CHICAGO — A trio of bond insurers sued Detroit Friday for defaulting on its general obligation bonds, a challenge that goes to the heart of the city's unprecedented effort to treat its unlimited-tax GO debt as unsecured.

National Public Finance Guarantee Corp., a subsidiary of MBIA Inc., and Assured Guaranty Municipal Corp., filed the lawsuit Friday morning in U.S. Bankruptcy Court, Eastern District of Michigan, Southern Division.

A few hours later, Ambac Assurance filed its own lawsuit. Ambac's lawsuit includes the city's limited-tax GO debt. Together the three insurers wrap all of Detroit's unlimited-tax general obligation debt.

The lawsuits ask federal Judge Steven Rhodes, who is overseeing the city's Chapter 9 case, to force Detroit to set aside property tax revenue raised by voter-approved referenda specifically for various unlimited-tax GOs issued between 1999 and 2008.

They're also asking the judge to block a proposed debtor-in-possession financing that would give a super-priority lien to Barclays, the bank that would loan the money to Detroit.

The super-priority lien would include the disputed voter-approved ad valorem funds, and would therefore directly hurt the insurers and bondholders, the insurers argue.

"Our efforts to date to resolve this dispute consensually have been rebuffed, and city officials have refused to comply with state law that requires ad valorem tax revenues, specifically approved by the voters of Detroit for repayment of the Unlimited Tax Bonds, to be used only for that purpose," Assured said in a statement issued after the filing. "As always, investors that hold bonds insured by Assured Guaranty can be certain they will continue to receive uninterrupted full and timely payment of scheduled debt service when due in accordance with the terms of Assured Guaranty's insurance policies."

It's one of the only times Assured has sued a city over defaulted unlimited-tax GO payments. It also sued Harrisburg, after that city defaulted on its ULTGOs.

The lawsuits comes on the final day of Detroit's nine-day trial to determine whether it's eligible to legally enter into Chapter 9. No bond insurer or bondholder challenged the city's eligibility.

The challenges are relatively narrow in that it only requests an order forcing the city to set aside the disputed voter-approved property tax revenue throughout the Chapter 9 proceedings, assuming the city is declared eligible. The lawsuits do not delve into the deeper, and possibly precedent-setting, question of whether Detroit can legally treat its ULTGOs as unsecured.

That's a future fight expected from muni market participants if the city formally proposes a plan of adjustment that treats its ULTGOs as unsecured. The city is expected to argue that only debt with a specific statutory lien attached to it is secured.

"Issues as to whether the restricted funds are impressed with a statutory lien … and constitute 'special revenues' … will likely need to be determined at a later time following necessary and appropriate fact and expert delivery," the Assured and National lawsuit says.

By including the city's limited-tax GO debt in its lawsuit, Ambac argues that Detroit issued the LTGOs only after the City Council outlined the specific capital projects that would be financed with the proceeds, and that the ad valorem taxes pledged for the limited-tax bonds financing those projects should also be used only for bond repayment.

The insurers say the city is violating several Michigan laws, as well as the state constitution, by not setting aside the revenue into restricted accounts and instead using it for general operating costs.

"Michigan's state law could not be more clear: the city is required to segregate the pledged property taxes and then only use them to pay debt service on the bonds," David Dubrow of Arent Fox, Ambac's counsel, said in a statement. "And bankruptcy law is equally clear on such matters: Michigan law must be followed."

Detroit has $369 million of outstanding ULTGOs that it's treating as unsecured. That does not include $100 million that are secured by a secondary lien on state aid.

Assured insures $146 million of unlimited tax bonds and National $88 million. Ambac wraps $171 million of Detroit GO debt, including $39 million of limited-tax GO bonds and $78 million of unlimited-tax GOs.

The city on Oct. 1 defaulted on $9.3 million of interest payments on ULTGOs insured by National and Assured, according to their lawsuit. It's expected to default on $47.6 million of ULTGO principal and interest payments due April 1, 2014, unless a settlement is reached before then.

The suit names Orr, finance director John Naglick, deputy finance director Michael Jamison, and Treasurer Cheryl Johnson as defendants. The lawsuit argues that the defendants are personally liable to the bondholder for failing to set aside the money.

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