Primacy of pensions in city bankruptcy may be issue for U.S. court in July

SAN FRANCISCO, April 26 Fri Apr 26, 2013 8:56pm EDT

SAN FRANCISCO, April 26 (Reuters) - A U.S. judge in July could take up the issue of whether a bankrupt city can shield workers' pensions while inflicting heavy losses on bond holders and other creditors, a lawyer for California's pension fund for public employees said on Friday.

Since filing for bankruptcy last year, the California city of Stockton has made a point of maintaining payments to the California Public Employees' Retirement System, or Calpers, while targeting creditors for steep losses.

Whether Stockton may press on with that approach could be taken up in coming weeks by U.S. Bankruptcy Judge Christopher Klein, who did not take up the matter during a three-day trial last month on Stockton's eligibility for bankruptcy.

Instead, he ruled the city of about 300,000 established it is eligible to proceed with its bankruptcy case and craft a so-called plan of adjustment for its debts.

But Klein at the same time signaled the closely watched role of Calpers in Stockton's bankruptcy case could come into focus when the plan of adjustment emerges.

Stockton aims to file the plan in the third quarter with an eye toward exiting bankruptcy by the end of the year. That means the plan could be put to Klein as early as July, said Michael Gearin, an attorney for Calpers in the Stockton case.

Stockton is the biggest U.S. city to pursue Chapter 9 bankruptcy, a move the city made in the face of a $26 million shortfall that years of steep spending cuts failed to prevent.

CHALLENGING CITY'S PRIORITY

To prop up its budget while pressing its bankruptcy case, Stockton pressed bondholders to swallow major losses, prompting them and the city's bond insurers to challenge the city in court.

Stockton's decision to keep paying into the state pension fund known as Calpers has been hotly disputed by the creditors, who argued in the recent eligibility trial that the city would not be able to repair its finances without tackling its pension expenses.

The creditors include bond insurers Assured Guaranty Corp, Assured Guaranty Municipal Corp and National Public Finance Guarantee Corp. They were joined by Wells Fargo Bank, the Franklin California High Yield Municipal Fund and the Franklin High Yield Tax-Free Income Fund.

Stockton officials say they need to maintain payments to Calpers to retain and recruit city employees and that state law bars the city from impairing payments to the fund.

The officials also say retired Stockton employees will suffer enough under the city's financial restructuring by losing their city-provided medical coverage.

Calpers was sidelined during the eligibility trial but is prepared to defend Stockton's pension payments before Klein.

Marc Levinson, a lawyer for Stockton, said a best case scenario is for the city and its creditors to reach settlements so they are included in an amicable plan of adjustment.

The two sides will be negotiating in confidential talks even as Stockton works on its plan of adjustment, Levinson said, noting he is optimistic about the talks.

"People are going to do their best," he said. "Klein has made it clear at every opportunity that he would like to see negotiations."

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