San Bernardino, Calif., was deemed eligible to remain in bankruptcy by a judge who rejected arguments by the $264.6 billion California Public Employees' Retirement System that the city didn't qualify for court protection.
U.S. Bankruptcy Judge Meredith Jury in Riverside, Calif., ruled Wednesday in the city's favor, saying it needs the “breathing space” afforded by bankruptcy to renegotiate debts.
“The city deserves a chance,” the judge said in her decision. “The creditor body deserves a chance. The citizens of the city deserve a chance.”
San Bernardino sought bankruptcy protection from creditors on Aug. 1, 2012, blaming a fiscal emergency brought on by a $46 million budget shortfall. Since filing, the city has fought its employee unions in an effort to cancel their contracts and quit making certain payments to Sacramento-based CalPERS.
Under the section of U.S. bankruptcy law used by municipalities, known as Chapter 9, creditors, including unions, lenders and bondholders, can force a municipality to prove it's eligible to remain in bankruptcy after a case is filed.
Ms. Jury's decision comes after Stockton, Calif., won a contested fight in April over its eligibility for bankruptcy. Detroit, which last month filed the largest U.S. municipal bankruptcy, has eligibility hearings scheduled in September and October.
CalPERS argued San Bernardino doesn't qualify because it failed to negotiate in good faith with creditors.
Ms. Jury initially issued a tentative ruling on the city's bid to remain in bankruptcy and allowed CalPERS to argue in opposition to the city. She then issued a final ruling granting the city's eligibility.
Michael Gearin, an attorney for the pension fund, told the judge she risked setting a “dangerous precedent” for other municipal bankruptcy cases. It will mean other cities can rely on a “self-inflicted crisis” to qualify for bankruptcy without considering alternatives and failing to negotiate with creditors, he said.
“It's going to create incentives for debtors to create a crisis to determine that they have an inability to negotiate with creditors because they've got a large number of creditors and then to walk into bankruptcy court without any intention of moving the plan process forward,” Mr. Gearin said.