The Plan. Detroit Emergency Manager Kevyn Orr today filed a proposed plan of adjustment and disclosure plan with the U.S. Bankruptcy Court that lays out how the Motor City proposes to allocate its $18 billion of debt amongst its 100,000+ creditors and provide for a sustainable future for the Motor City. (Note: please see the summary of the city’s plan below). The 120-page blueprint offers unsecured non-retiree creditors, including unlimited-tax GO holders, a roughly 20 percent recovery on their claims. The city would raise the funds to cover the claims through the issuance of new securities. The recovery rate could go up if the city brings in more revenue. The disclosure document lays out a 10-year plan of sustainability for the future through the revitalization of essential public services and public safety, proposing $1.5 billion be dedicated to capital improvements, blight removal, equipment, and technology upgrades, with up to $500 million utilized over the next five years.
As submitted, the plan proposes significant, but unequal reductions in payments to its many classes of creditors. The plan proposes reductions of 34 percent in monthly pensions for general retirees, but retired police officers and firefighters would receive 90 percent of their promised pensions. Part of the difference in treatment for the city’s pensioners hinges upon an $815 million plan that would depend upon state approval of about $465 million and money from foundations and private donors to bolster the city’s retirement funds and shield the DIA collection from creditors. Some of the funds are expected to be reserved to ensure that retirees whose household income is at or relatively near the federal poverty level will not fall below that level. If police and fire retirees agree to the plan and a proposed settlement with the state, they would likely receive in excess of 90% of their earned pensions after elimination of cost of living allowances, and general retirees would likely receive in excess of 70% of their pensions after elimination of cost of living allowances, according to Mr. Orr’s spokesperson. Nevertheless, because the Michigan constitution bars cuts to such pensions—an issue pending before the 6th U.S. Circuit Court of Appeals, after U.S. Bankruptcy Judge Steven Rhodes last December held that pensions could be cut in federal bankruptcy court. The documents propose that holders of $374.6 million of the city’s unlimited tax general obligation municipal bonds receive only 20 percent of the bond interest payments they are owed.
The plan begins to lay out the details with regard to ongoing attempts to spin off the city’s Water and Sewerage Department, protect the Detroit Institute of Arts, and restructure $11.5 billion in unsecured claims. It proposes treating the Motor City’s interest-rate swap counterparties as secured creditors. (The proposal reflects details of a new settlement with the swap banks which are expected to be made public shortly.)
In a statement today, Detroit Emergency Manager Kevyn Orr noted: “There is still much work in front of all of us to continue the recovery from a decades-long downward spiral,” but Mr. Orr emphasized the need for Detroit to emerge from bankruptcy court as rapidly as possible: “We must move swiftly to emerge from bankruptcy so that the financial distress harming the city can end…We maintain that the plan provides the best path forward for all parties to resolve their respective issues and for Detroit to become once again a city in which people want to invest, live and work.” Michigan Gov. Rick Snyder called the plan “a thoughtful, comprehensive blueprint.” Noting that “Detroit’s comeback is underway,” the Governor said: “There will be difficult decisions and challenges for all sides as this process moves forward.”
Next Steps. The ball is now in U.S. Bankruptcy Judge Steven Rhodes’ court and subject to his approval—his determination with regard to whether it is fair and equitable. Likely, it is also subject to a renewed, if more frenzied, set of negotiations—especially as key components of the blueprint—especially the state funding contribution, the potential lease of the Detroit water and sewer system, and the potential resolution with the city’s swap creditors—remain open. That is, notwithstanding that the city has filed its plan of adjustment in advance of the deadline of March 1 set by Judge Rhodes, that in no way means negotiations or the plan is set in stone. Rather it is setting in this afternoon that $18 billion divvied up amongst in excess of 100,000 creditors makes for much steeper cuts than many of the parties had realized—increasing the incentives now to negotiate. Ergo, the plan is almost certain to change in the coming weeks prior to a vote of the creditors, a final action by the Michigan Legislature, an agreement on the swaps package that gets an ok from Judge Rhodes, and some resolution between the city and its suburbs with regard to its proposed water and sewer package. The documents today, nevertheless, for the first time make stark how profound the fiscal depth into which the Motor City finds itself, so that it is a reality suddenly as harsh as this winter has been. One vital area of contention for creditors is likely to be over the disclosure document, wherein Mr. Orr proposes a fund for the Motor City’s sustainable future. As this is nearly unprecedented, it is certainly a package which creditors will have interest in disputing.
