More on Unfair Discrimination in Bankruptcy!

For those who have followed the never-ending saga of posts first on the Stockton municipal bankruptcy and now on Detroit's (some recent ones here and here), you may have noticed that I've frequently directed those whose interest in the topic includes the legal details to an article I published in the late spring in the American Bankruptcy Law Journal: Municipal Bankruptcy: When Doing Less Is Doing Best (download here).

My article addressed several issues in connection with Chapter 9 bankruptcy but there and subsequently I argued for one point consistently: the Bankruptcy Code's prohibition of "unfair discrimination" in a city's plan creates a strong presumption that all creditors of equal priority, say, retirees with their pensions and bondholders with their bonds, should be treated equally. In other words, whatever percentage of claims is paid to one set of creditors should be matched with respect to the other set(s) of creditors. To be fair to myself, I also argued that the rule that a plan be in the "best interests" of creditors required a plan to discriminate in favor of pensioners in a state like Michigan which protects public employees pensions by law. (Read my article if you want to know my solution to this statutory conundrum.)

Of course, I acknowledged that there was only a presumption in favor of equality, which suggests it can be rebutted. Indeed, Congressional antipathy toward unfair discrimination suggests that there's such a thing as fair discrimination.

Go here to read Andrew B. Dawson's unpublished draft piece, Pensioners, Bondholders, and Unfair Discrimination in Municipal Bankruptcy (download here). Dawson addresses the history of unfair discrimination in municipal bankruptcy and, taking a cue from yet another rule (actually, an exception to another rule, i.e., the new value exception to the absolute priority rule), argues for a wide notion of "fair" discrimination permitted by the Code.

In short (and here I'm going deep into the weeds), just as a class of creditors who would receive nothing in a Chapter 11 liquidation may nonetheless retain an interest in a reorganized debtor if they contribute "new value," so too a Chapter 9 plan may tilt its distributions in favor of a class of creditors if that class contributes new value.

I would be hard pressed to disagree but for Dawson's additional assertion that the "new value" contributed by a class such as Detroit's retirees can include such non-quantifiable (or unrelated) matters as not opposing Detroit's eligibility to be in bankruptcy, the state of Michigan's "micro-bailout," and the contributions of various foundations to the city to enable it to keep the Detroit Institute of Art. Even reducing something to which the retirees had no special statutory right in bankruptcy, their retiree health benefits, counts as "new value" in Dawson's analysis.

Dawson's piece is a valuable contribution to what remains a largely unexplored topic. Yet I fear that his nebulous conception of new value will in practice be nothing more that the nose of the camel that will quickly occupy the tent. If giving up weak legal arguments and claims not backed by law is enough to make discrimination fair, then the prohibition of unfair discrimination is infinitely malleable that may in some cases be satisfied by nothing more than an appeal to the bankruptcy court's sympathies.