Day Two: Detroit’s Bankruptcy Trial

Day Two: Detroit’s Bankruptcy Trial

The country’s biggest municipal bankruptcy trial enters its second day with opening statements continuing where they left off yesterday.

5:09 p.m. Court is wrapped up for the day. Jaye Quadrozzi, attorney for Oakland County, will re-appear tomorrow morning as she did not finish her opening statement. One of her topics was an objection to the 6.75 percent presumed rate of return on pension investments the city has included in its plan. Here’s part of her exchange with the judge:

Judge: It appears that accepted actuarial science and practice, if that’s what Gabriel Roeder (Smith & Company) and the plan followed, created a very large, somewhere between $1.5 billion and $3.5 billion UAAL (unfunded actuarial accrued liability). Yes?

Jaye Quadrozzi: I believe so…

Judge: Whatever the UAAL is, it occurred when this actuarial science that you are relying upon was used?

JQ: That is correct

Judge: Well, I hate to invoke my mother, but she used to say that just because everyone does it, doesn’t make it right.

JQ: I’m all for mothers. However, the fact of the mater is, not that there is UAAL but that the city has proposed an UAAL that is overstated and nearly everyone you hear will testify to that.

Judge: Using actuarial science that got us into the hole we’re in now.

JQ: They’re not using actuarial science.

Judge: What I’m asking is the experts you’re relying on to say that this rate of return, this .75 percent, is to low, are actuaries whose science got us into the hole we’re in in the first place.

JQ: I would agree with you, but I think simply because an event or group of events happened that caused the UAAL to exist, that you don’t look t sound methods or practices to get out of that difficulty and the city did not do that, your Honor. I think in large measure because they have created a UAAL that is based upon incorrect assumptions, that hey put themselves in a position to propose a plan that does something that is prohibited by law. For that reason, Oakland County objects to that portion of the city’s plan.

Judge: I guess the broader question I have is: if you have an investment enterprise, whether it is a pension plan or whatever it is, that has fiduciary obligations and is obligated to invest as a prudent person would invest, right, would that kind of investor on a long-range basis, which is I guess what we have to look at, be able or reasonably expect to achieve a 6.75 percent rate of return?

JQ: Yes and more than that. We will present expert and fact witnesses that will testify to just that.

4:26 p.m. Now up is Oakland County’s attorney, Jaye Quadrozzi. She says she’ll focus on the structure and legality of pension contributions from the Detroit Water and Sewerage Department that are part of the city’s restructuring plan.

“DWSD is critical to the regional economy and quality of life in this area,” she said. “It’s one of the largest water and sewerage departments in the nation. … You can see why Oakland County is concerned.”

The County is “party to contracts through which DWSD provides water and sewer” services to 62 townships and villages in Oakland County.

“We understand that this is not a trial about DWSD or how to fix DWSD but the city’s plan imposes burdens that will have a significant impact on DWSD and DWSD is already in trouble and they have been for decades,” Quadrozzi said. “So to examine the effect that the city’s pla has and will have is important as to whether that plan can be confirmed.”

She objects to making suburban residents pay for Detroit’s obligations.  “If the plan were to be confirmed it would force non Detroit residents … to fund the city’s retirement obligations,” she said.

4:24 p.m. First opening statements by telephone. Kristin Going, representing Wilmington Trust, a COPs contract administrator, is on the line. She only took two minutes.

4:05 p.m. Another attorney, another PowerPoint. Now Jonathan Wagner is arguing against the city’s Plan of Adjustment. He’s an attorney for the holders of the Certificates of Participation, the notes used in the 2005 deal to inject $1.5 billion into the city’s pension funds.

TITLE: The Plan Unfairly Discriminate Against the COPs Class.

On face of the plan, Pension Classes recover 59-60 %

On face of the plan, COPs class recover 0 to 10 %

City acknowledges that discrimination in excess of 50 percent is grossly disparate.

Level of discrimination is actually far greater.

3:55 p.m. Bond insurer FGIC’s attorney Alfredo Perez continues to make the case that some creditors in Detroit’s bankruptcy are getting unfair, undeserved treatment under the proposed debt restructuring plan.

FGIC insured the famed “COPs” deal, the certificates of participation issued in 2005 to fund pension debt.

“They’ve got a billion five of our cash, and we’re the bad guys. How could that be?” Perez said.

