Stockton, California bankruptcy eligibility trial begins

SACRAMENTO, California Mon Mar 25, 2013 7:44pm EDT

1 of 3. Shuttered and padlocked businesses line Main Street in Stockton, California in this June 27, 2012 file photo.

Credit: Reuters/Kevin Bartram/files

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SACRAMENTO, California (Reuters) - Lawyers for Stockton and its creditors kicked off a courtroom battle on Monday over whether the California city is eligible for bankruptcy protection to force its bondholders to swallow losses while leaving pensions intact.

The closely-watched case has broad implications for other local governments seeking protection in bankruptcy court from creditors and for struggling municipalities that may pursue a similar path.

The outcome in the case of Stockton, the biggest U.S. city to declare bankruptcy, also is an important test case for the $3.7 trillion U.S. municipal debt market, which provides financing for various public capital projects, from school construction to sidewalk repairs.

Unlike in corporate bankruptcies when all debt holders absorb some losses, bondholders in major municipal bankruptcies consistently have been repaid all of their principal since at least the 1930s.

Now Stockton and at least two others municipalities are challenging that premise: Jefferson County in Alabama and San Bernardino, California, also expect to ask bondholders to take losses in their bankruptcies.

The Stockton hearing is expected to last most of this week.

Bondholders and insurers, which will have to repay investors for any capital losses, argue the decision by Stockton to keep paying its largest creditor, the California Public Employees' Retirement System, shows a lack of good faith and should block Stockton's request for bankruptcy protection under federal bankruptcy law.

Stockton pays a yearly contribution of about $30 million to the $254 billion retirement system. The largest U.S. pension fund, known as Calpers, manages pension accounts for the city's employees and retired employees.

"The city ignores the 800-pound pension gorilla in the room," Guy Neal, one of the lawyers for the capital markets creditors, said in his opening remarks.

Bond insurers contesting Stockton's eligibility for bankruptcy protection have more than $300 million of exposure to the city's debt. Assured Guaranty Corp, Assured Guaranty Municipal Corp and National Public Finance Guarantee Corp were joined by Wells Fargo Bank, the Franklin California High Yield Municipal Fund and Franklin High Yield Tax-Free Income Fund.

Marc Levinson, a lawyer for Stockton, defended the city's right to go bankrupt. He argued Stockton had attempted to negotiate in good faith with its creditors as required by California law before demanding protection from creditors.

The city of 300,000 in California's Central Valley, which filed for bankruptcy last year, fell on hard times when its revenue plunged after its once-torrid housing market went bust. Two decades of generous employee benefits, poor fiscal management and too much debt also caught up with the city, which is 85 miles east of San Francisco.

Stockton's general fund-supported payroll has dropped to 972 positions from 1,360 in 2008-2009. The city has about 2,400 retirees, 1,100 of them affected by the city scrapping its retiree medical program. Savings from shedding retiree medical spending is helping bolster Stockton's finances while it presses its bankruptcy case, city manager Bob Deis said.

"These guys aren't giving us credit for that," Deis told Reuters after his testimony at the hearing.

Deis defended Stockton's pension contributions, saying they are "inextricably" tied to the crime-plagued city's ability to retain and recruit police officers.

Stockton's budget provides for 340 sworn police officers, compared with 401 in 2008-2009. If Stockton had done differently impairing its pensions after wiping out its retiree medical program police officers would have simply quitted.

"If it appears we'll impair retirement benefits, we'll have a mass exodus of police officers," Deis said.

By contrast, San Bernardino, which also filed for bankruptcy protection last year, is not making contributions to the state's pension fund as it contends with its financial troubles.

In other municipal bankruptcy cases, bondholders have been protected.

Central Falls, a tiny, poor Rhode Island city, had its bankruptcy plan approved by a judge in September. It slashed retirees pension payments in half and raised taxes, but left bondholders unscathed.

A Rhode Island law, passed as Central Falls' insolvency reached a crisis point, gave bondholders a lien on property tax revenue.

The Central Falls case, along with sweeping public pension changes at the state level, prompted labor unions and retirees in other struggling Rhode Island cities - including Providence, the state capital - to renegotiate retirement benefits and collective bargaining agreements.

Though Central Falls has exited bankruptcy, its case will remain open for several years so the court can step in if elected officials veer from the restructuring plan. Officials must give quarterly statements about the city's finances.

Because of the Central Falls case, "I don't think we're ever going to need a Chapter 9 again" in Rhode Island, said Theodore Orson at a distressed municipalities conference this month in Providence. Orson was the attorney for the state-appointed receiver who oversaw Central Falls' return from insolvency.

(Reporting by Jim Christie; Additional reporting by Michael Connor in Miami and Hilary Russ in New York; Editing by Tiziana Barghini, Mary Milliken and Chizu Nomiyama)

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Comments (1)
morbas wrote:
The federal budget is $3.8 trillion. Federal plus state plus municipality is greater than $8.06 trillion. The sum total of all personal income is $12.98 trillion. Thus, the governments are operating at 62 percent of total personal income.
With a centralized banking system, the federal government can print more money than collected in revenue; states and municipalities cannot. Taxation at state and municipal levels is less progressive than federal, which burdens the lowest income levels with the highest effective rate; and the upper 2 percent with the lowest effective rate. Thus, municipalities borrow more in a recession, as the lower quintile’ wages are more diminished. We have cities falling into bankruptcy.
In My Humble Opinion,
Responsibility thus traces to the Central Bank System; The House of Representatives has the authority of debt and taxation and can look no where else to shed it’s purpose. First comitment then is to the pension fund, to the innocent caught up in this banking flaw.Municipalities Bankrupt: San Bernardino CA, Mammouth LakesCA , Stockton CA, Central Falls MA, Hauppauge NY,
Jefferson County MI, Harrisburg PA, Boise County ID.

Write people write, the 2 year representatives are always vulnerable to constituent mandates.
George Washington: “The power under the [federal] Constitution will always be in the People. It is entrusted for certain defined purposes, and for a certain limited period, to representatives of their own chusing; and whenever it is executed contrary to their Interest, or not agreeable to their wishes, their Servants can, and undoubtedly will be, recalled.”
Honorable Senator/Representative/POTUS,
Stop Sequestration.
This is a mandate for a Federal income tax system that funds present Federal budget to include Health (Obama-Care, Medicade and Medicare) and Social security. One Margin level will yield the $3.8T revenue: %0-$20k 0% tax rate, $20k upwards 35% flat rate, income bundled and taxed in summation form, couples freely share, no business tax and no exemptions. The rate is less than 2011 single standard at under $200K. The Federal Reserve sets the rates, mandated to maintaining monetary value and supply.

Thank you for your immediate attention,
Your constituent [Zip Code]

Mar 25, 2013 9:54pm EDT  --  Report as abuse
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