Out of Control Policy Blog

Stockton Begins Legal Battle in U.S. Bankruptcy Court Today

Updated on Friday July 6, 2012 at 1:28 PM Eastern.

Last week Stockton, California became the largest city (by population) to file for bankruptcy in U.S. history. The initial hearing is today in U.S. bankruptcy court in Sacramento. The trial is especially significant because the city’s lawyers are attempting to use bankruptcy to impose losses on its bondholders, which include private financial institutions and the state of California. Steven Church of Bloomberg reports:

No U.S. municipality has used bankruptcy to force bondholders to take less than the full principal due since at least 1981, and possibly as far back as the 1930s, according to lawyers and court records.

Church reports the city’s three largest creditors include:

  1. California Public Employee Retirement System (CalPERS), $147.5 million;
  2. Wells Fargo Bank NA as trustee for $124.3 million in pension obligation bonds; and
  3. Wells Fargo Bank NA as trustee for three other sets of bondholders owed $107 million.

One of the most interesting subplots will be the legal battle between CalPERS, and Wells Fargo Bank North America and Assured Guaranty Ltd. Cate Long, a guest contributor to Reuters’ MuniLand blog, speculated on Twitter today whether or these calculations are accurate though. Assured Guaranty Ltd. insured $161 million of Stockton’s bonds. Meanwhile, National Public Finance Guarantee, which has insured about $224 million of Stockton's debt, is owned by MBIA Inc. Combined, MBIA Inc. and Assured Guaranty Ltd. hold approximately $385 million in Stockton's debt, and at this point they are allowed to argue together in court. In the case of principal reduction, these parties arguably have the most to lose.

This morning, Church wrote:

Bondholders will be limited to two main options if they are to block Stockton in court, said Lee Bogdanoff, a bankruptcy attorney: get the case thrown out or defeat the city’s reorganization proposal.

“The most important power they have is a seat at the negotiating table,” Bogdanoff, a founding partner of Klee, Tuchin, Bogdanoff & Stern LLP in Los Angeles, said in a telephone interview. “They can try to influence the decision makers.”

Today’s hearing will differ from a typical corporate case, Bogdanoff said. Unlike a company, the city doesn’t need to ask U.S. Bankruptcy Judge Christopher Klein for permission to pay any bills it ran up before filing for court protection, such as wages, utility bills or rents. As a result, creditors won’t be able to use the hearing to pressure the city on its spending habits, Bogdanoff said.

The first legal question today is about the city's mediation process. California Assembly Bill (AB) 506 passed earlier this year requiring distressed municipalities to enter mediation before declaring bankruptcy. While Wells Fargo Bank NA was awarded three city parking garages and city hall, the parties failed to resolve their differences. The intention behind AB 506 was for future cities filing for bankruptcy to avoid the flurry of lawsuits that ensued after Vallejo, California’s filed for bankruptcy several years ago.

Scott Smith of The Stockton Record reports:

Marc Levinson, the lead attorney hired to represent Stockton, will ask U.S. District Judge Christopher Klein to unseal a 790-page document at the heart of a three-month-long, closed-door mediation process that attempted, yet failed, to avert bankruptcy.

Levinson argues in court papers that this massive document, which resembles a bankruptcy plan, lays out in detail what the city in mediation asked its major creditors to give up...

Proving in court that a municipality first tried to avoid bankruptcy and that it is, in fact, broke are basic facts that must be established before moving ahead with a bankruptcy case...

(U.S. District Judge Christopher Klein) is expected to rule from the bench today on two other motions that Stockton filed:

  • First, the city wishes to set an Aug. 9 deadline for any challenges to the legitimacy to Stockton's bankruptcy.
  • Second, the city has asked to maintain a website designed to tell each of the 6,000 stakeholders of upcoming hearings and filings, rather than having to send each a notice by overnight mail, which would be costly and labor intensive."

For more on California municipal finance issues, see my previous posts on Stockton and Mammoth Lakes. For the latest on Detroit, Michigan, see Detroit and Michigan: A Fragile Bargain and Detroit and Its Unions Fight Over Work Rules from Melissa Maynard of Stateline.

Harris Kenny is Policy Analyst


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