Michigan Judge Rules Against Bankruptcy Push

A judge in Ingham County, home to Michigan’s capital, Lansing, ruled that Mr. Snyder’s action had violated the state Constitution because it could cut the pension benefits of retired public employees. The judge, Rosemarie Aquilina, said pensions were protected under state law, and issued an order that the bankruptcy filing be withdrawn.

Her ruling was immediately challenged by Michigan’s attorney general, who appealed to the state’s Court of Appeals on the grounds that the Chapter 9 bankruptcy filing stayed all legal proceedings related to Detroit’s debt obligations.

While the ruling may be overturned, it underscored the mounting tension in the city and the legal battles ahead as bondholders, retirees and other creditors attempt to recover money owed them by the city.

Mr. Snyder and Detroit’s emergency manager, Kevyn D. Orr, estimate the city’s debt and other long-term obligations at $18 billion.

After weeks of mostly unsuccessful negotiations with creditors to settle debts, Mr. Orr recommended a bankruptcy filing to Mr. Snyder this week. The city then filed for Chapter 9 on Thursday, minutes before Judge Aquilina was to hold a hearing on the employee pension funds’ constitutional challenge to a potential bankruptcy proceeding.

The president of one public employees’ union hailed the judge’s decision on Friday. “There is too much at stake to play political games with the hard-earned retirement security of Detroit’s public workers,” said Lee Saunders, head of the American Federation of State, County and Municipal Employees union.

But at a joint news conference on Friday, Mr. Snyder and Mr. Orr were resolute on the need for a bankruptcy filing.

Mr. Snyder, a Republican who has pushed a pro-business agenda in the state, said Detroit had no other options to deal with its debts and improve city services ranked among the nation’s worst.

“This is the time to say enough is enough in terms of the downward decline of the city of Detroit,” he said.

Now that the city has filed, Mr. Snyder and Mr. Orr said they wanted to reassure Detroit’s 700,000 residents that police, fire and other essential services will continue to function.

Mr. Orr, who was appointed by the governor, predicted that residents might start to see improvements soon, saying that the bankruptcy filing offers “breathing room” and will allow Detroit to use its limited resources to put more police cars and ambulances into service.

Depending on the outcome of the appeal of Judge Aquilina’s order, the initial bankruptcy hearings could begin as soon as next week.

On Friday, Judge Steven W. Rhodes was picked to oversee the case. Mr. Rhodes is a hometown selection, having served for 28 years as a bankruptcy judge in the Eastern District of Michigan.

The initial stages of the case will consist of Mr. Orr and possibly state officials showing that there was no available remedy for Detroit’s troubles other than bankruptcy.

“We didn’t make this decision in haste,” Mr. Orr said. “This is a decision that has been winding its way through the city for the better part of six decades.”

Employee unions and creditors may argue otherwise — either by challenging the size of Detroit’s debt, or Mr. Orr’s assertions that he bargained in good faith to reach out-of-court settlements with bondholders, retirees and others.

Some labor unions had accused Mr. Orr of using bankruptcy as a threat during negotiating sessions.

Mr. Orr said that despite marathon talks with creditors, there was little or no movement toward settlements.

“We are finally at a point where we simply can’t kick this can down the road any further,” he said.

There is no blueprint for Detroit’s recovery at this point. In the short term, Mr. Orr said that a deal with two secured creditors, Bank of America and UBS, to accept 75 cents on the dollar for $340 million in liabilities would free up casino revenues that could be used for city services.

The arrangement would provide the city with about $11 million a month in casino receipts. That cash is critical to keep the city safe and functional during a drawn-out bankruptcy process.

Mr. Orr said he expected Detroit to emerge from bankruptcy before his term as emergency manager ends in 14 months.

For Mr. Snyder, placing the state’s largest city in bankruptcy is a calculated risk that its decline could be reversed under court supervision.

He said that he did not anticipate any direct state or federal money would be needed in the effort, but that government grants to help remove abandoned buildings and improve Detroit’s infrastructure would be essential to the city’s comeback.

