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Bankruptcy Decision Could Put Public Pensions at Risk in California

creditor rights.jpgChapter 9 of the Bankruptcy Code allows municipalities, such as cities and counties to file for bankruptcy. Since 2011, there has been a wave of municipal bankruptcies due in part to the economic recession and also the issue of unfunded retirement obligations. The question is whether municipalities filing for Chapter 9 bankruptcy can reduce their payments to public pensions as part of a readjustment plan.

Can Municipalities Reduce Payments to Public Pensions in California?

Following a ruling by U.S. Federal Bankruptcy Judge Christopher Klein last October, public pensions in California can now be cut as part of a municipality's Chapter 9 plan of readjustment. Judge Klein's written decision was released this past February and clearly puts California cities, and the public for that matter, on notice that the state's public pension fund is on the negotiating table in municipal bankruptcies. The decision not only does away with the notion that public pensions enjoy an almost-sacred status in California law, but it is a blow to CalPERS, which administers the state's largest pension fund. CalPERS has spent years trying to build legal protections for public pensions through legislation and has been involved in two municipal bankruptcy cases.

In this case, the city of Stockton did not submit cuts as part of their readjustment plan, but Franklin Templeton Investments objected to the plan arguing that the city's debts would disproportionately adjust to capital market creditors while leaving pensions untouched. Franklin argued that this was in violation of the Bankruptcy Code requirement that the readjustment plan be "fair and equitable." CalPERS argued that California Government Code §20487 prevents a municipality from rejecting a contract regarding public pensions in Chapter 9 bankruptcy. Judge Klein ruled as a matter of law that pension administration contracts entered into between the city and CalPERS may be rejected pursuant to Bankruptcy Code §365. The judge also ruled that the $1.6 billion lien granted to CalPERS by statute in the event of termination of the pension administration contract could be avoided in bankruptcy.

What Does This Ruling Mean for Other Cities?

While Judge Klein ultimately approved Stockton's readjustment plan, it remains to be seen whether other cities facing bankruptcy will start to treat public pensions just like any other debts. Though creditors likely welcome this ruling, it may prove difficult for city officials to decide to reduce payments to public pensions as part of a readjustment plan. In Stockton, city officials did not want to cut public pensions for fear that people would leave for jobs in other cities. The other California cities that have filed for bankruptcy, namely San Bernardino and Vallejo, have similarly decided not to reduce public pensions as part of their readjustment plans. However, this decision may become increasingly difficult given that Californians owe nearly $200 billion for public pensions and these costs will only continue to increase.

For Chapter 9 bankruptcies, this ruling could mean that public pensions will be subject to negotiation just like any other creditor. The attorneys at Diemer, Whitman & Cardosi, LLP, represent the interests of creditors, both in bankruptcy court and in nonbankruptcy collections. Contact the skilled San Jose bankruptcy attorneys at Diemer, Whitman & Cardosi, LLP who can help you protect your rights and your business.






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