Detroit has seen signs of revival in its urban core following the near-death experiences of GM and Chrysler. Unfortunately, its municipal finances remain beaten down by the city’s long and precipitous decline over the past several decades. Labor and legacy costs, incurred when the auto industry thrived and the population well exceeded a million citizens, are now heavy shackles on a city whose population has dropped to 700,000. Those costs, combined with a dysfunctional municipal government that has been unable to make necessary reforms, are leading Michigan’s governor Rick Snyder and Treasurer Andy Dillon to launch a process to appoint an emergency fiscal manager for the city, a step that could well lead to a Chapter 9 bankruptcy filing.

Bankruptcy filings by municipalities and governmental entities have, despite dire predictions, remained fairly rare. The few recent well-publicized filings that have occurred have been driven by unusual circumstances. Jefferson County, Alabama faced the double body blow of corruption, cost overruns and financing with complex derivatives in connection with the upgrade its sewer system that ultimately saddled the County with over $3 billion in debt, and the invalidation of an occupational tax that provided the primary source of its unrestricted general fund revenues. California municipalities Stockton and San Bernardino faced huge underfunded pension liabilities and the residual effects of the collapse of the residential housing market. 

Those cases are already proving to be litigious and difficult, as the dearth of precedential law makes novel issues much tougher to resolve. However, a bankruptcy filing by Detroit would dwarf all of them in size and complexity. 

It is possible that such a case could effectively be “pre-negotiated”, in a manner similar to that of the automobile companies. In this instance, the State of Michigan, rather than the U.S. Treasury, might promise to provide the necessary financial backing in exchange for concessions from Detroit’s bondholders, unions, and retirees. The new arrangements would then be implemented through a bankruptcy filing in order to take advantage of certain powers afforded to municipal debtors under the Bankruptcy Code, such as the ability to reject burdensome contracts. 

Pre-negotiated cases, however, are difficult enough to achieve with business enterprises. With a city of the size of Detroit, a bankruptcy case could very easily devolve into a morass of litigation that could drag out for many months or even years. There is no question that a Chapter 9 filing for Detroit should be the absolutely last resort. Unfortunately, the time is fast approaching when there will indeed be no other options.