Stockton’s Rare Creditor Fight Presages Detroit Showdown

Stockton, the bankrupt California city seeking to resolve $1.18 billion in claims, is in the rare position of fighting a creditor in court to win approval of its debt-cutting plan, a dispute that may presage a much larger battle coming to Detroit.

The city began a four-day hearing today in Sacramento to win approval of a plan that will be modified this week as Stockton and Franklin Resources Inc. negotiate the size of the firm’s claim, said Marc Levinson, a lawyer for the city.

Franklin says it’s being unfairly targeted: two of its funds would get only 1 percent of the $35 million they are owed under the current plan, while other creditors are due to collect anywhere from half to all of what they are owed.

“The city can pay more than a penny on the dollar,” James Johnston, an attorney for Franklin, said in his opening statement today. Evidence presented this week will “confirm that what looks wrong is, in fact, wrong,” he said.

Few, if any, municipal bankruptcy cases have gone this far without big stakeholders settling, Jim Spiotto, an attorney with Chapman Strategic Advisors LLC in Chicago, said in an interview.

“It’s rare,” said Spiotto, who writes about the history of municipal bankruptcy. “I can’t think of one where there was a major creditor contesting confirmation.”

Detroit Fight

Detroit, which filed a record $18 billion municipal bankruptcy in July, may face a creditor fight on a much greater scale when it seeks approval of its plan in two months.

Like Stockton, it has settled contentious disputes over pensions and benefits. Still, bondholders and bond insurers say Detroit is offering them too little while giving public workers and retirees too much. They are seeking to force the city to use its art collection to bring in as much as $2 billion.

Stockton, a city of 298,000 about 80 miles (130 kilometers) east of San Francisco, filed for bankruptcy in 2012 after spending too much on downtown improvement projects and seeing its property-tax revenue plunge in the housing crisis. Creditors filed $1.18 billion in claims.

After months of negotiations with the help of a court-appointed mediator, Stockton cut deals with most creditors, including bond insurer Assured Guaranty Corp. and current and retired city workers, who claimed cuts to retiree health care would cost them $545 million over their lifetimes.

Office Building

Assured, which insured $164.7 million in bonds, was given an office building that Stockton had planned to use as a city hall. Current and former workers got $5.1 million.

Franklin, the San Mateo, California-based manager of the Franklin and Templeton mutual funds, refused to accept a deal and has asked U.S. Bankruptcy Judge Christopher Klein to reject Stockton’s debt-cutting plan.

The company said the city has enough money to give it as much as other creditors. Stockton “has the ability (if not the willingness) to pay vastly more of Franklin’s claim over time from future revenues,” it said in court papers last month.

Stockton said it can’t afford to pay more.

“Compared to the $1 billion Franklin funds, $37 million is a rounding error,” while Stockton is “in a fight for its life,” Levinson told the judge today. “The city has offered to pay what it thinks it can pay.”

The city said it treated Franklin’s debt the same way it handled the claim for retiree health benefits. Both were to get about 1 percent.

Calpers Paid

The California Public Employees’ Retirement System will be paid in full. Imposing cuts would have threatened Stockton’s participation in the pension system, and had Calpers thrown Stockton out of the fund, the city would have faced a $1.62 billion claim for unfunded pension liability, Stockton said in court filings.

Among plan modifications announced today, one involved Calpers.

“This does not change the pensions or the economics of the plan,” Levinson said.

Franklin’s case will turn on whether the judge decides Calpers should have been treated like an ordinary unsecured creditor, said Dale Ginter, a lawyer who represented creditors in the bankruptcy of Vallejo, California.

Stockton was one of three California cities to file for bankruptcy within a few months of each other in 2012. The mountain resort town of Mammoth Lakes filed in July after a court ordered it to pay $43 million to a land company. It settled that dispute about a month later and the bankruptcy was dismissed.

San Bernardino, about 60 miles east of Los Angeles, filed in August 2012. It’s still in bankruptcy, where a federal judge is helping to mediate its disputes with creditors.

The case is In re Stockton, 12-bk-32118, U.S. Bankruptcy Court, Eastern District of California (Sacramento).

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