FRESNO — A federal judge ruled Monday that Stockton was eligible for bankruptcy protection — rebutting Wall Street creditors who claimed the city wasn't really broke and setting up a battle over employee pensions.
U.S. Bankruptcy Judge Christopher Klein found that Stockton can move forward with a plan to reorganize its debt. The city's creditors, he said, had acted in bad faith by refusing to negotiate.
"The creditors got a big black eye today," said Karol Denniston, an attorney who helped draft the legislation that guided Stockton's mandated mediation before filing for Chapter 9 protection. "Now the stage is set for the real dog fight."
In late June, the port city of 300,000 became the largest U.S. city to fail financially. At that time Stockton stopped bond payments, slashed employee health benefits and made further cuts to a strapped budget that already had forced the Police Department in California's second-most-violent city to shrink by 25%.
During a three-day hearing that ended last week, Stockton officials testified that creditors had walked away from the table and refused to pay their share of negotiation fees because the city did not include cutting payments to the state's employee pension plan, CalPERS, in its reorganization plan. The $900 million that Stockton owes to the California Public Employees Retirement System to cover pensions is its biggest debt, as is the case with many cities in California.
The creditors also had suggested that, before claiming insolvency, Stockton should sell its rat-infested City Hall, tax 911 calls and hike fees in a city with an 18% unemployment rate.
Assured Guaranty, one of Stockton's major creditors, issued a statement Monday disagreeing with the judge's decision. The company, which according to its website guarantees "scheduled principal and interest payments when due on municipal, public infrastructure and structured financings," stressed that it had a "substantial interest in seeing the city emerge from its financial predicament as a viable and sustainable governmental enterprise for the long term."
Klein, however, said Stockton needed to reorganize under Chapter 9 in order to protect the people who live there.
"It's apparent to me the city would not be able to perform its obligations to its citizens on fundamental public safety, as well as other basic government services, without the ability to have the muscle of the contract-impairing power of federal bankruptcy law," the judge said during his two-hour ruling.
He left the door open for Stockton's CalPERS obligations to be negotiated in the next phase of the trial.
The key question will be whether federal bankruptcy law trumps California's requirement that CalPERS be funded. Until now, there has not been a major test of the conflict.
"There are very complex and difficult questions of law that I can see out there on the horizon," Klein said.
Stockton City Manager Bob Deis said that the judge's decision was a win for the city, but no cause for celebration.
"After nine months and millions of dollars in legal fees, the judge validated what we've been saying from the beginning, that the city is insolvent and needs the protection of bankruptcy," he said.