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.

CalPERS Fights for Retirement Security in Detroit

The California Public Employees' Retirement System ("CalPERS") filed an amicus brief in the United States Court of Appeals to support the Committee Retirees of the City of Detroit and others in appealing the bankruptcy court's determination that Detroit is eligible for bankruptcy.  Specifically, CalPERS seeks to reverse the bankruptcy court's ruling that, once a state authorizes a city to file for Chapter 9 bankruptcy, state laws and constitutions no longer control the city's actions.  The bankruptcy court's decision holds that a city can impair the rights of a public pension system in bankruptcy despite state laws prohibiting such impairment. 

In the amicus brief, CalPERS argues the bankruptcy court erred by providing an improper advisory opinion.  The bankruptcy court advised that retirement pensions may be impaired in a manner consistent with the 10th Amendment.  CalPERS argued the bankruptcy court should not have ruled on the constitutional issue when it was unnecessary to the court determining whether Detroit was eligible for bankruptcy.  CalPERS asserted the constitutional issue was not "ripe" for review, meaning it was not ready for the court's consideration.  Federal courts may not enter into a controversy before it has solidified, or before all other available remedies have been exhausted.

CalPERS also argues the bankruptcy court's decision nullifies Bankruptcy Code section 903, which expressly preserves state laws governing municipalities during bankruptcy.  Lastly, CalPERS argued the court's analysis was problematic because the court improperly created a presumption in favor of eligibility in interpreting the good faith filing requirement.  CalPERS seized the opportunity to weigh in on these critical issues affecting the retirement security of more than 1.7 million CalPERS members.

Trust Counsel: California Pensions More Secure Than Detroit's

After a Michigan bankruptcy judge opened the door to cutting public employees' pensions as part of the City of Detroit's bankruptcy, some observers suggested the ruling opens the door to similar tactics in California. But as Harvey Leiderman, the well-regarded trust counsel to CalPERS and other retirement systems, recently explained, California's pensions are very different from - and more secure than - Detroit's.

Leiderman explained Michigan's pension system hinges on a contractual relationship between two groups: retirees and employers, making it more vulnerable to impairment in bankruptcy.  That's because bankruptcy courts (unlike employers themselves) have special powers to impair contracts.  California's system, however, has three groups: retirees, employers, and pension trusts, such as CalPERS.

Leiderman explains that California's system includes legal duties between employers and pensions trusts on the one hand, and pension trusts and retirees on the other.  These duties are the product of state laws, not contracts.  He used this chart to illustrate the relationship:

Thus, even without contracts, California public employers have a duty to pay CalPERS and CalPERS has a duty to pay retirees.  Read the full article here.

Stockton POA President, Officer Vindicated of Insubordination Charges

As reported in LRIS, an arbitrator reversed the suspensions of Stockton's POA president and a board member after the City retaliated against them for participating in a POA charitable fundraiser and ordered full back pay.  The decision vindicates the officers and makes clear they did nothing wrong.  Indeed, according to the Stockton Record, "the dispute ended with an arbitrator finding that [the chief] mishandled the situation."

In the lead up to Stockton's bankruptcy, the City and the POA engaged in several legal battles, including the City’s unconstitutional attempt to void the POA contract through a declaration of fiscal emergency.  As the city manager tried to discredit the POA and blunt their public relations efforts, his chief of police claimed POA members couldn't do charitable work because it violated the Department's outside employment policy. 

Then he issued a vague order to "SPOA members" to not "directly or indirectly" participate in the selling/bartending of alcohol. The POA fought back and went forward with a charitable fundraiser, having members' families sell beer instead of the officers.  Then, after the POA made a vote of no confidence against the chief, he suspended SPOA President Stephen Leonesio and Director Mark McLaughlin for insubordination based on their participation in the charitable fundraiser.

The arbitrator ruled the suspensions unjustified.  The arbitrator ruled the chief's order was vague and confusing.  The order did not spell out what counted as selling/bartending and what it could even mean to "indirectly" bartend.  The arbitrator found that "they attempted to comply with the order as they reasonably understood it based on Leonesio’s discussions with Ulring and the language of the order itself.  It bears repeating that, before the event began, SPOA recruited family members and friends to staff the booths and sell alcohol in the place of SPOA members."

