Bankruptcy judge rejects CalPERS’ claim to protected status

April 3, 2013

By Chris Reed

Bankruptcy - exitAs John Seiler pointed out here Tuesday, Monday’s court ruling by U.S. Bankruptcy Judge Christopher Klein isn’t seen as definitive. Yes, the city of Stockton can proceed with its bankruptcy filing. No, Klein doesn’t yet agree with the city’s plan to only short bondholders and not CalPERS, its biggest creditor, as it reorganizes under Chapter 9 of federal bankruptcy law. He explicitly said later that he will decide on its fairness later.

But did Klein make one crucial point in his ruling and comments from the bench? Maybe, and I’m not the only one who thinks so.

Consider this: Every newspaper advance story that I saw before last week’s hearings in Klein’s court spoke of the centrality of the CalPERS argument that promised pensions were protected by the state Constitution, which should take precedence over federal bankruptcy laws which allow federal courts to modify contracts that bankrupt entities have with their creditors.

Pension preservation: State law vs. federal law

So did the most sophisticated legal analysis of Stockton’s pension-protection proposal that I read before Klein’s April 1 ruling. It appeared in January on the Bankruptcy Law Insights blog and was written by bankruptcy expert Ben Feder:

“The issues at stake — whether California state laws protecting public employee pension obligations are pre-empted and superseded by Congress’s Article I, Section 8 authority to establish uniform laws regarding bankruptcy, or are protected under the Tenth Amendment — implicate fundamental issues of federalism, and in all likelihood the Supreme Court will eventually need to resolve the questions being raised regarding the proper balance between state and federal power … .

“The [most] complicated question is whether priorities for unsecured claims created under state law — particularly regarding obligors that are themselves governmental units — can trump the distribution mechanisms of the U.S. Bankruptcy Code, and the Code’s underlying purpose of providing similar treatment for similarly situated creditors. Numerous states in addition to California have varying degrees of protection for public employee pension obligations. (Rhode Island, on the other hand, recently took the opposite tack and enacted a law that gave priority to bondholders in the Central Falls Chapter 9 cases.)

“Calpers will argue that the preference under California law for public employee< pension obligations is protected under the Tenth Amendment. San Bernardino’s bond investors will argue that the Bankruptcy Code expressly sets forth the priority of certain types of unsecured claims, that no other unsecured claims are entitled to more favorable treatment, and that California law regarding public employee pension obligations is pre-empted by the Supremacy Clause of the Constitution.”

‘Powers not delegated to the U.S. are reserved to the states’

statesWhat is the relevance of the Tenth Amendment? This is from CalPERS’ counsel:

“The Tenth Amendment provides that the ‘powers not delegated to the United States by the Constitution, nor prohibited by it to the states, are reserved to the states … or to the people.’ This is no minor addendum to the Bill of Rights; this amendment reflects the federal structure of our government.

“This structure allocates and ultimately provides limits on the powers of dual sovereigns — the federal government and the governments of the States. The Tenth Amendment and the principles of federalism preserve the integrity and residual sovereignty of the States, and ensure that the States function as political entities in their own right.”

But at least based on published accounts, the knotty question of deferring to the California Constitution’s pension protections or interpreting the Tenth Amendment to the U.S. Constitution as preserving the state’s decision-making authority on such matters didn’t seem knotty at all to bankruptcy Judge Klein.

Klein depicted CalPERS as a “garden-variety creditor” -– not one in a protected class.

He also said that going forward, he “is going to have a difficult time confirming a [bankruptcy reorganization plan] over the objection of unfair discrimination.” That’s a reference to Wall Street bondholders’ objecting to CalPERS being insulated from any of the pain facing other creditors. That’s another way of saying he rejects the idea that CalPERS is in a protected class.

Complex question — or not even a close call?

So instead of being a complex, challenging legal issue, Klein doesn’t appear to see this as a close call at all: Federal bankruptcy law supersedes the California Constitution, and the Tenth Amendment doesn’t shield CalPERS either.

I welcome any counter interpretation in the comments. And I acknowledge that an appeals court could completely disagree with Klein and go in another direction.

But I also think there is a chance that April 1, 2013, is remembered as a turning point in how Chapter 9 allows local governments to deal with their immense pension debts. We’ll see.



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  1. loufca
    loufca 3 April, 2013, 06:50

    I bet Jerry Brown will be really mad about this decision when rendered. Good, it’s due to his policies from the late 70s that some cities are in the same position as Stockton.

    Reply this comment
  2. Brown delta trout
    Brown delta trout 3 April, 2013, 08:51

    Africanized Swarm commenter needs to be put on suicide watch.

    Reply this comment
  3. Ulysses Uhaul
    Ulysses Uhaul 3 April, 2013, 08:56

    Rizzo got a bad rap!

    There are so many other financial black holes, so be careful where you walk.

