Bankruptcy Judge Delays Stockton's Decision until October 30. If City does not improve its offer to Franklin, rejection of its exit plan seems likely.

I expected the Judge to reject Stockton's bankruptcy plan of adjustment today, because it unfairly discriminates against Franklin.  However, he delayed a ruling on the plan until October 30th and reportedly said it was still "open season" on a negotiated settlement or for Stockton to amend their plan's treatment of Franklin.

While the delays in this case have been painful and costly for the City, I think he did them a favor here by giving them one last chance to avoid a rejection of their plan.  I think the Judge recognizes that rejecting the plan will be destabilizing to the City, but I doubt he is willing to confirm a plan that pays Franklin less than 1% on its unsecured debt and about 12% on its total debt when other creditors - both retirees and bondholders - are receiving so much more.

I also expected the Judge to make some sort of finding that CalPers pensions could be impaired by the City, and he did.  Since the City does not want to impair pensions, the ruling may seem to be of little practical importance to Stockton.  However, I do think that finding turns up the pressure for the City to improve its offer to Franklin and potentially make a last minute deal.

Below is an excerpt from what I wrote about the case in the most recent California and Metro Forecast.  I did not predict a rejection of the plan, but speculated at what the City would do if he does.

Judge Klein may confirm Stockton’s plan on October 1, but what happens if he does not?  The Judge could find that the City’s plan discriminates unfairly against Franklin, and he may also reach a conclusion that opens the door for Stockton to reduce pensions but he can’t compel the City to go through that door.  Even if the Judge gives Stockton an opening to impair pensions, City leaders have made it clear that they have no desire to go in that direction.  It is most likely that the City would simply amend its plan to offer Franklin a repayment of around 50%, roughly proportional to the recovery from fixed payments in the City’s settlement on its over $100 million in unsecured pension bonds.  The City would have a strong case that such an offer is fair, and would hopefully be able to still avoid a long and costly court battle over the pension issue.

While the judge did not reject the plan today, I expect he will unless the City produces something that is reasonably close to the settlement on the unsecured pension bonds announced last October. (The terms of the pension bond settlement essentially precludes the City from offering anything better.) Franklin also said today that it wants to be a "partner" in the City's recovery, which I believe is the same language that Assured Guaranty and the City used in describing their pension bond settlement last fall, because that deal provides a higher repayment if the City's future revenues exceed their current projections.

In my view, the City's argument for its harsh treatment of Franklin is illogical and inconsistent with its treatment of other creditors.  Sticking to that argument until October 30 seems like it could be a losing strategy. The City's plan hinges critically on being able to classify retiree's claims against the city for medical benefits and pensions into separate classes. The City's plan defines the medical claims as unsecured and sticks them in the same class as Franklin's unsecured claim for its bond debt, and the City puts the pension claims into a separate class. Since the retiree health care benefits were essentially eliminated by the bankruptcy plan, the City argues that the 1% recovery for Franklin's unsecured claim is fair since it is proportional to the treatment of retiree healthcare that it has placed in the same class. However, in ruling today that the pensions could be impaired and the $1.6 billion termination liability could not be enforced, it seems that the Judge views pensions as an unsecured retiree claim as well - at least they are not as protected as the City and CalPers claims. And at least to my non-lawyer brain, that suggests to me that it is highly unlikely that the judge will accept the City's classification scheme and agree with Franklin's argument that they are unfairly defining the classifications in order to impose a low recovery on them. I would also point out that the City considered separate secured claims from the same creditor (Assured Guaranty's secured bonds on the 400E Main building and unsecured pension bonds) as a package in describing the fairness in the settlements, so it seems to me that they are not being consistent here either. So I expect a settlement or adjustment to the plan in the next few weeks. I haven't made any serious attempt to estimate the cost of an adjustment on the City's budget, but it seems that the worst case would be $1 million per year over the next 30-40 years. While that hurts, it is much less painful for the City than having their plan rejected by the judge.

Disclaimer:  I am not a lawyer, and this is my immediate reaction to today's hearing.  As a non-lawyer, my opinion is based on my personal view of the logic and fairness behind the arguments and whether the business case and economic analysis supporting the arguments is sound.  I have been following this class closely, and have read all the briefs submitted by both sides leading up to the case, and have reviewed the City's financial projections in the past.