Originally posted at www.calpensions.com
Bond insurers arguing that Stockton is ineligible for bankruptcy because it did not attempt to negotiate a pension debt reduction with CalPERS, among other failings, may get their day in court in January.

U.S. Bankruptcy Judge Christopher Klein, who is presiding over the case in Sacramento, said in Berkeley Friday that the opponents of the bankruptcy are in the “discovery” phase, gathering evidence to support their positions.

“I’ll probably have a trial over that in January,” Klein told a conference on “California’s Fiscal Crisis” at the UC Berkeley Institute of Governmental Studies. “If I order relief, then it goes forward. If I don’t order relief, the case will be dismissed.”

Stockton, which filed for bankruptcy in June, is proposing to get major savings by eliminating $197.5 million in general fund payments on bonds during the next 25 years, leaving insurers to make payments preventing losses for bondholders.

The two insurers backing most of the bonds hired large global law firms and in August filed opposition to Stockton’s eligibility for bankruptcy. Blocking eligibility may be the insurers best chance to force a change in the Stockton plan.

The attorneys for National Public Finance Guarantee argued that municipal petitions for “Chapter 9” bankruptcy should be viewed with a “jaded eye,” citing two similar lines from past court rulings.

“Considering the bankruptcy court’s severely limited control over the debtor once the petition is approved, access to Chapter 9 relief has been designed to be an intentionally difficult task,” says one of the lines cited by the Winston & Strawn law firm.

If the judge determines Stockton is eligible for bankruptcy, the city would negotiate a “plan of adjustment” with creditors to reduce its debts. The court would have to approve the plan, but the court cannot impose a plan of its own.

“It’s the court’s obligation to review the plan of adjustment and determine whether it’s fair and equitable as to all parties,” said Klein.

“There would have to be very extensive litigation for the court to say, ‘Well, this plan doesn’t work,’ and authorize somebody to come back. So it winds up being an iterative process, and it’s highly negotiated among the parties.”

Klein said the plan in Vallejo, which emerged from a three-and-a-half year bankruptcy last November, was a consensus worked out, after “a great number of bodies on the floor,” by the city and its creditors.

“The only other leverage I have is dismissal,” said Klein. “But if I dismiss the case there is nothing to stop them from turning around and filing it again. So that’s the limitation.”

In July, Klein denied a request by a retiree group to block Stockton’s cuts in retiree health care. He said the federal bankruptcy law prohibits interference with the debtor’s political or governmental powers, property and revenues.

There is a widespread view that a series of court rulings mean that pensions promised state and local government workers on the date of hire are “vested rights,” protected by contract law, that cannot be cut unless offset by an equal benefit.

Klein said the U.S. Supreme Court has ruled that a state cannot pass a law that impairs a contract, but did not bar Congress from doing so. He said the bankruptcy law is reinforced by the constitutional supremacy of federal law over state law.

“Bankruptcy is all about impairing contracts,” said Klein.

In the Vallejo bankruptcy, U.S. Bankruptcy Judge Michael McManus reluctantly overturned an electrical workers union contract. He said dissolving the contract would trigger the city’s binding arbitration, which could have been done without bankruptcy.

Stockton officials have said they do not want to cut pensions, fearing a competitive disadvantage with other government employers, and have told unions in recent negotiations that their pensions will be protected.

Vallejo officials reportedly considered trying to use bankruptcy to cut pension debt (as in Stockton, CalPERS was the largest creditor) but did not after CalPERS privately threatened a long and costly legal battle.

Now the California Public Employees Retirement System has publicly staked out a legal position on municipal bankruptcies that was presented to the board on Sept. 12 by the CalPERS general counsel, Peter Mixon.

The main point for CalPERS, which says it is an “arm” of state government, is not whether labor contracts are overturned but the federal limits on bankruptcy court power cited by Klein in his retiree health care ruling.

“The relationship between CalPERS and a municipal employer is not a mere commercial contract between a creditor and a debtor,” said Mixon. “Instead, it is an aspect of the state’s control over a municipality that is protected from interference under constitutional principles and federal bankruptcy law.”

Mixon said CalPERS has a “fiduciary” duty to protect benefits and “does not have the right to ‘forgive’ or reduce employer contributions which are necessary to sustain the soundness of the system and ensure the payments of promised benefits.”

Under California law, he said, “statutes preclude an agency from lowering the benefit formula for existing employees who are members of the system. CalPERS does not have the right to approve a lower benefit formula for these members.”

In what may be a response to an argument in a bond insurer filing, Mixon said state law prevents an employer from terminating its CalPERS relationship through “rejection” of the contract with CalPERS.

Instead, the employer must follow a termination process that closes its pension plan and provides for payment of the debts. As a result, the typical employer would face a much larger pension payment.

The National Public Finance attorneys argued that Stockton could have terminated its pension plan, transferred the assets and debt to the CalPERS terminated agency pool and tried to “negotiate reduced contribution rates for existing and future retirees.”

Attorneys for another bond insurer, Assured Guaranty, said that in addition to failing to negotiate with CalPERS, Stockton “made no effort to engage in meaningful negotiations with Assured and certain other creditors” as it targeted bondholders.

Before defaulting on bonds, which caused Wells Fargo to take over parking garages and a proposed city hall building, Stockton in February shifted $4.5 million from its deficit-ridden general fund to restricted special funds, said the Assured filing.

The Assured attorneys from Sidley Austin also said Stockton failed to pursue $7 million in uncollected parking tickets, explore the sale of nearly 600 pieces of property, consider various tax increases or seek voter approval of a loan from restricted city funds.

“The city has the ability to reduce spending and increase revenues outside of bankruptcy, allowing it to remain solvent,” said the Assured attorneys.

Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at http://calpensions.com/ Posted 24 Sep 12