A federal bankruptcy judge dealt a serious blow to California's public employee pension systems by ruling Wednesday that payments for future worker retirements can be reduced when a city declares bankruptcy -- just like its other debts.
U.S. Bankruptcy Judge Christopher Klein ruled that bankruptcy law supersedes California pension laws that require cities to fund their workers' future retirement checks.
"I've concluded the pension could be adjusted,” Klein said.
But he stopped short of making a final decision on whether to accept Stockton's bankruptcy plan, which does not include cuts to pension payments. The next court date is scheduled for Oct. 30.
Klein can accept the city's plan to leave the pension payments intact or force the city to draw up a new plan that includes cuts.
"I need to reflect more carefully," Klein said.
The potentially groundbreaking decision came after a large creditor of Stockton, which filed for bankruptcy protection two years ago, asked the judge to reduce the amount the city owes to the California Public Employees’ Retirement System, the nation's largest public pension fund.
Until now, CalPERS had argued successfully in the bankruptcy cases of other California cities that amounts it requires for public worker pensions could not legally be reduced.
The city of Stockton argued in court against cutting the pension payments. It warned in court papers that failing to pay CalPERS would cause a “mass exodus” of employees and “irreparably damage” its ability to hire new ones.
The city also said it was not possible to leave CalPERS and create a less expensive retirement plan.
Stockton’s lawyers said the city already had a “staggeringly high crime rate,” and that the average tenure of its police officers had dropped to nine years from 14 years.
Michael Gearin, an attorney for CalPERS, downplayed the significance of Klein's comments. He said the agency does not believe the verbal ruling is setting a precedent.
“We disagree with his decision, but we don’t think it’s binding in the future,” Gearin said.
The agency said it is reserving further comment until Klein rules on the city's plan.
"What’s important to keep in mind is what the City of Stockton stated in court today: that they can’t function as a city if their pensions are impaired," CalPERS tweeted.
In its brief, creditor Franklin Templeton Investments argued that it's not fair for Stockton to pick and choose among creditors, “paying some in full and then pleading poverty as a justification for paying others virtually nothing.”
During trial, Stockton said it could not pay more than 1% of the $36 million it owes Franklin, according to court records.
“The City has now wasted millions of dollars attempting to cram down an unconfirmable plan,” the brief said. “The time has come for the City to abandon that foolish game, end its crusade, acknowledge its obligations under the Bankruptcy Code, and propose a realistic and reasonable plan of adjustment.”
Marc Levinson, a lawyer for Stockton, denied that the city was pushing a "cram-down" bankruptcy plan, and said it had tried hard to get all of its creditors on board. He said the city simply didn't have enough money to pay everyone.
"The city has gone to great lengths to cut costs," he said. "Those measures reduced city services to the bare minimum."
Jason Rios, an attorney representing a group of retired Stockton workers, argued in court Tuesday that the city tried hard to get all creditors on board with its proposed bankruptcy plan and that Klein should approve it.
“We don’t think Franklin should torpedo the city’s plan or the city’s effort to successfully emerge from bankruptcy,” he said.
City workers have suffered enough, Rios said.
"These are individuals who have dedicated their lives to the city ... with the reasonable expectation the city would honor its commitment," he said.
The U.S. bankruptcy code doesn’t contain special provisions giving priority to pensions -- nor does it require all creditors be treated the same.
Theresa Pulley Radwan, associate dean for administration business and law professor at Stetson University, says the code merely requires that bankruptcy plans be “fair and equitable” -- wording designed to provide maximum flexibility for the parties to work out a deal with which they can all live.
Bankruptcy law gives judges wide discretion, and often creditors’ arguments boil down to “how come they’re getting paid in full, and we’re not,” Radwan said.
Pensions have no specific protections under the code, but they do often get favorable treatment during bankruptcy negotiations, both for practical reasons -- they are usually a large, sometimes the biggest, creditor -- and for emotional ones.
“In stakeholders’ minds, there’s something emotionally challenging about modifying pension claims,” said Craig A. Barbarosh, a municipal bankruptcy specialist and partner at Katten Muchin Rosenman in Costa Mesa.