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Naming mediator brings authority to fractious Detroit bankruptcy case

The word 'Bankruptcy' is seen painted on the side of a vacant building by street artists as a statement on the financial affairs of the city
The word 'Bankruptcy' is seen painted on the side of a vacant building by street artists as a statement on the financial affairs of the city

By Nick Brown

(Reuters) - Of all the legal maneuvers so far in Detroit's bankruptcy case by unions or the city's emergency manager, the one that may have the most impact was when the judge decided to name a mediator.

In a July 23 filing in U.S. Bankruptcy Court, Judge Steven Rhodes said he would appoint another federal judge, Gerald Rosen, as a mediator.

A mediator would be an authoritative voice for compromise in a contentious, messy case, the biggest-ever municipal bankruptcy filing in U.S. history. Detroit, which filed on July 23, has more than $18 billion in debt and 100,000 creditors ranging from retired city workers to Wall Street bond investors.

"I think that's going to be the key move in the case, in terms of getting it toward a solution," Christopher Klein, a bankruptcy judge in Sacramento, California, said. Klein, who is overseeing the bankruptcy of the town of Stockton, spoke last week on a panel organized by the American Bankruptcy Institute.

Rosen, a Republican, is chief district judge of the U.S. District Court for the Eastern District of Michigan. With a long career in Michigan politics and as a member of the conservative-libertarian Federalist Society, he brings a unique perspective to a case that touches on the subjects of states rights and property rights.

Rhodes in his court filing deemed a mediator "necessary and appropriate" but did not specify which issues he feels should be mediated. He has scheduled a hearing on his proposal for Friday.

With Rhodes yet to lay out how mediation will be used, Rosen's role is unclear. He could be asked to help broker a deal resolving the initial objections to Detroit's filing under Chapter 9 of the U.S. Bankruptcy Code, which governs municipal cases. Alternately, his services could be reserved for the more substantive fights over pay back.

COMPLEX ISSUES

Retirees have turned to Michigan state court to try to block Detroit's U.S. Bankruptcy Court filing, saying the state constitution protects their pensions. Creditors have also argued that Detroit Emergency Manager Kevyn Orr failed to negotiate with them in good faith to try to avoid the bankruptcy filing.

On Saturday, Michigan Attorney General Bill Schuette, a Republican, said he would defend retirees who risk losing public pensions because of Detroit's bankruptcy. This put him at odds with Emergency Manager Orr, who was appointed by Governor Rick Snyder, a fellow Republican.

But legal experts say that, ultimately, the case is likely to be resolved in bankruptcy court.

If that happens, a mediator will have a disproportionate impact.

Bankruptcy judges have much less power in Chapter 9 municipal bankruptcies than they do in corporate bankruptcies filed under Chapter 11 of the U.S. Bankruptcy Code. For instance, a judge in Chapter 9 cannot remove municipal officials or tell cities what to do with their property.

A mediator in Chapter 9 bankruptcies plays a central role, acting in settlement talks behind closed doors, unifying disparate creditors and advising them on the realities of the law.

Marc Levinson, a partner at Orrick Herrington & Sutcliffe who represents Stockton, California, in its bankruptcy, said municipal bankruptcies feature less-sophisticated creditors who can benefit from a mediator to walk them through the process.

A mediator can help discourage extreme positions and help bitter adversaries find common ground, said James Spiotto, a Chapter 9 expert and bankruptcy lawyer at Chapman & Cutler.

"It's a reality test," Spiotto said. "Are they in the zone of reality, or do they have no real basis for what they're saying?"

CANDIDATE-TURNED-JUDGE

Rosen was a partner at Detroit-based law firm Miller Canfield in 1990, when President George H.W. Bush named him to the federal bench.

In the 1970s, Rosen was a legislative assistant to Senator Robert Griffin, a Michigan Republican, then ran for Congress in 1982, losing to Democrat Sandy Levin. He has served on the board of the Michigan chapter of the Federalist Society, which emphasizes states' rights and strict adherence to the original meaning of the U.S. Constitution.

Some of the most critical disputes in Detroit's case involve states' rights, namely whether Michigan's state constitution allows the city to cut the pensions of its retirees. But by the time the mediation comes to Rosen, any question of states rights may already have been decided. The case is also subject to Chapter 9 of the U.S. Bankruptcy Code.

"Reality trumps policy, reality should trump politics, and sometimes reality even trumps the law," said Patrick Darby of Bradley Arant Boult Cummings, who represents Jefferson County, Alabama, in its Chapter 9 bankruptcy. "And the reality in Detroit is, there's not enough money."

USE HIM WISELY

According to Darby, mediation works best when there is a clear issue and a limited number of parties.

"When there are two positions on a continuum, the mediator can help find middle ground," he said.

Mediation has had mixed results in Chapter 9. A mediator was unable to help the city of Vallejo, California, reach new labor terms with two of its unions. In Stockton, California, mediation sessions prior to the city's bankruptcy filing helped settle some labor disputes, while other issues remain in mediation.

Sessions typically start with parties together in a conference room presenting their sides, then splitting off into separate rooms, with the mediator shuttling between conferences with each side. It is less formal than court hearings -- while mediators are often judges, they don't wear robes, Spiotto said.

"Guys are usually in shirt sleeves," he said.

Mediators try to relate openly and honestly to parties.

"They say, 'I'm a federal judge, and here's how I think your argument is going to fare in court,'" Darby said.

It Detroit's case, with many creditors battling over a limited amount of money, the process is not so cut-and-dried.

"The best mediator is still going to find it extremely difficult to broker a settlement," Darby said.

(Reporting by Nick Brown; Editing by Eddie Evans and David Gregorio)

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