The order also didn't make sense because the POA had served alcohol at several charitable events in the past and "In fact, [the chief] himself has served and purchased alcohol at such events."  “If [the chief] truly had the concerns, … he should have said so in clear and unambiguous language,” the arbitrator said. “Instead, he issued an ambiguous and confusing order."  Since the order was unclear and the officers made a reasonable effort to comply with it, they should never have been suspended.

“The taint the city tried to put on their careers has been erased,” David Mastagni said. “The city insisted on going forward with the discipline on these two guys. … It was certainly personal on the city’s end.”  Mastagni attorneys David E. Mastagni and Jeffrey R. A. Edwards represented Officers Leonesio and McLaughlin.

Judge: Unconstitutional for Detroit to Go After Pensions in Bankruptcy

On Friday, a Michigan trial court judge ruled it violates Michigan's state constitution for Detroit to go after vested pension rights in bankruptcy.  The ruling follows Detroit's rush to bankruptcy court which may affect up to 21,000 retirees.  The Court ruled Detroit violated state law because the state constitution prohibits the government from doing anything to impair pensions.

Article IX, section 24 of the state constitution of Michigan reads, "The accrued financial benefits of each pension plan and retirement system of the state and its political subdivisions shall be a contractual obligation thereof which shall not be diminished or impaired thereby."  The judge explained "The Governor is prohibited... from authorizing an emergency a manager ... to proceed under Chapter 9 in a manner which threatens to diminish or impair accrued pension benefits."  Accordingly, the judge ordered Detroit's emergency manager to withdraw Detroit's bankruptcy petition.  Read the Court's ruling here.

Some advocates for bankruptcy in Detroit claimed the City must go after pensions to declare bankruptcy and address other forms of long-term debt.  However, in a related case, the U.S. Bankruptcy Court for the Eastern District of California ruled the City of Stockton does not have to go after pensions to be eligible for bankruptcy.

Court: Stockton Doesn't Have to Impair CalPERS Pensions for Bankruptcy Eligibility

The U.S. Bankruptcy Court in Sacramento ruled today that the City of Stockton is eligible for bankruptcy protection.  The ruling follows a trial when Wall Street bondholders challenged the City's bankruptcy, claiming the City should have to stop payments to CalPERS.  The Court said nothing in the federal Bankruptcy Code requires impairment of CalPERS benefits for a city to be eligible for bankruptcy. The Court also indicated it would be unconstitutional for the City to impair its contracts in any way except bankruptcy because the Constitution protects creditors.

In a press release, CalPERS praised the Court's decision, noting "Today’s action gives the City the opportunity to propose a forward looking plan of adjustment in the bankruptcy case that will allow them to restore long term financial stability and to provide essential services to the Stockton community through the City's valued public employees." CalPERS' also committed to continuing to protect and defend the integrity and soundness" of employees' pensions. Today's ruling clears the way for bankruptcy, but leaves open future challenges to the City's plan to pay back its debts.

CalPERS Challenges San Bernadino's "Sham" Bankruptcy

On December 14, 2012, CalPERS objected to the City of San Bernadino's bankruptcy. CalPERS bluntly called that city's bankruptcy a "sham", accusing the city of "criminal behavior" for withholding required CalPERS payments.  Read CalPERS' brief here.

Bankrupt San Bernardino Stops Payments to CalPERS

The Sacramento Bee reported today that the City of San Bernardino stopped making payments to CalPERS.  The City filed for bankruptcy protection on August 1, 2012. However, according the CalPERS "under the law of the State of California, a participating public employer in bankruptcy may not terminate its relationship with CalPERS through “rejection” of its “contract” with CalPERS in the bankruptcy proceeding."   The City's move comes on the heels of an announcement by the federal Securities and Exchange Commission that it was opening an investigation into the City's finances.

