By Ed Mendel
(February 16) The California Public Retirement System (CalPERS) has paid two law firms more than $7 million in the Vallejo, Stockton and San Bernardino bankruptcies, even though a federal judge doubts that it has the legal standing to object to city pension cuts.
The high-priced legal representation, at top rates of $530 an hour, did not dissuade the judge in the Stockton case from ruling that CalPERS pensions can be cut in bankruptcy like other debt.
But Vallejo did not try to cut pensions, reportedly fearing a costly legal battle threatened by CalPERS. Stockton did not want to cut pensions, leaving the CalPERS issue to bondholders. And a San Bernardino deal with CalPERS protects pensions.
At times in the Stockton case, Judge Christopher Klein verbally jabbed the CalPERS attorney, Michael Gearin (once said to be “bellowing and pawing the sidelines”), as if he were an over-blown nuisance of questionable relevance.
The judge was explicit this month when, after an oral ruling in October, he issued a 54-page written ruling that confirms Stockton’s plan to exit bankruptcy and explains why, despite past CalPERS defensive measures, pensions can be cut in bankruptcy.
“As CalPERS does not guaranty payment of municipal pensions and has a connection with a municipality only if that municipality elects to contract with CalPERS to service its pensions, its standing to object to a municipal pension modification through chapter 9 (bankruptcy) appears to be lacking,” Klein wrote.
After a federal judge ruled in the Detroit bankruptcy that pensions can be cut, CalPERS joined unions in an appeal, arguing that it’s an “arm of the state” not a city-run plan like Detroit, and thus is protected under the federal bankruptcy law for cities.
Klein ruled that Stockton has contracts with unions and CalPERS. He said the “third leg” of the triangle, the relationship between CalPERS and active and retired employees, is not a contract but a “third-party beneficiary relationship.”
Contrary to the widespread “myth” that CalPERS is Stockton’s largest creditor, the judge said, it’s a “small-potatoes creditor” and “pass-through conduit” only owed administrative expenses. The big pension debt is owed to employees and retirees.
Nothing about state structure or procedure “necessitates” CalPERS, the judge said. State law does not require that city employees have pensions. And cities can choose other pension providers: private, county or the creation of their own system.
But once a city contracts with CalPERS two state laws sponsored by CalPERS, which do not apply to county or city retirement systems, make it difficult to leave the big state system.
One state law bars rejection of CalPERS contracts in bankruptcy. The judge said states cannot modify federal law and cited, among other things, a Texas law allowing a school bankruptcy if state bonds were protected, which was overturned by the courts.
The other state law places a lien on the property of a city that terminates its CalPERS contract in bankruptcy, second only to wages, that enforces immediate payment of future pension obligations.
On termination, CalPERS sharply escalates future pension costs by dropping its investment earnings forecast of 7.5 percent a year from a diverse portfolio to a bond-based 2.98 percent, ensuring payment because employer-employee contributions cease.
For Stockton, the debt or unfunded liability due immediately on termination of its CalPERS contract would have jumped from $211 million to $1.6 billion. The judge said the big bill would be a “poison pill” if the city tried to move to another pension provider.
(Stockton did not want to cut pensions, saying they are needed to be competitive in the job market, particularly for police in the city with a high crime rate. And Stockton unions had agreed to pay cuts with the promise that pensions would not be cut.)
Klein ruled that the threat of a CalPERS termination lien forcing a $1.6 billion payment is a “toothless tiger” in a bankruptcy. CalPERS seems to agree that the lien, which only takes effect in bankruptcy, is vulnerable.
Part of the judge’s finding that the CalPERS lien is unenforceable is federal bankruptcy law that “authorizes the avoidance of liens that are not perfected or enforceable at the time of the commencement of the case.”
In April 2013, the CalPERS board approved a staff proposal to sponsor legislation that would “provide CalPERS with a present lien on all assets of a contracting public agency in the amount of all obligations owed to the system.”
Legislation for a CalPERS “present lien” that would be in place before a bankruptcy has not been introduced. Unless retroactive, the bill would not have affected Stockton or San Bernardino, which filed for bankruptcy about a month apart in 2012.
Another “myth,” said Klein, is that because the Stockton plan to cut debt and exit bankruptcy leaves pensions intact employees and retirees are “not sharing the pain” with bondholders.
In addition to pay cuts, Stockton replaced retiree health benefits valued at $545 million with a $5 million lump sum payment. The judge heard anguished pleas from retirees relying on health care promised by the city.
But in his first important ruling in the Stockton case, Klein declined to block the retiree health care cut. He said in a 40-page decision in August 2012 that the bankruptcy law forbids the court to “interfere with” the property or revenues of the debtor.
Stockton negotiated approval of its debt-cutting plan with all of its unions and its largest bondholders. A lone holdout, Franklin, received $4.35 million (the value of its weak collateral: two golf courses) for $36 million in bonds, a return of 12 percent.
Franklin, planning an appeal, contended the Stockton plan’s failure to cut the largest debt, pensions, is unfair and not proposed in “good faith.” Bondholders filed a similar objection to San Bernardino’s agreement with CalPERS to avoid pension cuts.
San Bernardino has been the biggest problem for CalPERS. The city filed an emergency bankruptcy, said to be needed to keep making payroll, then took the unprecedented step of stopping payments to CalPERS for the rest of the fiscal year.
After resuming regular CalPERS payments, San Bernardino reportedly is paying off its skipped payments, $13.5 million plus fees and interest. Judge Meredith Jury has set a May 30 deadline for the city to propose a dead-cutting plan.
Not making required payments gave CalPERS grounds to terminate its San Bernardino contract. But that might have resulted in pension cuts, something CalPERS is battling to avoid in the city bankruptcies.
Voters approved a union-backed state constitutional amendment, Proposition 162 in 1992, that makes providing benefits to members the highest CalPERS priority. Benefits previously had the same priority as minimizing employer contributions and administration costs.
The duty to provide benefits was mentioned by a CalPERS spokesman last week when asked for a comment on Judge Klein’s ruling on pension cuts, legal standing doubts and being a “bully” in the case.
“The judge’s written opinion restates the determination he had made previously and explained in court,” said Brad Pacheco, CalPERS spokesman.
“What we find important is that he recognized the significant and unacceptable risk to the retirement security of California’s public employees in the end,” he said, “which was behind our motivation as a trustee with a fiduciary duty to deliver the pensions promised.”
In the Vallejo bankruptcy, CalPERS from 2008 to 2012 paid $526,356 to the law firm of Felderstein Fitzgerald Willoughby & Pascuzzi.
Then CalPERS switched law firms and from 2012 through last November paid K&L Gates $3.2 million for the Stockton bankruptcy and $3.3 million for the San Bernardino bankruptcy.
Peter Mixon, the CalPERS general counsel for 11 years, left CalPERS in 2013 and became a partner in K&L Gates last October.
Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More of this articles are at Calpensions.co
By Ed Mendel