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One judge to decide the future of Detroit

DETROIT— In a trial set to open in the federal courthouse here on Tuesday, nothing short of this city's future is at stake.

If Judge Steven W. Rhodes approves a blueprint drawn up by Detroit officials to eliminate more than $7 billion of its estimated $18 billion in debts and to invest about $1.5 billion into the city's now dismal services, it will mark the beginning of the end of the nation's largest-ever municipal bankruptcy. The outcome will set this troubled city's new course for the coming decades, perhaps longer.

Grand River Avenue in Detroit.
Jeff Kowalsky | Bloomberg | Getty Images
Grand River Avenue in Detroit.

In deciding whether the city's plan is equitable, feasible and in the best interest of creditors, Judge Rhodes will send significant messages beyond Detroit about the rarely tested powers and limits of municipal bankruptcy, at a time when many cities are struggling with underfunded pensions, neglected infrastructure and declining industries.

Municipal bankruptcy, known as Chapter 9, was designed to give creditors, and even judges, less power than Chapter 11 corporate bankruptcy does, but the law has never before been tested on this scale. Leaders of other cities will be watching closely, turnaround experts said, as the judge decides whether a city may shelter municipal retirees even as it imposes harsher losses on financial creditors; whether it can use bankruptcy to repudiate some capital-markets debts entirely; and whether a city in bankruptcy may avoid selling off valuable assets to raise money for its creditors, as Detroit hopes to do with its art collection.

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For months, as the city's lawyers struck deals during mediation with retirees and other creditors, Detroit's passage through bankruptcy has gained momentum, raising the possibility that after seeking bankruptcy protection just one year ago, it might emerge with relative ease and remarkable speed, by fall. Yet, as Judge Rhodes prepares to hear what is expected to be more than a month of testimony on the city's blueprint, serious impediments and numerous unknowns remain.

In voting that is part of the bankruptcy process, majorities of six classes of the city's creditors cast ballots in favor of the city's plan in recent months, but five other voting classes rejected it. Some opponents, including the bond insurers Syncora and Financial Guaranty, have vehemently fought the plan, saying it improperly favors some creditors over others, and uses a questionable transaction to put the riches of the art collection beyond the creditors' reach.

Syncora went so far as to file an objection calling that transaction ''a quasi-political maneuver'' hatched by the chief mediator of the bankruptcy, Gerald E. Rosen, who Syncora said was biased in favor of Detroit's retirees. Judge Rosen is also the chief judge of the United States District Court for the Eastern District of Michigan, the seat of the bankruptcy court.

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''It's going from hardball to really hardball,'' said David Skeel, a bankruptcy law professor at the University of Pennsylvania. ''It sure seems like Syncora has concluded that they will not get what they want either out of the mediator or the bankruptcy judge, and they're using a scorched-earth policy to see if they can win on some kind of appeal.''

Last week, Judge Rhodes called Syncora's accusations ''manifestly improper and false'' and ordered them stricken from the court record.

Beyond those problems, Judge Rhodes must grapple with larger, essential questions about Detroit's fate: Even if the city's debt-cutting answers Detroit's immediate financial crisis, will it go far enough to prevent the city from sliding back into the same miserable circumstances of overwhelming debt, annual operating deficits and the threat of default and another bankruptcy in the years ahead? And will new spending to improve firefighting, police protection and archaic computer technology, and to remove tens of thousands of dilapidated buildings, be enough to restore city services and stop decades of departure and decline?

''This is a unique situation when you think about it,'' said Craig A. Barbarosh, a bankruptcy lawyer with the firm Katten Muchin Rosenman who is based in Costa Mesa, Calif., and represents some creditors. ''It's not like a company, where the judge can say, 'O.K., I'm going to liquidate the city.' ''

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Under the plan the city hopes Judge Rhodes will confirm, Detroit's more than 100,000 creditors would get a wide range of returns on their claims. Investors who bought $1.4 billion of certificates the city issued in 2005, to raise money for its pension system, could come away nearly empty-handed, since Detroit now calls the borrowing a sham transaction that should be voided entirely. By contrast, investors who bought a type of general obligation bond that was backed by a special, dedicated tax are slated to recover 74 cents on the dollar.

Thousands of retirees from the city's fire and police departments would expect no cuts to monthly pension checks, but smaller than expected cost-of-living increases in future years. General municipal retirees could see 4.5 percent cuts to their monthly pension checks, an end to cost-of-living increases and a clawback of previous payments from the pension system that are now deemed to have been improper. The more desirable outcomes for workers and retirees are possible with a separate, newly pledged pot of money: hundreds of millions of dollars from foundations, the state and other donors in an unusual, mediated deal called the grand bargain, to raise fresh money for the pension system and protect from sale the works of the Detroit Institute of Arts.

Creditors slated to get little or no money from the grand bargain hope to persuade Judge Rhodes that it cannot be approved, arguing that it discriminates unfairly and is not in the best interests of creditors.

During the trial, city lawyers will attempt to present evidence and witnesses, including Mayor Mike Duggan and Kevyn D. Orr, the emergency manager who has overseen this city for more than a year, to back up the need for their plan. A consultant hired by Judge Rhodes, Martha E. M. Kopacz, is to be questioned on her finding that Detroit's plan of debt adjustment is feasible.

An outright rejection of the city's blueprint would leave Detroit with no clear alternative. In municipal bankruptcy, unlike the corporate version, only the bankrupt government can propose an exit strategy. The judge can signal his preferences but cannot order amendments, and creditors cannot submit rival plans.

In the end, the up-or-down decision will belong to Judge Rhodes, a hard-to-read, sometimes intimidating force in the courtroom. Judge Rhodes, who got his law degree from the University of Michigan, was appointed as a bankruptcy judge in the Eastern District of Michigan in 1985. He is seen by those involved in the case as an expert on the bankruptcy code and a tough overseer of the proceedings, whose courtroom demeanor gives little hint at other aspects of his life, like his playing rhythm guitar in a classic rock band, the Indubitable Equivalents.

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For all sorts of political and legal reasons, leaders here are hoping for quick approval and a finish to the city's bankruptcy by the end of September. As of Sept. 27—18 months after Mr. Orr was assigned to take control of this city—he may be removed by a vote of elected officials in Detroit. Many residents have seen the state's appointment of an emergency manager as an undemocratic takeover of a mostly black city by the white Republicans who currently control the state government. Gov. Rick Snyder, the Republican who authorized a bankruptcy filing for the state's biggest city, is seeking re-election in November and if the city were to become bogged down in bankruptcy, it could become a campaign issue.

But even after Detroit leaves bankruptcy court, its issues will by no means be over. Legal appeals of the city's blueprint are likely. The city can expect years of financial oversight from a commission that includes representatives of the state as part of the deal struck to send state money to help spare pension cuts. And the city's larger questions will still loom: Can it actually begin rebuilding its tax base, financial stability and population, which has fallen below 700,000 and some demographers predict will drop still more?

—By The New York Times' Monica Davey and Mary Williams Walsh

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