Detroit is eligible for bankruptcy protection, the federal judge overseeing the case ruled Tuesday.
It means Detroit can legally enter into Chapter 9, launching the largest municipal bankruptcy to date in the U.S. The city says it has $18 billion of debt it will try to restructure over the course of the case.
Federal Judge Steven Rhodes ruled that the city met the criteria necessary to enter into Chapter 9, including proving insolvency and the impracticability of good-faith negotiations. "The city needs help," Rhodes said when he announced his decision.
In a surprise, Rhodes also ruled that the city can cut its pensions as it moves through the bankruptcy process. The ruling was not expected until later in the case.
Michigan's constitutional protection of pensions does not apply in federal court, the judge ruled. "Pensions are not entitled to any extraordinary protection," he said, settling what has been one of the most controversial debates in the city's case so far.
He added that his ruling does not mean he would necessarily confirm a plan that impairs the benefits.
The creditors fighting the city's eligibility, which includes unions and pension systems but no bondholders or insurers, have already said they will appeal the eligibility ruling and now, likely the pension ruling as well.
They want to appeal directly to the U.S. Court of Appeals for the Sixth Circuit, bypassing the U.S. District Court Eastern District of Michigan.
The case will proceed while the appeal is filed and considered.
The ruling will likely kick off a fresh round of negotiations with creditors. With the legal strength of Chapter 9 behind it, the city will now try to reach agreements with enough of its creditors that it can file a reasonable plan of adjustment. It needs to reach approval from a class of creditors who make up two-thirds of the amount of debt and over half by number.
Detroit's attorneys have said they hope to file a plan of adjustment by the end of year.
If the plan features cuts in pensions or unlimited-tax general obligation bonds, as expected, it will likely mean a long round of court battles with employees and bondholders who argue that the moves violate the state constitution. The bankruptcy judge needs to find that a final plan is in compliance with Michigan laws.
The creditors who agree to the plan, the less number of amendments and modifications will be needed going forward, bankruptcy experts said.
Appeals in the case will be made first to either the U.S. District Court, Eastern District of Michigan, or the bankruptcy appeals court in Michigan, then on to the U.S. Court of Appeals for the Sixth Circuit, and the U.S. Supreme Court.
Rhodes will post his 140-page written decision on the federal bankruptcy court web site today.
