The California Public Employees’ Retirement System is seeking to sue bankrupt San Bernardino over missed pension payments, the second potentially precedent- setting fight the fund picked with a California city this year.
San Bernardino can’t use U.S. bankruptcy law to justify its failure to make at least $5 million in payments, Calpers, the biggest U.S. public-employee pension fund, said in court papers filed Nov. 27. The motion relies on arguments the fund is also making in the bankruptcy of Stockton, California, and may be a warning to other cities struggling with high pension costs, said James E. Spiotto, a bankruptcy attorney and partner at Chapman & Cutler LLP in Chicago.
“You don’t know if they are trying to send a message to others through San Bernardino, which is to be respected,” Spiotto said yesterday in a telephone interview.
Other cities and municipal bond investors may fear that Calpers’s strategy will lead to long and costly legal battles that leave less money to pay for essential services such as police and fire protection while driving up borrowing costs, Spiotto said.
Bondholders would be penalized if Calpers gets its way, Matt Fabian, managing director of Municipal Market Advisors, a research firm in Concord, Massachusetts, said.
Statutory Liens
“The issue is, do Calpers obligations supersede unsecured bondholders?” Fabian said in a telephone interview. “There’s an awful lot of unsecured bondholders in California. If you put pension obligations to Calpers as secured and senior to unsecured debt, in effect those bonds have been downgraded.”
In the Stockton and San Bernardino cases, Calpers is arguing that pension contributions must be made ahead of payments to other creditors because they are so-called statutory liens, or debts that state law requires to be paid. Bondholders and other creditors that oppose Calpers argue that pension debt is a contractual obligation like any other.
San Bernardino City Attorney James Penman and Gwendolyn Waters, a city spokeswoman, didn’t return calls seeking comment on the court filing.
Since initiating bankruptcy proceedings, San Bernardino has skipped $6.9 million in payments to Calpers, the pension fund said in an e-mailed statement. The $241 billion fund has continued to pay pensions to the city’s retirees, according to the statement.
Spending Plan
“This legal action would allow us to collect the employer contributions from San Bernardino, which are required by state law, to maintain the integrity of the San Bernardino pension plan for its public employees and retirees and to avoid needless procedural disputes and additional legal costs,” Anne Stausboll, Calpers chief executive officer, said in the statement.
Earlier this week, San Bernardino passed a provisional spending plan for use in bankruptcy. Under the so-called pendency plan, the city would put off paying $13 million to California’s retirement system and $3.4 million for pension bonds.
The city has $90 million of outstanding debt repaid from the city’s general fund, according to an Aug. 29 council report. Its unfunded pension liability is about $143 million, according to court papers. To help curb spending, the city has fired school crossing guards, closed three branch libraries and cut 41 non-uniformed police jobs, the city said in budget memos.
Legal ActionAlison Frankel of Reuters also reports on this case writing,Calpers and the Constitution: a looming confrontation? (h/t Pension Tsunami):
The County of San Bernardino voted to authorize any legal action that may be needed to collect $1.5 million in landfill fees owed by the city, county spokesman David Wert said. The county, which has about 2 million residents, is run by a separately elected board of supervisors who represent the unincorporated areas of the region.
The Stockton fight is further along and may set a precedent for how Calpers payments are treated, Spiotto said. That decision will be made by the federal judge overseeing Stockton’s bankruptcy case in Sacramento.
Calpers also may set a legal precedent in the San Bernardino case if it wins the right to fight the city outside bankruptcy court, Kenneth N. Klee, who helped rewrite Chapter 9 of the U.S. Bankruptcy Code in the 1970s as a lawyer working for Congress, said in an e-mail. Once a city or private company enters bankruptcy, creditors can’t seize property or sue for payments without permission from the judge overseeing the case.
Exemption Claim
Calpers claims that it is exempt from that requirement because it is a governmental agency. The fund may have a hard time winning that argument because it isn’t exercising traditional police powers, Klee and Spiotto said.
“If participants in the Calpers system fail to timely make payments, then Calpers will be unable to provide an actuarially sound retirement system,” the pension fund said in a filing in U.S. Bankruptcy Court in Riverside, California.
In August, San Bernardino became the third California city to file bankruptcy in less than three months. The city of more than 200,000 people lies about 60 miles (97 kilometers) east of Los Angeles. A fiscal emergency, brought on by a $46 million budget shortfall, forced it to stop paying some creditors and seek court protection, the city said.
San Bernardino filed for bankruptcy under Chapter 9, which is reserved for governmental agencies. Companies use Chapter 11, which allows them to cancel pensions, often shifting the burden to the government’s Pension Benefit Guaranty Corp.
