A U.S. bankruptcy judge, Christopher Klein, on Thursday approved the Central California city of Stockton's plans for exiting bankruptcy, despite objections from a creditor that said it was treated unfairly.
Marking a critical moment in Stockton’s financial recovery, Klein ruled that the city could move forward with its proposed plan to reorganize more than $900 million in long-term debt.
The approval came despite objection from Franklin Templeton Investments — a creditor owed nearly $32.5 million by Stockton. The firm has argued that the city is asking that it walk away from collecting the debt, while refusing to touch a massive employee pension fund.
Earlier this month, Klein had ruled that bankruptcy law would allow the city to treat pension obligations like any other debt, stirring worries that city employees' pensions would be cut.
While the court cannot force Stockton to cut its obligation to California Public Employees' Retirement System (CalPERS), it could have prevented the city from exiting Chapter 9 after negotiating over $2 billion of debts.
A haircut to CalPERS pensions would have been unprecedented in municipal bankruptcy. And both Stockton and CalPERS have adamantly opposed the idea.
But Klein had called the issue of pensions "a festering sore" that requires the court "to get in there and excise it and figure out what the story is."
Marc Levinson, the city's lead bankruptcy attorney, declined to comment on the city's treatment of its contract with CalPERS, ahead of Klein's ruling.
"I don't know that it will come into play," San Francisco–based bankruptcy attorney Michael Sweet, who has closely watched the case, told The Associated Press. He said there have been no Chapter 9 bankruptcies that attacked pensions.
Klein could have approved the city's plan for adjustment, sent the city back into negotiations with Franklin or rejected the plan.
An inland port city of slightly more than 300,000 people about 80 miles east of San Francisco, Stockton filed for Chapter 9 protection in 2012, making it the nation's largest bankrupt city before Detroit filed last year. Another California city, Vallejo, went through bankruptcy before Stockton. A third, San Bernardino, filed shortly after Stockton, but it has yet to present an exit plan.
City leaders have said they turned to bankruptcy as a last resort, blaming an unforgiving boom-and-bust economic cycle.
Before the recession, leaders spent millions of dollars revitalizing Stockton’s downtown by buying a new City Hall and building a marina, sports arena and ballpark. The city issued about 3,000 permits annually to build new homes, and it paid police premium wages and health benefits.
But construction dried up with the recession, and Stockton became ground zero for home foreclosures in the state. Like many residents, City Hall could not pay its bills. The city slashed millions of dollars from its budget and laid off 25 percent of its police officers. Afterward, crime soared.
David E. Mastagni, an attorney for the Stockton Police Officers' Association, said he doubts the city will break its CalPERS contract in a move to leave bankruptcy. He said the city continues to have difficulty hiring new officers and maintaining its seasoned ones.
The city has warned that its public employees would flee for other communities if pensions were impacted. Many cities and counties are competing for the same officers as Stockton and offering raises, Mastagni said.
"If they impair the pensions, you'll see mass walk-offs," he told the AP.
That is a particular concern for Stockton, where homicides have totaled 45 so far this year. During one weekend this month, five people were shot to death within four hours.
Klein's ruling will also figure into a debate over whether other cities would seek bankruptcy to reduce workers' benefits.
"The judge's ruling is going to have an impact on various counties in California, as well as across the country," Bob Medlin, senior managing director at FTI Consulting, told Reuters. "It puts Chapter 9 in the discussion in a way that it may not otherwise have been."
California State Treasurer Bill Lockyer has warned that if "judges in California are going to be activists in this domain," the state legislature may "close that door" for municipalities to access Chapter 9 bankruptcy.