Detroit Bankruptcy Judge to Rule Today in Swaps Saga

by | April 11, 2014

By Nathan Bomey

For the third time, the fate of a settlement between Detroit and two global banks over a disastrous financial bet engineered by Mayor Kwame Kilpatrick's administration rests in the hands of a bankruptcy judge who has questioned the legality of the original transaction.

Judge Steven Rhodes will deliver a verbal ruling at 10 a.m. today on whether Detroit can pay a new $85-million settlement to UBS and Bank of America Merill Lynch to wipe out a pension debt interest-rate deal that helped wreck the city's budget.

After Rhodes dismissed two settlements of $230 million and then $165 million as too generous, the city nearly sued the banks before reaching a new deal.

At this point, it's a full-scale swaps saga.

"I believe when the last swaps settlement was rejected, there was a collective gasp in the courtroom," said Melissa Jacoby, a University of North Carolina law professor who has been closely tracking Detroit's bankruptcy and listening to court audio files.

If Rhodes approves the deal, the banks have agreed to vote in favor of the city's bankruptcy restructuring plan, potentially giving the city an avenue to force other creditors to accept the deal. For that reason, it's more than just a hearing about clearing out a debt, it could be the linchpin for Detroit moving out of bankruptcy by the fall.

The interest rate deal, called swaps, were brokered by Kilpatrick's administration in 2005 and 2006 to secure a steady interest rate of 6% on a $1.4-billion pension debt loan. The bet soured when U.S. interest rates plummeted, sticking the city with a $50 million-per-year bill.

In 2009, Detroit pledged its casino tax revenue as collateral on the swaps, jeopardizing the city's most dependable source of cash.

Rhodes has questioned the legality of the original swaps transaction and the collateral pledge. The collateral pledge might have been bogus because the Michigan Gaming Act limits the way casino taxes can be used.

In an April 3 hearing, Rhodes expressed reservations about approving the swaps settlement if it means he must declare the casino collateral as legitimate.

"It was notable that he was concerned about the ability of the court to sign off on a settlement premised on a lien that very well might be invalid, so I do expect some close attention to that issue," Jacoby said.

Detroit emergency manager Kevyn Orr testified that the city was close to filing a lawsuit against the banks, but eventually reached a deal he considered acceptable to avoid a risky and costly legal battle.

Pepper Hamilton attorney Robert Hertzberg, who is representing the city, argued that the settlement is "pretty straightforward" and can be approved despite Rhodes' questioning of the swaps' legality.

But several major creditors -- including the city's retiree committee, several European banks and bond insurers Syncora and Financial Guaranty Insurance -- have objected. Carole Neville, an attorney for the Detroit retiree committee, said Rhodes cannot allow the settlement because the casino revenue pledge was illegal.

"You can't put the blinders on," Neville told the judge.

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