Detroit’s bankruptcy heads for crucial hearing

Last modified: Wednesday, September 10, 2014
DETROIT — Detroit’s bankruptcy will culminate in a high-stakes court battle starting Tuesday that will determine the fate of the city’s plan, which would pay pensioners more than financial creditors, preserve the Detroit Institute of Arts and slash more than $7 billion in debt while reinvesting in services.

The city is facing extraordinary pressure to prove that its plan to resolve the bankruptcy and reinvest $1.4 billion over 10 years in services is fair.

The power to approve Detroit’s plan of adjustment or force the city to start over rests with U.S. Bankruptcy Judge Steven Rhodes, who will examine hundreds of exhibits and hear testimony from potentially more than 80 witnesses during a trial that could stretch through Oct. 17.

As Rhodes put it, the proceeding — called a “plan confirmation hearing” — will determine “the future of the city of Detroit.”

The city’s feud with its holdout financial creditors will take center stage — with the powerful bond insurers attempting to prove the plan of adjustment is a disaster that must be rejected.

Winning the judge’s approval won’t be easy.

The cornerstone of Detroit’s restructuring plan is called the grand bargain, which would allow the city to accept the equivalent of $816 million over 20 years from the state of Michigan, nonprofit foundations and DIA donors to reduce pension cuts and transfer the museum to a charitable trust.

But the city’s most vociferous opponents — bond insurers Syncora and Financial Guaranty Insurance Co. (FGIC) — argue that the grand bargain is illegal and amounts to unfair discrimination in favor of pensioners.

When taking into account the grand bargain cash, Detroit pensioners would get about six times more than the insurers, according to the city’s financial calculations.

Syncora and FGIC also contend that Detroit emergency manager Kevyn Orr is frittering away the DIA for billions less than it’s worth.

But the city’s lawyers argue that the deal is fair in part because grand bargain funding was never intended for financial giants.

In addition, unequal doesn’t necessarily mean unfair. The city is expected to argue that Detroit pensioners deserve better treatment in part because they are relinquishing their right to sue the state and city over pension cuts. U.S. bankruptcy law allows different unsecured creditors to be treated differently if there’s justification to do so.

Still, Rhodes recently reminded the city that it must justify its plan to obliterate the $1.4 billion in city debt insured by FGIC and Syncora. The valuation of the city-owned DIA’s property is in dispute and will be a significant issue.

On paper, the museum’s prized collection of more than 66,000 pieces is worth $4.6 billion to $8.1 billion, based on valuations conducted by a city-hired expert and a FGIC-hired expert, respectively.

“In essence, you’re taking a massive asset of the City of Detroit and taking it away from the citizens of Detroit — and the creditors also,” James Sprayregen, the lead attorney for Syncora, said in an interview. “Something that could be worth billions of dollars is no longer going to be valuable to the citizens of Detroit. We don’t just think this is a bad deal for Syncora; we think this is a bad deal for the city of Detroit.”

But the city’s adviser, Artvest Partners, concluded that a fire sale would yield only up to $1.8 billion. The city says it’s not clear whether the DIA’s art can legally be sold — and municipal bankruptcy law doesn’t require the city to sell assets.

“We believe the plan is fair,” Orr spokesman Bill Nowling said, “and we’re going to defend that strongly in court.”

Doug Bernstein, a bankruptcy lawyer representing the foundations that pledged cash for the grand bargain, said the deal is legally unique.

“Let’s face it,” he said. “The proposed settlement with the DIA is novel, hasn’t been tested anywhere else, is groundbreaking, and that’s going to be the focus.”

Syncora and FGIC will have few allies during the trial.

More than 600 individuals also filed official objections to the plan but for vastly different reasons. Most are angry about pension cuts.

But after an intense series of confidential mediation talks led by Chief U.S. District Judge Gerald Rosen - the lead mediator in the case - Detroit reached settlements with all major retiree groups, representing more than 30,000 pensioners.


The city’s supporters include the U.S.-government appointed Official Committee of Retirees, the city’s two pension funds, civil employee union American Federation of State, County and Municipal Employees (AFSCME) Council 25 and the largest police union.

Civil retirees voted overwhelmingly to accept 4.5 percent cuts to their monthly pension checks, the elimination of cost-of-living-adjustment (COLA) increases and a clawback in excessive annuity payments from 2003-13. Police and fire retirees voted to accept a reduction in COLA from 2.25 percent to 1 percent.

Altogether, pensioners are getting about 60 percent of their unfunded liabilities, while Syncora and FGIC are getting up to 10 percent.

“Each class of retirees did vote to approve the plan, so it’s at a point where we’re relying on the city to present and prove its case,” said Ryan Plecha, an attorney for the two Detroit retiree associations that helped negotiate a pension settlement.

The cuts were significantly lower than what Orr originally proposed.


How will Rhodes decide whether the cuts to pensioners and financial creditors are fair?

In an Aug. 21 hearing, Syncora attorney Stephen Hackney asked the judge to identify which of two well-established bankruptcy tests gauging the fairness of a restructuring plan the judge expects to use.

“There is a third alternative,” Rhodes said, crossing his arms.

Hackney paused. “The Rhodes test?” he asked.

The judge nodded slowly, without saying anything.

Detroit’s future depends on the Rhodes test.


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