I have now read the complaint filed by MBIA and AGO in the Detroit bankruptcy proceeding seeking a declaration that i) Detroit has no equitable or beneficial interest in the proceeds of the ad valorem taxes levied pursuant to voter-approved resolutions which authorized the issuance of the insured GO bonds, and which require that the taxes so levied be deposited into a segregated account and be used only for the payment of the bonds specifically authorized pursuant to such voter-approved resolutions, and ii) Detroit has no authority to grant a super-secured lien on these ad valorem taxes in favor of the lenders in a proposed debtor-in-possession loan.
I think I might want to reconsider my prior thinking on the matter.
The complaint recounts the procedure taken by Detroit in connection with the issuance of these insured GO bonds. In particular, these bonds are supported by the pledge of ad valorem taxes that Detroit was not authorized to levy, under the Michigan constitution, in the absence of a voter-approved resolution providing for i) the issuance of the insured GO bonds, ii) the levy of additional ad valorem taxes to support repayment of the bonds, and iii) the requirement that these ad valorem taxes be deposited into a segregated account and applied solely to the repayment of the insured GO bonds specified in the voter-approved resolution.
The complaint also walks through the provisions of Michigan statutory law that enforces the obligation of a municipality like to Detroit to honor its pledge and application of ad valorem taxes when such taxes are levied pursuant to a voter-approved resolution.
The complaint also highlights that Michigan statutory law imposes personal liability on any government officer that contravenes this application of the proceeds of the ad valorem taxes supporting the bonds issued pursuant to voter-approved resolutions.
Now, if there is a conflict between federal bankruptcy law and state finance law in a bankruptcy case, the Supremacy Clause of the US Constitution requires that federal bankruptcy law prevails. But MBIA's and AGO's complaint argues, quite rightly in my view, that there is no conflict presented by federal bankruptcy law and provisions of the Michigan Constitution and Michigan statutory law that require the segregation of taxes and the use of those taxes for the single purpose of paying bonds that have been approved by voters in the resolution that created the bonds and the taxes.
This is not the situation where the Michigan Constitution provides that pensions cannot be impaired, and federal bankruptcy law generally provides for the impairment of obligations. That is a direct conflict and, in my view, federal bankruptcy law will trump state law.
MBIA's and AGO's complaint shows how these provisions of Michigan state law set forth the terms of, or characterize, the insured GO bonds, and there is no provision of federal bankruptcy law that purports to transform a secured obligation into an unsecured obligation, or which purports to provide a debtor municipality an unfettered beneficial interest in funds which are the proceeds of taxes levied for a specific purpose and which are required to be applied only for that purpose.
I have no doubt that Detroit's EM, now alleged by MBIA and AGO to be on the hook personally for the diversion of funds from payment of the insured GO bonds (this diversion is already more than $9 million in amount), will argue that Chapter 9 goes beyond standard corporate bankruptcy provisions in authorizing the municipal debtor to apply proceeds for legitimate governmental functions in the manner it sees fit.
However, the ambit of whatever powers a municipal debtor might have beyond a corporate debtor has not been elucidated by the federal bankruptcy courts, and the notion that Chapter 9 goes so far as to trump a voter-approved resolution specifying how specially approved tax levies may be applied, where Chapter 9 does not so provide in clear and specific language, seems to me to be a bit of a stretch. (My personal view is that unlike a Chapter 11 corporate debtor, a Chapter 9 municipal debtor has wide latitude in determining how to apply funds that are legally at its discretionary disposal; that is to decide to use unrestricted moneys to fund the police department a certain amount and the fire department another amount. It is by no means clear that this enhanced discretion permits the Chapter 9 municipal debtor to apply funds in any manner that it sees fit that are the subject of a voter-approved resolution, which requires under state law that those funds to be segregated and applied for a specific purpose.)
I am wondering if after Detroit's EM read this complaint he started to reread the indemnification language that may apply to the performance of his duties.
Disclosure: Long MBI; AGO.