By Ryan C. Wood

On June 29, 2012, the City of Stockton filed a motion to disclose information about the failed neutral evaluation process (NEV).  The NEV was required to take place under California Law, California Government Code 53760.  The NEV process began on March 27, 2012, and ended approximately 90 days later after an extension of time to try and continue negotiations to avoid bankruptcy.  The NEV process concluded on June 25, 2012.  Code section 53760 allows for disclosure of NEV information under certain circumstances.  If it is determined that the confidential information disclosed during the NEV process is necessary to prove a municipality is eligible to be a debtor under Chapter 9 of the Bankruptcy Code.  This is the reason the City of Stockton sought permission from the Bankruptcy Court to release confidential information.  Stockton wanted to provide the Bankruptcy Court with a 790 page document that details their financial circumstances, the length of the negotiations and the participants.  Stockton needs to prove it filed its bankruptcy petition in good faith pursuant to Bankruptcy Code section 921(c).

A number of parties that participated in the NEV process opposed Stockton’s request including Wells Fargo National Association.  Their limited objection argued that Stockton’s request only sought permission for Stockton to release information about the NEV process and did not ask for permission for all parties that participated in the NEV process to disclose their information.  If only Stockton could disclose this information then it would look one sided.  The concern was that Stockton would merely pick and choose the information to disclose and not show the whole picture of the failed negotiations.

A hearing was held regarding Stockton’s request on July 6, 2012.  The Bankruptcy Court chose to deny Stockton’s request and a memorandum of decision on July 13, 2012.  The Court implemented a protective order on the confidential information and take an incremental approach to approach to allowing any of the NEV information to be disclosed.  The Court reasoned that there is no evidence that Stockton needs to disclose confidential information to prove its eligibility to be a debtor under Chapter 9 yet.

Unlike a consumer or business filing for bankruptcy protection under Chapter 7 or Chapter 13, an order for relief is not immediately entered when a municipality files for protection under Chapter 9.  A municipality must prove it is eligible for relief and that the petition was filed in good faith.  This will be the next major fight in Stockton’s bid to seek relief under the Bankruptcy Code.

By Ryan C. Wood

On June 28, 2012, the City of Stockton, California, filed for bankruptcy protection under Chapter 9 of the Bankruptcy Code, Bankruptcy Case Number 12-32118, in the Bankruptcy Court for the Eastern District of California.  After complying with California Government Code Section 53760 they were unable to negotiate with creditors and avoid filing bankruptcy.  So what happened here?  Why did Stockton California file bankruptcy?

In court documents the city refers to the collapse of the housing market and calls the mortgage crisis the Great Recession.  Like many individuals that choose to file bankruptcy Stockton tried to work things out.  The city renegotiated labor agreements, depleted reserves, imposed compensation reductions, reduced and eliminated services, missed bond payments and even deferred payments to retiring employees in an attempt to avoid bankruptcy.  Sounds like what an individual does to avoid bankruptcy too.  Many of our clients have sold jewelry, depleted their retirement accounts, cut back on bills such as cable or internet, missed payments on credit cards and anything else to avoid filing bankruptcy.  Unfortunately bankruptcy does become the best financial decision at some point.

Stockton’s retirement costs are out of control and have been for some time.  Stockton’s largest creditor by far is the California Public Employees Retirement System.  They owe PERS an estimated $147 million in unfunded retirement benefits.  The next largest creditor is Wells Fargo Bank.  The city owes Wells Fargo Bank approximately $126 million for pension obligation bonds.  What are pension obligations bonds?  Pension obligation bonds are basically a way to fund retirement benefits when a city does not actually have the money to pay for the benefits.  The bonds pass on the cost to future generations in the hope that the public entity will be able to continue to make the monthly payment for the bonds and continue to operate normally.  If a city does not set aside enough money during an employee’s career so that the employees lifetime retirement benefits are paid in full by the time the employee retires the city has to find the money somewhere.  It is more or less a Ponzi scheme at the tax payers’ expense.

Pension obligation bonds usually have low percentage rates.  The rate could be as low as 4 percent or as high as 7 percent.  Some government entities have even used these borrowed funds to invest and obtain a higher rate of return, say 8 percent, and in theory make money and be able to fund their retirement costs in the future.  It is basically gambling with borrowed money.  This is a recipe for disaster when property taxes and general funds do not continue to grow.  Many other municipalities across the United States are and will face the same problems Stockton is facing.