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February 1, 2014 2:14 am
Detroit has filed a lawsuit challenging the legality of a “disastrous” $1.44bn pension funding deal that it said “hastened” its insolvency and propelled it into the largest municipal bankruptcy in US history.
The city, now led by a state-appointed emergency manager, has asked the judge to let it stop making payments on the debt transaction “because it was void from the beginning”, it said on Friday.
Detroit owes roughly $1.45bn in principal on what it said were “sham” contracts, among its more than $18bn in debts. The pension funding deal was made in 2005 and 2006.
The move is likely to anger debtholders and bond insurers, already expected to take as little as 10 cents on the dollar in the city’s planned restructuring.
The complaint, filed with the US bankruptcy court in the eastern district of Michigan, which is overseeing the proceedings, alleges that the city violated a state rule by borrowing more than 10 per cent of the assessed value of private property owned in the city.
“City officials turned a blind eye to the requirements of state law,” the complaint alleges.
Facing a massive pension shortfall in 2005, along with 2,000 lay-offs, the city created “shell entities” to circumvent the law – “at the prompting of investment banks that would profit handsomely from the transaction”, according to the complaint.
It notes that the 2005 transaction was named “one of the most innovative financings of the year” by The Bond Buyer magazine, a leading industry publication.
“The debt burden created by [the deal] has put the very, fatal strains upon the city’s finances that the [state law’s] debt limit and . . . review requirements were imposed to prevent,” according to the complaint.
The city later entered into an interest rate swaps deal on the debt which went against Detroit, and cost it $50m a year in payments.
Kevyn Orr, the city’s emergency manager in charge of Detroit’s bankruptcy, said “the deal was bad for the city from the onset despite reassurances it would adequately resolve the city’s pension issues”. Mr Orr said the city had tried to negotiate a resolution to unwind “these illegal transactions” without success.
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