Stockton Ordered to Prove Bankruptcy Eligibility at Trial

The city of Stockton, California, must prove during a trial next month that it is eligible to remain in bankruptcy, where it is protected from creditors, a judge ruled.

U.S. Bankruptcy Judge Christopher M. Klein rejected a request by Stockton to decide whether the city is eligible without giving creditors a chance to cross examine city witnesses or present their own evidence.

Klein said he was ordering a four-day trial starting March 25 because whatever decision he makes will probably be appealed. If he ruled based on limited facts not in dispute, the decision may be overturned, forcing him to hold a trial anyway, he said.

“The simpler thing is put people in the position of saying ‘I rest,’ Klein said. ‘‘Then I can make findings of fact.’’

Stockton filed for court protection last year after failing to reach agreement on how to reduce its debt.

Under Chapter 9 of the U.S. Bankruptcy Code, governments, unlike corporations, must first prove to a judge that they are eligible to be in bankruptcy before they can use the court process to reduce debt through actions such as canceling contracts.

Pension Bonds

Assured Guaranty Corp., which insured about $161 million in pension obligation bonds, said in court papers in December that Stockton should raise taxes, cut employee benefits and close or sell city hall to repay bondholders. The city has said it can’t fully repay the bonds.

National Public Finance Guarantee Corp. also asked Klein to dismiss Stockton’s bankruptcy case, arguing that the city is unfairly forcing creditors to take excessive cuts. In its filing, the company repeated its argument that the city should force cuts on its biggest creditor, California Public Employees’ Retirement System.

Also today, Stockton and Ambac Assurance Corp. agreed to cap payments from the city’s general fund on $21.6 million in debt, officials said in a statement. Most city services, including fire and police protection, are made from the general fund.

The deal, ‘‘will serve as an important step to enabling the city to emerge from bankruptcy and reach fiscal sustainability,” City Manager Bob Deis said in a statement.

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

Before it's here, it's on the Bloomberg Terminal.