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Can Detroit bankruptcy proceed? What the judge must (and might) consider. (+video)

As closing arguments wrap up Friday, the judge overseeing the Detroit bankruptcy trial will consider four criteria to determine if the city can seek bankruptcy protection. Some experts wonder if an unspoken fifth might come into play.

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Was there an untoward rush to file for bankruptcy in Detroit, or did creditors of the financially ailing city not negotiate in a timely fashion to come to terms so that bankruptcy could be averted?

After two weeks of testimony from city officials, an emergency manager, creditors, and even Michigan Gov. Rick Snyder (R), that's perhaps the chief question before federal bankruptcy judge Steven Rhodes, who on Friday heard closing arguments in the trial that will determine if Detroit can in fact seek bankruptcy protection.

Such protections, many experts say, will allow the Motor City to emerge from insolvency after decades of population loss and financial mismanagement. And what if the judge were to deny bankruptcy status for Detroit?

Well, that's not something Judge Rhodes is supposed to consider, under the law. But several legal experts say the chaos that would ensue might be something that could cross his mind. 

“Throwing [bankruptcy] out creates disaster. You’re back to chaos,” says Douglas Bernstein, a bankruptcy attorney in Bloomfield Hills, Mich. The multiple lawsuits by creditors, plus the city’s debt and cash-flow crisis, would continue to vex Detroit – factors that the judge would certainly be aware of, says Mr. Bernstein.

“Who’s to say if it comes to play in the judge’s own mind," he adds. "In applying the law, it should not be a factor.” 

Under bankruptcy law, the city of Detroit must prove four things to satisfy eligibility for Chapter 9 relief: that it is insolvent, that it desires to present a restructuring plan, that it is authorized to seek bankruptcy under state authority, and it either tried or was unable to negotiate in good faith with creditors.

During the trial, the city and its creditors largely agreed on one point: that Detroit is insolvent, up to its eyeballs in $18 billion in debt. Attorneys representing pension funds, public employee retirees, and labor organizations argued instead that the city was never serious about avoiding bankruptcy and that it is trying to use the courts to sidestep protections afforded to public-worker pension plans by the state constitution. Their Exhibit A: that only 35 days elapsed between emergency manager Kevyn Orr's presentation of a plan to cut the debt (June 14) and the petition filing for Chapter 9 (July18).

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“There is no reason why [negotiations] could not have been addressed beforehand. Indeed, here, the unions had a history of coalition bargaining over concessions,” Thomas Ciantra, an attorney for the United Auto Workers, said Friday.

City attorneys have argued that they made a reasonable effort but that unions and others never countered with an alternative plan. The unprecedented nature of the city’s dire finances, they say, is forcing them to work fast.

“Spend more time? The city didn’t have more time. There was constant tension between spending more time in negotiations and facing more instability and risk,” city attorney Bruce Bennett said Friday in court. “What would more time have led to? There was no evidence or any overt indication [from creditors] that the city could have looked at and said, ‘There’s a path to a deal.’ ”

Although the creditors have presented a credible case, the widely held expectation is that Rhodes will rule in Detroit's favor. 

One reason is the unprecedented nature of this case, says Michael Sweet, a bankruptcy attorney in San Francisco who specializes in municipal restructuring. If allowed to proceed, Detroit would be the largest US municipality ever to declare bankruptcy. 

“There have been so few cases like this; the law is not highly developed," Mr. Sweet says. “At the end, there is no real robust law under the bankruptcy code in Chapter 9" for the judge to use as a comparison when he makes his determination about Detroit. 

Sweet, too, suggests that it may be impossible for Judge Rhodes not to factor in what would happen if Detroit does not gain bankruptcy protection.

“I think, pragmatically, the alternative of not granting the city bankruptcy protection would be more devastating than the city being in bankruptcy," Sweet says. "He’ll weigh the [eligibility] factors, but at the end of the day … it’ll be in the back of his mind.” 

Rhodes has indicated he will not rule until Thursday at the earliest. If he decides in favor of Detroit, the objecting parties can appeal.


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