Appellate panel orders action in Detroit courts

Appellate panel orders action in Detroit courts

Bond insurer Syncora hasn’t had many courtroom victories in Detroit’s bankruptcy case as its attorneys fight for the hundreds of millions of dollars the Bermuda-based company stands to lose. But last week the Sixth Circuit Court of Appeals ordered a lower court to not delay any longer and decide within days an issue Syncora raised before the city filed for bankruptcy nearly a year ago.

Syncora argues the city should use casino tax revenue to pay creditors instead of being allowed to keep it for operations, as has been ruled in earlier decisions in the Chapter 9 case. The roughly $170 million collected annually from three casinos is the third largest source of revenue for Detroit, behind income and property taxes, so it’s a significant part of the city’s balance sheet.

Whether the Appellate Court order turns into a type of “win” for Syncora or not, the 13-page ruling, issued at Syncora’s request, contains several noteworthy admonishments from the appellate court to the lower courts in Detroit. For example,

“Without a final decision on that question, the city will not know what amount its coffers will contribute to the bankruptcy estate, the creditors cannot know the size of the pie they are being asked to share, and the bankruptcy court cannot be confident that it is considering a legally and financially viable plan. An orderly bankruptcy process depends on a concomitantly efficient appeals process, and the district court’s stay of Syncora’s appeal improperly thwarts both processes.”

And:

“Insofar as a debtor’s plan of adjustment incorporates final decision reached by the bankruptcy court, any appeals from those decisions should generally be reviewed before the bankruptcy court confirms the plan,” the panel wrote. “The question presented in Syncora’s appeal — whether a substantial revenue stream is rightly considered property of the bankruptcy estate — is precisely the type of issue that should be reviewed before the bankruptcy court confirms the plan of adjustment.”

Court observers have noticed some other interesting phrases and perhaps innuendos in the ruling that relate to the case’s ambitious timetable, which has been supported and promoted by local and state political leaders. One interpretation is that perhaps this order serves as an indication the Cincinnati-based Sixth Circuit is willing to flex its power in reviewing — and possibly overturning — what’s happening in the Detroit courts.

While that may prove to be a stretch, the appellate panel clearly took issue with how the Detroit courts have handled this particular issue involving the casino tax revenue. Until the Sixth Circuit’s ruling last week, it could have remained undecided at the city’s bankruptcy trial where Judge Steven Rhodes will rule on the city’s Plan of Adjustment and how it restructures debt and future revenues for operations and services for residents.

The appellate panel found such a potential delay in deciding the question about the casino tax funds “presents the specter that Syncora may be forced to abandon its appeal and instead to seek appellate review of the bankruptcy court’s decision in the form of an emergency motion for a stay on the confirmation plan. In a bankruptcy case of such scope and complexity, that is not the proper way to adjudicate appeals that implicate legal questions of fundamental importance to the bankruptcy proceedings.”

The History

The issue in Syncora’s appeal dates back to 2005, when Detroit borrowed $1.4 billion to fund pensions. In doing so, two nonprofit service corporations were set up as pass throughs for the money because the deal pushed the city’s debt above the state-allowed limit. The debt was issued through what’s called “Certificates of Participation,” (COPs) which the service corporations sold. The proceeds went to the city and then to the two pension funds: one for police and fire, another for general service workers. The city periodically gave the service corporations money to cover the debt payments for the COPs. Some of the debt was at a fixed interest rate, some had a floating rate.

The city eventually sought to convert the floating interest rate to fixed in the deal that’s known as the “interest rate swaps.” The appellate court wrote, “Because of the city’s dire finances, however, investors were unwilling to buy the certificates and banks were unwilling to execute the interest-rate swaps unless an insurer guaranteed the city’s obligations. Syncora, a monoline insurer, enhanced the city’s creditworthiness by insuring some of the city’s obligations under both the certificates and the swaps.”

Then in 2009, a credit downgrade and rising interest rates meant the city owed  $300 million under the terms of the deal. To avoid the payment or termination of the agreement, the city and the swap counterparties, including Syncora, made an arrangement involving casino tax revenue, which is the issue involved in the appeal: The city and the swap counterparties bypassed the service corporations by creating two accounts at U.S. Bank.