Report: Stockton Losing Experienced Officers

KCRA News reports the City of Stockton is facing a new problems after filing for bankruptcy.  According the report, "experienced police officers are leaving in droves."  A big part of the problem is that the "new cuts in the bankruptcy, essentially eliminating Senior Officer Pay, are causing a flight of officers, the veteran officers that you want to keep: they know the streets, they know the crime," according to Mastagni Law partner David E. Mastagni.  The recent attention to the flight of officer comes after bond holders argued employees aren't paying their fair share in the bankruptcy.  However, "I think if anybody's not bearing their fair share, it's the bond market," Mastagni said. "The cops are the ones out there jumping fences and putting their lives on the line."  Watch the full report here.

Stockton’s Eligibility for Bankruptcy Protection Challenged

On August 8, 2012, National Public Finance Guarantee Corporation filed an objection to the City of Stockton’s qualifications for bankruptcy under Section 109(c) of the Bankruptcy Code. National issued over $93,000,000.00 in lease revenue bonds, lease revenue refunding bonds, and revenue bonds. Today, August 9th, is the deadline for creditors to object to Stockton's eligibility for bankrupcty.

Challenges to eligibility typically involve disputes over insolvency and/or the requirement that the City negotiated with creditors in good faith during the 60-90 days of the AB 506 period. Federal bankruptcy law also requires good faith negotiations with creditors.

National argues the City did not negotiate in good faith with its creditors and did not file its bankruptcy petition in good faith. National accuses the City of “sheltering” its CalPERS pension obligations and not treating creditors equitably. National frames its objections as failing to negotiate in good faith with CalPERS, but argues that the pendency plan does not treat creditors equitably.

National’s claim of inequitable treatment appears premature as the Court must determine the City’s eligibility for bankruptcy, before considering the fairness of the plan of adjustment. In denying retirees facing the complete elimination of retiree medical benefits next year, Judge Klien an August 6, 2012 Opinion holding that “[s]ettled bankruptcy law permits the City to implement interim contractual modification before the confirmation of a chapter 9 plan of adjustment but such revisions do not, as a matter of law, become permanent unless and until made part of a confirmed plan of adjustment or otherwise voluntarily agreed.” Judge Klein noted that the remedy for addressing objections to the pendency plan is negotiating their treatment under a chapter 9 plan. The same reasoning would seem to apply to National’s objection to the treatment of CalPERS.

National’s argument also fails to account for the tens of millions of dollars in wages and benefits withheld from employee since 2010 through purported emergency actions unconstitutionally impairing labor contracts. These additional cuts reduced pension benefits, required employees to contribute up to 9% of their pay towards their pensions, drastically reduced medical coverage. The effect of these cuts is directly reflected in the City’s record breaking homicide rates and inability to retain or recruit police officers.

A status conference before the Judge will be heard on August 23, 2012 at 10:00 a.m. for trial setting for challenges to eligibility.

Stockton Officials Mired in New Scandals

Just months after the Stockton Record blew the whistle on city council members accepting questionable payouts, city officials face new allegations of wrongdoing.  The Record reports that city manager Bob Deis is being investigated for battery on a high school teacher/protester in front of city hall.  At the same time, former police chief Blair Ulring withdrew his application to be the police chief of Spokane, Washington after local press there "questioned the validity of Ulring's diplomas."  Watch the video report on Ulring here.

Judge Denies Stockton’s Motion to Disclose AB 506 Negotiations, Prepares for Challenge to Bankruptcy Eligibility

In the first hearing since Stockton’s June 28, 2012 filing of a bankruptcy petition, Judge Christopher M. Klein established firm control over the proceedings. This initial hearing focused on motions brought by the City of Stockton to lift the statutory confidentiality of its pre-bankruptcy negotiations under A.B. 506, notice to creditors, and scheduling deadlines for anticipated challenges to Stockton’s eligibility to file bankruptcy.

