Calpers and the Constitution: a looming confrontation?

November 28, 2012

On its face, the brief filed late Tuesday night by the California Public Employees’ Retirement System in the municipal bankruptcy of San Bernardino isn’t especially provocative. As Reuters was the first to report, Calpers wants U.S. Bankruptcy Judge Meredith Jury of Riverside to lift the automatic stay on litigation against San Bernardino, which filed for Chapter 9 protection in August, facing a gaping $46 million deficit. San Bernardino stopped making monthly payments to Calpers after it entered Chapter 9, and its debt to the pension fund now tops $5 million. Calpers’ lawyers at K&L Gates argued in Tuesday’s brief that under California’s pension and labor laws, as well as the federal bankruptcy code, San Bernardino must make good on its obligations and pay the money it owes the pension fund. Those pension contributions, Calpers argued, are part of employee compensation, which is entitled to priority in federal bankruptcy. If San Bernardino won’t pay, the brief said, the pension fund must be permitted to bring an enforcement action.

You won’t find any sweeping pronouncements of Calpers’ priority over San Bernardino’s other creditors in Tuesday’s brief. There’s not even any mention of the city’s proposed plan to resolve its deficit, which waspassed Tuesday by the city council and calls for the city to continue to defer payments to Calpers. It’s certainly possible that when Jury hears Calpers’ motion to lift the stay in December, she’ll treat it as a routine matter of Chapter 9 housekeeping.

But I don’t think that’s going to happen.

Calpers didn’t file Tuesday’s motion in a vacuum. The pension fund is the biggest creditor not just in San Bernardino’s municipal bankruptcy but also in Stockton’s; San Bernardino’s unfunded pension obligation is about $143 million and Stockton’s is about $245 million. In the Stockton case, which predates San Bernardino’s Chapter 9, Calpers has aggressively asserted its rights as a creditor. In response to complaints from bond insurers about Stockton’s failure to negotiate any reduction in payments to Calpers, the pension fund said that it has priority over all other creditors and that the pension rights of public employees are protected by California’s constitution. The bond insurers Assured Guaranty and National Public Finance Guarantee (an arm of MBIA) filed formal objections to Stockton’s eligibility for Chapter 9 protection, challenging Calpers’ claim of priority and hinting at a collision between the Supremacy Clause of the U.S. Constitution, which holds that federal law trumps state statutes, and the California state constitution’s pension protections. (I’ve previously written about the federalism issue in the Stockton Chapter 9, which hinges on the intersection between 10th Amendment limits on federal judges overseeing municipal bankruptcies and the simultaneous requirement that cities show they’re entitled to federal bankruptcy protection.)

The federalism issue has been pushed aside for now in the Stockton Chapter 9, as Calpers, the bond insurers and the city engage in mediation over Stockton’s deficit reduction plan. A hearing on the bond insurers’ challenge to Stockton’s eligibility for bankruptcy protection isn’t scheduled until March.

Calpers’ motion in the San Bernardino Chapter 9 is on a much faster track. So if bond insurers want to test the strength of Calpers’ power under the California constitution, they may well raise their Supremacy Clause arguments in responses due on Dec. 7. I believe the bond insurers are eager for the federalism fight; in the Stockton case, U.S. Bankruptcy Judge Christopher Klein of Sacramento has already ruled once that the whole purpose of federal bankruptcy is to permit debtors to sidestep contractual obligations and that “the Supremacy Clause trumps the similar contracts clause in the California state constitution.” Klein wasn’t ruling on Stockton’s obligations to Calpers, but his reasoning bodes well for creditors who believe the pension fund’s reliance on the state constitution is misplaced.

Calpers also engaged in some muscle-flexing in the San Bernardino motion that must have irritated the bond insurers. The fund cited its “police powers” as an instrument of the state of California and asserted that it’s not even obliged to ask the court to lift the stay on litigation. It said it was only filing the motion “out of an abundance of caution.” Calpers held out the prospect of terminating its relationship with San Bernardino, which would leave the city $319.5 million in the hole. And the pension fund also in c luded several references to its powers under the California constitution. Though the motion addresses only San Bernardino’s missed payments and not the city’s long-term plan to pay its debt to Calpers, the brief can be read as bait by someone who is looking for a fight.

Calpers counsel at K&L Gates declined to comment. A Calpers representative told Reuters, “This legal action would allow us to collect the employer contributions from San Bernardino which are required by state law, to maintain the integrity of the San Bernardino pension plan for its public employees and retirees and to avoid needless procedural disputes and additional legal costs.” National Public Finance is represented in both the Stockton and San Bernardino Chapter 9 cases by Winston & Strawn, which declined to comment. The bond insurer Ambac is represented in the San Bernardino bankruptcy by Arent Fox, which didn’t respond to a phone message.

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