Friday, 14 November 2014

Franklin Appeals Stockton Bankruptcy Confirmation

Franklin filed an appeal of Stockton’s bankruptcy confirmation this week.  I hope that my previous prediction that Stockton’s plan would be rejected in Court will continue to be wrong. 

Franklin claims that Judge Klein’s ruling included 4 errors:
1. It incorrectly interpreted the Best Interest of Creditors Test.
2. The classification of Creditors was discriminatory and unlawful.  [The City’s plan grouped Franklin’s claim "class 12" with the retiree health plan claim.]
3. The plan was proposed in Bad Faith.
4.  The City has not adequately disclosed payments and fees related to the case.
 
I find the second argument most compelling, and it is a big reason why I originally thought the Court would reject the plan.  Of course, I am not a lawyer.  According to Judge Klein, Stockton’s classification scheme does not discriminate illegally, and the appellate court may agree.
 
Below is an excerpt on this topic from Franklin’s appeal.
 
“Disparate And Discriminatory Classification And Treatment. Franklin also established that
the Plan’s classification scheme – in which Franklin’s unsecured claim was classified together with
part of the claims of City retirees (health benefit claims but not pension claims) and separately from
the claims of all of the City’s other bondholders – had only one purpose: to enable the City to avoid
the “cramdown” requirements of section 1129(b)(1) of the Bankruptcy Code. By improperly
gerrymandering Franklin’s unsecured claim into a class whose other members (the retirees) had
committed to vote to accept the Plan due to the promise of unimpaired pensions, the Plan violates the
strictures of section 1122(a) of the Bankruptcy Code. In re Barakat, 99 F.3d 1520, 1525 (9th
Cir. 1996) (plan violates section 1122 where “the classifications are designed to manipulate class
voting”) (quoting In re Holywell Corp., 913 F.2d 873, 880 (11th Cir. 1990)). The Court erred in
concluding otherwise.
The Court also erred in disregarding the disparate treatment of Class 12 claims and creditors
holding Class 12 claims. Specifically, the Court turned a blind eye to the direct linkage under the
Retirees Settlement between the retirees’ recovery in Class 12 and the City’s agreement to leave the
retirees’ pensions unimpaired. While nominally providing a sub-1% recovery to all claims within
Class 12, the Plan actually provides retirees with a recovery of somewhere between 53% and 70%
 

due to the fact that, as quid pro quo for the sub-1% “settlement” of Retiree Health Benefit Claims,
the City agreed to pay pensions in full. As many cases cited by Franklin establish, that treatment
violates section 1123(a)(4), which requires that claims and creditors in the same class receive the
same treatment. The Court erred by disregarding that authority.
Finally, the Court erred by failing to consider the undeniably unfair discrimination against
Franklin’s unsecured claim. Had the Court properly rejected the City’s gerrymandered classification
and disparate treatment of Franklin’s unsecured claim, it would have concluded that the sub-1%
payment on that claim unfairly discriminated against Franklin in comparison to the Plan’s 50%-70%
payment of retiree claims and 52% to 100% payment of other City bonds, including the wholly unsecured Pension Obligation Bonds. This legal error is likely to lead independently to reversal.”

About the Author

Ethan Jacob

Author & Editor

I am Ethan Jacob Executive Director of the Center for Business and Policy Research at the University of the Pacific, where I have a joint faculty appointment in the Eberhardt School of Business and the Public Policy Program in the McGeorge School of Law..

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