Taking Bankruptcy’s Temperature. Detroit filed suit on Friday to invalidate some complex transactions it used to finance its pensions, contending they were illegal from the very beginning. In a complaint filed in United States bankruptcy court, the city argues that deals with special entities set up in 2005 and 2006, which raised $1.4 billion, were aimed only at circumventing a ceiling on the amount of debt it could take on. It is seeking a ruling that it has no obligation to make payments on the so-called certificates of participation issued to raise the money.
In a stunning turnaround, Detroit is also seeking to cancel some costly long-term contracts that were part of the deal, leaving two large banks, Bank of America and UBS, empty-handed just weeks after offering to pay them $165 million to get out of them. If a judge agrees, Detroit could be freed from having to honor the contracts, known as interest-rate swaps, which require it to pay tens of millions of dollars a year to the two banks.
Detroit’s lawsuit came two weeks after its bankruptcy judge, Steven Rhodes, rejected the $165 million proposal as “too much money” and sent the city back to negotiate less costly terms. He also suggested that the city could bring suit contesting the legality of the transactions. Rather than proposing to pay a smaller amount to terminate the swaps, Detroit is seeking a court ruling that they were illegal from the outset. It says that in 2005 it was in no position to borrow, having exhausted its capacity to issue debt under state law. It argues that the two banks led a team that created sham corporations and made it look as if those corporations, and not Detroit, had issued the debt.
“This deal was bad for the city from its onset despite reassurances it would adequately resolve the city’s pension issues,” Kevyn Orr, the city’s emergency manager, said in a statement. “We have tried without success to negotiate a resolution to this dispute and to allow the city and its taxpayers to move forward and unwind these illegal transactions.”
Some creditors, angry at seeing the swaps being paid while they were being told to expect losses, have argued that the city should try to claw back some of the money it has been paying the two banks.
Detroit explained some of the mechanics of the coming litigation in a proposed plan of adjustment that it recently gave to its creditors. The city said it would set aside $4.2 million a month in a special reserve in case its lawsuit failed. If the judge finds that the swaps were not only valid but also a secured credit, then Detroit said it would use the money to pay some portion of the claim on the swaps.
In case of a partial victory, with the court deciding that swaps were valid but unsecured, Detroit said it would to take back all the money in the reserve and use it to provide services. Instead of cash, Bank of America and UBS would be given portions of some notes that the city proposes to issue to unsecured creditors. Some of those notes would also be used to pay the investors who bought the 2005 debt and the insurers that have promised to step in and make Detroit’s payments if it defaults.
The swaps have been a big sticking point in the bankruptcy case because Detroit had previously pledged some casino tax revenue to the two banks to secure the stream of payments the contracts called for it to make. In bankruptcy, Detroit wanted to get the casino money back to use as collateral for a special new loan it needed to finance its activities in bankruptcy.
The lawsuit names as defendants the service corporations and trusts that were set up in 2005 to enter into contracts with the city to issue the debt.
The city, represented by Jones Day, argues that the financing relied on an illegal structure designed to get around state debt limits that would have otherwise precluded the sale.
The deal was “void from the beginning,” Detroit emergency manager Kevyn Orr’s office said in a statement. “This deal was bad for the city from its onset despite reassurances it would adequately resolve the city’s pension issues,” Orr said. “We have tried without success to negotiate a resolution to this dispute and to allow the city and its taxpayers to move forward and unwind these illegal transactions.”
The lawsuit marks a reversal by Orr and Jones Day, who have spent the last several months urging the bankruptcy court to approve a settlement that would have paid the swap counterparties up to $230 million. The city has treated its swap debt as secured until Bankruptcy Judge Steven Rhodes in January rejected the swaps settlement. Rhodes told the city it would have a reasonable chance of winning if it sued over the deal.
The city had set a 5 p.m. deadline Friday for the swap counterparties to offer up with terms for a new swaps settlement more favorable to the city. The lawsuit was posted on the city’s Chapter 9 bankruptcy court docket late Friday, after the deadline passed.
The lawsuit names as defendants the four non-profit corporations and trusts that the city itself set up in 2005 to issue and service the debt. The corporations are made up of various city officials.
Detroit maintains throughout the lawsuit that it was led by investment bankers into the dubious deals. The lawsuit says the city had only $660 million remaining under its state debt limit as of May 2005 when it issued $1.44 billion of the taxable certificates. In order to fund its two under-funded pension funds, the city began “searching for a means” of borrowing over its limit, the lawsuit says.
