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UPDATE 1-U.S. Bankruptcy Court to decide if Detroit really is broke

Joseph Lichterman and Bernie Woodall
Wednesday, 23 Oct 2013 | 12:45 PM ET

DETROIT, Oct 23 (Reuters) - Is Detroit bankrupt? A federal judge began hearing arguments Wednesday morning in Detroit on the largest municipal bankruptcy filing in U.S. history that will ultimately will answer that question.

For a city saddled with massive debts and fighting to deliver services to its residents, the answer may sound simple. But the decision by U.S. Bankruptcy Judge Steven Rhodes on whether Detroit is eligible to restructure its debts and liabilities under Chapter 9 of the U.S. Bankruptcy Code that covers municipalities will rest on a slew of complicated issues to be addressed over a multi-day hearing.

Prominent politicians and other public officials are expected to testify. Kevyn Orr, the city's emergency manager who has broad powers over Detroit's finances, is expected to testify on Friday, his spokesman, Bill Nowling said by a Twitter message.

Michigan Governor Rick Snyder, who appointed Orr, is expected to testify on Monday, Matthew Schneider, chief legal counsel for the Michigan attorney general, told Rhodes on Wednesday morning minutes before the hearing started.

Detroit Police Chief James Craig also is expected to testify this week about the city's poor public services, including its sorely strained police department.

The need to tackle Detroit's battered public services was one of several issues discussed in opening arguments on Wednesday.

"Without solving that problem, there may not be a city to reorganize," Bruce Bennett, an attorney with Jones Day who is representing the city, said in his opening statement.

Orr resigned from Jones Day to take the emergency manager position.

The hearing will pit retirees, pension funds and unions trying to preserve retirement benefits for city workers against the city in the fight over bankruptcy -- which will determine how Detroit's emergency manager can try and right the city's strained finances.

Outside the federal courthouse on Wednesday, about 300 protesters rallied, most of them union members who face cuts to their pension benefits under Orr's plan. They carried signs and chanted slogans saying that banks and not people should be made to feel the pain of any payment cuts the city makes.

"Hands off our pensions! Take it from the banks!" they chanted.

That Detroit is struggling is no secret. Whether its massive troubles amount to bankruptcy under federal law is still to be decided.

More than one-third of the city's residents live below the government poverty line. There are some 78,000 abandoned structures and just 40 percent of the street lights work. The population has shrunk to less than 700,000, from a peak of 1.8 million in 1950, and only 53 percent of property owners paid their 2011 property taxes.

THE CITY'S INSOLVENT. NO IT ISN'T.

At the multi-day hearing at the Theodore Levin U.S. Courthouse, Detroit's attorneys are expected to tick off arguments meant to meet the standard to prove the legal requirements for Chapter 9 bankruptcy protection.

Among the arguments: Detroit had proper authorization to file the case; it is financially insolvent; it negotiated in good faith with its creditors or had so many creditors that such negotiations were not feasible, and it requires bankruptcy protection in order to deal with $18 billion in debt and other liabilities.

Objectors have argued that Chapter 9 is unconstitutional and that Michigan's constitution protects pensions from being slashed. And unions, pension funds and retirees, which have all filed objections to the bankruptcy, are expected to argue that the city is not insolvent.

Many bankruptcy experts say Rhodes is likely to find Detroit eligible, though his ultimate ruling is hardly a foregone conclusion.

"Chapter 9 is never routine," said Juliet M. Moringiello, a law professor at Widener Law School in Harrisburg, Pennsylvania, who has followed proceedings in the Detroit case.

The city filed the case on July 18, and it said about half of its liabilities stem from retirement benefits, including $5.7 billion for healthcare and other obligations, and $3.5 billion involving pensions. How the city restructures its debt may set precedents for other struggling municipalities, bankruptcy experts said.

"We'll see other Chapter 9s," said Kenneth Klee of Klee, Tuchin, Bogdanoff & Stern in Los Angeles, who is representing Jefferson County, Alabama, in its Chapter 9 case. "The pension problem is one that will require resolution, and with the labor relations being strained in parts of the country and some politicians not able to say no to employees and retirees, I expect there will be other chapter 9s to be filed."

The opening of arguments on the eligibility for bankruptcy followed a pre-trial hearing that finished on Monday on legal authority issues surrounding the bankruptcy as objectors argued that Chapter 9 is unconstitutional and that Michigan's constitution protects pensions from being slashed.

"It's one of those moments that I think that we will look back on and say, 'This is where Chapter 9 changed,"' attorney Barbette Ceccoti told the court on Monday on behalf of the United Auto Workers union, which represents some city workers.

Moringiello said parties tend to object to bankruptcy filings because they think they can do better under state law, and she said if Rhodes does not grant eligibility the creditors likely will try to get a state court to force the city to pay its debts.

"Those are not terribly effective remedies," she said. "You don't have the same remedies you have against a private debtor."

UNION OBJECTIONS

A lawyer representing the city's pension funds said in court on Wednesday that the city and the governor's office were fully intent on filing for bankruptcy without negotiating with the city's unions.

Jennifer Green, of law firm Clark Hill, displayed copies of emails and documents from city and state officials that she said show the city had planned weeks ahead of time to file for bankruptcy on July 19.

She said that Orr used a pencil to the filing date on legal documents, to show a date of July 18, in order to beat a state court filing that had the potential to prevent the city from filing with the federal bankruptcy court.

The unions, pension funds and retirees that are fighting against bankruptcy, have said that the city did not appropriately negotiate with its creditors because Orr only held informational meetings, not formal negotiating sessions, before filing for bankruptcy.

They also are expected to contend that Detroit is not insolvent, with assets that include its water and sewer system or the works of the Detroit Institute of Arts that it could be monetize.

City attorney Bennett, in his opening statement on Wednesday, countered the claim that part of the museum's collection could be easily sold. No sale would be possible without "significant change in the current management of the museum or litigation," he said.

Michigan's attorney general earlier this year issued an opinion saying the museum could not sell any of its art.

Bennett said it was impossible for the city to negotiate with all its creditors, but said that the city tried "really hard" to negotiate with the creditors out of court in good faith.

Rhodes has scheduled 10 days of hearings over the next three weeks, but attorneys have indicated the arguments could wrap up as early as next week. It is not clear how soon Rhodes could issue his ruling.

"There are only so many things they can fight about," said John Pottow, a University of Michigan professor who specializes in bankruptcy law. "They can fight about the solvency and they can fight about the negotiating in good faith. It probably won't take too long to have a trial, but it's a big stakes thing."