Michigan’s Schuette on Both Sides of Detroit’s Bankruptcy

Bill Schuette was forced to leave Washington after losing his House seat in a failed bid for the U.S. Senate in 1990. He returned to his native Michigan, seeking lesser political jobs to slowly rebuild his career.

Now, as Michigan’s attorney general, he has a national platform courtesy of Detroit’s bankruptcy, where the Republican has weighed in on the side of state pensioners, seeking to protect their fixed incomes from any reductions by intervening in the case.

Schuette’s leap into Detroit’s $18 billion collapse has put him on shaky legal ground, according to lawyers following the case. Bankruptcy law is against him, and his role in helping Republican Governor Rick Snyder fight off union efforts to prevent Detroit’s filing, lawyers said, has made his move to join the case seem like he is on both sides of the debate.

Schuette, 59, said he will use his office to protect public-worker pensions, citing the state’s constitution, while at the same time pledging support for Snyder, who backs a proposal to cut those pensions.

“I don’t lick my finger and stick it up to see which way the wind blows,” Schuette said in a telephone interview this week. “These are cops, these are retirees, these are the human side of the story.”

Court Hearing

Lawyers for the city are back in federal court in Detroit today, where U.S. Bankruptcy Judge Steven Rhodes is scheduled to propose a timetable for resolving the main disputes in the case, including Schuette’s position on the Michigan constitution.

“The attorney general has filed a notice of appearance, preceded by some public comments, that confuses us a bit about the role the attorney general expects to take in this case,” David Heiman, a lawyer for the city, told the judge today. “We want to try to unravel that.”

Claiming that the state constitution bars cuts to public-employee contracts may be politically popular, though bankruptcy attorneys said it’s wrong as a matter of law.

U.S. bankruptcy law allows any contract, even one related to pensions and protected by state law, to be “impaired” by a federal judge, bankruptcy attorney Patrick Darby said.

“This is well-settled law,” said Darby, a lawyer at Bradley Arant Rose & White LLP in Birmingham, Alabama. He represents that state’s Jefferson County, which before Detroit, had filed the biggest U.S. municipal bankruptcy.

Can’t Dictate

Once a state allows its cities and counties into U.S. bankruptcy court, it can’t tell the federal judge which debt can and cannot be reduced, Darby said.

Schuette said his positions are based on law, not popularity. That view may win him political points among labor-friendly Michigan voters because he is siding with a “sympathetic class of people,” Bill Ballenger, who publishes “Inside Michigan Politics,” a political newsletter in Lansing, the state capital.

Schuette is also pledging to use his office to continue defending Snyder, who authorized the bankruptcy and appointed the emergency manager, bankruptcy lawyer Kevyn Orr. Orr is trying to restructure Detroit’s debt by imposing cuts on retirees and bondholders.

Detroit sought court protection on July 18 after decades of decline left the traditional home of U.S. automakers unable to pay its debt and provide needed services.

‘Honest Response’

Orr said creditors had refused to give an “honest response” to his debt-reduction proposal the month before, and instead sued him and Snyder in state court to block any potential bankruptcy filing.

When a Michigan judge sided with Detroit’s pension officials, concluding that a bankruptcy filing violated the state constitution, Schuette challenged that ruling in Michigan’s appellate court, where he served six years as a judge. He quickly won a suspension of the state case, removing a potential obstacle to the federal bankruptcy petition.

Schuette is “required to act as the attorney for the people of the state whose interests are in accord with Michigan law,” said Larry Dubin, a law professor at the University of Detroit. “It makes sense that the attorney general should be taking a legal position consistent with the Michigan constitution.”

He’s also the attorney for state officials including Snyder, Dubin added. As a result of that dual role, he didn’t see a conflict in the positions Schuette has taken.

‘Governor’s Authority’

“The position the attorney general took in the state proceedings wasn’t to support the diminution of the pensions, but to stay the state actions that had been brought and have the issue decided in the bankruptcy court,” Dubin said. “The challenge in the state court action was to the governor’s authority to initiate the bankruptcy.”

“That’s a legal issue separate and apart from the pension holders’ rights,” he said.

“As attorney general, I’m the chief law enforcement officer of the state of Michigan and part of the job is to defend the constitution of the state,” Schuette said in the interview.

