United States: Michigan’s Emergency Financial Manager Law And Its Impact On Creditors Of Municipalities And School Districts

Last Updated: March 14 2012
Article by John T. Gregg and Patrick E. Mears

A. Introduction

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, then the Act will be immediately deemed not "effective" 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.

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 governments 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. 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.

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. 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

1. 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.

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.

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