Detroit bankruptcy: Pensioners clear plan, creditors erect new hurdle

Just when it looked as if Detroit would have clear sailing to end the largest municipal bankruptcy in US history, a couple of storm clouds popped up on the horizon – in the form of two major bond insurers that don't like the repayment terms Detroit is offering them.

The duo – Financial Guaranty Insurance Co. (FGIC) and Syncora – said Tuesday they plan to fight the city in federal court, on grounds Detroit is giving a much better deal to city pensioners and is unfairly discriminating against bondholders from whom the city has borrowed heavily. Their complaint comes a day after two pension groups, made up of retired police, firefighters, and other public workers, voted to accept slightly reduced pensions under the the city's plan to restructure its crippling debt.

“We understand why the retirees and unions voted in favor of the city’s plan – if we were offered a similar deal we too would approve the plan,” FGIC said in a statement. “Unfortunately, the city’s current offer to FGIC … is completely inferior, and until the city treats us fairly, we are compelled to fight for the fair and equitable treatment that is our right under the bankruptcy code.”

The two insurers say Detroit is legally bound to a $1.4 billion debt deal established in 2005. Both this week vetoed a plan to offer them between 0 and 10 cents on the dollar owed. Detroit Emergency Manager Kevyn Orr has argued that the debt deal – brokered by former Mayor Kwame Kilpatrick, now in federal prison on a corruption conviction – is illegal.

Mr. Orr is set to bring the debt restructuring plan before US Bankruptcy Judge Steven Rhodes starting Aug. 14. It's possible that proceedings will move forward even without bondholders in full agreement, says John Pottow, a University of Michigan bankruptcy law professor.

“I don’t think [the creditors are] going to get to an agreement before trial because they’ll be litigating all these issues. Everyone knows that, so there’s no mystery what they’re going to say or do,” Professor Pottow says.

If there's no settlement that eliminates the need a trial, Judge Rhodes has the power to force cuts to creditors, or to determine that the city and its creditors need to reach a new deal.

Orr says he is encouraged that the pension groups are on board with his plan. “The voting shows strong support for the city’s plan to adjust its debts and for the investment necessary to provide essential services and put Detroit on secure financial footing,” he said in a statement Monday.

Pottow agrees that the yes vote from the pension groups is “a big relief for the city.” About 82 percent of retired and active police and firefighters approved Orr's plan, as did about 73 percent of general public workers. Police and firefighters will see no cut to their pensions except for a partial reduction in their annual cost-of-living increase; general retirees will see their monthly pension benefits cut 4.5 percent and an end to their cost-of-living increases. Had they not accepted the offer, their pension benefits could have been cut by at least 27 percent, Orr said.

Cuts to city retirees were not as deep as expected because of a “grand bargain” forged in May between labor unions and the city. If Rhodes approves the grand bargain next month, Detroit's pension liability will shrink by $816 million over 20 years compared with its pre-bankruptcy obligation.

Moreover, labor unions agreed to the plan that would spin off the city’s art collection at the Detroit Institute of Art (DIA) into an independent trust that would be required to keep the artworks in the city. This would happen by combining a $350 million cash injection from the state of Michigan, $366 million currently pledged by 12 philanthropic foundations, plus $100 raised by the DIA itself. The bondholders, by contrast, are pushing for sale of the collection.

While pension groups digged in their heels, they were the most likely to accept Orr’s terms because they are more dependent on Detroit’s future comeback, says Pottow.

“It was a pretty well-ventilated issue and both sides were both pretty aggressive,” he says. “But [pensioners] live around here and, while they want the best for themselves, they also want the streetlights on and recognize the city has to move forward. Bondholders are not as bound by that.”

It is “too early to say” if the concessions Detroit's pensioners made will be sign of things to come in other financially strapped US cities, Pottow says. However, one issue in the Detroit bankruptcy remains clear: Pension rights that are enshrined in state constitutions are now vulnerable to change when municipalities go belly-up.

“Even states with strong constitutional protections for workers can still yield concessions in Chapter 9 [bankruptcy protection],” he says. “That will give some municipalities in states with similar laws some encouragement.”