By Deepa Seetharaman
DETROIT (Reuters) - Detroit intends in coming days to propose a new settlement in U.S. bankruptcy court to end costly interest-rate swaps, the third such attempt since the city declared bankruptcy, an attorney representing the city said on Wednesday.
Robert Hertzberg, a partner at law firm Pepper Hamilton, told Judge Steven Rhodes that the city will file a motion in the next three or four days. Rhodes rejected two prior settlement proposals with swap counterparties UBS AG and Merrill Lynch Capital Services, calling them too costly for the city.
Notice of the new deal came during a hearing on other matters in the city's historic bankruptcy, including whether Detroit is obliged to pay off voter-approved general obligation (GO) bonds and the need for an unsecured creditors committee in the case.
If GO bonds emerge as unsecured debt in this case, it could severely raise borrowing costs for Detroit and other local governments in Michigan. It could also draw investors in the $3.7 trillion municipal market towards bonds from states with laws and history that protect payments on such debt.
Rhodes formally declared Detroit bankrupt late last year, clearing the way for potentially sweeping cuts for worker pensions and bondholders, and ordered the city to present a blueprint for how it treat some $18 billion of debt.
Lawyers for the city said Wednesday that Detroit hoped to file this plan of adjustment this week.
"The goal is to complete this restructuring in the warmer months of this year," said Jeffrey Ellman, an attorney for the city with law firm Jones Day
SETTLING THE SWAPS
The city's swap agreements were meant to hedge interest rate risk on some of the $1.45 billion of pension debt Detroit sold in 2005 and 2006. But the swaps, valued at $400 million in 2011, soured as interest rates dropped along with Detroit's credit ratings. The money owed the banks was a key element that drove the city to file for Chapter 9 municipal bankruptcy in July.
Rhodes rejected last month a proposed settlement that would have allowed Detroit to end the swaps at a 43 percent discount of $165 million plus up to $4.2 million in fees.
At that time, the judge also said the city could succeed with legal challenges to the validity of the swaps, noting that the city probably did not have a right under Michigan law to pledge its casino revenue as collateral to secure the swaps.
Detroit filed a lawsuit on January 31 in U.S. bankruptcy court seeking to invalidate the pension debt, a move that could also void the swaps.
Rhodes also heard arguments about the need for an unsecured creditors committee formed by U.S. Trustee Daniel McDermott in December. The committee includes Detroit's two pension systems, which are its largest unsecured creditors, and bond insurer Financial Guaranty Insurance Co.
The judge said he will issue a written opinion after grilling attorneys for the U.S. Trustee and the committee on whether its existence was a cost-effective move.
"We've got to control costs. Everybody has to add value to the case. Where's your value?," Rhodes asked one lawyer.
Detroit's attorneys argued that all of the city's major unsecured creditors have already participated in the case, including mediation, and have legal representation.
Earlier in the bankruptcy case, McDermott at the city's request put together another committee to represent scores of retired Detroit workers.
Between July and September, the retirees committee has cost the city nearly $1.96 million in fees and $61,500 in expenses, according to a report released this month by a court-appointed fee examiner.
KEY BOND DISPUTE
Rhodes was also hearing arguments over whether Detroit's pledge of tax revenue to pay off voter-approved bonds is a binding obligation or merely a promise that the broke city cannot keep.
Kevyn Orr, the state-appointed emergency manager running Detroit, has deemed some $410 million of general obligation bonds outstanding at the end of the city's fiscal 2012 as unsecured debt, and the city defaulted on an October 1 payment on the bonds.
Detroit has asked the judge to dismiss lawsuits filed by bond insurers on the hook to make up millions of dollars in missed principal and interest payments on Detroit's bonds. The insurers contend that only they and bondholders have a right to property tax revenue collected and pledged to pay off the debt.
In court filings, the city argued that while Michigan law refers to a "pledge" on the bonds, it is "only as a synonym for 'promise,' as in 'I pledge allegiance to the flag.'"
(Reporting by Deepa Seetharaman and Rachel Jackson in Detroit, writing by Karen Pierog. Editing by Steven C. Johnson and Andrew Hay)