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Detroit Chapter 9 Bankruptcy … What we know today!

Tuesday, July 23, 2013   (0 Comments)
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As you all should know, the City of Detroit filed for protection under Chapter 9 of the federal bankruptcy code last Thursday afternoon, July 18th. The next day Ingham County Circuit Court Judge, Rosemarie Aquilina, ruled that Governor Rick Snyder and City of Detroit Emergency Manager, Kevyn Orr, violated the state constitution and ordered that Detroit’s federal bankruptcy filing be withdrawn. US Bankruptcy Court Judge Steven Rhodes has set a hearing for Wednesday, July 24th, to address Judge Aquilina’s ruling and the Michigan Court of Appeals has issued a stay blocking Judge Aquilina’s ruling that the City’s bankruptcy petition be withdrawn.
We have consulted with MITA counsel, and provide the following information to help you better understand what Chapter 9 bankruptcy means for the City of Detroit, and what impact that bankruptcy may have on City of Detroit public works contracts.
Chapter 9 is not Chapter 11:
Despite some similarities, Chapter 9 differs materially from Chapter 11 in ways that are important to construction clients, and construction companies engaged in business with the City of Detroit should be cautious with advice related to Chapter 11 cases.  As a very general matter, described in more detail below, municipalities in Chapter 9 have far greater control over their business than does a Chapter 11 debtor.
Section 363, Section 904 and the ability of the City to continue to do business:
Section 363 of the Bankruptcy Code does not apply in Chapter 9 cases.  Section 363 generally prohibits the Debtor from taking the following actions without Court approval:
  1. Use of cash collateral;
  2. Sale, use or lease of property outside the ordinary course of business;
  3. Entering into contracts outside the ordinary course of business; and
  4. Settling disputes outside the ordinary course of business. 
Not only does Section 363 not apply, but Section 904 of the Bankruptcy Code prohibits the Court from entering any stay, order or decree that interferes with any of the property or revenues of the debtor, or the debtor’s use or enjoyment of any income-producing property.
Because Section 363 does not apply, the bankruptcy does not restrict the City’s ability to enter into new contracts, continue work on existing contracts, settle disputes with contractors or otherwise manage its affairs.
More controversial is whether the City can pay pre-bankruptcy claims, if it chooses to do so (without assuming contracts, as set forth below).  There is nothing in the Bankruptcy Code that directly prohibits the City from doing this, nor is there anything that requires Court approval before the City makes such a payment.  However, the process is supposed to culminate in “the [filing] of a plan for the adjustment of the debtor’s debts.” (Section 941 of the Bankruptcy Code), and payments made to creditors without Court authorization may be subject to later challenge under Section 549(a) of the Bankruptcy Code. 
Section 365, Construction Contracts with the City
Uncompleted construction contracts with the City are “executory contracts” as defined by the Bankruptcy Code.  Section 365 of the Bankruptcy Code provides that the City may assume or reject these contracts. 
If the pre-petition contracts are assumed:
  1. The City must continue to perform all of its obligations under the contracts; and
  2. The City must “promptly cure” all past-due obligations under the contract.
In numerous past circumstances, Judge Rhodes, the bankruptcy judge in the City of Detroit’s case, has held that “promptly” means immediately.  Other courts have held that promptly might permit payments over time.  Unless the Judge reverses his past position, assumption of a contract should lead to speedy payment of all past due amounts, and is the “gold standard” protecting contractors both for past and future work.
If pre-petition contracts are rejected:
  1. The City is excused from any future performance;
  2. All claims become pre-bankruptcy unsecured claims subject to modification under a plan (modification would include payment of substantially less than the full amount due under the contract);
  3. Work done after the filing of the bankruptcy, but before a contract is rejected is likely an administrative expense claim, which has higher priority than general unsecured claims.  Unlike in Chapter 11, however, there is no deadline set in Chapter 9 to pay these claims, and payments could be termed out for an extended time. 
Key notes and recommendations for contractors:
  1. Amounts due are administrative expenses only if the work done benefitted the City during its bankruptcy.  Before doing any work post-bankruptcy, obtain a written statement from the City or any Department that they wish for you to go forward.  While not completely conclusive, that will help prove a case for higher priority for claims.
  2. City officials may tell you that work is an “essential service” or words to that effect.  That is helpful, but not conclusive, especially as it does not guarantee payment of pre-bankruptcy amounts.  The City could still decide to reject certain contracts and keep others.  The legal context is important and assumption of the contracts is the gold standard.
  3. Remember that any City official may be replaced during this process.  Any statements that they make to you should be in writing. 
Post-petition contracts may be also rejected under the Bankruptcy Code.  Further, even contracts that have been assumed may be rejected after assumption.  Both of these events are very rare.
In the unlikely event that this occurs, it is likely that all damage claims, including consequential and future damages arising from the rejection, would be high priority administrative claims.
MDOT Contracts:
Unless otherwise agreed by the State and the City, Chapter 9 will not interfere with MDOT’s ability to recover the City’s share of funding from future ACT 51 monies.  MDOT contracts should be secure as the Local Agency Agreement included in every contract includes provisions that allow MDOT to capture the City’s ACT 51 monies should the City default on its’ funding commitment for a project.  It is possible, however, that MDOT and the City could agree to cancel or significantly modify any existing contracts.
In terms of bid, but not awarded contracts, MDOT is “holding” (i.e. not actively moving toward award) several recently let projects involving the City of Detroit pending direction from the MDOT Attorney General.
This bulletin is intended to provide general information and guidance to the MITA membership. As these bankruptcy proceedings are quite dynamic in nature, we will keep you informed of impending developments through future bulletins.
If you have any questions about the content of this bulletin or this matter in general, do not hesitate to contact Mike Nystrom at mikenystrom@mi-ita.com or Glenn Bukoski at glennbuksoki@mi-ita.com.