After a thoughtful discussion of competing interests, Judge Klein denied Stockton’s request for permission to disclose confidential communications made during the A.B. 506 pre-bankruptcy process. The California statute provides that negotiations during the 506 process cannot be disclosed except by court order if necessary to challenge the City’s bankruptcy eligibility. Judge Klein followed federal evidence rules providing for confidentiality of settlement negotiations with similar exceptions for information needed to determine eligibility for bankruptcy. The court explained the issue could be revisited if the information becomes necessary to determine eligibility. The Court did authorize the disclosure of the number and length of 506 meetings, the participant, the subject matters discussed, and the City’s “Ask” (the requested plan of adjustment).

Challenges to eligibility typically involve disputes over insolvency and/or the requirement that the City negotiated with creditors in good faith during the 60-90 days of the AB 506 period. Good faith negotiations are also required under federal bankruptcy law. A representative from the capital market indicated that it may challenge the City’s method of claiming insolvency on a budgetary basis as opposed a cash flow basis (an inability to pay obligations as they come due). Assured Guaranty, which insured $161.4 million of Stockton’s bonds, publicly stated it intends to vigorously enforce its rights as a creditor in any Chapter 9 proceeding, including the right to contest eligibility and confirmation of any plan of adjustment proposed by the city.

Judge Klein modified the City’s proposed timelines, setting a deadline of July 20th was set for the City to submit all its evidence of eligibility for bankruptcy and August 9th for filing objections to the City’s eligibility. A status conference before the Judge will be heard on August 23, 2012 at 10:00 a.m. for discussing discovery, motions, pretrial and trial setting for challenges to eligibility. Judge Klein also authorized the Stockton Police Officers Association (SPOA) to set a noticed motion to lift the stay over disciplinary appeals. After filing the Petition on June 28th, the City has taken the position that it will not proceed with appeals of disciplinary actions imposed against police officers. The City argues that because the appeals involve potential back-pay they are automatically stayed by the bankruptcy. While evaluating potential challenges to the City’s eligibility, the SPOA continues to negotiate with the City over its plan of adjustment.

 Chapter 9 requires as a condition of confirmation that a majority of each classes of claims impaired accept the plan. Although Chapter 9 also includes “cramdown” provisions requiring only acceptance of one class of claims, the court informed the City that it did not intend to simply confirm the City’s plan of adjustment. Rather Judge Klein told the City it would have to negotiate a plan of adjustment with its creditors, likely requiring further mediation.

Tom Sullivan Interviews David P. Mastagni on Why Cities Scapegoat Cops and Firefighters

Mastagni Law partner David P. Mastagni recently appeared on the Fox's Tom Sullivan Show to explain why California cities, including Stockton, are trying to scapegoat public safety professionals and violate their contractual obligations.  He explained that in light of what cities are doing with their contracts, "you dont have to be an Apache Indian or Geronimo to understand what the government thinks of its contractual obligations."

The real problem is that cities made "bad business judgments" by approaching infrastructure projects like it was "college lab class," investing other people's money in ventures they knew little about.  Now that cities are seeing red, they're blaming police officers and firefighters, but "blaming the police is nothing but a red hering." 

Watch the whole video here.

Court Rules Stockton POA Likely to Succeed in Contract Impairment Case

The Stockton Police Officers Association returned to court Friday for a hearing on its application for a preliminary injunction requiring the City to cash out paid leave for officers retiring or leaving the City for new jobs. At the hearing, San Joaquin Superior Court Judge Lesley Holland found that the POA was likely to succeed on the merits of its claim that the City of Stockton unlawfully impaired its contract. Judge Holland ultimately denied the POA’s application on the grounds that the case was stayed while the Third District Court of Appeals considered an appeal of the court’s ruling on the POA’s special motion to strike two of the causes of action alleged in the City’s cross-complaint.  Mastagni Law attorneys David E. Mastagni, Alan Davis, Isaac S. Stevens and BJ Pierce represent the Stockton POA in the matter.

State Controller Launches Audit of City of Stockton

KCRA News and the Stockton Record report that State Controller John Chiang has launched a financial audit of the City of Stockton's financial records.  In a four-page letter dated April 2, 2012, Chiang announced he has discovered "several discrepancies" in the City's financial reports that "raise questions" about the reliability of the City's reports.

