Bankruptcy Judge in California Challenges Sanctity of Pensions
A
federal bankruptcy judge on Wednesday upended the widely held belief
that public workers’ pensions have a special status in California that
makes them impossible to cut, further chipping away at the idea that
pensions are sacrosanct in a municipal bankruptcy.
The ruling, which came
during a hearing on a plan by the City of Stockton to exit bankruptcy,
did not order the city to cut its pension plan or take any specific
action. The judge said that he needed more time to reflect on Stockton’s
situation and that he would decide Oct. 30 whether the city could
emerge from its two-year bankruptcy or whether it still had more work to
do.
But the decision, by
Judge Christopher M. Klein of the Eastern District of California, dealt a
blow to California’s giant state-led pension system, known as Calpers,
which has been leading efforts to preserve defined-benefit pensions
nationwide.
California City’s Return to Solvency, With Pension Problem Unsolved
Stockton has gone
through what Detroit faces and hopes to emerge from bankruptcy
protection in the spring. But its biggest problem, pension payments,
still looms.
It echoed a decision
made last year by Detroit’s bankruptcy judge, but went even further.
While Detroit’s pension system was a struggling local entity with few
friends in the state capital, Calpers is a powerful arm of the state,
with statutory powers that include liens allowing it to foreclose on the
assets of a city that fails to pay its pension bills.
Calpers had argued
that if Stockton stopped making payments and dropped out of the state
pension system, the lien would let it claim $1.6 billion of its assets.
But Judge Klein said those statutory powers were suspended once a
California city received federal bankruptcy protection.
“Why should I take
that lien seriously?” he asked a lawyer for Calpers, Michael Gearin. “I
may avoid it as a black-letter matter of bankruptcy law,” he said,
referring to well-established legal principles.
He did not dispute
that Stockton would be billed $1.6 billion to leave Calpers and said
such a termination fee “can be seen as a golden handcuff.” But in
bankruptcy, he said, Stockton could legally refuse to pay the bill
because it arose from the city’s contract with Calpers, and contracts
are broken routinely in bankruptcy.
“The bankruptcy code provides that the lien can be avoided and be treated as an unsecured claim,” Judge Klein said.
Judge Klein also said
that Stockton had many options other than Calpers for retirement
benefits: a private provider, like an insurance company; a multiemployer
pension plan affiliated with a union; one of California’s county-run
pension plans; or it could even offer no pensions at all.
“There are lots of
permutations and combinations out there with respect to the art of the
possible,” he said, adding that nothing in the law required any city to
give its business to Calpers. “The whole world is out there.”
Judge Klein’s ruling went beyond anything that Stockton was seeking.
In oral arguments on
Wednesday, Stockton’s lawyer, Marc A. Levinson, said that for Stockton
to switch to another retirement plan administered by a different entity
would probably take two years, and in the meantime all the city’s
workers were likely to quit. Their first choice would be to seek similar
jobs in cities that were still part of Calpers, he said, adding that he
thought Calpers was a more efficient plan administrator than any other
entity Stockton might try.
Mr. Levinson said
Stockton wanted to use its “business judgment” to keep its existing
relationship with Calpers, something bankruptcy law permits.
The issue of cutting
pensions was raised by a holdout creditor, Franklin Templeton
Investments, a mutual fund company that had previously bought about $36
million of Stockton’s debt. In mediation, the city had initially
proposed to settle the entire debt for less than a penny on the dollar,
but Franklin managed to improve its position somewhat by showing that
about $4 million of the debt was secured and had to be paid. That
helped, but the city was still offering less than a penny on the dollar
for the unsecured portion.
That left Franklin to
argue that Stockton’s exit strategy could not be approved by the court
because it unfairly discriminated among creditors because Calpers was
not going to lose a penny and Franklin would receive so little. A
bankruptcy plan of debt adjustment is supposed to treat similar
creditors more or less the same; it allows for some discrimination as
long as there is a reason for the different treatment. Stockton said its
treatment of Franklin Templeton constituted “fair discrimination.”
In court proceedings
in July, Judge Klein said it was not clear to him that Calpers was even a
creditor. He adjourned the hearings until the city and other parties
could brief him on Stockton’s relationship with Calpers.
Calpers responded by
saying it was part of “a triangular relationship,” in which the city,
its past and present workers and Calpers worked together, with some
interactions governed by contract but the most important activities
governed by statute.
But Judge Klein said
that he had been studying the state law that governs public retirement
benefits in California, which he said was “like a jigsaw puzzle.” Once
he put the pieces together, he said, he realized that what he saw in the
statute was different from what had been described to him.
Much of Judge Klein’s
analysis revolved around subtle federalist issues like whether an arm of
the state could still enforce the laws of that state once a city has
taken shelter in federal bankruptcy court. California’s public pension
law has a provision that anticipated these issues and specifically says
that the contract a city enters into with Calpers cannot be impaired, no
matter what other laws might say.
Judge Klein said
legislative history showed that California lawmakers were responding to
the increased possibility of a municipal bankruptcy that grew out of New
York City’s bankruptcy near miss in 1975.
He said that
California’s lawmakers had also enacted laws that specified exactly the
steps cities had to take to obtain authorization from the state to file
for federal bankruptcy protection. He said that when the legislature
enacted that law, it tacitly agreed that if the city earned the
authorization for bankruptcy, it would be governed by the federal
bankruptcy code.
“Those conditions are
the opening of the gate,” he said. “Once the city passes through the
gate, it’s what’s specified in the United States Bankruptcy Code.
Otherwise, you come to the conclusion that the California Legislature
can edit the federal law.”
In a statement,
Calpers said: “We disagree with the judge’s opinion on the issue of
pension impairment. This ruling is not legally binding on any of the
parties in the Stockton case or as precedent in any other bankruptcy
proceeding and is unnecessary to the decision on confirmation of the
city of Stockton’s plan of adjus
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