CalPERS outfoxes bond insurer in San Bernardino bankruptcy

June 17, 2013

By Wayne Lusvardi

Call it “lawyer wars.” The city of San Bernardino’s bankruptcy case is getting messy, pitting lawyer against lawyer.

Last week federal Judge Meredith Jury barred the law firm Winston and Strawn from representing a major bond insurer, National Public Finance Guarantee, in the city’s legal battle with the California Public Employees’ Retirement System. CalPERS asserts it has first claim over city revenues for its pension fund over the claims of bondholders or even city funding for public safety.

The reason for Jury’s action: the attorneys from the law firm of Winston and Strawn had also worked on the case of another bankrupt city, Stockton, but in that instance for CalPERS.

She said, “No matter how good the ethical firewall is, there will always be a sense that there is a fox in the henhouse.”

CalPERS filed a complaint alleging that Winston and Strawn recruited members of the bankruptcy team from K&L Gates, which had represented CalPERS in the Stockton case. Winston and Strawn contended that the selected attorneys would be internally “screened” off from San Bernardino case.  CalPERS alleged the attorneys were “tainted.”

“Screening” is typically a practice of large law firms who hire attorneys from smaller firms.  It involves creating a communication wall inside the law firm to restrict contamination of a case.

As reported in the Stockton Record, Professor John Sprankling of the University of Pacific’s McGeorge School of Law in Sacramento said lawyers switching sides in the San Bernardino case did not necessarily create a conflict of interest.  He said it was a common practice in large law firms the size of Winston and Strawn.

Is CalPERS trying to shift losses onto insurers?

But that argument didn’t convince Jury, who disqualified the Winston and Strawn firm in a huge blow to National Public Finance and Guarantee. Having to switch to new attorneys mid-stream in the case will likely weaken National’s legal defense until its new attorneys can get up to speed.

In the related pre-bankruptcy negotiations for the city of Detroit, Mich., National Public Finance and Guarantee and other insurers could be forced to take a loss — not bondholders, the city or its pension fund.  So in the high stakes chess game of the San Bernardino-Stockton bankruptcy cases in California, it may be the bond insurers that also will be forced to take a loss. Thus, weakening the bond insurers in the San Bernardino case came at a critical time when there is an apparent legal strategy by public pension funds to try to shift losses onto bond insurers.

Stockton was the first city to try to use a bankruptcy action to shift losses onto bondholders.  The Detroit case is the first to try to peg losses on bond insurance companies.

San Bernardino may be the first to try to knock out opposing legal counsel for bond insurers. But why?

Even if San Bernardino’s second largest creditor — Wells Fargo pension obligation bondholders — was forced to absorb a loss, doing so would only represent 15 percent of all debt owed by the city.  CalPERS is San Bernardino’s biggest “creditor,” reflecting 48 percent of all debt owed as of August 2012. Thus, there is a shift toward looking to bond insurers rather than only creditors to additionally absorb some of the losses.

In the Stockton bankruptcy case, a ruling is scheduled for July 2 on the matter of lawyers switching sides.

The biggest creditors to the City of San Bernardino are:

Selected Large Creditors — City of San Bernardino

Creditor	Amount
CalPERS – Unfunded Pension Costs	$143,334,524
Wells Fargo Bank Trust Services – Pension Obligation Bonds	$46,140,860
Kohl’s Corporate Offices – Revenue Sharing Contract in Sales Taxes – Redevelopment Project	$29,447,685
U.S. Bank – Certificates of Participation	$14,795,000
U.S. Bank – Certificates of Participation	$10,400,000
California Infrastructure Bank and Economic Development Bank – Street Construction Lease	$9,306,005
U.S. Bank – City Hall Lease Refunding Bonds	$8,055,000
Public Agency Retirement Services – Unfunded Pension Costs	$3,317,502
Total Owed All Creditors	$300,952,612
Source: City of San Bernardino – Chapter 9 List of Creditors as of Aug. 30, 2012