Detroit, Monoline Insurers In ‘All Or Nothing’ Lawsuit

Detroit1848983 / Pixabay

Detroit and monoline bond insurance companies are waiting for a ruling on whether the city’s general obligation bonds (GOs) are secured or unsecured obligations, and the decision seems to hang on how the judge chooses to interpret the word ‘pledge’.

Detroit pledged to pay back the GOs with special taxes whose proceeds could only be deposited into an earmarked bond repayment account, and could only be used for that purpose. The municipality has argued that the pledge doesn’t hold now that it has declared bankruptcy.

Ruling will affect future GO bonds

Detroit currently plans to pay back secured debt in full, but to only pay unsecured debt back at 20 cents on the dollar. Compared to the $18 billion Detroit currently has on its balance sheet that’s not a great sum, but there is also the issue of setting future precedent.

“We believe the ruling’s real impact could be to create a precedent for the treatment of GO debt that could be applicable to such debt throughout the country,” writes BTIG Research analyst Mark Palmer. It’s still possible (though not likely) for the two sides to reach a repayment agreement, but once the decision comes down there won’t be much room for negotiation.

“The decision here is most likely all or nothing,” said U.S. Bankruptcy Judge Steven Rhodes. “One side is going to win and the other side is going to lose.”

Precedent favors the monolines, not Detroit

Attorney and monolines blogger Christian Herzeca thinks Detroit should be worried. Rhodes has already said that he will follow Michigan law during Detroit’s bankruptcy, and there is already precedent on the books for similar situations.

“When Judge Rhodes turns to Michigan law to answer this question, he will be directed by the monolines to a state Michigan court of appeals decision, Kinder Morgan v. City of Jackson,” writes Herzeca.

In that case, the court ruled that “obligations pledging the unlimited taxing power of the local governmental unit are necessarily obligations by which a municipality pledges its unlimited taxing power as security for the repayment of the debt.”

Since the taxing power was used as ‘security’ in that case, Detroit will either need to find something that significantly distinguishes the two cases or provide a compelling reason for Rhodes to go against existing precedent.

“I am still thinking that the monolines have the better of this one,” writes Herzeca.

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About the Author

Michael Ide
Michael has a Bachelor's Degree in mathematics and physics from Boston University and Master's Degree in physics from University of California, San Diego. He has worked as an editor and writer for several magazines. Prior to his career in journalism, Michael Worked in the Peace Corps teaching math and science in South Africa.

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