A federal bankruptcy judge ruled Monday that the city of Stockton, Calif., was eligible for court protection from its creditors, clearing the way for a battle over whether public workers’ pensions can be cut when the city they work for goes bankrupt.
After declaring Chapter 9 bankruptcy last year, Stockton eliminated tens of millions of dollars in city services and said it would cut back some bond payments in a way unseen before in municipal bankruptcy. But bondholders objected to Stockton’s effort to protect pensions while forcing losses on investors.
Many states have statutes and constitutional provisions making it illegal to cut public workers’ pensions. Until now, there has not been a prominent test of those laws in bankruptcy — particularly not in California, where the big state pension system, known as CalPERS, has been girding for battle on the issue, trying to avoid the precedent of a cutoff or shortfall in a city’s pension contributions.
Federal bankruptcy law often trumps state laws, but municipal bankruptcies are so rare that there is almost no precedent on how to apply the law to state pension provisions.
In the ruling issued Monday in Sacramento , which affirmed the legal status of Stockton’s bankruptcy, Judge Christopher M. Klein said he could see battle lines being drawn between CalPERS — formally the California Public Employees’ Retirement System — and the city’s other major creditors, including several Wall Street companies that either bought Stockton’s bonds or insured them. But he ruled that it was still too early in the case for that battle to be joined.
“There are very complex and difficult questions of law that I can see out there on the horizon,” he said.
The judge said he would decide those questions during the next phase of Stockton’s bankruptcy, in which the city’s creditors will contest whether its so-called plan of adjustment is fair. A plan of adjustment in a municipal bankruptcy is comparable to a plan of reorganization in a Chapter 11 bankruptcy; a city cannot emerge from bankruptcy unless the judge confirms its plan of adjustment.
“The day of reckoning will be the day of plan confirmation,” Klein said near the end of a two-hour session in which he read his decision from the bench. “The city is going to have a difficult time confirming a plan over the objection of unfair discrimination.”
The Wall Street creditors had been trying, until now, to persuade Klein to throw out the case, arguing that the city was not truly insolvent and had not treated them fairly.