By Jonathan Weber
SACRAMENTO, Calif., April 1 Stockton,
California, is eligible for bankruptcy protection, a federal
judge ruled on Monday, turning aside creditors' arguments the
city was not truly insolvent when it sought protection and
improperly failed to seek pension concessions.
U.S. Bankruptcy Court Judge Christopher Klein's ruling
permits Stockton to proceed with a Chapter 9 municipal
bankruptcy case after it became the largest U.S. city ever to
file for bankruptcy.
The decision is likely to increase scrutiny of how the city
will handle its pension obligations, managed by the California
Public Employees Retirement System (Calpers).
Stockton is being closely watched by the $3.7 trillion
municipal bond market and by other cash-strapped cities.
Creditors have claimed a lack of good faith by Stockton in
its decision to fully pay its obligation to the $254 billion
Calpers system but impose losses on bondholders and bond
The expected move by the California city of 300,000 - along
with Jefferson County in Alabama and San Bernardino in
California - breaks with a long-standing tradition to fully
repay bondholders the principal in most major municipal
CALPERS ISSUE LOOMS
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
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 foot part of the bill for
mediation. He dismissed their arguments that the city wasn't
really broke, stating that Stockton was "by any measure
insolvent" prior to its filing.
The judge also rejected the argument that city had
improperly exempted the $254 billion Calpers from concessions
during the pre-bankruptcy mediation. He did, however, suggest
that the issue of how pension payments are treated will be a
central issue in the case going forward.
"This does not mean there is not potentially a serious issue
involving Calpers," Judge Klein said in reference to his ruling.
"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.
But those issues are properly addressed as part of the
effort to finalize a so-called "plan of adjustment" for emerging
"SCORCHED EARTH" TACTICS
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
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.
Bond insurers 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 in
contesting Stockton's bid for bankruptcy eligibility.
They argued that the city could have done more to cut
spending and raise taxes, and that it was unfair to demand
concessions from bondholders without also demanding cuts in
payments to Calpers.
But Judge Klein, citing crime statistics and the city's
extensive cost-cutting pre-bankruptcy, agreed that further cuts
in public safety and other services were not options.
He also rejected bondholder arguments that they were not
required to negotiate in good faith in the mediation, noting
that it was impossible to negotiate with a "stone wall."