By Joseph Lichterman
DETROIT Jan 16 A U.S. bankruptcy judge on
Thursday rejected a deal allowing Detroit to end interest-rate
swap agreements with two investment banks, a move that puts
pressure on banks for more concessions while throwing a wrench
into the city's plans to exit bankruptcy by September.
Ending costly swaps agreements with UBS AG and
Bank of America Corp's Merrill Lynch Capital Services
has been a key component of Detroit emergency manager Kevyn
Orr's plan to adjust the city's finances through the bankruptcy
But Detroit's proposal to pay $165 million - a 43 percent
discount from its original obligation - was still "too high a
price to pay," federal bankruptcy judge Steve Rhodes ruled.
Rhodes, who is overseeing the city's historic bankruptcy,
said Detroit likely could succeed with legal challenges to the
validity of the original swaps agreements.
Since Detroit would make such a challenge in Rhodes' court,
the ruling is a strong signal that banks could leave with
nothing if they do not give up more in negotiations. UBS and
Bank of America declined to comment as did bond insurer Syncora
Guarantee, which had opposed the deal Rhodes rejected.
Rhodes said that settling the swaps was better for Detroit
than lengthy, costly litigation over the claims. Rhodes said he
"strongly encourages the parties to continue to negotiate" even
if the city decides that filing suit is its best option.
Orr, who previously had said he was uncertain of victory in
a legal dispute over the swaps, in a statement said the city
would "continue to work toward a resolution" of the swaps deal.
Detroit's bankruptcy plan depended on raising cash by ending
the swaps, which were used to hedge interest-rate risk for some
of the $1.4 billion of pension debt the city sold in 2005 and
2006. Therefore the ruling puts on hold the process, which
Detroit hoped to end by September, when Orr's term ends.
Detroit had planned to finance the swaps termination with
part of a $285 million loan from Barclays Plc, but the
judge denied the city's request to borrow that sum. Detroit
could, however, still borrow $120 million to improve services,
The $285 million loan from Barclays had been contingent on
Detroit's pledging funds from the city's casino tax as
collateral, but those funds may not be available to secure a
loan because they are pledged as security on the original swaps,
which remain in effect because of Rhodes' ruling.
It was not immediately clear if Barclays would be willing to
provide the $120 million loan to help Detroit cover the cost of
STRONG LEGAL ARGUMENTS
In rejecting the swaps deal, Rhodes said the city could
argue that the use of the casino tax revenue as a lien in the
original swaps transaction violated Michigan gaming law. The
city could convincingly argue that the swaps themselves were
illegal, he added.
An attorney following Thursday's proceeding said if he were
Detroit he'd be considering litigation with an eye on a
"They have to seriously consider having a complaint on his
desk by Tuesday or Wednesday following his comments," the
That could mean delay.
"I'm willing to place a wager. If the over/under is
September, I'll take the over," said Kenneth Klee of legal firm
Klee, Tuchin, Bogdanoff & Stern in Los Angeles. He represented
Jefferson County Alabama, which recently came out of its Chapter
"The judge is on Detroit's side but it will take a long
time," he said.
'FAR TOO RICH'
Robert Gordon, lawyer for the city's pension funds, which
opposed the deal, said Detroit's planned payment to UBS and
Merrill essentially treated them as secured creditors. "Paying
them close to whole dollars was just far too rich," Gordon said.
Detroit's pension funds, bond insurers, banks and others
opposed the termination deal. The objectors argued that the city
should not have settled with the banks because it had convincing
legal arguments to completely terminate the swaps.
But Orr, who has been running Detroit since March, testified
in court that the city had only a 50-50 shot of winning the
litigation, and he did not want to risk expensive legal
proceedings or losing access to casino tax revenue, which was
used as a lien in the swaps. The casino tax accounts for about
20 percent of the city budget, Orr has said.
The deal Rhodes rejected was the city's second such
agreement with its swaps counterparties. Detroit originally had
proposed a deal with Merrill and UBS in which the city would
have ended the swaps at 75 cents on the dollar with a $230
million payment, but in a December hearing Rhodes called on the
city to negotiate more favorable terms.
Detroit reached the new agreement with the banks after two
days of mediation in late December.
Orr testified in court earlier this month that Detroit
initially proposed a termination fee of $145 million to $150
million but that the investment banks would not agree to
anything less than $165 million.
Meanwhile, mediation efforts have begun to bear fruit, with
philanthropic foundations connected to Detroit pledging $330
million to help the city. In addition, Governor Rick Snyder is
preparing to propose $350 million of support, over 20 years, to
help protect worker pensions and prevent the Detroit Institute
of Arts collection from being sold, according to reports on
Thursday in the Detroit Free Press and elsewhere.