3:54 p.m. As the FGIC attorney continues to make his case to sell pieces of the collection at the Detroit Institute of Arts, Judge Rhodes interrupted him and asked, “What about libraries, would you sell them too?”

“I wouldn’t sell the libraries,” Perez said.

“They are, what, more valuable, more significant than art?” the judge asked.

“I don’t know what intrinsic value…”Perez started to answer.

“What is if it had really valuable books in it?” Rhodes asked.

“Then perhaps,” Perez said.

3:40 p.m. FGIC’s attorney is using a PowerPoint presentation to guide arguments. Here’s what the first slide says:

TITLE: Reasonableness of the DIA Settlement – Four Factors

1)      What is the debtor’s probability of success in litigating the issues to be settled?

2)      What difficulties, if any, would the debtor have in collecting any amounts that would be owed in the event of a successful litigation?

3)      How complex are the issues being settled, and what expense, inconvenience and delay would necessarily result from litigating them, instead of settling?

4)      Is the proposed settlement in the paramount interest of creditor, giving deference to the view of those creditors that would be adversely impacted by the settlement?

3:20 p.m. Alfredo Perez for bond insurer Financial Guaranty Insurance Company is at the podium, making opening statements that so far are advocating for selling the artwork to pay creditors.

FGIC’s CEO, Timothy Travers authored this op-ed piece in the Detroit Free Press today, titled “Why we creditors are fighting Detroit’s bankruptcy plan.”

3:06 p.m. At the conclusion of his prepared statement, Syncora attorney Marc Kieselstein was questioned by Judge Rhodes who demanded to know what offer the bond insurer would accept from the city as a settlement on what it’s owed.

“Something that’s within shouting distance of what the retirees are getting,” Kieselstein said at first.

“I want a percentage and I want it now,” Judge Rhodes said.

After more exchanges, including Kieselstein first saying he would have to consult with his client, he finally said,” 75 cents.”

And Judge Rhodes asked him where that money would come from.

“Through a combination of all the initiatives I’ve talked about,” Kieselstein said.

“There’s the art,” Kieselstein continued. “You could sell one or two pieces. You could finance  a few pieces and you could get us to that number pretty quickly.”

He also mentioned some kind of sharing in the revenue that could occur through revitalization of the city.

2:59 p.m. Syncora attorney calls the statement “the city can’t be forced to sell the art” a “red herring” in the case.

Marc Kieselstein has been making opening statements for more than two hours. He has challenged repeatedly how the city prepared its bankruptcy claim, including what work was done to determine the value of the collection at the Detroit Institute of Arts and spread such funds to creditors like bond insurer Syncora, to whom the city owes hundreds of millions of dollars.

2:50 p.m. Here is the text of a slide the Syncora attorney is using in his opening arguments in the bankruptcy trial to criticize the city’s Plan of Adjustment.

TITLE: PLAN IS NOT FAIR AND EQUITABLE

SUBTITLE: Plan fails to live up to “all that the creditors could reasonably expect under the circumstances.”

SLIDE TEXT Debtor has:

Failed to explore potential benefits to new tax policy;

Failed to explore monetizing art collection (or portion of art collection) before Grand Bargain;

Failed to explore monetizing art collection (or portion of art collection) after Grand Bargain;

Failed even to try to challenge alleged legal impediments to realizing art value.

2:30 p.m. Syncora’s attorney also showed video of conflicting deposition testimony as to whether the city, in preparing its Plan of Adjustment, did any analysis of what would happen if taxes were raised. One consultant said yes, Robert Cline did such an analysis. But Cline said no, he didn’t.

“We have asked ourselves a thousand times in recent weeks why the debtor left such a gaping hole in its confirmation case,” Kieselstein said, adding the city had the “mindset of using every short cut” and the city would have to “throw itself on the mercy of the court” during the confirmation hearing.

(Cline, incidentally, was the trial’s first witness. He appeared Aug. 18. Here is a summary of his testimony.)

2:20 p.m. In his arguments that the city did not meet its obligation to do a “best interest” test of the settlement’s effect on creditors, Syncora’s attorney wondered about the city’s lack of analysis of what would happen if the bankruptcy was dismissed.

As part of his argument, Kieselstein first played video from Emergency Manager Kevyn Orr’s deposition in which Orr described a dismissal analysis done by one of the city’s consultants, Kenneth Buckfire, of the Miller Buckfire firm. Then Kieselstein played Buckfire’s deposition during which he said he never did such an analysis.

