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Stockton’s Chapter 9 Bankruptcy as it Relates to CalPERS Relationship

by on October 14, 2014

posted in Municipal Bankruptcy,

Municipalities facing apparently insurmountable financial obstacles have been keeping a close eye on the City of Stockton as it weaves its way through Chapter 9 bankruptcy.  On October 1, 2014, Bankruptcy Judge Christopher Klein made a ruling from the bench that changes the landscape of Chapter 9 bankruptcy as it relates to pension liabilities.  Specifically, Judge Klein addressed the constitutional question of whether federal bankruptcy law trumps California law which states that money owed to the state pension fund (CalPERS) must be paid.    Judge Klein ruled that it does.  However, the City of Stockton may terminate its contract with CalPERS, thereby allowing bankrupt municipalities to treat the CalPERS system like other debtors.

A Change in the Treatment of CalPERS

CalPERS had long argued successfully that California law provides extra protection for public pensions, allowing CalPERS to use special liens to force cities to pay for withdrawing from the system.  Here, if Stockton stopped making payments and dropped out of the state pension system, CalPERS argued that the lien would let it claim a $1.6 billion “termination fee.”

Judge Klein did not dispute that Stockton would be billed $1.6 billion to leave CalPERS, but stated that in bankruptcy, Stockton could legally refuse to pay the bill because it arose from the City’s contract with CalPERS, and contracts are broken routinely in bankruptcy.  He stated, “The bankruptcy code provides that the lien can be avoided and be treated as an unsecured claim.”

Negative Consequence on Municipalities

The practical effect of Judge Klein’s ruling is unclear.  If he ultimately accepts Stockton’s financial reorganization plan – a plan under which the City agreed to keep making its annual $29 million pension payments in order to retain its relationship with CalPERS – the impact of his ruling will not have such deviating implications. Judge Klein will rule on the City’s plan on Oct. 30, 2014.

If Stockton’s financial reorganization plan is not approved, there is no question that there will be negative consequences for the City:

  • If it doesn’t pay the pension fund in full, default would occur, and the City would either have to make a one-time payment of $1.6 billion to keep pensions whole, or let CalPERS slash benefits by 60 percent. The result would be a mass exodus of employees creating an enormous setback, including an inevitable increase in crime rate.
  • If the City is terminated from CalPERS, it will not be able to rejoin for at least three years.

We will continue to follow this issue and provide updates as new information emerges.

 

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tags: bankruptcy, CalPERS, retirement benefits,

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