    Reply this comment
  4. Sean Morham
    Sean Morham 3 April, 2013, 10:46

    This is huge…we are not far away from time when life span expands significantly more…….folks could be collecting pensions, social security far longer than career years….the entitled generation has a moral dilemma…probably not, “pay me forever, I am owed it. “

    Reply this comment
  5. SkippingDog
    SkippingDog 3 April, 2013, 11:01

    Your claim that “Klein depicted CalPERS as a “garden-variety creditor” -– not one in a protected class” is, shall we say for the sake of courtesy, factually incorrect, John.

    If you read page 588 of Judge Klein’s decision in the transcript, you’ll easily find that the reference to CalPERS being a “garden-variety creditor” was Judge Klein’s explanation of how opposing creditor Capital Markets had characterized CalPERS in its arguments. He made no such finding in his opinion. Read page 588 of the transcript if you want proof.

    Basic facts are still important in journalism, even when it’s the kind you practice here on CWD. You can find them here:

    Reply this comment
  6. SkippingDog
    SkippingDog 3 April, 2013, 11:07

    Since you solicited other opinions in your post, you might consider the fact that Judge Klein only opined that an argument based on the “contracts clause” of the state constitution would be vulnerable to a challenge. He also said he had no evidence whatsoever in front of him for making any such determination, and that the proper time for such an argument would be during the negotiation, litigation and eventual implementation of the plan of adjustment. He made no finding as to whether CalPERS was subject to 10th Amendment protections, as required under Chapter 9.

    Reply this comment
  7. Chris Reed
    Chris Reed Author 3 April, 2013, 12:23

    SkippingDog: Read the bottom of Page 577, not 588. Judge Klein cites the power of federal bankruptcy law to trump contract clauses in state constitutions and calls that a “garden variety constitutional law proposition.”

    Reply this comment
  8. CalWatchdog
    CalWatchdog Author 3 April, 2013, 13:21

    SkipingDog wrote: “Your claim that ‘Klein depicted CalPERS as a ‘garden-variety creditor’ -– not one in a protected class’ is, shall we say for the sake of courtesy, factually incorrect, John.”

    Actually, this article was written by Chris Reed, not me. He only mentioned my previous article.

    But as Chris noted in his reply, Klein did refer to a “garden variety constitutional law proposition.”

    — John Seiler

    Reply this comment
  9. SkippingDog
    SkippingDog 3 April, 2013, 14:15

    Klein’s comment on 577 is nothing more than an observation on the operation of the federal Supremacy Clause over state law on the impairment of contracts. Whether CalPERS has a “contract” relationship with Stockton or is a trustee of public retirement funds and therefore beyond the reach of the court was not determined. In fact, Klein stated that it was a complex area of the law and he didn’t know what the outcome would be.

    That’s far different from asserting the claim that Klein has determined CalPERS to be nothing more than a “garden-variety creditor.”

    Reply this comment
  10. Chris Reed
    Chris Reed Author 3 April, 2013, 15:38

    SkippingDog, if you don’t think a local government’s hiring of CalPERS to run pensions is a contract, I don’t know what to say. Google “city contract with CalPERS.” Or see how the top pension reporter characterizes Stockton’s arrangement with CalPERS as a contract:

    Back to Judge Klein and the fuller context from Page 577:

    “I’ve been doing this job for more than 25 years. I’ve had more than 138,000 bankruptcy cases. I’ve been party to impairment of millions of contracts and it’s all constitutional,” wrote Judge Klein.

    “And I explained [in a previous decision related to the Stockton case] that a parallel contracts clause in the state constitution must give way to the Bankruptcy Code, to the power of Congress under the Supremacy Clause of the U.S. Constitution; perfectly straightforward garden variety constitutional law proposition.”

    Reply this comment
  11. Donkey
    Donkey 3 April, 2013, 17:22

    Skdog, get ready to have your pension halved. The day of reckoning is at hand for the RAGWUS feeders.

    The days of stealing from the non-represented taxpayers is coming to an end. The well has run dry, and all the bad legislation the RAGWUS has put in place to seal and protect their thievery will be of no avail. 🙂

    Reply this comment
  12. SkippingDog
    SkippingDog 3 April, 2013, 18:15

    Sorry Donkey. I didn’t work for Stockton and my pension is currently funded at above 95%, so I’m not going to worry about it. After this whole thing makes it through the bankruptcy court and the inevitable appeals process, it will result in a plan of adjustment in which CalPERS either will or will not have some of its required payments by Stockton either extended or restructured in some way. There won’t be any widespread default on the payments various municipalities owe to CalPERS, nor will CalPERS make any widespread changes to the payments it makes to retirees. That’s the way every municipal bankruptcy eventually works itself out, since the very purpose of Chapter 9 is not dissolution but debt restructuring.

    Reply this comment
  13. SkippingDog
    SkippingDog 3 April, 2013, 18:26

    There are different kinds of contracts, Chris. While the bankruptcy court can certainly impair what are legally known as executory contracts, it does not appear to have the same ability for non-executory contracts – those in which all of the performance by the parties is complete. That would be, for example, the contracts that apply to former employees who have completed their performance, retired, and are receiving benefits from the retirement trust.

