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The Deal: Detroit Eligible to Proceed Through Chapter 9

NEW YORK (TheStreet) The city of Detroit, Michigan, can stay in bankruptcy.

Judge Steven Rhodes of the U.S. Bankruptcy Court for the Eastern District of Michigan in Detroit on Tuesday, Dec. 3, verbally ruled the city was eligible for Chapter 9 protection, sources said. An order on his decision had not been filed as of Tuesday afternoon.

Meanwhile, Michigan Council 25 of the American Federation of State, County and Municipal Employees moments later filed a notice that it would appeal the decision. The General Retirement System of the City of Detroit and the Police and Fire Retirement System of the City of Detroit also said they would appeal Rhodes' ruling.

"We're disappointed; we think it's devastating for the retirees," AFSCME counsel Sharon Levine said of the judge's decision. "Unlike in a private company, there is no Pension Benefit Guaranty to protect the retirees. So our retirees, who on average earn $19,000 per year and who run the risk of losing a substantial amount of their pensions, have no safety net."

Levine noted that if pension benefits are slashed in the bankruptcy of a private company, the PBGC would cover up to $57,000 per year in pension benefits, which would not apply in the Detroit case.

"[Here], if the pension disappears, it just disappears," she said.

Levine said AFSCME would participate in a court-ordered mediation with the city and hopes to be involved in devising a plan of adjustment.

In their Tuesday statement, GRS and PFRS maintained Detroit cannot cut accrued pensions because of state law.

"The state constitution represents the people's will. That will cannot be ignored or subverted because it's financially convenient to do so or because slashing pensions allows for a city to escape from its constitutionally protected pension benefit obligations," the pension funds said.

The groups asserted a clause in the constitution forced Rhodes to determine that either the state law authorizing the Chapter 9 petition was unconstitutional, and thus the case should be dismissed, or that Detroit cannot alter the pensions.

The pension funds sued the city on July 17 in the Michigan Circuit Court for the County of Ingham. arguing a bankruptcy petition would violate Michigan's constitution if it aimed to impair pension payments. The Motor City commenced the Chapter 9 case a day later.

In a Tuesday statement, Detroit emergency manager Kevyn D. Orr said: "We are pleased with Judge Rhodes' decision today, and we will continue to press ahead with the ongoing revitalization of Detroit. We look forward to working with all our creditors, pension funds, unions and lenders to achieve a consensual agreement on a restructuring plan that balances their financial recoveries with the very real needs of the 700,000 citizens of Detroit."

Orr said in the statement the city is "making good progress," adding that Detroit has transferred its electric operations and customers to DTE Energy and begun a program to improve city lighting. Detroit also intends to privatize trash collection, which Orr said would save the city $6 million annually.

"The city is also committed to the federal mediation already under way aimed at resolving disputes with its creditors, and we fully support U.S. District Court Chief Judge Gerald Rosen's efforts to find additive solutions, particularly from the philanthropic community, to the city's financial issues," Orr said in the statement. "Time is of the essence, and we will continue to move forward as quickly and efficiently as possible. We plan to submit a plan of adjustment in the coming weeks, file a disclosure statement early next year and work to exit Chapter 9 protection by the end of September. We hope all parties will work together to help us develop a realistic restructuring plan that improves the financial condition of Detroit and the lives of its 700,000 citizens."

Rhodes appointed Rosen as mediator on Aug. 13.

"We look forward to engaging in a constructive dialogue with the city, as well as other creditors, as we move into the next stage of this process, said a spokesman for FGIC, one of Detroit's bond insurers. "We continue to believe that a responsible, transparent and collaborative approach remains the best path towards a fair and timely solution which would offer the best possible outcome for all parties."

In a Nov. 6 supplemental brief, the city had argued it should be eligible for relief under Chapter 9. Lawyers for the Motor City, Michigan and objecting parties gave closing arguments two days later in an eligibility trial that began Oct. 23.

The city contended objections from AFSCME and the official committee of retirees suggested Public Act 436 violated the Michigan Constitution. Detroit said questions about the legislation should be addressed through a referendum, not in a court.

The Michigan legislature last year passed Public Act 436, which governs the powers of emergency managers such as Kevyn D. Orr for Detroit.

"The Michigan Supreme Court has made clear that, if the state's citizens believe its legislators to have been improperly motivated, their recourse is not the judiciary, but the constitutional powers of referendum and initiative and the ballot box," lawyers for the city wrote in court papers.

Counsel for the city also asserted that through consenting to the filing of a municipality's bankruptcy petition, a state that is constitutionally forbidden from impairing improvident contracts, such as pensions, nevertheless may allow the municipality to obtain relief from the entity that is empowered to impair those contracts: the federal government.

Detroit now is set to return to court on Dec. 17 to seek approval of a proposed $350 million debtor-in-possession financing from Barclays Capital.

Though Detroit's city council on Oct. 21 unanimously voted to reject the financing, because the group did not propose alternate financing within a 7-day deadline, the city was to seek approval of the Barclays DIP from a local emergency financial assistance loan board.

In an Oct. 11 statement, Orr said the financing would allow the city to obtain a more than $60 million discount on the settlement of certain pension debt interest rate swap obligations, save millions of dollars of annual debt service, fund Detroit's restructuring and improve the future recoveries of its creditors.

The DIP also would put money in the city's nearly empty coffers for the delivery of municipal services to its residents, including public safety initiatives, blight removal and technology infrastructure improvements.

The city would use about $230 million of the DIP to terminate certain pension debt interest rate swap obligations. Detroit purchased the swaps in 2005 to ensure 6% interest rates on about $800 million in variable-rate pension debt. The swaps are held by UBS and Bank of America Merrill Lynch.

The remainder of the DIP, about $120 million, would go into municipal services, according to the Oct. 11 statement.

The DIP, comprising two series of secured bonds, would accrue interest at Libor plus 250 basis points, with a 1% Libor floor. In the event of a default, including the failure by the city to redeem the note in full on the maturity date, the initial spread would increase by 200 basis points.

The financing would mature on the earliest of the dismissal of the bankruptcy case, the effective date of a plan of adjustment, the acceleration of the debt or 30 months after issuance.

Financial adviser Miller Buckfire and debtor counsel Jones Day conducted a "highly competitive" bidding process to find the DIP, contacting more than 50 institutions, the statement said. Sixteen financial institutions, including commercial banks, investment banks and hedge funds submitted "high-level financing proposals."

By Sept. 23, talks continued with four prospective lenders. Comprehensive term sheets and commitment letters were due Sept. 30, and the city and its advisers ultimately selected the Barclays financing.

The Motor City filed for Chapter 9 protection on July 18, staying the state court lawsuit of GRS and PFRS.

As of June 30, the city had more than $18 billion in liabilities and an unrestricted general fund deficit of $237 million. The deficit grew about $47.4 million in the year ended June 30.

Bruce Bennett, Heather Lennox and David G. Heiman at Jones Day are debtor counsel. Jonathan S. Green and Stephen S. LaPlante of Miller, Canfield, Paddock & Stone plc are local counsel.

Ernst & Young and Conway MacKenzie are advising the city on its restructuring along with Miller Buckfire.

Orr was a Jones Day partner before stepping down on his appointment as emergency manager.

He notably was debtor counsel for Chrysler.

Ann D. Fillingham, James P. Kiefer and Courtney F. Kissel of Dykema Gossett represent Michigan on the DIP financing.

George E. Zobitz of Cravath, Swaine & Moore is counsel to Barclays.

--Written by Kelsey Butler in New York

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