The lawsuit contends the city and its retirement systems violated
Michigan law when they set up "sham" service corporations and
funding trusts to facilitate the debt sales in 2005 and 2006. All
other contracts or obligations connected to the debt are also void,
the lawsuit claims.
Detroit in its lawsuit said the pension debt was "nothing more" than
a borrowing by the city, and it violated borrowing limits imposed on
Detroit by the state of Michigan.
In the suit, Detroit asked bankruptcy judge Steven Rhodes to issue a
judgment declaring the city is not obligated to continue making
payments on the so-called pension certificates of participation
(COPs). The COPs were issued during the term of former Mayor Kwame
Kilpatrick, now in prison on federal corruption charges.
"This deal was bad for the city from its onset despite reassurances
it would adequately resolve the city's pension issues," Kevyn Orr,
Detroit's state-appointed emergency manager, said in a statement.
"We have tried without success, to negotiate a resolution to this
dispute and to allow the city and its taxpayers to move forward and
unwind these illegal transactions."
A ruling in the city's favor could invalidate the interest-rate swap
contracts Detroit reached with investment banks UBS AG and Merrill
Lynch Capital Services, a unit of Bank of America Corp. The swaps
were meant to hedge interest-rate risk arising on variable-rate
COPs, and Detroit in the lawsuit claims any contract arising from
the COPs would be invalid from the start since "all other
obligations incurred by the city in connection with the COPs
transactions are unenforceable and void."
Bill Nowling, Orr's spokesman, said Detroit still is negotiating
with Merrill Lynch and UBS to end the city's swap agreements. The
swap deals, valued at $400 million in 2011, soured as interest rates
dropped along with Detroit's credit ratings. The money owed to the
banks was a key element that drove Detroit to file for municipal
bankruptcy in July.
Earlier this month, Rhodes rejected a deal the city reached with the
firms to end the swaps at a 43 percent discount of $165 million plus
up to $4.2 million in costs.
Rhodes in his ruling said Detroit could succeed with legal
challenges to the validity of the swaps, noting that the city
probably did not have a right under Michigan law to pledge casino
tax revenue as collateral to secure the swaps.
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Orr has been trying to free the up to $180 million in annual casino
revenue so that it could be used to help revitalize the city.
UBS and Bank of America declined to comment.
Steve Spencer, financial adviser to Financial Guaranty Insurance Co,
one of the bond insurers, said the COPs issue was a strategic and
lower-cost way for the city to pay down its unfunded pension
liability in 2005.
"It's inaccurate and irresponsible to group the COPs with some of
the 'bad' deals the city previously entered into under the past
administration," he added.
Bruce Babiarz, spokesman for Detroit's Police and Fire Retirement
System, said the pension funds support the city's legal assault on
the COPs deals. "Let's be clear, this lawsuit is not against the
retirement systems or pension funds, but service companies and
trusts that were created by the city to complete the COPs
transactions," he said in a statement.
The city names "service corporations" associated with its general
retirement system as well as its police and fire retirement systems
among defendants in the suit.
Detroit defaulted on a $39.7 million June payment on the pension
COPs after Orr labeled that debt as unsecured, along with some of
the city's general obligation bonds. Bond insurance provided
payments on some of the pension debt.
A proposed debt adjustment plan Orr sent to creditors this week
cited the interest rate swaps as a disputed claim that is not part
of the settlement.
(Reporting by Karen Pierog in Chicago; editing by Chris Reese and
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