Michigan's Emergency Financial Manager Law and Its Impact on Creditors of Municipalities and School Districts
On Feb. 29, 2012, a Michigan citizens' group opposed to the State of Michigan's emergency financial manager law (officially entitled "Local Government and School District Fiscal Accountability Act," MCL §§ 141.1501 et seq. and referred to herein as the "Act"), filed petitions to place the issue of the Act's rejection on the state ballot in November. These petitions and the signatures on them will now be reviewed by the State Board of Canvassers, two of whom are Republicans and two of whom are Democrats, to determine if the petitions and signatures comply with applicable Michigan law. MCL §§ 168.471, et seq . If the Board validates the form of the petitions and determines that they contain valid signatures of 161,305 registered voters i, then the Act will be immediately deemed not "effective"ii unless the Act, after being placed on the ballot for a voter referendum, is later "approved by a majority of the electors voting thereon" on Nov. 6, 2012.iii
Thus, the political drama continues to unfold over whether this statute, enacted by a Republican legislature in March, 2011 at the behest of a recently elected Republican governor, Rick Snyder, will survive the political process. The statute and its effects, which include the appointment by the governor of emergency financial managers for municipal governmentsiv and school districts with broad powers to reject, modify and terminate contracts and even specific terms and conditions of contracts between municipalities/school districts and third parties (including collective bargaining agreements) has polarized the politicians and the public. Fiscal conservatives tend to support the statute as a means to stabilize the finances of local governments and school districts in severe financial distress short of seeking relief under Chapter 9 of the Federal Bankruptcy Code.v Some liberals, unions, city officials and employees have attacked the Act and the requirements of emergency financial managers appointed thereunder as "dictatorships" that run roughshod over the democratic rights of elected officials and common citizens.vi
In order to fully understand how the Act works and to assess these comments and criticisms made in a politically-charged atmosphere, the history of the Act, as well as its predecessor statutes, and the specific powers and duties imposed upon emergency financial managers must be carefully examined. As will be discussed below, the provisions of the Act permitting managers to reject, modify and terminate contracts and even their specific terms and conditions should give rise to concerns by third parties who are parties to contracts with local governments being operated by emergency managers in a receivership. The clear language of the statute could permit a manager to alter unilaterally the quantity and price terms of a contract to deliver goods and services to the local government or to reject and terminate the contract altogether. This is obviously not a result that contracting parties did not bargain for when they entered into pre-receivership contracts with local governments.
B. Constitutional Limitations on Emergency Financial Managers
The United States Constitution in Article 1, Section 8, provides that only the United States Congress may enact uniform laws for the states on the subject of bankruptcies. Thus, no state may enact laws on the subject of bankruptcy when federal laws governing bankruptcy are in force, as they are today. In addition, no state may enact laws impairing "the Obligation of Contracts." U.S. Constitution, Article 1, Section 10, Clause 1. In general, any state law negatively impacting the contractual rights of a private party must be in furtherance of a valid state purpose and satisfy other conditions to be valid.vii As discussed below, by importing legal concepts of receivership into the Act, the Michigan legislature comes close in the Act to a bankruptcy-type law, which is a province that may only be occupied by the United States Congress. In addition, the Act may run afoul of the constitutional prohibition against states impairing contractual obligations by permitting emergency financial managers to modify, reject and/or terminate contracts between local governments/ school boards and third parties and to alter particular terms and conditions of these contracts.
C. History of the Act
The Predecessor Statutes
Although an emergency financial manager statute was enacted by the Michigan legislature in 1988, this statute was substantially expanded by the passage of Public Act 72 of 1990, codified as MCL §§ 141.1201, et seq. This predecessor of the Act permitted the governor to appoint emergency financial managers for local governments and school boards. However, this prior statute did not authorize these managers to reject, modify or terminate existing contracts between the local governments in receiverships and third parties. See, e.g., MCL § 141.1221, 141.1241. See also, Savage v City of Pontiac, 743 F.Supp. 678 (E.D. Mich. 2010).
