Detroit Bankruptcy Judge Denies Proposal to Pay Off Disastrous Debt Deal

Detroit workers, retirees and community activists protest the forced bankruptcy of the city on October 23, 2013 outside federal court., a photo by Pan-African News Wire File Photos on Flickr.

Detroit bankruptcy judge denies proposal to pay off disastrous debt deal

8:48 PM, January 16, 2014
Detroit Free Press

Bankruptcy Judge Steven Rhodes denied Detroit's proposal to pay off a debt deal originating in 2005, saying the city must stop making poor financial decisions

By Nathan Bomey and Alisa Priddle
Detroit Free Press Business Writers

U.S. Bankruptcy Judge Steven Rhodes rejected the City of Detroit’s bid to pay off a disastrous debt deal from 2005, slamming a proposed $165-million settlement as too generous and cautioning the city to stop making irresponsible financial decisions.

Calling the original debt deal legally dubious, Rhodes said the city “likely” could challenge it successfully in court and pay substantially less. It was the second time Rhodes rejected a proposed settlement with UBS and Bank of America Merrill Lynch. The first was for about $230 million.

“The court ... will not participate in or permit the city to perpetuate the very kind of hasty and imprudent financial decision-making that led to the” original deal, Rhodes said Thursday from the bench. Rhodes said he “strongly encourages” the banks to renegotiate.

The settlement’s demise could trigger a high-stakes legal battle over the fate of the original deal, which involved a $1.4-billion loan and contracts called “swaps” that locked in interest rates at 6%. The ruling leaves in limbo the city’s casino tax revenue, which was pledged in 2009 as collateral for the growing debt as the city faced a $300-million to $400-million balloon payment.

The ruling was a stunning blow to UBS and Bank of America Merrill Lynch and a big win for the city’s residents, retirees and other financial creditors who want more money left to pay for city services and also to help pensioners and other creditors.

Thursday’s developments also further solidify the federal judge’s reputation as a no-nonsense jurist willing to impose his will on behalf of the city and its residents.

Detroit emergency manager Kevyn Orr has argued he needs to pay off the banks so the city’s share of the casino revenue, roughly $170 million to $180 million a year, can be directed to pay for reinvented city services. Such a settlement would become an integral part of Orr’s “plan of adjustment,” or master blueprint for restructuring the city and exiting bankruptcy.

Orr said earlier that his plan of adjustment would be introduced some time this month. But with Rhodes’ rejection of the settlement, it could be delayed along with the final resolution of the bankruptcy case.

In his sharply worded ruling, Rhodes said the city must stop making poor financial decisions and stressed that it’s his judicial responsibility to ensure the city emerges from Chapter 9 bankruptcy as a financially sustainable municipality.

Rhodes’ ruling and the real threat of legal challenges could hasten a new, less-expensive settlement with the two banks.

Borrowing also nixed

The judge also rejected Detroit’s accompanying proposal to borrow $165 million from London-based Barclays to finance the settlement.

He did approve a proposal to borrow $120 million to pay for “quality of life” services — but the money comes with conditions that could make it harder for the city to use the money to improve emergency services, lighting, utilities and to address blight, the most pressing needs, according to Orr.

Those conditions include a 14-day window for each creditor to object to how the money is being spent. For example, if the city wanted to repair streetlights with $5 million, a creditor could file an objection within 14 days and Rhodes would need to examine it and make a ruling.

“We are reviewing today’s decision but we are thankful the court has approved our ability to pursue quality of life financing for the benefit of the city’s 700,000 residents,” Orr said in a statement. “As recommended, we will continue to work toward a resolution of the pension ‘swaps’ ” and to improve the lives of Detroiters.

Thursday’s court action was a victory for Detroit retirees, city residents, the pension funds, several European banks and a bond insurer called Ambac Assurance, which aggressively fought the swaps settlement. Because Rhodes denied the deal, they stand to get more money from the city’s eventual bankruptcy restructuring.

“We’re really gratified,” said Robert Gordon, an attorney for Detroit’s two pension funds, adding that “paying them even close” to $165 million was too much.

The settlement’s demise was a loss for Orr, who testified in favor of the deal during a trial in Rhodes’ court, and a loss for bankruptcy law firm Jones Day, which pursued the settlement aggressively.

Rhodes said the settlement was “just too high a price.”

“It is higher than the highest reasonable number,” he said. “If it were close, the court would approve it. But it’s not close. The court looked for every way it could to approve this settlement. It could not find a way. It’s just too much money.”

By rejecting the swaps deal, Rhodes also rejected the recommendation of Detroit bankruptcy mediator and U.S. District Chief Judge Gerald Rosen, who personally endorsed the settlement.

“It’s a real slap at Judge Rosen,” Wayne State University law professor Laura Beth Bartell said. “He stood up and said, ‘This is it. I want you to approve it.’ ”

Rhodes also emphasized that he would carefully scrutinize Orr’s future plan of adjustment to ensure it’s in the best interests of the city and its creditors.

“I’m glad the judge refused to give the banks the money,” said Walter Knall, a 70-year-old Detroit resident who worked for the health department for 31 years.

Cecily McClellan, a retiree from the human services department, called it a victory for the citizens of Detroit, retirees and the region. “I am elated,” she said.

“The judge recognizes the city is in crisis and is not giving more money to banks that have already made a lot of money on this deal,” said Jerry Goldberg of the Moratorium Now Coalition of protesters fighting to protect pensions.

Collateral questioned

Rhodes said Detroit has convincing arguments that its 2009 decision to pledge its casino taxes as collateral on the transaction was illegal under the Michigan Gaming Act, which limits how the money can be used.

He also said the city has a strong argument that the swaps were invalid altogether. The Free Press reported in September that the swaps deal might have been illegal.

Detroit currently pays about $50 million a year to the banks in exchange for the swaps, which provided a steady interest rate of about 6% on a $1.4-billion pension funding deal. That equals nearly 5% of the city’s sparse general fund budget.

The original deal — brokered by former Mayor Kwame Kilpatrick’s administration to eliminate the city’s unfunded pension liabilities — soured after U.S. interest rates plummeted during the recession. In 2009, the city pledged its casino revenue as collateral to avoid an immediate payment of $300 million to $400 million on the swaps, potentially violating the Gaming Act.

An original settlement between the city and the banks — negotiated mostly before Detroit filed for bankruptcy in July 18 — to settle the swaps for $230 million collapsed last month after Rhodes questioned whether the city was getting a good deal.

Detroit and the banks negotiated the new deal in a Christmas Eve bargaining session moderated by Rosen.

But several major creditors maintained their opposition to the settlement — including bond insurers Syncora and Financial Guaranty Insurance, the city's two pension funds and several European banks.

Contact Nathan Bomey: 313-223-4743 or nbomey@freepress.com. Follow him on Twitter @NathanBomey. Business writer Brent Snavely contributed to this report.