In re City of Stockton, 12–32118–C–9.

• Citation: 493 B.R. 772
• Decision Date: 12 June 2013
• Docket Number: No. 12–32118–C–9.,12–32118–C–9.
• Parties: In re CITY OF STOCKTON, CALIFORNIA, Debtor.
• Court: United States Bankruptcy Courts. Ninth Circuit. U.S. Bankruptcy Court — Eastern District of California

493 B.R. 772

In re CITY OF STOCKTON, CALIFORNIA, Debtor.

No. 12–32118–C–9.

United States Bankruptcy Court,

E.D. California.

June 12, 2013.

Marc A. Levinson, Norman Hile, Jonathan Riddell, John W. Killeen, Orrick, Herrington & Sutcliffe LLP, Sacramento, CA, for Debtor.

Nicholas De Lancie, Jeffer Mangels Butler & Mitchell LLP, San Francisco, CA, for Union Bank, N.A.

Michael S. Gardener, Boston, MA, for Wells Fargo Bank, National Association.

James O. Johnston, Joshua D. Morse, Jones Day, Los Angeles, CA, for Franklin High Yield Tax Free Income Fund and Franklin California High Yield Municipal Fund.

Lawrence A. Larose, Winston & Strawn LLP, New York City, NY, for National Public Finance Guarantee Corporation.

Guy S. Neal, Sidney Austin, LLP, Washington, DC, for Assured Guaranty Corporation and Assured Guaranty Municipal Corporation.

Michael Ryan, K & L Gates, Seattle, WA, for California Public Employees' Retirement System.

Michael J. Gearin, K & L Gates LLP, Los Angeles, CA, for California Public Employees' Retirement System.

Matthew M. Walsh, Winston & Strawn LLP, Los Angeles, CA, for National Public Finance Guarantee Corporation.

OPINION REGARDING CHAPTER 9 ORDER FOR RELIEF

CHRISTOPHER M. KLEIN, Bankruptcy Judge.

Chapter 9 is unique among voluntary Bankruptcy Code cases in that a municipality must litigate its way to the order for relief before restructuring its debt. Capital markets creditors of the City of Stockton have required the City to prove its eligibility for chapter 9 relief under 11 U.S.C. §§ 109(c) and 921(c). Such a proceeding is like a qualifying round in a competition; success leads only to the main event—the process of achieving a viable plan of adjustment. Without a confirmed plan, a municipality lacks constitutional authority to compel impairment of contracts.

This opinion addresses chapter 9 eligibility issues that arose during the three-day trial on the question whether to order relief and the post-trial motion to alter or amend the findings regarding the strategy adopted by certain creditors. The focus is on pre-filing obligations of the municipality in dealing with creditors and stakeholders. Concluding that the City carried its burden to establish the elements required for an order for relief and concluding that the objectors inappropriately used an issue relatingto plan confirmation, but that is irrelevant to eligibility, as a pretext to decline to negotiate in good faith and to force a trial that should not have been necessary, relief will be ordered.¹

STATUTORY REQUIREMENTS

As chapter 9 eligibility is governed by Bankruptcy Code §§ 101(32)(C), 101(40), 109(c), and 921(c) and (d), it is appropriate to situate those statutes front and center:

§ 101(32). The term “insolvent” means—

...

(C) with reference to a municipality, financial condition such that the municipality is—

(i) generally not paying its debts as they become due unless such debts are the subject of a bona fide dispute; or

(ii) unable to pay its debts as they become due.

11 U.S.C. § 101(32).

* * *

§ 101(40). The term “municipality” means political subdivision or public agency or instrumentality of a State.

11 U.S.C. § 101(40).

* * *

§ 109(c). An entity may be a debtor under chapter 9 of this title if and only if such entity—

(1) is a municipality;

(2) is specifically authorized, in its capacity as a municipality or by name, to be a debtor under such chapter by State law, or by a governmental officer or organization empowered by State law to authorize such entity to be a debtor under such chapter;

(3) is insolvent;

(4) desires to effect a plan to adjust such debts; and

(5) (A) has obtained the agreement of creditors holding at least a majority in amount of the claims of each class that such entity intends to impair under a plan in a case under such chapter;

(B) has negotiated in good faith with creditors and has failed to obtain the agreement of creditors holding at least a majority in amount of the claims of each class that such entity intends to impair under a plan in a case under such chapter;

(C) is unable to negotiate with creditors because such negotiation is impracticable; or

(D) reasonably believes that a creditor may attempt to obtain a transfer that is avoidable under section 547 [preferences] of this title.

