Bankruptcy judge explains pension cut hurdles

A federal judge, who earlier ruled CalPERS pension contracts can be overturned in bankruptcy, yesterday outlined the difficulty of cutting pensions while approving Stockton’s plan to exit bankruptcy with pensions intact.

U.S. Bankruptcy Judge Christopher Klein issued a ruling on Oct.1 that CalPERS pensions, despite attempted safeguards in state law, can be cut in a municipal bankruptcy much like any other debt.

“Nobody should think that Chapter 9 (municipal bankruptcy) is an easy or inexpensive process,” Klein said yesterday, one of several remarks aimed at any thought that bankruptcy might be a painless way out of financial problems.

Judge Klein said some press reports of his earlier ruling did not pick up the “triangular arrangement” of the Stockton pension contracts, which was described in briefs submitted by the retiree committee and other parties.

“We have a triangle of bilateral relations in the law,” he said.

The contract between the city and its employees for pay and pensions is “the basic pension contract.” A second contract is between the city and CalPERS, which is the one the judge ruled can be rejected.

Another leg of the triangle is the relationship between CalPERS and the city employees, who are “third-party beneficiaries” under the law with rights enforceable as contracts.

To cut pensions, said the judge, the city would have to reject its contract with CalPERS and “more importantly” its contract with employees. Pensions are part of total pay, and while in bankruptcy Stockton negotiated contracts with unions.

Klein said employees agreed to pay cuts during the negotiations with the understanding that pensions would not be cut. He said all of the concessions were “made on the direct income side not the pension side.”

So to cut pensions, the city would have to reject a collective bargaining agreement. A U.S. Supreme Court decision (Bildisco 1984) set a higher standard for rejecting a collective bargaining agreement.

The judge said Congress responded by setting a higher standard than Bildisco for rejecting a collective bargaining agreement in business bankruptcies (Chapter 11), which so far is not applicable to municipal bankruptcies.

He said rejecting a “garden variety” contract is a low-level hurdle, rejecting a collective bargaining agreement under Bildisco is a higher hurdle, and rejecting a bargaining agreement in a business bankruptcy is an even higher hurdle.

“So it would be no simple task to go back and redo the pensions,” said Klein. In the case of Stockton, the package of pay concessions would have to be reopened, which “as a practical matter would be difficult to do.”

The judge did not directly discuss an issue he has mentioned in the past: Whether the Stockton restructuring and debt-cutting plan will keep the city out of the red and avoid a second bankruptcy.

A credit-rating agency, Moody’s, said last February that Stockton and San Bernardino, another bankrupt city, are at risk of returning to insolvency if they do not get relief from rising pension costs.

Some points of the Stockton plan mentioned by the judge: Voter approval of a ¾-cent sales tax, pay cuts that result in lower pensions, the elimination of retiree health care and removing debt payments from the deficit-ridden general fund.

“This plan, I am persuaded, is the best that can be done in terms of the restructuring and adjustment of debts of the city of Stockton,” Klein said.

Agreements with creditors approved by Stockton City Council last April

Agreements with creditors approved by Stockton City Council last April

Stockton does not want to cut pensions, arguing they are needed to be competitive in the job market, particularly for police. City officials warned that a pension cut would cause a “mass exodus” of employees.

But a lone holdout creditor, two Franklin bond funds owed $36 million, raised the pension issue by arguing that the Stockton exit plan gave Franklin a penny on the dollar while making no cut in the city’s largest debt, pensions.

A federal judge in the Detroit bankruptcy ruled last fall that pensions can be cut in bankruptcy. CalPERS joined in an appeal of the ruling, arguing among other things that it operates as an “arm of the state” and is protected in municipal bankruptcies.

Klein said his Oct. 1 ruling “undermines what heretofore had been assumed to be an important assurance of pensions.” The ruling is not a binding precedent, but it will be read by other judges and, some think, may give cities bargaining leverage with unions.

Klein ruled that two CalPERS-sponsored state laws are invalid in a federal bankruptcy. One prevents a city from rejecting a CalPERS contract in bankruptcy. The other places a CalPERS lien on all assets, except wages, when a city declares insolvency.

