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Analysis: Detroit set to beat bad-faith charge over bankruptcy

Vehicles enter and exit the downtown on the freeway, in front of General Motors World Headquarters in downtown Detroit, Michigan July 20, 20
Vehicles enter and exit the downtown on the freeway, in front of General Motors World Headquarters in downtown Detroit, Michigan July 20, 20

By Tom Hals

WILMINGTON, Delaware (Reuters) - Meetings without the chance for any back and forth, unreturned phone calls and brusque tactics. To opponents of Detroit's bankruptcy filing, Emergency Manager Kevyn Orr has utterly failed to negotiate with them.

But retired city workers, who are fighting to stop their pensions from being cut, and hope to stop Detroit's bankruptcy by claiming in court that Orr didn't engage in good-faith negotiations, are likely out of luck.

To be sure, Orr would have done himself a favor if he'd done more negotiating, legal experts say, but his cursory approach to talks won't derail the city's bid to go into bankruptcy.

In fact, Detroit more than meets the prevailing legal standards and Orr should have no difficulty persuading a federal judge to allow the bankruptcy to go ahead, they said.

"It's highly unlikely that creditors will be able to block Detroit's eligibility," said Patrick Darby of Bradley Arant Boult Cummings. Darby, who represents Jefferson County, Alabama, in its bankruptcy, is not involved in Detroit.

In municipal bankruptcies, unlike corporate cases, cities and towns must prove they are eligible to go into bankruptcy before they can get court protection from their creditors.

Municipalities have several paths they can choose to be granted bankruptcy protection, including proving that they negotiated in good faith with its creditors.

In Detroit's case, the numerous creditors and creditor groups have cried foul.

Instead of negotiations, the city held what creditors say were more like presentations. Creditors sat in an auditorium and wrote questions on index cards, which they passed on to Detroit's lawyers from Jones Day.

And, for example, Syncora Guarantee Inc, which insured millions of dollars of the city's bonds, complained in court documents it was unable to get Orr or members of his team on the phone.

David Skeel, a professor at the University of Pennsylvania Law School, said the standard for proving good-faith in negotiations was relatively low. While it probably would require more effort than one mass meeting of creditors "you don't have to go to the ends of the earth with every creditor," he said.

The city, though, has a much stronger argument on its side.

LAW CHANGED

Under a change to Chapter 9 bankruptcy law that was made while New York was in difficulties in the 1970s, municipalities can instead argue that good-faith negotiations are impractical.

Detroit has made this argument.

"Despite the ultimate impracticability of such negotiations, the City nevertheless attempted, where possible, to negotiate with its various creditor constituencies in good faith," Detroit said in court papers.

Because municipal bankruptcies are rarer than corporate ones, there are fewer precedents. But Detroit can point to a ruling from June involving the California city of Stockton to make its case.

U.S. Bankruptcy Judge Christopher Klein in Sacramento ruled that even if Stockton had not negotiated in good faith, it was still eligible for bankruptcy because such negotiations would have been impractical given it had 2,400 retirees.

By comparison, Detroit estimates it has well over 100,000 creditors, many of which it still has not identified.

Doug Mintz, a Chapter 9 specialist with the law firm Orrick, Herrington & Sutcliffe in Washington, said he was unaware of a municipality ever failing to win the argument when it said that negotiations were impractical.

The change in the law stemming from New York City's financial crisis almost 40 years ago, was adopted for just such a situation as Detroit now finds itself in, experts say.

In a report in 1975, the U.S. Congress said Chapter 9 was "hopelessly archaic and unworkable for all but the smallest" entities. It then adopted the changes making the eligibility requirements more flexible.

In addition to the requirement on negotiations, Detroit must also pass four other tests: The city has to prove it is a municipality, that it was authorized to file, that it is insolvent and that it is seeking bankruptcy to implement a plan to deal with its obligations.

U.S. Bankruptcy Judge Steven Rhodes has not set a date for an eligibility hearing. The hearing is likely to include many days of testimony including expert witnesses. The eligibility hearing for Stockton's far less complex case ran three days.

Once it is found eligible for bankruptcy, the harder task for Detroit and Orr is to find a way to get past the current war of words with creditors.

"It's kind of hard to get that genie back in the bottle once everyone has drawn their weapons," Skeel said.

(Reporting by Tom Hals in Wilmington, Delaware; Editing by Eddie Evans and Tim Dobbyn)

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