What is a Lien? Lessons from Municipal Bankruptcy

Abstract

From the outset of Detroit’s bankruptcy, an unlikely set of issues kept coming up: What exactly is a lien? Who has a property interest or its equivalent in bankruptcy? Did general obligation bondholders have special status, due to Detroit’s promise to use its “full faith and credit” for repayment? What about Detroit’s pension beneficiaries, who could point to a provision in the Michigan Constitution stating that accrued pension benefits cannot be diminished or impaired. In this Article, I explore these and related issues that have arisen in Detroit and other recent municipal bankruptcy cases.

Part I of the Article briefly compares liens and a variety of lien substitutes. In Part II, I recount the history of bankruptcy’s statutory lien provision, which honors state liens but not state priorities, and requires that the lien be good both in bankruptcy and outside of bankruptcy. My focus in Part III is the status of general obligation bonds in Detroit, a question which has turned out to have different answers for the two different types of Detroit GO bonds. In Part IV, I explore Rhode Island’s remarkable statute purporting to give a sweeping lien to GO bondholders. I then discuss the question whether pensions can be restructured in bankruptcy in Part V. I conclude that they can, and that the precise status of pension claims turns in large part on bankruptcy’s treatment of trusts.

Keywords: public finance, insolvency, Chapter 9 bankruptcy, municipal bonds, municipal bankruptcy revenue bonds, general obligation bonds, secured and unsecured creditors, lien substitutes, ad valorem taxes, Detroit, Central Falls RI, trusts, pensions, pension funds and obligations, public employees

JEL Classification: H74, H77, J32, K39