Detroit sues retirement funds to void pension debt

January 31

Detroit on Friday filed a lawsuit in U.S. bankruptcy court seeking to invalidate $1.44 billion of debt sold to fund public worker pensions — a move that also could void the ill-fated interest-rate swaps contracts that were a factor leading Detroit into bankruptcy.

The lawsuit contends that the city and its retirement systems violated Michigan law when they set up “sham” service corporations and funding trusts to facilitate the debt sales in 2005 and 2006. All other contracts or obligations connected to the debt are also void, the lawsuit claims.

In the suit, Detroit said that the pension debt was “nothing more” than a borrowing by the city, and it violated borrowing limits imposed on Detroit by Michigan.

Detroit asked bankruptcy judge Steven Rhodes to issue a judgment declaring that the city is not obligated to continue making payments on the pension certificates of participation (COPs). They were issued during the term of former mayor Kwame Kilpatrick, now in prison on federal corruption charges.

“This deal was bad for the city from its onset despite reassurances it would adequately resolve the city’s pension issues,” Kevyn Orr, Detroit’s state-appointed emergency manager, said in a statement.

A ruling in the city’s favor could invalidate the interest-rate swap contracts that Detroit reached with investment banks UBS and Merrill Lynch Capital Services, a unit of Bank of America. The swaps were meant to hedge interest-rate risk arising on variable-rate COPs. In the suit, Detroit claims that any contract arising from the COPs would be invalid from the start since “all other obligations incurred by the city in connection with the COPs transactions are unenforceable and void.”

Bill Nowling, Orr’s spokesman, said Detroit still is negotiating with Merrill Lynch and UBS to end the city’s swap agreements. The swap deals, valued at $400 million in 2011, soured as interest rates dropped along with Detroit’s credit ratings. The money owed to the banks was a key element that drove Detroit to file for municipal bankruptcy in July.

UBS and Bank of America declined to comment.

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