Art & the 'Public Trust' in Municipal Bankruptcy

On July 18, 2013, the City of Detroit, Michigan filed for municipal bankruptcy under Chapter 9 of the Bankruptcy Code. It was the largest municipal bankruptcy filing in US history, affecting about $20 billion in municipal debt to pensioners and bondholders.

During the bankruptcy proceedings, Detroit proposed several draft plans of adjustment, which increasing numbers of its creditors accepted. Ultimately, the bankruptcy court had to decide whether to approve Detroit’s final plan of adjustment, which the overwhelming majority of its creditors had accepted. Among other things, the bankruptcy court considered whether Detroit could and should sell certain works of arts that it owned in order to satisfy its creditors.

Unlike most cities, Detroit owned its municipal art museum, the Detroit Institute of Arts (‘DIA’), and all of the works of art in the DIA collection, which were potentially worth billions of dollars. Detroit’s creditors argued that that the DIA art was a non-core asset that could and should be liquidated in bankruptcy. The DIA corporation and the Michigan Attorney General argued that Detroit could not sell the DIA art, because it owned the art subject to the public trust, a charitable trust, and gift restrictions specific to particular works of art. 

While Detroit initially considered selling the DIA art, ultimately it argued that it could not and should not sell the DIA art. Detroit’s final plan of adjustment included the ‘DIA Settlement’ or ‘Grand Bargain’, under which Detroit would transfer the DIA art to the DIA corporation, in exchange for contributions of $816 million over twenty years from the DIA corporation and other charities, which would be used to partially satisfy Detroit’s debt to its pensioners.

The bankruptcy court confirmed Detroit’s final plan of adjustment, including the DIA settlement. It concluded that the DIA settlement was fair and in the best interests of the creditors, because Detroit could not, would not, and should not sell the DIA. First, the court found that Detroit could not sell the DIA art, listing the arguments advanced by the DIA corporation and the Michigan Attorney General, but not identifying a specific basis for its finding. Second, the court found that Detroit would not sell the DIA art, and that it lacked the authority to force Detroit to sell the DIA art. And third, the court found that Detroit should not sell the DIA art, because the DIA was necessary to Detroit’s economic recovery.

The court’s finding that Detroit could not sell the DIA art was incorrect on the facts and the law. Detroit owned most or all of the DIA art outright, not subject to the public trust, a charitable trust, or gift restrictions. Nothing prevented Detroit from selling some or all of the DIA art. Indeed, not only did the court implicitly acknowledge that Detroit could sell works of art from the DIA collection in order to purchase other works of art, but also the DIA settlement literally amounted to the sale of the DIA art to the DIA corporation.

However, the court correctly found that the DIA settlement was fair and in the best interests of the creditors, because creditors had not relied on the DIA art as collateral, the court could not force Detroit to sell the DIA art, and Detroit reasonably believed that preserving the DIA collection was necessary to its economic recovery. Accordingly, the DIA settlement and Detroit’s final plan of adjustment provided the largest recovery that the creditors could reasonably expect under the circumstances, and was better than the only alternative, which was the rejection of the plan of adjustment.

Detroit correctly decided to sell the DIA art to the DIA corporation in order to ensure that it could satisfy its obligations to its pensioners. But professional standards prevent most art museums from making the same decision. That is wrong. The Detroit bankruptcy and the DIA settlement support the conclusion that art museums should be permitted, and even required, to sell works of art when necessary to continue operations.

Brian L. Frye is the Spears-Gilbert Associate Professor of Law at the University of Kentucky, College of Law.