Court says city of Stockton, California may proceed with bankruptcy

SACRAMENTO, California Mon Apr 1, 2013 9:44pm EDT

1 of 2. Crumbling sidewalks and shuttered businesses line a downtown street in Stockton, California, in this June 27, 2012, file photo.

Credit: Reuters/Kevin Bartram/Files

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SACRAMENTO, California (Reuters) - A federal judge on Monday approved the city of Stockton's petition for bankruptcy in a case that sets the stage for a lengthy battle between bondholders and the California pension system.

In a case being studied by other cash-strapped American cities including Detroit, U.S. Bankruptcy Court Judge Christopher Klein's decision was a setback for bondholders and insurers who had resisted the California city's bankruptcy filing. Stockton is the largest U.S. city ever to file for bankruptcy.

The judge also signaled that the California Public Employees Retirement System's position in the case was not above review. Stockton, a city of 300,000, has so far not reduced pension payments to retired city workers, although it has eliminated retiree healthcare benefits.

"This does not mean there is not potentially a serious issue involving Calpers," Judge Klein said. "But at this point I do not know what that is." He added that there were "very complex and difficult questions of law that I can see out there on the horizon," relating to Calpers.

The decision on Stockton marks the start of a lengthy restructuring of the obligations that currently overwhelm its finances, which were crippled by the housing crisis and recession.

Investors in the $3.7 trillion municipal bond market are concerned that if Stockton is able to avoid paying bondholders in full without cutting pension payments, other cities will pursue a similar strategy as they struggle to cope with budget shortfalls.

Kenneth Naehu, head of fixed income at Bel Air Investment Advisors in Los Angeles, agreed that the case could cloud the issue of where bondholders stand in relation to retirees and pension funds in a municipal bankruptcy.


In a lengthy preamble to his ruling, Klein delivered a stinging rebuke to the so-called capital market creditors - mainly the insurers for bondholders who own hundreds of millions of dollars of Stockton debt - who had opposed the bankruptcy filing.

He rejected the arguments of bondholders and insurers that Stockton was not truly insolvent when it sought Chapter 9 bankruptcy protection last summer and that it had improperly failed to seek relief from its pension obligations.

Klein said capital market creditors had failed to negotiate in good faith in a pre-bankruptcy mediation, as required by law, and also criticized their refusal to pay part of the bill for mediation.

Calpers is far from off the hook, but the city's obligations to the retirement system are properly addressed as part of the effort to finalize a "plan of adjustment" for emerging from bankruptcy, the judge said.

Michael Sweet, a municipal bankruptcy lawyer with Fox Rothschild who is not involved in the case, said the judge's remarks suggested that "somewhere along the line the city will have to go to Calpers, because otherwise they will have problems with discrimination in the plan."

A plan of adjustment, like any bankruptcy reorganization plan, cannot favor one group of creditors over another.

"You're going to see an issue teed up that could go to the U.S. Supreme Court," Sweet said.

Calpers asserts that California law protects pensioners from any haircut even in bankruptcy, but that position has never been tested in court.


Bob Deis, the Stockton city manager who is largely responsible for managing the bankruptcy process, called the judge's verdict a "vindication" of the city's position.

He criticized the "scorched-earth" legal strategy of the bond creditors as a waste of time and money, and said the city had already spent $6 million to $7 million on the mediation and legal costs.

Assured Guaranty Ltd, one of the bond insurers, said in a statement that it "disagrees" with the judge's ruling but that it looked forward to working with the city on a "consensual approach" to resolving its debts. A company spokesman also said that it had tried to negotiate with the city prior to bankruptcy, but without success.

Others opposing the city's bankruptcy included National Public Finance Guarantee Corp, Wells Fargo Bank, the Franklin California High Yield Municipal Fund and Franklin High Yield Tax-Free Income Fund.

Throughout his two hours of comments, the judge made it clear that he thought the city had done everything it could to avoid bankruptcy. He noted that sharp cost-cutting had begun years ago, and that 77 percent of the city's budget was devoted to already-diminished police and fire services.

Klein agreed that further cuts in public safety and other services were not options.

It was not clear on Monday if any of the capital market creditors would appeal the ruling. A spokesman for Assured Guaranty said the company wanted to see the written ruling before it determined next steps. National Public Finance Guarantee had no comment on a possible appeal.

(Reporting by Jonathan Weber; Additional reporting by Michael Connor in Miami; Editing by Chris Reese, Tiziana Barghini and Will Dunham)

(This story was refiled to add California in the headline)

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Comments (14)
4sight2020 wrote:
another city run by democrates is circling the drain.

Apr 01, 2013 9:49pm EDT  --  Report as abuse
deansmith1010 wrote:
If the pensioners win, there will be a lot of folks bailing out of the bond market.

Most of these pensioners, if they live to be 85, will receive over one million dollars in retirement. Since they are union members, you know they are worth it.

Apr 01, 2013 11:14pm EDT  --  Report as abuse
tab wrote:
Well I say let the bond holders deal with the loss.

I understand that that may sound bad but the truth is the people that are retired and trying to make ends meet had a long standing contract with the city. They worked for 20-30 years and fulfilled the agreement to work for the city and in return if they stay loyal to the city one day they will get to retire. There is no way to recover for them if they loose their pension they are to old.

I also understand that the bond holders had a contract as well however the bondholder are well aware of the risk involved in investing in a city. Sure they hope to get their profit out of it however as with all investments it is a gamble.

I know nothing of how the city was run either by democrats or republicans and to be honest it doesn’t matter to the people whos entire security is in jeopardy here. I am sure a lot of people will blame one party or the other but those people who worked for the city where most likely good hardworking people that were not collecting money from entitlement programs. They are firemen, police officers and garbage men that made everyone life better for 20 – 30 years.

Apr 01, 2013 11:20pm EDT  --  Report as abuse
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