California cities may turn to bankruptcy courts to ease pension obligations after a judge ruled the California Public Employees’ Retirement System doesn’t deserve special protection, a decision that may reverberate across the country as municipalities struggle with their finances.
Bankrupt cities can cancel contracts with Calpers because federal law overrules state protections given the pension giant, U.S.Bankruptcy Judge Christopher Klein said yesterday in a hearing over the municipal bankruptcy of the city of Stockton. The judge will decide later this month how to apply his ruling to the city's reorganization plan, which protects Calpers.
Stockton’s bankruptcy pits public-pension advocates against Wall Street creditors, who stand to get pennies on the dollar for their bonds. The ruling would make it more attractive for California cities with unmanageable pensions to use bankruptcy law to cut debt, just as private companies do.
“It means a city can get control of its retiree liabilities and pension liabilities,” said Dale Ginter, a lawyer who represented retirees in the bankruptcy of Vallejo, California. “That’s huge.”
Bankruptcy lawyers and public-pension advocates nationwide have watched Stockton’s case to see whether Calpers would be given deference, or if the judge would side with another creditor, San Mateo, California-based money manager Franklin Resources Inc. Last year, a bankruptcy judge in Detroit sided with the city in ruling agaianst pension funds in a similar situation.
Stockton, a city of 298,000 about 80 miles (130 kilometers) east of San Francisco, filed for bankruptcy in 2012 after spending too much on downtown improvement projects and seeing its property-tax revenue plunge in the housing crisis. Creditors filed $1.18 billion in claims.
Its debt plan would protect Calpers, the $296 billion pension fund, from cuts while imposing steep reductions on Franklin. Under the proposal, Calpers would be fully repaid while two Franklin funds would get back only about 1 percent of the unsecured portion of the $36 million they’re owed.
Calpers argued that California cities should be legally bound to use all their assets to pay pension debt before ever reducing retirement benefits.
Klein disagreed. The state’s public employee retirement law “is simply invalid in face of the U.S. Constitution,” he said yesterday. Calpers contracts with cities can be canceled like other agreements that can be modified in federal court under the U.S. Bankruptcy Code, he said.
“We disagree with the judge’s opinion on the issue of pension impairment,” Brad Pacheco, a Calpers spokesman, said in an e-mail yesterday. He said the ruling wouldn’t be a precedent for any other bankruptcies.
“What’s important to keep in mind is what the city of Stockton stated in court today: that they can’t function as a city if their pensions are impaired,” Pacheco said.
Californians for Retirement Security, a coalition of school teachers, police officers and other public employees, decried the ruling.
“We are disappointed that the judge has sided with Wall Street in a decision that has the potential of devastating citizens, employees, and making bad situations worse,” said Dave Low, the group’s chairman.
Stockton designed its bankruptcy exit plan assuming that Calpers would hold a $1.5 billion lien secured by city assets if the pension contract was canceled. Without the lien, the bargaining position of Calpers in the case would have been severely weakened.
Klein said yesterday that the pension fund’s claims against a city in bankruptcy are unsecured and aren’t superior to debts including unsecured bonds.
“To the extent cities are saddled with unsustainable pension promises, they will have a stronger hand in negotiating with their unions to modify those promises,” Dan Pellissier, president of Sacramento-based California Pension Reform, said in a phone interview yesterday.
Only a handful of California cities or counties have ever filed for bankruptcy, which means there are few major precedents to guide municipal officials about what’s possible in Chapter 9. For that reason, Klein’s ruling is likely to be influential, Ginter said.
“Next time a city sits down with its employees saying ‘We’ve made promises we can’t keep,’ they will know that at the end those obligations can be modified in bankruptcy court,” said Pellissier, who served as a pensions adviser to former Governor Arnold Schwarzenegger, a Republican.
Franklin has attacked the bankruptcy plan as unfair because pensions aren’t being reduced, while investors are being forced to take less than they are owed. The company has long claimed that Calpers shouldn’t be given special treatment.
Even though the judge concluded that Stockton can cancel the Calpers contract, the city still has a chance to convince him the plan should be approved anyway. Klein has said previously that if he ruled against Calpers, he may still approve Stockton’s proposal.
He ended yesterday’s hearing saying he will rule at the end of the month on the plan, while encouraging Franklin and the city to try to settle their differences before he rules.
“It’s still open season for some kind of adjustment to be made,” he said.
The case is In re Stockton, 12-bk-32118, U.S. Bankruptcy Court, Eastern District of California (Sacramento).