Detroit, once the center of the U.S. auto industry, filed the biggest municipal bankruptcy in the nation’s history after decades of decline left it too poor to pay billions of dollars owed bondholders, current city workers and retired police officers and firefighters.

“I know many will see this as a low point in the city’s history,” Michigan Governor Rick Snyder, a Republican, said in a letter yesterday authorizing the filing in U.S. Bankruptcy Court in Detroit. “Without this decision, the city’s condition would only worsen.”

While under court protection, Detroit can stop paying some debts, is temporarily immune from most lawsuits and may be able to ask a judge to cancel contracts, including union agreements. Under Chapter 9 of the U.S. Bankruptcy Code, the first step is likely to be a court fight over whether the city was entitled to bankruptcy protection, a challenge that would ask if it’s truly insolvent and it had no alternative.

Before joining Jefferson County, Alabama, and the California cities of San Bernardino and Stockton in bankruptcy, Michigan’s largest city had seen its population decline 7 percent since 2010, to about 700,000, according to U.S. Census data. Median household income was less than $28,000, compared with $49,000 statewide, and more than 36 percent of residents lived in poverty as of 2011, Census data show. The median home value of $71,000 was barely half the $137,000 value statewide.

New Notes

Kevyn Orr, the city’s emergency manager, filed the case after asking creditors owed more than $11 billion to accept just $2 billion in new notes in exchange for canceling their debt. That debt includes about $2 billion in what Orr claims are unsecured bonds and billions more in pension, health-care and other obligations owed to current and former city workers.

Appearing at a press conference today with Mayor Dave Bing, Orr, 55, said even a casual observer could see Detroit was “not on a sustainable footing” and there was no more time for delay.

“Detroit has been working its way to a level of insolvency for decades,” Orr said. The city, he said, was “continuing to borrow, continuing to defer pension payments, continuing not to pay its bills on time, continuing a deepening insolvency -- $18 billion.”

Orr said he hoped Detroit would emerge from bankruptcy by the late summer or fall of 2014. Meanwhile the city would continue its normal business.

“It is business in the ordinary course,” he said. “Services will remain open, paychecks will be made, bills will be paid. Nothing changes from the standpoint of the ordinary citizen’s perspective.”

Different Chapter

Chapter 9 is reserved for municipalities and differs from the rules used by bankrupt companies in Chapter 11. Before the filing, Orr said the city’s total debt includes more than $5.4 billion in debt guaranteed by water and sewer fees. Those utility-related bonds would have been refinanced and fully repaid under Orr’s pre-bankruptcy proposal.

Orr’s proposal to restructure its debt and long-term obligations includes cutting pension payments for public employees, ending cost-of-living increases, removing some workers from the system and making the rest pay more.

City pension plans sued Snyder and Orr yesterday, contending a bankruptcy filing would conflict with a provision of the Michigan Constitution that bars any government in the state from reducing pension benefits. Two similar suits were filed in the same state court earlier this month on behalf of individual retirees and current workers.

Restraining Order

The retirement systems sought an emergency restraining order today to stop the bankruptcy. The city filed moments before Ingham County Circuit Court Judge Rosemarie E. Aquilina in Lansing could rule. Aquilina said she would have issued an order temporarily blocking the bankruptcy, said attorney John Canzano, a lawyer for one current Detroit employee and one retiree.

Aquilina did temporarily bar Snyder and Orr from taking “any further action that may cause the accrued financial benefits of the retirement systems or their participants from in any way being diminished or impaired,” citing the state constitution. A hearing on the challenges to the bankruptcy and the pension benefit cuts is set for Monday before Aquilina.

The retirees and workers will seek a declaration on whether the constitution can be applied to block reductions in pension benefits, Canzano said in an interview. They may also seek to get the bankruptcy filing withdrawn, he said.

Pensions ‘Dismayed’

The city employee pension plans said in a joint statement that they were “dismayed” by the bankruptcy.

“We are surprised and disappointed that the emergency manager would file a Chapter 9 petition before he has had substantial negotiations with the retirement systems and other significant creditor constituencies,” Robert Gordon, an attorney for the pension plans, said in the statement.

Orr said today that he “bent over backward” in talks with creditors.

“We’ve spent a lot of time negotiating in good faith,” he said. “We’ve had over 100 meetings with stakeholders.”

