By Ed Mendel
Monday, March 2, 2015

On the day that Stockton emerged from bankruptcy last week, ending 32 months of debt protection, the final court argument was about the “cram down” imposed on the only creditor that did not cut a deal.

Is Franklin bonds getting a 12 percent payment from Stockton for a $36 million loan or, as the city contends, a 17 percent payment?

The answer depends on whether $2 million of the loan, held in reserve like a “last month’s rent” security deposit, is counted along with a $4 million city payment to Franklin or simply regarded as the bond fund reclaiming its own money.

It’s a minor issue, one Judge Christopher Klein suggested he may resolve by being less specific in his 54-page decision confirming the Stockton plan to exit bankruptcy, which said Franklin recovered about 12 percent of the money owed.

“I’m not surprised people want to put a finer point on the pencil,” the federal bankruptcy judge said.

Larger questions remain, however, from the judge’s first-of-its-kind ruling that CalPERS pensions can be cut in a municipal bankruptcy, even though in this case Stockton chose not to do so.

Will CalPERS appeal the pension ruling or let it stand unchallenged, possibly clouding the sense of security of state and local government employees, encouraging future bankruptcies and giving management leverage in labor negotiations?

And does Stockton’s decision not to cut pensions in bankruptcy risk future insolvency, as Moody’s credit rating service warned a year ago, possibly putting the city on a path to future budget deficits, which Vallejo has faced since its bankruptcy?

Franklin is appealing the judge’s approval of the Stockton exit plan, arguing creditors are treated unfairly because pensions are not cut. It’s not clear whether CalPERS will appeal the judge’s ruling for the opposite reason: that pensions can be cut.

The California Public Employees Retirement System joined a union appeal of a federal judge’s ruling in the Detroit bankruptcy in December 2013 that municipal pensions can be cut in bankruptcy.

CalPERS argued, among other things, that Detroit has a city-run plan and that an “arm of the state” like CalPERS cannot under federal bankruptcy law be impaired in a municipal bankruptcy.

After Judge Klein issued an oral version of his ruling last Oct. 1, an initial CalPERS reaction was there is nothing to appeal, no written ruling or action, just a “hypothetical” from one judge. Klein issued his written ruling on Feb.4.

“While we’re still considering all options, we don’t generally discuss litigation strategy,” a CalPERS spokesman, Brad Pacheco, said last week.

Stockton officials know the city has high pension costs. In a city video posted on YouTube after bankruptcy was filed on June 28, 2012, Councilwoman Kathy Miller said some employees earn 25 percent more than the statewide average.

“In Stockton employees made what’s known as pension ‘spiking’ into an art form, using overtime and ‘add pays’ in their final working years to secure much larger pensions for the rest of their lives,” Miller said.

But if not for Franklin, there may have been no ruling on the pension issue Klein called a “festering sore.” Stockton did not want to cut pensions. City officials said they are needed to be competitive in the job market, particularly for police.

In a 90-day mediation leading up to Stockton filing bankruptcy on June 28, 2012, Stockton negotiated pay and staff cuts with most of its unions, promising in exchange that pensions would not be cut.

Two bond insurers backing most of the Stockton bonds were the first to raise the issue of whether all creditors are treated fairly, as required by federal law, if most debt is cut except one of the largest, pensions administered by CalPERS.

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