On Wednesday, the federal judge overseeing Detroit's bankruptcy ruled that city employees couldn't go to state courts to keep their pensions out of the bankruptcy case. Bankruptcy Judge Steven Rhodes said he would hear the pensioners' arguments in his court.
Some cities, like Detroit, are located in states where pension benefits are guaranteed in full according to state constitutions, statutes or court precedent. Yet Detroit's emergency manager is asserting that those guarantees go away in federal bankruptcy court, leaving retirees in the same pool as numerous other creditors who may get mere cents for each dollar they are owed.
"There's not a lot of previous case law that tells us what's going to happen here," said Paul Secunda, a Marquette University law professor who specializes in labor and benefits issues.
"It's not just an issue of bankruptcy law and pension law, it's also an issue of federalism," Secunda said. "Can a federal bankruptcy court basically ignore a state constitutional provision and allow a city like Detroit to ignore its previous promises concerning public employee pensions?"
The question matters because pensions pose a major liability for states, counties, cities, schools and other local governmental entities. A report released earlier this year by the Pew Charitable Trusts found that the nation's largest cities had a combined pension shortfall of almost $100 billion and an even larger shortfall in retiree health-care benefits as the nation's financial crisis peaked in the 2009 fiscal year.
Although municipal finances generally have improved since then, many local retirement plans remain on an unsustainable path, the Pew organization said.
Michigan Gov. Rick Snyder and Detroit emergency manager Kevyn Orr contend that retiree benefits should be able to be trimmed along with other debts to restore the city's finances. Detroit has about 21,000 retired workers who are owed benefits, with underfunded obligations of about $3.5 billion for pensions and $5.7 billion for retiree health coverage.
"There have to be concessions," Orr said earlier this week.
A similar situation is unfolding in Stockton, Calif., which entered bankruptcy in April after its property-tax revenues were hit hard by the housing crisis.