Detroit v. Syncora: A Lot at Stake

By Steven Jacobson

Steven Jacobson is a rising freshman at University of Pennsylvania.

Detroit's descent into urban decay has been well documented. Formerly a beacon of the United States' industrial might, “Motown” soon became the capital of the rust belt when US automakers outsourced their factories to cheaper manufacturing hubs. The deterioration culminated in last summer's declaration of Chapter 9 bankruptcy, a nadir reached through declining economic fortunes and years of mismanagement by city officials. It was the largest declaration of bankruptcy by an American municipality. Detroit’s ties to the auto industry have also been largely severed over the past half-century. While American carmakers have had some of their best years after their 2009 bailout, the city to which they were once inextricably linked has never been worse. 

Detroit's problems largely arose from the pensions it doled out to municipal workers. For decades, when negotiating with the unions, the city would guarantee lofty retirement packages in exchange for slimmer current salaries. These benefits were modeled on those of the auto industry workers of the glory days, which was all fine and good—except that Detroit was no longer in its glory days. And while the private sector largely switched over to employee-funded plans, most municipal governments stuck with defined-benefit plans, in which workers were given a pre-determined payout based on their tenure and salary earned in their last year of work. [1] While these are more generous plans, they are also more difficult to honor when the economy slumps and asset prices plummet as liabilities soar.

Of course, that's exactly what happened late last decade. On July 18, 2013, Detroit found itself $18 million in debt, with over half of that money owed to retired city workers. This was money the city did not have and could not borrow, as its credit rating had deteriorated. It was left with no choice but to follow the paths of General Motors and Chrysler, declaring bankruptcy. 

Detroit sensed its slide into financial insolvency far before it officially underwent Chapter 9. In 2005, in an attempt to shore up its finances and acquire more with which it could fund its pensions, the city set up a system of swap payments that it executed with debt it had issued. Even at this point, Detroit was running up against Michigan's debt ceiling, so it arranged these transactions indirectly—through two service corporations it set up, instead of by issuing municipal bonds. [2] A swap is when two parties exchange the interest payments they have to make, so the city, through those corporations, exchanged their floating-rate interest payments for fixed-rate ones to protect themselves against risk.

However, because the city was already in dire straits, investors were unwilling to buy the "certificates" the corporation issued on behalf of the municipal government. So, that was where bond insurer Syncora Guarantee Inc. came into the picture. 

Syncora guaranteed investors that it would make payments on Detroit's behalf should the city not be able to pay its own bills. In return, Detroit put its best revenue stream—the tax money it received from casinos, which now amounts to about $15 million per month—up as collateral.

Forgoing the corporations and creating a direct connection between Syncora and Detroit, the agreement set up a complicated "lockbox" scheme by which the city's casino revenue would be frozen if there were an "event of default." Sure enough, when Detroit defaulted on repaying the $40 million debt from 2005 a month before it declared bankruptcy, the bond insurer began to set in motion the legal action to claim the casino money.

Detroit has the strong argument on its side that the money is protected under 11 U.S.C. § 362(a)(3), which defines cases of automatic stay. Automatic stay is a measure that protects debtors’ property temporarily from creditors. [3] Detroit’s bankruptcy triggered a provision of automatic stay. This is the case the city has argued successfully before the US Bankruptcy Court for the Eastern District of Michigan and the Eastern Michigan District Court before heading to the Sixth Circuit Court of Appeals, where it is currently being heard.

Syncora, on the other hand, argued that the money was never Detroit’s to stay: the company claimed that it would remain in the lockbox until the city made its required payments. The proceedings, like the entire situation surrounding Detroit’s financial nosedive, have been messy. The case languished in the district court for over half a year before the appeals court handed down an order mandating that a decision be reached.

The Court decision will prove crucial to Detroit as it struggles to re-emerge from bankruptcy, as emergency manager Kevyn Orr and his administration have been working to structure a bankruptcy settlement; the loss of the nearly $180 million annual revenue would prove crushing for Motown’s hopes to work itself back to a state somewhat resembling normalcy. Syncora, meanwhile, is trying to speed up the court proceedings so it can hear a decision before such a settlement, with the money it argues that it is entitled to, goes into effect. For now, wild dogs continue to roam the scarcely lit and scarcely policed streets of the Michigan city. Detroit must do everything it can to hold onto the casino revenue if it hopes to provide a safe locale for its rapidly depleting population.


[1] Chappatta, Brian. "Pension Pinch." Bloomberg News. March 10, 2014. Accessed August 1, 2014.
[2] Gibbons, J., K. Kethledge, and J.J. Stranch. "Opinion." US Court of Appeals for the 6th District. July 11, 2014. Accessed August 1, 2014.
[3] "Automatic Stay." Investopedia. Accessed August 1, 2014.

Photo Credit: Flickr user Sam Beebe