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Analysis: Detroit bankruptcy expected to survive appeals process

Pigeons are seen near graffiti in Detroit, Michigan, December 3, 2013. REUTERS/Joshua Lott
Pigeons are seen near graffiti in Detroit, Michigan, December 3, 2013. REUTERS/Joshua Lott

By Tom Hals

(Reuters) - Detroit's financial overseers should prevail against appeals lodged by city worker unions and pension plans after a federal judge's landmark ruling on Tuesday allowing the city to become the largest U.S. city ever to enter bankruptcy protection.

Legal experts said U.S. Judge Steven Rhodes' ruling appears firmly rooted in the facts about Detroit's financial failure presented to him at last month's eligibility trial, and that will be more difficult to overcome on appeal than a ruling based solely on the judge's reading of a law.

"It's really hard to overturn that kind of finding," said Emanuel Grillo, a bankruptcy attorney with Goodwin Procter in New York. "That's a factual finding, and a factual finding is subject to a clearly erroneous standard."

Rhodes cited in his ruling details of the city's financial decline, such as the time it takes for police to respond to calls, as well as the spread of blight throughout the city. Rhodes has not released the text of his ruling but read from it on Tuesday.

Still, the appeals process will carry some risk for Detroit that some portions of Rhodes' ruling could be overturned, in part because there is no precedent for a city as large as Detroit to file for bankruptcy protection.

Fewer than 700 cities, counties and other government agencies have filed for Chapter 9 bankruptcy protection, which is reserved for government entities, since the Great Depression. Detroit is by far the largest. The city of 700,000 residents has more than $18.5 billion in debt and thousands of creditors.

BATTLE LINES

Rhodes found the city met a menu of eligibility tests for bankruptcy, such as being both insolvent and authorized by the state to seek protection from creditors.

That said, Rhodes found the city had failed to meet a requirement that it negotiate in good faith with creditors but had met an alternative standard that it had so many creditors as to make negotiating with them all an impractical undertaking.

Battle lines for the appeals were being sketched out even before a text of Rhodes' ruling had been published.

Moments after the judge delivered his ruling from the bench, the American Federation of State, County and Municipal Employees filed a notice of appeal.

The AFSCME attorney, Sharon Levine of a Lowenstein Sandler, said after Rhodes' ruling that the city filed for bankruptcy just 30 days after presenting a plan to creditors, which is not enough time to prove talks were unfeasible.

Overturning Rhodes on that issue will be difficult, Grillo said, because his ruling relies so heavily on the evidence and testimony presented in his court.

Critically for Detroit, Rhodes did not stay the proceedings pending the outcome of the appeal.

That means unless the process is halted by the U.S. District Court, Detroit's bankruptcy would continue as planned. The city will seek court authority for its proposed plan to borrow $350 million, and mediation would continue between the city and its creditors with the aim of reaching a consensual plan to deal with the city's debts. The mediation is being overseen by Gerald Rosen, the chief federal judge in Detroit.

POSSIBLE TIME FRAMES

Still, expert opinion is divided on what impact a lengthy appeals process might have on Detroit's progress through bankruptcy.

Stephen Lubben, a professor at Seton Hall Law School, took the view an appeal should be heard at "Chrysler-like speed. You can't negotiate a plan with that kind of uncertainty hanging over the case," he said before Rhodes issued his ruling.

Chrysler's sale to Fiat SpA during its 2009 Chapter 11 case was approved by the U.S. Bankruptcy Court and affirmed by U.S. Appeals Court in New York in the same week.

Rhodes turned down efforts to bring appeals directly to the U.S. Court of Appeals for the 6th Circuit in Cincinnati, a move that surprised some as it might have sped up the review process. Rhodes said those requests for direct appeal to the Circuit Court would have to be filed separately.

The next big hurdle will be a plan to cut the city's debt which will likely include reducing what is owed on city pension plans. However, because Michigan's constitution bars cutting pensions, experts said the debt plan may eventually end up in the U.S. Supreme Court.

But few expect the eligibility appeal to interest the highest court in the United States.

"Merely being a sexy case is not enough for the Supreme Court," said John Pottow, a professor at the University of Michigan Law School, speaking before Rhodes' ruling. "I can't see the Supreme Court caring if (Detroit's emergency manager) Kevyn Orr negotiated in good faith with creditors."

(Reporting by Tom Hals in Wilmington, Del.; additional reporting by Bernie Woodall and Joseph Lichterman in Detroit; editing by Matthew Lewis)

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