When a city contract with CalPERS is terminated, the big retirement system imposes a fee, based on a low earnings forecast, that is large enough to cover all of the future pension obligations.

The termination fee for Stockton is $1.6 billion, large enough to make leaving CalPERS financially difficult if not impossible. Klein suggested that the termination fee could be adjusted in bankruptcy, much like any other debt.

Although some have said CalPERS is Stockton’s largest creditor, the judge said CalPERS is only owed the cost of administering the pensions. The pension debt is owed to employees and retirees.

“They are, as I have said on several occasions, the real victims of any (debt) adjustments,” he said.

The CalPERS general counsel, Matthew Jacobs, told reporters the approval of Stockton’s plan that leaves pensions intact makes the earlier ruling “less significant.” He said CalPERS is looking at its options, including the possibility of an appeal.

Klein said the city’s debt-cutting “plan of adjustment,” approved yesterday, pays 12 percent of the Franklin debt, not a penny on the dollar. He said the plan pays Franklin $4 million for its collateral, two golf courses and a park.

Franklin objected to being placed in the same class of creditors as retirees, who voted to accept a $5 million lump sum for a long-term retiree health care debt of $545 million. The big retiree vote approved a similar debt cut for all creditors in the class.

“Obviously, we are disappointed by your ruling,” James Johnston, a Franklin attorney, told the judge after the Stockton plan was confirmed. “We will evaluate our next steps.”

Johnston said Franklin does not think the city has met the requirement for fully disclosing bankruptcy fees. Last June the city reported $13.9 million in fees, including $10.4 million to the law firm of Orrick, Herrington and Sutcliffe.

Marc Levinson, an Orrick attorney for Stockton, told reporters the city hopes to be out of bankruptcy by the end of the year. Stockton filed for bankruptcy on June 28, 2012.

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 31 Oct 14

17 Responses to “Bankruptcy judge explains pension cut hurdles”

  1. Bring Back the WPA Says:

    Good grief Franklin just take the loss and move on. You guys make $8 bil a year in revenue of which $2.1 bil a year is profit. A $36 mil loss is a drop in the bucket. Just record the loss on your next 10-Q and be done with it.

  2. SDouglas47 Says:

    As I understand, most creditors other than Franklin got a much better deal from the beginning. I never heard any explanation why.

    Until I hear otherwise, I can only assume Franklin was originally trying to play hardball and the city called their bluff.

    Does anyone know?

  3. SeeSaw Says:

    Whatever happened to the fans of Judge Klein? Have they gone into seclusion to nurse their grief?

  4. Fred Says:

    The City of Stockton made deals with every single creditor, including ALL other bond holders, with the exception of Franklin, that is true. Most of these deals were made during the pre-bankruptcy AB506 process, but a few were made after. Franklin never made any deal, I think one can draw their own conclusion from that.

    It is my belief that for Franklin, their fight, whatever you believe personally, was more about getting a favorable decision regarding CALPERS, no matter what. The amount of money owed on their bonds was quite small compared to the others.

    They certainly decided to play hardball, rolled the dice, and it did not work out the way they wanted.

    The judge pointed out in yesterdays court proceeding to Franklin, had they made a deal earlier, could have been a part of a contingent fund the city is making specifically for bond holder debt repayment, but they themselves chose not to.

    He also stated that two assertions continually raised throughout this trial by Franklin were factually untrue. One being that they were only going to get one penny on each dollar they loaned (It’s actually .12) And two, that CALPERS is NOT a creditor to the city, but that the affected employees are.

    Franklin stood to gain more out of this had they reached an agreement with city earlier, quite possibly full repayment on their bond over time, but as I said, they decided they had more to gain by forcing a trial.

  5. SDouglas47 Says:

    “I think one can draw their own conclusion from that.”

    Thanks, Fred. I’m still not clear. It sounds as if you’re saying Franklin was willing to risk a bigger loss, IF it meant they could force CalPERS to take a haircut. Almost sounds like a political vendetta.

    I’ll confess, I did suspect that, but I thought I might be paranoid. There ARE people out there for whom $36 million plus legal costs would be considered a reasonable cost to “bust the unions”.

  6. SeeSaw Says:

    And here, most thought Franklin was trying to protect its investors!

