Stockton Bankruptcy: A Bump or a Roadblock?

I've posted early and often on the chapter 9 bankruptcy of the City of Stockton but not so much of late. You can check here and here to get a flavor of my thoughts.

I've also written (and you can download) a lengthy draft of an article with an even longer title: Fairness and Risk in Stockton: Pensions, Bonds, and Taxes -- When Doing Nothing is Doing Well. I argue that chapter 9 of the Bankruptcy Code contains two irreconcilable provisions. One requires that the city's plan of adjustment be in the "best interests" of creditors; in other words, creditors couldn't get more outside of the bankruptcy than they are promised in the plan. The other mandates that the plan not "discriminate unfairly" against any class of creditors. This provision bars a city's plan from paying equally situated creditors (equally situated in terms of legally recognized priorities) different amounts. In other words, unless a creditor has collateral, everyone's in the same pot when it comes to the percentage that will be paid.

What happens when a plan of adjustment violates one or the other of these provisions? In my opinion, the bankruptcy court must dismiss the case unless the short-changed creditors settle. We see the stage set for such a showdown with a 73-page objection filed on February 26 by two owners of some of Stockton's municipal bonds. For some reason they're perturbed that they'll recover .25% of what's owed to them while other bondholders will get 52% or more. Unfair discrimination? What do you think?

Of course there's more to the story and Stockton and the other bondholders believe they have good reasons for discriminating. And, when push comes to shove, it's likely that the objectors will be happy to take a smaller share than the others, just not this much smaller. I nonetheless hope that the Bankruptcy Court won't signal its intentions and will let all three sides negotiate under the implicit threat of dismissal of the case if they can't agree. A "negative nuclear option," so to speak, should get everyone to the table and willing to negotiate.