Tuesday, December 17, 2013

Detroit Emergency Manager Does a Laydown on Security for Unlimited Tax General Obligation Bonds

In my last post, I argued that the Detroit unlimited tax general obligation bonds (UTGOs) that MBIA and Assured Guaranty (AGO) insured were secured obligations, based upon the terms and provisions of their issuance under Michigan state law.  This question was recently at issue in connection with the Detroit Emergency Manager's (EM's) request for court approval of a debtor-in-possession (DIP) loan.  

Super-priority claims status for the DIP loan would be granted in all Detroit revenues not pledged to secure repayment of other obligations.  Of course, MBIA and AGO have filed a joint complaint arguing that their insured UTGOs are secured by certain ad valorem tax revenues created at the time the UTGOs were authorized and issued, so this raises the question for the court as to whether these tax revenues would be available to repay the DIP.

The wisdom and efficacy of the DIP has been discussed in an excellent article in the Financial Times by an author who goes by the twitter nome de plume of bondgirl (@munilass).  Focusing instead on the legal question as to whether certain tax revenues secure repayment of the insured UTGOs and are thus not available to repay the DIP, it can only be stated that the EM's argument against such secured status for the UTGOs in connection with approval of the DIP was extraordinarily weak. 

EM's argument was contained in two throw-away paragraphs at the end of his reply to objections to the DIP (EM Reply).

Paragraph 91 of the EM Reply states that MBIA and AGO have presented no evidence that there is a statutory lien upon the tax revenues that they assert secure repayment of their insured UTGOs.  Of course, this is correct.  It is also completely beside the point.

There are essentially two ways that UTGOs can be secured: (i) state law may provide that there is a statutory lien that automatically is granted upon certain revenues upon bond issuance (see Spiotto, Primer on Municipal Debt Adjustment--Statutory Liens Protect Bondholders), or (ii) the terms and provisions of the UTGO provide for the financing of a specified improvement, and are secured by a pledge of taxes that were levied specifically in connection with the issuance of the UTGOs.

MBIA and AGO argue that their insured UTGOs are secured by means of (ii) above.  The EM argued that they were not secured because (i) above was not satisfied.  This response by the EM doesn't meet the red face test.  (One might think that the EM would fire his counsel, Jones Day, after seeing such a weak legal argument made in his case...except that, one recalls, the EM was a partner of Jones Day, and one might assume will again be a partner of Jones Day once the Detroit bankruptcy plan is confirmed.)

The second response of the EM was contained in paragraph 92 of the EM Reply.  Essentially, the EM argues that Judge Rhodes doesn't have to decide now, in connection with his approval of the DIP, whether the insured UTGOs are secured; if the court eventually finds that they are secured, the DIP super-priority claim will not apply to the tax revenues that support the insured UTGOs.

Taken together, these two paragraphs, which constitute the entirety of the EM's response made up to now to the monolines' argument of secured status of the insured UTGOs, are known in the trade as a complete laydown.  You offer one response which is not germane to the question, and you follow with a second response that says if we lose, then we will lose, but you don't have to tell us right now that we have lost.

Accordingly, if the DIP is to be approved on the basis of the EM laydown (hearings are being conducted today and tomorrow), it will carve out (for now) from the DIP loan super-priority claim the tax revenues securing the insured UTGOs.  The proposed order reads:

"There is litigation pending before the Court between certain bond insurers of certain of the limited and unlimited tax obligation bonds, on the one hand, and the City, on the other, in respect of ad valorem property tax revenue (the “Property Tax Revenue”).  To the extent this Court finds and determines (and pending such finding or determination), or approves any settlement or confirms any plan of adjustment that provides that any Property Tax Revenue of the City is subject to a property interest (such as a lien or pledge) of any holders of limited or unlimited tax general obligation bonds issued by the City or that such Property Tax Revenue is not generally available for use by the City other than for payment of such limited or unlimited general obligation bonds and is not available for distribution to general unsecured creditors as part of a plan of adjustment in this case, then the Superpriority Claim granted hereunder shall not, in such circumstance, be paid from the Property Tax Revenue unless and until any allowed claims arising from such limited or unlimited general obligation bonds have been satisfied in full."

So, you have now seen the EM's best shot in support of his initial determination that the insured UTGOs are unsecured, and it is nothing more than a laydown. 

Disclosure:  Long MBI; AGO.

NB:  this blog is not intended to be investment advice, and should not be relied upon by anyone to constitute investment advice.  Investing is a tough game, and everyone must do and "own" their own work, because you will certainly own your investments.

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