By Joseph Lichterman
DETROIT (Reuters) - In a federal court building in downtown Detroit, beginning on Wednesday morning, the largest municipal bankruptcy filing in U.S. history comes down to a single question: Is Detroit bankrupt?
Federal bankruptcy judge Steven Rhodes will begin hearing arguments on the crucial issue of whether Detroit is eligible to restructure its debts and liabilities under Chapter 9 of the U.S. Bankruptcy Code that applies to municipalities.
The hearings will pit retirees, pension funds and unions trying to preserve retirement payments to city workers against Detroit's state-appointed emergency manager, charged with righting the city's finances.
Detroit clearly is struggling. More than one-third of its residents live below the government poverty line. There are some 78,000 abandoned structures and just 40 percent of the street lights work. Detroit's population has shrunk to less than 700,000, from a peak of 1.8 million in 1950, and only 53 percent of property owners paid their 2011 property taxes.
But such troubles do not necessarily amount to bankruptcy under federal law. And in the multi-day hearing that opens at the Theodore Levin U.S. Courthouse, Detroit's attorneys will need to prove that Detroit meets the legal requirements for Chapter 9 bankruptcy protection.
City lawyers are expected to tick off arguments meant to meet that standard: Detroit had proper authorization to file the case, it is financially insolvent, it negotiated in good faith with its creditors or had so many creditors that such negotiations were not feasible, and it requires bankruptcy protection in order to deal with $18 billion in debt and other liabilities.
Many bankruptcy experts say Rhodes is likely to find Detroit eligible, though his ultimate ruling is hardly a foregone conclusion. "Chapter 9 is never routine," said Juliet M. Moringiello, a law professor at Widener Law School in Harrisburg, Pennsylvania, who has followed proceedings in the Detroit case.
The city filed the case on July 18, and it said about half of its liabilities stem from retirement benefits, including $5.7 billion for healthcare and other obligations, and $3.5 billion involving pensions. How the city restructures its debt may set precedents for other struggling municipalities, bankruptcy experts said.
"We'll see other Chapter 9s," said Kenneth Klee of Klee, Tuchin, Bogdanoff & Stern in Los Angeles, who is representing Jefferson County, Alabama in its Chapter 9 case. "The pension problem is one that will require resolution, and with the labor relations being strained in parts of the country and some politicians not able to say no to employees and retirees, I expect there will be other chapter 9s to be filed."
On Monday, attorneys wrapped up a three-day hearing on legal authority issues surrounding the bankruptcy as objectors argued that Chapter 9 is unconstitutional and that Michigan's constitution protects pensions from being slashed.
"It's one of those moments that I think that we will look back on and say 'This is where Chapter 9 changed,'" attorney Barbette Ceccoti told the court on Monday on behalf of the United Auto Workers union, which represents some city workers.
Moringiello said parties tend to object to bankruptcy filings because they think they can do better under state law, and she said if Rhodes does not grant eligibility the creditors likely will try to get a state court to force the city to pay its debts.
"Those are not terribly effective remedies," she said. "You don't have the same remedies you have against a private debtor."
Detroit's unions, pension funds and retirees have all filed objections to the bankruptcy, and will argue that the city is not eligible for court protection.
They have submitted a number of arguments, including that the city did not appropriately negotiate with its creditors because Detroit's emergency manager, Kevyn Orr, only held informational meetings, not formal negotiating sessions, before filing for bankruptcy.
Objectors also are expected to contend that Detroit is not insolvent. It has assets like its water and sewer system or the works of the Detroit Institute of Arts that it can monetize.
"There are only so many things they can fight about," said John Pottow, a University of Michigan professor who specializes in bankruptcy law. "They can fight about the solvency and they can fight about the negotiating in good faith. It probably won't take too long to have a trial, but it's a big stakes thing."
Attorneys on both sides will present evidence and call witnesses before Rhodes. The city plans to call five witnesses, including Orr and Detroit Police Chief James Craig, said Geoffrey Irwin, a lawyer with Jones Day representing the city.
The objectors said they have not finalized their witness list. But they have said they could call up to 15 or so witnesses, including Michigan Governor Rick Snyder, who was subpoenaed by the UAW.
Rhodes has scheduled 10 days of hearings over the next three weeks for all sides to present their arguments, but attorneys have indicated the arguments could wrap up as early as next week. It is not clear how soon Rhodes could rule on eligibility.
Throughout the case, Rhodes has been committed to expediting the process and encouraging the parties to negotiate with one another. Rhodes appointed Chief District Judge Gerald Rosen as chief mediator, and he's leading a team of five additional mediators to help the process along.
"He is finding ways to take control of this case to keep it on schedule, in ways people didn't necessarily think were possible in a Chapter 9, in ways that aren't necessarily written into the statute," said Melissa B. Jacoby, a professor and bankruptcy expert at the University of North Carolina School of Law.
(Reporting by Joseph Lichterman in Detroit, Tom Hals in Wilmington, Del. and Nick Brown in New York; Editing by David Greising and Tim Dobbyn)