“In the end, the city – at the prompting of investment banks that would profit handsomely from the transaction – decided to embark upon transactions to sell so-called ‘certificates of participation’ (‘COPs’) to investors,” the lawsuit says. “The purpose, design and effect of the 2005 service contracts was to allow the city to borrow money in violation of [state debt law] and other state laws by characterizing the city payments as ‘contractual obligations’ rather than debt service.”
The city also did not seek or receive the approval of the state Department of Treasury before issuing the debt, as required under state law.
“City officials turned a blind eye to the requirements of state law and to the city’s desperate financial condition,” attorneys argue.
The deal was celebrated by the investment banking community, the city says, noting that the Bond Buyer singled it as one of the most unique financings of 2005.
The financing in fact put “very fatal strain” on the city’s finances, the city argues. The interest-rate swaps hedging the debt increased the pain and to helped lead directly to the city’s historic bankruptcy filing on July 18, 2014.
The city names as defendants the Detroit General Retirement System Service Corp. the Detroit Police and Fire Retirement System Service Corp., the Detroit Retirement systems Funding Trust 2005, and Detroit Retirement System Funding Trust 2006.
Motor City mediators this morning announced a tentative agreement reached late yesterday between the municipality and the Committee of Retirees to settle a key issue over reductions in retirement health care benefits. The mediators, in a statement, reported reaching a settlement-in-principle that is projected to resolve the committee’s suit concerning health insurance and other post-employment benefits for Detroit’s retirees―the agreement opened the door for U.S. Bankruptcy Judge Steven Rhodes to drop the scheduled session in his court on Monday—pending receipt of a stipulation to the bankruptcy court dismissing the lawsuit: “The mediators are privileged and pleased to be able to play a constructive role in assisting the parties to find common ground on the very important issues in this lawsuit and to facilitate a resolution…In announcing this settlement, the mediators wish to express their appreciation to the parties and their counsel for the good faith spirit and professionalism in which they engaged in the mediation sessions with both the mediators and with each other…The mediators hope that this settlement will provide a foundation for all of the parties to the bankruptcy to re-double their mediation efforts to reach meaningful agreements which can be incorporated into a fair and balanced agreed-upon plan of adjustment to be presented to the bankruptcy court for confirmation.” Under the stipulation, the new agreement would go into effect on March 1st. As settled, the proposed agreement would provide additional money for some retirees who are not yet eligible for Medicare, but also offer resources for retirees on Medicare to purchase their own coverage plan instead of relying on coverage provided by the city. The yet-to-be approved resolution is the outcome from the initial suit filed by the Official Committee of Retirees, the American Federation of State, County and Municipal Employees, and two retiree associations challenging Motor City Emergency Manager Kevyn Orr’s proposal to terminate traditional city retirement health care benefits—instead offering to provide retirees younger than 65 a $125 monthly check to use toward purchasing private health insurance.
Canada plans to begin buying land in Detroit’s Delray district for the New International Trade Crossing even without assurances the U.S. will pay more than $200 million for a needed customs plaza, Canadian officials said last week.
The willingness to move ahead despite U.S. foot-dragging does more than keep the project on track for a 2020 opening. It also brings closure to about 1,000 residents in Detroit’s Delray neighborhood who have waited for years to learn if they’ll be displaced.
“People have been on the tether here for how many years? It seems like nearly a decade,” said Tom Cervenak, director of the nonprofit People’s Community Services of Metropolitan Detroit branch office in Delray.
The NITC would span the Detroit River from southwest Detroit to Windsor, about 2 miles downstream from the existing Ambassador Bridge. The construction project is expected to create thousands of jobs on both sides of the border. It also requires about 1,000 parcels of land to be taken in the Delray neighborhood, already one of the most distressed and abandoned districts in the city.
It also would begin to assure residents of Windsor — who have long battled with Ambassador Bridge owner Manuel (Matty) Moroun over truck traffic on Windsor streets and his desire to demolish houses near his bridge — that those battles may ease in the future.
Roy Norton, Canada’s outgoing consul general in Detroit, told the Free Press the project is too important not to move ahead despite the doubts about U.S. participation. Canada is paying nearly all of the more than $2-billion cost on both sides of the river and recouping the U.S. share from future tolls.
