Will Stockton get pension reform in bankruptcy?

July 10, 2014


Although the Detroit bankruptcy case gets the lion’s share of media attention, the bankruptcy proceedings in Stockton, California might have longer-term implications for muniland.

Detroit’s federal bankruptcy judge Stephen Rhodes quickly determined in his eligibility ruling that the city may reduce retiree pensions. But Stockton’s judge, Christopher Klein, has been making his way to a decision about the legality of cutting pensions for two years. Klein has set October 1 as the next date to possibly rule on the issue.

In Detroit there are essentially two parties involved in a reduction of pensions: the city and the retirees. Technically there are also service corporations, but in reality these are just legal shells to pass the city’s pensions payments through.

In Stockton there are three parties involved in the pension issue: the city, the retirees and a powerful state retirement system [CalPERS]. CalPERS has fought against a reduction of pensions in Chapter 9 bankruptcy proceedings in three California cities: Vallejo, Stockton and San Bernardino. CalPERS has even gone so far as to file an amicus brief for an appeal in the Detroit case.

Judge Klein has questioned whether CalPERS is even a creditor in the bankruptcy. The Bond Buyer reported:

Based on his interpretation of California public employee retirement Law, Klein said CalPERS itself could not be impaired, but employees’ pensions could be.

‘It looks to me like CalPERS does not bear the financial risk of a shortfall in payments,” he said. “Instead it’s on the employee.’

One point he brought up was the validity of the $1.5 billion termination fee that the California Public Employees’ Retirement System said it could impose on Stockton if it breaches its contract.

‘Everyone assumes this number is valid,’ Klein said. ‘I’m going to need some explanation why I should take that seriously.’

Klein’s idea that CalPERS is not a creditor could send shockwaves through California. Ed Mendel of Calpensions summed up the court proceedings:

The judge set a schedule for receiving briefs and responses before the next hearing Oct. 1. ‘Ideally, I would like to be able to make findings that conclude the matter,’ he said.

A decision to confirm the debt-cutting plan of adjustment, allowing Stockton to exit bankruptcy, would have to find that creditors are being treated fairly. The judge questioned whether the California Public Employees Retirement System is a creditor.

If a city pension plan is terminated and there is not enough money to cover obligations, Klein said, state law authorizes CalPERS to close the funding gap by cutting the pensions of workers and retirees.

‘It seems to me if you are going to take away part of an individual’s pension, the individual is the creditor and CalPERS is in effect a servicing agency,’ the judge said.

Relegating CalPERS to the status of “servicing agency” would remove much of the power the group has asserted in bankruptcy proceedings. Stockton officials have stated repeatedly that they don’t want to cut pensions because it would cause an exodus of employees from the struggling city. It’s possible that Judge Klein could rule that the city’s payments to retirees may be cut, but the city does nothing. This would open the door for other distressed California cities to review their options for going into Chapter 9 bankruptcy. A few might find the expense and effort worthwhile.

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