Stockton's Bankruptcy Allowed to Proceed ... Could Be a Huge Case for Pensioners, Creditors and Other Claimants

This news just in this afternoon. A judge has approved Stockton, California's petition for bankruptcy.

Creditors, pensioners, employees and taxpayers all have a vested interest in the eventual outcome, and the case could be an important benchmark for cities throughout the nation.

Judge Allows Stockton, Calif., to Enter Bankruptcy has the breaking news:

"Stockton, Calif., successfully fought off Wall Street creditors for the power to restructure its debt in Chapter 9 bankruptcy, but a bankruptcy judge signaled the city may have to find financial stability in an unprecedented place: its pension fund.

At a court hearing Monday, Judge Christopher Klein of the U.S. Bankruptcy Court in Sacramento refused to dismiss the city's Chapter 9 case, saying that it "will not be able to perform its obligations to its citizens relating to such fundamental matters as public safety, as well as other basic governmental services, without the ability to have the muscle of the contract-impairing power of federal bankruptcy law.". . .

During a three-day trial last week, bondholder groups asked Judge Klein to dismiss the case, arguing that the city was unfairly trying to use bankruptcy to cut its debt payments while leaving its obligations to the California Public Employees' Retirement System—which holds city workers' retirement money—untouched.

Calpers, which handles pension benefits for the state's 1.6 million public employees and retirees, is scheduled to collect hundreds of millions of dollars from Stockton over the next decade.

Municipal experts and other struggling California cities are closely watching Stockton's case to see whether a city's debt to Calpers is immune from cuts imposed by a bankruptcy judge.

Judge Klein disagreed that bondholders were being unfairly targeted, but he said the group could try to block the city's debt-restructuring plan.

"The city is going to have a difficult time confirming a plan over an objection and claim of unfair discrimination without being able to explain that problem away," Judge Klein said Monday.

Bondholder groups have said that, while Stockton's bond payments account for roughly 7% of the city's budget, city leaders have asked for concessions valued at 44%. Attorneys for the bondholders argued that the city can't use federal bankruptcy protection to target some creditors, but not others.

Before the trial, Assured Guaranty Corp., the insurer of $161 million of the city's debt, and others scrutinized the city's finances, suggesting that it sell buildings such as its City Hall, the Bob Hope Theatre and the Stockton Events Center while raising taxes on utilities, tourists and those who make emergency 911 phone calls, according to earlier court papers.

But Stockton attorneys argued the city already imposed harsh cuts on its departments and its roughly 1,300 workers in recent years. Weakening pension benefits, they argued, could scare off police officers during a time of record crime.

City attorneys have said Stockton, which ranks as one of the state's most dangerous cities, employs about 1.2 police officers for every 1,000 residents—a ratio that's almost half of what's recommended by a national study.

"When Stockton should be adding to its police force, it cannot impair its pension…and run the fatal risk of [an] even tougher recruitment problem," said Stockton bankruptcy attorney Norman Hile during the trial.

Judge Klein's ruling that Stockton is eligible for Chapter 9 protection marks a major milestone for the city, which could become the first municipality to use bankruptcy protection to force bondholders to take less than the principal they are owed. Two other areas operating under Chapter 9 protection—658,000-resident Jefferson County in Alabama and 210,000-resident San Bernardino in California—are also trying to negotiate concessions from bondholders.

Unlike corporations that seek Chapter 11 protection, cities that file for Chapter 9 have to prove that their leaders first followed steps set forth by the Bankruptcy Code—a requirement that often gives creditors who face harsh cuts during a city's bankruptcy the chance to object.

In the past, challengers have been successful; nearly one-third of the roughly 260 municipal bankruptcy cases filed since 1980 have been thrown out, according to figures kept by the Chapman and Cutler LLP law firm in Chicago.

Stockton's leaders are expected to begin putting together a reorganization plan for the city, which would have to be approved by Judge Klein."

Summing Up

It ain't over 'til it's over, or at least until the fat lady sings, and this one ain't over by a long shot.

Since retirees, current employees, citizens' rights to have adequate city services, bondholders' rights to equal treatment with other creditors, and many other city obligations are all legitimate claims against the bankrupt city, which they are, something's gotta give.

Stockton officials have overpromised and now all the claimants want fair and equal treatment. In fact, some think it's only fair that they be treated more equally than others.

But the money is not there to do all that's been promised.

We'll all watch attentively as this case unfolds. The is one bankruptcy proceeding that won't be boring. It's going to be a thriller and perhaps a national precedent setter as well.

So stay tuned. The battle has only just begun.

Thanks. Bob.