‘Orr completely unprepared for bank negotiations’
Swaps are illegal; Say chances high of winning in court
By T. Kelly
The Michigan Citizen
DETROIT — Emergency Manager Kevyn Orr and his job performance took a beating in federal bankruptcy court Jan. 13.
Attorneys presented closing arguments for and against the plan presented by Orr and his former law firm Jones Day to settle the city’s interest rate swap obligations. The EM and his advisers want approval from presiding Judge Steven Rhodes to borrow $350 million from Barclays bank. They will use $230 million to pay off two clients of Jones Day: UBS AG and Bank of America. Both banks are parties to the interest rate swap agreements with the city. The remaining $120 million will be reinvested in the city, according to the Orr plan.
The city entered the swap agreements in 2005 to borrow $1.44 billion, propping up the city’s pension funds. Under the terms, if interest rates were low, the city would earn money and if interest rates were high, the banks would make money. Interest rates shot up shortly after the deal was made and to date the city has paid $300 million, according to attorney Jerry Goldberg who represented retiree David Sole in court opposing the Orr plan.
Since Orr filed for Chapter 9 bankruptcy in July, community groups such as Moratorium Now, National Action Network and Detroiters Resisting Emergency Management (D-REM) have been calling on Orr to sue the banks for fraud.
“Instead of going after these banks for their predatory lending practices which caused Detroit’s financial crisis by foreclosing on 100,000 homes and then putting the city in bankruptcy through interest rate swaps, which continued the banks’ fraudulent lending practices against the city itself — Orr is asking Judge Rhodes to approve a termination fee of an additional $165 million payment to these banks, funded by a loan by Barclays Bank at up to 8.5 percent interest with $4.2 million in ‘breakage fees,’” said Attorney Jerry Goldberg, Moratorium Now. “If this deal is approved, the people of Detroit will be paying 20 percent of city income tax revenues, $48 million a year, to these banks for the next four years, at the expense of city pensions, jobs and services,” Goldberg said.
Attorney Caroline English, representing creditor Ambac Insurance and other attorneys opposing the Barclays deal argued in the point the community has insisted on: The swaps are void; they were illegal agreements and the city has no obligation to repay the banks.
The swaps are illegal because the city did not follow Michigan municipal finance law, Act 34, in entering the swap agreements, and the city used casino revenues as collateral for the swaps in violation of the state gaming law, English argued in court Jan. 13.
The city created a corporation to appear as the borrower, because the city could not legally borrow any more money, English said. “It is inescapable the city is indebted under the swap obligations. The service corporations were used unlawfully to evade the Municipal Finance Requirement… The service corporations have no revenue.”
Orr and the Jones Day attorneys claim the city’s Home Rule status allowed it to borrow the money without the limitations of Act 34. But Home Rule has limitations, English said, and Act 34 is one such limitation.
“If the swap transaction is void under law, it is void as though it never existed.”
While Orr argues that using the casino revenues as collateral is legal, English said such use of the casino revenues does not fall under the list of general, quality of life purposes allowed by gaming laws.
English then questioned how Orr could have said the city only had a half chance of winning if it sued the banks to settle the swaps. “How did Orr say this claim has a 50-50 chance?”
“Orr did not go into negotiations armed,” said English.
The city’s negotiator and lead financial adviser, Kenneth Buckfire, “was completely unprepared,” English said. “There was not a serious consideration given to litigation.”
She listed Orr and Buckfire’s failures:
- They never seriously considered litigation;
- They did not request a cash flow analysis from Ernst and Young;
- They did not pursue the illegality of the swap deals;
- Orr provided only five emails and no other documents to show there had been no analysis of the finances;
- They could not substantiate the grounds on which Orr claimed the city had only a 50-50 chance of winning litigation against the banks;
- They settled for a deal that did not take into account where interest rates will be by year’s end;
- They did not acknowledge liabilities of the potential deal; and,
- They gave no consideration to the violations of using casino revenues as collateral; among other shortcomings.
“The city put itself in a box in June,” English said, referring to the Barclays deal promising the banks 75 cents on the dollar. In December, Rhodes ordered a renegotiation of that deal.
English said the new renegotiated deal “may be worse” than the original deal because of how ill-prepared Orr and Buckfire were in not having an expert projection of where interest rates are going in 2014. She presented a graph of interest rate projections showing the city may actually end up paying 78 cents on the dollar with the new deal.
English believes the city has a good chance of winning a suit that would void the debt. The swap obligations would be uncollectable, there would be no liens on casino revenues and the city could use that money for quality of life. The banks would instead owe the city millions.
“This deal should have the swap parties paying the city about $50 million a year,” English said. Rhodes asked what would happen to the parties if the city wins.
“You unwind the deal. The pension fund did not benefit in any way,” she said. “We submit the settlement agreement is far too rich for the banks.”
There is no way the court can determine if Orr’s agreement with Barclays is “fair and equitable” without knowing what the interest rates will be in January, English said.
Attorneys for retirees also presented legal and factual arguments before Rhodes that the deal should be rejected. They said:
- Orr did not, as law requires, try to borrow unsecured funds. Instead, Orr, claiming he had no experience with municipal bankruptcy, provided Barclays with the security casino revenues for the loan.
- Orr did not provide the council with the full loan agreement as required by PA 436, the Emergency Manager Law. Orr withheld the fact the interest rate for the Barclays deal ranged from 3.5 to 6.5 percent loan. Council was told it was 3.5 percent.