The bankrupt city of Stockton may avoid a constitutional confrontation over the legality of imposed pension cuts as a way to resolve its insolvency. The city has a potential deal with one of its bond holders and may be on the way to a deal with a bond insurer. In the city’s proposed plan to get out of bankruptcy, the city kept in place current pensions and avoided a head-on confrontation with its largest creditor, CalPERS, the state’s employee retirement system.
One bondholder, Franklin Resources Inc. was owed $2.9 million and Assured Guarantee Corp. insured city $164.7 million in city bonds. The firms were frustrated by the city’s continued payment of debts to CalPERS, while cutting out debtors.
Assured unsuccessfully challenged Stockton’s eligibility in bankruptcy and asked U.S. Bankruptcy Judge Christopher Klein in Sacramento to find that the city must cut its payments to CalPERS, just the same as any other creditor.
Klein declined to decide the CalPERS issue, saying that would be more appropriately argued when it comes to a fairness review of the city’s plan of adjustment, which lays out how the city will resolve its bankruptcy and pay creditors.
At the time of its bankruptcy filing in 2011, Stockton was the largest U.S. city to file for Chapter 9, municipal bankruptcy. Since then the city of Detroit has filed for bankruptcy protection.
The case has been closely watched for potential testing of the legal question of whether public pensions could be cut in federal bankruptcy court just like any other contract debt. (Public pensions are protected only in state contract law against cuts.)
That test may now be averted.
Still looming is how the to handle long-term debt for retiree health care. It is still unclear if retiree health care is a benefit that may be cut or is also a contract benefit protected in state law from cuts.
Klein allowed Stockton to eliminate retiree health care in 2012, while the city sought bankruptcy protection.
Chapter 9 bankruptcy sharply limits a judge’s ability to interfere in the managing of the city while it pursues reorganization. Klein said he could not interfere with Stockton’s actions.
A Stockton city council meeting is set for October 3 to approve the plan for paying debts and send it to the bankruptcy court for approval.
Case: In re Stockton, 12-BK-32118, Eastern Dist. of California.