A showing of good faith is a threshold question when filing under Chapter 9, said Kenneth E. Noble, head of the insolvency and restructuring practice at Katten Muchin Rosenman LLP in New York.

“The filing was rushed in the sense that he wanted to file before a state-court judge could issue an injunction,” Noble said in an e-mail. “This may make the showing more difficult than it might otherwise have been.”

Job Losses

Detroit is the home of General Motors Co., while Ford Motor Co. is in nearby Dearborn and Chrysler Group LLC is based in suburban Auburn Hills. Years of job losses at U.S. automakers intensified a decline that began in the 1950s, when white homeowners began moving to the suburbs, Scott Martelle, author of “Detroit: A Biography,” said in an e-mail before the filing.

“As the tax base eroded, basic city services eroded, too,” he said. Detroit today “is too big geographically -- 140 square miles -- for its dwindling and impoverished tax base to support.”

Detroit’s filing “is going to affect a number of local governments around the country,” said Keith W. Mason, a bankruptcy attorney with McKenna Long & Aldridge LLP. “It calls for greater early intervention.”

President Barack Obama is monitoring the situation, Amy Brundage, a White House spokeswoman, said in a statement.

“While leaders on the ground in Michigan and the city’s creditors understand that they must find a solution to Detroit’s serious financial challenge, we remain committed to continuing our strong partnership with Detroit as it works to recover and revitalize and maintain its status as one of America’s great cities,” she said.

City Advantage

Chapter 9 will give Detroit an advantage over companies using Chapter 11 to reorganize. Unlike companies, municipalities don’t need to ask the bankruptcy court for permission to pay any bills they ran up before filing for court protection, including wages, utility bills and rents.

That means creditors can’t put as much pressure on a city over its spending habits, as sometimes happens in Chapter 11 cases. Chapter 9 creditors also can’t offer their own reorganization plan and aren’t entitled to form an official committee with legal fees paid by the municipality. Unsecured creditors typically have those rights under Chapter 11, which is used by companies to try to stay in business and reorganize.

“The city can prioritize its own needs, not the creditors’,” said Mark Schwartz, a former bond lawyer who tried unsuccessfully to help the city of Harrisburg, Pennsylvania, restructure debt using Chapter 9. That city was thrown out of bankruptcy after a judge found that filing was not authorized under state law.

Seeking Approval

Standing in Orr’s way are the retirees and bond insurers. To get a court to approve a restructuring, the emergency manager must show that the plan is “fair and equitable,” Noble said.

“That will draw a lot of litigation, since bonds and retiree liabilities have never been reduced,” Noble said. Issues include how high the tax levies must be and whether assets such as an art collection should be sold or preserved to draw tourists, Noble said.

Among the biggest drains on the city’s general fund, which pays for police, fire and other basic services, are health benefits paid to retired city workers, mostly former police and firefighters, according to Orr’s May report. Without changes, the city will pay $163 million for retiree health-care costs in the next fiscal year, which starts July 1, the report found.

Unfunded pension liabilities may reach $3.5 billion, Orr said.

20,100 Retirees

Retirees would receive $100 to $250 a month to defray health-care costs, according to Orr. Detroit has about 20,100 retirees, about twice the number of active employees, he said.

Orr, who was appointed by Snyder, said before the filing that if he couldn’t strike a deal with creditors and employees, he would file bankruptcy, where a judge has the power to impose losses on creditors. Orr has ordered an investigation of all benefit programs, including pension systems.

Under Chapter 9, Orr can try to force creditors to take losses by persuading a judge to approve a so-called plan of adjustment that eliminates debt. Creditors can counter that by arguing the plan isn’t feasible, Craig Barbarosh, a bankruptcy partner at Katten Muchin in Orange County, California, said in an e-mail.

Borrowed Funds

Detroit’s bankruptcy is the biggest in the U.S. based on the size of its debt, followed by Orange County, which filed in the 1990s, and Jefferson County, which filed in 2011.

In Orange County, creditors were eventually repaid in full after the bankruptcy ended and years of lawsuits. Jefferson County is seeking to impose bigger losses than creditors have ever taken in a municipal bankruptcy.

Orr is proposing creditors lose more than those proposed in Jefferson County.

“Let me be blunt: Detroit is broke,” Snyder said in a video posted on YouTube after the filing. “This was a difficult and painful decision, but I believe there are no other viable options.”

The case is City of Detroit, 13-53846, U.S. Bankruptcy Court, Eastern District of Michigan (Detroit).