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DETROIT, July 24 (Reuters) - A showdown over the biggest municipal bankruptcy filing in U.S. history begins in a federal court on Wednesday morning as creditors challenge its legality.
Attorneys for Kevyn Orr, a corporate bankruptcy lawyer tapped by Michigan officials in March as Detroit's emergency manager, want U.S. Bankruptcy Judge Steven Rhodes to put on hold a flurry of lawsuits claiming the Chapter 9 bankruptcy filing violates the state constitution.
Rhodes agreed on Monday to an expedited hearing requested by Orr that seeks to extend Chapter 9's automatic stay of litigation to lawsuits filed against Governor Rick Snyder, Michigan Treasurer Andy Dillon, and Orr by Detroit workers, retirees and pension funds that are pending in state court in Michigan's capital city of Lansing.
Those lawsuits were halted by a Michigan Appeals Court panel on Tuesday in response to State Attorney General Bill Schuette's request to stop proceedings while he seeks to overturn orders issued by a lower court judge hearing the cases. One of those orders directs Orr to withdraw the bankruptcy petition on state constitutional grounds.
The federal court in Detroit is expecting an overflow crowd of media, attorneys, labor union representatives and others participating in or witnessing the unfolding of the historic drama.
Detroit, a former manufacturing powerhouse and cradle of the U.S. automotive industry and Motown music, has struggled for decades as companies moved or closed, crime became rampant and its population shriveled by almost two thirds since the 1950s to about 700,000 now. The city's revenue failed to keep pace with spending, leading to years of budget deficits and a dependence on borrowing to stay afloat.
Concerned that retirement benefits will be slashed, the American Federation of State, County and Municipal Employees Council 25, which represents about 70 percent of Detroit's civilian workforce, on Monday filed an objection to pushing the lawsuits aside. They said if they were stopped, Orr, Michigan's governor and others would be able to continue to operate beyond state constitutional authority.
In a June 14 proposal to creditors, Orr called for "significant cuts in accrued, vested pension amounts for both active and currently retired persons."
Bill Wertheimer, an attorney handling one of the retiree lawsuits, said pension benefits "are sacrosanct under state law."
"The state has certain powers that the federal government cannot superimpose itself on, unlike a normal bankruptcy," he said.
Rhodes could rule immediately that all the litigation seeking to derail Detroit's bankruptcy petition be put on hold, according to legal experts.
Laura Bartell, a law professor at Wayne State University in Detroit, said Judge Rhodes was not likely to permit interference from Michigan judges.
"I personally think the argument that a bankruptcy filing violates the Michigan Constitution is specious and will be quickly dismissed by Rhodes," she said.
Ken Schneider, a bankruptcy attorney with Detroit-based Schneider Miller PC, predicted the city's bankruptcy case will proceed. "The federal constitution preempts state law," he said.
A 2012 Michigan law that governs emergency managers like Orr who are selected by the state to run fiscally troubled local governments gives the governor the final say on whether to file for bankruptcy.
Bankruptcy opponents could attempt to appeal to the federal district court any order by Judge Rhodes enforcing the stay of litigation against Detroit. But, because such an order would not be considered a final judgment under bankruptcy laws, the federal court could decline to hear the appeal.
In a declaratory judgment on Friday, state Judge Rosemarie Aquilina ordered Orr to withdraw the bankruptcy petition, saying the state law that allowed Snyder to approve the bankruptcy filing violated the Michigan constitution. The governor cannot take actions that would violate constitutional protections covering retirement benefits for public workers, she said.
Aquilina's order was in response to a lawsuit filed this month by a Detroit worker and retiree. Two other lawsuits are also pending, one backed by the United Auto Workers union and another filed by the city's general retirement system and police and fire retirement system.
To remain in bankruptcy court, Detroit must prove that it is insolvent and that it made a good faith effort to negotiate with its creditors, including its employee pension funds, over the city's more than $18 billion of debt and unfunded liabilities. That includes $5.7 billion in liabilities for healthcare and other retiree benefits and a $3.5 billion pension liability.
Union officials on Monday contended some of the city's 48 bargaining units were shut out of pre-bankruptcy negotiations, although Orr's spokesman said Orr was not obligated to engage in collective bargaining negotiations with the unions under the 2012 state emergency manager law.
The arguments over eligibility could take a long time as the unions challenge the legality of the filing. In the case of Stockton, California's bankruptcy case, the eligibility determination took a year.