Franklin High Yield Tax–Free Income Fund v. City of Stockton (In re City of Stockton)

• Decision Date: 11 December 2015
• Docket Number: Bk. No. 12–32118–CMK,BAP No. EC–14–1550–DJuF
• Citation: 542 B.R. 261
• Parties: In re: City of Stockton, California, Debtor. Franklin High Yield Tax–Free Income Fund; Franklin California High Yield Municipal Fund, Appellants, v. City of Stockton, California, Appellee.
• Court: U.S. Bankruptcy Appellate Panel, Ninth Circuit

542 B.R. 261

In re: City of Stockton, California, Debtor.Franklin High Yield Tax–Free Income Fund; Franklin California High Yield Municipal Fund, Appellants,

v.City of Stockton, California, Appellee.

BAP No. EC–14–1550–DJuF

Bk. No. 12–32118–CMK

United States Bankruptcy Appellate Panel of the Ninth Circuit.

Argued and submitted on November 19, 2015

Filed December 11, 2015

Appearances: James C. Johnston, Jones Day, appeared and argued on behalf of Appellants Franklin High Yield Tax–Free Income Fund and Franklin California High Yield Municipal Fund.

Marc A. Levinson, Orrick, Herrington & Sutcliffe LLP, appeared and argued on behalf of the Appellee City of Stockton, California.

Before: DUNN, JURY AND FARIS, Bankruptcy Judges.

OPINION

DUNN, Bankruptcy Judge:

Franklin High Yield Tax–Free Income Fund and Franklin California High Yield Municipal Fund (collectively, "Franklin") appeal the bankruptcy court's order ("Confirmation Order") confirming the City of Stockton, California's ("City") first amended plan of adjustment ("Plan") in chapter 9.¹ We DISMISS, as equitably moot, Franklin's appeal of the Confirmation Order generally and otherwise AFFIRM the Confirmation Order's treatment of Franklin's general unsecured claim under the Plan.

I. FACTUAL BACKGROUND²

A. Events prior to bankruptcy

The financial problems that drove the City to seek chapter 9 relief did not arise overnight. The City was an epicenter of the subprime mortgage default crisis that arose in conjunction with the recession that began in 2007–08. During this period, real estate values, both commercial and residential, in the City declined by around 50%, and unemployment grew to about 22%. The median home price in the City dropped from $397,000 in 2006 to $109,000 in 2012, a decline of 72%. Disclosure Statement, at 17. The City had one of the highest foreclosure rates in the country. Consequently, property tax, sales tax and other public revenues declined precipitously.

Two self-inflicted factors worked to exacerbate significantly the City's financial problems: 1) As noted by the bankruptcy court,

In better times, [the City] committed its general fund to back long-term bonds to finance development projects based on an overly-sanguine "if-you-build-it-they-will-come" mentality. They did not come. Hence project revenues were insufficient to pay project bills.

City of Stockton, 493 B.R. at 779.

2) In addition, the City had a history of compensating its employees at above-market levels.

Among other things, the City paid for generous health care benefits to which employees did not contribute, including lifetime health care regardless of length of service. It permitted, to an unusual degree, so-called "add-pays" for tasks that allowed nominal salaries to be increased to totals greater than those prevailing for other municipalities. And there were pre-determined automatic annual cost-of-living pay increases not tied to the state of the economy or local finances.... Pensions were allowed to be based on the final year of compensation, which compensation could include essentially-unlimited accrued vacation and sick leave. This led to a phenomenon of so-called "pension-spiking" in which a pension could be substantially greater than the retiree's actual final salary. Nor were individual employees required to contribute to their pensions.

Id .

The City's financial problems were obscured by faulty management and accounting practices. "City accounts were in such disarray that it has taken literally years to unscramble them." Id. However, ultimately, the City's fiscal excesses, particularly in light of the recession, proved unsustainable.

Beginning in 2008, the City declared a series of financial emergencies and took certain unilateral actions to try to get its fiscal house in order. The City reduced its work force "by 25% from 1,886 on July 1, 2008 to 1,420 on December 31, 2011."

Id. at 780. "[S]worn police officers were cut by 25%, non-sworn police staffing by 20%, fire staffing by 30%, and non-safety staffing by 43%." Disclosure Statement, at 9. Compensation to City employees was reduced by $52 million, and staffing and service levels were cut by $38 million, "for an overall General Fund budget reduction of approximately $90 million during fiscal years 2009–10, 2010–11, and 2012–13." Id. Unfortunately, these actions were not enough to solve the City's fiscal problems.

