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Detroit hits back against opposition to its bankruptcy

A sculptor of a giant fist in honor of American boxer and heavy weight champion Joe Louis sits at the intersection of Woodward and Jefferson
A sculptor of a giant fist in honor of American boxer and heavy weight champion Joe Louis sits at the intersection of Woodward and Jefferson

By Tom Hals

(Reuters) - Attorneys for Detroit made their case for the city's request for bankruptcy in court papers on Friday, knocking down individual objections to the process and saying filing for protection would not necessarily cut pensions.

Unlike corporations or individuals, the city must prove it is eligible for bankruptcy protection from creditors, and oral arguments are set to begin later this month in the U.S. Bankruptcy Court in Detroit.

In the court papers filed on Friday, the city refuted objections one-by-one, taking on the unions, pension funds and other creditors who are expected to oppose the Detroit Bankruptcy in a series of hearings starting later this month.

The Detroit argument appears constructed to meet each of the qualifications for bankruptcy under Chapter 9 of the federal bankruptcy code.

To proceed into bankruptcy, Detroit must overcome 109 objections filed in court, mostly from labor unions, that range from accusations that the city failed to negotiate in good faith to claims that Detroit's state-appointed emergency manager, Kevyn Orr, overstepped his legal authority by filing for bankruptcy.

Detroit's filing is focused on persuading federal bankruptcy judge Steven Rhodes that the city is insolvent, had the legal authority to file, and intends to implement a debt-reduction plan. Detroit also must show that it either negotiated in good faith with its creditors or that the number of creditors is so large that negotiations were not feasible.

"Confronting a state-declared 'financial emergency' that includes approximately $18 billion in debt, over 100,000 creditors, over 100 discrete bond issuances and related loans (as well as multiple insurers of such bonds) and nearly 50 union bargaining units representing the City's employees - all of which rendered any out-of-court solution impracticable - the City commenced this Chapter 9 case on July 18, 2013," the city argues in an opening passage of its filing.

The city takes on the basic requirement of financial insolvency head on. The petition states that Detroit was "cash insolvent," "budget insolvent" and "service delivery insolvent". Without restructuring, Detroit states, it will experience negative cash flows since it says it cannot materially increase its revenues or reduce its expenses.

Claims that Detroit was not insolvent "offer little more than innuendo and suspicion," according to the filing.

Negotiations were not feasible, Detroit added, because "the numerosity and fragmented nature of the City's creditors made negotiations with the creditor body impracticable."

No bond holders filed objections to Detroit's Chapter 9 petition, and the city notes that fact in arguing that no bondholders claimed negotiations could be feasible.

Unions that object to the filing have claimed Detroit's bankruptcy filing, in federal court, violates the U.S. Constitution's protection of states' rights. Detroit countered with a direct response in its brief: "Because States have a 'legitimate choice' whether to allow their municipalities to invoke Chapter 9, Chapter 9 is not an unconstitutional infringement of State sovereignty."

Objectors to Detroit's bankruptcy also claim Detroit's filing violates a prohibition in Michigan's state constitution against any "diminishment or impairment" of public-employee pensions, but the city argues that no impairment has taken place simply as a result of the Chapter 9 filing. "After the Governor authorized the City to file this case, and even after the City filed the Petition, the City's pension obligations have remained unimpaired," the city argues.

The city's attorneys also said authorizing Chapter 9 would not "diminish or impair any pension. These are simply steps that begin the bankruptcy process."

The city said many of its 48 unions refused to negotiate on behalf of their retirees, leaving it unable to bind 20,000 retirees with a single agreement.

"The majority of the unions either expressly indicated unwillingness or legal inability to represent retirees or neither agreed nor refused to represent retirees," said the 135-page document. Chapter 9 would help to solve that problem by allowing formation of a committee of retirees to negotiate on behalf of retired workers.

Chapter 9 bankruptcy, if granted, would give Detroit broad latitude to deal with creditors while seeking to reorganize its finances and reinvigorate one of the country's most blighted urban areas. The city's population has plummeted to less than 700,000 from nearly 2 million over the past half century. City services have broken down, thousands of homes have been abandoned and crime has soared.

Orr has said he wants the city to be out of court by the time his term is scheduled to end in the fall of 2014.

Unions sued Governor Rick Snyder before the bankruptcy was filed in hopes a state court judge would find that by authorizing a Chapter 9, the governor was violating the state constitution which protects public pensions. The U.S. Bankruptcy Court stayed those lawsuits.

In papers filed Friday, the state of Michigan asked the U.S. Bankruptcy Court to reject those arguments or set them aside for when the court will consider Detroit's plan to cut its debt.

There have been fewer than 700 municipal bankruptcies over the past 80 years, and many cities have been found to be ineligible. A bankruptcy judge ruled in 2011 that Harrisburg, the capital of Pennsylvania, lacked the legal authority for its bankruptcy petition.

However, bankruptcy experts generally expect Judge Rhodes will find Detroit eligible for bankruptcy. Even then, city still is expected to face challenges to its plans, particularly involving disputes over the legality of cutting pensions and disputes over the treatment of certain bonds as unsecured.

Rhodes has set five hours of oral arguments for September 18 on purely legal questions, such as the constitutionality of Chapter 9 and whether his court has jurisdiction.

Rhodes will oversee a trial beginning October 23 on factual disputes over the city's solvency and whether it negotiated in good faith. On Tuesday, Rhodes will hear arguments about whether Gov. Snyder must testify.

(Additional reporting by Mica Rosenberg; Editing by Douglas Royalty and Ken Wills)

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