Michigan Judge Rules Against Bankruptcy Push

A judge in Ingham County, home to Michigan’s capital, Lansing, ruled that Mr. Snyder’s action had violated the state Constitution because it could cut the pension benefits of retired public employees. The judge, Rosemarie Aquilina, said pensions were protected under state law, and issued an order that the bankruptcy filing be withdrawn.

Her ruling was immediately challenged by Michigan’s attorney general, who appealed to the state’s Court of Appeals on the grounds that the Chapter 9 bankruptcy filing stayed all legal proceedings related to Detroit’s debt obligations.

While the ruling may be overturned, it underscored the mounting tension in the city and the legal battles ahead as bondholders, retirees and other creditors attempt to recover money owed them by the city.

Mr. Snyder and Detroit’s emergency manager, Kevyn D. Orr, estimate the city’s debt and other long-term obligations at $18 billion.

After weeks of mostly unsuccessful negotiations with creditors to settle debts, Mr. Orr recommended a bankruptcy filing to Mr. Snyder this week. The city then filed for Chapter 9 on Thursday, minutes before Judge Aquilina was to hold a hearing on the employee pension funds’ constitutional challenge to a potential bankruptcy proceeding.

The president of one public employees’ union hailed the judge’s decision on Friday. “There is too much at stake to play political games with the hard-earned retirement security of Detroit’s public workers,” said Lee Saunders, head of the American Federation of State, County and Municipal Employees union.

But at a joint news conference on Friday, Mr. Snyder and Mr. Orr were resolute on the need for a bankruptcy filing.

Mr. Snyder, a Republican who has pushed a pro-business agenda in the state, said Detroit had no other options to deal with its debts and improve city services ranked among the nation’s worst.

“This is the time to say enough is enough in terms of the downward decline of the city of Detroit,” he said.

Now that the city has filed, Mr. Snyder and Mr. Orr said they wanted to reassure Detroit’s 700,000 residents that police, fire and other essential services will continue to function.

Mr. Orr, who was appointed by the governor, predicted that residents might start to see improvements soon, saying that the bankruptcy filing offers “breathing room” and will allow Detroit to use its limited resources to put more police cars and ambulances into service.

Depending on the outcome of the appeal of Judge Aquilina’s order, the initial bankruptcy hearings could begin as soon as next week.

On Friday, Judge Steven W. Rhodes was picked to oversee the case. Mr. Rhodes is a hometown selection, having served for 28 years as a bankruptcy judge in the Eastern District of Michigan.

The initial stages of the case will consist of Mr. Orr and possibly state officials showing that there was no available remedy for Detroit’s troubles other than bankruptcy.

“We didn’t make this decision in haste,” Mr. Orr said. “This is a decision that has been winding its way through the city for the better part of six decades.”

Employee unions and creditors may argue otherwise — either by challenging the size of Detroit’s debt, or Mr. Orr’s assertions that he bargained in good faith to reach out-of-court settlements with bondholders, retirees and others.

Some labor unions had accused Mr. Orr of using bankruptcy as a threat during negotiating sessions.

Mr. Orr said that despite marathon talks with creditors, there was little or no movement toward settlements.

“We are finally at a point where we simply can’t kick this can down the road any further,” he said.

There is no blueprint for Detroit’s recovery at this point. In the short term, Mr. Orr said that a deal with two secured creditors, Bank of America and UBS, to accept 75 cents on the dollar for $340 million in liabilities would free up casino revenues that could be used for city services.

The arrangement would provide the city with about $11 million a month in casino receipts. That cash is critical to keep the city safe and functional during a drawn-out bankruptcy process.

Mr. Orr said he expected Detroit to emerge from bankruptcy before his term as emergency manager ends in 14 months.

For Mr. Snyder, placing the state’s largest city in bankruptcy is a calculated risk that its decline could be reversed under court supervision.

He said that he did not anticipate any direct state or federal money would be needed in the effort, but that government grants to help remove abandoned buildings and improve Detroit’s infrastructure would be essential to the city’s comeback.