Under this predecessor statute, Governor Snyder's predecessors appointed emergency financial managers for the cities of Hamtramck, Flint, Highland Park, Pontiac and Ecorse, the Village of Three Oaks as well as for the Detroit Public Schools. See generally Citizens Research Council of Michigan, Financial Emergencies in Michigan Local Governments , Rep. No. 362 (April 2010). Because the Act specifically provides for the continuation of emergency financial managers appointed under this predecessor statute, the managers for Ecorse (Joyce Parker), Pontiac (Louis Schlimmel), Benton Harbor (Joseph L. Harris) and the Detroit Public Schools (Robert Bobb, succeeded by Roy Roberts) are still operating as managers.viii
Hamtramck's experience under this predecessor statute is instructive and interesting. In 2000, former Michigan governor John Engler appointed Louis Schlimmel as emergency financial manager for this city that is surrounded by the City of Detroit except for a small common border on the west shared with the City of Highland Park. The ethnic makeup of Hamtramck in the first three-quarters of the Twentieth Century was overwhelmingly Polish and employment opportunities abounded for the city's population in nearby automotive plants. However, as the strength of the Detroit automotive industry declined in the late-Twentieth and early Twenty-First Centuries, so did the fortunes of Hamtramck. Automobile plants were shuttered, many long-time residents moved away and the city's tax base precipitously declined.
In 2005, the voters of Hamtramck approved a new city charter and, two years later, the emergency manager's tenure and the receivership imposed by the predecessor act were terminated on account of the alleviation of the city's financial distress. Nevertheless, in December, 2010, Hamtramck was involved in a dispute over its claimed entitlement to taxes collected by the City of Detroit and Hamtramck's refusal to pay water and sewage charges owed to Detroit. As a result of the resulting financial squeeze, the Mayor of Hamtramck sought the permission of then Michigan Governor Jennifer Granholm to commence a bankruptcy case under Chapter 9 of the Bankruptcy Code. Governor Granholm, however, denied this request. Thereafter, Hamtramck and Detroit settled their disputes which resolved that financial crisis, at least for the time being.
2. The 2010 Election Results in Michigan
In the general election of November, 2010, the Republicans recaptured the governorshipfromthe Democrats and also secured control of both the State Senate and House of Representatives bylarge majorities.ix On March 16, 2011, the Act became immediately effective, having been passed by the state legislature and signed into law by Governor Snyder.
D. Main Provisions of the Act
1. Legislative Findings
Section 3 ofthe Act, MCL § 141.1503, contained the Michigan legislature’sfindings on the need for this legislation. This section begins by stating that the “health, safetyandwelfare” of Michigan citizens wouldbe “materiallyand adversely affected the byinsolvencyof local governments.” The legislature further found that it is a "valid public purpose” for Michigan to assist a local government in a condition of financial stress or financial emergency."
2. The Processfor Appointment of Emergency Managers
In order to place a “local government” into receivership and appoint an emergency financial manager for that body, the“state financial authority” of a “local government” (viz.,either a municipal government or a school district)x may conduct a preliminaryreview to determine whether a financial problemexists for the local government involved. In making this determination, at least one or more of 18 enumerated conditions must exist. MCL § 141.1512(1). These conditions include (i) the request of the governingbodyor chief administrative officer of a local government for a preliminaryreview; (ii) the written request of a creditor whose claimremains unpaid for 6 months and which claim exceeds the greater of $10,000.00 or 1% of the annual general fund budget of the local government involved; and (iii) anyother “factsor circumstancesthat in the state treasurer’ssole discretion for a municipal government are indicative of municipal financial stress, or,that in the superintendent of public instruction’s sole discretion for a school district are indicative of school district financial distress.” MCL § 141.1512(1) (a),(b), (r).
If the state treasurer, in the case of a municipal government, or the superintendent of public instruction, inthe case of aschool district, determines that it is appropriate to make a preliminary review of a local government’s financial condition, then the local governmentmust be given written notice of that determination. MCL§ 141.1512(2). All suchreviews must be completed no later than 30 days after theybegin andall local government officials must cooperate with the persons making this review. Id.
If the preliminary review includes a finding of “probable financial stress,” then the governor must appoint a “review team.” The members of a review team will differ when the subject of the review is a municipal government or a school district. MCL § 141.1512(3), (4). After appointment, the review teamis empowered to examine the books andrecords of the local government andmay enter into a consent agreement with the “chief administrative officer”xi of the local government. MCL § 141.1513(1)(a)-(c).A consent agreement may contain undertakings by the local government to relieve financial stress or a financial emergency short of placing the local government in receivership and appointing an emergency financial manager. MCL § 141.1513(1)(c).
After performing its work and meeting with the local government to discuss the results of its investigation, the review team must report its findings to the governor.MCL § 141.1513(2),(3).The reportmust be delivered to the governor by the review teamwithin 60 days of its appointment,although the governor maygrant one 30-day extension of this deadline. MCL § 141.1513(3). This report must indicate whether anyof one or more of 15 specified conditions have occurred or are likely to occur including (i) a default on payment of principal or interest on bonded obligations; (ii) failure to transfer on a timely basis taxes withheld on employee income; and (iii) failure to eliminate any existing deficient in any of the local government’sfunds on a timely basis. MCL § 141.1513(3).