The casino taxes would be paid directly into one of the accounts (about $15 million a month), and the city would make payments to the second account under the terms of the interest rate swaps deal (about $4 million a month). U.S. Bank would release the funds from the second account on a quarterly basis to the swap counterparties and from the first account to the city if all obligations were met.

In June 2013, Syncora, as one of the counterparties with obligations of about $276 million in the deal, notified U.S. Bank there was “an event of default” and asked the bank not to release casino tax revenue to the city. The city sued in Wayne County Circuit Court to force the release of the funds, but Syncora moved the case to U.S. District Court. The issue became part of the bankruptcy case in July 2013, and the funds were frozen while the Chapter 9 case proceeded.

In August 2013, Judge Rhodes ruled that the casino tax revenue were city property and therefore protected by the bankruptcy filing from payment at that time. Syncora appealed Judge Rhodes’s decision in U.S. District Court, and the case was assigned to Judge Friedman. He received briefs from both parties in the case, but as the appellate court wrote, “…the district court never adjudicated the appeal, and it has languished in that court for seven months.”

In December, Judge Rhodes ruled the city was eligible for bankruptcy, a decision that was appealed by several parties including Syncora. In February the Sixth Circuit said it would consider the eligibility appeals, and last week scheduled arguments for July 30. Meanwhile, the city reached an agreement to pay $85 million of the $285 million owed on the swaps deal and keep the casino tax revenue instead of paying it to banks. (The city, under Emergency Manager’s Kevyn Orr’ direction, is suing the service corporations, challenging the legality of their existence.)

In April the district court stayed Syncora’s appeal of the bankruptcy eligibility determination, and a month later Syncora filed the writ of mandamus asking the appellate court to order Judge Friedman to decide on the issue of whether the casino tax should be part of the city’s assets in the bankruptcy case and counted among available funds to pay creditors.

The Appellate Decision

The Sixth Circuit Court of Appeals last week ordered Judge Friedman to decide by July 14 on Syncora’s request for release of the funds. A three-judge panel (including Raymond Kethledge, a University of Michigan Law School grad) granted Syncora’s writ of mandamus – that’s a party’s request to a higher court to force a lower court to make a decision, in case you don’t remember that lesson from the landmark Marbury v. Madison case in civics class.

Such a ruling isn’t common. Of the 10 cases found in the Sixth Circuit online database since the beginning of 2013, just two were granted.

The appellate panel justified its ruling for two reasons. One was “to protect this court’s future appellate jurisdiction and to ensure that the district court’s stay order does not deprive Syncora of a meaningful opportunity to obtain timely review of the bankruptcy court’s decision.” The other was because the “deprivation of meaningful and timely appellate review itself constitute substantial and irreparable prejudice … and we undertake no inquiry at this point as to whether or not the bankruptcy court correctly decided the underlying dispute.”

The Sixth Circuit panel went on to say that one of Judge Friedman’s reasons for staying Syncora’s appeal — that if a Sixth Circuit decision related to eligibility “rendered moot” any decision of the bankruptcy court — was “no reason to say other appeals that present independent questions of law.” In other words: deciding whether the casino tax revenue is part of the city’s assets for the bankruptcy case should not be postponed until a separate appeal on the bankruptcy’s eligibility is adjudicated.

In the simplest of terms: Do your job when it should be done.

In its ruling on Syncora’s writ of mandamus, the Sixth Circuit did recognize the prospect that it might ultimately uphold all the lower and bankruptcy court decisions. Still, the panel wrote, Whether a substantial revenue stream is rightly considered property of the bankruptcy estate, is precisely the type of issue that should be reviewed before the bankruptcy court confirms the plan of adjustment,” the appellate court said. “The problem posed by the district court’s stay is that it fails to account for all of the potential implications of that court’s inaction.”

With the trial scheduled to begin Aug. 14, that timetable is getting tight.

-By WDET’s Sandra Svoboda

@WDETSandra on Twitter and nextchapter@wdet.org