“The debtor has no idea what would happen in dismissal,” Kieselstein said, adding the city’s attorneys “cannot do a stand-up analysis of the dismissal scenario from the podium. …

“The debtor has dropped a big mess on your doorstep.”

1:50 p.m. And we’re back!

The schedule for the afternoon, as we know it, is for Syncora attorney Marc Kieselstein to finish his opening remarks. He’ll be followed by Alfredo Perez for bond insurer Financial Guaranty Insurance Company. Then UAW attorney Peter DeChiara  and Richard Mack for AFSCME Council 25 are scheduled.

Attorneys for Macomb, Oakland and Wayne counties – not necessarily in that order – will follow.

Will that take us to the 5 p.m. quit time or will we get a witness today?

12:37 p.m. We’re on lunch break until 1:50 p.m. but here’s some catching up I needed to do from the Detroit Institute of Arts’ attorney’s statement: Arthur O’Reilly previewed some of the arguments witnesses will make later in the trial relevant to the grand bargain and the protection of the museum’s collection from sale to pay creditors.

He described the museum’s relevance and importance to southeast Michigan – not just the city’s balance sheet – and said it has innovative programming to reach a large audience. O’Reilly also said, in his opinion, it is “one of the most accessible museums in the world.”

“Despite population decline (in the city), the museum in recent years has attracted as many as 600,000 visitors a year,” he said. “Any sale of the collection would actually put the museum in jeopardy.”

A few of O’Reilly’s points:

The “great preponderance” of art was donated to the museum, not the city, and were made with restrictions on their use. “It’s held in trust and the public is the beneficiary,” he said. “This museum deserves to stay right where it is.”

While the museum’s history dates back to the 19th century and the bulk of its collection was acquired through donations and purchases in the 20th century, the DIA’s importance in the 21st century endures. “The museum isn’t the glittering link to the history of the city” as creditors called it in some filings, O’Reilly said. “But it’s key to our present and our future.”

Selling the art would “chill philanthropic giving in a city that needs charitable giving more than ever.” O’Reilly referred to the judge’s bus tour that city attorneys arranged. (More about that here) “You went through various parts of town. Some were blight. Some were in various forms of decay,” he said. But the tour also included the DIA and visits to some of the galleries. And although Rhodes entered the museum from a back door, O’Reilly said he hoped the judge saw the motto etched above the museum’s Woodward Avenue entrance: “Dedicated to the people of Detroit for the knowledge and enjoyment of art”

“What would it mean if that statement of promise and ambition and hope were rendered a dead letter?” he (somewhat) rhetorically asked the judge. “What would charity mean if the creditors have their way?”

12:15 p.m. The Syncora attorney, Marc Kieselstein, continues to argue that the city has failed to justify its ‘unfair discrimination” in paying different creditor groups different amounts relative to what they were owed. (Syncora stands to lose hundreds of millions of dollars in the bankruptcy restructuring plan, which calls for paying pennies on the dollar for what the bond insurer is owed.)

The slide looks like this:

TITLE: Discrimination is Not Supported by a Reasonable Basis

SUBTITLE: Debtor’s Reply justified discrimination based on:

1: Employee morale

2: Settlement of eligibility litigation;

3: Pensioners’ inadequate ability to protect themselves;

4: The Grand Bargain proceeds are outside the Plan and shouldn’t be counted for discrimination purposes;

5: And discrimination is minimal when OPEB (health care) and pension claim recoveries are viewed in the aggregate.

Kieselstein said all of the above justifications for the discrimination fail to meet legal standards established in bankruptcy cases.

11:49 a.m. Syncora attorney Marc Kieselstein in his opening arguments reviewed what Emergency Manager Kevyn Orr said during his deposition about how decisions were made about what amounts to pay different creditor classes.

(He’s building a case that pensioners were treated much better than financial creditors and that such treatment is contrary to bankruptcy law.)

At his July deposition, Orr was questioned by another Syncora attorney, Stephen Hackney, about what rationale could exist for the discrimination against certain creditors of the city. Orr said they were: the human dimension, the city’s covenant with retirees, the potential invalidity of COPs, and assets in retirement systems.

