Jul. 9, 2014

Detroit seeks Kwame Kilpatrick records in bankruptcy fight

The City of Detroit is digging for records to expose details of Kwame Kilpatrick’s $1.4-billion pension borrowing scheme that helped drive the city into bankruptcy and now lingers as one of the last remaining obstacles to a successful restructuring.

Detroit bankruptcy lawyers have subpoenaed a New York trade publication and several key players in the hunt for any information that could bolster the city’s case that the entire 2005 deal was illegal and that the bankrupted city does not owe anything.

The high finance deal, designed to eliminate the city’s unfunded pension liabilities, also included a complex hedge bet meant to control interest rates on the massive loan.

The city wants to use any evidence it finds so it can block any attempt from two bond insurance companies to derail the city’s bankruptcy plan to be argued out during a scheduled mid-August court date.

If the city’s proposed bankruptcy plan is approved by the judge, the two bond insurers, fighting for their financial lives, will have to cover some or all of the soured debt. It could drive at least one of them out of business.

Among the documents the city’s bankruptcy lawyers are searching for include communications between Kilpatrick and his associations about the deal, which Detroit emergency manager Kevyn Orr now argues was improper and should have never been approved, or insured.

Among the possible problems was that the massive amount of borrowing was set up in a way to circumvent Michigan’s municipal borrowing limits.

Bill Nowling, a spokesman for Orr, said the city does not comment on its legal strategy.

Related: How Detroit went broke

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The city has subpoenaed the Bond Buyer to provide records documenting why it gave a the Midwest Regional Deal of the Year award to Kilpatrick in a glitzy ceremony in New York in December 2005. The subpoena thrusts the New York trade publication into the middle of the largest municipal bankruptcy in U.S. history.

Michael Scarchilli, editor in chief of the Bond Buyer, declined to comment.

The honor was mostly ignored at the time, but it surfaced in September 2013 in the Free Press’ “How Detroit went broke” report as an example of how the debt deal was celebrated at the time.

One city adviser on the deal, Robert W. Baird & Co., issued a news release bragging about the award.

The award honored Kilpatrick and then Detroit finance chief Sean Werdlow for orchestrating a complex $1.4-billion borrowing deal — called pension obligation certificates of participation — to eliminate the city’s unfunded pension liabilities.

The city also subpoenaed Werdlow to testify and provide records about his role. Werdlow, the architect of the deal on Kilpatrick’s behalf, joined the company that lined up the financing a few months after the transaction was completed.

The subpoena instructs Werdlow to deliver documents regarding the “terms of and circumstances surrounding your employment” with Siebert Brandford Shank & Co., which helped broker the pension debt deal and related swaps transaction.

Bob Berg, a spokesman for Werdlow, said the SBS executive would comply.

Another person involved — former Detroit budget director and finance official Roger Short — also was subpoenaed to explain his role in the transaction. He did not respond to a request from the Free Press for comment.

Detroit’s bankruptcy lawyers from Jones Day argue that deal was a “sham” and should be wiped out.

Kilpatrick’s administration structured the deal to create two shell corporations that borrowed the cash and purchased a financial product called “swaps” from two global banks, allowing the city to secure a steady 6% interest rate on the debt.

But the deal went south when U.S. interest rates plummeted. As part of its bankruptcy dealings, the city is set to pay $85 million to UBS and Bank of America Merrill Lynch to get rid of the swaps debt. The city had pledged its critical casino tax revenue as collateral on the swaps in 2009, further endangering the city’s finances.

On Wednesday, the U.S. 6th Circuit Court of Appeals ruled that a U.S. District Court judge in the Eastern District of Michigan must rule whether the casino tax revenue is the property of the city — or whether Syncora has a right to seize the revenue because of the city’s bankruptcy.

The appellate panel ordered the District Court judge to rule by July 14, so that Syncora has a right to appeal before Rhodes rules on the city’s bankruptcy restructuring plan.