The Art of the Deal
Detroit’s restructuring proposal.
Apr 21, 2014, Vol. 19, No. 30 • By DAVID SKEEL
From the moment Detroit filed for bankruptcy last summer, comparisons to the 2009 Chrysler and General Motors bailouts have abounded. Most highlight the differences, noting that the federal government is unlikely to pump billions of dollars into Detroit. But although the differences are real, the restructuring plan that Detroit has recently proposed suggests that the city’s bankruptcy may have more in common with the car bailouts than anyone imagined. Unfortunately, it’s the abuses of the latter that could be replicated—and even extended—if Detroit’s plan is upheld in its current form.
Can its riches fund payouts to just some city creditors?
The centerpiece of the proposed plan, which was released in February and revised late last month, is an $816 million art-for-pensions deal. A group of foundations and other donors, including the Ford, Kresge, and Knight foundations, propose to pay at least $330 million for the Detroit Institute of Art’s (DIA) collection so long as, among other things, the state of Michigan contributes $350 million, the collection is transferred to a nonprofit trust that will keep it in Detroit, and the funds are used to increase the bankruptcy payout to Detroit’s retirees. This last feature, the insistence on picking winners and losers, comes straight from the Chrysler bailout.
The art deal is in some respects a brilliant stroke. Ever since Detroit emergency manager Kevyn Orr hinted that some of the DIA’s art might need to be sold, and arranged for a Christie’s appraisal, the art world has fretted about the possibility of sales (and insisted, as has Michigan’s attorney general, that sales would be illegal). The proposed deal would put these fears to rest. By directing the proceeds of the sale to Detroit’s working-class pension beneficiaries, it also preempts complaints that fine art is unimportant as compared with the needs of struggling Detroiters. The $816 million would assure that pension beneficiaries receive a much higher percentage of what they are owed than many feared.
But the art-for-pensions deal achieves these benefits by flouting the bankruptcy rules. Detroit’s pension beneficiaries are only one of many groups of creditors. The idea that Detroit could sell its art and use the proceeds to pay them but not other creditors flatly contradicts the core bankruptcy principle that similarly situated creditors need to be given similar treatment. The city and the foundations cannot simply decide that they will pay pension beneficiaries but not, say, the holders of Detroit bonds.
When a bankruptcy lawyer and I described the deal to a handful of other bankruptcy experts who have not been following the issue closely at a dinner last week, two of the experts literally started shouting. One said, “They can’t do that!” And another: “That’s a fraudulent transfer of assets!”
To complaints like these, defenders of the art deal argue that a buyer can set any terms it wants for a sale. In this case, the buyers won’t put up the money unless the funds go to pension recipients. Before the car bailouts, arguments like these wouldn’t have passed the proverbial straight face test. But they now must be taken very seriously.
In 2009, the government arranged for Chrysler to “sell” its assets to a newly created entity for $2 billion, far less than the assets were worth. The new entity (also funded by the government, of course) was required to make massive payments to Chrysler’s retirees and trade creditors, while giving its senior lenders only a fraction of what they were owed. The transaction was deeply problematic, but it was allowed to proceed.
In one respect, the Detroit art deal is even worse. With Chrysler, the government at least pretended that the buyer, New Chrysler, had simply decided to make payments to the favored creditors after and apart from the sale itself. The $2 billion sale price was distributed to Old Chrysler’s creditors in accordance with normal bankruptcy rules, according to this reasoning. The proponents of the Detroit art deal aren’t even pretending. They not only want to be the only bidders in the sale; they also want to decide what happens with their funds in the bankruptcy case.
Oddly enough, Detroit’s unions have complained nearly as loudly about the art deal as other creditors, even though union members would be the main beneficiaries. Why is this? One reason is that the unions seem to be worried about the precedent. If Detroit’s pensions can be restructured, so can the pensions of other cities, and not just in Michigan. Second, although the bankruptcy judge has said, rightly, that the pensions can be restructured, union representatives run the risk of being voted out of office unless they insist that pension beneficiaries be paid every last penny, even if other creditors get far less.
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