(In 5th paragraph corrects to show that date for trial on bankruptcy eligibility has been set, not that the date still needed to be set)
By Nick Carey and Joseph Lichterman
DETROIT, Aug 2 (Reuters) - In a high-stakes hearing on Friday in Detroit's bankruptcy filing, a judge approved a city plan to form a creditors' committee of retired workers, but gave unions and pension funds that opposed the plan a measure of satisfaction by declaring an independent trustee - and not the city - will select committee members.
Federal bankruptcy Judge Steve Rhodes' ruling on the city's effort to create a new negotiating partner independent of unions and pension funds was a key moment in a three-hour session that packed the largest courtroom in Detroit's downtown federal building. Rhodes also put off setting a date for a hearing on Detroit's eligibility to file for bankruptcy, while Detroit lawyers disclosed an ambitious aim to present a plan for reorganization by the end of 2013.
Detroit, whose course in bankruptcy court is being set by a state-appointed emergency manager, Kevyn Orr, set its target date at least three months earlier than the March 2014 deadline Rhodes previously had proposed.
Outside of court, Orr on Friday also proposed a new healthcare plan for city workers that would save Detroit $12 million annually by raising deductibles and trimming the number of available plans.
The next step in the largest U.S. municipal bankruptcy will be a trial beginning on Oct. 23 to determine whether Detroit is eligible for a Chapter 9 bankruptcy. To remain in bankruptcy court, Detroit must prove it is insolvent and has negotiated in good faith with creditors owed more than $18 billion, or that there are too many creditors to make negotiating feasible.
Pension funds and unions representing city workers are expected to contest Detroit's eligibility.
An attorney for the city also disclosed Detroit is in regular but pointed dialogue with creditors even while in bankruptcy court. "There are significant differences that we feel will be difficult to breach," said David Heiman, an attorney who represents the city.
Detroit, a former manufacturing powerhouse and cradle of the U.S. automotive industry and Motown music, has struggled for decades as companies moved or closed, crime surged, and its population dwindled. The city's revenue fell short of spending, while city budgets and borrowing ballooned.
The city now says it can't afford to pay its retired workers the pensions and benefits they were promised. The committee that the trustee will select could help determine how much money and benefits the retirees may lose.
Unions argued the committee should include labor union representatives. They also asked the judge to adjust his proposed timetable for the case to allow the committee to become established and permit negotiation and mediation with the city.
U.S. Trustee Daniel McDermott will form the committee, though Judge Rhodes has the power to reject the committee's composition if it lacks adequate representation.
Brian O'Keefe, an attorney who represents associations of retired Detroit police, firefighters and city employees, said it was important the city not dictate the committee's composition.
"We were objecting to the fact that it seemed like the city wanted to be involved in the structuring of the committee and I think Judge Rhodes made it clear that it really will be up to the U.S. Trustee," said O'Keefe.
The judge approved the city's offer to pay costs associated with the retiree committee's work. And Edward McNeil, the lead negotiator for a coalition of 33 of Detroit's 48 labor unions, told Reuters the union expects the city's funding to cover the cost of an independent actuarial study of the city's unfunded pension liability.
Orr, the city's emergency manager, contends the city faces $3.5 billion in unfunded liability, though the city prior to Orr's estimate in June had put the unfunded liability at $644 million for 2011. A larger unfunded liability could increase pressure on retirees and workers to make concessions to help Detroit fix its failed finances.
Estimates of pension valuations vary widely based on a number of factors, including return on investments and 30-year amortization of pension obligations. Rachel Barkley, a municipal credit analyst at Morningstar who studied the way Detroit calculated pensions valuations, said Detroit was within industry norms in its calculations.
"We feel an 8 percent investment return may not be conservative but definitely would be defensible by the city," she said.
Lawyers for some city unions argued Judge Rhodes' proposed schedule for the eligibility phase - at which the city must prove it belongs in bankruptcy - was too tight and left little time for discovery. Rhodes had proposed an Oct. 23 trial date.
"The whole schedule as a package is fairly aggressive," said Babette Ceccotti, a lawyer for the United Auto Workers, one of the city's unions.
Rhodes did not set a firm date for the eligibility trial and said he would consider concerns about scheduling and set an Aug. 21 date for the next hearing in the case.
During the hearing, Rhodes said he intends to appoint an examiner to review the fairness of fees charged by Detroit's lawyers and other service providers.
He gave the parties seven days to nominate candidates for the job. He also put off any action on a simmering debate over a deal Detroit struck with counterparties to interest-rate swap agreements that would save the city more than $70 million.
Detroit's target of filing a reorganization plan by year-end compares with the March 1 date proposed earlier this week by Rhodes. While the city would "enthusiastically accept" the judge's deadline, Heiman said, it wants to move faster.
"Our view is that time is our enemy," Heiman said. "The facts are not going to change no matter how long we wait. ... So we aim to file a plan by the end of the year."
The target date for Detroit's reorganization plan may prove tough to meet if recent municipal bankruptcies are any guide.
Stockton, California, took nearly a year just to prove its eligibility for Chapter 9 bankruptcy, and San Bernardino, California, is still awaiting a declaration more than a year after filing for protection.
Detroit's bankruptcy has drawn national attention at a time when many cities and states are dealing with budget deficits and pension crises.
St. Louis Federal Reserve President James Bullard, in remarks after speaking at a Boston conference Friday, warned bankruptcy will not be a quick fix.
"Declaring bankruptcy is no panacea," Bullard said. "It is not a solution. It is a mess." (Additional reporting by Deepa Seetharaman, Hilary Russ and Ed Krudy. Writing by Karen Pierog; Editing by David Greising, Nick Zieminski, Phil Berlowitz and Lisa Shumaker)