Judge Says Bankrupt City Can Dismiss Pension Obligations

October 2, 2014 (PLANSPONSOR.com) - A federal judge in California has ruled that the city of Stockton may eschew paying its pension obligations, and treat them just like other debts in its bankruptcy plan.

According to news reports, U.S. Bankruptcy Judge Christopher Klein said, “California public employee retirement law … is simply invalid in the face of the supremacy clause of the United States Constitution.” That means federal bankruptcy and contract law applies to the pension fund, “just like anybody else,” Klein said.

The city has reached deals with all of its major creditors, except for Franklin Templeton Investments, which took Stockton to trial. An attorney for the investment firm said the firm is being offered one cent on each dollar for a $35 million loan given to Stockton in 2009 to build firehouses and parks, and to move its police dispatch center. The attorney told the judge that Stockton struck much more favorable deals with other creditors.

In the lawsuit, Stockton argued that it must make its pension contributions for public employees before its creditors are paid the entire amount they are owed.

The California Public Employees Retirement System (CalPERS) praised Stockton’s stance, saying in a statement, “The real precedent of today’s proceedings is that even if municipalities are allowed to impair pensions in the rare situation of bankruptcy, cities like Stockton can make the smart decision to protect the pension promises for their public employees.” CalPERS said it is hopeful that Klein will approve Stockton’s adjustment plan, and noted that Stockton said in court that it can’t function as a city if pensions are impaired.

In a separate statement, the nation’s largest pension fund said it disagrees with the judge’s opinion on the issue of pension impairment and that the ruling “is not legally binding on any of the parties in the Stockton case or as precedent in any other bankruptcy proceeding and is unnecessary to the decision on confirmation of the City of Stockton’s plan of adjustment.” CalPERS said it will reserve any further comment until the court renders its final written decision.

CalPERS reacted positively to the plan of adjustment announced last year by the city of Stockton, which calls for it to continue to make all required pension payments to CalPERS.