SAN FRANCISCO – The Stockton, Calif. City Council voted Tuesday night to file for bankruptcy as part of a plan to try to keep the city solvent after city officials said negotiations with creditors failed.

Following the council’s 6 to 1 vote to adopt a “pendency” plan, Stockton’s bankruptcy attorneys are expected to file for bankruptcy before the end of the fiscal year on Sunday.

Stockton, with a population of more than 300,000 in California’s Central Valley, will become one of the largest municipalities by debt ever to file for Chapter 9 protection in Federal court.

“This is probably the most difficult decision I have ever had to make as an elected official,” said Mayor Ann Johnston during the meeting. “It is with a heavy heart that we go forward.”

City Manager Bob Deis said negotiations with the city’s 18 creditors failed by Monday’s deadline to provide enough cuts to close Stockton’s estimated $26 million gap for the next fiscal year.

“We think Chapter 9 protection is the only choice left,” Deis told council during the meeting.

Deis said that city hoped to reach agreements with some of the creditors during informal talks that would be honored during the bankruptcy process.

Stockton’s bankruptcy attorney, Marc Levinson from Orrick, Herrington & Sutcliffe, said the city could not release details from the confidential mediation process. He said the city will ask a bankruptcy judge to make the information public.

Under Chapter 9 protection, the city can reject contractual agreements, including those with unions, and negotiate with creditors by class.

The city must pass a balanced budget by the end of the fiscal year, according to the state constitution.

Under the adopted plan, the city will slash all debt payments tied to the general fund to zero. It also will adopt major employee cuts, including to retiree medical benefits, but it also plans to spend $3.5 million on its bankruptcy.

Stockton has been struggling for years under the high cost of rich retirement benefits and debt it incurred during the housing boom.

The decision to file would also likely start a long slog in federal court to come up with a plan to trim its debts that a bankruptcy judge would need to find acceptable.

By comparison, Vallejo, Calif., spent more than three years and around $12 million on attorneys before exiting bankruptcy. As part of its plan, Vallejo slashed bondholder debt by almost 50% and unsecured claims by 80% or more.

Stockton has hired the same bankruptcy attorney who represented Vallejo, Marc Levinson.

After years of declaring fiscal emergencies, Stockton’s City Council lurched towards bankruptcy when it voted on Feb. 28 to enter into deliberations with creditors under last year’s Assembly Bill 506, which directs municipalities to try mediation prior to filing for Chapter 9 protection.

After 60 days of confidential talks were extended another 30 days, city manager Bob Deis announced last week that council members would consider the plan to slash more than $10 million of debt payments to help close its $26 million budget gap, if the mediation with creditors failed.

Stockton will withhold a $2.58 million payment on its 2007 variable-rate lease revenue bonds and a $5.7 million payment on its 2007 pension obligation bonds during the next fiscal year. It would also continue to miss payments on its 2004 lease revenue bonds.

Stockton has already let three sets of bonds default — the 2007 and the 2004 lease revenue bonds, as well as another set issued in 2009 — after the city decided in February to stop paying its part on $110 million of par value of debt through the end of the fiscal year. Seven bond issues rely in some way on support from the city’s general fund.

As a result of the defaults, the city has lost possession of three parking garages tied to the 2004 bonds along with an office building that had been slated to become the next city hall, and whose lease revenues support the 2007 bonds. Stockton lost possession of the two properties after Wells Fargo, the trustee for the debt, sued for control of the revenues.

Another $55 million of variable-rate revenue bonds issued in 2010 by Stockton’s financing authority could be declared in default by Union Bank, the letter-of-credit provider on the debt, resulting in a mandatory tender, according to city officials.

The city had more than $702 million of bonds outstanding as of the end of June 2010, including debt issued for restricted enterprise funds such as water, sewer and parking enterprise debt, according to the city’s most recent audited financial statements.

Stockton officials have said the debt tied to restricted funds would be protected from the bankruptcy process.

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