Stockton filed a revised debt-cutting plan last week that could lead to a deal with a holdout creditor, Franklin bonds, possibly enabling the city to emerge from bankruptcy without cutting pensions.
But however that plays out, a federal judge may make a clarifying ruling on the general issue of whether public pensions issued through the California Public Employees Retirement System can be cut in bankruptcy like other debts.
Two Franklin bond funds, which would get a $350,000 payment for a $35 million bond issue, claim unfair treatment because other creditors get most of what they are owed and the largest creditor, CalPERS, is untouched.
Stockton was able to negotiate agreements with all city unions, retirees and other major creditors, including two insurers of the city’s largest bond issues, who opposed the city’s eligibility for bankruptcy.
In a trial triggered by the opposition of Franklin, U.S. Bankruptcy Judge Christopher Klein last week heard closing arguments about whether the Stockton debt-cutting plan to exit bankruptcy should be confirmed by the court.
The judge took a step toward settling the holdout by scheduling July 8 for his decision on the value of the Franklin bond collateral, two golf courses and a park. Stockton put Franklin in the same creditor class of unsecured debt as retiree health care.
The small payment to Franklin was said to be similar to the deep cut in retiree health care. After Judge Klein’s ruling that retiree health care can be cut in bankruptcy, a debt valued at $544 million by the city was cut to a one-time payment of $5.1 million.
Stockton argued that the two money-losing golf courses and the park have little value due to use restrictions and other factors. But an expert testifying for Franklin said the golf course property was worth nearly $15 million.
A revised plan Stockton filed last week put Franklin in a class by itself. After the judge sets a value for the golf courses and park, said the new plan, the city will choose one of three options: full payment, full payment over time or transfer of the property.
Klein said he may produce something before the scheduled July 8 ruling on the value of the Franklin bond collateral.
“I might write a couple of decisions because we have a couple of very distinct facets to the case,” he said.
The judge made a reference to the CalPERS contention that it’s “an arm of the state” protected by federal law in bankruptcies, and he said if a debt-cutting exit plan is “confirmed and not performed” there is a question about what can be done.
“I think the law is very confused in the area,” he said.
Klein previously has said he does not want to confirm an inadequate debt-cutting plan that could lead to a second bankruptcy. He mentioned reports that Vallejo, which did not cut pensions in bankruptcy, still faces deficits despite a 1-cent sales tax increase.
During the first phase of the Stockton trial last month, the judge reportedly said while listing several possible actions: “Or I might conclude the CalPERS contract can be impaired, but in this case the decision (by the city) not to do so made sense.”
A federal judge ruled in the Detroit bankruptcy that pensions can be cut. In a brief backing an appeal, CalPERS argued the ruling nullifies section 903 of the bankruptcy code that “expressly preserves state laws governing its creatures” in bankruptcy.
Noting that it’s a state-run system, CalPERS asked the appeals court to limit its ruling on Detroit’s eligibility for bankruptcy to city-run retirement systems like the one in Detroit.
The CalPERS brief filed last month also argued that the ruling was “not absolutely necessary” to determine Detroit’s eligibility for bankruptcy, and therefore is an “improper advisory opinion.”
At the Stockton trial last week, an attorney for CalPERS, Michael Gearin, said any ruling on the impairment of pensions should be framed in specific terms. He said none of the parties in the trial have asked to impair or cut CalPERS obligations.
Gearin asked Judge Klein not to make an unnecessary ruling on the impairment of pensions and to wait until impairment becomes an issue. He said a ruling would trigger a costly legal battle.
Stockton has spent $13.9 million on the bankruptcy filed two years ago, a report filed last week said. The Orrick, Herrington and Sutcliffe law firm received $10.4 million that includes $500,000 to $1 million for consultants and vendors.
Franklin argued during the trial that Stockton’s plan, which builds a large reserve and understates revenue, will have enough money to pay both Franklin and the full CalPERS pension obligations.
“This isn’t a case of inability to pay; it’s unwillingness to pay,” said the Franklin attorney, James Johnston.
Franklin has pointed to the lack of consistency or fairness in the Stockton proposal to pay Franklin a penny on the dollar while paying the largest creditor, CalPERS, in full.
When the judge asked what Franklin is proposing, Johnston said Stockton can impair pensions and treat creditors fairly or assume pension liabilities and pay Franklin a fair share, but it shouldn’t pay CalPERS in full and severely short Franklin.
So, the judge asked, Franklin contends pensions should be impaired? “Yes,” replied Johnston. He said the judge’s decision allowing a cut in Stockton retiree health care “comes close” to deciding that state law is pre-empted in bankruptcy.
Among other decisions cited by Johnston was a ruling by Judge Michael McManus in the Vallejo bankruptcy that overturned a city labor contract with an electrical workers union after lengthy mediation failed.
Stockton argues that pensions are needed to be competitive in the job marketplace, particularly for police. The employee share of debt reduction is said to be pay cuts, no retiree health care and a state law giving new hires lower pensions.
“If you attack CalPERS, it’s attacking the retirees and the future retirees,” Margaret Garms, an attorney for the Stockton Police Officers Association, told the judge last week.
Garms said police have had pay cuts totaling about 30 percent. She said only 350 of the 480 authorized police positions are filled. “As fast as they hire new officers people leave,” she said, with an average experience of 2½ years on the job.
“I would urge that the court does not need to address pensions in this case,” said Jason Rios, an attorney for the Stockton retiree committee. He said a pension cut would drop the income of some retirees below the poverty level.
Marc Levinson, an attorney for Stockton, said Franklin rejected a much higher debt payment offer in early negotiations. “Now Franklin wants to pick up everything that’s left and benefit from concessions other creditors made,” he said.
Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at Calpensions.com. Posted 9 Jun 14