By Ryan C. Wood

The City of Stockton bankruptcy case has now officially become a complete mess.  Bankruptcy lawyers everywhere should keep an eye on this one.  On or around August 9, 2012, multiple creditors or interested parties filed opposition to the City of Stockton’s eligibility to be a debtor under the bankruptcy code.  It also appears that Stockton’s choice to try the Neutral Evaluation Process under California law, rather than declare a fiscal emergency, will add thousands and thousands of dollars to their goal of reorganizing their debts.  Going through the Neutral Evaluation Process also appears to have given those owed money a better argument for Stockton not being eligible to be a debtor under the Bankruptcy Code.  California passed AB506 and created California Government Code Section 53760 to help make filing bankruptcy a last resort for municipalities.

The party that really calls out Stockton is a company called National Public Finance Guarantee Corporation (“National”).  They filed their opposition to Stockton’s bankruptcy petition on August 8, 2012.  National insures the repayment of over at least $90 million in bonds Stockton has issued for various projects.  National would have to pay all principal and interest on these bonds in the event Stockton defaults completely or is not required to pay the bonds.  National’s main argument is that Stockton does not meet the requirements under bankruptcy code section 109(c) to file bankruptcy.  This section requires a municipality to have negotiated in good faith with creditors and failed to obtain agreement from creditors holding at least a majority in amount of the claims of each class that such entity intends to impair (change) under a plan in a bankruptcy case under Chapter 9.

A question you may be asking yourself is why did the California legislature pass a law under California state law requiring a municipality conduct the Neutral Evaluation Process (negotiating with creditors) or declare a fiscal emergency before filing for bankruptcy if this provision of the bankruptcy code already existed?  Who knows?  The California legislature added another layer of costs for a California municipality to file bankruptcy to the detriment of those who are owed money.

So what does Stockton do during the Neutral Evaluation Process?  It allegedly failed to negotiate with the California Public Employees’ Retirement System (CALPERS).  The entity that is the single largest unsecured creditor for the city and the biggest issue that needs to be addressed if Stockton is ever going to be financially healthy again.  The National opposition discloses that the plan Stockton proposed during the Neutral Evaluation Process unbelievable said the city would have deficits due to CALPERS of $5 million in 2013-2014 growing to over $17 million a year by 2020-2021, with a total deficit over the projection period of $100 million.  What!  Are you telling me that Stockton submitted a plan to reorganize its debts that ignored CALPERS ongoing deficits and asked other people they owed money to reduce interest rates or take less money?  Sure sounds like it.  Why is that?  Stockton lists CALPERS as its single largest creditor with an estimated claim of $147 million.  According National’s opposition: “The City(Stockton) does not even list CalPERS in its Outcome of AB 506 Mediation Sessions.  Moreover, the City explicitly states in the Ask ( the Neutral Evaluation Process reorganization plan) that it is going to attempt to ‘preserve funding for current retirees and current employees who will retire under the CalPERS system.”  Really?  So that is why Stockton ignored CALPERS.  So you are telling me the same people who benefit from the unsustainable benefits Stockton has been handing out did not want to cut their own benefits to save the City of Stockton from bankruptcy?

To make matters worse, Stockton issued $125 million in Pension Obligation Bonds to pay CALPERS money it did not have to fund the retirement of its employees.  That $125 million dollars given to CALPERS, and invested by CALPERS, is now only $82.5 million because the financial crisis decreased the value of CALPERS’ investments.  What a mess.  Stockton allegedly submitted a plan of reorganization during the Neutral Evaluation Process that did not even allow Stockton to become financially sound again because of continued deficits owed to CALPERS.  If you were owed money from Stockton would you have agreed to take less under these circumstances?  As a bankruptcy attorney it will be interesting to see how the bankruptcy court rules regarding National’s opposition.