(Reuters) - A unit of insurer MBIA Inc challenged Stockton, Calif.'s eligibility for bankruptcy, saying the city's decision not to ask for concessions from the California Public Employees' Retirement System pension fund undermined its case.

The filing in bankruptcy court sets up a battle between creditors and the city which could determine whether Stockton is allowed court protection and could set precedent over whether and how cities, counties and the state can cut retirement benefits.

A federal judge must approve Stockton's eligibility for Chapter 9 protection before the city can reorganize its debts under court protection from creditors, and a primary criterion is whether the bankruptcy petition was filed in good faith.

“The city has not presented evidence that it negotiated with its creditors equitably and thus, in good faith,” National Public Finance Guarantee Corp wrote.

The company, which insured nearly $94 million of the city's revenue bonds, said Stockton had not negotiated at all with Calpers, and that its initial proposal to creditors, called 'the Ask,' showed a financial shortfall even after bond payments were cut. The insurer said that was due to retirement fund payments.

“The terms of the Ask itself are fatal to the City's argument for eligibility,” it wrote, adding that city officials with Calpers pensions benefited from the pension fund treatment.

“The protection of Calpers benefits for the Mayor, city council and other city employees is clearly not in good faith,” it said.

Bond insurer Assured Guaranty Ltd has also questioned Stockton's eligibility for bankruptcy in public statements and has until the end of the day on Thursday to file a motion with the court.

The case is In re: City of Stockton, California, debtor, U.S. Bankruptcy Court, Eastern District of California, No. 12-32118.

Special Reports /

Insurers Contest Stockton, Calif. Bankruptcy

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