Analysis: Stockton and San Bernardino, a tale of two bankruptcies

By Tim Reid

LOS ANGELES (Reuters) - Stockton and San Bernardino, the two California cities that have filed for bankruptcy protection, are both considered test cases in the epic battle over whether municipal bondholders or pensioners will absorb most of the pain when a government goes broke.

A federal court ruling on Monday that allowed Stockton's bankruptcy case to move forward underscored the huge differences between the two cases and how they are likely to unfold.

Stockton, the largest U.S. city to seek bankruptcy protection, engaged in years of cost-cutting and attempted to negotiate with its creditors before declaring insolvency - actions that were lauded by U.S. Bankruptcy Judge Christopher Klein on Monday when he ruled the city eligible for bankruptcy protection.

Stockton has kept current on its payments to Calpers, the state pension fund, even as it has defaulted on some bond payments and declared its intention to wring concessions from Wall Street creditors. Thus Calpers has supported Stockton's bankruptcy filing, while the so-called capital-market creditors have opposed it.

Stockton has also produced a plan for operating in bankruptcy that runs to nearly 800 pages. City Manager Bob Deis, by all accounts, has run the process with an iron fist, and the bankruptcy proceedings are likely to be orderly even as the central conflict between creditors and pensioners is fought bitterly.

In San Bernardino, none of this has happened. The city did not engage in substantial staff nor budget cuts in the years prior to the bankruptcy, nor did it seek to negotiate with any creditors. Instead, the city declared a fiscal emergency, a move aimed at avoiding negotiations, and simply stopped paying both bondholders and Calpers.

Its pre-bankruptcy plan ran to just 12 pages. Its interim city manager, overwhelmed by the process and the city's corrosive politics, quit earlier this year, as did the finance chief. Affairs in the city are so chaotic that on Monday night the council voted to contract out its finance department.

In court, San Bernardino's Wall Street creditors - some of them the same as in Stockton's case - have supported its quest for bankruptcy eligibility, because the city is treating them and Calpers equally. And in another mirror image to Stockton, Calpers is opposing San Bernardino's request for bankruptcy protection.

"Because San Bernardino did not negotiate with creditors at all before declaring bankruptcy, it has a far heavier burden to prove eligibility for bankruptcy," said Karol Denniston, a bankruptcy attorney with Schiff Hardin in San Francisco and the author of part of California's bankruptcy code.

Under both state and federal bankruptcy law, cities must prove that they attempted good faith negotiations with creditors before filing for bankruptcy - or that a sudden fiscal emergency of such scale made negotiations impossible.

Because San Bernardino took the fiscal emergency route, "the city has to show that negotiations were impossible and would not have accomplished anything, and that is much more difficult," Denniston said.

James Spiotto, a municipal bankruptcy specialist and a partner at Chapman & Cutler in Chicago, said because San Bernardino declared a fiscal emergency, it must now prove that the health, safety and well-being of its residents was in jeopardy if it had not taken such a drastic step.

"That's a separate, distinct burden of proof, and it's a difficult and higher one," Spiotto said.

But, Spiotto added, the chaos suffusing San Bernardino's affairs "may be the weight of evidence they need to prove they had to declare a financial emergency."

In Monday's Stockton ruling, U.S. Bankruptcy Court Judge Christopher Klein suggested that the issue of how pension payments are treated relative to bond payments will be a central one in the case going forward - and the issue will likely be resolved by Klein himself.

In San Bernardino, if the city fails to achieve bankruptcy protection, the same fight between Calpers and Wall Street creditors will take place - but without the orderly supervision of a bankruptcy judge.

Instead, the issue would likely play out in a chaotic flurry of state court cases as city workers, unions, pensioners, bondholders and other creditors press for enforcement of their contractual rights.

Who might come out on top in that is anyone's guess.

(Reporting by Tim Reid; Editing by Jonathan Weber and Leslie Gevirtz)

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Exclusive: Bankrupt San Bernardino picks twice bankrupt manager

LOS ANGELES (Reuters) - The bankrupt city of San Bernardino has hired a new city manager who, according to court filings, has twice declared personal bankruptcy and was recently ousted from the board of a small community's water company after being sued by shareholders.

The city council voted unanimously on Tuesday night to hire Allen J. Parker, 71, as its city manager on an annual salary of almost $222,000. He replaces an interim city manager who resigned last month because, according to friends, she was exasperated by the city's internal divisions.

The interim city manager, Andrea Travis-Miller, could not be reached for comment.

