December 3, 2013 5:44 pm

US judge clears way for Detroit debt restructuring talks

A federal judge has declared the US city of Detroit eligible for Chapter 9 protection, clearing the way for debt repayment talks to move forward in the country’s biggest municipal bankruptcy.

Judge Steven Rhodes of the US Bankruptcy Court on Tuesday said the city had proven its eligibility by fulfilling the major requirements of a municipal bankruptcy, following a nine-day trial last month.

The ruling cleared a hurdle for the troubled city as it begins to rebuild severely diminished municipal services. It paves the way for the emergency city manager to move forward with plans to restructure $18.5bn worth of debts, which will see impairments to both employee pensions and creditor obligations.

Detroit’s bankruptcy and debt talks are seen as a test for the $4tn US muni bond market, where states and municipalities fund themselves. They could set the stage for other cities to declare bankruptcy as they struggle to resolve fiscal problems.

The bankruptcy has sent shockwaves through munis, which are popular with wealthy individuals and retirees, who benefit from tax exemptions associated with the debt. While overall municipal defaults have been rare, funds investing in the securities have experienced large redemptions this year in the aftermath of Detroit’s bankruptcy filing.

According to the ruling, Detroit proved it was insolvent and had the legal authority to file for bankruptcy. While the city did not negotiate in good faith with creditors, the judge said such talks were impracticable, another key requirement.

“The city’s debt and cash flow insolvency is causing the city’s 700,000 residents to suffer hardship,” Judge Rhodes said. “The residents of the city of Detroit would be severely prejudiced if this case is dismissed.”

Kevyn Orr, the emergency manager appointed by the state to steer the city through bankruptcy, said he expected to file a restructuring plan in the first week of January, and hoped to exit Chapter 9 by the end of September.

“Time is of the essence and we will continue to move forward as quickly and efficiently as possible,” Mr Orr said.

Mr Orr said the city remained committed to continued federal mediation aimed at resolving disputes with creditors, including the level of pension cuts. An adjustment plan will detail how the city will pay its unfunded pension liabilities, unsecured and secured debts and healthcare for retired workers.

FT Video

Selling Detroit

July 2013: Michigan governor Rick Synder and Detroit’s emergency manager Kevyn Orr say they hope the bankruptcy will help to illustrate the investment opportunity for Detroit

As part of Mr Orr’s plan, creditors are expected to take a “haircut” by accepting far less than what they are owed. Retirees are also likely to see pension and healthcare benefits cut sharply under any proposal.

Judge Rhodes must certify a plan once a majority of creditors agree to one.

The American Federation of State, County and Municipal Employees – which had opposed the city’s eligibility – immediately appealed the ruling, and is likely to be joined by others, which could delay negotiations.

Judge Rhodes declined to rule on the total amount of the city’s unfunded pension liabilities, which Mr Orr’s office estimates at $3.5bn. Unions and pension funds say that figure is inflated.

But the judge did rule that the city could impair pension benefits as part of its restructuring, a move that has been argued unconstitutional by unions. Judge Rhodes said the state constitution did not offer pensions special protections, but that the court would not rubber-stamp such cuts.

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