear far steeper cuts.  This would hurt worker motivation and cause labor unrest, both of which would induce heavy discounting of Detroit’s already distressed debt.  Avoiding such a discount and approving the plan may offer unsecured creditors the best long-term recovery they can expect under the circumstances.

The Disclosure Statement Notes that the City Plans to Reduce Labor Costs

Detroit’s disclosure statement explains that “[a]s part of the City’s overall financial restructuring, reductions in costs associated with represented and unrepresented workers will be necessary.”  The disclosure statement outlines five key elements of a strategy for reducing costs:

• Collective Bargaining Agreements: Somewhat cryptically, the disclosure statement notes that “[s]ignificant modifications to CBAs and labor-related obligations will be necessary to optimize staffing and reduce employment costs.”  Currently, Detroit doesn’t have CBAs for around 80% of unionized city employees.  These employees work under City employment terms (CETs).  Detroit imposed the CETs unilaterally in 2012 to provide employment terms for all City employees not covered by a CBA.  The CETs achieved cost savings by, among other things, imposing wage and benefit cuts. Detroit hopes to “work cooperatively” with unions to reach agreements that “mirror” the CETs.

• Operational Efficiencies/Work Rules: The City’s disclosure statement speculates that “[s]ignificant labor cost reductions may be possible by restructuring jobs and streamlining work rules for both represented and unrepresented workers . . . .”  These efficiencies can be achieved using the CETs as a benchmark.  According the disclosure statement, Detroit will cooperate with labor representatives to achieve these changes. 

• Salaries and Wages: In blunt terms, the disclosure statement notes that Detroit must reduce employment costs to successfully implement its restructuring.  But the City also recognizes that “the potential for reductions in wages and salaries must be balanced against likely reductions in benefits and the City’s need to attract and retain skilled workers.”  Because workers covered by the CETs already experienced 5-10% wage and salary reductions, the plan provides that Detroit will “carefully evaluate” the “utility” and any additional cuts.  The disclosure statement notes, however, that reductions in non-wage compensation and overtime payments “may be achievable.”

• Staffing Levels and Headcount: The disclosure statement suggests that “[s]ignificant labor cost savings may be achievable by rationalizing staffing levels and reducing
  employee headcounts.”  For instance, where service improvements or costs savings can be realize—by consolidating departments or eliminating redundant functions, for example—those changes will be implemented.  Detroit plans to work with unions to “minimize the effects” of headcount reductions.

• Outsourcing: The City plans to explore outsourcing opportunities when cost savings or improvements to service delivery can be achieved.  Unions will have an opportunity to bid on contracts as part of a competitive process.

Conclusion

Whether the Motor City will get a new lease on life remains to be seen.  Changes to Detroit’s plan of adjustment can be expected as negotiations with creditors and labor representatives continue into the summer.  If approved, Detroit’s plan of adjustment would create a precedent for cities dealing with overwhelming debt, under-funded obligations to current and future retirees, and uncompetitive employee salaries.

*The United States Court of Appeals for the Sixth Circuit has agreed to hear a direct appeal of Judge Rhodes’ ruling that Detroit is eligible for chapter 9 bankruptcy.  The appeal is not proceeding on an expedited basis.