DETROIT, Oct 23 (Reuters) - A trial on Detroit's eligibility for bankruptcy protection kicked off on Wednesday with opponents claiming the city tried to bypass restrictions on cutting workers' pensions, as experts in municipal bankruptcy around the country watched closely in a case that could set important precedents.
At issue is whether Detroit, which in July filed the largest municipal bankruptcy in U.S. history, negotiated in good faith before it sought protection from its creditors.
The city says that there is no alternative to bankruptcy, that no other solution exists to rescue Detroit from its deep financial troubles.
Attorneys for labor unions, retirees, and the city's pension fund argued that the city and the state of Michigan were so hell-bent on filing for bankruptcy that Detroit's emergency manager, Kevyn Orr, failed to meet requirements for a proper filing.
U.S. Bankruptcy Judge Steven Rhodes, who is presiding over the trial, gave Detroit and its opponents three weeks to file written arguments on what may be a key point of contention in the case: What constitutes "good faith" bargaining.
The trial, which pits retirees, pension funds and unions trying to preserve retirement benefits for workers against the city, has become a touchstone for a city that has seen corruption, poor management and a declining population base contribute to a sense of stagnation and decline.
Outside the Theodore Levin U.S. Courthouse in downtown Detroit Wednesday morning, about 300 protesters rallied, most of them union members who face cuts to their pension benefits under Orr's plan.
"Hands off our pensions! Take it from the banks!" they chanted as they carried signs and shouted slogans saying that banks and not people should be made to feel the pain if the city cuts pension payments or other outlays.
Orr, appointed by Michigan Governor Rick Snyder as the city's emergency manager, has said he hopes to use federal bankruptcy to repair Detroit's troubled finances.
Unions and pension funds claim that negotiations outside of bankruptcy would lead to the best outcome for a city facing $18.5 billion in debt, declining population, a high crime rate and a breakdown in urban infrastructure.
Bruce Bennett, in an opening statement, said the city needs bankruptcy for the good of its financial health and the well-being of its citizens, saying that tax increases and other revenue-generating measures are not an answer.
"There's nothing left to do here," Bennett said, arguing that the city is insolvent. "There's no revenue solution."
Labor officials disagreed.
Babette Ceccotti, representing the United Auto Workers union, in her opening statement said the city had a "deliberate plan" to use bankruptcy to restructure its debts because it would allow it to pre-empt the state constitution which stipulates that pensions cannot be reduced.
"We think that by connecting all the dots here, the plan was to use Chapter 9," she said.
The trial is expected to extend at least into next week. Rhodes has scheduled 10 days of hearings over three weeks. He likely will not rule whether the city was eligible to file for bankruptcy until at least mid-November.
Rhodes will decide whether Detroit is eligible to restructure its debts and liabilities under Chapter 9 of the U.S. bankruptcy code, which gives cities wide latitude in how to deal with creditors and grants the court broad powers to resolve disputes.
THE CITY'S INSOLVENT. NO IT ISN'T.
None of the parties question whether Detroit is in deep trouble. 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 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.
Whether those troubles amount to bankruptcy under federal law is legal question, not a financial one.
To prove its eligibility for a Chapter 9, Detroit must show it had proper authorization to file the case; is financially insolvent; negotiated in good faith with its creditors or had so many creditors that such negotiations were not feasible, and requires bankruptcy protection in order to deal with $18 billion in debt and other liabilities.
Prominent politicians and other public officials are expected to testify in the trial, Orr and Snyder among them.
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.
Many bankruptcy experts say Rhodes is likely to find Detroit eligible. But Rhodes' ultimate ruling is hardly a foregone conclusion.
How Rhodes rules, and how the city restructures its debt, may set precedents for other struggling municipalities, bankruptcy experts said.
Detroit's case is closely watched nationally, especially by other U.S. cities considering bankruptcy because of their inability to solve underfunded pensions, strained labor relations and "some politicians not able to say no to employees and retirees," said Kenneth Klee of Klee, Tuchin, Bogdanoff & Stern in Los Angeles, who is representing Jefferson County, Alabama, in its Chapter 9 case.
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 change 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 federal bankruptcy action.
Anthony Ullman, attorney for a committee representing the 23,500 city retirees, said Detroit could monetize assets that include its water and sewer system, or some works in the Detroit Institute of Arts to avoid bankruptcy.
City attorney Bennett countered, stating no sale of art assets would be possible without "significant change in the current management of the museum or litigation," he said.