Bankruptcy Judge Hammers Unions by Allowing Stockton Pension Cut

Bankruptcy Judge Hammers Unions by Allowing Stockton Pension Cut

In what will be a devastating blow to California public employee unions, U.S. Bankruptcy Judge Christopher Klein ruled in the Chapter 9 municipal bankruptcy of the City of Stockton that pensions managed by the California Public Employee Retirement System, known as CalPERS, can be cut in bankruptcy “like any other garden variety” unsecured debt. He rejected the unions’ argument that the world’s largest pension fund is an “arm of the state” and that public employee pensions are protected by federal and state laws.

Stockton city employees and city council members, who are all CalPERS pension beneficiaries, received retirement benefit enhancements shortly before filing for bankruptcy that many observers are calling pension spikes. The city’s position against cutting any CalPERS pension enhanced benefits is that the city will not be a competitive employer in retaining or hiring quality police and fire employees.

The city had reached what some are calling a crony deal with three bond insurers owed $265 million and all the labor unions, retirees, and other major creditors that would have retained the city pension enhancements. But the key to the deal was paying two Franklin municipal bond funds owed $36 million only about $350,000. 

Franklin sued, and Judge Klein held a trial in May on the Stockton “plan of adjustment” to cut debt and emerge from the city’s two year bankruptcy. Franklin argued that an exit plan that provides full payment of the city’s “massive” pension liability, while paying Franklin a penny on the dollar, cannot be confirmed under the federal bankruptcy code requiring fair treatment of creditors.

Judge Klein called the issue of the legal right to cut the amount of CalPERS pensions in bankruptcy a “festering sore.” 

Klein made his CalPERS ruling after trial and the submission of extensive written briefings from both sides which he requested at the May trial. His lengthy oral ruling, covering the disputed legal points in detail, may be followed by a written decision.

“We have a plan that proposes not to adjust pensions,” Klein said. “I have concluded that pensions could be adjusted, at least the CalPERS contract could be adjusted, and by inference the pensions could be adjusted,” according to Calpensions.

A federal judge ruled in the City of Detroit bankruptcy last fall that pensions can be cut. CalPERS is supporting an appeal of the decision, arguing that Detroit has a city-run plan and that CalPERS is an arm of the state whose operations are protected under federal bankruptcy law, according to an article by the New York Times.

“We disagree with the judge’s opinion on the issue of pension impairment,” CalPERS said in a news release reported by Bloomberg. “This ruling is not legally binding on any of the parties in the Stockton case or as precedent in any other bankruptcy proceeding and is unnecessary to the decision on confirmation of the City of Stockton’s plan of adjustment. CalPERS will reserve any further comment until such time as the court renders its final written decision. What’s important to keep in mind is what the City of Stockton stated in court today: that they can’t function as a city if their pensions are impaired.”

Matthew Jacobs, CalPERS general counsel, said, “The city [Stockton] has made a choice to protect pensions for its public employees and find a reasonable path forward to a more fiscally sustainable future. This is the right decision. While we disagree with today’s ruling on pensions, we are hopeful that Judge Klein will approve Stockton’s plan. Providing great services to a city requires great employees, and Stockton said today in court that it can’t function as a city if pensions are impaired.”

Judge Klein ruling states that CalPERS pensions are not California “governmental or political powers” protected under federal bankruptcy law, because unlike state workers who are automatically enrolled in CalPERS by statute, cities can choose to join CalPERS, their county pension plan, or manage their own pensions. Therefore, the City of Stockton benefits are not protected by the federal bankruptcy law, but instead are unprotected “business powers.” 

Judge Klein said CalPERS-sponsored state laws that prevent cities from rejecting their CalPERS contracts in bankruptcy are “flat-out invalid” under the constitutional “supremacy clause” that gives federal law priority over state law in the federal bankruptcy process. Judge Klein also said that CalPERS-sponsored state law that tried to give CalPERS a lien on all city assets, except wages, when they declare insolvency is an invalid attempt by the state Legislature to “edit” the federal bankruptcy law.

Stockton argued that union employees and retirees should only be liable for their share of the bankruptcy by taking pay cuts, workforce reductions, and the eliminating a $545 million obligation for the city to pay for a retroactively approved retiree health care plan.

Judge Klein’s federal bankruptcy ruling that public employee pensions for California cities, counties, and agencies are unsecured claims is a devastating blow to the power of California unions. From now on, public employee unions and their members will be financially at risk for the burden of the wages and benefits they negotiate for. 

Chriss Street suggests that if you are interested in the risk of California insolvency please click on: California May Face Similar Utility Crisis that Caused Gray Davis Recall


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