By Ed Mendel
Monday, September 24, 2012

Bond insurers arguing that Stockton is ineligible for bankruptcy because it did not attempt to negotiate a pension debt reduction with CalPERS, among other failings, may get their day in court in January.

U.S. Bankruptcy Judge Christopher Klein, who is presiding over the case in Sacramento, said in Berkeley Friday that the opponents of the bankruptcy are in the “discovery” phase, gathering evidence to support their positions.

“I’ll probably have a trial over that in January,” Klein told a conference on “California’s Fiscal Crisis” at the UC Berkeley Institute of Governmental Studies. “If I order relief, then it goes forward. If I don’t order relief, the case will be dismissed.”

Stockton, which filed for bankruptcy in June, is proposing to get major savings by eliminating $197.5 million in general fund payments on bonds during the next 25 years, leaving insurers to make payments preventing losses for bondholders.

The two insurers backing most of the bonds hired large global law firms and in August filed opposition to Stockton’s eligibility for bankruptcy. Blocking eligibility may be the insurers best chance to force a change in the Stockton plan.

The attorneys for National Public Finance Guarantee argued that municipal petitions for “Chapter 9” bankruptcy should be viewed with a “jaded eye,” citing two similar lines from past court rulings.

“Considering the bankruptcy court’s severely limited control over the debtor once the petition is approved, access to Chapter 9 relief has been designed to be an intentionally difficult task,” says one of the lines cited by the Winston & Strawn law firm.

If the judge determines Stockton is eligible for bankruptcy, the city would negotiate a “plan of adjustment” with creditors to reduce its debts. The court would have to approve the plan, but the court cannot impose a plan of its own.

“It’s the court’s obligation to review the plan of adjustment and determine whether it’s fair and equitable as to all parties,” said Klein.

“There would have to be very extensive litigation for the court to say, ‘Well, this plan doesn’t work,’ and authorize somebody to come back. So it winds up being an iterative process, and it’s highly negotiated among the parties.”

Klein said the plan in Vallejo, which emerged from a three-and-a-half year bankruptcy last November, was a consensus worked out, after “a great number of bodies on the floor,” by the city and its creditors.

“The only other leverage I have is dismissal,” said Klein. “But if I dismiss the case there is nothing to stop them from turning around and filing it again. So that’s the limitation.”

In July, Klein denied a request by a retiree group to block Stockton’s cuts in retiree health care. He said the federal bankruptcy law prohibits interference with the debtor’s political or governmental powers, property and revenues.

There is a widespread view that a series of court rulings mean that pensions promised state and local government workers on the date of hire are “vested rights,” protected by contract law, that cannot be cut unless offset by an equal benefit.

Klein said the U.S. Supreme Court has ruled that a state cannot pass a law that impairs a contract, but did not bar Congress from doing so. He said the bankruptcy law is reinforced by the constitutional supremacy of federal law over state law.

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