Even as the state Treasury prepares to begin another financial review of Detroit's books, a plan is being solidified in the governor's office that would guide Michigan's largest city through what is being called a managed bankruptcy.The working concept, still evolving, assumes that the state's financial review would find severe financial distress in Detroit, that Mayor Dave Bing and City Council would be unable to push through overdue restructuring, and that the process would culminate in appointment of an emergency financial manager under Public Act 72.
The case would be filed under Chapter 9 of the federal bankruptcy code, according to two ranking sources familiar with the situation, following efforts to reach prenegotiated settlements with as many key creditors -- unions, vendors and pension funds among them -- as possible before any filing.
"Clearly, we will always try to do that," one source familiar with the situation said in an interview Thursday. "You can move on a much more expedited basis if you can demonstrate that your cash is running out" -- as Detroit clearly is with each passing week.
The evolving bankruptcy scenario is a clear signal that Gov. Rick Snyder and Treasurer Andy Dillon have lost confidence in the ability of the mayor, his management team and council to honor their commitments under the eight-month-old consent agreement with the state, or to make any meaningful progress on restructuring.
Contingency planning in Lansing for a possible Chapter 9 bankruptcy filing is not likely to be popular inside council chambers or the Mayor's Office. But it's the responsible and necessary thing to do, whatever the protests from the elected officials whose denial and self-delusion are hastening the arrival of a reckoning they can no longer avoid.
The goal of a managed bankruptcy is to streamline the protracted process by minimizing the chaos, uncertainty, delay and steep costs associated with Chapter 9. It would be the largest municipal bankruptcy in the nation's history, an unambiguous symbol of the city's epic failure and a chance for a fresh start.
"That's exactly the strategy you should do," said Douglas Bernstein, managing partner of Plunkett Cooney's banking, bankruptcy and creditor rights group. "You're never going to be able to get all the unions -- and all you need -- to agree in advance, not a chance. You try to do it outside of bankruptcy or you drop it in. It's prudent, too. It's very prudent."
In bankruptcy, pre-packaged deals arrange settlements with all creditors in advance of a filing that is usually followed quickly with a plan of reorganization (called "plan of adjustment" in Chapter 9). A pre-negotiated deal akin to the one being explored in the Governor's Office would reach settlements with some creditors and leave others to be litigated in court.
A Chapter 9 filing for Detroit may be increasingly likely given the dysfunction and infantile posturing atop City Hall. But bankruptcy is not yet certain, provided three obstacles can be removed or settled outside of court: pending litigation designed to slow the process; pension debt of $1.4 billion and $440 million in outstanding swap contracts; and liabilities for retiree health care.
Planning for a possible bankruptcy of Detroit should not be surprising coming from Snyder, an accountant-turned-CEO, and Dillon, a former investment banker. Both possess keen financial minds, strategic savvy and a habit for planning further ahead than most politicians, particularly the elected officials in Detroit flailing from one crisis to the next.
In anticipation of Detroit's financial collapse, for example, Dillon retained an investment banking firm in December 2010 -- before taking office -- to advise the Treasury on ways to restructure Detroit's balance sheet, reduce its liabilities and return the city's credit rating to investment grade.
City Council, by comparison, is blocking the mayor's effort to hire a local law firm, Miller Canfield, citing conflicts of interest. Nor has the city, likely about a month away from Snyder appointing an emergency financial manager, showed any inkling of forward planning and retained bankruptcy counsel.
It should, because there is no president of the United States or consortium of banks coming to the rescue. Both Public Act 72, the existing emergency financial manager law, and revised legislation that passed the House this week enable an emergency financial manager and his counsel to negotiate settlements with creditors in advance of a Chapter 9 filing.
Under Public Act 72, an emergency financial manager cannot move to abandon the city's financial workout plan in favor of bankruptcy until 180 days have passed. But the timeline to Chapter 9 filing can be accelerated if the city is in danger of running out of cash.
Still, bankruptcy for Detroit would require the governor to first appoint an emergency financial manager. The appointee would be charged with devising a financial plan, making it public and beginning the effort to execute it -- unless the city's meager cash hoard runs out first.
It probably will, which is why the governor and his treasurer are taking their jobs seriously and planning for the worst. Someone has to.