    If Stockton or San Bernardino were to default on their payment obligations, our government code permits CalPERS to initiate a statutory lien on the assets of the defaulting agency. Statutory liens can’t be discharged through Chapter 9, so that will be another hurdle the bond creditors need to overcome.

    The comments you posted by Judge Klein clearly refer to an argument based on the prohibition against impairment of contracts under the state or federal constitutions. That is well settled law, as the judge notes. But he also noted there were much more complex questions than that in regards to CalPERS status both as a creditor and as a government agency holding funds in trust under both the state constitution and government codes. It’s not only the contracts clause of the state and federal constitutions that require CalPERS to ensure compliance by its member agencies. There are multiple provisions of the Government Code (particularly in the statutes regarding public pension acts) that make the same requirement without need or benefit of a contract. Since Chapter 9 prevents the federal bankruptcy court from approving a plan of adjustment that violates state law, it will be interesting to see what kind of arguments the creditors make to overcome that obstacle.

    Reply this comment
  14. SkippingDog
    SkippingDog 3 April, 2013, 18:43

    Here’s the money shot from Judge Klein’s decision, at least as it pertains to CalPERS:

    “And the gravamen of the argument that the Capital Markets Creditors make is one of unfair discrimination. But that is not an eligibility question to be a problem at this stage of the case. To the contrary, it is a plan confirmation problem. And the City is going to have a difficult time confirming a plan over an objection and claim of unfair discrimination without being able to explain that problem away. And that problem is probably going to require me to get down into the nitty-gritty of the CalPERS situation. And I, at this point, have no clue how that’s going to come out, but that is the protection.”

    Reply this comment
  15. Brown delta trout
    Brown delta trout 3 April, 2013, 19:54

    It’s pretty easy really Skippy. You can be assured if there is any money left that the pensions for government workers will be honored. But it Stockton can not function as a government without cutting pension payments, that will happen. Not withstanding the murder and crime going on to an unprotected citizenship. That will not go on for long because no taxpayer will stay in some place where the city can not pay to protect it’s citizens. aka: Detroit

    Reply this comment
  16. Donkey
    Donkey 3 April, 2013, 21:37

    Skdog, you just don’t get it do ya!! This nation is broke! This state is Broke! The counties, and cities are broke!

    California is over a trillion dollars in debt just to it’s pensions, and the cities and counties are three to four trillion more. The funding of your pension is irrelevant, they are all going down, and you with them.

    Like I wrote earlier, the math is simple, why are the RAGWUS feeders oblivious to math?

    Intelligent people need to step forward and put a stop the crooks and thieves running the RAGWUS.

    Niccolo must have knew the intelligence of the average RAGWUS feeder: “There are three classes of intellects: one which comprehends by itself; another which appreciates what others comprehend; and a third which neither comprehends by itself nor by the showing of others; the first is the most excellent, the second is good, and the third is useless.” Yes SKdog, you are in the third class. 🙂

    Reply this comment
  17. SkippingDog
    SkippingDog 3 April, 2013, 22:21

    Keep hoping for that apocalypse, Donkey. It’s hard to see how you rationally work out your claim that everyone is broke when our securities markets are once more at record highs and large business is sitting on a mountain of ready cash. The U.S. economy is recovering much faster than elsewhere in the world, even as our greatest potential market rival, China, is watching the wheels of its economy begin to loosen and wobble.

    The facts just don’t back up your continuing claims of an economic apocalypse, nor do the actions of the people who would truly be in the position to see such a thing coming.

    You might as well break out some of those MRE’s and that freez-dried food you’ve been prepping with, since it will go bad long before you ever have a chance to make yourself a post-apocalypse warlord like in your fantasy life.

    Reply this comment
  18. Donkey
    Donkey 4 April, 2013, 07:35

    Because you spent your working life sucking off the labor of others it is no wonder you find nothing wrong in the world of securities SKdog, you have the mindset of all Communists, the worth of the dollar is quickly evaporating on the world market, go to any store and check out the prices of products. Your day is conming soon!! 🙂

    Reply this comment
  19. SkippingDog
    SkippingDog 4 April, 2013, 15:58

    Now you’re claiming that the financial security industry, the very center of free market capitalism in the world, is a Communist conspiracy? You’re starting to sound as deranged as Rex and Observer.

    Reply this comment
  20. Donkey
    Donkey 4 April, 2013, 18:32

    The only “conspiracy” I see, is the RAGWUS, with its long list of offenses against the citizens of this state. 🙂

    Reply this comment
  21. Brown delta trout
    Brown delta trout 4 April, 2013, 20:50

    I met a man who worked in a high position in the banking and securities industry, who twenty years ago said the whole thing was going under and was really scared. He bought a big ranch in Wyoming, made it a fort/compound with hi-tech security and moved out into the “woods.” Haven’t talked to him since then. But that was before Michael Milkens incarceration, before the Saving and Loan scandals, and long before our sub-prime junk bond meltdown, and obviously before the coming municiple junk bond meltdown.

    Reply this comment

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