The audit comes on the heels of the Stockton POA's demand the City provide transparent evidence of its financial condition.  The Stockton Record reports, "Sacramento attorney David Mastagni, who represents the Stockton Police Officers Association, said he has argued over and over that the city doesn't have adequate financial figures in the union's ongoing litigation... "I think this is very helpful," he said. "Finally, some people outside the control of the city and its attorneys are taking a look into what's happening."

Stockton Selects Noted Bankruptcy Mediator

Reuters reports the City of Stockton and its creditors selected Ralph Mabey to mediate pre-bankruptcy negotiations.  Mabey, a former federal bankruptcy judge, also serves a court-appointed mediator in the Lehman Brothers Holdings Inc bankruptcy.

Pre-bankruptcy mediation is required by state law before the city can declare bankruptcy.  The article reports the creditors participating in the mediation include CalPERS, Wells Fargo, the U.S. Housing and Urban Development Department and the Stockton Police Officers' Association.  David E. Mastagni, Alan Davis, Isaac S. Stevens and BJ Pierce represent the Stockton POA in the matter.

Stockton POA Sues To Force City to Pay Out Unused Leave

The Stockton Police Officers Association went to court Wednesday to force the city to honor its duty to pay officers for unused sick and vacation time when an officer laterals to another department. 

According to the Stockton Record, the city suspended the cash payouts to departing employees even though police officers took their jobs with the understanding they were earning the cash payouts when their work was done.

"People are entitled to this," said attorney David E. Mastagni, who represents the police union. "Its already earned compensation."  Mastagni said city officials threaten bankruptcy as a bullying tactic anytime they do not get their way.  A ruling against Stockton would not be as damaging as the city contends, he said.

At the hearing the judge ordered the city to show cause by April 16, 2012 why the court should grant the POA's request for a temporary restraining order.  See more about the case here.

Stockton POA Challenges City to Prove Financial Problems

On March 9, 2012, ABC News 10 reported on the City of Stockton's failure to provide required financial documents to prove its alleged financial situation.  The Stockton Police Officers Association challenged the City of Stockton to prove its financial problems and stop withholding a mandatory Comprehensive Annual Financial Report or CAFR.  According to the report, city officials admit the report is months late, but have not provided it to labor groups ahead of the planned pre-bankruptcy mediation.  The report indicates the City is only willing to provide an unaudited version.  Mastagni Law attorney David E. Mastagni will represent the Stockton Police Officers Association in the pre-bankruptcy mediation.  See the full report here or below.

California Supreme Court to Hear Challenge to City's Purported Fiscal Emergency

The California Supreme Court recently depublished City of Los Angeles v. Superior Court (Engineers and Architects Association) (2011) 193 Cal.App.4th 1159, and granted review.  The decision of our Supreme Court to grant review appears to reflect a greater willingness of the courts to provide judicial oversight of local bureaucrats attempting break contractual obligations by declaring fiscal emergencies, rather than negotiate concessions or seek bankruptcy protection.

Some prominent law firms representing public agencies have been advocating that the Los Angeles case supported their contention that agencies can suspend MOUs merely by declaring fiscal emergencies and that the resulting contract violations could not be arbitrated because declarations of emergency are not subject to review, and that more cities should declare emergencies to avoid contractual obligations.   These firms contend that review of cities' declarations of emergency and suspension of MOU terms is an improper delegation of cities' salary setting and budget making powers.  Under this rationale, cities' would not need Chapter 9 bankruptcy, because they could avoid court oversight of their true financial situation and any reorganization plan by suspending contractual obligations at their discretion.

This expansive reading of the Los Angeles case conflicts with Prof'l Engineers in Cal. Gov't v. Schwarzenegger (2010) 50 Cal.4th 989, 1043, where in our Supreme Court held the establishment of an emergency does not provide any substantive power to take an action not already authorized, but only avoids meet and confer obligations.   The Supreme Court will likely address the ability of local agencies to suspend their contractual obligations through misuse of emergency declarations in this case.