  7. Fred Says:

    My guess is that Franklin thought they would recover more by going to trial than by making any kind of deal with the city prior, and further by forcing a cut to CALPERS. But again, the Judge pointed out that CALPERS is only a creditor insofar as their costs to administer the retirement plan for city employees, which isn’t much compared to the employees and retirees. (Of which I am one, which I stated several months ago in another post).

    But clearly, the Franklin lawyers argued a scorched earth policy towards all current and retired city employees and damn the consequences. For them to make the statement that they wanted to, “Partner with the city to help solve the problem” was a load of BS, in my opinion. And I think the Judge saw it that way as well.

    I’ve read too many newspaper accounts (And many posts on this board) where people have made continual claims about how it was specifically the employees pensions that got Stockton into this mess. While that was certainly a contributing factor, it in no way tells the real story of how city leaders acted like idiots and spent money on many, many ridiculous projects in the city.

    Something that most, if not all articles I’ve read gloss over very briefly and in no detail whatsoever how much city employees and retirees gave up before and during this bankruptcy. Retiree medical until Medicare eligibility-Gone. Current medical for city workers-A joke. The most senior employees took the largest cuts in pay, my own over 25%. My future pension also reduced substantially as well. No city employee has received any COLA to my knowledge since 2007-08. I could go on but the point is that the city employees gave back, plenty. Any further impairment was no longer a haircut, it was decapitation. Which by some of what I read on here would make some of these people very happy. Judge Klein recognized this and straight up told Franklin that they were wrong, and that most of their argument was wrong as well.

    Franklin is insured against the loss on their bonds, something else the Judge pointed out yesterday.

  8. SDouglas47 Says:

    Thanks, Fred.

    “I’ve read too many newspaper accounts (And many posts on this board) where people have made continual claims about how it was specifically the employees pensions that got Stockton into this mess.”

    And you no doubt will read more accounts that, whatever “haircuts” you took, it wasn’t enough.

    That’s why I wondered about Franklin. There investment was relatively small, they could risk a loss to set an example to impair pensions.

    Lily Tomlin said: No matter how cynical you are, it’s not enough.

  9. SDouglas47 Says:

    Fred:

    ” My future pension also reduced substantially as well. No city employee has received any COLA to my knowledge since 2007-08.”

    Same here. If “reducing pensions” is the goal, and SB400 is the culprit in raising pension costs, I have written several times that SB400 increased my pension by about 3%.

    If, instead of passing SB400 in 1999, the legislature had passed automatic COLA increases, my pension would have increased by more than 10%. That’s a 7% savings for CalPERS.

    You’re welcome.

    Best of luck in the next few years of Stockton finances. There are a LOT of peoples hoping you will fail.

  10. Mike Says:

    It is really, really sad when people are so distraught because they have reduced income(join humanity. There are ups and downs) and still have health care , understood at higher cost. That is why we give all of our charity to causes for 3rd world countries, where people have to walk to get water. So many Americans should be ashamed of themselves, and the world has lost respect for us because of our self absorption. Hey USA, Oink.

  11. SDouglas47 Says:

    Who is distraught, Mike?

  12. Mike Says:

    Have a good week as aiding the truly needy. It nourishes the spirit.

  13. SeeSaw Says:

    Mike, you are trying to make this issue into a subject that it is not. Pensioners are ordinary people who care about and help the needy. There is no requirement that if something legally and fairly earned is taken away, the “would-have-been” recipients should take it and shut up because, after all, other people have less.

  14. Mike Says:

    Who brought up pensioners? America needs a wake-up call.

  15. SeeSaw Says:

    Oh, sure. You were just talking to Joe Blow walking down the street.

  16. SDouglas47 Says:

    Ed Mendel did. That’s what the article is about.

    World peace and brotherhood is on the Miss America Blog.

  17. Berryessa Chillin' Says:

    I hope that this bankruptcy plan works for Stockton in the years ahead. Earlier Judge Klein had mentioned that he wasn’t inclined to approve a plan that would have Stockton back into bankruptcy in a few years. Since I don’t know Stockton’s numbers, I’m assuming that this revised plan works. Good for Stockton!

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