Implications. As we wrote this morning, because of the conflicts with Michigan’s constitution with regard to pension obligations, and because the plan proposes to treat its general obligation bonds as unsecured, the plan could have repercussions for state and local leaders throughout the nation. Given the unprecedented number of creditors and not only the depth of the cuts Detroit Emergency Manager Kevyn Orr will be proposing for creditors—but also the significant discrepancies, the plan is almost certain to trigger legal challenges, although Mr. Orr’s urgency is heightened because his tenure as the state-appointed controller of Detroit is scheduled to expire next September.
OVERVIEW OF DETROIT’S PLAN OF ADJUSTMENT
The Plan of Adjustment (“Plan”) that the City of Detroit (“Detroit” or “City”) filed with the U.S. Bankruptcy Court for the Eastern District of Michigan on February 21, 2014 represents a critical step toward the City’s rehabilitation and recovery from a decades-long downward spiral. The Plan provides for the adjustment of up to as much as $18 billion in secured and unsecured debt and offers the greatest possible recoveries for the City’s creditors while simultaneously allowing for meaningful and necessary investment in the City.
In connection with the Plan, the City intends to:
Invest approximately $1.5 billion over 10 years to, among other things:
- Improve and provide essential municipal services to the City’s 700,000 residents, including police, fire and emergency medical services, garbage removal and functioning streetlights;
- Attract and retain residents and businesses to foster growth and redevelopment;
- And, Improve the City’s information technology systems, thereby increasing efficiency and decreasing costs.
Provide pension treatment that is intended to deliver pensions that the City can afford and by which retirees can continue to meet their needs and maintain their current quality of life:
- If police and fire retirees agree to the Plan, they would likely receive in excess of 90% of their earned pensions after elimination of cost of living allowances. General retirees who agree to the Plan would likely receive in excess of 70% of their pensions after elimination of cost of living allowances.
- Detroit’s current active employees would continue to earn pensions in the future under traditional defined benefit formulas, rather than defined contribution arrangements.
- The two pension funds – the Police & Fire Retirement System and the General Retirement System – would operate under more conservative investment return assumptions. This will allow pension contribution predictability and stability, which is critical for the City to be assured that it has sufficient funds for operations and its $1.5 billion investment program in the future.
- Contributions to the two pension funds would come from three sources over the next 10 years – accelerated pension funding contributions from the Detroit Water & Sewer Authority, contributions made in connection with a comprehensive settlement to preserve City-owned art for the benefit of the region, and CLI-2187394v4 contributions to the pension funds from the State of Michigan (“Michigan”) under certain settlement conditions.
- The State support will be further designed to ensure that those retirees whose household income is at or relatively near the U.S. federal poverty level will not fall below those levels.
Lay the foundation for a solvent Detroit that can live within its means and meet realistic obligations.
- Essentially all creditors are entitled to a recovery under the Plan.
- Unsecured, non-retiree creditors (including certain unlimited tax and limited tax general obligation debt that is currently the subject of pending litigation) will generally receive (i) an approximately 20% recovery on their claims in the form of new securities to be issued by the City and (ii) the potential to share in any increased revenues realized by a revitalized City.
Continue to negotiate with surrounding counties regarding the potential creation of a regional water and sewer authority. Emphasize negotiated solutions – including through continuing federal mediation – that maximize creditor recoveries while allowing the City to meet its obligations and have a viable future. The Plan contemplates:
- A consensual resolution of matters related to the DIA expected to yield approximately $465 million from certain philanthropic foundations and DIA Corp., which funds would be devoted to increasing the assets of the City’s two pension funds.
- A potential agreement involving the State that would provide as much as $350 million for pension claims in exchange for releases from pension claimants that elect to participate in the settlement.
- The continued pursuit of a potential resolution of a costly interest-rate swaps arrangement.