If the governor determines, after considering the review team’s report, that a financial emergency exists and that determination is later confirmed as described in MCL § 141.1515(2), then the governor must “declare that local government in receivership” and “shall appoint an emergencymanager” to act for the local government. MCL § 141.1515(4). The Act grants to emergency managers “broad powersin receivership to rectify the financial emergency and to assure the fiscal accountability of the local government and the local government’s capacity to provide or cause to be provided necessary governmental services essential to the public health, safety, and welfare.”Id.
3. Qualifications for Emergency Managers’ Appointment and Compensation
In order to be appointed as an emergencymanager,the candidate must be an individual with a minimumof 5 years’experience and “demonstrable expertise in business, financial, or local and state budgetary matters.” MCL §§141.1515 a),(c). The individual may, but is not required to, be a resident of the local government involved.MCL §141.1515(b).The emergency manager generally serves “at the pleasure of the governor” but maybe impeached and convicted by the legislature. MCL §141.1515(d).An emergency manager’s compensation and reimbursement for expenses will be paid byt he local government pursuant to the terms of a written contract approved bythe state treasurer. MCL § 141.1515(5)(e).xii The emergency manager must submit quarterly reports to the state treasurer concerning the financial condition of the local government in receivership. MCL §§ 141.1515(7), 141.1522. Finally, an emergency manager may appoint staff and hire professionals as he or she “considers necessaryto fulfill his or her appointment.” MCL §141.1515(6).
4. Development and Submission of Financial and Operating Plan
Emergency managers are required todevelop andare permittedto later amend a “written financial and operating plan” forthe local government involved. MCL § 141.1518(1). These plans must provide for the following actions:
- Conducting the local government’s operations “within the resources available according to theemergency manager’s revenue estimate.”
- Paying in full all scheduled debt service requirements on all bonds, notes and municipal securities and “all other uncontested legal obligations.”
- Modifying, rejecting, terminating and re-negotiating contracts under MCL § 141.1519.
- Timely depositing all required payments for the local government’s pension funds.
- Preparing academic and educational plans forschool districts.
- Performing all other necessaryand appropriate actions.
This plan must be submitted bythe emergency manager to the state treasurer by no later than 45 days after the manager’sappointment. Within 30 days after this plan is submitted to thestate treasurer, the manager must conduct a “public informationalmeeting on the plan and any modifications to the plan.” MCL § 141.1518 (4).
5. Other Enumerated Powers of Emergency Managers
Section 19 of the Act contains a long laundrylist ofthe powersof the emergencymanager with respect to the local government in receivership. These powers include the following:
- The manager may “amend, revise, approve or disapprove the local government’s budget” and may “limit the total amount appropriated or expended.”MCL § 141.1519(1)(b).
- The manager may receive and disburse for the local government “all federal, state and local funds earmarked for the local government.” MCL§ 141.1510(1)(c).
- Examine all records and books of account of the local government and require witnesses to appear and produce “books, papers, contracts, and other documents relevant to an analysis of the financial condition of the local government.” MCL § 141.1519(1)(f).
- Reject, modify or terminate “one or more terms conditions of an existing contract”. MCL § 141.1519(1)(j).
- Reject, modify or terminate an existing collective bargaining agreement (or more terms and conditions of suchan agreement) after meeting and conferring“with the appropriate bargaining representative” of the affected union, provided that certain specific conditions are first satisfied.MCL § 141.1519(1)(k).
- Authorize the borrowingof moneyby the local government “asprovided bylaw.” MCL § 141.1519(1)(u).
- Enter into settlements with creditorsconcerning unpaid debts of the local government. MCL §§ 141.1519(1)(w), (x).
- To sell, lease, convey, assign or otherwise useor transfer assets, liabilities, functions or responsibilities of the local government subject to certain limitations. MCL§ 141.1519(r).
During the period of the local government’s receivership, the authority of the chief administrative officer and the governing bod yto exercise powerson behalf of the local government under applicable law, charter and ordinance is suspended and transferred to the emergency manager. MCL §141.1519(2).
If the local government inreceivership is a school district, MCL §141.1520 grants additional, specific powers to the emergency managers. These additional powers include the following:
- To negotiate, re-negotiate, approve andenter into contracts. MCL§141.1520(a).
- To receive and disburse on the district’s behalf all federal, state and local funds earmarked for the district.
