How mediation has put Detroit bankruptcy on the road to resolution

Feb. 02--When Detroit filed for bankruptcy, the case was expected to mirror others around the country: contentious with several years of pitched courtroom battles ahead.

But in Detroit, two powerful federal judges have refused drawn-out battles in favor of quick rulings and aggressive mediation that's speeding the process along. Much of the action has been happening on the 7th floor of the federal courthouse, in the private chambers of Chief U.S. District Judge Gerald Rosen, where he convenes confidential mediation sessions producing rapid-fire results.

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Mediation breakthroughs -- most notably lining up about $800 million of private and state money for a pension rescue fund -- have shifted Detroit's historic bankruptcy case into high gear with a quick resolution potentially in sight that was unthinkable just a few months ago.

On Wednesday came the first draft of the city's highly anticipated plan of adjustment, a detailed document that shows how Detroit will reduce its $18 billion in debt and long-term liabilities, restructure city government and emerge from bankruptcy. How creditors will react remains to be seen.

On Friday, meanwhile, the city dropped a bombshell, announcing it's suing over a bad pension deal from the Mayor Kwame Kilpatrick era that helped push Detroit into bankruptcy. The move follows U.S. Bankruptcy Judge Steven Rhodes' rejection of two proposed settlements with the two major banks involved.

But many of the city's other most pressing issues are nearing resolution with far more collaboration:

-- On Thursday, Detroit retirees and the city reached a settlement involving health care cuts, which includes the creation of a special health care trust for Detroit retirees.

-- On Wednesday, the Detroit Institute of Arts pledged $100 million to the growing rescue fund that would shore up municipal pensions as it protects the DIA's world-class art collection and spins off the museum into an independent nonprofit.

-- On Tuesday, the W.K. Kellogg Foundation announced a $40-million pledge to that same rescue fund.

-- Meanwhile, negotiations are coming to a head on a 40-year deal to lease the water department to a new regional authority in exchange for $47 million in annual payments that would help the city reinvest in services such as police, fire and blight removal.

A balancing act

Legal experts attribute much of this progress to mediation, a process that few bankrupt municipalities have ever used. But they're not Detroit.

"Detroit is a special place. It's huge. Without mediation, the court would say it lacks the resources to move the case along," said Alabama bankruptcy attorney Patton Hahn, who worked on the municipal bankruptcy case in Jefferson County, Ala., which did not use mediation.

That's because the Alabama case was driven by a single sewer debt issue, "not acute infrastructure problems like Detroit, or a giant pension problem," Hahn said.

While mediation likely will speed Detroit's bankruptcy process, it also could rub some taxpayers the wrong way, given its highly confidential nature, Hahn said.

"The rub here is that Detroit is a public entity. Its true stakeholders are its citizens, and there's a clash between the goals of mediation -- which is to simply get to a result -- and the public interest, which is to know the content of those negotiations," Hahn said.

Court-ordered mediation, by law and design, is meant to be private. It allows parties to air their issues -- and any potential dirty laundry -- without the fear of having confidential information exposed, with the ultimate goal to reach a settlement.

What has transpired is a delicate balancing act in bankruptcy court, where the public's right to know how public money is being handled is being weighed against the rights of creditors and debtors to resolve their disputes in private.

Detroit also has few potentially lucrative assets, beyond the DIA artwork and water system, so a mediator has to come up with cash from somewhere, which can only be done in private.

Endgame taking shape

Announcements from mediators and details from the draft plan of adjustment last week show an endgame for Detroit's bankruptcy crystallizing, said Douglas Bernstein, a bankruptcy expert for the Plunkett Cooney law firm.

The 99-page plan appears to favor pensioners over other unsecured creditors. It's still full of financial blanks to be filled in once dollar figures are nailed down on cuts and changes to retiree pensions and health care plans.

But early indications suggest the pension funds will get more cents on the dollar than other unsecured creditors. To attach hard numbers, there needs to be an agreement on how much the city's two pensions are underfunded. Detroit emergency manager Kevyn Orr and his team say it's $3.5 billion; the pension boards and unions say it's much lower.

The plan recommends setting up a health care trust called the Detroit VEBA to manage retiree insurance benefits -- much like Detroit's automakers did to off-load that liability to a separate entity.

While the plan is tweaked, experts say, the aggressive mediation already in process can help bring the whole bankruptcy to a close.

