Detroit’s three attempts to cancel interest-rate swaps for less than $100 million show how tough a fight it may face in July to reduce $18 billion in debt without cooperation from thousands of creditors in its record municipal bankruptcy.
“It’s going to be an even bigger battle,” attorney George South, a bankruptcy specialist, said. “Ultimately, that’s going to be the end of the day for these creditors. They are going to be fighting even harder.”
U.S. Bankruptcy Judge Steven Rhodes is scheduled to tell the city today whether he will approve its proposed settlement with UBS AG and Bank of America Corp. to end interest-rate swaps that have cost taxpayers $200 million since 2009. The deal calls for the city to pay the banks $85 million in installments.
Detroit has been trying for months to win court approval of a deal to end the swaps. An agreement to pay $230 million was put together in July, just days before the city’s bankruptcy was filed. Even after the payment was pared to $165 million, Rhodes rejected it as too costly.
“The judge has been very cautious in his decision-making,” Larry Dubin, a professor at the University of Detroit Mercy School of Law. “And he has shown a lot of independence.”
Detroit has said it can’t provide necessary public services and still meet its financial obligations in full. Kevyn Orr, the emergency financial manager shepherding Michigan’s largest city through bankruptcy, has said time is running for creditors to agree on proposed cuts before the court imposes a plan on them.
The swaps are just one of the many issues Orr is trying to resolve before September, when the city council can remove him from his post.
Unions and retiree groups have objected to Orr’s proposal to reduce pensions for public workers. The city has also said it plans to pay some bondholders 15 cents on the dollar. All told, the city has about 170,000 creditors, according to Orr.
“The emergency manager is confident that the city can emerge from bankruptcy by mid-October,” Bill Nowling, a spokesman for Orr, said in an e-mail. “The issues are difficult, but they are not impossible to resolve.”
Court-appointed mediators on April 9 announced an agreement with one group of bond holders to pay them about 74 percent of their $388 million claim. Some of that savings will go to retirees.
The legal standard for approving the swaps settlement is typically easier to meet than the standard for winning confirmation of an entire debt-adjustment plan over creditor objections, said South, who contributed to a guidebook on municipal bankruptcy law for the American Bankruptcy Institute.
The swaps, tied to pension obligation bonds issued in 2005 and 2006, were designed to protect against rising interest rates by requiring the banks to pay the city if rates rose above a certain level. Instead, rates fell, forcing the city to pay about $4 million a month.
Opponents of the $85 million accord include Syncora Guarantee Inc. The bond insurer says the deal violates agreements that give it a right to have a say in the settlement. A retired city worker and former union official has said the city is better off suing to cancel the swaps.
Without a deal, the city says it may be forced to pay $288 million to end them.
Under U.S. bankruptcy law, a judge typically applies the so-called business judgment rule in deciding whether to approve a settlement. Under that standard, the judge normally assumes that a manager “acted on an informed basis, in good faith,” according to past rulings by Delaware’s Supreme Court, where the rule has been defined.
To win approval of a bankruptcy-exit plan, a judge must find that the proposal is feasible and takes into account how creditors are being treated, which can be a much more difficult case to make, said South.
The city also must justify paying different rates of recovery to creditors who appear similar, South said.
“Detroit is going to be hard-pressed to prove that case,” South said.
The case is In re City of Detroit, 13-bk-53846, U.S. Bankruptcy Court, Eastern District of Michigan (Detroit).