Stockton is largest U.S. city to seek bankruptcy

Updated 9:48 PM ET

(AP) SACRAMENTO, Calif. - Stockton has filed for Chapter 9 protection, making it the largest American city ever to declare bankruptcy.

City Manager Bob Deis said officials sought the status Thursday in federal bankruptcy court in Sacramento, as expected.

The filing comes after officials were unable to reach a deal with the city's creditors to restructure hundreds of millions of dollars of debt under a new state law designed to help municipalities avoid bankruptcy.

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Stockton, a river port of 290,000 in Central California, was one of less than half dozen larger governments to seek Chapter 9 protection in U.S. history, according to James Spiotto, a Chicago bankruptcy attorney who tracks municipal bankruptcies.

It's the first California city to file for bankruptcy since Vallejo, which sought protection in 2008.

Chapter 9 has been used sparingly and mostly by small government entities such as water utilities and other special districts, Spiotto said, because it halts a city's ability to develop.

The City Council on Tuesday approved a bankruptcy budget to plug next year's anticipated $26 million deficit.

"Cities and counties fear that their ability to fund capital improvements and build infrastructure will be denied or costs will go up if they file" Spiotto said. "Chapter 9 provides short term gains, but also long term pain."

In the past, large municipalities have received assistance from states or have internally refinanced their obligations, he said.

Since Congress added Chapter 9 to the bankruptcy code in 1937 to allow municipalities to seek protection, some 640 government entities have filed.

Stockton is the largest city by population to seek Chapter 9 protection, Spiotto said. Other large ones were Bridgeport, Conn. in 1991 (its filing was dismissed by a judge), Orange County in 1994, Vallejo and Jefferson County, Alabama in 2011.

By comparison, roughly 1.5 million Americans file for personal bankruptcy each year, while some 50,000 companies file for business bankruptcy.

"People will be watching," Spiotto said. "Is Stockton just another aberration, or is it a growing trend?"

In Stockton on Tuesday, the City Council approved a budget-in-bankruptcy that plugs next year's anticipated $26 million shortfall out of the city's half billion spending plan.

The special budget suspends debt payments, reduces payments for retiree medical benefits and increases revenue through code enforcement and parking citations, among other measures.

City officials declined to provide the city's total debt, or a list of all its creditors. The 18 largest creditors who participated in mediation included Wells Fargo & Co., retiree groups and labor organizations.

Under bankruptcy protection, Stockton officials will retain power over day-to-day city operations and staffing, but a judge will take over all decisions concerning the city's debts, said Robert Benedetti, professor of political science at the University of the Pacific in Stockton.

The judge will decide which creditors should be paid, how much and in what order. But he will also make allowances for expenditures needed by the city to function, and it will be up to city officials to decide how to spend that money.

"One of reasons a city might want to go the bankruptcy route is that they don't want a situation where they have to pay out debts and have to close the police or fire department," Benedetti said.

Thousands of new homes mushroomed in Stockton during construction bubble, and the city in California's agricultural heartland became beset by foreclosures with the second highest rate in the nation. Stockton's property taxes and other revenues sharply declined, while expensive investments and generous retiree benefits drained city coffers.

Stockton was the first California city to test a new state mediation law, Assembly Bill 506, which is less than six months old.

Under the law, municipalities considering bankruptcy must first negotiate behind closed doors with creditors for up to three months, with the goal of settling debts without filing for Chapter 9 protection.