CHICAGO — A pair of bond insurers filed lawsuits challenging key aspects of Detroit's bankruptcy plans, litigation that could derail the city's effort to exit Chapter 9 by the fall, legal experts said.
"This is the game of blink," said bankruptcy attorney James Spiotto, managing director of Chapman Strategic Advisors LLC and co-publisher of Muninetguide.com. "These are all strategic positions, which are purportedly there to create leverage, but at the end you have to settle to get something done."
Syncora Guarantee Inc. Tuesday filed a motion asking U.S. Bankruptcy Judge Steven Rhodes to reject the city's one and only settlement, an $85 million agreement with its interest-rate swap counterparties.
If approved, the swaps settlement could help the city reach its goal of getting its plan for debt adjustment approved and exit Chapter 9 as soon as possible. The city's police and fire retirement system also filed an objection Tuesday to the swaps settlement.
On Monday, Financial Guaranty Insurance Corp. asked to intervene in Detroit's lawsuit seeking to invalidate $1.4 billion of pension certificates of participation, which were used to fund the city's two pension systems in 2005. The city filed the lawsuit in January.
FGIC's challenge says the city benefitted from the deal and is now "turning a crooked eye to history" by trying to repudiate the debt.
If the bankruptcy court approves the city's lawsuit, the insurer argues, then the pension systems should be forced to disgorge the proceeds of the deal, and FGIC should be released from its duty as an insurer.
Detroit said it would respond to the challenges with its own court filings.
"Suffice it to say the city disagrees with the insurers' characterizations and believes [there] is strong legal support for its case," Bill Nowling, spokesman for Detroit Emergency Manager Kevyn Orr, said in an email to The Bond Buyer.
The litigation comes at an important time in the historic bankruptcy case. Detroit is trying to nail down enough votes to win court approval of its plan of debt adjustment. A cramdown plan for dissenting creditors is expected.
The city has said repeatedly that it wants to exit bankruptcy by October, when Orr's 18-month term expires. Rhodes has also set a fast-track schedule with plan confirmation hearings starting in mid-July.
"In a lot of respects this is a chess game, and you've now got people staking out different positions," said Michael Sweet, a California-based attorney at Fox Rothschild LLP who specializes in municipal restructuring and Chapter 9.
Sweet noted that the city's unions are appealing Rhodes' eligibility filing, which bond insurers have left alone while instead fighting the city's swaps settlement and now its repudiation of the COPs. The insurers are also challenging the city's attempt to treat general obligation bonds as unsecured.
"For everyone, you've got the undercurrent of when Orr's term expires in six months," Sweet said. "Some people have a sense that it would be good to run out the clock. The bonds don't do any better if they play nice than if they don't, so what do they have to lose?"
The new litigation could significantly delay the plan confirmation hearing schedule, said Melanie Cyganowski, a retired bankruptcy judge, Eastern District of New York, who now practices law at Otterbourg PC.
"It'll be interesting to see whether or not the insurers are successful in somehow putting the brakes on confirmation," Cyganowski said. "It's almost unimaginable for a lawsuit to go from complaint to trial in a year," she said, noting that the confirmation hearings are only four months away. "We'll have to watch for whether or not the insurers or the city will be trying to put the lawsuit on a fast-track schedule."
If Rhodes rules in favor of the bond insurers, then the "confirmation hearings could be turned upside down," Cyganowski added.
FGIC's lawsuit is a 1,027-page document that argues the insurer needs to intervene in the city's lawsuit because its interests will otherwise not adequately be protected and because the outcome could have major, complex repercussions.
FGIC wraps $1.1 billion of the pension COPs. Syncora insures $329 million. Syncora also insures the interest-rate swaps that hedge the certificates.
Detroit named the two service corporations set up in 2005 to issue the pension certificates as defendants when it sued to repudiate the pension certificates.
FGIC argues that the service corporations, which are made up of city officials, will not adequately protect the insurer's interest if the issue goes to court.
Detroit's effort to repudiate the COPs is "opportunistic and revisionist," FGIC argues.
"Courts have not looked favorably on financially troubled municipalities that regret and then seek to unwind past promises, years after such promises were lawfully made, and with the knowledge that innocent third parties have relied to their detriment on such promises," the insurer says, with a reference to Harrisburg, Pa.
Proceeds from the 2005 COPs deal funded the city's two pension systems.
If Detroit is successful in overturning the debt, the pension systems should be forced to disgorge the money, the insurer says.
"This in turn raises significant questions about the city's future, including the feasibility of the city's existing proposed Chapter 9 plan. The issues are complicated and there is much at stake," FGIC argues.
Syncora and Detroit have been locked in battle over the city's repeated attempts to settle its swaps, which began even before the bankruptcy was filed last July.
Syncora says in its new filing that the revised settlement is materially different than the previous two the city presented - which the court rejected as too costly — and that the bankruptcy court does not have the authority to sign off on key provisions of the deal.
The main difference, says Syncora, is that the new settlement leaves out of the agreement the service corporations that issued the pension certificates. The city left them out of the deal in light of the January lawsuit repudiating the COPs.
Leaving out the service corporations "profoundly" changes the nature of the settlement, Syncora argues. It is the service corporations, not the city, that have the power to grant the counterparties the liens on casino revenues, so they need to be a party to the deal, the insurer says.
"Their absence from the agreement, coupled with the contractual provisions of the collateral agreement, means that the new settlement cannot achieve the goal of freeing up the casino revenues," the insurer argues. Syncora also notes that the deal does not actually terminate the swaps, so that its benefits are not immediately clear.
Detroit says the new deal is key to the city's overall plan of debt adjustment. The deal calls for the city to pay the two counterparties, UBS AG and Merrill Lynch Capital Services Inc., $85 million in exchange for access to the casino revenues and the banks' approval of the debt adjustment plan.
Sweet, Spiotto, and Cyganowski agreed that it's politics as much as law driving this stage of the bankruptcy negotiations, and that litigation could end up taking years.
Spiotto said Rhodes is pushing hard for mediation because it could ease the process. "He's giving them, from his perspective, the best advice to getting it done," he said. "Because if it's litigated, it's going to take time and there are risks. In a settlement, you may not get everything you want, but it's resolved and you can go from there."