Five Things to Know About Detroit’s Bankruptcy

Detroit, once the fourth-largest city in the U.S. and a hub of industry and innovation, filed the nation’s biggest municipal bankruptcy yesterday. Here is a summary of the basics of municipal bankruptcy and how Detroit might use it, according to court filings and the U.S. judiciary.

What is a municipal bankruptcy?

Cities and towns with debt they can’t afford to pay can use a provision of U.S bankruptcy law, known as Chapter 9, to restructure what they owe. The law gives municipalities breathing space to negotiate with creditors such as bondholders or retired workers with pensions.

Why did Detroit file for bankruptcy?

Detroit’s collapse was fueled by an $18 billion debt load and decades of job losses that left behind a shrinking and increasingly impoverished population, tens of thousands of abandoned properties and decaying infrastructure. All of it amounts to a crisis that can only be solved in bankruptcy, according to the city’s emergency manager, Kevyn Orr, who said a deal with creditors was out of reach. Michigan Governor Rick Snyder authorized the bankruptcy filing on July 18.

What can and can’t be done in bankruptcy?

Bankruptcy shields Detroit from actions by creditors to collect on debt and allows the city to stop payments on general obligation bonds. Detroit can end costly labor agreements with unions and bind creditors opposed to the restructuring.

Cities in bankruptcy have more discretion in their operations and use of property than a business reorganizing in bankruptcy, and the judge overseeing the case can’t order the sale of assets through a liquidation. Also unlike a business bankruptcy, creditors can’t offer a competing restructuring plan if they oppose the city’s proposal.

What will happen next?

Detroit will first have to establish that it’s eligible to remain in bankruptcy and may face a fight from creditors that want to force the city out of bankruptcy to negotiate outside of court. The city will have to show it’s insolvent and that negotiating with creditors beforehand was impractical. Earlier this year, Stockton, California, successfully defeated creditor opposition to its bankruptcy filing.

What’s Detroit’s plan?

Before the bankruptcy filing, Orr proposed cutting pension payments, removing some workers from the system and making the rest pay more. The plan also called for swapping more than $11 billion in unsecured debt with new notes of $2 billion. Detroit has about $5.4 billion worth of water and sewer bonds that Orr said would be paid in full.

Before it's here, it's on the Bloomberg Terminal.