A federal bankruptcy judge's decision that Stockton could toss out its contract with CalPERS, the state's giant pension fund, may lead to deep cuts in workers' and retirees' pensions, even though the city didn't ask for any cuts at all. It also could lead other cities to use the bankruptcy process to rewrite employee pensions over their workers' objections.
Whether those things happen, however, depends on a second decision that Chief Judge Christopher Klein of the U.S. Bankruptcy Court in Sacramento has not yet made. That's his decision whether to approve Stockton's plan, a choice he put off until the end of the month. If he gives the plan the green light, it would make his comments on the vulnerability of pensions all but moot.
Stockton, like most local governments in California, pays money into CalPERS every year for its pensions and retiree health benefits, and the fund writes checks to former workers for their pensions and retiree health benefits. If the city tried to end that relationship, its contract with CalPERS would still require it to cover the cost of all the benefits owed to its current retirees as well as the future pension benefits accrued by employees not yet retired. For Stockton, CalPERS estimated, the bill would be $1.6 billion.
California courts have long held that governments can't alter their pension plans unilaterally, except to create new plans for workers not yet hired. (Even the latter point may be subject to collective bargaining; witness the Los Angeles City Council's battle with the city's Employee Relations Board over the council's introduction of a new, lower pension tier in 2012.) The underlying legal principle is that federal and state constitutions explicitly bar governments from interfering with contracts, such as an employer's promise of pension benefits.
When a city goes into bankruptcy, however, all contracts are subject to being "impaired," in bankruptcy-speak. What hasn't been clear is whether cities had free rein to impair employee pensions. The most common view was that pension obligations were immune to municipal bankruptcy filings.
Stockton hadn't planned to test that view. It didn't ask the Bankruptcy Court to impair its contract with CalPERS or change its pension benefits in any way. It had separately cut its payroll and used collective bargaining to impose higher employee pension contributions and virtually eliminate retiree health benefits. Its main goal in the bankruptcy process was to slash its debts to bondholders and other creditors.
All but one of the creditors agreed to the city's proposal. The objection came from Franklin Templeton Investments, which holds $32.5 million in unsecured debt linked to the construction of city parks and public safety facilities. Franklin objected to being offered pennies on the dollar for its claim while other unsecured investors, including the pension plan, received far more.
Ruling from the bench this week, Klein said that Stockton could, in fact, impair its contract with CalPERS without facing a termination fee. That contract was just like any other, Klein held, dismissing the notion that pensions were somehow inviolate. Throwing out the CalPERS agreement would force the pension fund to get into line with the rest of the creditors and accept something less than the $1.6 billion needed to pay the benefits already accrued.
If all $1.6 billion of that debt were canceled, a Stockton official told the court, pensions would be cut 60%. It's worth noting here that CalPERS imposes cuts on a pro-rata basis, hitting retirees as well as people who are still working.
Just because Klein believes Stockton's contract with CalPERS could be impaired, there's no guarantee that it will be. In fact, legal experts say, if Klein accepts Stockton's plan, siding with the city over Franklin, then his comments from the bench this week are reduced to dicta -- nonbinding remarks that don't form the basis for a legal judgment. As such, other courts would be far less likely to use them as the basis for their own pension rulings.
The judge presiding over Detroit's bankruptcy has already reached a similar conclusion, but he was seen as an outlier until Klein's ruling. The other unusual thing about Klein's action is that CalPERS is a state agency, not an ordinary contractor. So his ruling is particularly important, unless he steps around it and approves Stockton's plan.