There has been some muddy thinking about the Chapter 9 bankruptcies of Stockton and Detroit involving the potential application of the Supremacy Clause of the U.S Constitution to conflicts between federal bankruptcy law and provisions of state constitutions.
Let's be clear when the Supremacy Clause applies, and when it does not apply.
In my view, the Supremacy Clause applies in the case of Stockton because there is a direct conflict between the provisions of Chaper 9 and the California constitution. The California constitution contains a provision that prohibits the reduction of vested pension benefits of retired Stockton public employees. However, these vested pension benefits are a simple unsecured liability in the view of federal bankruptcy law, and if in connection with a fair and equitable plan of adjustment Stockton wanted to impair these benefits, or was required to do so in order to get that plan confirmed, it is clear in my mind that federal law would prevail to uphold pension fund impairment.
Why? Because the Supremacy Clause says so.
It appears that with recent agreements reached between Stockton and its municipal finance insurers, Stockton may avoid confronting this federal/state law conflict issue.
Detroit's chapter 9 case may also eventually involve a federal/state law conflict over pension impairment. If so, my view regarding the application of the Supremacy Clause and federal law prevailing would apply as well in the case of Detroit. But I want to focus on another issue in the Detroit case that, contrary to what I have read in some press reports, does not invoke application of the Supremacy Clause.
In the case of the Detroit bankruptcy, there is a significant question under the Michigan constitution regarding the Emergency Manager's classification of the unlimited general obligation bonds (GOs) as unsecured debt, and the application of tax revenues specifically approved by voters to support those GOs towards the payment of other obligations and expenses.
This is a classification question which creates no conflict between the Michigan constitution and federal bankruptcy law. The Supremacy Clause is only invoked to say that federal law prevails if there is a conflict between federal and state law. In the case of Detroit, federal bankruptcy law looks to state law to determine whether an obligation should be treated as secured or unsecured in the bankruptcy proceeding.
Federal law is agnostic on the question. Therefore, the Detroit Emergency Manager has no power under federal law to treat the GOs as anything other than secured, if indeed the Michigan constitution so provides.
Another instance of federal bankruptcy law agnosticism is whether a municipality is authorized to file to commence a Chapter 9 case. Chapter 9 looks to state law for this answer.
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As a side note, I have heard much commentary about the Detroit Institute of Art's (DIA) art collection being held "in trust" for the benefit of the people of Detroit (and therefore unreachable by creditors in bankruptcy). I have one question.
Where is the trust instrument?
If DIA and Detroit wanted its art collection, valued at $2-3 billion apparently, to be owned by a trust and insulated from Detroit creditors, it certainly could have done that (absent the existence of any grantor proscriptions that I have not heard about).
$2-3 billion worth of art looks to me like pretty good collateral that could be applied towards the rebuilding of Detroit.