A legal showdown over pension obligations in municipal bankruptcies was averted in both Vallejo and Stockton, largely because officials in both cities chose not to make that fight.
No small factor was a rather heavy-handed threat by the California Public Employees’ Retirement System to wage high-octane legal war should either city seek to “impair” pension obligations. The bankruptcy judge in Stockton’s case implied that he was receptive to including pension obligations as a debt to be reduced under federal bankruptcy law despite their seemingly impregnable standing in the state constitution. And insurers of the city’s bonds took a stab at including them.
However, the issue was sidestepped when most of the bondholders and their insurers cut a deal with the city that excluded pensions.
San Bernardino is a different story.
It stopped making payments to CalPERS for a while, still owes $15 million in past-due payments, and indicated in its bankruptcy filing that it wants pension debts on the table. And the huge retirement fund did what it threatened to do in Stockton and Vallejo – wage legal war.
CalPERS tried, unsuccessfully, to persuade the judge hearing San Bernardino’s petition to block bankruptcy, but whether the case eventually hinges on pension obligations remains to be seen.
Meanwhile, a U.S. bankruptcy judge in Detroit ruled Tuesday that the city’s truly massive bankruptcy can include a pension reduction, saying, “It has long been understood that bankruptcy law entails the impairment of contracts.”
That’s almost word-for-word what the Stockton bankruptcy judge, Christopher Klein, had said during one proceeding.
The uncanny similarity of the Detroit case to those in California extends to the almost identical provisions in the California and Michigan state constitutions that prohibit “impairment of contracts.”
Michigan pension officials, and the state’s public employee unions, are just as adamantly opposed to having pension obligations on the table as those in California, and if Detroit’s bankruptcy culminates in a reduction of pensions, either retroactively or prospectively, the subsequent legal battle is destined for the U.S. Supreme Court.
The potential fallout is immense. If pensions can be reduced in bankruptcy, California cities, struggling with ever-increasing demands for pension fund payments, will use it as leverage to demand concessions from their unions.
Moreover, the unsettled situation could affect the outcome of a proposed 2014 or 2016 ballot measure sponsored by San Jose Mayor Chuck Reed, which would allow local officials to modify future pension benefits. If Reed gets his measure on the ballot, he could – and would – contend that doing something about mounting pension payments through that process would be better than leaving it to the complexities of bankruptcy.