Objections roll in on Detroit bankruptcy filing, to what effect?

Some 100 creditors of the city of Detroit have now filed their objections to a bankruptcy filing that, if it proceeds, would be the largest municipal default in US history. Even if they lose, they may be able to slow the process – and postpone losses for city workers and retirees.

Carlos Osorio/AP/File
The Detroit skyline is seen from Grand River in Detroit, July 19. Monday was the deadline for a host of banks, bond insurers, two employee pension systems, and others standing to lose big if a federal judge declares Detroit insolvent to legally file their objections to the largest municipal bankruptcy in U.S. history.

Some 100 creditors of the city of Detroit, which has petitioned a federal court for bankruptcy, have now filed their objections to that course of action on grounds it would be unconstitutional – a move that bankruptcy experts says is likely to slow, but probably not halt, the city's efforts to get out from under its mammoth debt burden through bankruptcy.

The official objections filed Monday were primarily from public-sector unions, whose retirees and pensioners stand to lose mightily if the city's bankruptcy filing under Chapter 9 were to proceed. They argue that Detroit is not insolvent, despite its claim that it owes creditors billions of dollars, and they take issue with the debt assessment of Kevyn Orr, the emergency financial manager for the city appointed in May by Michigan Gov. Rick Snyder (R).

Mr. Orr says Detroit is saddled with at least $18 billion in debt, including $3.5 billion in underfunded pension liabilities and $5.7 billion in other retiree benefits. If the bankruptcy proceeds, it will be the largest of any city in US history.

The unions suggest that Orr is inflating the debt levels to support the political agenda of Governor Snyder, and they also worry that a federal bankruptcy court will void a statute in the state constitution that protects pensions from bankruptcy restructuring.

“The proposal is part of a deliberate strategy mapped out by lawyers now on the city’s legal team in which Chapter 9 is used as ‘leverage’ – a blunt instrument – to force [city] retirees and pension-vested workers into negotiating away their benefits, despite the protection afforded those benefits by the Michigan constitution, which dictates that such benefits should not be at risk in this process at all,” Babette Ceccotti, attorney for the United Auto Workers (UAW), wrote in a court filing.

Many bankruptcy experts say the filing of Monday’s objections is more or less perfunctory and that US Bankruptcy Judge Steven Rhodes, who is presiding over the case, will not likely be swayed by arguments that Detroit's bankruptcy filing would be unconstitutional. They also say that federal law on bankruptcies will trump state constitutional requirements.

“I don’t think that, at the end of the day, it’ll be persuasive,” says Randye Soref, a bankruptcy attorney in Los Angeles, who believes the challengers are merely doing due diligence to have their objections heard.

“You have to raise objections. If you don’t do that, then it just proceeds. So it’s no harm, no foul to the creditor or union to raise these objections. Because if it’s successful, it works; if not, they’re no worse off,” Ms. Soref says.

What the challengers are likely to accomplish is to help run down the clock on Orr. He has said he wants his office to be cleared to proceed with Detroit's financial restructuring by November. That would give him until Sept. 25, 2014, to implement his plan to put Detroit on more solid financial footing. Under state law, Orr is allowed 18 months on the job; after his term expires, the City Council can vote, through a public referendum, to remove him. If it succeeds, Governor Snyder can appoint a new emergency manager, because the declared financial emergency would still exist.

“There is nothing prohibiting Mr. Orr from serving longer than 18 months, but he would need a new contract,” says Bill Nowling, an Orr spokesman.

But the hearings to address the objectors' challenges “will use up time and resources [that Orr] will want to focus on other things” related to the restructuring, says Soref. “If I’m a creditor or a person who doesn’t want the bankruptcy, I’ll do whatever I can to muck that up. The judge’s biggest role is to keep this on track and moving,” she adds.

Judge Rhodes scheduled an Oct. 23 trial date to determine Detroit's eligibility for bankruptcy. The timing is unusually swift compared with previous high-profile municipal bankruptcies, says Michael Sweet, a bankruptcy attorney in San Francisco. Stockton, Calif., for example, had to wait nine months after it filed Chapter 9 to be designated bankrupt under law, which establishes a process for wiping the slate clean and settling debts (usually for cents on every dollar owed).

“The judge set a very aggressive calendar, but he clearly is intent on moving the process along quickly,” Mr. Sweet says.

The main potential delay could stem from creditors' challenges to Orr’s numbers that show the city to be insolvent. For example, Orr calculates the underfunded pension liabilities are $3.5 billion. But the Police and Fire Retirement System and the General Retirement System both say they are unfunded by only $640 million. The pension systems say the city is not accounting for assets, none of which they specified.

“If people want to get into nuts and bolts of city’s finances, they’re going to want to see documents, and that could really cause some delay,” Sweet says.

Mr. Nowling would not comment on what Orr would do if the court were to find that Detroit is not eligible for bankruptcy. Orr’s restructuring plan “represents the best plan possible” for the city, he says, and “it is the plan from which the city will make its case to creditors and stakeholders, whether in bankruptcy or, if necessary, out of bankruptcy.”

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