By Joseph Lichterman
DETROIT, Dec 18 (Reuters) - The judge overseeing Detroit’s bankruptcy case on Wednesday suspended a hearing on a $350 million accord to end interest-rate swaps and provide working capital for the city, instead urging the city to renegotiate the deal.
The hearing was scheduled to continue through Thursday, but U.S. Bankruptcy Court Judge Steven Rhodes asked Detroit to use the time scheduled for court instead to seek better terms from the swaps counterparties. The current deal has the city paying 75 percent of what it owes those firms, UBS AG and Bank of America Corp’s Merrill Lynch Capital Services.
Rhodes ordered the parties back to court on Friday at 10 a.m. (1500 GMT) to discuss the status of the negotiations. He said the hearing would be continued at a later date.
“I would encourage that as strongly as I can,” Rhodes said, regarding the city’s efforts to negotiate a better deal.
Thomas Cullen, an attorney at Jones Day who is representing Detroit, said the city would see if “there is a number, a sweetening of the deal, that would make it go away.” Though he said he was doubtful it was possible.
The abrupt change to the hearing schedule came about during the testimony of Detroit Emergency Manager Kevyn Orr, who said he would not disclose the contents of internal memos that discussed the legality of the swaps.
The city used the swaps contracts to hedge interest rate risk on some of the $1.4 billion of pension debt that it sold in 2005 and 2006.
Rhodes pushed the city attorneys for information about the swaps deal that Detroit struck with the counterparties prior to the city’s July 18 bankruptcy filing. Under the deal, the city would only have to pay about $230 million, which is 75 percent of the cost of terminating the swaps. The judge said the information would be revealed during the litigation process if the city were to sue the swap counterparties.
The current agreement to terminate the swaps at a discount would require Detroit to pay a higher percentage of the original termination fee, 82 percent instead of 75 percent of the original cost, if Detroit cannot close the transaction by Dec. 31.
Spokesmen for UBS and Bank of America declined to comment.
A spokesman for Orr said the city needs court approval for a plan by Dec. 26 and an extention will likely be discussed.
Bond insurers that covered the swaps and payments on the pension debt, holders of the debt, Detroit pension funds and others objecting to the deal have argued it gives an unfair advantage to the counterparties over other creditors.
The city has defended the move as a way to protect casino tax revenue used as collateral for the swaps, money it views as Detroit’s most reliable revenue source.
“How can I decide whether this was a fair settlement without understanding what the city’s assessment of the strength of its claims against the swaps and the COPs were?” asked Rhodes.
COPs, or certificates of participation, are the type of debt Detroit sold for its public pension funds.
Cullen defended not releasing the information because he said the city still might pursue litigation to nullify the costly agreements.
“One of the reasons we haven’t disclosed the memoranda, because we still may sue,” Cullen told Rhodes.
Earlier in the hearing, the judge said “probably the most significant question in this trial” was what arguments Detroit was using to negotiate a termination of the interest-rate swaps.
Rhodes said he was not seeking information that was subject to attorney-client privilege.
“My request was that you consider whether maintaining the privilege is in the best interest of the city,” Rhodes said. “If you think it is and you think you can prove what you need to prove to get the settlement approved go for it. I think your challenge is more difficult if you keep the privilege.”
Included in the approximately 25 documents in question were two draft complaints, Cullen said. He did not name the targets of the complaints.
Gregory Shumaker, another attorney representing Detroit, said the city needed to ensure that the casino revenue was freed in order to stabilize the city, saying, “I don’t know how we can right the ship without freeing the casino revenue”
Rhodes replied: “The question is, are you overpaying for that?”
The deal to end the swaps has emerged as a major component in Detroit’s Chapter 9 municipal bankruptcy, the largest ever in U.S. history.