By Ryan C. Wood

The single largest issue in the City of Stockton’s Chapter 9 bankruptcy case is the cities qualification under section 109(c) of the bankruptcy code to be a debtor. The City has filed its Statement of Qualification. In my previous blog articles I discussed the various arguments by parties in interest as to why the City faces challenges proving it qualifies to be a debtor and obtain relief under the Bankruptcy Code. Assured Guaranty Corp. (“Assured”) is definitely leading the charge. Assured has guaranteed bonds issued by Stockton and does not want to allow the bankruptcy court to allow Stockton to not have to pay the bonds back in full. If that happened then Assured would be on the hook to satisfy the bond holders. On December 14, 2012, Assured’s bankruptcy lawyers filed a supplemental objection to the City’s Chapter 9 petition and statement of qualifications.

The supplemental brief is a scathing analysis of events leading up to Stockton’s bankruptcy filing. To recap, Stockton must prove that it was insolvent under pursuant to 11 U.S.C. § 109(c)(3); (ii) has satisfied the negotiation requirement contained in 11 U.S.C. § 109(c)(5); (iii) has negotiated in “good faith” under Cal. Gov’t Code § 53760.3(o), which is a requirement for specific authority under Cal. Gov’t Code § 53760(a) to be a debtor under 11 U.S.C. § 109(c)(2); and (iv) has filed its petition in “good faith” under 11 U.S.C. § 921(c). Cal. Gov’t Code § 53760 was passed by the California legislature to force California municipalities down two paths before filing for bankruptcy protection. A municipality can either declare a fiscal emergency or participate in the neutral evaluation process before filing for bankruptcy protection under Chapter 9. Stockton chose the neutral evaluation process and it has caused the city nothing but problems since. Assured is using Stockton’s participation in the neutral evaluation process against them now that Stockton is trying to prove it qualifies to be a debtor under Chapter 9 of the bankruptcy code.

Back to the supplemental objection filed by Assured. Assured argues that Stockton purposely to budget itself into not being able to pay a few bills on time in an attempt to show it was not paying its bills as they came due. Assured also argues that Stockton has not changes its ways regarding spending. It appears Stockton is still paying millions to subsidize entertainment venues that are non-essential. Prior to filing for bankruptcy protection Stockton’s Chief Financial Officer direct the various departments to reduce general fund spending by identifying ways to cut costs by 5%, 10% or 15%. Each department head submitted ways to cut costs but Stockton’s city manager did not recommend the cuts the city council did not adopt any of the cuts. Stockton then initiated the neutral evaluation process to try and negotiate with debt holders. Why did Stockton not adopt the cuts suggested by its department heads?

As pointed out before the single most significant factor in Stockton’s financial problems is how it compensated employees. The most egregious was the medical benefits for retirees. Retirees enjoyed free medical care for themselves and a dependent for life without any co-pays or premiums. This just simply does not exist in the real world. Especially not for all the other hard working citizens of Stockton who do not work fo the City of Stockton.
Assured also argues that Stockton failed to seek additional revenue sources to prevent revenue shortfalls prior to bankruptcy. Assured argues that the City has not sought to increase taxes, has not charged for reimbursable services and not evaluated its saleable property.

Assured further argues that Stockton cannot prove it was insolvent as of the bankruptcy filing date given that Stockton’s record keeping and internal controls were so poor. Apparently the CFO in September 2011 called Stockton’s record keeping grossly negligent and California’s State Controller has launched an investigation into Stockton’s record keeping.
Assured’s supplemental brief provides many concerning alleged financial practices by the City of Stockton leading up to the bankruptcy filing. The hearing on Stockton’s qualifications to be a debtor under chapter 9 is actually today, February 26, 2013, at 1:30 p.m. It will be very interesting what arguments Stockton’s bankruptcy attorneys make to explain Assured’s allegations.