- To sell, assign, transfer orotherwise use school district assets to pay indebtedness or otherwiseassurethe districts fiscal accountability provided that such actions do not “impair the education of pupils in the school district.” This power includesthe closing of schools other school buildings.MCL § 141.1520(d).
6. Elimination of Compensation Due to Chief Administrative Officer and Members of Governing Body
Upon the imposition of areceivershipfor a local government and while the receivership lasts, the“salary,wages or other compensation and other benefits” payable to the chief administrative officer of the local government and the membersof the local government’s governingbodyare immediately “eliminated.” MCL § 1519a. This elimination does not, however, affect vested pension benefits but will affect the accrual of post-employment benefits. Id. These eliminated wages, salaries and benefits maylater be restored bythe emergencymanager, however. Id.
7. Authorization to Seek Bankruptcy Relief
An emergency manager of a local government may recommend to the governor and state treasurer that the local government be authorized to file a petition under Chapter 9 of the Bankruptcy Code provided that the manager believes that “noreasonable alternative to rectify the financial emergency. .. exists.” MCL § 141.1523(1). If the governor approves this recommendation, the governorshall then advise the state treasurer and emergency manager in writing of this decision. Id.Upon receipt of this authorization, the local government, acting through the emergency manager, ma yfile a Chapter 9 petition with the proper bankruptcycourt, therebycommencing a bankruptcy case.Id. During the pendency of this Chapte r9 case, the emergency manager is empowered “toact exclusively on the local government’sbehalf.”Id. See generally John T.Gregg, Eligibility of Michigan Municipalities for Relief Under Chapter 9 of the Bankruptcy Code, Federal Bar Association for the Western District of Michigan Bankruptcy Newsletter (June 2011).
8. Termination of the Receivership
Once the emergency manger has determined thatthe local government’s financial problems have been addressed and rectified, the manager will make such a declaration in one of his or her quarterly reports to the state treasurer. MCL § 141.1524. This finding will be subject to the concurrence of the state treasurer and, if a school district is involved, the concurrence ofthe state superintendent of public instruction.Id.
Before the receivership of a local government can be terminated, the emergency manager is required to “adopt and implement a 2-year budget, including all contractual and employment agreements, for the local government commencingwith the termination of receivership.” MCL § 141.1527(1).This budget may not be amended bythe governing bodyof the local government after the receivership is terminated in absence of the state treasurer’s approval. MCL §141.1527(2). In addition, the governing bodyis prohibited from revising“any order or ordinance implemented bythe emergencymanager during his or her term prior to1 year after the termination of receivership.”Id.Once the financial emergency affecting the local government is rectified, the emergencymanagerwill cease to continue in that capacity. MCL §141.1515(8)(b). The local government will be removed fromreceivership upon the correction of the financial conditions“in a sustainable fashion as determinedby the state treasurer” inaccordance with the Act. MCL § 141.1515(9).
E. The Immediate Impact of the Act
A number of receiverships for local governments have been imposed upon local governments since the passage of the Act in March,2011. The City of Flint, which has never recovered from the initial shocks to the domestic auto industry beginning in the 1980s, is now governed by an emergency manager, Michael K.Brown, appointed by Governor Snyder on December 1, 2011.The Highland Park School District is also subject to receivership and governance by an emergency financial manager, Jack Martin, a certified public accountant and former chief financial officer of the U.S. Department of Education. According to media reports, the Muskegon Heights School District is reportedly engaged in talks with the state over the possible imposition of a receivership. A preliminary review determined in January that “possible financial stress” existed in this school district. Finally, the City of Detroit may become the next municipal government to become the subject of a receivership under the Act. A preliminary review conducted under the Act recently concluded that there was “probable financial stress” in Detroit’s city government - - the city suffers from a deficit in its general fund in the approximate amount of $200 million. The 10-person review team appointed by Governor Snyder for Detroit is expected to deliver its recommendation for Detroit to the governor by March 28, 2012. xiii
F. Issues and Concerns Arising from Local Government Receiverships
Under the Act
The Act should cause creditors that are parties to pre-receivership contracts with a municipal government or school district great concern insofar as emergencymanagers now have the power to reject, modifyand terminate specific terms and conditions of these contracts and to reject and terminate these contracts altogether. Thus, an emergency manager could simplynotifythe non-local government partyto a long-term supply contract that he or she is modifying the contract price of goods or services to be supplied under the agreement or simply terminating that contract. For emergency managers,the provisions of the Act authorizing these actionscould be a powerful tool to force the other contracting partyto renegotiate the contract on termsmore favorable to the local government. It is important to note that these statutoryprovisions are new; they were not present in Public Act 72, the Act’s predecessor.
