The suit filed Friday contends the deal resulted in the city being saddled with $1.4 billion in debt and should be dissolved by a federal bankruptcy judge.
"This deal was bad for the city from its onset, despite reassurances it would adequately resolve the city's pension issues," Kevyn Orr, Detroit's emergency manager, said in a written statement. "We have tried, without success, to negotiate a resolution to this dispute and to allow the city and its taxpayers to move forward and unwind these illegal transactions."
The city contends then-Mayor Kwame Kilpatrick and his administration concocted a complex plan involving so-called pension obligation certificates of participation, which the city said in its lawsuit was "illegal from the outset because it was a thinly disguised municipal bond issue using shell entities to exceed the city's statutory debt limit."
The city's move to eliminate the massive pension debt that has built up puts Orr and his team at odds with a cadre of major bond insurers, the Detroit Free Press reported, although city retirees and employer unions were expected to support the effort because it would lead to more money for them once the dust settled.
Steve Spencer, a financial adviser to bond insurer FGIC, said the debt reflected "common and widely accepted approaches to addressing retiree costs."
"The deal was looked at rigorously by outside advisers on both sides and was a necessary step for the city at the time," Spencer said in a written statement.