“We all appreciate the human dimension, your Honor, but let’s remember the rule of law,” Kieselstein told Judge Rhodes. “The debtors’ decision to rely on the human dimension … is a legal nonstarter. That affects the whole legal discrimination analysis, it’s enough to sink the ship. It doesn’t matter what else the debtor says.”

In other words: while the human dimension may be a sympathetic argument, it has no place in bankruptcy and doesn’t exist in bankruptcy law, Kieselstein argued.

“Bankruptcy is the land of broken promises,” he said.

11:35 a.m. Syncora attorney Marc Kieselstein, who is from the Kirkland & Ellis firm in Chicago, told Judge Rhodes he is being “asked by faith alone to find that the debtor has met its many burdens” and urged him to look more closely at bankruptcy law in deciding whether to confirm the city’s Plan of Adjustment.

“This plan unfairly discriminates, fails the best interests tests and is not fair and equitable,” Kieselstein said.

Kieselstein took aim squarely at the “grand bargain,” specifically how it has potentially resulted in money for a single creditor class – the pensioners — and took the “asset” of the Detroit Institute of Arts collection of the bargaining table “for a relative song.”

Kieselstein said the city was enjoying the benefits of bankruptcy – automatic stays of payments, a “fresh start” – without adhering to certain principles of Chapter 9 filings.

“The plan provides vastly disparate treatment for creditors,” Kieselstein said. “It cannot be confirmed without doing serious harm to the rule of law.”

11:13 a.m. That concludes opening statements from the city and its supporters (at least for the purposes of the confirmation of the Plan of Adjutsmen): the Detroit Institute of Arts and the Official Committee of Retirees. Now we will have several attorneys representing creditors who oppose the city’s plan.

First up: Marc Kieselstein who represents bond insurer Syncora, a staunch opponent to the city’s plan. He starts by saying it has “epic levels of discrimination” and says “discovery has revealed the the debtor in many instance gave itself a hall pass from even having to develop basic evidence.”

11:06 a.m. Attorney Sam Alberts, of the Denton’s firm, represents the Official Committee of Retirees. (There’s a provision in bankruptcy law that provides for this committee that exists to protect the interests of all retirees. The committee has representatives from the various pensioner, employee and retiree groups.)

Alberts opened his statement with a review of the importance of the city’s workforce, saying many of them had bypassed higher wages in the private sector for the promise of the public sector benefits including pensions and health care. In some cases, he said, they literally sacrificed “life and limb.”

Alberts reviewed a few of the provisions in the Plan of Adjustment and how they affect pensioners. These include a 4.5 percent reduction to the general service retirees along with a loss of cost-of-living increases. Alberts said the cuts to those increases will save the city $700 million.

In addition, he said, “Thousands of these general service workers will have their pensions reduced further to cover alleged interest overpayments … to annuity savings funds. I say alleged because … these payment were determined without any of their input and were made with respect to contracts and city ordinance.”

Here’s some background on the “annuity clawback” that also will be addressed by individual pensioners Judge Rhodes will allow to testify during the trial.

Under the proposed Voluntary Employee Benefits Association, a replacement to city-funded health care, pensioners will assume a far greater share of their own medical insurance and direct costs. “As you get older, it’s a much more challenging request,” Albert said. “These retirees are more than just pensioners. They received a promise of valuable health care benefits going forward.”

10:45 a.m. Now up: Sam Alberts, who represents the Official Committee of Retirees.

(You can listen to Sam Alberts on WDET here.)

10:26 a.m. DIA attorney Arthur O’Reilly says his opening statement will focus on “respecting charitable donations and respecting the people’s right to arts and culture.”

10:20 a.m. First up to support the city in urging Judge Steven Rhodes to confirm the city’s Plan of Adjustment is Arthur O’Reilly, who represents the Detroit Institute of Arts. Some of the city’s creditors have had an intense focus on the value of the museum’s collection and advocated that it be sold to pay debts to ALL creditors, not just used as leverage to raise money for pensions, as the “Grand Bargain” did.

10:12 a.m. City attorney Bruce Bennett, of the Jones Day firm, concluded his three-hour opening statement. Throughout his time at the podium, Bennett asserted that the Plan of Adjustment was proposed in good faith, that the plan meets the “best interest of creditors” test under bankruptcy law, and that the plan discrimination against different classes of creditors is not unfair.

“We couldn’t do any better for the creditors. The numbers show that,” he told Judge Steven Rhodes.

