Judge Rhodes brought down the gavel last evening, concluding the 9th day of hearings on Detroit’s eligibility for municipal bankruptcy; now he will have to make difficult and hard decisions that will determine the future of Detroit.

Motor City Bankruptcy Eligibility. Last evening, U.S. Bankruptcy Judge Steven Rhodes brought down the gavel after nearly eight hours of closing arguments from attorneys for the city and its creditors over whether Detroit should be eligible for federal bankruptcy protection. Yesterday’s proceedings were a rehashing of hundreds of pages of city and state records presented by bankruptcy eligibility objectors, as well as the historic testimony from Michigan Governor Rick Snyder, Emergency Manager Kevyn Orr, and former state Treasurer Andy Dillon. Judge Rhodes closed out the long and tense day by asking Bruce Bennett, the attorney for Detroit, whether Emergency Manager Kevyn Orr had misled the city’s retirees by saying their pensions were “sacrosanct” — a month before filing a Chapter 9 case that threatens drastic pension cuts: “What impact should that have on the court’s analysis of good faith (negotiations) here?” Judge Rhodes noted, as he sought to prepare himself for the lonely decisions he must render: “That’s ultimately the point.” That final question highlighted the nine-day trial in the biggest municipal bankruptcy case in U.S. history—with an increasingly sharp focus on whether the city had cleared the critical hurdle of demonstrating to the court that the city had negotiated with creditors in good faith — a requirement of Chapter 9 law. Judge Rhodes did not rule from the bench, but seemed focused on the teeter-totter issues of the issue of good faith—of both sides in the historic case—noting that creditors did not present an alternative plan this summer before Detroit filed for municipal bankruptcy. Judge Rhodes also scrutinized creditor claims that Gov. Snyder authorized the bankruptcy to dodge a state court injunction blocking him from doing so. The judge is giving attorneys involved in the case until this coming Wednesday to file additional legal briefs about whether he should consider labor or bankruptcy law standards for good-faith negotiations.

Were the Negotiations in Good Faith? Much of the day was spent with Judge Rhodes pressing Detroit whether Emergency Manager Kevyn Orr’s videotaped comment to a retiree during a June 10 public meeting that pensions would be untouched amid Detroit’s restructuring, as well as a second statement that there was only a “50-50 chance” of a Detroit bankruptcy, demonstrated whether Mr. Orr negotiated in good faith with creditors. City Attorney Bennett noted: “This may not have been the moment he used the best words…If your honor believes the statement was misleading, it was corrected three … or four days later.” (On Flag Day, four days later [June 14}, Mr. Orr had unveiled a restructuring proposal that prescribed unspecified pension cuts.)  Mr. Bennett yesterday sought to downplay the statement, noting:  “It’s bad, but there are 685,000 residents and 23,000 retirees,” Mr. Bennett said. “Mistakes happen. I can’t do anything about this one.” Mr. Bennett told the court Detroit’s taxpayers need federal bankruptcy court relief, because they are expending nearly 43 cents of every tax dollar on debt, pensions, and retiree health care while city services suffer: “This problem gets worse and worse and worse and worse in future years…This has to be addressed. This cannot be ignored.” But Ms. Barbara Patek, an attorney for public safety unions, testified that Mr. Orr had dumped the $3.5 billion pension debt claim on retirees and the pension funds through a “swallow it whole or else” proposition, stating: “I think they set any possible negotiations up for failure.” AFSCME attorney Sharon Levine warned Judge Rhodes he would set a “dangerous precedent” if he allows Detroit to proceed with its publicly stated plans to slash pension benefits in the contentious debt-cutting phase of bankruptcy, in which litigation could intensify: “It will be a road map for governors across the country to use Chapter 9 to create a self-created emergency.” But the state’s attorney, Mr. Schneider, defending Governor Snyder’s authorization of the filing, said: “This world is full of critics…The objectors can criticize the governor and state and treasurer and emergency manager because they don’t like where they think this case is headed.”

