What the Detroit bankruptcy ruling means for Illinois

Today U.S. Bankruptcy Court Judge Steven Rhodes ruled that “nothing distinguishes pension debt from any other debt” – and that Detroit’s pension debt can therefore be partially discharged in bankruptcy. What does that mean for Illinois, where huge unfunded pension liabilities threaten to render the state government and many local governments insolvent? If the courts...

Today U.S. Bankruptcy Court Judge Steven Rhodes ruled that “nothing distinguishes pension debt from any other debt” – and that Detroit’s pension debt can therefore be partially discharged in bankruptcy.

What does that mean for Illinois, where huge unfunded pension liabilities threaten to render the state government and many local governments insolvent? If the courts here follow Judge Rhodes’ example, it could mean that Illinoisans in local government pension systems could see some of their promised benefits disappear in bankruptcy as well.

In Detroit, public sector unions argued that the bankruptcy court couldn’t touch pension benefits because of the Michigan Constitution’s “Pensions Clause,” which says that any pension obligation of the state or a local government “shall be a contractual obligation thereof which shall not be diminished or impaired thereby.” According to the unions, discharging pension debt would diminish and impair their benefits and would thus violate the Michigan Constitution.

Judge Rhodes rightly rejected that argument. Pension clauses in state constitutions were meant to give government workers a contractual right to future benefits as part of their payment for doing their jobs. In other words, the clauses establish that pension benefits are not a mere “gift” from the government and are not like welfare benefits, which the Legislature can reduce or discontinue at any time.

As Judge Rhodes recognized, there’s nothing special about pensioners’ contractual rights that makes them superior to anyone else’s contractual rights. So just like anyone else who is owed money under a contract, pension recipients can lose out on some of what they are contractually owed when the entity that owes them declares bankruptcy.

Judge Rhodes’ opinion isn’t binding on bankruptcy courts in Illinois, but they should find his analysis persuasive and conclude that the Illinois Constitution’s Pension Clause, which is substantially the same as Michigan’s Pensions Clause, does not prevent a bankruptcy court from discharging Illinois local governments’ pension debt.

But there are some conditions that would have to be met before an Illinois local government could even file for bankruptcy.

Under bankruptcy law, a city can only file for bankruptcy if a state law authorizes it to do so. Illinois has no law authorizing Chicago or other large cities to file bankruptcy, but there is nothing stopping the General Assembly from passing such a law if it chooses. If Chicago became insolvent like Detroit, one would hope that legislators would have the political will to authorize a bankruptcy.

Illinois law does currently allow small municipalities to file bankruptcy under limited circumstances. Under a state statute, a “financial planning and supervision committee” created by the governor can recommend that a municipality of less than 25,000 residents declare bankruptcy. Such a committee can only come into existence if the municipality petitions the governor to create it and the governor determines that the municipality is in a “fiscal crisis.”

As it happens, many small cities across the state are in a fiscal crisis, or may be soon, because many of them have grossly underfunded police and fire pension funds.

We might find out just how relevant the Detroit bankruptcy is to Illinois sooner than many people expect.