DealBook: Strategic Posturing Behind the Suit Against Corzine

Harry Campbell

Louis J. Freeh, the bankruptcy trustee for the failed futures firm MF Global, filed a lawsuit aimed at pinning its collapse squarely on Jon S. Corzine, the former chief executive, and two of his top lieutenants. And unlike in many other suits, Mr. Freeh has not named other groups like a company’s directors.

The tale Mr. Freeh weaves in the complaint presents Mr. Corzine and the other defendants, Bradley I. Abelow, the former chief operating officer, and Henri J. Steenkamp, the former chief financial officer, as having failed to properly manage risk at MF Global while recklessly trading in European sovereign debt. It is a picture of a headlong rush into failure. Mr. Freeh asserts that the three defendants breached their fiduciary duties by allowing MF Global to take on excessive risks.

The core of the case is that the three men did not properly “develop the appropriate controls, procedures and systems needed to transform” MF Global into a full-service investment bank. Not only that, but Mr. Corzine took personal control of MF Global’s proprietary trading “without ensuring that the Company had sufficient controls and adequate liquidity to properly manage the risks inherent in such trading.”

Mr. Corzine’s representatives have vehemently denied the accusations, and question why Mr. Freeh is taking such actions while court-order mediation is still proceeding.

But regardless of the merits of the case, Mr. Freeh is clearly making a tactical move with his lawsuit. Among the questions that arise in any corporate failure is this important one: Where were the directors, who are ultimately responsible for oversight of the company? In Mr. Freeh’s version of events, it turns out they were quite active in approving the risk limits and other acts by Mr. Corzine. But they were not the primary wrongdoers in this tale, and are not named as defendants. This seems to be part of his legal strategy in this suit. He appears to feel he has a better chance at overcoming the legal hurdles to holding executives liable for business decisions than members of MF Global’s board.

Mr. Freeh’s complaint is noteworthy for adopting an all-in strategy against Mr. Corzine, Mr. Abelow and Mr. Steenkamp. Strategically, Mr. Freeh may be hoping the directors will turn on Mr. Corzine and blame him for being a pied piper who led them to approve policies that turned out to be disastrous for MF Global. In corporate litigation, it is always helpful to have someone inside the boardroom pointing the finger at a wrongdoer to help show that these were not just ordinary business decisions that turned out badly.

It may be that Mr. Freeh will settle a claim against the directors later. But by suing Mr. Corzine first, the directors should get the message that they are bit players at best in Mr. Freeh’s account.

In addition, it is much easier under the law to hold officers liable for misdeeds than it is in the case of directors. Under Delaware law, where MF Global was incorporated, corporate directors cannot be sued to recover monetary damages for anything except a breach of the duty of loyalty, which usually requires showing that they gained improper benefits from their actions. To establish that directors are liable for failing to oversee the company and its risk management practices, Mr. Freeh would have to prove that “the directors demonstrated a conscious disregard for their responsibilities” and acted in bad faith.

This is an extremely high standard to meet, and Delaware courts regularly dismiss such claims. In a shareholder derivative case involving claims that Citigroup’s board failed to properly oversee the bank’s risk management before the financial crisis, for example, a Delaware court refused to find the board liable despite the bank’s near collapse and subsequent government bailout. Indeed, the court stated that under Delaware law “[t]o impose oversight liability on directors for failure to monitor ‘excessive’ risk would involve courts in conducting hindsight evaluations of decisions at the heart of the business judgment of directors.” The case against the Citigroup directors was dismissed because the plaintiffs could not show that the directors had acted in bad faith, but instead may have merely failed in their risk monitoring.

Mr. Freeh is keenly aware that Delaware law presents an almost insurmountable barrier to any suit against the directors. The board certainly looks foolhardy in trusting Mr. Corzine to take the risks that he did, but proving that they acted in bad faith would be quite difficult.

In contrast, Delaware law does not afford corporate officers the same level of protection. That means Mr. Freeh can seek to recover for a breach of the duty of due care by showing gross negligence on the part of the leaders of MF Global.

