By Karen Pierog
DETROIT (Reuters) - Detroit's controversial sale of $1.4 billion of pension debt, which has become one of the biggest disputes in the city's historic bankruptcy case, involved risks known to all the parties in the transaction, an attorney for the city said on Wednesday.
Geoffrey Stewart, a Jones Day attorney, said bond insurers and investors were not misled about the legality of the certificates of participation (COPs) Detroit sold in 2005 and 2006 to raise money for its unfunded pension liability.
"Everyone knew it was iffy," he argued in U.S. Bankruptcy Court. "Everyone chose to take a risk."
Financial Guaranty Insurance Co, the city's last major hold-out creditor, has claimed it was "fraudulently" led to guarantee payments on the debt.
Detroit, which is working its way through the biggest municipal bankruptcy in U.S. history, filed a lawsuit in January, claiming the sale of the COPs violated borrowing limits imposed on the city under Michigan law. The debt was issued during the term of former Mayor Kwame Kilpatrick, now in prison on federal corruption charges.
Bond insurer FGIC, which has a $1.1 billion exposure from the certificates, then filed a counterclaim against Detroit asking the court to dismiss the city's lawsuit seeking to void the debt.
The city defaulted on the COPs shortly before filing for bankruptcy in July 2013, leaving FGIC and another insurer, Syncora Guarantee Inc., to make debt service payments to investors.
Lawyers for FGIC and Wilmington Trust, the COPs trustee, argued that the debt sale allowed Detroit to meet a requirement under the Michigan constitution to fund its two retirement systems.
The parties asked the court for restitution and damages to be determined at a trial if the city prevails in its lawsuit. Paul H. Saint-Antoine, Wilmington's attorney, said there is an identifiable source for payment - the city's pension funds.
Judge Steven Rhodes, who is conducting a hearing on Detroit's plan to exit bankruptcy, said he would issue a ruling on the city's motion to dismiss the counterclaims.
Rhodes questioned why there should be restitution if the contracts the city entered into to sell the COPs were indeed illegal.
Under Detroit's plan to adjust $18 billion of debt and obligations and exit bankruptcy, COPs creditors, apart from Syncora, would only be entitled to share a remaining recovery of $123 million, according to Stewart. Syncora settled with the city last month.
He also said the city would have been better off tackling its pension funding problem in 2005 instead of getting deeper in debt through the borrowing, which he asserted benefited participating parties like bankers and lawyers.
"This wasn't a favor to the city," Stewart said.
Rhodes appeared to agree, saying the city substituted one debt for another.
"What good did that do?" the judge asked. "Better terms is only good if you can pay the better terms."
Rhodes must determine if Detroit's debt adjustment plan is fair and feasible for the city to exit bankruptcy.
(Reporting By Karen Pierog, additional reporting by Lisa Lambert in Washington; Editing by Cynthia Osterman)