SACRAMENTO — A federal bankruptcy judge dealt a 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.
In a ruling while considering the city of Stockton’s bankruptcy, Judge Christopher Klein said, “California public employee retirement law … is simply invalid in the face of the supremacy clause of the United States Constitution.”
“I’ve concluded the pension could be adjusted,” he added.
But the judge stopped short of making a final decision about whether to accept Stockton’s bankruptcy plan for repaying its debts, 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 require the city to draw up a new plan that could include cuts.
“I need to reflect more carefully,” the judge said.
The 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.
With more cities facing financial troubles, the ruling could have broad implications. It raises questions about whether cities that have filed for bankruptcy would be free to slash their pension contributions — and even use the money to repay other debts.
Stockton, hundreds of other municipal agencies and the state annually pay $8 billion to CalPERS to cover their workers’ retirements. Stockton owes the pension agency more than $15 million this year.
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 pension fund had argued that public worker pensions are protected by state law and outside the jurisdiction of bankruptcy courts.
Michael Gearin, an attorney for CalPERS, downplayed the significance of Klein’s oral ruling, saying the agency does not believe it sets a precedent.
“We disagree with his decision, but we don’t think it’s binding in the future,” Gearin said.
“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 said in a statement.
Stockton lawyers 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.
Stockton already has a “staggeringly high crime rate,” the lawyers said. The average tenure of its police officers had dropped to nine years from 14 years, they noted. The city’s lawyers also contended that it was not possible for Stockton to leave CalPERS and create a less-expensive retirement plan.
Wednesday’s ruling was prompted by a protest by Franklin Templeton Investments, which lent the city tens of millions of dollars in Stockton’s better days.
In court papers, Franklin 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.”
Although agreeing to pay CalPERS in full, Stockton has said in court that it could not pay more than 1% of the $32 million it owes Franklin.
“The city has now wasted millions of dollars attempting to cram down an unconfirmable plan,” Franklin’s lawyers argued in court papers. “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 that the city 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, said in court that the city’s employees had suffered enough. “These are individuals who have dedicated their lives to the city,” he said.
Legal experts said Klein’s ruling might help settle what had been an open question: whether a city’s worker pension obligations can be modified in bankruptcy.
Theresa J. Pulley Radwan, associate dean for administration business and a law professor at Stetson University in DeLand, Fla., said Klein’s decision could put public workers’ pensions more at risk during bankruptcies.
She said the ruling is not binding on other bankruptcy courts, but that those courts typically look to one another’s rulings in similar cases. “I would be surprised if other courts did not find the same thing,” she said.
Public union leaders criticized Klein’s oral ruling.
Dave Low, the chairman of Californians for Retirement Security, a coalition of state public employees, said the decision could hurt not only workers but also residents of cities across the state.
“We are disappointed,” he said, “that the judge has sided with Wall Street in a decision that has the potential of devastating citizens, employees and making bad situations worse.”
If cities are forced to break promises made to employees, Low said, “it will result in a mass exodus of police, firefighters and other public employees who will have no incentive to rebuild bankrupt cities.”
Times staff writers Dean Starkman and Joseph Serna contributed to this report.
Megerian reported from Sacramento and Petersen from Los Angeles.
Twitter: @chrismegerian @melodypetersen