Stockton Bankruptcy Judge Rules against Pensions

by | October 2, 2014

A federal judge has ruled that California cities may alter pensions in bankruptcy – a move that none of the state’s three cities to enter Chapter 9 protection have attempted.

The ruling came as the judge presiding over Stockton’s bankruptcy trial delayed making a decision in that case about whether the city’s exit plan is acceptable. That plan does not include cuts to pension payments and includes settlements with every major creditor except Franklin Templeton Investments. Stockton is proposing paying 1 percent of the $36 million it owes the company while Franklin is asking the judge to reduce the amount the city owes to the California Public Employees' Retirement System (CalPERS), the nation's largest public pension fund.

Judge Christopher Klein’s ruling on Wednesday is potentially groundbreaking. Until now, CalPERS had argued successfully in the bankruptcy cases of other California cities that the amounts it requires for public worker pensions could not legally be reduced. As a potential window into his thinking, many of his questions for Stockton revolved around what it would mean for the city to exit CalPERS. At one point he noted that the so-called $1.6B exit fee to leave the pension system could be avoided in a Chapter 9 case.

“It's still open season for some kind of adjustment,” he said before concluding court.

The city argued it was not possible to leave CalPERS and create a less expensive retirement plan. Additionally, city lawmakers have said that current and past city workers had given up enough when Stockton decided to stop subsidizing retiree and current employee’s healthcare. That cut, worth $23,000 per the average employee, amounted to anywhere from a third to a 50 percent cut in total retirement benefits for most retirees, said Councilmember Kathy Miller. “It was a moral decision and a business decision,” she told Governing during an interview last month.

Stockton's lawyers also said Wednesday in court 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. In court papers, the city warned that failing to pay CalPERS would cause a "mass exodus" of employees and "irreparably damage" its ability to hire new ones. But Franklin has argued the city’s plan is unbalanced because it pays some creditors back all their money, pays others much less and keeps retiree pensions intact. "The City has now wasted millions of dollars attempting to cram down an unconfirmable plan," a pre-hearing 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."

But Stockton’s attorney, Mark Levinson, implied Wednesday that Franklin had been resistant to any offers of a deal. “There is no settlement to be had,” he said, even though “we know how to make deals.”

Stockton, which filed for bankruptcy in 2012, is one of three cities in California have entered Chapter 9 protection since the 2008 recession. Vallejo filed in 2008 and exited three years later without altering pension while making some cuts to retiree healthcare. It still struggles with balancing its budget. San Bernardino entered bankruptcy about a month after Stockton did in 2012. Its case is still pending and while it has reportedly reaching a settlement regarding its pensions, the ruling in Stockton’s case could impact how that judge rules on the Southern California city’s plan.

Still, there’s a reason three cities have avoided altering pensions thus far. Although pensions have no specific protections under the code, they ususally get favorable treatment during bankruptcy negotiations for practical reasons – they are often 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.

The Los Angeles Times and the Stockton Record contributed to this report.