The case is In re San Bernardino, 12-28006, U.S. Bankruptcy Court, Central District of California (Riverside).
On its face, the brief filed late Tuesday night by the California Public Employees' Retirement System in the municipal bankruptcy of San Bernardino isn't especially provocative.
As Reuters was the first to report, Calpers wants U.S. Bankruptcy Judge Meredith Jury of Riverside to lift the automatic stay on litigation against San Bernardino, which filed for Chapter 9 protection in August, facing a gaping $46 million deficit. San Bernardino stopped making monthly payments to Calpers after it entered Chapter 9, and its debt to the pension fund now tops $5 million. Calpers' lawyers at K&L Gates argued in Tuesday's brief that under California's pension and labor laws, as well as the federal bankruptcy code, San Bernardino must make good on its obligations and pay the money it owes the pension fund.
Those pension contributions, Calpers argued, are part of employee compensation, which is entitled to priority in federal bankruptcy. If San Bernardino won't pay, the brief said, the pension fund must be permitted to bring an enforcement action.
You won't find any sweeping pronouncements of Calpers' priority over San Bernardino's other creditors in Tuesday's brief. There's not even any mention of the city's proposed plan to resolve its deficit, which was passed Tuesday by the city council and calls for the city to continue to defer payments to Calpers. It's certainly possible that when Jury hears Calpers' motion to lift the stay in December, she'll treat it as a routine matter of Chapter 9 housekeeping.
But I don't think that's going to happen.
Calpers didn't file Tuesday's motion in a vacuum. The pension fund is the biggest creditor not just in San Bernardino's municipal bankruptcy but also in Stockton's; San Bernardino's unfunded pension obligation is about $143 million and Stockton's is about $245 million.
In the Stockton case, which predates San Bernardino's Chapter 9, Calpers has aggressively asserted its rights as a creditor. In response to complaints from bond insurers about Stockton's failure to negotiate any reduction in payments to Calpers, the pension fund said that it has priority over all other creditors and that the pension rights of public employees are protected by California's constitution.
The bond insurers Assured Guaranty and National Public Finance Guarantee (an arm of MBIA) filed formal objections to Stockton's eligibility for Chapter 9 protection, challenging Calpers' claim of priority and hinting at a collision between the Supremacy Clause of the U.S. Constitution, which holds that federal law trumps state statutes, and the California state constitution's pension protections.
(I've previously written about the federalism issue in the Stockton Chapter 9, which hinges on the intersection between 10th Amendment limits on federal judges overseeing municipal bankruptcies and the simultaneous requirement that cities show they're entitled to federal bankruptcy protection.)
The federalism issue has been pushed aside for now in the Stockton Chapter 9, as Calpers, the bond insurers and the city engage in mediation over Stockton's deficit reduction plan. A hearing on the bond insurers' challenge to Stockton's eligibility for bankruptcy protection isn't scheduled until March.
Calpers' motion in the San Bernardino Chapter 9 is on a much faster track. So if bond insurers want to test the strength of Calpers' power under the California constitution, they may well raise their Supremacy Clause arguments in responses due on Dec. 7.
I believe the bond insurers are eager for the federalism fight; in the Stockton case, U.S. Bankruptcy Judge Christopher Klein of Sacramento has already ruled once that the whole purpose of federal bankruptcy is to permit debtors to sidestep contractual obligations and that "the Supremacy Clause trumps the similar contracts clause in the California state constitution." Klein wasn't ruling on Stockton's obligations to Calpers, but his reasoning bodes well for creditors who believe the pension fund's reliance on the state constitution is misplaced.
Calpers also engaged in some muscle-flexing in the San Bernardino motion that must have irritated the bond insurers. The fund cited its "police powers" as an instrument of the state of California and asserted that it's not even obliged to ask the court to lift the stay on litigation. It said it was only filing the motion "out of an abundance of caution."
Calpers held out the prospect of terminating its relationship with San Bernardino, which would leave the city $319.5 million in the hole. And the pension fund also included several references to its powers under the California constitution. Though the motion addresses only San Bernardino's missed payments and not the city's long-term plan to pay its debt to Calpers, the brief can be read as bait by someone who is looking for a fight.
Calpers counsel at K&L Gates declined to comment. A Calpers representative told Reuters, "This legal action would allow us to collect the employer contributions from San Bernardino which are required by state law, to maintain the integrity of the San Bernardino pension plan for its public employees and retirees and to avoid needless procedural disputes and additional legal costs."