Was the City’s Bankruptcy Filing Constitutional? After the city rested its case, Judge Rhodes turned his probing focus to the state, grilling Mr. Schneider about why the Wolverine Legislature added a $5.78 million appropriation to the new emergency manager law that Gov. Rick Snyder used to authorize Detroit’s bankruptcy. The new law — enacted a month after voters rejected Snyder’s first emergency manager law — included an appropriation that insulated the statute from being overturned by voters again. Retirees and unions have pressed Judge Rhodes to consider whether the emergency manager law is unconstitutional, because it denies voters the right to a second referendum. Gov. Snyder, when he testified in the trial, testified that the appropriation was added to fund emergency managers, financial consultants, and attorneys working in financially distressed cities and school districts, leading Judge Rhodes to ask Mr. Schneider: “Am I missing something?…So putting an appropriation in the bill has the effect of denying what would otherwise be a right of referendum?” Counselor Schneider responded: “But plenty of bills have appropriations.” To which Judge Rhodes countered: “Do they?….There’s no evidence of that. Let’s assume that’s true. Does it show anything other than that the Legislature often violates the right of referendum?”

“It will be a road map for governors across the country to use Chapter 9 to create a self-created emergency.” ~ AFSCME attorney Sharon Levine, telling U.S. Bankruptcy Judge Steven Rhodes that he would set a “dangerous precedent” if he allows Detroit to proceed with its publicly stated plans to cut pension benefits as any part of the city’s recovery plan.

More Court Time in the Motor City: How Secure Are Full Faith and Credit Municipal Bonds? National Public Finance Guarantee Corp., a subsidiary of MBIA Inc., and Assured Guaranty Municipal Corp., filed suit yesterday in U.S. Bankruptcy court against the Motor City for defaulting on its general obligation bonds, a challenge that goes to the heart of Detroit’s unprecedented effort to treat its unlimited-tax GO debt as unsecured—naming Kevyn Orr, Detroit Finance Director John Naglick, deputy finance director Michael Jamison, and Treasurer Cheryl Johnson as defendants. The suit claims the defendants are personally liable to the bondholders for failing to set aside the revenues to meet the pledge of full faith and credit. Later, yesterday, Ambac Assurance filed a parallel suit, adding the city’s limited-tax GO debt. Mayhap concerned Judge Rhodes does not have enough on his plate, the litigation seeks to mandate that Detroit set aside property tax revenue raised by voter-approved referenda specifically for various unlimited-tax GOs issued between 1999 and 2008. The suits also seek an order from Judge Rhodes to block a proposed debtor-in-possession financing that would give a super-priority lien to Barclays, the bank that would loan the funds to Detroit―the super-priority lien would include disputed voter-approved ad valorem funds. In a statement issued subsequent to its filing, Assured stated: “Our efforts to date to resolve this dispute consensually have been rebuffed, and city officials have refused to comply with state law that requires ad valorem tax revenues, specifically approved by the voters of Detroit for repayment of the Unlimited Tax Bonds, to be used only for that purpose…As always, investors that hold bonds insured by Assured Guaranty can be certain they will continue to receive uninterrupted full and timely payment of scheduled debt service when due in accordance with the terms of Assured Guaranty’s insurance policies.” The bond creditors are seeking an order from Judge Rhodes which would require the city to set aside the disputed voter-approved property tax revenue throughout the Chapter 9 proceedings, assuming Judge Rhodes determines Detroit is eligible for chapter 9. The insurers, in addition, are claiming Detroit is violating not only several state laws, but also the Michigan constitution, by not setting aside revenues into restricted accounts―instead using it for general operating costs: “Michigan’s state law could not be more clear: the city is required to segregate the pledged property taxes and then only use them to pay debt service on the bonds…And [federal] bankruptcy law is equally clear on such matters: Michigan law must be followed.” The Motor City has $369 million of outstanding ULTGOs (unlimited tax general obligation bonds) that it has been treating as unsecured—not including $100 million that are secured by a secondary lien on state aid. Assured insures $146 million of unlimited tax bonds and National $88 million. Ambac wraps $171 million of Detroit GO debt, including $39 million of limited-tax GO bonds and $78 million of unlimited-tax GOs. The city on Oct. 1 defaulted on $9.3 million of interest payments on ULTGOs insured by National and Assured, according to their lawsuit. It’s expected to default on $47.6 million of ULTGO principal and interest payments due April 1, 2014, unless a settlement is reached before then.


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