In addition, there exist open questionsof whether the Act violates the provisions of the United States Constitution reserving the power to enact uniform bankruptcy laws to the federal government and prohibiting states frominterfering with contractual obligations, discussed above. The Act provides that receiverships maybe imposed upon local governments in financial distressand grants to emergency managers far-reaching powers to operate local governments and to restructure their relationship with third parties. Bypermitting these managers to reject, modifyand terminate contracts, the Act goes beyond the powers previously granted to managers under its predecessor. The United States District Court for the Eastern District of Michigan, in litigation involving Pontiac’s then-emergency manager, held that this predecessor statute did not contain provisions similar to those found in section 365 of the Bankruptcy Code permitting bankruptcy trustees to reject executory contracts.Savage v. City of Pontiac, 743F.Supp.2d 678, 686 (E.D. Mich. 2010). Indeed, anemergency manager’s power to reject collective bargaining agreements specificallypermitted b ythe Act is not only unprecedented in Michigan law but has been criticized by one leading bankruptcy law scholar,Professor Kenneth Klee, as follows: “[N]o prior legislature has had the audacit yto legislate the unilateral termination, rejection or modification of a collective bargaining agreement.” xiv In addition, the Act permits not only the unilateral rejection and termination of executory contracts, but also permits emergency managers to revise these contracts by modifying particular terms and conditions in those contracts. Not even bankruptcy trustees have this power under the Bankruptcy Code. If a bankruptcy trustee wishes to assume or reject and executory contract, he or she must do so cum onere-- the trustee maynot reject some contract provisions and retain others.
.i In order for a ballot referendum for the rejectionof a law to be placed on the general election ballot inMichigan,petitions seeking this referendum and containing the signaturesof registered voters totalingat least 5%of thetotal vote castf or all candidates for governor in the last preceding general electionmust befiled with the State. This threshold number of requiredsignatures isnow 161,305.
ii The meaning of the word, “effective,” asused in Article 2,Section 9 of the Michigan Constitution,is not further defined or explained therein.One opinion of the Michigan Court of Appeals equates this word with “suspended” and “inchoate.”Farm Bureau Mut.Ins.Co. of Michigan v.Commissioner of Insurance,204 Mich. App.361 (1994),appealden.,445 Mich.917 (1994). In the interim between the invocation of the referendum power and the certification of the election, the state legislature may nevertheless enactare placement statute or reenact the same statute that is subject to the referendum. Reynolds v.Bureau of State Lottery,240 Mich.App.84 (2000),appeal den.,463 Mich.983(2001).
iv A “municipal government” is defined in the Act as a “city, a village, a township, a charter township, a county, anauthority established by lawor apublic utility owned by a city, village, township or county.” MCL § 141.1505(g)).
v 11 U.S.C.§§901-946. Chapter 9 of the Bankruptcy Code is exclusively designed for insolvent municipalities, authorized by state law or a state officer or organization, to seek Chapter 9 relief by means of a confirmed plan for restructuring of debts.11 U.S.C.§ 109(c).
vi See,e.g., http://abcnews.go.com/Business/bankrupt-cities-benton-harbor-mi-emergency-financial-managers/story?id=13472258. See also the recent local commentary authored by United States Congressman John Conyers(D-Michigan) entitled “Aim for afairfix of emergency manager law” published in the March 1,2012 issue of the Detroit Free Press at page15A (hereinafter cited as “Conyers”).
ix Rick Snyder,the GOPcandidate for governor,defeated his Democratic challenger, Virg Bernero,by 18 percentage points. The Republican Party presently holds 26 seats in the state Senate versus12 seats in the possession of Democrats. In the State House of Representatives, the Republicans are in control by a 62-46 margin.
xThe “state financial authority” for a local government is the State Treasurer of Michigan. The“state financial authority”fora school district is Michigan’sSuperintendentof Public Instruction.MCL § 141.1505(k).
xi The Actdef nes “chief administrative officer” as either(i) the manager of a villageor, if one is not employed, the presidentof the village;(ii) the city manager or, if one is not employed, the city mayor; (iii) the township manager or the manager or superintendent of a charter township, or if not is not employed, the township supervisor; and (iv) the elected county executive or appointed county manager. If feither of these positions do not exist ,the chairperson of the county’sboard of commissioners. MCL § 141.1505(a).
xiii “Emergency manager alone can’t save Detroit: City’s financial outlook called ‘hopeless’,”http://www.freep.com/article/20120306/NEWS05/203060404.