[DEBATE] : Contracts Now Seen as Being Rewritable

[Yoshie Furuhashi]

<http://www.nytimes.com/2009/03/31/business/economy/31contracts.html>
March 31, 2009
Contracts Now Seen as Being Rewritable
By MARY WILLIAMS WALSH and JONATHAN GLATER

Contracts everywhere are under assault.

The depth of the recession and the use of taxpayer dollars to bail out
companies have made it politically acceptable for overseers to tinker
with employment agreements.

So federal and local governments are looking for ways to pare payouts,
endangering the promises made before the financial storm to people
like Wall Street traders, automobile workers and garbage collectors.

“We run roughshod over some contracts and not over others,” said David
A. Skeel, a law professor at the University of Pennsylvania, about
economic downturns. “Right now, employment contracts seem to be the
type of contract that is viewed as eminently rewritable.”

The Treasury Department is seeking broad powers to seize troubled
companies and rewrite contracts like the ones promising bonuses at the
American International Group. Some A.I.G. employees, meanwhile, have
been pressured by officials into repaying their bonuses to the giant
insurance company rescued by the government.

Across the country, Vallejo, Calif., just got permission in bankruptcy
court to tear up its contracts with firefighters and other workers. In
Stockton, the city manager is studying whether to follow Vallejo’s
lead.

In Michigan, Gov. Jennifer M. Granholm just ordered the city of
Pontiac put under emergency financial management, after it failed,
among other things, to rein in the cost of police, fire and trash
collection services.

And President Obama’s auto task force, after replacing the top
management at General Motors, is looking for ways to overhaul the
contracts that G.M. and Chrysler have signed with unionized workers.

Honoring any type of contract can be hard in a down economy, but
financial agreements, like the ones between A.I.G. and its derivatives
counterparties, are so far faring better.

The possible ripple effects of not keeping those financial contracts,
or defaulting, have raised alarms and prompted arguments that it would
be too dangerous to void them. After all, the collapse of Lehman
Brothers is widely blamed for paralyzing the credit markets last fall,
which may in turn have prompted the Federal Reserve to stand behind
A.I.G.’s derivatives contracts, making its trading partners whole.

Employment agreements have enjoyed no such help. In the past, the
belief that voters would make their disdain known has at least
discouraged politicians from using a heavy hand.

Now, though, officials in the Obama administration may be looking
ahead to a rescue of the automakers, an enormous challenge that could
be simplified, from the government’s point of view, if kept out of
court and under tight administration control. That would make it
easier to change the terms of contracts governing retiree benefits,
said David L. Gregory, a law professor at St. John’s University in New
York.

“The issue is, how can the government calibrate and contour and
control the process of reorganization,” without the time, expense and
compromise inherent in bankruptcy, Mr. Gregory said. “The executive
branch is proposing to do what the bankruptcy courts have had the
exclusive prerogative to do.”

This month, the town of Vallejo demonstrated not only that it was
possible for a city to tear up its union contracts in bankruptcy, but
that it was even easier for a city to do so than for a company. The
precedent may matter.

Municipalities do not file for Chapter 11 bankruptcy protection; they
use Chapter 9, which has different terms and a much smaller body of
legal precedent. Municipal bankruptcies are so rare that until the
Vallejo ruling, it was not clear whether a city could get out of its
union contracts in Chapter 9.

Unions representing Vallejo’s public employees tried to argue that
state labor laws protected the contracts. But the federal judge
handling the bankruptcy, Michael S. McManus, wrote that federal
bankruptcy law trumped the state labor law. He also observed that
Congress could have set tougher standards for municipalities voiding
their labor contracts — it did so for companies. But such bills died
in committee.

After reaching his decision, the judge gave both sides one more chance
to try to negotiate less-onerous concessions.

“The world is watching, and I don’t say that with pride, because we
never wanted to file a Chapter 9,” said Marc A. Levinson, a partner
with Orrick, Herrington & Sutcliffe who is representing Vallejo in the
bankruptcy. The city ran out of money last year, after promising
benefits that it could not afford when the recession drove down tax
receipts.

Vallejo’s bankruptcy is being closely watched because its problems
mirror those in many communities that have promised benefits that now
look unsustainable. In many places the benefits have been locked in
with statutory and constitutional guarantees.

“That’s why Vallejo is so important,” said James E. Spiotto, a Chapter
9 specialist with the firm of Chapman & Cutler in Chicago. “Chapter 9
and bankruptcy is the land of broken promises.” He said unions were
better off negotiating concessions now than landing in bankruptcy
court and ending up with no contract at all.

But entirely different rules apply to bonded debt, and to a related
problem plaguing some communities: derivatives. Chapter 9 was never
meant to be a place where governments could get out of their bonded
debt, Mr. Spiotto said.

Derivatives are largely untested, but the issue may reach a decisive
point in Jefferson County, Ala., which is entangled in interest-rate
swaps. The swaps were intended to shield the county from rising
interest rates after it issued a large amount of variable-rate debt to
pay for a new sewer system.

The swap arrangements broke down amid last year’s turmoil in the
credit markets, leaving Jefferson County with $3.2 billion in debt
that it can neither pay nor refinance. Some officials are now calling
for a Chapter 9 filing; others are against it.

Alabama’s governor, Bob Riley, has written to the Treasury secretary
and the Federal Reserve chairman, asking for help in stretching out
Alabama’s financial obligations, rather than repudiating them.

The Treasury secretary, meanwhile, is working on a much broader
initiative to give the federal government the power to modify the
contracts of the financial institutions it takes over. The proposal
raises several new issues, because it would eliminate the judicial
oversight of bankruptcy proceedings and the opportunity for affected
parties to challenge the changes.

The goal is to speed up reaction time to crises, said Lisa Hill
Fenning, a retired bankruptcy judge who now practices at Dewey &
LeBoeuf in Los Angeles. “Traditional ways of dealing with these
problems are too complicated and would take too long,” Ms. Fenning
said. “They’re trying to cut through red tape.”