By Richard Simon and Abby Sewell
Detroit's historic bankruptcy filing -- already thrown into turmoil by a Michigan court Friday -- has ignited a largely uncharted legal front in the closely watched battle between public employee unions and governments across the country struggling to meet costly pension obligations.
In Detroit, city pension funds sued Republican Gov. Rick Snyder and the city's emergency manager, saying they could not use bankruptcy to reduce the pensions of about 30,000 current and retired workers to help ease the city's $18-billion debt. They contended that the pensions were protected by the state constitution.
The uncertainties ahead came into focus Friday when a state judge ruled in favor of the pension fund suits, saying that the bankruptcy filing the day before had violated the Michigan Constitution. The governor lacks the power to "diminish or impair pension benefits," according to the ruling by Ingham County Circuit Judge Rosemarie Aquilina.
The state attorney general's office filed an emergency appeal with the Michigan Court of Appeals late Friday.
The first salvo in the legal battle has public employee unions and pension funds, including CalPERS, on edge.
"All bets are off in bankruptcy," said Jack Dean of the Orange County-based PensionTsunami.com. "That's why the unions are so panicked. And CalPERS is panicked. Because they don't know what's going to happen."
In Sacramento, Amy Norris, a spokeswoman for CalPERS, formally known as the California Public Employees' Retirement System, said Friday, "We will be watching what happens in Detroit." So are the cities of Stockton and San Bernardino, which have also filed for bankruptcy protection.
Detroit unions cheered the court ruling.
"There is too much at stake to play political games with the hard-earned retirement security of Detroit's public workers," said Lee Saunders, president of the American Federation of State, County and Municipal Employees.
The Detroit unions said the city had failed to negotiate in good faith. And while pension fund officials contend the state constitution protects pensions, others argue that federal bankruptcy law trumps state law.
In addition, current and retired public employees could find themselves competing with municipal bondholders for payment.
"Bondholders have been pretty immune until now," said Richard Lehmann, president of Income Securities Advisors, a bond advisory and research firm in Miami Lakes, Fla. "The question here is what prevails -- the guarantee to bondholders or the guarantee to pensioners."
The Detroit battle comes after a number of governors have gone to war with unions to limit public employees' collective bargaining rights or to require government workers to pay more for healthcare and pensions to ease state fiscal woes.
In fiscal 2010, the gap nationwide between states' assets and their obligations for public-sector retirement benefits was $1.38 trillion, up nearly 9% from 2009, according to the most recent figures available from the Pew Charitable Trusts. Of that, $757 billion was for pension promises, and $627 billion was for retiree healthcare.
In Detroit the underfunded pension liability has been estimated to be $3.5 billion.
Experts say the Detroit battle could ultimately reach the U.S. Supreme Court.
"Detroit could be a step in destroying public pensions, though the law says you can't cut benefits," said John Logan, director of the labor studies program at San Francisco State University. "If they a find a way around that, it opens Pandora's box, and the battle on whether to dump bank loans or dump pensions may go all the way to the Supreme Court."
In California, CalPERS contends that its retirement system is "an arm of the state ... different than other creditors."
Still, CalPERS chief counsel Peter Mixon expressed concern in a recent interview that municipalities could "seize on a 'bankruptcy solution' if they felt like the state laws ... could be avoided."
Stockton has continued making its payments to CalPERS since filing for bankruptcy protection in June 2012, despite the objections of bond investors who argued that the city should have sought concessions from the pension fund beforehand.
San Bernardino stopped paying into CalPERS after it filed for bankruptcy protection in August, faced by a $46-million general fund deficit. The city started making its payments again this month, but still owes $14.2 million from last year, according to Norris. It remains unclear what the ultimate impact on the city's retirees will be.
Public employee pension funds have argued that cities should not be allowed to treat their pensioners like other creditors while in bankruptcy.
The courts have yet to decide the issue. San Bernardino is still trying to make its argument to the court that it is eligible for bankruptcy. In Stockton, the question of pensions will probably become a key piece of the proceedings as the city moves forward with its plan in September.
"Truth be told, we know nothing," said Karol Denniston, a San Francisco-based attorney who specializes in municipal bankruptcy. "We know that under bankruptcy code there's an ability to impair creditors, but whether or not that extends to pension obligations -- there is no answer."
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