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Bond insurers sue Detroit over October 1 bond default

'Detroit' is seen on the top of an iron man-hole cover on a street in Detroit, Michigan July 27, 2013. REUTERS/ Rebecca Cook
'Detroit' is seen on the top of an iron man-hole cover on a street in Detroit, Michigan July 27, 2013. REUTERS/ Rebecca Cook

By Karen Pierog

(Reuters) - Three insurance companies that guaranteed payments on Detroit's voter-approved general obligation bonds sued the city in U.S. Bankruptcy Court on Friday over its October 1 default on $9.37 million in payments due to bondholders.

National Public Finance Guarantee Corp, the public finance subsidiary of MBIA Inc, and Assured Guaranty Municipal Corp claimed Detroit violated Michigan law by paying operating expenses using property taxes that had been levied exclusively to pay off the bonds. Ambac Assurance Corp separately filed a suit raising the same objections.

The insurers asked U.S. Bankruptcy Judge Steven Rhodes, who is currently determining whether Detroit is eligible for municipal bankruptcy, to force the city to set aside the tax money for bond payments. They also want to make sure that tax money that had been earmarked for payment of the bonds would not be tapped for Detroit's proposed $350 million debtor-in-possession financing with Barclays PLC.

Sinking under more than $18 billion of debt and other liabilities, Detroit filed the biggest Chapter 9 municipal bankruptcy in U.S. history on July 18.

Prior to the filing, Detroit's state-appointed emergency manager, Kevyn Orr, included more than $400 million of the city's voter-approved unlimited tax general obligation bonds in a nearly $12 billion pile of debt he labeled as unsecured. Orr said the city would cease payments on unsecured bonds, and that unsecured creditors, including bondholders, would eventually be paid just pennies on the dollar.

Orr's treatment of bonds backed by specific Detroit property tax levies and the city's full-faith and credit pledge roiled the $3.7 trillion U.S. municipal market. General obligation bonds traditionally are considered secured debt, making them one of the safest bets for investors.

Detroit's October 1 default on bonds caused insurers, including National and Assured, to make most of the $9.37 million interest payment to bondholders. The lawsuit claims Detroit publicly has stated it intends to continue to levy the property taxes backing the bonds, while not segregating the revenue from other city funds.

"The city also has indicated that post-petition it is using and intends to continue to use the restricted funds for payment of its general operations. This conduct violates Michigan law," the lawsuit stated, adding that Detroit rejected "numerous efforts" by the insurers to resolve the dispute consensually.

"Michigan's state law could not be more clear: the city is required to segregate the pledged property taxes and then only use them to pay debt service on the bonds," David Dubrow, an attorney with Ambac's counsel Arent Fox, said in a statement. "And bankruptcy law is equally clear on such matters: Michigan law must be followed."

Assured in a statement said it is "prepared to work with the emergency manager, governor and other stakeholders to achieve a fair and equitable resolution for all parties that respects the laws of the State of Michigan."

"The City is reviewing the suits and will respond appropriately in court, but suffice it to say the City disagrees with the allegations and characterizations made by the plaintiffs," said Bill Nowling, spokesman for Detroit Emergency Manager Kevyn Orr, who is named in the suit.

Michigan Governor Rick Snyder, who authorized Detroit's bankruptcy filing, declined to comment on specifics of the lawsuit, but said it was not surprising that new objections have been raised. It is "just part of the process," he said.

Snyder said he was pleased that the bankruptcy court remains the only venue for the resolution of all issues around Detroit's insolvency dispute.

The lawsuit also raises concerns over a financing deal Detroit reached with Barclays last month. The deal, which is subject to bankruptcy court approval, would enable the city to get out of costly interest-rate swap agreements at a discount while providing funds to improve city services.

Under the deal, Detroit would pledge its income tax and casino tax revenue to secure the loan from Barclays. If those funds prove insufficient, net cash proceeds from any potential monetization of city assets exceeding $10 million would serve as collateral for the debtor-in-possession loan.

The bond insurers' lawsuit asks the court to prohibit Detroit from giving any creditors a "super-priority status" allowing them to tap into the property tax money earmarked for the bonds.

The two insurers said in the lawsuit they guaranteed payments on about $233 million of the estimated $369 million of Detroit unlimited tax general obligation bonds outstanding as of June 30.

National, which made a $2.3 million payment to bondholders in the wake of the default, insured voter-approved bonds Detroit sold in 2001 and 2002, according to the lawsuit. Assured, which insured bonds sold in 1999, 2005 and 2008, paid bondholders $4.2 million.

The next payment date for the bonds is April 1 when nearly $47.6 million in principal and interest is due to bondholders, the lawsuit said.

(Reporting by Karen Pierog; additional reporting by Dan Burns in New York and Joseph Lichterman in Detroit; Editing by James Dalgleish, Leslie Adler and Chizu Nomiyama)

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