"The more you can agree on in advance, the better," Bernstein said. "What's proving to be true, especially with the urging of Judge Rhodes, is that the negotiations continue throughout the bankruptcy ... right up to, and sometimes on the day of, confirmation."

Not everyone is happy

Not everyone walks away happy in mediation.

"If you're a litigant, sometimes you like mediation when it gets the result you want. And you don't like it when you don't get the result you want," said New York bankruptcy attorney Glenn Siegel, who sits on the Board of Directors for the American Bankruptcy Institute.

Siegel, who cochairs the bankruptcy and restructuring group at New York'sMorgan Lewis law firm, explained how mediation drives the settlement process: Each time one party strikes a deal, there's less money to pay the next creditor.

"That's what drives people to the mediation table," Siegel said. "It goes back to the scarce resources. If you're dealing with scarce resources and the suggestion is, 'You better get in there sooner than later,' that may end the case quickly."

He continued: "Some may be unhappy ... but the most important thing at the end of the day is for the city to be in much better shape. Its goal cannot be to make everybody happy."

Two major banks know that all too well.

On Jan. 16, Rhodes rejected a $165-million settlement involving an old pension debt between Detroit and Bank of America Merrill Lynch and UBS. He said the city could reasonably succeed at litigating the debt in court and pay substantially less. He also cautioned the city to stop making irresponsible financial decisions.

The ruling was a big blow to many: the banks; Orr, who has said he needs to pay off the banks to free up roughly $50 million in annual casino revenue that the banks are holding as collateral; the prestigious Jones Day law firm, which aggressively pursued the deal; and even Rosen, who recommended the settlement as a quick resolution.

Rosen declined to comment for this report. In court documents, he acknowledged that the $165-million deal was not "a perfect settlement." But he said it was in the best interest of the city and that Rhodes should approve it so the city could move forward.

Rosen's recommendation drew the ire of several creditors, who, in a rare move, criticized the federal judge and accused him of improperly supporting the bank settlement. "Confidentiality is key to any mediation so that all parties can speak freely in the spirit of negotiation," objectors wrote in a court filing, arguing that mediators should act "as facilitators, not arbitrators."

"We're really gratified," said Robert Gordon, an attorney for Detroit's two pension funds, adding that "paying them even close" to $165 million was too much.

More to be mediated

As lead mediator, Rosen has overseen several contentious restructuring talks between the city and its creditors. He also brokered the rescue fund to boost pensions and shield artwork from being sold. The grand bargain, however, also likely will require some cooperation from the unions. They likely will have to agree to more concessions to help solve the pension crisis and help dig the city out of debt. Rhodes already has hinted that such cooperation will be key in moving ahead.

Given the scope of the case, plenty more disputes are headed Rosen's way, say legal experts, who now expect Detroit's bankruptcy case to be resolved largely in mediation.

"The more that parties and a mediator can resolve without having to utilize or drain the resources of the court, I think everyone is better off," said New York bankruptcy attorney Seth Lieberman, who has worked on the bankruptcies involving American Airlines, Tropicana Entertainment and Lehman Brothers.

According to Lieberman and other bankruptcy experts, use of mediation in large bankruptcy cases is a growing trend, with companies including Borders Group and Hostess Brands embracing the process in recent years. Few municipalities have used mediation in bankruptcy, they note, but that's because such cases are rare.

For example, since 2010, just eight towns and municipalities filed bankruptcy nationwide, according to Washington, D.C.-based Governing, a research magazine that tracks government issues. Lieberman said that with mediation, "if any party doesn't like what's on the table, that party can have its day in court."

"That's the beauty of bankruptcy court. Even if you weren't at the table when the deal was cut, you can still have your day (to object)," Lieberman said.

That's what happened in Detroit's bank settlement. That's what's likely to happen down the road, too, experts say.

"Detroit's a big city with a very complex capital structure. There are lots of people out there that the city has financial obligations with," said Siegel, arguing mediation is the quickest way to go, even though not everyone will be happy. "Municipal bankruptcies have their own quirks. But at the end of the day, in these big cases where time is of the essence, where you want the subject of the bankruptcy to move on ... your mediator is your best way to get there."

Contact Tresa Baldas: [email protected]. Staff writers Nathan Bomey and Mark Stryker contributed to this report.

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