As of June 30, 2012, the City's general fund budget for the 2012–13 fiscal year was projected to be $25.9 million under water, with funding potentially not available to cover July 2012 payroll, unless drastic action was taken. Id. Accordingly, the City Manager and Stockton's City Council took steps to initiate the neutral evaluation process under California Government Code ("Cal.Gov.Code") § 53760 as a prelude to a chapter 9 filing. City of Stockton, 493 B.R. at 780–81.

Former bankruptcy judge Ralph Mabey was selected as the neutral evaluator. Thereafter, the neutral evaluation process continued for ninety days, as authorized by Cal. Gov.Code § 53760.3(r), and some positive results were achieved: Agreements were negotiated to adjust all unexpired collective bargaining agreements with City employees, and substantial progress was made in negotiations with some other stake holders. Id. at 783. However, no agreements were reached with any capital markets/bond creditors, including Franklin. Id. at 782–83.

B. Chapter 9 filing and events prior to confirmation

The City filed its petition for relief under chapter 9 on June 28, 2012. From the outset, proceedings in the City's bankruptcy case were contentious. The capital markets/bond creditors contested eligibility, and "only after many months of costly discovery, briefing, legal maneuvering, and ultimately a trial" did the bankruptcy court determine that the City was entitled to relief in chapter 9. The order for relief was entered on April 1, 2013, and the bankruptcy court's opinion stating its findings and conclusions as to the City's eligibility for chapter 9 relief was entered on June 12, 2013. See City of Stockton, 493 B.R. 772, 776–98 (Bankr.E.D.Cal.2013). The bankruptcy court's eligibility decision was not appealed and is final.

In the meantime, the bankruptcy court had appointed Oregon bankruptcy judge Elizabeth L. Perris as mediator on July 12, 2012, and negotiations continued between the City and interested parties under her auspices, with the goal of reaching agreement on the terms for a consensual plan of adjustment. These negotiations were protracted and proceeded in fits and starts, but over time, they were largely successful, with definitive settlements reached with the following creditors and creditor groups:

1) The Stockton Police Officers' Association—the only labor organization with which the City had not reached agreement prepetition;

2) The Official Committee of Retirees—which represented 2,100 retirees with pension benefits, of which approximately 1,100 also claimed rights to lifetime health benefits ("Retiree Health Benefit Claims");

3) California Public Employees' Retirement System ("CalPERS")—which administers the City's pensions;

4) Assured Guaranty Corp. and Assured Guaranty Municipal Corp. (collectively, "Assured")—which insured the City's pension bonds;

5) National Public Finance Guarantee Corporation ("NPFG")—which insured an aggregate of approximately $93.8 million in 2004 and 2006 City bonds, secured in part by parking structures, among other things.

6) Ambac Assurance Corporation ("Ambac")—which insured approximately $13.3 million in 2003 City certificates of participation; and

7) Wells Fargo Bank ("Wells Fargo")—which served as the indenture trustee for a number of the City's bond issues.

In fact, the only major creditor group with which no settlement was negotiated was Franklin.

C. Plan provisions and confirmation proceedings

The Plan submitted by the City for confirmation classified claims, incorporating the mediated settlements with creditor constituencies, including the following:

1) Claims of CalPERS and pension plan participants (Class 15): The claims of pension plan participants and CalPERS were treated as unimpaired because the City settled with them on the basis that it would remain bound to honor their legal, equitable and contract rights unaltered. (The quid pro quo for the City's settlement was that it would be relieved of liability to pay Retiree Health Benefit Claims, except for $5,100,000, to be paid as provided for general unsecured claims in Class 12.)

2) Claims of Assured (Classes 5 and 6): Assured's claims were treated as impaired, entitling Assured to vote both as Class 5 and Class 6. Under the Plan, the City agreed to transfer fee title to its interest in an office building located at 400 E. Main Street in Stockton ("400 E. Main"), its planned replacement for city hall, to Assured in exchange for the extinguishment of the City's obligations under 2007 lease obligation bonds. Lease arrangements with respect to 400 E. Main were to be altered to provide that the City would lease space in 400 E. Main from Assured for eight years at below-market rates, with four one-year options to renew. As part of their settlement, the City and Assured agreed that the City's obligations under pension bonds would be reduced to 52%, but allowed for contingent full repayment of the bond obligations if the City's revenues outperformed certain baseline projections.

3) Claims of NPFG (Classes 2, 3 and 4): NPFG's 2004 parking structure bonds were to be paid through a new Parking Authority, to be created by the City, that would take ownership of all downtown Stockton parking facilities. The payment obligation for the bonds would be shifted from the General Fund to the Parking Authority, removing the obligation from the General Fund ledger. NPFG's 2004 arena-related bonds were secured by both a lease of the arena and a pledge of certain restricted tax revenues. The bonds were to be restructured to provide debt service savings and make it more likely that the restricted...