Judge Approves Stockton Bankruptcy Plan - Saves CalPERS Investment

In a decisive win for public employees, Judge Christopher M. Klein today ruled in favor of Stockton's bankruptcy plan of adjustment, preserving the city's contract with CalPERS. The judge noted that the bankruptcy cuts had already reduced compensation below market. Hopefully this ruling will help stabilize police recruitment and retention in Stockton which has been unable to fill vacant police positions and has experienced a loss of nearly half its veteran officers over the last 3 years.

Earlier this month, Judge Klein had ruled that bankruptcy law preempted state law barring the impairment of CalPERS pensions in bankruptcy. City officials acknowledged that if the pensions were impaired they would experience a further exodus of police officers and city employees, who would have to obtain employment in another CalPERS or reciprocal agency within six months to retain their classic employee pension status under PEPRA. Judge Klein noted that re-doing the entire pension system would be no simple task. To even compete in the labor market, the City would also have to establish a new similar pension system that might be more expensive than CalPERS.

Judge Klein also held that PERS is not the creditor that would suffer the impairment. He found that the employees would receive the pension cuts, not PERS, and that employee compensation must be considered as a whole, including pension obligations. Many Stockton employees, including the police department, had made considerable sacrifices to keep the city afloat. These sacrifices included eliminating retiree health care completely, cutting salaries for current employees by 20-30%, reducing pensions for new hires, and requiring employees to contribute to their pensions. The Judge held that these changes were the result of long, difficult negotiations between labor organizations and the city. Judge Klein held that labor agreements cannot easily be set aside and recognized the importance of those negotiations and post-bankruptcy labor agreements.

Judge Klein concluded his ruling by issuing a stern warning to other public entities considering Chapter 9 bankruptcy. As the City's attorneys fees alone totaled nearly $14 million, Judge Klein stated that the high costs exceeded expectations and present a sobering lesson why municipalities should not file for bankruptcy. The objecting creditor, Franklin Templeton's, attorney told Judge Klein:  "Obviously, we're disappointed by your ruling. We will evaluate our next steps."

Stockton Bankruptcy Ruling May Not Have Practical Affect on Employee Pensions

During Stockton bankruptcy proceedings on Wednesday, October 1, 2014, Judge Klein stated the City could reject the CalPERS contract under the bankruptcy code. Pension reform supporters overstate Judge Klein's oral ruling as a major blow to public employee pensions. In reality, this ruling may not affect Stockton employee pensions.

Judge Klein heard oral arguments from the City and its creditors about whether the contract between CalPERS and the City could be rejected in bankruptcy. The City's proposed bankruptcy plan maintains the City's CalPERS obligations and preserves employee pensions. One of the City's creditors, Franklin Templeton Investments, argued it was unfair for the City to maintain its contract with CalPERS at the expense of other creditors. State law provides that CalPERS contracts may not be impaired in bankruptcy. However, the state law contradicts the bankruptcy code, which allows impairment of contracts that have not been fully performed. Judge Klein ruled the City could cut ties with CalPERS under the bankruptcy code and impair employee pensions to allow more money for other creditors.

While this ruling suggests pensions may be vulnerable during municipal bankruptcies in the future, it is unlikely to affect pensions in this case. Judge Klein's oral ruling is not yet binding. He is scheduled to rule on the City's proposed plan on October 30, 2014. If he confirms the plan, this issue is avoided altogether because the current plan does not impair the CalPERS contract.

Even if the City has the option to reject the CalPERS contract, the City recognizes doing so would be highly impractical. The costs of losing the CalPERS contract greatly outweigh any potential benefits. This would force Stockton to join another retirement system, such as the San Joaquin County Employee Retirement Association, or create its own retirement system. Both options would likely cost at least as much as maintaining its CalPERS contract. 

If the City lost its contract with CalPERS, it may not be able to offer pensions to employees. The City estimated it could only recover 60% of the money necessary to fund its employees' pensions if CalPERS terminated its contract. Losing employee pensions would make the City unfit to compete in the labor market. This would inevitably cause a mass exodus of employees from the City and make it extremely difficult to attract new employees. Under PEPRA, Stockton employees would have to start working for another CalPERS contracting agency within six months after CalPERS terminates its contract with the City to avoid being treated as "new employees" and subjected to significantly worse pension formulae and cost-sharing rules.

Terminating the CalPERS contract would also throw the entire bankruptcy proceeding back into chaos. It would breach most, if not all, labor agreements as well as the settlement the City negotiated for retiree medical. The City would be forced to revise its current plan and reallocate the available funds. Additionally, it would give CalPERS a claim in the bankruptcy worth well over $1 billion.

In short, while the ruling is disconcerting, there is a significant chance this will not have any practical affect on Stockton employee pensions.