The Detroit bankruptcy ruling on Dec. 3 has turned into the “new shot heard round the world” for both pension plan participants and municipalities saddled with pension debt and trying to stay afloat.
U.S. Bankruptcy Court Judge Steven W. Rhodes last week accepted the city's petition enabling it to seek protection under Chapter 9 of the U.S. bankruptcy code, and ruled Detroit may legally reduce public pension benefits, despite protection of public pensions under Michigan's constitution.
Mr. Rhodes' ruling — which came on the same day Illinois passed a wide-ranging pension reform bill for its state-administered plans — is reverberating throughout the country for cities grappling with bankruptcy or pension problems, from Chicago to San Bernardino and Stockton in California.
Michigan, Illinois and California all have stipulations in their state constitutions that retirement plans should not be impaired or diminished, but that did not protect the pension benefits in Detroit.
“Under the Michigan Constitution, municipal pension rights are contract rights. Therefore, because the State of Michigan authorized the filing of this case, municipal pension rights in Michigan can be impaired in this bankruptcy case, just like any other contract rights,” according to a summary of Mr. Rhodes' ruling cited in a court news release.
“The biggest ramification is adjusting to the legal uncertainty that has been created from the certainty that pension benefits are bullet proof,” said Karol Denniston, municipal bankruptcy expert and San Francisco-based partner at law firm Schiff Hardin LLP. She added the ruling is noteworthy because it is the first time it has been said in a bankruptcy court that public pensions can be impaired.
“There is now a credible case that the table has been reset,” Ms. Denniston said. “There could be a direct or immediate possibility compared to a hypothetical” impairment to benefits.
Unions and retiree groups in both Detroit and Illinois have vowed to appeal the ruling and legislation, respectively.
Illinois' pension reform is designed to save the state $160 billion over the next 30 years by making changes to state plans that include reducing cost-of-living adjustments, increasing retirement ages and capping pensionable salaries. The reform measure, which was signed by Gov. Pat Quinn on Dec. 5, is expected to be tied up in the courts for at least a year.
Meanwhile, the Detroit decision has a “better than 50% chance” of being appealed to the U.S. Supreme Court, said Frank Shafroth, director of the Center for State and Local Government Leadership at George Mason University in Fairfax, Va.
Mr. Rhodes' ruling means public employee union leaders need to face a new reality, Mr. Shafroth said. The historic stance of some union leaders that they did not need to negotiate regarding pensions because of the constitutional protection is no longer safe, he added.
“You can't do that (refuse to negotiate), effective 1 p.m. Tuesday (Dec. 3),” Mr. Shafroth said. “Everyone understands the rules of the world changed on Tuesday ... It was the new shot heard round the world.” Unions now have a huge stake in states or municipalities balancing their budgets because pension benefits might not be guaranteed anymore, Mr. Shafroth said.
Ms. Denniston said the ruling should result in a shift in negotiating strategies for unions in that they would be more likely to participate in talks.
Sarah Wetmore, vice president and research director at The Civic Federation, an independent government research organization in Chicago, agreed unions need to participate in pension reform talks, as they did for recently passed reform for the $420 million Chicago Park Employees' Annuity & Benefit Fund.
“Labor is an important participant in pension reform negotiations,” Ms. Wetmore said. “What happened in Detroit is definitely an added incentive for all parties to work together to ensure that the pensions are sustainable for employees, retirees and taxpayers.”