By Jim Christie
SACRAMENTO, Calif., March 25 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
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
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
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
A Rhode Island law, passed as Central Falls' insolvency
reached a crisis point, gave bondholders a lien on property tax
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.