Wells Fargo, Stockton Police Group Take City to Court

Stockton, California, went to trial today against Wells Fargo & Co. (WFC) and will have a hearing tomorrow on litigation by its police officers that may signal whether it becomes the largest U.S. city to file for bankruptcy.

Beleaguered by escalating retiree costs, dwindling tax revenue, accounting errors and the lingering effects of the recession, Stockton, a farming center about 80 miles (130 kilometers) east of San Francisco, said in a court filing that it is “teetering precariously on the edge of insolvency.”

After the city missed a bond payment for parking garages on Feb. 25, Wells Fargo sued. The City Council decided on Feb. 28 to default on $2 million in bond payments, begin mediation with creditors, and to suspend sick leave and vacation payouts to retiring workers. That prompted an objection from the Stockton Police Officers’ Association in a previously filed lawsuit.

“These lawsuits only advance the narrow agendas of two creditors and possibly push the city into insolvency,” Stockton City Manager Bob Deis said in an e-mailed statement yesterday.

He said Wells Fargo and the police are “trying to elbow their way to the front of the line, which harms all other employees, creditors and the citizens of Stockton. This is what happened in Vallejo, sending that city spiraling into uncontrolled bankruptcy.”

Standard & Poor’s lowered its rating on the garage bonds to CC from BB- on Feb. 29, citing concerns about the city’s “willingness to meet its obligations” after the Feb. 28 council meeting.

Outside Mediation

Under a state law signed last year, Stockton is relying on an outside mediator to resolve disputes with creditors and unions. After 60 days without a resolution through mediation, or if the city runs out of money, it may then seek court protection. The law was sought by public-employee unions after Vallejo, a city of 120,000 in the San Francisco Bay Area, went bankrupt in 2008 and asked a court to help it void labor contracts.

The suit brought by Wells Fargo, being tried in Stockton before San Joaquin County Superior Court Judge Roger Ross, claims Stockton missed a $779,935 payment due Feb. 25 on revenue bonds issued in 2004.

Jeff Davis, a lawyer for Wells Fargo, told Ross today that after Stockton failed to make its bond payment, the bank served the city with a three-day “pay or quit” notice followed by a filing claiming Stockton is occupying the garages illegally.

‘Not Being Paid’

“The bondholders are not being paid,” Davis told the judge. With a court order allowing Wells Fargo to repossess the garages the bank could collect parking fees, “investors would get some of their money back, and the city would get credit for those payments,” Davis said.

Thomas Keeling, a lawyer representing Stockton, told Ross that Wells Fargo had adopted a “shoot first and ask questions later strategy.” The order the bank seeks isn’t a “permissible remedy” because under state law regulating financing for the garages, Stockton must benefit from the bank’s re-leasing.

“Wells Fargo has not presented a plan for re-letting, much less a plan showing that city will benefit from it,” Keeling said.

Wells Fargo argues that the city entered into a lease agreement for the garages and has defaulted on that agreement, allowing the San Francisco-based bank to repossess the property. Stockton acknowledges the missed bond payment, though claims in court documents that the repossession isn’t permitted because the relationship between the city and the bank is “not that of a landlord-tenant.”

‘Helping Hand’

“It seems when certain banks were in trouble, they asked for a helping hand and received a bailout from the government,” Deis said in his statement.

“Now that our city government is in trouble -- largely because of a mortgage foreclosure crisis caused by some banks -- this bank is responding with a lawsuit instead of constructive participation in the larger effort to find a solution,” Deis said. “The irony should not be lost on the public.”

Elise Wilkinson, a Wells Fargo spokeswoman, said in an e- mail that the bank, as the trustee of the bonds at issue, filed its suit at the direction of the bond insurer, National Public Finance Guarantee Corp. The company backs the debt.

“Wells Fargo has no funds at risk in this case, nor are we attempting to recover funds for our own accounts,” Wilkinson said. “Rather, we are acting solely in the interest of the bond insurer and the bondholders and at their direction.”

Accrued Vacation

The Stockton Police Officers’ Association, in its lawsuit originally filed in 2010, is seeking a court order requiring the city to restore payouts to retiring for accrued vacation. The group, accusing the city of breach of contract, claims Stockton unilaterally cut police pay by about 30 percent by declaring an emergency rather than negotiating concessions.

In court documents, Stockton argues it temporarily suspended payouts of accrued vacation for all city employees as one element of a wide-ranging effort to close a budget gap and preserve critical public safety services through the end of its fiscal year -- and while the state-mandated mediation continues. The measures have left Stockton with a general fund of less than $1 million, lawyers for the city said in the filings.

The police officers’ association “brazenly seeks to push its way to the front of the line,” threatening to trigger a city-wide payout of more than $1 million that would “most likely force the city into bankruptcy,” according to the filing.

‘Smokescreen’

David E. Mastagni, a lawyer representing the police officers, said in a phone interview that the city has no legal right to withhold approximately $321,000 in accrued vacation pay that some officers earned over 30 years of service. The threat of a bankruptcy is a “smokescreen,” he said.

Such a small sum wouldn’t trigger a bankruptcy filing, Mastagni said. He said the city manager’s “real intention is to throw the accrued vacation pay into the bankruptcy” once it’s filed “so he doesn’t have to pay the full amount of these earned wages.”

Wells Fargo rose 32 cents to $33.94 at 3:54 p.m. in New York Stock Exchange composite trading.

The cases are Wells Fargo Bank National Association v. City of Stockton, 39-2012-00277662, Superior Court of San Joaquin County (Stockton); and Stockton Police Officers’ Association v. City of Stockton, 39-2010-00245197, Superior Court of San Joaquin County (Stockton).

To contact the reporters on this story: Joel Rosenblatt in San Francisco at jrosenblatt@bloomberg.net; Alison Vekshin in San Francisco at avekshin@bloomberg.net

To contact the editors responsible for this story: Michael Hytha at mhytha@bloomberg.net; Stephen Merelman at merelman@bloomberg.net

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