Bankruptcy Court OKs $5.7-Billion O.C. Pool Payout : Agreement: Disbursement to cash-strapped cities, schools and other agencies will stave off potentially disastrous defaults. But county’s problems still loom.

Orange County on Tuesday won Bankruptcy Court approval to disburse $5.7 billion to more than 200 cash-strapped cities, schools and government agencies, staving off a possibly devastating string of municipal defaults and bankruptcies.

U.S. Bankruptcy Judge John E. Ryan approved the complex agreement during a five-hour hearing that overflowed from his courtroom into two nearby rooms. Court officials issued color-coded lapel tags to help identify the nearly 175 lawyers, creditors, citizens and reporters on hand.

The agreement frees assets that have been trapped in the county-run bond pool that lost $1.7 billion in value last year as its complex and heavily leveraged investment strategy soured, plunging the county into bankruptcy. Former Treasurer-Tax Collector Robert L. Citron, who operated the pool, pleaded guilty last week to six felony charges.

Public officials praised Tuesday’s agreement, thought to be the largest settlement plan ever approved in a bankruptcy court, as the first step toward an eventual fiscal recovery.

“I think it’s wonderful,” said Irvine City Manager Paul O. Brady Jr., who attended the hearing. “It proves what we said all along: We said we’re going to get it done; we’ve got it done.”

Yet while government agencies invested in the pool in hopes of earning above-market interest rates, the settlement pays them just 77 cents in cash on the dollar, along with “recovery notes” convertible to cash at a future date and an IOU.

Nor does the plan mean there is light at the end of the dark financial tunnel that Orange County entered with its Dec. 6 bankruptcy filing.

“This is not a cure,” said Patrick C. Shea, a lawyer who represents pool investors.

The plan--crafted during months of back-room meetings and court hearings--will pale in complexity, Shea said, when compared to the “heavy lifting” needed to pull the county out of its own ongoing bankruptcy case.

Said County Supervisor William G. Steiner: “Today’s action is an important milestone, especially in getting the money back to these local governments so they can protect their own fiscal integrity. It’s a major accomplishment. . . . It’s the most significant, positive achievement since the bankruptcy.”

County officials said that they would start cutting checks for investors as soon as May 19. About $4 billion is earmarked for cities, school districts and other agencies that had invested in the ill-fated pool. The remaining $1.7 billion will be turned over to the cash-strapped county, which was the pool’s largest single investor.

The hard-fought agreement, brokered by some of Orange County’s top business leaders, will ease intense financial pressure building on strapped government agencies that are struggling to make payrolls and debt payments.

The agreement drew overwhelming support from fund investors and county creditors, but the document was clearly a creature of compromise that satisfied no one. “A settlement is never totally satisfactory to either side,” Ryan said. “No one gets everything that they want.”

Balanced against that frustration, Ryan said, was the stark realization that Orange County faced “a real tragedy” if trapped cash wasn’t quickly released to school districts and cities that otherwise faced massive spending cuts and possible insolvency.

“Weighing all the factors,” Ryan said, “the resolution proposed by the county is a fair one. I know it is not a satisfactory one.”

The settlement survived a last-ditch attempt by some Orange County creditors to gain more protection for their claims.

Ryan listened patiently as attorneys for a handful of bondholders argued for the right to sue pool investors should the county not meet its own debt obligations. Bondholders maintained that they had the right to share in the funds that soon will be released to cash-strapped cities, schools and special districts.

But Ryan refused to guarantee county debt holders the right to sue pool investors. Instead, the judge said bondholders would have to seek eventual repayment through the county’s ongoing bankruptcy case.

Holders of existing Orange County bonds are worried about the bankrupt county’s future credit-worthiness because the plan calls for the issuance of $1 billion in new debt that will be used to restructure old debt and pay pool investors. The county also agreed to give “superpriority status” to more than $200 million in debt, which will be used to pay off pool investors.

That special status of the new debt does not please vendors who are still waiting for money owed them by the county, said attorney Richard Marshack.

The new debt “should not be given any more status than our claims,” said Marshack. “But it’s acceptable if the whole settlement is approved and paves the way for a reorganization that pays vendors in full.”

Bondholders were generally supportive of the agreement--in large part because many school districts and cities faced their own possible bankruptcies. “This is a fair resolution of disputed claims in the” bond pool, said Robert Moore, an attorney who represents the county’s creditors and bondholders.

The hard-fought plan underscored the complexities of Bankruptcy Court, which is designed to give debtors breathing room in which to begin restructuring their finances. The laws governing municipal bankruptcies have never been tested on the scale of the Orange County case.

“Complex bankruptcy cases are always contests of competing agendas,” Shea said. “You get into big cases like this and there are a million issues people can shoot at.”

Steiner acknowledged that the settlement was a fragile agreement that hinges on the county’s ability to make good on the recovery notes. “If we are not successful backing the recovery notes, the whole settlement plan unravels,” he said.

William J. Popejoy, the county’s chief executive officer, described Tuesday’s settlement as “an important signal to bondholders and vendors that we’re moving forward to get this out of the way.”

Supervisor Marian Bergeson recognized that the agreement probably doesn’t please every pool participant.

“I think it’s a very important piece of the puzzle. It’s encouraging that we have reached this point,” Bergeson said. “The agreement was as good as we could possible get. It is fair.”

Considering the complexity of the county’s bankruptcy case, Board Chairman Gaddi H. Vasquez said the settlement was reached with remarkable speed.

“I don’t think anyone should underestimate the significance of this ruling,” Vasquez said. “It represents a closure to the investment pool crisis.”

But like his colleagues, Vasquez said the county “still needs to deal with its financial situation” and grapple with its recovery efforts.

Even before the hearing was over, bankruptcy attorneys were planning for upcoming hearings.

“This is just the beginning,” said Bruce Bennett, the county’s bankruptcy attorney. “There’s a lot more to do. We’re not near the finish line yet. I’m relieved, but I’m sobered by the challenges that are coming ahead.”

Bennett said at least five attorneys had approached him during Tuesday’s hearing to schedule additional meetings on Wednesday. “This thing doesn’t stop,” he said, smiling.

Times staff writers Jodi Wilgoren and Matt Lait contributed to this story.

More Coverage: O.C. in Bankruptcy

* MONEY DILEMMA--Participants in pool try to determine where to put funds in wake of settlement. A12

* STATE REVIEW--A legislative committee asks state auditor to assess county’s recovery plans. A12

(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

Staving Off Disaster

U.S. Bankruptcy Judge John E. Ryan approved the county’s plan to disburse $5.7 billion to more than 200 cash-poor cities, school districts and government agencies. The picture now:

Elements of Settlement

* Each participant in investment pool receives an average of 77% back in cash

* Those receiving balance in series of “recovery warrants” and IOUs may not sue county

* Those taking only cash retain rights to sue county

What Now?

* Objectors have 10 days to appeal before the agreement becomes final May 12

* County then has five days to disburse 77% in cash

* County must arrange for cash-convertible recovery warrants they are giving pool participants

* Investors would get remainder of their money if county recoups losses through litigation

Key Dates

* May 12: Settlement scheduled to become final

* May 15: Target date for cash distribution

* May 18: Final deadline for cash distribution

* June 5: Recovery warrants must be convertible to cash

“A settlement is never totally satisfactory to either side. No one gets everything that they want. Weighing all the factors, the resolution proposed by the county is a fair one. I know it is not a satisfactory one.”

--U.S. Bankruptcy Judge John E. Ryan