As federal bankruptcy judges deal with the insolvencies of two medium-size California cities, Stockton and San Bernardino, and the huge fiscal collapse of Detroit, they are confronting an issue with almost incalculable impacts – whether public employee pensions are ordinary debts or enjoy special protections.
Stockton excluded pensions from the list of debts it wants to reduce, leaving bondholders and their insurers as the city’s targets for financial haircuts as it writes a plan to put its finances back in the black.
The bond creditors opposed the city’s bankruptcy petition because it excluded pensions as debts to be reduced and won support from the California Public Employees’ Retirement System.
The judge handling Stockton’s case, Christopher Klein, overruled the creditors’ claims, but has indicated that the city may still be compelled to include pensions.
The dynamics of San Bernardino’s case are exactly opposite. That city wants to reduce its pension obligations in bankruptcy, and CalPERS opposed its bankruptcy petition for that reason, arguing, as it did in Stockton’s case, that pensions have special legal protections.
However, the San Bernardino case’s judge, Meredith Jury, rejected CalPERS’ position, declaring that the city could proceed with a “term sheet” outlining its plan to regain solvency.
While awaiting further court action, both cases are also in mediation aimed at achieving compromises, but mediation in Stockton’s case reportedly is stalled while it hasn’t begun yet in San Bernardino’s.
The San Bernardino situation is complicated further by looming changes in the makeup of its City Council. Three members are up for re-election, and two others are targets of recall campaigns.
Were the council to change dramatically, it could reverse its position on the exposure of pensions to bankruptcy. But should that occur, it could then face flak from bondholders.
Barring negotiated settlements, both cases will wind up in confrontational proceedings with the status of city pensions the chief issue. Both judges would have to decide whether, despite their seemingly strong protections in state law, pensions would be on the chopping block. And no matter what they declare, the cases would probably climb the judicial ladder, possibly to the U.S. Supreme Court.
And then there’s Detroit, where pension obligations also loom as the major issue. There, as well as in California, pension fund managers are claiming special protections under the state constitution and contend that federal bankruptcy law must respect those protections.
This is clearly an unexplored legal frontier. But if the final outcome is to expose pensions to modification via bankruptcy, the impacts would be broad and very heavy throughout the nation.