CHICAGO – Detroit late Friday filed a lawsuit challenging its controversial 2005 sale of pension certificates and the interest-rate swaps hedging the debt.

The lawsuit names as defendants the service corporations and trusts that were set up in 2005 to enter into contracts with the city to issue the debt.

The city, represented by Jones Day, argues that the financing relied on an illegal structure designed to get around state debt limits that would have otherwise precluded the sale.

The deal was "void from the beginning," Detroit emergency manager Kevyn Orr's office said in a statement. "This deal was bad for the city from its onset despite reassurances it would adequately resolve the city's pension issues," Orr said. "We have tried without success to negotiate a resolution to this dispute and to allow the city and its taxpayers to move forward and unwind these illegal transactions."

The lawsuit marks a reversal by Orr and Jones Day, who have spent the last several months urging the bankruptcy court to approve a settlement that would have paid the swap counterparties up to $230 million. The city has treated its swap debt as secured until Bankruptcy Judge Steven Rhodes in January rejected the swaps settlement. Rhodes told the city it would have a reasonable chance of winning if it sued over the deal.

The city had set a 5 p.m. deadline Friday for the swap counterparties to offer up with terms for a new swaps settlement more favorable to the city.

The lawsuit was posted on the city's Chapter 9 bankruptcy court docket late Friday, after the deadline passed.

The lawsuit names as defendants the four non-profit corporations and trusts that the city itself set up in 2005 to issue and service the debt. The corporations are made up of various city officials.

Detroit maintains throughout the lawsuit that it was led by investment bankers into the dubious deals.

The lawsuit says the city had only $660 million remaining under its state debt limit as of May 2005 when it issued $1.44 billion of the taxable certificates. In order to fund its two under-funded pension funds, the city began "searching for a means" of borrowing over its limit, the lawsuit says.

"In the end, the city – at the prompting of investment banks that would profit handsomely from the transaction – decided to embark upon transactions to sell so-called 'certificates of participation' ('COPs') to investors," the lawsuit says. "The purpose, design and effect of the 2005 service contracts was to allow the city to borrow money in violation of [state debt law] and other state laws by characterizing the city payments as 'contractual obligations' rather than debt service."

The city also did not seek or receive the approval of the state Department of Treasury before issuing the debt, as required under state law.

"City officials turned a blind eye to the requirements of state law and to the city's desperate financial condition," attorneys argue.

The deal was celebrated by the investment banking community, the city says, noting that the Bond Buyer singled it as one of the most unique financings of 2005.

The financing in fact put "very fatal strain" on the city's finances, the city argues. The interest-rate swaps hedging the debt increased the pain and to helped lead directly to the city's historic bankruptcy filing on July 18, 2014.

The city names as defendants the Detroit General Retirement System Service Corp. the Detroit Police and Fire Retirement System Service Corp., the Detroit Retirement systems Funding Trust 2005, and Detroit Retirement System Funding Trust 2006.

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