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Originally published August 18, 2013 at 8:15 AM | Page modified August 18, 2013 at 10:29 AM

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Creditors face deadline in Detroit bankruptcy case

Banks, bond insurers, employee pension systems and others standing to lose big if a federal judge declares Detroit insolvent are expected to legally file their objections to the largest municipal bankruptcy in U.S. history.

Associated Press

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DETROIT —

Banks, bond insurers, employee pension systems and others standing to lose big if a federal judge declares Detroit insolvent are expected to legally file their objections to the largest municipal bankruptcy in U.S. history.

Monday is the deadline for creditors to file eligibility objections to Detroit's bankruptcy petition - marking the beginning of legal challenges for those hoping to recoup all or most of what Detroit owes them.

The deadline is just one of several steps that could lead to federal Judge Steven Rhodes allowing Detroit into bankruptcy protection while it restructures. Conversely, it also could spell disaster for the struggling city if its petition is denied, allowing creditors to sue Detroit if it defaults on payments, said bankruptcy expert Doug Bernstein.

State-appointed emergency manager Kevyn Orr filed for bankruptcy July 18. He claims the city has at least $18 billion in liabilities, from underfunded pensions and health care costs to bonds that lack city revenue to be paid off.

Orr stopped payment on $2.5 billion in debt in June.

Revenue from property and business taxes continues to lag, while expenses and city service costs swell. Meanwhile, Detroit's population has dropped by more than one million since the 1950s to just about 700,000 residents.

By filing for bankruptcy, Orr prevented a mad rush by worried creditors who could have sued Detroit to collect their money.

"The significant objections in a Chapter 9 bankruptcy come at eligibility," said Bernstein, managing partner of the Banking, Bankruptcy and Creditors' Rights Practice Group for the Michigan-based Plunkett Cooney law firm. "In a Chapter 9, they can't force the liquidation of assets. The only recourse is to have the case dismissed."

A multi-day hearing on the eligibility question is scheduled to start Oct. 23.

"Anybody who opposes the filing can be heard from," said experienced bankruptcy attorney and law professor Anthony Sabino. "But they must prove ... that they have legal standing to come to court in the first place and be heard."

If creditors successfully remove Detroit from bankruptcy protection it "would be nothing less than catastrophic" for the city, he added, and would throw Detroit to the "wolves."

"A key to bankruptcy is it stops all litigation and attempts to collect debts," Sabino said. "This prevents the dismembering of the assets of the entity."

Without bankruptcy's protective umbrella "it will be sued and attacked in state court, federal court, from all sides, by every creditor in sight, with uneven and possibly unjust results," Sabino said. "The wolves - creditors - will selfishly rend the city from limb to limb, leaving scraps, if that, to the less powerful."

Orr, serving an 18-month contract, had threatened bankruptcy as an option when he took the job in March. He met with more than 100 creditor representatives in mid-June, laying out plans that asked many to take 10 cents on the dollar or less.

After getting authorization from Gov. Rick Snyder, Orr filed bankruptcy on Detroit's behalf just over a month later.

Union leaders and officials with the city's employee pension systems have said the filing violates the Michigan Constitution, which they believe protects accrued municipal pension benefits. Orr said federal bankruptcy law trumps state law.

A restructuring team representing Detroit's Police and Fire Retirement System and General Retirement System will file objections by Monday's deadline, spokesman Bruce Babiarz told The Associated Press on Thursday. He said the group believes the governor's bankruptcy authorization was unconstitutional.

Bankruptcy filings show the pension systems are the top two unsecured creditors. The city has about 21,000 retired workers who are owed benefits, with underfunded obligations of about $3.5 billion for pensions and $5.7 billion for retiree health coverage.

Several other creditors contacted by The Associated Press, including National Public Finance Guarantee Corp. and BlackRock's Municipal Bonds Group, declined to comment on whether they would make an objection filing by Monday.

"The primary argument ... will likely be that Detroit did not, and cannot, demonstrate that either prior to the filing, it negotiated a plan of adjustment in good faith with creditors, or it was unable to do so because such negotiation was impracticable," said George B. South III, a partner with DLA Piper's Restructuring group in New York.

The city has until Sept. 6 to file its responses to any objections by creditors, which number in the thousands and include corporations, large and small companies, and individuals.

"Given the scope of the financial issues faced by Detroit, I anticipate that the Chapter 9 filing will be upheld notwithstanding any objections that are filed," South said.

But Bernstein said such objections have worked to get some municipal bankruptcy petitions tossed out.

"It has worked in Boise County, Idaho, on the basis they were not insolvent," Bernstein said. "Harrisburg, Pa.'s, bankruptcy was thrown out on the basis it was not authorized by state law."

By the end of the year, the city hopes to submit a plan to emerge from bankruptcy.

"Detroit has jumped into the bankruptcy pool with both feet," Sabino said. "Now that it's there, it needs the process to work out of its problems."

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