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A federal judge allowed Stockton, Calif., to restructure its finances under bankruptcy protection Monday, but he signaled it might have to cut payments to its pension fund, possibly setting a precedent for other cities.

 

Stockton, a port and agriculture center of 300,000 residents 80 miles east of San Francisco, filed in June 2012 for Chapter 9 under the U.S. Bankruptcy Code, which allows municipalities to seek protection from creditors by establishing a plan to resolve their debt. It is the largest U.S. city to file for bankruptcy.

 

Judge Christopher Klein of the U.S. Bankruptcy Court in Sacramento on Monday declined a request by the city's creditors that he dismiss the bankruptcy case, saying the city "will not be able to perform its obligations to its citizens relating to such fundamental matters as public safety, as well as other basic governmental services," without bankruptcy powers.

 

Stockton is the latest in a string of California cities that have moved toward bankruptcy—it follows San Bernardino, Vallejo and Mammoth Lakes—after their finances crumbled in the face of the recent recession and as costs such as city pension obligations mounted.

 

Stockton, which had $700 million in bond debt and faced a $26 million annual budget shortfall when it filed for bankruptcy, also could become one of the first municipalities to use bankruptcy protection to force bondholders to take less than the principal they are owed. Two other areas operating under Chapter 9 protection, San Bernardino and Jefferson County, Ala., are also trying to negotiate such concessions from their bondholders.

 

 

Bondholder groups have argued that Stockton was unfairly trying to use bankruptcy to cut debt payments while leaving untouched its obligations to the California Public Employees' Retirement System, or Calpers, which holds city workers' retirement money.

 

Municipal experts and struggling cities in California and elsewhere have been closely watching the case to see whether a city's debt to its pension funds is immune from cuts imposed by a bankruptcy judge. A ruling against pension funds could inspire more cities to file for bankruptcy.

 

Judge Klein disagreed that bondholders were being unfairly targeted. But he said the group could still try to block the city's debt-restructuring plan, thus not extinguishing bondholders' fight against Calpers, which is scheduled to collect hundreds of millions of dollars from Stockton over the next decade.

 

Calpers will work to "protect and defend the integrity and soundness of the pension plan" during the case, said Calpers Chief Executive Anne Stausboll, in a statement.

 

Assured Guaranty Ltd., AGO -3.25% insurer of $161 million of Stockton's debt, said in a statement that the city's current demands fall "short of the fairness requirements mandated by Chapter 9."

 

Stockton's leaders are expected to begin putting together a reorganization plan for the city that would have to be approved by Judge Klein.

 

"The next steps are to confirm a plan of adjustment through the restructuring of our debt, begin the recovery process and move Stockton forward," City Manager Bob Deis in a statement said after Monday's ruling.

 

The economic conditions that have forced California cities toward bankruptcy have eased greatly of late. Vallejo emerged from bankruptcy protection in 2011, while housing markets that contributed to the financial troubles of Stockton and many other California cities are mostly on the rebound.

 

—Jim Carlton
contributed to this article.