Detroit— The historic trial over whether Detroit is eligible for bankruptcy may shape up to be as much about how Michigan’s largest city ended up in court as its well-documented financial collapse.
During opening arguments Wednesday of an eligibility trial over a case drawing interest nationwide, attorneys for Detroit and its creditors laid out starkly different interpretations of the events that led to the wide-reaching Chapter 9 case and efforts to pare down $18.5 billion in debts and liabilities.
As hundreds protested outside the downtown courthouse over possible pension and benefit cuts, city lawyers laid out what they called a “mountain of evidence” that Detroit is insolvent. They argued that negotiations with thousands of creditors were fruitless before Emergency Manager Kevyn Orr sought bankruptcy relief July 18, one month after his debt-cutting plan failed to gain traction among creditors.
“They were insensitive to the overall problems the city faced,” City Attorney Bruce Bennett said.
“What’s the city supposed to do? Say, ‘Gee, we were just kidding, we found money in the mattress’? That’s not the right response. You can conclude negotiations have failed.”
Attorneys for unions and retirees spent little time debating the city’s finances, but contended Detroit officials didn’t negotiate in good faith, a requirement for bankruptcy eligibility. They contend Gov. Rick Snyder’s administration plotted to take Detroit into bankruptcy in 2012 to slash pensions in violation of Michigan’s Constitution.
“The evidence will show very clearly that the emergency manager understood his (creditor) proposal could not be implemented outside of bankruptcy court,” said Anthony Ullman, an attorney representing a committee of retirees.
“He therefore intended to use Chapter 9 as a vehicle, again in his word, to ‘trump’ the pensions clause.”
The trial is expected to last at least five days and could stretch into November. Much of the first day was consumed by opening arguments and only one witness, city financial consultant Gaurav Malhotra, who said Detroit would rack up a $4 billion deficit over the next 10 years without any reductions to pensions, retiree health care and other legacy costs.
Snyder is expected to take the stand Monday afternoon, a state attorney announced Wednesday.
Among the revelations Wednesday:
■The city’s bankruptcy law firm, Jones Day, began preparing to pitch its debt-restructuring services as far back as December 2011. One of the firm’s partners met with Snyder in June 2012 to lay out options for the city.
Prior to landing the contract, the law firm devoted 1,000 hours to studying Detroit’s operations and related state laws and later developed six memorandums about how to restructure Detroit’s finances, including the use of Chapter 9 bankruptcy and slashing of pensions.
■Jones Day’s pitch documents advised state and city officials that “Chapter 9 could be used as a means to further cut back or compromise ‘accrued financial benefits’ otherwise protected by the Michigan Constitution.”
■In late January, more than six weeks before he was appointed emergency manager, Orr wrote in an email to a Jones Day partner that the new emergency manager law the Legislature passed the month before “is a thin veneer” and “essentially a redo” of the statute voters rejected in a November statewide referendum.
Some creditors have focused their legal strategy on trying to persuade U.S. Bankruptcy Judge Steven Rhodes that the emergency manager law, which was used to authorize the bankruptcy filing, should be found unconstitutional because the Republican-controlled Legislature attached an appropriation making it immune to a referendum.
Rhodes has asked both sides for evidence explaining why the funding was tacked onto the bill.
'It's an awful mess'
During opening arguments, Bennett said the city followed a “playbook” for going into Chapter 9 municipal bankruptcy by laying out the dire realities of Detroit’s finances and then proposing sweeping out-of-court cuts to unsecured creditors.
On June 14, Orr met with creditors and offered them a deal: Take $2 billion for the $11.5 billion in unsecured claims. Each creditor would get a share based on what they were owed. The amount included a disputed $3.5 billion pension shortfall and $5.7 billion in unfunded retiree health insurance.
After the plan was presented, the city found it impractical to negotiate with bondholders who couldn’t be easily identified and retirees whose former labor unions refused to represent them, Bennett said.
“The bottom line is it’s an awful mess,” Bennett said. “There are many, many issues, many, many holders (of city debt).”
Bondholders and insurers are not objecting to Detroit’s eligibility, purportedly saving their legal power for the debt-cutting stage of bankruptcy, assuming Rhodes grants the city relief from its creditors.
City officials and consultants determined the most organized way to negotiate with an estimated 100,000 creditors would be bankruptcy court, Bennett said.
A flurry of lawsuits in early July by retirees and the city’s pension funds added to the hostile environment of negotiating out of court, Bennett said.
“They were frankly insensitive to the overall problems the city faced,” Bennett said of unions and retiree groups.
Objectors: Decision set
Attorneys for the objectors painted a different picture of the events that transpired in the run up to the bankruptcy filing.
As early as July 8, Orr spokesman Bill Nowling had developed a communications plan explaining why the city was filing bankruptcy — 10 days before the actual filing and just two days before the city planned a series of meetings portrayed as good faith negotiations, according to a trial exhibit.
An attorney for the city’s pension funds produced a July 9 email from state Treasurer Andy Dillon to Snyder suggesting the city was still trying to distribute information about Orr’s June 14 plan to pensioners and other creditors.
“The objecting parties submit that Chapter 9 was already a foregone conclusion,” said Jennifer Green, attorney for Detroit’s police and fire and general retirement systems.
Barbara Patek, an attorney for police and firefighter unions, said the negotiations period was designed to create “a record of impracticality (for the city) where they set themselves up for failure.”
Detroit's bankruptcy eligibility trial resumes at 9 a.m. today with creditor attorneys cross examining city financial consultant Gaurav Malhotra, followed by testimony from consultant Charles Moore about the health of the city's pension funds.
The city also plans to call Police Chief James Craig and Emergency Manager Kevyn Orr either today or Friday, depending on how fast the trial proceeds.
Gov. Rick Snyder has agreed to testify Monday afternoon.