Bankruptcy Judge Permits Stockton to Reduce Pension Obligations

Bankruptcy Judge Christopher Klein rocked California’s Public Employees Retirement System (“CalPERS”) on October 1, 2014, verbally ruling that the City of Stockton may reduce pension payments in bankruptcy like its other debts. However, Judge Klein declined to issue a final ruling on Stockton’s bankruptcy plan, preferring to “reflect more carefully” until the parties’ next scheduled proceeding on October 30.

Stockton filed for bankruptcy two years ago, in large part due to the $200 million in bond debt it holds. Franklin Templeton Investments, one of Stockton’s bond creditors, protested the City’s plan to give its creditors a haircut while striving to make its annual $29 million pension payments to CalPERS in full. This clash precipitated Wednesday’s ruling.

Stockton’s plight parallels that of another municipality in Chapter 9 bankruptcy, the City of Detroit. Bankruptcy Judge Steven Rhodes issued a seismic ruling last fall, declaring that federal bankruptcy law trumped Michigan state law and permitted Detroit to reduce contractual pension obligations. Judge Klein evoked this same analysis in his verbal ruling, declaring that “California public employee retirement law… is simply invalid in the face of the supremacy clause of the United States Constitution.”

Judge Klein did not issue a written decision, nor did he address Stockton’s plan for reducing and repaying its debts. The City’s proposal does not currently include cuts to CalPERS payments. However, Judge Klein’s ruling permits Stockton to do so. Additionally, Wednesday’s ruling may signal the bankruptcy court’s inclination to require Stockton to draft a new plan that includes cuts to pensions.  We note that, as is currently playing out in Detroit, public sector bankruptcy disputes are often resolved through negotiation prior to a final ruling by the court.  We will provide an alert update when Judge Klein addresses these outstanding issues in the forthcoming weeks.

As it presently stands, the ruling is a game-changer for those public agencies that are currently grappling with severe fiscal difficulties and considering bankruptcy as a means of relief.

A special thanks to Eric Riss in preparation of this update.

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