Protecting Detroit pensions may violate bankruptcy code: judge

By Joseph Lichterman DETROIT (Reuters) - The federal judge overseeing Detroit's bankruptcy filing called the city's pension funds "unsecured creditors" and stated that any special protections for them would violate federal bankruptcy law. The statement by U.S. Bankruptcy Judge Steven Rhodes, in an exchange with an attorney representing Detroit's two pension funds, came in the closing session of a three-day hearing examining legal issues in the bankruptcy case. The judge will hold a trial, starting Wednesday, to determine if Detroit is eligible for protection under Chapter 9 of the U.S. Bankruptcy Code while it tries to restructure $18.5 billion in debt and other liabilities including pension funds the city says are underfunded by $3.5 billion. The city filed the largest municipal bankruptcy in U.S. history on July 18. Robert Gordon, the pension funds' attorney, argued that the city should not be eligible for bankruptcy protection because Michigan's constitution protects pensions from impairment and the city did stipulate in its filing that pensions could not be cut. Rhodes said the U.S. Bankruptcy Code would not afford special protection to pensions because, "It gives a priority to one unsecured creditor over all the others. Or one group of unsecured creditors, over all the others." Rhodes did not issue an opinion on the pension matter, but he did pose tough questions to attorneys representing Detroit's unions, retirees and pension funds as they disputed the legal arguments the city's attorneys made last week. At the trial beginning Wednesday, the city must show it is insolvent and negotiated in good faith with its creditors. Detroit's other creditors would not tolerate special treatment for the pension funds, said Bruce Bennett, the city's lawyer. He added that conversely, unions and others opposing cuts in pension benefits would object if bondholders got preferential treatment. Bennett also argued that the federal bankruptcy court can impair contracts and pensions despite state constitutional protections. "You can say pensions cannot be impaired, but the reality is, at the end of the day, there isn't enough money to pay them," Bennett said. Rhodes is expected to make a formal ruling on the question after the eligibility trial is completed. EMERGENCY MANAGER LAW Rhodes also said he wants to hear arguments during the trial later this week on why a spending provision was added to Michigan's emergency manager law. The state emergency manager law, Public Act 436, was passed last December by a lame-duck session of the state legislature. It was passed after voters last November repealed a 2011 overhaul of the emergency law that had given managers more power over municipal finances. Lynn Brimer, an attorney representing the Retired Detroit Police Members Association, argued that the legislature added the spending provision to prevent the law from being subject to another voter referendum because Michigan law prohibits referendums on laws that include an appropriation. But the state said the appropriation was added to the bill to pay for the costs associated with the law. (Reporting by Joseph Lichterman; Editing by David Gregorio)