A federal judge handling the Stockton bankruptcy may be moving toward a landmark ruling that CalPERS pensions can be cut, possibly while allowing the city to exit bankruptcy in October without cutting its pensions.
U.S. Bankruptcy Judge Christopher Klein yesterday outlined an argument, a “summary from 50,000 feet,” for treating CalPERS pensions like other debt, then invited CalPERS, Stockton and other parties to respond with written briefs.
The judge said he wanted to share his “preliminary thoughts” to give the lawyers in the case a chance to “straighten me out before I make some dramatic boneheaded mistake” about a simple understanding of the law.
Klein emphasized at the end of his remarks that his view of the “jigsaw puzzle” of how state pension law fits with federal bankruptcy law is still tentative. “I could be persuaded of opposite propositions,” he said.
A federal judge ruled in the Detroit bankruptcy that public pensions can be cut in bankruptcy. But CalPERS has argued, among other things, that Detroit has a city-run plan and an “arm of the state” like CalPERS cannot be impaired in a federal bankruptcy.
Klein said the implication of his remarks is that he might conclude the CalPERS contract with Stockton is being rejected, and the $1.5 billion CalPERS would charge for terminating the contract is unenforceable.
“But that does not necessarily mean that this plan of adjustment (of debt to exit bankruptcy), which is proposed without any change to pensions, is necessarily not confirmable,” he said.
Stockton does not want to cut pensions, arguing they are needed to be competitive in the job market, particularly for police. Stockton voters approved a ¾-cent sales tax increase last November to add more police and other public safety measures.
After filing for bankruptcy in June 2012, Stockton reached agreements with three bond insurers, all city unions and other major creditors. But in closed-door mediation the city could not reach an agreement with two Franklin bond funds, triggering a rare trial.
The city exit plan would pay Franklin $135,000 for a $36 million bond debt. Klein yesterday put a value of $4 million on the loan collateral the city said was of little value to Franklin due to use restrictions and other problems: two golf courses and a park.
A Franklin attorney told the judge $4 million in cash would be acceptable, but two other options mentioned by the city would be an issue: payment over time or giving Franklin the property.
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.
Klein mentioned that when ruling Stockton was eligible for bankruptcy, despite opposition from two big bond insurers who later settled, he found that workers took a “de facto haircut” through employment reduction and collective bargaining.
The judge also made an important ruling in 2012 that retiree health care can be cut in bankruptcy, allowing a debt valued at $544 million by Stockton to be replaced with a one-time payment of $5.1 million.
Klein may have been addressing the CalPERS “arm of the state” argument when he said the big system has “two different pieces” to the puzzle: state workers and cities and other local governments that contract for pension services.
The local governments voluntarily contract with CalPERS, he said, even though under state retirement law they can form their own retirement system or contract with county retirement systems or private providers.
“It looks like a city could bow out of CalPERS without necessarily being thrown out of CalPERS,” he said, although that would be difficult.
Klein said he would like an explanation of two state laws that allow CalPERS to put a lien on the property of bankrupt cities and prevent bankrupt cities from rejecting their CalPERS contract.
He said a state law enacted in 1982 appears to be a response to a federal law in 1979, enacted in the wake of New York City’s financial crisis, that allowed more than bond debt to be cut in a municipal bankruptcy.
“All of a sudden all sorts of debt potentially could be discharged,” he said. “So it’s no surprise … this lien is created.”
Klein said the state lien law appears to conflict with federal bankruptcy in several ways. “As against that, it makes me wonder if this so-called lien is the kind of thing that could be enforced,” he said.
The judge said exhibits filed during the trial show that a 1996 state law preventing bankrupt local governments from rejecting CalPERS contracts, prompted by the Orange County bankruptcy in 1994, was intended to protect CalPERS from losses.
Under his reading of state law, said Klein, the employees are at risk of losses in a bankruptcy, not CalPERS. “So I’m kind of wondering who was pulling the wool over the eyes of the California Assembly and state Senate,” he said.
The judge said he would need a good explanation of what authority allows the California Legislature to revise the federal bankruptcy code. “My usual answer is none, unless specifically provided by the bankruptcy code,” he said.
In addition to urging CalPERS to respond, the judge said a “helpful” city brief would show why the Stockton exit plan should be confirmed despite “what I have been hearing about CalPERS and the inviolability of the CalPERS contract and the lien.”
A CalPERS statement issued after the hearing yesterday said: “In fulfillment to our fiduciary duty, CalPERS will continue to protect the benefits promised to our members.
“We welcome the opportunity to respond to the questions Judge Klein raised in court today, to discuss the implications of the California laws that govern pensions and that create a stable retirement system that provides significant value to cities and their employees.”
Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at Calpensions.com. Posted 9 Jul 14