Insurers Seek Enforcement Of State Law Protections For City Of Detroit GO Bonds

On November 8, 2013, three monoline insurers of the City's general obligation bonds commenced adversary proceedings in the City of Detroit bankruptcy case.1Through these actions, the monoline insurers seek to compel enforcement of the status quo for the general obligation bonds by requiring the City to continue to segregate ad valorem taxes in accordance with Michigan law. As these actions progress, they may clarify whether state law protections for general obligation bonds apply in chapter 9 and test the jurisdictional limitations imposed on a bankruptcy court by section 904(2) of the Bankruptcy Code.

Background

National Public Finance Guarantee Corporation, Ambac Assurance Corporation, and Assured Guaranty Municipal Corporation (the "Plaintiffs") filed adversary complaints in the Bankruptcy Court for the Eastern District of Michigan against the City of Detroit, the City's Emergency Manager, and other City officials. The complaints were filed in response to the City's payment default on certain series of unlimited tax general obligation bonds and limited tax general obligation bonds (collectively, "GO Bonds") and in response to the City's recently filed motion seeking approval of post-petition financing. The Plaintiffs seek declaratory relief that, among other things, would limit the City's use of ad valorem taxes and require the City to continue segregating certain ad valorem taxes to satisfy its obligations under the GO Bonds.

On October 1, 2013, the City failed to make a $9.37 million payment on the GO Bonds. The Plaintiffs, as insurers of the GO Bonds, paid under their policies and became subrogated to the rights of the GO Bondholders. According to the Plaintiffs, Michigan law imposes strict limitations on the City's ability to use ad valorem taxes for any purpose other than the repayment of general obligation bonds. The Plaintiffs also contend that Michigan law requires that the ad valorem taxes be deposited into segregated debt retirement accounts as they are collected.

According to the Plaintiffs, the City allegedly stated publicly that it intends to continue to use the ad valorem taxes to fund the City's general operations. The Plaintiffs also allege that the City stated that it will not segregate the ad valorem taxes. Further, the Plaintiffs maintain that the City is prohibited from granting a super-priority lien on the ad valorem taxes in favor of a potential post-petition lender to the City.

According to the Plaintiffs...