Detroit — U.S. Bankruptcy Judge Steven Rhodes said Wednesday he’ll issue a crucial decision in two to three weeks about whether general obligation bondholders are secured creditors in Detroit’s bankruptcy case.
Rhodes announced his plans at the end of a daylong hearing over legal action bond insurers have taken against Detroit to try to force the city to resume paying principal and interest on bonds with voter-approved taxes.
The judge urged the city and bond insurance companies to try to negotiate a resolution to the dispute as the city is expected to prescribe deep cuts to bondholders in its plan of adjustment it expects to file this week.
“The decision here is most likely all or nothing,” Rhodes said from the bench. “One side is going to win and the other side is going to lose. ... For you to maintain control of this, you’ve got two or three weeks to settle it.”
Ambac Assurance Corp., Assured Guaranty Municipal Corp. and National Public Finance Guarantee Corp. want Rhodes to order the city to segregate special property taxes Detroit voters approved for economic development, cultural and recreation projects and public safety facilities and resume paying bondholders the full amount owed.
“These monies were raised solely for repaying the bonds and no other purpose,” Guy Neal, attorney for National Public Finance Guarantee, said in court Wednesday.
But city attorney Bruce Bennett countered that the federal bankruptcy code allows Detroit to sidestep state laws requiring the city to pay bondholders with designated funds while the city reorganizes its finances in Chapter 9.
Bennett said the bondholders and their insurers have no more right to be paid for their debts than pensioners and other unsecured creditors.
“There is no lien, there is no property interest, these creditors are like all others,” Bennett told U.S. Bankruptcy Judge Steven Rhodes.
Bennett argued that state laws about general obligation bonds being backed by unlimited taxes only provide “secured feelings to creditors that are concerned about things that could change inside a municipality.
Detroit’s legal team has argued that general obligation bondholders owed $369 million do not have a legal lien against specific tax revenues like other bondholders who get repaid through state aid distributions to the city or water and sewer bondholders, whose investment is secured by revenue from ratepayers.
In October, the city skipped $9.3 million in interest payments due to the investors of tax unlimited general obligation bonds, which have traditionally been viewed as safe investments because of state laws requiring municipalities pay them with restricted tax revenue.
Detroit’s default on interest payments cost the three insurers a combined $8.3 million in payouts to bondholders, according to court records. Some of the bonds were used in recent years to cover the city’s deficit spending, Bennett said.
The insurance companies argue bondholders have a property right to the tax dollars that supersedes any contractual obligation that can be terminated in bankruptcy.
A team of six attorneys representing the three insurers argued in court Wednesday afternoon bondholders have a statutory lien on tax revenues designated by voters for limited uses.
“These are not covenants and promises. These are state statutory requirements and they weren’t just put in place in on a whim,” said Caroline Turner English, attorney for Ambac Assurance.
Rhodes’ decision on the issue could affect Detroit’s ability to redirect taxes previously approved for capital improvement projects to improving city services and paying its bankruptcy bills for attorneys and consultants.
The hearing was held as the city’s legal team prepares to file a debt-cutting plan of adjustment this week that is expected to prescribe deep cuts for bondholders.
During the morning hearing, Rhodes asked Bennett what happens to the special taxes voters have approved to pay for the bonds if he were to determine the bondholders are unsecured creditors.
“That’s between the taxpayers and the city,” Bennett replied.
Mayor Mike Duggan may have to decide whether to continue levying any taxes above the amount the city agrees to pay the bondholders post-bankruptcy through its debt-cutting plan of adjustment, Bennett said.
Presuming the city exists bankruptcy, Bennett said taxpayers could sue the city in state court to get the extra property taxes removed from their bills. The issue “will be the subject of a risk factor” detailed in a disclosure statement to creditors that will be attached to the plan of adjustment, Bennett said.