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Legality of Detroit bankruptcy contested in court

DETROIT (Reuters) - Lawyers representing Detroit unions, retirees and creditors tussled with city attorneys on Tuesday in bankruptcy court, seeking to derail the city's claim of bankruptcy with an assertion that Michigan's constitution protects retiree pension benefits from being slashed.

The lawyer representing Detroit's largest public union also said that Chapter 9 municipal bankruptcy is unconstitutional because it impairs states' rights to manage their own finances.

"States are ceding accountability for their own financial management," said attorney Sharon Levine, representing Council 25 of the American Federation of State, County and Municipal Employees. "By turning it over to the federal government and hiding behind the bankruptcy process, we lose that accountability, which is a cornerstone of the state constitution."

Levine said it should be left to the states to restructure municipal debt because Chapter 9 unfairly requires a municipality to settle debts in federal bankruptcy court without full consent from all its creditors.

Bruce Bennett, an attorney with Jones Day that represents Detroit, said during Tuesday's proceeding that the bankruptcy is legal and is needed to readjust the city's crippling debt. He said the city spends up to 65 cents of every tax dollar to pay its liabilities.

Bennett added that eventually the city will not be able to sustain itself if it cannot restructure its debt through bankruptcy.

"Ultimately, debts of all kinds will not be paid, and no provision of any constitution will change this," Bennett said.

Tuesday marked the start of a two-day hearing that will address the thorny legal issues surrounding Detroit's July 18 bankruptcy filing, the biggest in U.S. history. On Wednesday, a lawyer from the U.S. Department of Justice is expected to testify in support of an argument, filed previously with federal bankruptcy court Judge Steven Rhodes, that Chapter 9 should withstand constitutional review.

Lawyers representing the objectors also contend that Michigan's constitution protects public pensions from being cut. But Rhodes questioned whether the city's eligibility for bankruptcy should hinge on a plan of action it might take at a later date.

Attorney Claude Montgomery, representing a committee of Detroit retirees, said Detroit Emergency Manager Kevyn Orr already indicated in a June proposal to creditors that he plans to slash pension benefits to help deal with Detroit's $11.9 billion in unsecured debt and other obligations. Orr deemed some of the city's outstanding bonds, along with the city's pension and retiree health care obligations, as unsecured debt that would be paid at just pennies on the dollar.

"The only way that the emergency manager in his own mind can do that is to have access to the bankruptcy court because he believes bankruptcy law will trump the state constitution," Montgomery said, suggesting the city could reapply for bankruptcy protection with stipulations that protect pensions.

Bennett asserted that federal law does supercede the clause in the state constitution that state pensions cannot be reduced.

"Federal law here is supreme," Bennet said. "Period. End of story."

Rhodes also raised the question of whether the state constitution prevents the bankruptcy court from impairing pension benefits.

"The law prohibits the city from doing it, but the question is whether it prohibits bankruptcy court from doing it," Rhodes said.

Arguments objecting to the underlying facts in the case, such as whether the city negotiated with creditors in good faith, will be heard next week as part of a trial to determine the city's eligibility to receive bankruptcy protection.

(Reporting by Joseph Lichterman; Editing by Dan Grebler and Ken Wills)

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