Detroit BK Ruling Provides SB Leverage To Reduce Pensions

(December 4) Some 2,220 miles across the country, a decision made in a major municipal bankruptcy case this week could have a controlling impact on how the city of San Bernardino fares in its effort to restructure its debt and reduce the generous pension benefits it committed to providing city employees as a strategy in working itself out of its bankruptcy. Generous pension provisions to its retired employees are now considered a major factor in San Bernardino’s bankruptcy.
In August 2012, after years of financial challenges, the city of San Bernardino filed for Chapter 9 bankruptcy protection. As a consequence, San Bernardino found itself at the forefront of a profound financial and public policy issue. Emerging as a significant question in that matter is whether public pension obligations are to be held as sacrosanct, no matter how generous or reasonable individual pensions are, or whether troubled municipalities can skip out on their commitments to continuously fund the retirement accounts of their current and past employees.
Public employees, their pension fund associations and their advocates maintain that under the law, municipalities and other governmental entities must honor their payment schedules for contributions toward pension funding, no matter the governmental entity’s state of solvency or if it is seeking bankruptcy reorganization.
The relatively few California cities that have found themselves in the position of having to declare bankruptcy have shied away from testing whether, in fact, employee pension funds enjoy a specialized status vis-à-vis claiming to be first in the line of creditors to be paid by a governmental entity that is struggling financially.
In California, San Bernardino is one of three cities with populations of over 100,000 which have sought bankruptcy protection. The other two, Vallejo and Stockton, have elected to continue to stay current on their pension fund obligations. San Bernardino, however, has taken the position that pension payments should not be  excluded from the list of debts it wants to reduce, and that the California Public Employee Retirement System, known as CalPERS, should accept for the time being a pendency plan that reduces the payments it will receive from the city in the same ratios that the city is reducing its payments to its other creditors, including its bondholders and suppliers of goods and services,  until such time as the city is able to regain its financial footing. San Bernardino, which currently has a $25 million annual obligation to the retirement system, withheld more than $14 million  in pension fund payments from July 2012 until July of this year. The city wants to continue to make partial payments until such time as it gets back on its feet financially. Even more alarming to CalPERS is the perception that the city is looking down the road at a longer-term solution that would include renegotiating the amount of its commitment to the retirement system, one that would indeed set a precedent in California of reducing the pensions of retired or soon-to-retire city employees.
CalPERS opposed San Bernardino’s bankruptcy petition, asserting that the pension fund system has a special status.
Moreover, CalPERS has, disputed since shortly after the municipality’s filing of its August 2, 2012 bankruptcy petition, San Bernardino’s contention that it is in dire fiscal straits. The pension system maintains that San Bernardino has hundreds of millions of dollars worth of assets that can be tapped into or liquidated to satisfy its many creditors. CalPERS asserts San Bernardino is simply skipping out on its financial responsibility and is not eligible for bankruptcy.
U.S. Bankruptcy Judge Meredith Jury, who is overseeing the city of San Bernardino’s Chapter 9 bankruptcy filing, has consistently ruled that San Bernardino is as insolvent as it claims. In August, she ruled that the city’s bankruptcy should be granted pursuant to a pendency plan by which the city continues to pay its employees and other expenses critical to its day-to-day operations but services its other debts on the basis of the limited financial means available to it.
CalPERS wants out of Jury’s courtroom and is pressing for leave to appeal the matter to another judge, a request Jury has already denied.
This week, CalPERS has been forced to contemplate the consideration that other bankruptcy judges may prove every bit as, if not even more, accommodating of the city’s requests to back away from its pension commitments to current and former employees.
U.S. Bankruptcy Judge Steven Rhodes is hearing the city of Detroit’s bankruptcy case. Detroit, the largest U.S. city to ever declare bankruptcy, is beset with an estimated debt – $18 billion – that makes San Bernardino, with its $180 million in ongoing unfunded liabilities and $49 million annual operating deficit, by comparison seem as if it is almost flush with cash.  On December 3, Rhodes ruled that Detroit is not only eligible for bankruptcy but can also cut pension benefits as part of its strategy to map its way out of the financial abyss it has found itself in. Pensions, just like any other contracts, can be altered, given the exigency of bankruptcy, Rhodes ruled.
Rhodes’ ruling provides a precedent that outfits San Bernardino with more leverage in its match with CalPERS, providing the city with the potential option of abrogating a contract that CalPERS and the city’s municipal employee’s unions considered sacrosanct, unbreakable, and absolutely ironclad.
CalPERS’ position appears to be eroding by the minute. The pension system has maintained that it has special status among the city’s creditors and that it should go to the front of the line when the city begins to pay those to whom it is in arrears. Jury did not accept that, ruling that CalPERS has no greater or lesser standing than the scores of other entities the city owes money to.
In the cases of two other cities in California that have sought bankruptcy protection, Stockton and Vallejo, those cities have chosen to stay current on their obligations to CalPERS. However, in the Stockton case, the federal bankruptcy judge hearing the matter, Christopher Klein, granted Stockton’s request to set aside the city’s health benefit debts. And while he ratified the plan to make good on the city’s obligation to CalPERS, Klein indicated that had the city requested the authority to modify its pensions, he would have gone along with the request.
With Rhodes’ ruling in the Detroit matter, financially troubled cities may now be emboldened to do battle with the managers of their employees’ pension funds.
And while CalPERS maintains that municipal retirees are due all retirement moneys they qualify to receive under current formulas since those pensions represent  “promises made in exchange for the financial and physical investments that public employees and retirees make in our communities,” others see the matter somewhat differently. Many retirees are availing themselves of pensions utilizing a formula based not upon a percentage of their maximum salaries as municipal employees but a percentage of their salaries plus vacation pay, overtime pay, vehicle allowances, educational allowances, travel allowances, computer and cell phone allowances, clothing allowances and other stipends.  In recent years, there have been several highly publicized cases of pension spiking, including examples of high ranking public employees who, while employed earned salaries in the $200,000 per year range but by adding on various addenda to their salaries and other forms of compensation for their retirement calculations, are now receiving yearly pensions approaching $300,000.
Unexplored in the bankruptcy proceedings so far is an examination of the tactics used by employees and their unions to extract from elected city officials generous salary and benefit packages, including concerted efforts to elect or reelect politicians willing to provide them with those budget-busting salaries and benefits and chase from office those elected officials unwilling to break the city treasury to accommodate the unions.
Upon the demonstration that such tactics were used by unions to strong-arm elected leaders into providing their members with generous retirement benefits, a judge who is requested to grant pension modifications might seriously entertain such a remedy under the principle of the “balancing of hardships” whereby a city in a state of financial duress beset upon by a multitude of creditors, all of which could not be fully satisfied by that city’s available financial means, would appear to have grounds to seek to reduce pensions deemed to be excessive.

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