11 U.S.C. § 109(c).

* * *

§ 921

(c) After any objection to the petition, the court, after notice and a hearing, may dismiss the petition if the debtor did not file the petition in good faith or if the petition does not meet the requirements of this title.

(d) If the petition is not dismissed under subsection (c) of this section, the court shall order relief under this chapter notwithstanding section 301(b).

11 U.S.C. § 921(c)-(d).

* * *

Relevant parts of California's gateway statute, Government Code §§ 53760, 53760.1, and 53760.3, also deserve a billing: ²

§ 53760. A local public entity in this state may file a petition and exercise powers pursuant to applicable federal bankruptcy law if either of the following apply:

(a) The local public entity has participated in a neutral evaluation process pursuant to Section 53760.3.

(b) The local public entity declares a fiscal emergency and adopts a resolution by a majority vote of the governing board pursuant to Section 53760.5.

Cal. Gov't Code § 53760.

* * *

§ 53760.1(d). “Good faith” means participation by a party in the neutral evaluation process with the intent to negotiate toward a resolution of the issues that are the subject of the neutral evaluation process, including the timely provision of complete and accurate information to provide the relevant parties through the neutral evaluation process with sufficient information, in a confidential manner, to negotiate the readjustment of the municipality's debt.

Cal. Gov't Code § 53760.1(d).

* * *

§ 53760.3( o ). The local public entity and all interested parties participating in the neutral evaluation process shall negotiate in good faith.

Cal. Gov't Code § 53760.3( o ).

§ 53760.3(s). The local public entity shall pay 50 percent of the costs of neutral evaluation, including, but not limited to, the fees of the evaluator, and the creditors shall pay the balance, unless otherwise agreed to by the parties.

Cal. Gov't Code § 53760.3(s).

FACTS

When Bob Deis became City Manager for the City of Stockton on July 1, 2010, the first day of its fiscal year, he encountered a municipality in financial distress. In a progression beginning in 2008, the City Council had declared fiscal emergencies and imposed certain unilateral actions in an effort to staunch the hemorrhage. On June 22, 2010, the Council adopted an “Action Plan For Fiscal Sustainability' ” that it hired Deis to implement.

Some of the problems were due to the state of the economy in the Great Recession. Stockton was ground zero for the subprime mortgage crisis. Unemployment was 22 percent; median income for a family of four was about $63,000. Property values, both commercial and residential, had declined by 50 percent.³ Stockton had one of the highest foreclosure rates in the nation, a fact of which this court is painfully aware from the ordeal of presiding over the tragedy of bankruptcies of literally thousands of individual Stockton citizens who had done nothing wrong other than be seduced by easy credit when purchasing a home in a housing bubble before being slammed by unexpected loss of income when laid off or furloughed. Property tax, sales tax, and other public revenues characteristic of a functioning municipal economy had plummeted. For example, sales tax revenue declined from $47.0 million in fiscal year 2006 to $32.7 million in fiscal year 2010.⁴ Recovery was far over the horizon.

Some problems were due to excessive optimism. In better times, Stockton 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.

Some problems were due to encrustation of a creeping multi-decade, opaque pattern of above-market compensation of employees. /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.

The submerged compensation problems included surprisingly generous retirement practices. 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. In consequence, projected pension expenses were soaring.

City management before the Great Recession deserves some of the blame. City accounts were in such disarray that it has taken literally years to unscramble them. Various work rules were contractually agreed upon, often without approval in public view by the City Council, that left little latitude for exercise of managerial supervision. And one wonders about what prior City Councils had been doing.

In each fiscal year during Deis' tenure, fiscal emergencies have continued to be, declared, which have enabled some limitation of the adverse effects of some collective bargaining agreements.

In the fiscal year beginning July 1, 2010, unrepresented employees suffered: furloughs of 96 hours; new medical premiums; and increased health plan deductibles and co-pays. Similar concessions were obtained from collective bargaining units.⁵

In the fiscal year beginning July 1, 2011, the...