A federal judge ruled in April that the city of Stockton, CA, was legally eligible to enter Chapter 9 bankruptcy after they had filed in late 2012. This case raises questions that are also present in Detroit’s bankruptcy, especially the respective rights of the state pension fund and the city’s major creditors.
California law states that money owed to the state pension fund must be paid because it is illegal to cut public workers’ pensions. But federal bankruptcy law provides its own set of priorities for distributing a bankrupt entity’s assets. While bankruptcy law often incorporates and builds on state law, if the two are in conflict, bankruptcy law generally preempts state law. According to the article, the intersection of the bankruptcy code with California’s public pension law presents a question of first impression.
Now that Stockton has been declared legally bankrupt, bondholders are not happy that they are left with an estimated $900 million in losses while the pension fund known as CALPERS – essentially the city’s largest creditor – is left intact. They argue that Stockton did not pursue all viable options before declaring bankruptcy.
The judge in this case disagreed with the bondholders, finding that the city made large cuts to both its budget and its workforce. Further cuts would have put Stockton residents at risk due to reduced fire and police protection and growing gang violence and drug trafficking. Furthermore, the City of Stockton insists on the importance of providing benefits to its employees, especially in the face of significant pay cuts.
The next phase of the Stockton bankruptcy is the process of negotiating the terms of partial debt repayment. In Chapter 9 bankruptcies, the municipality proposes a “plan of adjustment” which is similar to a “plan of reorganization” in the more familiar Chapter 11 or Chapter 13 bankruptcy case. One of the requirements that the debtor must satisfy before the court may confirm a plan is that it must be fair to any class of creditors that does not accept the proposed restructuring of their debt. Creditors will probably disagree over the fairness of Stockton’s proposed plan, and then the judge will have to decide whether the plan is fair before he may confirm it and Stockton may emerge from bankruptcy.
Please contact us with your questions regarding bankruptcy. Although we don’t regularly encounter municipal bankruptcies under Chapter 9 of the Bankruptcy Code, we routinely handle Chapter 7, Chapter 11, and Chapter 13 bankruptcy cases. We also help borrowers and lenders explore resolutions outside of bankruptcy. Contact our office in Wilmington today to schedule a consultation: (910) 763-3626.