That is still a high standard, requiring something akin to proving recklessness by Mr. Corzine. But unlike a suit against the directors, which would probably be dismissed quickly, this claim has a reasonable chance of surviving a motion to dismiss that would allow it to proceed toward a trial. A public airing of MF Global’s plunge into bankruptcy is probably the last thing Mr. Corzine wants, so the settlement value of the case is higher.

Mr. Corzine was very careful to state in his Congressional testimony that he acted in good faith and that his actions were based on advice provide by others for policies that were ultimately approved by the directors. He will offer the business judgment rule, a cornerstone of Delaware corporate law, to argue that these were merely bad business decisions, which cannot create liability. Even Mr. Freeh admits that the MF Global directors signed off on much of the conduct, giving Mr. Corzine some cover for his management of the firm.

While Mr. Freeh has an uphill battle to win the case, Mr. Corzine’s more immediate problem may be the high costs of a potential trial. Because MF Global is in bankruptcy, he cannot look to the company to indemnify him for any settlement or even pay his legal expenses, something normally provided to corporate officers sued for their actions.

Instead, Mr. Corzine must rely on MF Global’s insurance – and it had two pretty hefty policies. At the time of the bankruptcy, MF Global had a “directors and officers” liability policy for $225 million and an “errors and omissions” liability policy for $150 million. The judge in the bankruptcy case has already authorized Mr. Corzine and other employees to draw up to $30 million from the policy to pay for their legal fees.

But this cap has probably been exceeded by now, given the numerous Congressional hearings about MF Global’s collapse and the criminal and regulatory investigations of the firm. The question is whether the bankruptcy court will allow Mr. Corzine and the other defendants to continue to draw on the insurance to pay for their mounting legal costs or seek to preserve the policy for payments to MF Global’s customers and claims holders.

Mr. Corzine’s biggest concern is not that he may lose the case, but that the mounting legal fees will take a significant bite out of the fortune he amassed from his days at Goldman Sachs. Mr. Freeh is clearly aiming straight at Mr. Corzine, and is not the type of opponent who can be sent packing with a quick settlement.

DealBook: Strategic Posturing Behind the Suit Against Corzine

Harry Campbell

Louis J. Freeh, the bankruptcy trustee for the failed futures firm MF Global, filed a lawsuit aimed at pinning its collapse squarely on Jon S. Corzine, the former chief executive, and two of his top lieutenants. And unlike in many other suits, Mr. Freeh has not named other groups like a company’s directors.

The tale Mr. Freeh weaves in the complaint presents Mr. Corzine and the other defendants, Bradley I. Abelow, the former chief operating officer, and Henri J. Steenkamp, the former chief financial officer, as having failed to properly manage risk at MF Global while recklessly trading in European sovereign debt. It is a picture of a headlong rush into failure. Mr. Freeh asserts that the three defendants breached their fiduciary duties by allowing MF Global to take on excessive risks.

The core of the case is that the three men did not properly “develop the appropriate controls, procedures and systems needed to transform” MF Global into a full-service investment bank. Not only that, but Mr. Corzine took personal control of MF Global’s proprietary trading “without ensuring that the Company had sufficient controls and adequate liquidity to properly manage the risks inherent in such trading.”

Mr. Corzine’s representatives have vehemently denied the accusations, and question why Mr. Freeh is taking such actions while court-order mediation is still proceeding.

But regardless of the merits of the case, Mr. Freeh is clearly making a tactical move with his lawsuit. Among the questions that arise in any corporate failure is this important one: Where were the directors, who are ultimately responsible for oversight of the company? In Mr. Freeh’s version of events, it turns out they were quite active in approving the risk limits and other acts by Mr. Corzine. But they were not the primary wrongdoers in this tale, and are not named as defendants. This seems to be part of his legal strategy in this suit. He appears to feel he has a better chance at overcoming the legal hurdles to holding executives liable for business decisions than members of MF Global’s board.

