UPDATE 1-Bond insurer claims fraud in Detroit pension debt lawsuit

Thu Aug 14, 2014 5:58pm EDT

(Adds trial date for case, penultimate paragraph)

Aug 14 (Reuters) - A bond insurance company fired back at Detroit's attempt to invalidate $1.45 billion of pension debt, claiming in a court filing late Wednesday that it was "fraudulently" led to guarantee payments on the debt.

Financial Guaranty Insurance Co, which insures more than $1 billion of the city's pension certificates of participation (COPs), filed a counterclaim against Detroit asking the U.S. Bankruptcy Court to dismiss the city's lawsuit seeking to void the debt.

If the city prevails in its lawsuit, FGIC, one of Detroit's biggest hold-out creditors, asked the court for restitution and damages from the city or its pension funds that would be determined at a trial.

Detroit, which is working its way through the biggest municipal bankruptcy in U.S. history, filed the lawsuit in January, claiming the sale of the COPs in 2005 and 2006 violated borrowing limits imposed on the city under Michigan law. The COPs were issued during the term of former Mayor Kwame Kilpatrick, now in prison on federal corruption charges.

At a Thursday court hearing on the COPs, Robert Hertzberg, an attorney representing Detroit, said the city will probably seek to dismiss FGIC's counterclaims.

FGIC said it agreed to issue insurance policies that earned the COPs triple-A ratings based on representations from the city and its lawyers that the debt was a legal vehicle for Detroit to raise money for its constitutionally mandated obligation to fund its two employee retirement systems.

"The city now alleges in its complaint that the many representations and statements it made in connection with pension funding transactions were false," FGIC's filing stated. "The city intended for its fraudulent statements to induce FGIC's issuance of the policies."

FGIC also filed counterclaims against the city for misrepresentation and unjust enrichment, noting that "it would be inequitable for the city to retain the benefits it received" in the event the debt was invalidated.

Shortly before filing for bankruptcy in July 2013, the city defaulted on the COPs, leaving FGIC and another insurer, Syncora Guarantee Inc, to make debt service payments to bondholders.

Syncora, which has a $400 million exposure, and FGIC have emerged as Detroit's biggest hold-out creditors after the city entered settlements with other major creditors, including its pension funds and various labor unions. A hearing on Detroit's plan to adjust $18 billion of debt and exit bankruptcy is scheduled to begin Aug. 29.

Judge Steven Rhodes, who is overseeing Detroit's bankruptcy, on Thursday set a June 2015 trial date for the city's COPs lawsuit. The city, meanwhile, could exit bankruptcy this fall if Rhodes confirms its debt adjustment plan.

If the COPs are voided, a litigation trust created in the plan would allocate money the city would have used to pay off the debt to retiree healthcare and to certain general obligation bondholders and creditors.

(Reporting by Karen Pierog; Editing by Dan Grebler)