As for the testimony that will come about the feasibility of the plan’s success, Bennett called it “an intensely and unavoidable factual determination.”

“There is not much law that is going to frame that discussion,” Bennett said. He described some of the conclusions the city’s expert witnesses will make about the feasibility of the Plan of Adjustment:

“The projections are sound. They were prepared by a team.” (Bennett showed a chart with witnesses on two sides: revenues and expenditures. The city’s CFO Jon Hill and Ernst & Young expert Gaurav Malhotra are at the top.)

“There’s also the reality that in the future, things will happen that we haven’t planned for. Unexpected things will most certainly happen, and other people, not necessarily the emergency manager and not necessarily the team that put this together are going to have to adjust to the future over time. We expect those adjustments. We expect those changes. They are impossible to predict and nail down,” Bennett said. “It is therefore important to remember while hearing the testimony that the focus is whether it’s more likely than not, more than a reasonable but a probable chance that everything that’s been put in place under the plan will achieve its intended result.”

Bennett says the city’s witnesses will say, “We think this is the city’s last best chance and that it’s going to work.”

In concluding his nearly three-hour statement, Bennett told the judge “Detroit has a better future after Chapter 9 … Detroit has earned this Court’s help in escaping from its current distressed state. … The Plan will succeed.”

9:25 a.m. City attorney Bruce Bennett is going through a chart titled “Pension Recovery Using Legally-Cognizable (sic) Standards” to show the judge, in part, a “lack of discrimination” in calculating the returns on pension investments. Feels like half the media covering trial have used the phrase “deep in the weeds” to describe the last half hour of courtroom “action.”

9:07 a.m.  Some of Detroit’s best journalist are covering this trial. Follow them live at these blogs and Twitter feeds:

The Detroit Free Press live blog, where you can give a letter grade to the city’s opening statements.

Freep Reporters tweet at @MattHelms and @NathanBomey on Twitter

Detroit News Reporters tweet at @RobertSnell_DN and @ChristineFerretti_DN

WDIV’s Rod Meloni is blogging here.

8:55 a.m. Early in his statement today, city attorney Bruce Bennett referred back to the months immediately after the Chapter 9 case was filed and he described conversations with opposing counsel.

“For several months whenever I spoke to a creditor, that creditor said, ‘Detroit is in a very unfortunate, difficult economic situation but we should be paid 100 cents (on the dollar) and here are all the reasons we should be paid 100 cents,’” Bennett said. “Your Honor saw that played out in the courtroom.”

He summarized some of those legal maneuvers and arguments:

Retirees argued the Michigan Constitution protected pensions.

UTGO holders “said among other things that … we have a lien on certain revenues collected by the city.”

LTGO noteholders argued “they had a superior position.”

Bennett also challenged the notion that the case should be dismissed and sent to the state courts. He summarized the potential scenarios, relating back to the early disputes and assertions from creditors:

“There is no reason why all of that wouldn’t happen again. There is every reason to expect that all of that would happen again in state courts but with a very important difference: state court judges would not have the supremacy clause and ordering principles that happen under the U.S. Bankruptcy Code, in particular, that deal with all of the conflicts ad all of the priorities that are being asserted. Instead, you would have stat courts having to give credit to all of these laws, there being no federal law, reason not to, and then having to reconcile all of them.

“Whether there is a race to the courthouse, or courthouses, or a mob scene at the courthouse, there is not going to be a single line where everybody agrees what their rights are and settled for some treatment that arises out of a pro rata assessment where everyone expects it will be fully paid and the allocation scheme from which it occurs are not quite clear under the law. .. It’s a further demonstration that dismissal scenario is not good for creditors generally.”

8:30 a.m. Jones Day attorney Bruce Bennett is back at the podium for the city of Detroit.

He’s continuing his introductory statements in favor of the city’s Plan of Adjustment. Two other attorneys also plan to make opening statements in support of the restructuring plan: Arthur O’Reilly, who represents the Detroit Institute of Arts, and Sam Alberts, who represents the Official Committee of Retirees.

(You can listen to Sam Alberts on WDET here.)

Several creditor attorneys say they will counter the city and its supporters with opening statements objecting to the plan as it now stands. They’re expected to present some arguments about why Judge Steven Rhodes should not approve the Plan. They include lawyers for bond insurers Syncora and FGIC, as well as counsel for the UAW, AFSCME and Macomb, Oakland and Wayne counties.