The Detroit bankruptcy and the US Constitution

By Susan P. Fino

Bankruptcies of state governmental entities are relatively rare. Until the Detroit bankruptcy the largest example was a county. In the 1970s, two cities came close to the edge—New York and Cleveland—but both managed to find a way back from the precipice. There are myriad reasons why Detroit is in Chapter 9 bankruptcy now.

The US Constitution grants Congress the power to make uniform rules for bankruptcies, and Congress has used this power to create and modify such laws throughout the nation’s history. Before the Great Depression bankruptcy laws addressed the insolvency of private persons both real and corporate. The depth and scope of the Great Depression placed state and local governments in the same position as private parties. Certainly states possess the power to tax to raise revenue, but when financial resources are scarce everywhere raising taxes would be the equivalent of squeezing blood from a stone. Congress responded in 1934 with a new law, Chapter 10 (now Chapter 9) of the bankruptcy code to afford state governments the same relief as private parties. Here it is important to note that the Constitution contains another provision that is relevant to Chapter 9 bankruptcies, the 10th Amendment.

This initial attempt to provide for bankruptcies of state governments met a hostile response from the Supreme Court when the Court, over the solo dissent of Justice Cardozo, nullified Chapter 10 as unconstitutional. The Court acknowledged that the Constitution explicitly grants Congress the power to create laws related to bankruptcy. The problem arose from another part of the Constitution. The 10th Amendment reserves powers not granted to the national government to the states. The Court took the position that the Amendment protects state governmental autonomy from federal intrusion even in the instance of voluntary petitions for bankruptcy. Congress tried again two years later and passed another version of Chapter 10 that did not differ significantly from the nullified version. This time in 1937 the Supreme Court sustained the law not because of changes to the law, but the membership of the Court had changed to one much more sympathetic to congressional use of its constitutional powers. For a long time Court observers assumed that the 10th Amendment had been practically ruled out of the Constitution. However in the past two decades the 10th Amendment has undergone a revival through the efforts of conservative justices committed to greater protection of state autonomy. This resurrection will be important to the discussion of the powers of the bankruptcy judge in Detroit’s case.

Another provision of the national Constitution that is relevant to the Detroit case is the “supremacy clause.” Article VI, section 2 of the Constitution states that: “This Constitution, and the laws of the United States which shall be made in pursuance thereof; and all treaties made, or which shall be made, under the authority of the United States, shall be the supreme law of the land; and the judges in every state shall be bound thereby, anything in the Constitution or laws of any State to the contrary notwithstanding.” There’s a simple way of thinking about the supremacy clause: generally anything federal trumps anything state.

As bankruptcy proceeds in Detroit, retirees who worked for years for the city are confronted with the specter of seeing their pensions evaporate as the city “emergency manager” in conjunction with the bankruptcy proceedings attempt to satisfy the demands of creditors. The Michigan constitution does indeed speak to the state government’s obligation to retirees. Article IX, section 24 states “The accrued financial benefits of each pension plan and retirement system of the state and its political subdivisions shall be a contractual obligation thereof which shall not be diminished or impaired thereby.” Can this section of the Michigan constitution save the hard-earned pensions of Detroit’s municipal retirees? The unhappy answer is “no,” and the reason is the supremacy clause.

Putting everything together, does the bankruptcy proceeding reduce the City of Detroit to the status of hostage? The happier answer here is “no.” Here we must revisit the 10th Amendment and the limitations it places on the exercise of national power. Despite the bankruptcy proceedings Detroit is and remains part of the structure of government in Michigan. A city cannot be treated like a private party in bankruptcy proceedings in which assets are liquidated to satisfy creditors. For example, the Detroit cannot be compelled to sell city hall or its parks to developers to satisfy creditors. As the Judicial Conference of the United States puts it: “Although similar to other chapters in some respects, chapter 9 is significantly different in that there is no provision in the law for liquidation of the assets of the municipality and distribution of the proceeds to creditors. Such a liquidation or dissolution would undoubtedly violate the Tenth Amendment to the Constitution and the reservation to the states of sovereignty over their internal affairs (emphasis added).” The city’s “emergency manager” has engaged a New York auction house to appraise the collection at the Detroit Institute of Arts, a city-owned museum of national prominence. Citizens of Michigan have been overwhelmed with the fear that the great works of art owned by the DIA will be auctioned off in a kind of everything-must-go fire sale. Thanks to the 10th Amendment this is not a likely scenario.

Susan P. Fino is an Associate Professor of Political Science at Wayne State University. She is the author of The Michigan State Constitution, part of the Oxford Commentaries on the State Constitutions of the US series.

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Image credit: Details from the “million dollar courthouse,” the Theodore Levin United States Courthouse, Detroit Federal Building, Detroit, Michigan. Photographs in the Carol M. Highsmith Archive, Library of Congress, Prints and Photographs Division. Public domain.