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Bond Creditors Challenge Stockton's Bankruptcy

SAN FRANCISCO — Bond market creditors filed final legal challenges on Friday to Stockton, Calif.’s petition for bankruptcy protection, laying the groundwork for a potentially precedent-setting legal battle. 

The so called “Capital Market Creditors,” a group of bond insurers, banks and financial trustees, filed by a Friday deadline the formal objections that said the city is ineligible for Chapter 9 protection according to the Federal bankruptcy code.

Bond insurer Assured Guaranty Corp. said in its filing that Stockton failed to show it is insolvent and hadn’t negotiated or filed its petition in “good faith” as required by bankruptcy law.

 “The law is clear. Chapter 9 is not a resort — it is the last resort,” Assured said in its filing. “A municipality cannot budget itself into insolvency to gain access to Chapter 9 or use Chapter 9 to harass or target certain groups of creditors. Stockton has done both.”

Assured, bond insurer National Public Finance Guarantee, investor Franklin Advisors, and trustee Wells Fargo N.A., make up the consortium of bond market creditors. Assured and National filed their own supplemental objections, while Franklin and Wells Fargo joined both filings, according to a spokeswoman for Assured. The documents had yet to appear in the online Federal court filing system as of Monday morning.

The formal objections are similar, although more expansive, than public challenges Assured and National have made since Stockton filed for bankruptcy on June 28.

“We are not going to argue this in the media,” Connie Cochran, a spokeswoman for the city, said in a statement Friday. “The city will need time to fully evaluate and assess the objections contained in the filing. The City Council and staff will do everything possible to structure a reasonable plan for putting the City’s fiscal house in order, taking into consideration the objections from the creditors.

Stockton still needs to show the bankruptcy judge a plan for restructuring its debts.

Among the challenges by the creditors is that the city decided to cut debt payments while not even considering reducing payments to its largest creditor, California Public Employees’ Retirement System.

The insurer said Stockton has not “adequately addressed long-term pension benefit costs, which are expected to increase by 94% over ten years.”

This, Assured said, is an example that the city has decided to target bondholders and shows they didn’t negotiate fairly or honestly.

Stockton officials have said, as a member of CalPERS, that they need approval from the state Legislature to make changes to benefits.

During 90 days of state-directed mediation with creditors before it filed the bankruptcy petition, Stockton proposed slashing debt payments by more than $350 million, including permanently ceasing payments from the general fund toward $124 million in outstanding Assured Guaranty insured pension obligation bonds.

Legal experts have said this would be an unprecedented cut for bondholders in a Chapter 9 case.

Assured said in an earlier court filing that bondholders, whose claims represent only 8% of the city’s general fund budget, would be expected to account for 42% of the city’s proposed savings under its mediation proposal, while current employees make up 51% of the general fund budget yet only contribute 19% of savings.

The court filing also questioned the city’s finances, arguing that they have not adequately cut non-essential services, such as supporting entertainment venues and libraries. It also raised concerns about the city’s bookkeeping, which Stockton officials have admitted was incorrect in past years.

Assured said, as it has in the past, that the city could have also attempted to raise taxes before filing for bankruptcy.

The next hearing in the case is scheduled for Jan. 30 before Judge Christopher Klein of the U.S. Bankruptcy Court for the Eastern District of California in Sacramento.




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