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Detroit bankruptcy judge to hear crucial bond dispute

By Karen Pierog

Feb 19 (Reuters) - For Detroit, the long and winding road out of the largest-ever U.S. municipal bankruptcy may get a bit straighter on Wednesday.

First, U.S. Bankruptcy Judge Steven Rhodes will consider litigation over whether Detroit's pledge of tax revenue to pay off voter-approved bonds is a binding obligation or merely a promise that the broke city cannot keep.

And while in court for the hearing, the city's state-appointed emergency manager may file a blueprint on how the city plans to treat its $18 billion debt burden and exit bankruptcy.

Bill Nowling, a spokesman for emergency manager Kevyn Orr, said the plan of adjustment could come "anytime after" Tuesday.

Both the result of the case and the plan for the future will be watched closely by participants in the $3.7 trillion U.S. municipal bond market.

The outcome of the dispute before Rhodes could have a far-reaching impact on municipal finance as unlimited tax general obligation bonds traditionally have been considered secured debt, making them one of the safest bets for investors.

Orr has deemed some $410 million of general obligation bonds outstanding at the end of the city's fiscal 2012 as unsecured debt, and the city defaulted on an Oct. 1 payment on the bonds.

In their lawsuits, bond insurers on the hook to make up millions of dollars in missed principal and interest payments on Detroit's bonds contend that only they and bondholders have a right to property tax revenue collected and pledged to pay off the debt.

Detroit, however, argues that while Michigan law refers to a "pledge" on the bonds, it is "only as a synonym for 'promise,' as in 'I pledge allegiance to the flag.'"

Rhodes will also consider the future of an unsecured creditors committee formed by U.S. Trustee Daniel McDermott in December. The committee included Detroit's two pension systems, which are its largest unsecured creditors, and bond insurer Financial Guaranty Insurance Co.

Earlier in the bankruptcy case, which Detroit filed in July, McDermott at the city's request put together another committee to represent scores of retired Detroit workers.

In a court filing arguing against the unsecured creditors committee on Tuesday, Detroit said that all of its major unsecured creditors have already participated in the case, including mediation, and have attorneys representing them.

"Under the circumstances, there simply is no need for a new committee at this point in the city's Chapter 9 (bankruptcy) case," Detroit's filing said. "There likewise is no justification for the costs that the city will be required to incur addressing or responding to the activities of such a committee."

Since the case began in July through the end of September, the retirees committee has cost the city nearly $1.96 million in fees and $61,500 in expenses, according to a report released earlier this month by a court-appointed fee examiner.

Another matter before Rhodes is litigation involving Detroit's plan to end interest-rate hedging contracts with investment banks at a discounted cost. The judge twice rejected proposed settlements between the city and UBS AG and Merrill Lynch Capital Services.

Bond insurer Syncora Guarantee Inc had sued the banks in an attempt to stop the termination of the so-called swaps, which were hedging interest-rate risk on some of the $1.45 billion of pension debt Detroit sold in 2005 and 2006. Syncora insured some of the debt and swaps. Shortly after the city officially ended the deal with the banks on Feb. 6, Syncora dropped the lawsuit.

Detroit on Jan. 31 filed a lawsuit in U.S. Bankruptcy Court seeking to invalidate the pension debt, a move that could also void the swaps.