Holdout creditor files appeal to Stockton, Calif., exit from bankruptcy

(Reuters) - The holdout creditor in the bankruptcy case of Stockton, California, has filed an appeal this week to a judge’s ruling that allowed the city to exit Chapter 9 protection.

Franklin Templeton Investments is appealing the court’s decision in which it ruled in October to give Franklin more than $4 million from an original debt of roughly $36 million.

Franklin argued that Stockton’s plan unfairly treated the creditor, particularly compared to other debts such as pensions managed by California Public Employees’ Retirement System (CalPERS), and said the city could “pay far more to Franklin.”

Last month, U.S. Federal Bankruptcy Judge Christopher Klein ruled that Stockton’s plan was fair, explaining that “substantial concessions” had been made by all creditors. In addition to haircuts taken by bondholders, public employees had renegotiated contracts, the city had cut positions, and retirees had lost healthcare benefits.

The city’s cost savings from the elimination of retiree healthcare benefits was calculated at $545 million, but Franklin argued, in its appeal, that the city had improperly inflated the figure and the true savings was $261.9 million.

“The city was incentivized to inflate the amount of retiree health benefit claims,” Franklin’s attorneys wrote, “and thus minimize its payment to Franklin”.

Stockton’s case had been closely watched by the $3.7 trillion U.S. municipal bond market along with Wall Street investors, city workers, and other cities and towns across the nation to see how bondholders are treated compared to employee benefits, such as pensions.

Prior to his final ruling, Klein had determined that pensions managed by CalPERS could be reduced in municipal bankruptcy. The judge carefully examined the role of pensions, at times calling it “a festering sore” that required the court “to get in there and excise it and figure out what the story is.”

Ultimately, Klein confirmed the city’s plan, acknowledging that city workers and retirees had made sacrifices, which justified leaving pensions untouched.

Moody’s Investor Service reported that Stockton’s confirmation would continue the likelihood of higher pension recoveries than other debts in California bankruptcies.

But Klein offered a stark warning to any municipality considering Chapter 9 as a backdoor to settling debts.

“This is a very expensive case, and probably should be an object lesson as to why the Chapter 9 process is not lightly to be entered into,” said Klein. “The industry overall will look at the cost a Chapter 9 case and be sobered.”

Reporting By Robin Respaut; Editing by Bernard Orr