Two of the largest insurers of Detroit’s general obligation (GO) bonds have sued the city in a federal bankruptcy court, claiming a proposal by the city’s emergency manager to forgo payments to bondholders is illegal.

The case is the latest challenge against Detroit in recent weeks as the city’s eligibility for Chapter 9 bankruptcy is still being debated in federal courts. A verdict is expected next week.

Assured Guaranty Municipal Corp and National Public Finance Guarantee Corp allege that the city is “unlawfully diverting voter-approved” taxes meant for “the sole purpose of paying principal and interest” on unlimited tax GOs, according to the joint complaint filed Friday.

On October 1, the city defaulted on $9.3m in interest payments due to investors of tax unlimited GO bonds, forcing the two insurers to pay bondholders, according to the complaint.

If the city is deemed eligible for bankruptcy, Kevyn Orr, Detroit’s state-appointed emergency manager, i s expected to challenge the city’s full faith and credit pledge in order to reduce nearly $370m in outstanding debt for tax-unlimited GO bonds.

Such bonds are generally considered safer because of state laws mandating their payment using restricted funds.

The insurers have asked the judge to order Detroit to stop mixing taxes reserved for paying off debt with the city’s general fund and asked for a hearing on the matter before the end of the year. Another payment of $47.58m in principal and interest comes due on April 1.

“Nothing in Chapter 9 or federal bankruptcy law allows the city to disregard state-law restrictions imposed on the restricted funds and use such funds for a non-authorised purpose,” attorneys wrote in the complaint.

Assured Guaranty insures $146m of GO bonds, with exposure to $2.1bn of Detroit’s $18.5bn in debts. NPFG insures $2.4bn in water, sewer and general use bonds.

“Our efforts to date to resolve this dispute consensually have been rebuffed, and city officials have refused to comply with state law,” according to a statement by Assured Guaranty.

Earlier this week, Syncora, another bond insurer, filed a motion objecting to the city’s funding plan to revamp its street lighting system to address chronic outages in part because it is “economically unsound”.

Last month, representatives of city retirees sued the city to block its plan to cut retiree health insurance benefits.

Detroit’s bankruptcy, the largest in US history, has sent shockwaves throughout the $3.7tn muni market in which states and municipalities raise funds. Funds investing in the widely popular tax-exempt securities have experienced large redemptions for over 20 consecutive weeks.

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