Detroit Bond Insurer to Judge: Debt Plan Causes ‘Serious Mayhem’

Detroit’s proposal to exit its record municipal bankruptcy by paying retirees more than bond investors will cause “serious mayhem,” an attorney for the plan’s opponents told a judge.

Marc Kieselstein, an attorney for bond insurer Syncora Guarantee Inc., outlined the opponent’s case against the city’s proposal on the second day of a trial in Detroit federal court. The bond insurer says the plan would illegally pay retired city workers much more on their claims than investors who hold more than $1.4 billion in pension-related debt.

The city’s debt-cutting plan can’t be approved “without doing serious mayhem to the rule of law, popular demand notwithstanding,” Kieselstein told U.S. Bankruptcy Judge Steven Rhodes.

Rhodes has set aside seven weeks to hear arguments and evidence concerning the plan before deciding whether it’s fair and feasible. The case will test an unusual partnership among the city, wealthy donors and Michigan lawmakers, who aim to shore up Detroit’s public pension system. As part of what the the parties call a “grand bargain,” the city has agreed not to use its art collection of masterpieces to pay creditors.

Detroit filed for bankruptcy last year, saying decades of decline left it unable to provide basic services to almost 700,000 residents.

Kieselstein followed Detroit bankruptcy attorney Bruce Bennett, who said the plan should be approved even though it pays more to retirees. If the plan is rejected and the bankruptcy dismissed, unsecured creditors, including the pension-debt holders, would get even less, he said.

Rhodes questioned Kieselstein more closely than Bennett, focusing on how to reconcile two legal standards in bankruptcy law. Normally, winning approval of a settlement like the grand bargain is easier than an entire debt-cutting plan.

The grand bargain should be rejected by Rhodes because it causes “unfair discrimination” between two groups of unsecured creditors — retirees and bond holders, Kieselstein said. Detroit doesn’t have any evidence that justifies the different treatment, he added.

Yesterday, Bennett said that imposing cuts on bondholders, retired city workers and other creditors is the only way to stabilize Detroit’s finances and raise money to revive decaying neighborhoods. He dismissed a claim by Syncora and another bond insurer, Financial Guaranty Insurance Co., that the city could raise more money using its art collection.

The bond insurers may be forced to cover bondholder losses should the city’s proposal be approved. Current and former city employees, as well as investors, will be forced to take less than the $10.4 billion they are owed if Rhodes approves the plan. The plan proposes to cut about $7 billion of the debt.

After creditors opposing the plan conclude their opening statements, the city will call the first of more than 25 witnesses. The city may finish presenting its case by early October, one of its attorneys, Greg Shumaker, told Rhodes.

The case is In re City of Detroit, 13-bk-53846, U.S. Bankruptcy Court, Eastern District of Michigan (Detroit).