Everyone gathered last week at the meeting convened by Detroit Emergency Manager Kevyn Orr knew that the news would be dire. Nonetheless, Orr’s report on Detroit’s financial condition and his proposal for the treatment of the city’s creditors – an offer of approximately ten cents on the dollar for the city’s unsecured bonds – still managed to drop jaws. Therein lies what is perhaps the city’s best hope for a path forward that does not involve years of costly litigation.
Orr clearly has enough bankruptcy and restructuring experience to understand that he will only get to any form of global resolution by presenting a credible worst case scenario for bondholders and unions. He also appears to have made the determination that his least bad alternative will be to commence a Chapter 9 bankruptcy case for Detroit in which he has reached an agreement with at least a portion of his creditor constituencies. By presenting a realistic estimation of the drastic reduction that would result from an unplanned, or “freefall” Chapter 9 case, he has strongly increased his chances of obtaining support for a “pre-negotiated” plan that would provide for a somewhat higher recovery. If, for example, he can gain the support of the holders of certain classes of general obligation bonds, then once in Chapter 9, he could utilize provisions of the Bankruptcy Code that would permit him to resolve other vexing issues, such as the power to reject union contracts and cram down non-consenting creditors.
He is laying the foundation as well for the inevitable gating issue that prospective municipal debtors much face as to whether they are eligible for Chapter 9 protection. Unlike corporate debtors, municipal debtors must demonstrate that they are insolvent and show that they have negotiated in good faith with their creditors. Also, as with his recent suggestion that priceless works of art from the city-owned Detroit Institute of Arts could be sold to pay off debts, he is delivering an unmistakable message to all parties as to the potential pain that will result if some level of consensus cannot be reached.
The audacity of what Orr is seeking to accomplish here reflects not so much a gamble as a clear-eyed calculation. The time for half measures in Detroit is long past. It is a city that bears virtually no resemblance to what it was in its heyday many decades ago. There are numerouspromising signs of private sector revitalization, but on a much smaller scale from what once existed. The city’s debt structure and government must be ruthlessly rescaled in order for a new, much smaller Detroit to become once again a functioning municipality. Orr’s strategy here may not work, but it is the only approach that has any realistic chance of success.