[JURIST] Detroit [official website] on Friday filed a lawsuit in the US Bankruptcy Court for the Eastern District of Michigan [official website] seeking to invalidate the $1.44 billion of debt the city sold to finance by establishing “sham” service corporations to facilitate the debt sales, and claiming and that all contracts or obligations connected to the debt are also invalid. Detroit claims the pension debt violated the borrowing limits [Reuters report] imposed on the city by the state of Michigan [official website] and asked the judge to declare that the city has no further obligations to make payments on the pension certificates of participation (COPs). However, a court ruling for the city might also invalidate the interest-rate swap contracts Detroit had with investment banks UBS and Bank of America [corporate websites], since the swaps were countering the interest-rate risks on the COPs. The lawsuit could render all claims based on any COPs-related contract unenforceable and void. The swap deals were valued at $400 million in 2011 and served as a primary reason Detroit filed bankruptcy.

Detroit’s bankruptcy matter has been working its way through the court system since the city filed for Chapter 9 bankruptcy in July of last year. A judge for the Bankruptcy Court for the Eastern District of Michigan in January rejected [JURIST report] a proposed $165 million settlement agreement for the city of Detroit to pay off UBS and Bank of America. In December Judge Rhodes ordered the city to renegotiate its bankruptcy-related financing with UBS and Bank of America, serving as the impetus for this week’s proposed settlement between the parties. Earlier in December Rhodes ruled that Detroit is eligible and authorized [JURIST report] to file for bankruptcy, declaring the city insolvent because it owes approximately $18 billion to more than 100,000 creditors, which is harming the city’s residents and making it essentially impossible for the city to negotiate with creditors. In July Rhodes allowed [JURIST report] Detroit’s bankruptcy filing to continue, declaring that his federal bankruptcy court had exclusive jurisdiction over the matter. This action placed a stay on a Michigan circuit court ruling that had been announced three days earlier, which declared the filing unconstitutional [JURIST report] because it threatened public pension benefits and those benefits are protected by the Michigan Constitution [text, PDF]. Earlier this fall JURIST guest columnists Patrick Brady and Igor Shleypak discussed how Detroit’s pension plan holders have been fighting for their rights and explored the broader consequences [JURIST op-eds] that Detroit’s actions may have on other cities that consider filing for protection under Chapter 9.