Decision Day Nears for Detroit Bankruptcy

Within days, Detroit could become the country's largest-ever municipal bankruptcy case as the city's emergency manager accelerates his plan for restructuring nearly $20 billion of long-term liabilities. As city tax revenue has fallen, Detroit has been struggling financially, spending on average $100 million more than it took in every year since 2008.

Updated July 17, 2013, 8:00 p.m. ET
Wall Street Journal

DETROIT— This automobile capital and onetime music-industry powerhouse could within days become the country's largest-ever municipal bankruptcy case, people familiar with the matter said, as the city's emergency manager accelerates his plan for restructuring nearly $20 billion of long-term liabilities.

The expected bankruptcy filing would come after Kevyn Orr, the emergency manager, failed to reach agreements with enough of the city's bondholders, pension funds and other creditors to restructure Detroit's debt outside of court.

Detroit's strategy, unveiled last month, is to pay off the majority of what secured creditors such as certain bondholders are owed while offering pennies on the dollar to unsecured bondholders, unions and pension funds. The moves are likely to prompt heated debates before a bankruptcy judge as each group argues its case for why it deserves a bigger payout.

The financial outlook has never been bleaker for the Motor City, which has shrunk from its peak of nearly two million people in 1950 to 700,000 today.

Hurt by a flight of residents and businesses to the suburbs, cuts in state aid and a crash in real-estate values, Detroit borrowed to meet operating costs as well as long-term liabilities such as pensions and health care for retired city workers.

As city tax revenue has fallen, Detroit has been on financial life-support, spending on average $100 million more than it took in every year since 2008.

Most at risk under the expected bankruptcy case is the city's $11 billion in unsecured debt. That includes almost $6 billion in health and other benefits for retirees; more than $3 billion for retiree pensions; and about $530 million in general-obligation bonds.

Municipal-worker retirees are set to get less than 10% of what they are owed under the plan.

The decision by the nation's 18th largest city by population is being closely watched by other states and municipalities burdened by steep pension and retiree health costs. But others say Detroit's problems are so acute that its case is an exception.

Mr. Orr, a longtime corporate bankruptcy lawyer, said in an interview that he still holds out hope the city can avoid a Chapter 9 filing.

But aides to Mr. Orr said the odds of an out-of-court settlement are extremely slim. So far, the city has an agreement to pay some secured creditors 75 cents on the dollar on nearly $340 million in debt. In exchange, the city would get back $11 million a month in tax revenue from the city's three casinos originally used as collateral to back the debt. But negotiations with unsecured creditors who were offered about $2 billion to cover $11 billion in debt remain stalled.

Any hope of a federal bailout to avert bankruptcy fizzled last week after Mr. Orr spoke with the White House, including Obama confidante Valerie Jarrett, according to city and White House officials.

A Chapter 9 filing would surpass the 2011 filling by Jefferson County, Ala., which ran into problems paying back $3.1 billion in debt linked to a troubled sewerage system.

Mr. Orr acknowledged he has been under pressure from his boss, Republican Gov. Rick Snyder, to move more quickly since his March appointment to chart the city's course out of fiscal insolvency. Mr. Orr and his top aides briefed Mr. Snyder at a two-hour meeting Monday with more than a dozen people in the governor's Detroit offices.

In the maple-lined conference room with barrel-vaulted ceiling that once was a boardroom for General Motors Co., GM -0.49% Mr. Snyder said he wanted to know more about how a potential bankruptcy would affect the life of average Detroiters, including 20,000 on city pensions, according to a person familiar with the matter. The governor also indicated he wanted to read the draft of the filing and all supporting documents before signing off on a bankruptcy.

No timetable was finalized and Mr. Orr didn't formally ask for the governor's approval for the filing, people familiar with the matter said.

The city's default in June on a $39.7 million payment for unsecured debt demonstrated its insolvency and recent discussions with creditors show Detroit is trying to negotiate in good faith, two criteria necessary for a government to file for bankruptcy, said Matt Fabian, managing director at research advisory firm Municipal Market Advisors.

Mr. Orr "has taken such a hard line with creditors that a bankruptcy filing is inevitable," Mr. Fabian said.

If Detroit seeks Chapter 9 protection, Mr. Orr said he hopes to steer the city out of bankruptcy court in a record six to eight months, during which it would restructure about $20 billion in liabilities with creditors. His plan also calls for $1.25 billion in new spending, including efforts to reduce crime and eliminate blight.

Some in the municipal finance world object to Detroit's treatment of some of its outstanding general-obligation bonds as unsecured, offering pennies on the dollar for repayment. They say the move could result in higher borrowing costs for municipalities across Michigan and, potentially, the U.S.

A "free fall" bankruptcy filing—one without a clear plan or much agreement beforehand with creditors—is a likely outcome.

People familiar with the matter say bondholders could tie the city up for months if not years in court with delay tactics in a bid to secure more favorable terms. And future borrowing at reasonable rates could be difficult for Detroit.

As for the city's costs of bankruptcy, Mr. Orr said legal and consulting fees could be substantial—$100 million or more—but declined to say how much he'd be willing to spend for fear of tipping off creditors opposing his efforts.

Some creditors remain skeptical about Detroit's prospects. Craig Barbarosh, a partner at Katten Muchin Rosenman LLP which is representing a Detroit creditor, said "a bankruptcy gives Detroit some breathing room and some new tools to try to resolve their problems." But just because a city files for bankruptcy, "that doesn't mean it will be successful."

But Mr. Orr said a Chapter 9 filing may go more smoothly for Detroit than other municipalities "because there is no other way out of here if we don't reach consensus."

A bankruptcy filing, according to Mr. Orr's team, could protect the city from related lawsuits filed by creditors and assemble all of the city's unsecured stakeholders in one class, likely the only way to deal with the thousands of pensioners.

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