Roadmap for driving in constitutional hazard of Detroit's pension obligations

Participants in the Detroit bankruptcy are engaged in the legal and metaphysical question of whether a state constitutional provision can mandate that, unlike other contracts, unfunded pension obligations must be paid in a municipal bankruptcy without any impairment or reduction. Unfortunately, bankruptcy is the land of broken promises and impaired contracts but, regardless of the outcome of the legal debate, there may be practical answers emanating from the case for all those who are watching Detroit.

There are some truths about pension obligations and municipalities that we all know. Pensions are long-term obligations. As we are seeing, the failure to fund today can lead to insurmountable problems tomorrow. The municipality's ability to adequately fund pensions is inextricably intertwined with its ability both to have funds to pay the pensions and also to meet the necessary costs to govern a city effectively and survive. Municipalities cannot pay that which they have no revenues to fund. When obligations become so overwhelming to a municipality as to crowd out necessary expenses for essential governmental services and infrastructure, the consequences can be devastating and lead to the melt down of the municipality, as Detroit has amply demonstrated.

It appears self-evident that if a municipality such as Detroit is required to first and foremost pay everything it owes on its pensions now, it will not be able to succeed because it cannot afford such payment in full. Consequently, the municipality will not be able to develop a recovery plan to stimulate and encourage business with the accompanying creation of jobs that are sorely needed in the community. In such a situation, funds necessary for essential governmental services, such as public safety, education of future workers and infrastructure improvements necessary to move goods, services and workers through the community will not be there. In reality, the future of pension funding, workers' continued employment and the recovery plan for Detroit is dependent upon determining what costs and expenses are sustainable and affordable. This would include determining what amount of pension obligations can be paid that is reasonable, prudent and feasible. Such determination must take into account the necessity of sufficient funding for a recovery plan whereby essential governmental services can be raised to an acceptable level and infrastructure provided to encourage, stimulate and ensure business and employment growth. This will ensure not only Detroit's short-term recovery but also its long-term success.

Clearly, the challenge of a recovery plan is to reduce expenses, including pension payments, to a level that is sustainable and affordable not only so that the municipality recovers and grows but also so that pensions can and will be paid. With a true recovery comes increased tax revenue, and thus more funding can be available to share among competing obligations and programs.

If we were honest with ourselves, we would all admit that there is a simple answer to this controversy. Workers, current and retired, who have labored hard and especially those who are necessary for the recovery and success of a municipality deserve to be paid for past efforts and as much as can be paid should be paid to meet these obligations as promised. Likewise, workers and retirees rely on the continued success and growth of the municipality for continued employment and pension payments. If the municipality continues to erode and does not succeed with its recovery plan, there will be less not more to fund pensions and to keep workers employed. It is truly unfortunate that some promises made to public employees may not have been attainable, may not have been realistic, and may not have been founded on any prudent notion of governance.

Fortunately, the answer to all of this is simple. Rather than positioning and fighting among ourselves as to what can be paid, what cannot be paid and what must be paid, it is in the best interests of all parties striving for the recovery and success of the municipality to recognize and determine what is sustainable and affordable, acknowledging the resulting adjustments are simply a recognition of reality. In the long term, this will pay more than the best litigation strategy.

Pension obligations can be appropriately adjusted to what is sustainable and affordable, allowing the municipality to invest in that which will help it recover and grow. There would be the determined affordable fixed payments and contingent payments that would be paid only if there are increased revenues from the success of recovery. If the municipality does better, there will be more funding. Pensions are not impaired or diminished because realistically all that can be paid is being paid. Pensions plan beneficiaries have improved expectations that the municipality operating under a realistic recovery plan will make future payments to fund their pensions based on anticipated recovery. Also, there could be periodic adjustments in the fixed and contingent payments based on actual results of recovery and what is affordable.

The reason this approach has not been followed to date in Detroit or in other situations is because we are playing the game of blink. Everyone believes that the other side should give in and blink. From the standpoint of the workers and the retirees, they can achieve a resolution that is better than what can be obtained in the best fought litigation or any other mechanism by working with the municipality and recognizing that, together, they must determine what is sustainable and affordable to allow recovery and growth for the municipality and develop how the municipality can stimulate and attract business and new jobs to the community. In that way, workers and retirees hopefully can participate in a share of the new tax revenues as the fulfillment of their future pension funding needs. In doing so, the solution to underfunding can be obtained. Namely, the price for the adjustment to what is sustainable and affordable is the hardwiring of pension funding going forward. The municipality must identify and dedicate a sustainable and sufficient revenue source for the funding of pension obligations so that we will never again repeat the unfortunate scenario that to balance budgets we forego pension contributions and promise future pension benefits that are not sustainable and affordable.

James E. Spiotto is a partner with Chapman and Cutler LLP, Chicago, and a Chapter 9 specialist.