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Detroit braces for landmark bankruptcy ruling

Judge Steven Rhodes would declare whether Detroit is eligible to stay in court, more than four months after filing for Chapter 9 protection. It is the most critical decision so far because it could give local officials the green light to scrub the balance sheet and slowly improve the quality of life in a city that has lost more than 1 million residents since 1950.

'Eligibility means working down a specific check list and making sure the city has done what it needed to do to be in court. If the city gets its ticket punched, it is game on,' said Michael Sweet, a bankruptcy expert who has advised struggling local governments in California.

Rhodes' task at this stage is limited to deciding if Detroit has met certain conditions to be in bankruptcy. A local government must do more than claim it's broke. There must be evidence that Detroit tried to negotiate in 'good faith' with creditors or that such talks were simply impossible because of the number of parties and other factors.

During a nine-day trial, unions and pension funds with much to lose in bankruptcy vigorously fought the city on the good-faith requirement, saying a month was not enough time to make deals and avoid the historic filing last summer. Detroit Emergency Manager Kevyn Orr offered just pennies on every dollar owed to creditors. If Rhodes finds Detroit isn't eligible for bankruptcy, it likely means the city would have to sit down again with creditors and try to reach an agreement outside of court. If that fails, the city could return and file again for Chapter 9.

But Orr is predicting an 'Armageddon-like scenario' if the Chapter 9 petition is rejected on Tuesday. He said creditors who have been owed money since July will clog the courts with lawsuits to get anything they can while the city attempts to stay afloat.

'The issue at this point is very narrow... I think Detroit will be ruled eligible,' Sweet said. 'I think the judge will find, given the factors the city and the emergency manager had to deal with, they did the best they could with what they had.'

Detroit's largest creditors include two pension funds that are underfunded by $3.5 billion, according to Orr. The Michigan Constitution protects public pensions, but Orr believes bankruptcy law trumps that provision. If the city is found eligible for bankruptcy, pension cuts for 23,000 retirees are possible in the final plan. Most get less than $20,000 a year.

The city’s art trove at the Detroit Institute of Arts too might be vulnerable. New York auction house Christie’s is working on an appraisal of works that could be worth billions. Orr hasn’t signaled a strategy yet but even creditors are demanding a role in determining whether art can be used to raise the money.
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