Monday, February 24, 2014

Detroit Chapter 9 Redux: Finding the Lien Securing the Insured GOs

In my last blogpost, I discussed the merits with respect to the secured status of Detroit's insured General Obligation bonds (GOs) in terms of whether there had been a pledge as security for purposes of the Bankruptcy Code of the ad valorem taxes that have been levied to provide for the repayment of the GOs.  

In my view, the City of Detroit's emphasis that you won't find the word, "lien", in the granting language of the resolutions was unavailing, given the specific circumstances relating to the issuance of the GOs.

It is apparent, however, that Judge Rhodes won't have to strain himself unduly to find the lien in favor of the GOs that the City of Detroit has argued is absent.

Section 101(37) of the Bankruptcy Code defines "lien" to include "an interest in property to secure repayment of a debt."  I discussed in my last post that the legislative resolutions that authorized the levy and collection of the ad valorem taxes in connection with the issuance of the GOs mandate that Detroit deposit these tax proceeds into a segregated debt repayment account, and use such funds solely to repay the GOs.  Michigan law imposes personal liability upon any city official that doesn't apply such funds in this manner. The legislative resolutions also mandate that the City collect such taxes until the GOs have been retired.

Do the GO bondholders and the monolines insuring the GOs have a property interest in the ad valorem tax collections that are mandated to be deposited into the bond repayment account?  In other words, are such funds secured by a lien in favor of the insured GO bondholders and monolines, for purposes of Section 101(37) of the Bankruptcy Code?

As with all matters construing whether there is a property or security interest in favor of a Detroit Chapter 9 creditor under bankruptcy law, Judge Rhodes must look to Michigan law.  The monolines in their opposition brief refer to a Michigan Supreme Court case, Sawicki v. City of Harper Woods, that makes it clear that, under Michigan law, when taxes are levied and collected for the express purpose of being deposited into a segregated account and used for the sole purpose of paying specified debt, 

"[s]uch money, when collected from the several property owners becomes a trust fund, to be used only for the purpose specified, and when the bonds and interest and other legal expenses chargeable against such fund have been satisfied, the balance belongs to the landowners".

Sawicki makes it abundantly clear that, for purposes of Michigan law, the GO bondholders and the monolines are the beneficiaries of an equitable trust and, therefore, have a beneficial and equitable interest in and to the ad valorem taxes that must be levied, collected and deposited into the bond repayment account.

The GO bondholders' and monolines' ownership of this entire equitable and beneficial interest in and to the tax proceeds makes it clear that the GO bondholders and monolines are secured by a "lien" for purposes of the bankruptcy code.

So, to the City of Detroit's refrain, "where's the lien?", one can simply reply, Sawicki!

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.

Friday, February 21, 2014

In Detroit Chapter 9, When is a Pledge Just a Promise, Not Security?

The City of Detroit and the monolines have finished their arguments before Judge Rhodes with respect to whether or not the insured Detroit GOs are secured obligations.  What turns on this question?  Seems like about 80% of the insured GOs aggregate principal amount (over $300 million), when you see that the Detroit plan of adjustment seeks to treat secured debt as fully-protected (100% recovery), whereas if the insured Detroit GOs are deemed unsecured, the plan's opening gambit is for only a 20% recovery.

The monolines' argument, boiled down for the sake of brevity (I do write this on a Friday afternoon, after all), seems to be that the resolutions that authorized the issuance of the insured GOs pledged a special levy of ad valorem taxes as a stream of revenue dedicated towards the repayment of the insured GOs.  This dedication took the form of a legislative requirement that the proceeds of the special ad valorem taxes be deposited into a special account, and be used solely for the repayment of the GOs.

Moreover, the legislative resolutions pledge these special taxes, which may only be deposited into this bond repayment account, toward repayment of the bonds.

The City of Detroit argues by asking, "Where's the Lien?"  This form of rhetoric worked for Wendy's, but not candidate Mondale, a few decades ago; will it work for the City of Detroit?  In other words, the City of Detroit is arguing that of the two common language definitions of "pledge," a) a promise, and b) an act of providing something as security for repayment, the proper understanding of the pledge underlying the creation of the insured GOs is only that of a "promise"(and mere promises may be impaired in bankruptcy).

Of course, the monolines argue for "security" as the proper understanding of the pledge, for purposes of constructing the meaning of the legislative resolutions relating to the insured GOs.

Everything turns on this because, if the monolines are right, then the pledge as security of the special taxes will mean these taxes constitute "special revenues" and the insured GOs should be deemed secured, under Sections 902E and 928 of Chapter 9.

Where will Judge Rhodes look for guidance to construe the meaning of "pledge," as it relates to these insured GOs?  He has no choice but to look to Michigan state law.  He has made clear that Michigan state law governs the application of questions like this, as well as whether Detroit's pension obligations were solely unsecured, or secured, obligations.

When Judge Rhodes turns to Michigan law to answer this question, he will be directed by the monolines to a state Michigan court of appeals decision, Kinder Morgan v. City of Jackson (744 N.W 2d 184, 2007), wherein the court states "'obligations pledging the unlimited taxing power of the local governmental unit' are necessarily obligations by which a municipality pledges its unlimited taxing power as security for the repayment of the debt." (emphasis added).

So, my guess is that Judge Rhodes will come to a decision about the secured status of the insured Detroit GOs based upon whether he signifies the word "lien" with shamanistic power, and focuses on the absence of the word in the legislative resolutions, as the City of Detroit would have him do, or is persuaded by the monolines' argument that in Michigan, a pledge is more than a mere promise and signifies security for repayment...especially in the context where, as here, the tax revenues are required by legislative mandate to be deposited only to a restricted account for application solely to repay the insured GOs.

I am still thinking that the monolines have the better of this one.

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.