CHICAGO — Detroit filed a lawsuit seeking to invalidate $1.4 billion of its pension certificates.

In the lawsuit, filed late Friday, the city argues that Detroit itself — led by unscrupulous investment bankers — set up an illegal structure to issue the pension certificates in 2005 and 2005.

The lawsuit is the latest maneuver in the bankrupt city's months-long effort to settle or terminate a series of eight interest-rate swaps that hedge $800 million of the pension debt.

A disposition of the swaps is one of the biggest hurdles Detroit must overcome to exit bankruptcy.

The lawsuit seeking to overturn the pension debt could be the first step toward a lawsuit with the banks that act as counterparties on the swaps.

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. It was filed in the U.S. Bankruptcy Court, Eastern District of Michigan, which is overseeing the city's Chapter 9 case.

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 Friday 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."

Detroit had set a 5 p.m. deadline Friday for the swap counterparties to offer up with terms for a new swaps settlement after the bankruptcy judge rejected the results of earlier negotiations.

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

Orr and Jones Day have spent the last several months urging the bankruptcy court to approve a settlement that would have paid the swap counterparties up to $250 million. The city treated its swap debt as secured until Bankruptcy Judge Steven Rhodes in January rejected the most recent $165 million swaps settlement.

Rhodes at the time told the city it would have a reasonable chance of winning if it sued over the deal. A plan of adjustment circulated to creditors last week for the first time labeled the swaps debt, as well as the pension debt, as unsecured.

Despite the lawsuit, the city is still negotiating with the banks, Orr spokesman Bill Nowling told local reporters.

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 the $1.44 billion of taxable certificates. To shore up 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.

UBS Financial Services Inc. was the book-running manager on the original COPs deal. Citi and Siebert, Brandford, Shank & Co. were the co-senior managers for the Series A portion — the fixed-rate piece — with 12 co-managers.

Loop Capital Markets, Merrill Lynch & Co. and Morgan Stanley were co-seniors on both the Series A and B COPs.

Lewis & Munday was bond counsel for the transaction. Robert W. Baird & Co. Inc. and Scott Balice Strategies LLC were co-financial advisors with respect to the service contracts and the certificates, according to bond documents. Scott Balice also acted as the city's advisor on the swaps.

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.

The lawsuit came at the end of a fast-moving week in Detroit, which is pushing to file a debt adjustment plan with the bankruptcy court within the next two weeks. Rhodes has set a deadline of March 1 for the city to file a formal plan of adjustment.

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