“We’re about to proceed with land purchases some time in the next few months, and we’re going to do that whether there’s been an indication from the U.S. government on a commitment to the customs plaza or not,” Norton said. “That involves a little bit of risk on our part, obviously, but we’re so confident that this ultimately will be built that it’s prudent to do that.”
Gov. Rick Snyder, an ardent supporter of the project, provoked controversy in January when he told the Free Press editorial board that U.S. officials were stalling on committing to pay for the plaza. The most recent cost estimate for the plaza work, which includes connectors to I-75, was $325 million in 2010.
After Snyder’s comments to the Free Press, calls and e-mails to federal officials seeking comment were not immediately returned. U.S. Sen. Carl Levin, D-Mich., has told the Free Press that he would pursue the matter with federal officials.
Meanwhile, the Moroun family continues to pursue lawsuits to try to block the NITC, which is likely to draw significant traffic and toll revenue away from their privately owned bridge. Lawsuits are pending in courts in Michigan, Washington, D.C., and Canada.
Word that Canada hopes to move ahead anyway could bring relief to residents of the Delray district, who continue to seek a formal agreement with Michigan and Canada to benefit those left behind once the bridge is built. Relief could come in the form of job retraining so that some could get jobs on the project.
“I think that people want to see something happen,” Cervenak said. “If their homes are going to be taken, they understand and they’re ready.”
Land acquisition is key to keeping the project on track for an expected 2020 opening because the NITC bridge will require about 1,000 parcels in Detroit’s Delray district. The land is needed for the customs plaza, where incoming cars and trucks can be inspected, as well as for the interchanges connecting the bridge to I-75. The current estimate of land needed for the plaza is 160 acres, although it could be smaller or greater once more detailed plans are drafted.
Under terms of the agreement that Snyder signed with Canadian officials in June 2012, Michigan Department of Transportation staff will actually handle much of the land acquisition and be reimbursed by Canada, which will then be repaid through future tolls.
In a report submitted to the Legislature dated May 1, 2010, MDOT estimated that the costs of utility relocation and land acquisition for the plaza and I-75 would total approximately $325 million. More recent cost estimates are unavailable.
If land purchases begin this year, as Norton predicted, officials hope that a large majority of parcels will be acquired by the end of 2015. Condemnation proceedings on parcels where owners resist selling may stretch into 2016, but that wouldn’t necessarily delay construction work since Michigan law allows the government to take the land and arrive at the appropriate cost later in court.
Canadian officials are continuing to lobby U.S. officials over the need to commit to pay for the plaza, expected to cost in the range of $200 million. Canada Transport Minister Lisa Raitt will meet with U.S. Secretary of Transportation Anthony Foxx in Washington this month. The visit is planned “to impress that this is something that should be a priority, (and) that it’s not a done deal,” Norton said.
Canada also has begun a search for a CEO of the new Windsor Detroit Bridge Authority that will oversee construction and operation of the bridge. Canada is also working on utility relocation on the Detroit side.
The moves indicate a strong desire to keep the project on track despite questions of when or even whether the U.S. government will pony up the money for the plaza. Canadian officials have called the NITC bridge their most critical infrastructure priority and essential to the growth of commerce in both nations.
The delay in the U.S. government committing to paying for the plaza has led to speculation over whether there may be other ways to get the plaza built. Among those: That the U.S. government might have someone else build it and pay lease payments; that a smaller-than-planned plaza could be built to lessen the cost; or that all inspections might be done on the Canadian side of the bridge.
Norton said that any suggestion that Canada pick up the cost of the U.S. plaza was farfetched.“For people to muse about Canada paying for it really is preposterous,” he said. “We’re paying for fifteen-sixteenths of this project. It’s silly.”
He noted that U.S. officials were part of the negotiations that led up to the June 2012 agreement. “The U.S. government was party to the negotiations throughout,” Norton said. “They know that if the project is to proceed that it’s their role and responsibility to build their customs plaza.”
With a seven-year schedule to finish the project, a few months’ delay now on the U.S. paying for the plaza won’t necessarily delay it. But the issue must be resolved this year, or the project will start to face delays, both Norton and Snyder have said.
Norton said Canadian officials are hoping that President Barack Obama will include money for the plaza in his new budget that he is expected to unveil this month or next.
“If there was an indication in the president’s budget that they were looking to Congress to approve the cost, then that might be sufficient for us to call the bids later this year,” Norton said. “But if there isn’t, that will indeed constitute a real roadblock.”