CHICAGO -- The outcome of Detroit's high-profile bankruptcy case could influence how other distressed Michigan governments weigh their retirement obligations against other types of debt, according to Moody's Investors Service.
Detroit's bankruptcy plan features higher recovery rates for pensioners and retirees than bondholders and other debtors, a treatment that will come under court scrutiny at an August trial on the plan.
The city's settlement with its unlimited-tax general obligation bondholders, which calls for a 74% recovery, also requires the debt to be treated as secured going forward.
Both moves could have an impact on how other struggling Michigan governments think about their debt, Moody's said in a report Friday.
"The final outcome will likely have broader implications for future bankruptcy cases involving distressed local governments in Michigan, potentially setting an important benchmark for the relative position of debt versus pensions," analyst Genevieve Nolan wrote. "The settlements reached in this case may guide future negotiations between Michigan local governments and their creditors and pensioners. However, neither the agreements themselves, nor the court's potential approval of the plan, would be a binding precedent for future bankruptcies in Michigan."
Meanwhile, said Moody's, the split vote among the city's creditors for the bankruptcy plan means the federal court will play a greater role in deciding key issues in the case.
Dissenting votes from a handful of creditors will likely prompt Detroit to ask the judge for a cram down, Nolan noted. It also means that Bankruptcy Judge Steven Rhodes, who oversees the case, will have to decide if the city's confirmation plan treats all creditors fairly under Chapter 9 rules.
Detroit announced the creditor votes on July 22. Pensioners and retirees voted by a wide margin to accept the plan's treatment of their pensions as well as the deep cuts to their retirement health care claims. Unlimited-tax general obligation bondholders also voted in favor of the plan.
The majority of the water and sewer bond holders, with a collective $5.3 billion of claims, voted to reject the plan, though Financial Guarantee Insurance Co. voted to accept.
The limited-tax GO holders voted against the plan, which called for a 10% recovery, but may get a chance to vote again in light of a recent settlement that calls for a 34% recovery.
Finally, holders of the $1.4 billion of certificates of participation -- which the city is attempting to repudiate-- voted unanimously against the plan. Hedge funds have recently purchased most of the COPs debt, and their position on a settlement is not yet clear.
If Detroit wins its lawsuit repudiating the COPs, the city's two pension funds, which received the proceeds of the 2005 deal, could be forced to disgorge the money, experts say. That could lower recoveries for retirees and pensioners.
"The city's attempted repudiation of the COPs is a continued unknown in the Detroit case and could alter the recovery landscape for multiple creditor classes," Nolan wrote.
The city's effort to repudiate the COPs goes against historical precedent and "strains notions of fairness and justice," bankruptcy expert James Spiotto, managing director of Chapman Strategic Advisors LLC, warned in a recent article.
"There is no disputing the economic plight of the city of Detroit," Spiotto wrote on MuniNet Guide, which he co-publishes. "The question is whether the repudiation of $1.4 billion is going to help Detroit regain financial credibility or will it sour the municipal markets against Detroit and possible government debt in general."
Spiotto argues that the ability of U.S. states and municipalities to design and fund a project is unique in the world and "in the past, allowed us to create the world's best infrastructure and the world's largest economy.
"The inevitable consequences to Detroit and to the municipal market upon which all states and municipalities rely for funding their long-term capital improvements and sometimes their essential services, cannot be tolerated," Spiotto wrote. "While the legal and political correctness of past administrations can be argued, there should be no doubt that good funds were provided by investors, that benefits were received by the City through its use of those good funds to pay down pension obligations and a public benefit was achieved. It strains the notion of fairness and justice if a benefit can be retained but the consideration for it can be repudiated."
