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Judge: Bankruptcy Offers Detroit a 'Fresh Start'

CHICAGO -- Detroit is eligible for bankruptcy protection, the federal judge overseeing the case ruled Tuesday.

The ruling means Detroit can legally enter into Chapter 9, launching the largest American municipal bankruptcy to date. The city says it has $18.5 billion of debt it will try to restructure over the course of the case.

Detroit emergency manager Kevyn Orr and Michigan Gov. Rick Snyder hailed the decision and said it marks a fresh start for the struggling city. Orr said the city hopes to file a plan of adjustment by early January.

In a surprise, federal Judge Steven Rhodes also weighed in on one of the most controversial questions in the case so far. Rhodes ruled that Chapter 9 allows the city to cut its pensions, despite state constitutional protections. He was expected to consider the question later in the case. The decision could reverberate across the country for cities struggling with retirement obligations.

Rhodes’ eligibility ruling came after a nine-day trial over the issue. In his ruling, the judge said the city met the tests that serve as gatekeepers to entering Chapter 9 protection. The city proved it was insolvent and that it had the legal authority to file. Rhodes ruled that the city did not negotiate in good faith with its creditors -- a key threshold that city attorneys fought to prove throughout the trial -- but that such negotiations were impossible.

“This once proud and prosperous city cannot pay its debts,” Rhodes said. “It is insolvent. It’s eligible for bankruptcy. But it also has an opportunity for a fresh start.”

Michigan’s constitutional protection of pensions does not apply in federal court, the judge ruled. “Pensions are not entitled to any extraordinary protection,” he said, saying the pensions are contractual in nature.

He added that his pension decision does not mean he will necessarily confirm a plan that impairs the benefits.

In his 90-minute ruling, Rhodes addressed each creditor argument against eligibility. He began with a history of the city, and repeatedly brought up the climbing tension between Detroit’s essential services and its debt obligations. That’s an important emphasis that marks a first in Chapter 9, according to one attorney.

“This is the first time we’ve heard a court say this process has an impact on services, and that’s helpful for other cities thinking about Chapter 9,” said Karol Denniston, partner at Schiff Hardin LLP, which represents some of the city’s pension certificate holders.

“This court, because of the serious circumstances that Detroit finds itself in, made it clear that [delivering services] is going to be part of the confirmation process,” she said.

Rhodes’ ruling on the eligibility criteria and pensions will help future Chapter 9 cases by setting more precedents, Denniston said. The judge ruled that the city sought Chapter 9 in good faith, overturning creditors’ objections that the city had always intended to file and therefore did not negotiate in good faith.

Rhodes said in many ways, the city’s bankruptcy was a foregone conclusion, and in fact should have happened years ago.

“It has added significantly to our precedents for Chapter 9,” Denniston said. “This was a well-done, well-reasoned opinion, and he addressed everything. We haven’t had a whole lot of guidance about what constitutes good faith.

“What we need is to get to the point where this eligibility process is over as quickly as possible,” she added. “His comments about negotiations were, if you haven’t yet, you need to start, and that’s going to be a common theme that develops in municipal restructurings.”

After the ruling, Orr said the city hopes to work through the month to craft a plan of adjustment that it will first present to creditors and laborers and then release to the public. The goal is the first few weeks of January 2014, according to Orr. The plan will likely resemble the creditor proposal Orr unveiled on June 14, 2013, he said.

“Think of [the creditor proposal] of flying at 40,000 feet -- the plan of adjustment will be more at ground level,” he said. “The concepts may fluctuate a bit, but that’s the broad template of what we’re expecting to do.”

The plan will feature additional information on creditor classes, including dividing pensioners into separate classes, Orr said. It will include details on the city’s assets and plans for its art collection and water and sewer departments, the city’s two most valuable assets. Orr said he expects to release an appraisal of the city’s art by Christie’s in the next week or two.

The manager said Rhodes’ eligibility ruling was an “invitation” to creditors to reach a settlement with the city. “It’s an overture to work together on a consensual plan so we don’t have to get to a cramdown,” he said.

In a statement released after the ruling, Snyder said the decision was a “call to action. We are confronting fiscal realities that have been ignored for too long,” the governor said. “Today’s decision will allow Detroit to regain its financial footing and spark investments in key areas that will improve the quality of life for all residents.” 

The creditors fighting the city’s eligibility, which include unions and pension systems but no bondholders or insurers, have already said they will appeal the eligibility ruling and now, likely the pension ruling as well.

They want to appeal directly to the U.S. Court of Appeals for the Sixth Circuit, bypassing the U.S. District Court Eastern District of Michigan.

The case will proceed while the appeal is filed and considered.

The city needs to reach approval from a class of creditors who make up two-thirds of the amount of debt and over half by number.

Appeals in the case will be made first to either the U.S. District Court, Eastern District of Michigan, or the bankruptcy appeals court in Michigan, then on to the U.S. Court of Appeals for the Sixth Circuit, and the U.S. Supreme Court.

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I've never seen such a ground-breaking bond case.
Will G.O.'s be considered unsecured?
Will limited- and unlimited-tax G.O. bonds be treated differently?
And how about their insurers?
Will the dedicated water and sewer income streams continue to go to their trustees and revenue bondholders?
Will senior and subordinate lien revenue bonds be treated differently?
Not to mention the fate of the city art assets.
Fascinating!

Wilson White
Municipal Bond Expert Witness
Posted by wwilson | Tuesday, December 03 2013 at 1:24PM ET
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