National Public Finance is represented in both the Stockton and San Bernardino Chapter 9 cases by Winston & Strawn, which declined to comment. The bond insurer Ambac is represented in the San Bernardino bankruptcy by Arent Fox, which didn't respond to a phone message.Finally, southern California public radio, 89.3 KPCC, also reports, Pushback: State pension giant CalPERS challenges San Bernardino's refusal to pay into retirement plan:
The city of San Bernardino has missed making payments of more than a million dollars a month to its employee pension plan since July, when the city first declared its fiscal emergency.Earlier this month, I asked an important question: will California's bankruptcies rock munis? I've been tracking CalPERS's looming constitutional showdown very closely because if they manage to secure pension payments ahead of unsecured bondholders, it could potentially rock the municipal bond market, making it more expensive for cities to borrow money.
That non-payment is part the city's plan to show a bankruptcy court judge how it will close a deficit of nearly $46 million and restore the city to solvency.
The San Bernardino City Council decided Monday to not direct nearly $13 million it would normally have paid this fiscal year into California's public employee retirement system, known as CalPERS.
The city is already $6.9 million in arrears, the most any California city has fallen behind in recent months, said CalPERS spokeswoman Amy Norris. She was not immediately able to say if other municipalities have gone deeper into debt to CalPERS in past years, so it's difficult to put San Bernardino's non-payment into historical context.
CalPERS responded to the plan Wednesday by asking the judge who's monitoring the city's bankruptcy case to let it sue the city for payment. Normally, a city that files for bankruptcy would be shielded from lawsuits while it restructures its finances.
Mayor Pat Morris said insolvent San Bernardino had no choice but to temporarily halt paying into the pension plan.
"We have to first of all keep our essential services alive to protect our community and deliver those baseline services and doing that is taking all of our resources, it's that simple," Morris said.
The city had negotiated with CalPERS to try and arrange a different payment schedule and to pay interest on the mounting debt, Morris said. The agency manages pension funds for about 3,000 current and future retirees.
Morris says the city plans to pay up eventually, and does not want CalPERS -- which he described as a good partner to the city -- to drop or terminate the city's pension business.
"We're a member of the family in acute distress, and we're hoping that here in the ER room they will be one of the doctors who will help us through this and not an assassin," the mayor said.
Rising public employee pension costs worry other California cities, and some might be tempted to copy San Bernardino's strategy, said Karol Denniston, a San Francisco attorney who helped write the state's process for cities to declare bankruptcy.
"It matters to every municipality in California that's looking at having cash flow challenges and not been able to make their CalPERS payments either now or in the future," Denniston said.
She said California cities and financial industry players are closely watching the San Bernardino case to see whether the federal bankruptcy court will permit the city to pay CalPERS less than its contract called for, something that California law appears to forbid.
A bankruptcy judge would also decide whether CalPERS gets top priority, or must stand in line for payment behind other creditors.
Municipal bankruptcies are so rare that those issues have never before been decided in court, Denniston said. If San Bernardino can alter the terms or timetable of its pension payments, other cities might follow.
"We have over 450 municipalities in California right now. A good number of them are looking at struggling to make their CalPERS payments," she said.
While only three other California cities -- Stockton, Mammoth Lakes and Vallejo -- have declared bankruptcy in recent years -- none had withheld payments to CalPERS, said agency spokeswoman Norris.
In September, Compton tried the tactic. It had fallen about $3 million behind in its pension payments, Norris said. But CalPERS sued, and Compton has since made up the shortfall.
But if CalPERS loses this case, it opens up a Pandora's box as other municipalities will follow San Bernardino and suspend their pension payments. If that happens, CalPERS will have to make difficult choices, like drop or terminate city pensions. This isn't in anyone's best interest.
I titled this comment "When CalPERSs meets Greece?" because this is what happens when cities, states and countries run out of money. All the constitutional laws in the world don't protect pensions. Just go and read Andreas Koutras's latest comment, Euro council bond risk, a new type of bond risk, where he notes:
If Greek banks marked to market their nGGB (new GGB) holdings then they would suffer no additional losses due to this. If on the other hand they have them booked at par then all the benefits would be negated by the increase in capital injection by the state. As for the Greek pension funds, their massive losses and funding gaps do not count in the Greek debt. So it is a free raid on the future pension.Greek pensions got royally screwed because they were forced to invest in Greek bonds and stocks. There is no pension governance whatsoever in Greece where these funds are routinely raided for political purposes.
Luckily CalPERS doesn't face these governance issues but they do face a looming constitutional battle to try and secure pension payments ahead of unsecured bondholders. The ramifications of this case will be felt across the United States and I fear that if CalPERS loses this case, US pensioners will face the same fate as Greek pensioners.
Below, Fox Business interviews former Schwarzenegger Press Secretary Aaron McLear and attorney Joey Jackson on CalPERS lawsuit against San Bernardino, California, for not making pay.