Mr. Freeh’s complaint is noteworthy for adopting an all-in strategy against Mr. Corzine, Mr. Abelow and Mr. Steenkamp. Strategically, Mr. Freeh may be hoping the directors will turn on Mr. Corzine and blame him for being a pied piper who led them to approve policies that turned out to be disastrous for MF Global. In corporate litigation, it is always helpful to have someone inside the boardroom pointing the finger at a wrongdoer to help show that these were not just ordinary business decisions that turned out badly.

It may be that Mr. Freeh will settle a claim against the directors later. But by suing Mr. Corzine first, the directors should get the message that they are bit players at best in Mr. Freeh’s account.

In addition, it is much easier under the law to hold officers liable for misdeeds than it is in the case of directors. Under Delaware law, where MF Global was incorporated, corporate directors cannot be sued to recover monetary damages for anything except a breach of the duty of loyalty, which usually requires showing that they gained improper benefits from their actions. To establish that directors are liable for failing to oversee the company and its risk management practices, Mr. Freeh would have to prove that “the directors demonstrated a conscious disregard for their responsibilities” and acted in bad faith.

This is an extremely high standard to meet, and Delaware courts regularly dismiss such claims. In a shareholder derivative case involving claims that Citigroup’s board failed to properly oversee the bank’s risk management before the financial crisis, for example, a Delaware court refused to find the board liable despite the bank’s near collapse and subsequent government bailout. Indeed, the court stated that under Delaware law “[t]o impose oversight liability on directors for failure to monitor ‘excessive’ risk would involve courts in conducting hindsight evaluations of decisions at the heart of the business judgment of directors.” The case against the Citigroup directors was dismissed because the plaintiffs could not show that the directors had acted in bad faith, but instead may have merely failed in their risk monitoring.

Mr. Freeh is keenly aware that Delaware law presents an almost insurmountable barrier to any suit against the directors. The board certainly looks foolhardy in trusting Mr. Corzine to take the risks that he did, but proving that they acted in bad faith would be quite difficult.

In contrast, Delaware law does not afford corporate officers the same level of protection. That means Mr. Freeh can seek to recover for a breach of the duty of due care by showing gross negligence on the part of the leaders of MF Global.

That is still a high standard, requiring something akin to proving recklessness by Mr. Corzine. But unlike a suit against the directors, which would probably be dismissed quickly, this claim has a reasonable chance of surviving a motion to dismiss that would allow it to proceed toward a trial. A public airing of MF Global’s plunge into bankruptcy is probably the last thing Mr. Corzine wants, so the settlement value of the case is higher.

Mr. Corzine was very careful to state in his Congressional testimony that he acted in good faith and that his actions were based on advice provide by others for policies that were ultimately approved by the directors. He will offer the business judgment rule, a cornerstone of Delaware corporate law, to argue that these were merely bad business decisions, which cannot create liability. Even Mr. Freeh admits that the MF Global directors signed off on much of the conduct, giving Mr. Corzine some cover for his management of the firm.

While Mr. Freeh has an uphill battle to win the case, Mr. Corzine’s more immediate problem may be the high costs of a potential trial. Because MF Global is in bankruptcy, he cannot look to the company to indemnify him for any settlement or even pay his legal expenses, something normally provided to corporate officers sued for their actions.

Instead, Mr. Corzine must rely on MF Global’s insurance – and it had two pretty hefty policies. At the time of the bankruptcy, MF Global had a “directors and officers” liability policy for $225 million and an “errors and omissions” liability policy for $150 million. The judge in the bankruptcy case has already authorized Mr. Corzine and other employees to draw up to $30 million from the policy to pay for their legal fees.

But this cap has probably been exceeded by now, given the numerous Congressional hearings about MF Global’s collapse and the criminal and regulatory investigations of the firm. The question is whether the bankruptcy court will allow Mr. Corzine and the other defendants to continue to draw on the insurance to pay for their mounting legal costs or seek to preserve the policy for payments to MF Global’s customers and claims holders.

Mr. Corzine’s biggest concern is not that he may lose the case, but that the mounting legal fees will take a significant bite out of the fortune he amassed from his days at Goldman Sachs. Mr. Freeh is clearly aiming straight at Mr. Corzine, and is not the type of opponent who can be sent packing with a quick settlement.