Pat Morris, the mayor of the city in California, praised Parker's "wealth of city management experience" and expressed "great confidence" in his ability to oversee the city's affairs. Parker, who began working in the job on Wednesday, will be crucial in guiding the city of 210,000 people through municipal bankruptcy, in a case that could set a national precedent for Wall Street bondholders and pension funds in future municipal bankruptcies.

The mayor and council members knew about both of Parker's personal bankruptcies - the first in 1991 and the second in 2011 - and the litigation surrounding his water board tenure before they interviewed him, according to the mayor's chief of staff. They discussed both issues with him when they interviewed Parker last Friday. They say the issues were no impediment: the council interviewed two final candidates but voted unanimously to hire him.

The California newspaper The Press-Enterprise reported on Thursday that Parker filed in 2011 for personal bankruptcy. In comments to the paper, Parker said that his bankruptcy and his ability to handle the city's fiscal problems were "apples and oranges."

Calls and emails to Parker asking about his bankruptcy filings and his tenure on the water board went unanswered. An email to Parker asking if his wife Sara, with whom he jointly filed for bankruptcy in the 2011 petition, would comment also did not elicit a response.

The bankruptcy of San Bernardino, a city 65 miles east of Los Angeles, is a national test case as to whether the pensions of government workers take precedence over other payments in a municipal bankruptcy - a high stakes issue for pension plans and their beneficiaries, and for the Wall Street bondholders who lend money to governments.

City managers are central to any city's quest to seek bankruptcy protection, because they have a pivotal role in answering questions from creditors and the court. The judge overseeing San Bernardino's case must still rule on whether the city is eligible for bankruptcy before the case proceeds.

A TINY COMMUNITY

A 2009 lawsuit brought by a shareholder in the Banning Heights Mutual Water Company, where Parker was a director and then president of the board between 2004 and 2010, resulted in Parker being voted off the board in February 2010 after a court-ordered special election.

Banning Heights is a tiny unincorporated community 85 miles east of Los Angeles. The water company was formed in 1913 to provide water and today it serves about 250 residents.

Despite its small size, the water rights and land upon which the community sits are worth millions of dollars, according to John McClendon, the water board's general counsel. At one point under Parker's tenure on the water board, an entity called The Tahiti Group had placed $7 million in an escrow account to purchase the company, according to correspondence attached to court filings.

Court filings in the 2009 lawsuit, and a subsequent separate lawsuit brought by the water company allege that Parker, along with others, used their position on the board to try to sell the water company, against the wishes of shareholders.

Parker and others were also accused of withholding information from shareholders, according to those court filings. The shareholder sued in 2009 because he said Parker and others ignored the results of previous shareholder elections when they were voted off the board. Parker is not a defendant in the second lawsuit which is still active.

According to one court filing by the water company dated September 20, 2010, when shareholders gained access to the water company's office after Parker and others were voted off the board, computers were missing, hard drives had been wiped and bags of shredded documents sat on the floor.

In a deposition dated November 9, 2010 relating to the 2009 lawsuit, Parker said he never shredded documents and did not believe anyone "during our regime" on the water board shredded any documents.

After a judge ruled against Parker and others in the 2009 lawsuit and ordered a special shareholder election, they were voted off the board by shareholders in February 2010.

CITY DID ITS CHECKS

According to his resume, which does not mention Banning Heights Water Company, Parker has long experience as a local manager in several other California cities such as East Palo Alto, Half Moon Bay, Seal Beach, and Compton.

Jim Morris, the son and chief of staff to Pat Morris, San Bernardino's mayor, said the city had done its own thorough background check on Parker before he was interviewed by the council, last Friday. His bankruptcies, and the Banning Heights Mutual Water Company litigation, were known about by the time the interview took place, Morris said.

"We talked to the attorneys involved, and pulled the court filings. These were disputes over election results," Morris said. He said the Banning Heights litigation did not involve serious issues, and that such disputes occur on small entities such as the water board all the time.

Morris said there was no reason why Parker should have included his tenure on the water board on his resume. "He wasn't employed by the water board," Morris said. "His resume was an employment resume. If someone was a member of their local homeowners' association you wouldn't expect that to be on their resume."

Parker filed for personal bankruptcy in 1991, in San Mateo, California, according to court records. No further details were available. In February 2011, he filed for bankruptcy with his wife, in the U.S. Bankruptcy Court, Central District of California.

According to the 2011 bankruptcy filing, Parker and his wife listed among their debts two home mortgages with unsecured balances of $267,500, as well as bank and credit card debt of $137,252.

(Reporting by Tim Reid; Editing by Martin Howell, Tiziana Barghini and Claudia Parsons)

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