In the lower-court cases seeking to block the bankruptcy, Schuette, representing Snyder, argued that the issue had to be in the bankruptcy judge’s hands, Dubin said.

‘Conflict Wall’

In arguments before the bankruptcy court, if there are conflicts because of the state cases, “a conflict wall” would be established, Schuette said, with different lawyers from the attorney general’s office assigned to different sides.

This isn’t uncommon, he said. The attorney general’s office often represents the Public Service Commission on one side in the utility rate-setting process and ratepayers on the other side, Schuette said.

Once Snyder leaves the governor’s office, Schuette may try to succeed him, positioning himself as a more conservative Republican, Ballenger said. For that, he will need the support of primary voters, who won’t be impressed by his defense of public pensions, but may like his stance on the state constitution, said Tom Shields, a Republican political consultant in Lansing.

At the court hearing today, the second since the city filed its bankruptcy petition, Heiman said there are still “significant differences” in talks with creditors. Rhodes gave the parties seven days to make comments and suggestions about his choice of a mediator and to offer details on the timing and substance of the mediation.

Rhodes said this week that he wanted a plan for the city’s reorganization by March. Heiman said today that a plan could be ready by the end of this year.

Potential Fights

The hearing may also include any potential fights over issues such as the role of Michigan’s constitution and other objections creditors may raise. Schuette didn’t plan to attend any of the hearings, he said, leaving that to the lawyers he has appointed to handle the case.

Schuette’s decision to defend the pensions surprised John Canzano, the attorney who filed one of the state lawsuits challenging Snyder’s authority to initiate the bankruptcy.

“I’m kind of surprised, because they opposed us in the other cases,” Canzano said. “I hope the attorney general continues to maintain that position.”

Schuette was first elected to the U.S. House of Representatives in 1984 when he was 31. Six years later he gave up that seat to challenge Senator Carl Levin, a Democrat who has held the office since 1979.

He “absolutely” was an underdog in the 1990 Senate campaign, said John Truscott, a Lansing consultant who in 1990 was press secretary for Republican gubernatorial candidate John Engler.

‘Driven Guy’

Truscott said Schuette was “a pretty driven guy” who disliked being in the minority in the U.S. House of Representatives.

After his defeat, Schuette returned home to become director of the Michigan Department of Agriculture under then-Governor Engler, and later joined the state senate. In 2002, he won election to the state’s appeals court. In 2010, he was elected attorney general.

Schuette’s position on Michigan’s constitution is a common error made by people who don’t understand bankruptcy law, especially union officials and municipal bond investors, said Dale Ginter, who represented the official committee of retired city workers in the bankruptcy of the California city of Vallejo.

The judge in that case allowed the city to cancel a union labor contract even though state law said they can’t be impaired by a court.

Retirees Settle

Ginter had been preparing to argue that retiree benefits were protected by state law when the retirees and city officials settled their dispute by accepting a reduction to their medical benefits.

The case didn’t directly challenge pensions, but the legal concept was the same, Ginter said.

The U.S. Constitution reserves the power to break contracts to the federal bankruptcy courts, Ginter, Darby and other bankruptcy lawyers said. Such federal pre-eminence prevents local judges in one state from canceling a debt owed by one of its citizens to those from another state.

A federal bankruptcy judge has the final say on whether a pension contract, or an unsecured bond contract, or any other contract can be canceled, said James E. Spiotto, a partner with Chapman & Cutler LLP in Chicago who has written and lectured on the provisions of the U.S. Bankruptcy Code governing municipal reorganization.

Same Cuts

Bondholders who don’t have any collateral rights will face the same cuts as the pensioners because both are considered unsecured debt in bankruptcy court, Spiotto said.

Unsecured creditors come after secured creditors in terms of who gets paid first out of a bankruptcy estate.

If Schuette’s position that pension contracts should be protected in bankruptcy became widely accepted by federal courts, it would undermine the bankruptcy system, Ginter, Spiotto and Darby said.

“Contracts are impaired all day, every day in bankruptcy court,” Ginter said.

The case is City of Detroit, 13-bk-53846, U.S. Bankruptcy Court, Eastern District of Michigan (Detroit).

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