THE BLOG
10/25/2013 04:46 pm ET | Updated Jan 23, 2014

Detroit Is in Debt, But Is it Eligible for Bankruptcy?

Can a municipality claim bankruptcy when its assets potentially surpass its debts?

That's the question facing a federal judge, who will determine in the coming weeks if Detroit is eligible to file bankruptcy, despite having billions of dollars worth of assets.

In recent years, roughly half of the American cities that have tried to file bankruptcy were denied when judges ruled their assets (buildings, property, and other valuable holdings) exceeded their liabilities. The debate in Detroit shall only intensity next week when Christie's, the international auction house that has been hired to evaluate the collection owned by the Detroit Institute of Arts (DIA), releases its appraisal. Should the total be large, there will be growing pressure to deny the bankruptcy appeal by the city.

One of the most acclaimed art museums in the world, the DIA owns almost 70,000 pieces of art, including a sizable group of masterpieces like Madonna and Child" by Giovanni Bellini, "The Nightmare" by Henry Fuseli, a 27-panel fresco by Diego Rivera, and "Gladioli" by Claude Monet. Some estimates have placed the value of the masterpieces alone at $2.5 billion, with the entire collection worth somewhere between $10 and $20 billion. How can Detroit be bankrupt if its art collection -- that one asset by itself -- is worth all of its debt, $18.5 billion, or at least a sizable portion of it?

There is little doubt Detroit is in trouble. In the city, 78,000 buildings stand abandoned and only 40 percent of the streetlights work. It takes the police 58 minutes to respond to an emergency call. A mere 8.7 percent of crimes are solved, well below the national average of 30.5 percent. Not surprisingly, the homicide rate is the highest it has been in 40 years. Because of a lack of municipal services -- or because they couldn't afford it -- 47 percent of landowners did not pay their property taxes in 2001. In this bleak scenario, Detroit's unemployment rate has tripled since 2000, double the national average.

For union members in Detroit, the bankruptcy is a critical problem because it is putting their pensions in jeopardy. Early this week, in the ongoing bankruptcy proceedings, Judge Steven W. Rhodes raised the stakes for union members when he made a comment indicating how he viewed the 23,500 retired workers caught up in the city's financial crisis. During a hearing to answer legal questions, Rhodes said he regarded the union pension funds as "unsecured creditors."

Moreover, to consider the pension funds immune from bankruptcy -- they are protected under the Michigan state constitution -- would be a violation of federal bankruptcy law, according to Rhodes. "It gives a priority to one unsecured creditor over all the others," he said, "or one group of unsecured creditors over all the others." How can a state constitution be ignored on such a vital issue? To Rhodes, who was appointed to the bench by Ronald Reagan -- known for his clashes with unions -- federal bankruptcy law trumps state constitutional law, even if unions get harmed as a consequence.

Rhodes's comment, made during an exchange between the judge and an attorney representing the two city pension funds, has wide-ranging implications. In essence, it means that if Rhodes allows the bankruptcy to move forward thousands of retired city workers could see their pension checks slashed -- a move that represents a severe blow to unions not just in Detroit and Michigan but nationwide.

That's one reason why so much drama surrounded the trial's first day on Wednesday. As hundreds of union protesters marched outside the Theodore Levin United States Courthouse in downtown Detroit, carrying signs that read "Hands Off Our Pensions!," Rhodes heard opening arguments of a trial triggered when Detroit filed for bankruptcy protection under Chapter 9 of the U.S. Bankruptcy Code on July 18.

"There's nothing left to do here," Bruce Bennett, an attorney for the city, said in his opening statement. "There is no revenue solution.... Chapter 9 is more needed here than any other possible scenario you could think of. [Witnesses] will present a mountain of evidence showing the insolvency of the city. This is one of those cases where the data speaks very clearly and persuasively on its own. It needs no gloss."

But lawyers for the unions, who oppose the bankruptcy, disagreed. In her opening remarks, Jennifer Green, who represents union pension funds, claimed the city did not negotiate in good faith. "It really was a foregone conclusion," she said, articulating a widely held belief that once Governor Rick Snyder appointed Kevyn D. Orr as Detroit's emergency manager in March the city did not intend to negotiate with creditors, mainly the unions, but file for bankruptcy. Babette Ceccotti, an attorney for the United Auto Workers, argued the city had a "deliberate plan" to use bankruptcy as a means to force concessions from unions, all but charging government officials with union busting.

In the end, the art held by the DIA might be the most important factor in the bankruptcy. It could compel the judge to reject the bankruptcy -- or he could order the art sold. Either way, whether or not union retirees in Detroit continue to receive pensions checks may be determined by the fate of one of the world's finest art collections.