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.

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