Threat or Feint?

Go here to read the Reuters account of the second day of the hearing on confirmation of Stockton's plan of adjustment. The California city of Stockton, you will know (if you've read my posts here, here, and here) is in Chapter 9 (municipal) bankruptcy. Stockton in many ways is the prequel to Detroit's far larger bankruptcy case. We know that because the bondholders (or their insurers) who so strenuously opposed Stockton's eligibility to be in Chapter 9 have settled and taken their fight to Detroit where their potential losses are orders of magnitude greater than Stockton.

Well, not all bondholders. Those whose bonds were secured by a public golf course in Stockton have taken umbrage at the city's plan to pay them pennies on the dollar, all the while paying other bondholders--who had zero collateral--much more of what's owed them, and paying CalPERS, the state retirement fund manager, 100%. "Unfair discrimination" is the label for the objection of the small-fry bondholders who are getting squeezed.

In the Reuters article you will note that Bankruptcy Judge Christopher Klein opened the door to considering whether he can confirm a plan that provides for such substantial disparities in treatment of similarly situated creditors. In particular he stirred the pot about giving CalPERS everything it wants. Why, he mused, should one creditor escape unscathed while others must suck it up?

There are, of course, reasons why Stockton picked on bondholders and not the behemoth that is CalPERS. The question of the day is whether those reasons are satisfactory. The Bankruptcy Code does not forbid all "discrimination," only discrimination that is "unfair."

FWIW, I do not believe the reasons proffered by Stockton and supported (not surprisingly) by CalPERS are adequate. And so I argued in my recently published piece Municipal Bankruptcy: When Doing Less is Doing Best, 88 Amer. Bankr. L. J. 85 (2014). Those who have access to WestLaw can download it. In short, I argue that Chapter 9 of the Bankruptcy Code creates an institutional forum for a high-stakes game of Chicken. If at least two of the parties don't swerve, i.e., settle, then the court cannot confirm a plan that doesn't comply with the no "unfair discrimination" requirement.

Then what, you ask? Either back to the drawing board for the parties or dismissal of the case by the court. It's the threat of "no" to confirmation that I hope Judge Klein sufficiently telegraphed yesterday. There's still time to settle.