Oct. 24 (Bloomberg) -- Detroit faced a “payless payday” before it filed its $18 billion bankruptcy, a financial analyst told the judge conducting a trial to determine whether the city should be stripped of court protection from creditors.
To avoid running out of money for basic services, the city moved cash around, canceled payments to its pension funds and defaulted on debt in the months before it filed for bankruptcy, Gaurav Malhotra, a partner at Ernst & Young LLP, testified yesterday in Detroit.
These actions were designed “to ensure that the city did not have a payless payday,” Malhotra told U.S. Bankruptcy Judge Steven Rhodes. Without a change, the city would build up a $3.9 billion deficit over 10 years, mainly because of the cost of providing pension and health-care benefits to retirees, he said.
Malhotra was the first of five witnesses the city said it will present at the trial. Lawyers for retired and current city workers have attacked the decision by a state-appointed emergency manager to put Detroit into bankruptcy, where creditors can’t try to seize assets or file suits that disrupt reorganization efforts.
In opening statements yesterday, lawyers for the retirees and city workers said Detroit hasn’t met the standard set out in Chapter 9 of the U.S. Bankruptcy Code to remain under court protection.
The law says the city must show that it’s insolvent, that it’s entitled under state law to file for bankruptcy, that it tried to negotiate with creditors or was unable to do so, and that it intends to file a plan to adjust its debts.
The emergency manager, Kevyn Orr, was never serious about trying to fix the city’s finances outside of bankruptcy, said Jennifer K. Green, an attorney for a city pension system fighting the Chapter 9 case.
Last year, state officials conspired with Jones Day, the law firm that Orr hired to file the bankruptcy, to create a new emergency manager law and use it to file for bankruptcy, giving Detroit leverage over unions and retirees, she said.
“It really was a foregone conclusion,” Green said.
Detroit has a “mountain of evidence” showing it’s entitled to federal bankruptcy protection, Bruce Bennett of Jones Day, a lawyer for the city, said at the beginning of the trial, which is scheduled to continue through Oct. 29. Detroit is “failing to provide basic services,” he said.
Orr told unions that the talks the city was holding with them were not negotiations, said Sharon Levine of Lowenstein Sandler PC, who is representing one of Detroit’s biggest unions, the American Federation of State, County and Municipal Employees.
Bennett said Orr was trying to avoid having the talks come into conflict with labor laws. For bankruptcy purposes, the city’s meetings with creditors were a good-faith effort to negotiate with creditors, Bennett said.
That distinction was lost on the audience of union officials, who believed it meant the city was not open to their opinions, Levine said. Detroit was simply presenting its plan, not trying to solicit a counter-proposal, she said.
“It was basically a classroom-type instruction, period,” Levine said.
The questioning of Malhotra in the confines of the federal courtroom yesterday afternoon contrasted with the noisy atmosphere outside the courthouse earlier in the day, where more than 100 protesters marched and carried signs.
The city should keep its “hands off pensions and restore health care,” said Detroit resident Walter Knall, 70, a retired analytical chemist for the city. Knall was part of a group calling itself the Moratorium NOW! coalition. All were wearing white T-shirts over their cold-weather garb with the words “Hands Off My Pension.”
In July, the city filed the biggest U.S. municipal bankruptcy, listing about $18 billion in debt and saying it didn’t have the money to pay its bondholders, retirees and employees everything it owes them while still providing basic services to citizens.
Unions, retirees and the city’s pension system claim Michigan’s constitution prevents Detroit from cutting pensions.
Governor Rick Snyder, who testified under oath in a videotaped deposition this month, is prepared to testify in court Oct. 28, said Matthew Schneider, a lawyer with the state. Snyder, a Republican, is being called as a witness by the United Auto Workers, which represents some city workers and is trying to show that the bankruptcy filing wasn’t in good faith.
Bennett said yesterday that the city did negotiate in good faith, answering questions it was asked by creditors in talks in June and July and trying unsuccessfully to persuade unions to present a counter-proposal.
Holding talks with all bondholders was impractical because of their number, and cutting bond debt outside of bankruptcy would have required the consent of all of them, he said.
The case is City of Detroit, 13-bk-53846, U.S. Bankruptcy Court, Eastern District of Michigan (Detroit).
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