Federal Judge Rules That Detroit Is Entitled to Revenue From Casinos

A federal judge ruled on Friday that Detroit was entitled to casino revenue worth about $15 million a month and could use the money to settle its debts in bankruptcy, rejecting arguments from a bond insurer that the money was beyond the city’s reach.

The insurer, Syncora Guarantee, said it would appeal the decision quickly to the United States Court of Appeals for the Sixth Circuit so the matter could be resolved before Detroit starts seeking court approval of its bankruptcy-exit plan in mid-August. An appeals court ruling in Syncora’s favor could reduce the pot of money that Detroit proposes to distribute to its many creditors, and that, in turn, could disrupt Detroit’s planned exit from bankruptcy.

The city’s emergency manager, Kevyn Orr, has been trying to push the giant bankruptcy case forward rapidly in the hope of restoring a semblance of normalcy in Detroit and giving residents a reason to stay and rebuild.

Also on Friday, Detroit’s bankruptcy judge, Steven Rhodes, asked the United States attorney general, Eric H. Holder Jr., to provide a brief on whether Chapter 9 bankruptcy is unconstitutional if it impairs the claims of property owners whose land has been seized under eminent domain, or the demands for compensation of people injured in confrontations with the police. In his request for the brief, Judge Rhodes said people in such circumstances were objecting to Detroit’s plans for settling its debts and emerging from bankruptcy, and he asked the attorney general to weigh in by Aug. 13.

The dispute with Syncora over casino taxes grew out of a transaction that has been a serious sticking point for Detroit since before it declared bankruptcy: a $1.4 billion borrowing of cash to shore up the city’s rickety pension system in 2005. The debt issued in that deal was the first thing the city defaulted on as it prepared to file for bankruptcy last summer, and now Detroit’s plan of adjustment proposes to give the investors who bought it one of its lowest recovery rates.

Some of the 2005 pension debt had floating interest rates, and Detroit added interest-rate swaps to protect itself if interest rates rose. Syncora insured some of the debt as well as some of the swaps and even bought some of the debt. Its resulting exposure is about $400 million, according to court filings.

The swaps had to be restructured in 2009, and Detroit agreed with its two counterparties, Bank of America and UBS, to use its casino-tax revenue to backstop the payments it owed them. The tax money went into a “lockbox” arrangement, in which Detroit could not spend it until it made its swap payments.

But with bankruptcy looming in June 2013, Detroit canceled a $40 million payment on the 2005 debt, setting off a tug-of-war over the money accumulating in the lockbox. Syncora reported a default and called on the lockbox custodian to “trap” the casino revenue. But Detroit, which planned to use the money to help finance its operations in bankruptcy, sued Syncora in state court and won a temporary order releasing the money. Syncora then went to federal court, seeking to have Detroit’s order dissolved.

From there, the battle escalated as the city and the insurer traveled to half a dozen state, federal and appellate courts, in Michigan, New York and Ohio, both arguing that the money was rightfully theirs.

Detroit said that once it had declared bankruptcy, Syncora could no longer lay claim to the money because the bankruptcy court automatically stayed such efforts by creditors.

Syncora disagreed, arguing that Detroit did not in fact have the money when it declared bankruptcy. It was supposed to stay in the lockbox until Detroit had corrected its default on the debt instruments. As an insurer of Detroit’s obligations under the deal, Syncora said it was the beneficiary of the lockbox arrangements.

In August, Judge Rhodes ruled that the money was city property and protected by the bankruptcy stay. Syncora appealed to the Federal District Court for the Eastern District of Michigan and both sides submitted their briefs, but nothing happened for seven months, even as the proceedings in bankruptcy court went forging ahead.

Finally, this month, the federal appeals court said that the district court judge had improperly held up Syncora’s appeal and ordered the judge to rule by Monday.

Correction: July 12, 2014
An earlier version of this article described incorrectly a request from the judge overseeing Detroit's bankruptcy for a legal brief from the United States attorney general. He is asking whether Chapter 9 bankruptcy is unconstitutional if it impairs the claims of property owners whose land has been seized under eminent domain or the demands for compensation from people injured in confrontations with the police, not whether it is unconstitutional if it allows cuts to public workers’ pensions.