Government pensions were once considered untouchable, ironclad, off limits even if the employer went bankrupt.
On Tuesday, a federal bankruptcy judge in Sacramento inched closer to changing all that. Commenting during a hearing on Stockton’s bankruptcy case, U.S. Bankruptcy Judge Christopher Klein suggested that employees and retirees could have their pensions reduced to facilitate the city’s financial reorganization.
“I might be persuaded that the pensions can be adjusted,” Klein said.
The judge stressed he hasn’t made a ruling yet, and said “I’ve been sharing with you my thinking.” Nonetheless, his remarks could have broad implications for public pensions and bankruptcy law in California and beyond.
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Klein acknowledged that Stockton’s retirees are facing “a haircut” if he rules that pensions can be reduced. His comments sparked concern from Steven Felderstein, a Sacramento lawyer representing Stockton retirees in the bankruptcy.
“It’s very troubling, but he does recognize that the retirees are the ones who are going to suffer,” Felderstein said.
In a prepared statement, CalPERS said it “will continue to protect the benefits promised to our members. We welcome the opportunity to respond to the questions Judge Klein raised in court (Tuesday), to discuss the implications of the California laws that govern pensions and that create a stable retirement system that provides significant value to cities and their employees.”
The dispute over pensions stems from Stockton’s plan to exit bankruptcy protection. The city reached agreement with most of its creditors last fall to restructure about $200 million in debts. Many creditors accepted around 50 cents on the dollar. But negotiations fell apart with Franklin Templeton Investments of San Mateo, and the city told the court it would give the firm barely a penny on the dollar on a $36 million debt.
Franklin went to war, launching a full-scale legal challenge to the city’s plan. At a trial last month, Franklin suggested that Stockton scale back its $29 million-a-year pension contribution to CalPERS.
CalPERS said that could not happen. The powerful California Public Employees’ Retirement System has long stood as a defender of government pensions in court, and said Stockton had to keep paying in full to remain in good standing.
Not paying in full, according to CalPERS and city officials, would lead to chaos. If Stockton defaulted on its obligations to CalPERS, pension benefits could be slashed by 60 percent, according to trial testimony last month. City officials say that would lead to a mass exodus of police, firefighters and other municipal employees, making the city essentially ungovernable.
City officials said it’s far from certain that the judge will force a cutback in pensions.
“He’s thinking about it; I don’t believe he’s made up his mind,” said one of the city’s bankruptcy lawyers, Marc Levinson.
Even if Klein does rule that pensions can be reduced, that doesn’t necessarily mean Stockton’s retirees will get hit. He could conceivably decide that the Stockton reorganization plan is fine even if it leaves pensions unaffected.
The legal turmoil over public pensions has been building for some time. Last fall, the judge overseeing Detroit’s bankruptcy said pensions could be scaled back to conserve money. CalPERS has argued that the Detroit case is irrelevant and California public pensions have broader legal protections.
In court Tuesday, the judge seemed to chip away at some of CalPERS’ defenses. For instance, CalPERS has said that it could place a lien on some of Stockton’s municipal assets to cover nonpayment of pension contributions. Klein indicated he doesn’t think CalPERS has that power.
“Why should I take that lien seriously?” he said.
The city did raise its offer to Franklin. The judge ruled Tuesday that Franklin’s collateral on its debt – a couple of golf courses and a city park – were worth $4 million. Levinson said the city would pay Franklin that amount in cash.
But that still amounts to a little more than 10 cents on the dollar, and it was uncertain if that would appease Franklin. The firm’s lawyer, James Johnston, referred a reporter to a company spokeswoman, who couldn’t be reached for comment.
A formal decision is months away; Klein scheduled a hearing on the pension issue for Oct. 1 in U.S. Bankruptcy Court in Sacramento.
In the meantime, CalPERS has been making peace with California’s other bankrupt city, San Bernardino, which had threatened to tackle the issue of pension costs. Last month the two sides reached an “interim agreement” that could stave off a separate legal battle over pensions in that city. No details have been released, but city attorneys have indicated that San Bernardino will repay CalPERS for overdue pension contributions.
After filing for bankruptcy protection in 2012, the city withheld payments from CalPERS for several months and still owes $13.5 million plus interest.