Detroit, the largest municipality to file for bankruptcy, filed a lawsuit in court that harshly criticizes Kwame Kilpatrick, the former Detroit mayor, and his city government for creating a bogus legal scheme to receive $1.4 billion in loans to pay for pensions. This legal claim is intended to wipe out the enormous debt incurred during the Detroit city government under Kilpatrick in the United States Bankruptcy Court.
Throughout 2005 and 2006, the Kilpatrick administration set up a complex debt deal through two semi-legal entities and two trusts that effectively removed the unfunded pension that city owed to pensioners. This deal, however, haunted and throw Detroit into the Chapter 9 bankruptcy, similar to the Chapter 11 bankruptcy process, but only available to municipalities.
The Kilpatrick city government secured the loan embedded with swap deals that made stable 6 percent interest rate possible. Such swap deals are essentially a bet that the interest rate would not change dramatically. However, when the interest rate plunged, the city owed $50 million a year to counter-parties in the swap deals.
The city also gave a tight deadline to Bank of America and UBS to settle the claim against them for setting up the swap deal that encumbered Detroit with $1.4 billion debt, which helped drive the city to go insolvent. Detroit emergency manager Kevyn Orr gave two banks until 5 p.m. Friday to respond and told Detroit Free Press that the city is still negotiating with them on the settlement agreement with them.
The lawsuit marked another chapter in the drama of Detroit bankruptcy estimated $18 to $20 billion. As it criticizes its former mayor in the lawsuit challenging the debt deal sponsored by him, Detroit admits that the city government blatantly violated the laws of State of Michigan.
The loan deal crusaded by Kilpatrick and Sean Werdlow, the city’s finance director, at the time was aimed to reduce the uncontrollable pension liabilities and avert the politically dangerous situation of laying off 2,000 people in 2005. In the lawsuit, the city claims that the loan arrangement was unlawful from the ground, for it was in essence designed to surpass the debt limit allowed by the Michigan state law. Under the state law, Michigan municipalities are not allowed to borrow more than 10 percent of the private property value assessed. Major bond insurers, mostly banks from Europe who backed the loan deal, are likely to challenge the city’s claim. Meanwhile, the city does not claim that Kilpatrick, who is already serving time for corruption, or his partners committed any corruption in the loan deal.
The lawsuit came one day after the city present a debt-cutting program to move itself out of bankruptcy. Although the city through a federal mediator raised $800 million to save the art collection in the Detroit Institute of Arts and pay off the city’s pension liabilities, there is still $18 billion debt that the city is negotiating with debt holders, unions, and pension funds.
The lawsuit would have not been filed by the city until the court ruling earlier this month. U.S. Bankruptcy Judge Steven Rhodes rejected the $165 million settlement between the city and the banks. It was only the settlement so far that Orr was able to secure for Detroit. Subsequently, the city chose to file the lawsuit to get out of the entire loan deals by criticizing its former mayor along with the banks involved of creating deals that might be another nail in the coffin of Detroit.
By Jonathan JY Jung