California cities struggling with pension obligations, two of which are in bankruptcy, may be recalculating their strategies for survival after a decision last week by a federal judge in Detroit.

Judge Steven W. Rhodes, presiding over the Motor City’s Chapter 9 bankruptcy, ruled that longstanding pension agreements will not be off-limits during negotiations over how Detroit will cover billions of dollars in debt, despite a state constitutional protection similar to one in California.   

“Pension benefits are a contractual right and are not entitled to any heightened protection in a municipal bankruptcy,” Rhodes said, in accepting Detroit’s application for protection. Many people in the legal community have argued that was the case for years, but legal experts say this is the first time a bankruptcy judge ruled that way.

His decision ignited efforts to appeal the ruling, and set the stage for a showdown that pits bondholders, bond insurance companies and other creditors against municipal workers and retirees. Also at stake in negotiations is one of the city’s largest assets, the Detroit Institute of Arts and its magnificent holdings.

The Detroit battle unfolds in a different political environment than in California. Michigan’s Republican governor and Legislature have taken the radical step of effectively replacing the city’s mayor and council with an emergency manager. Kevyn D. Orr is a bankruptcy expert who, some think, was appointed by the governor months ago with the objective of placing the Democratic-controlled city into Chapter 9 without a reasonable effort to negotiate over pensions first. 

Bankruptcy judges have extraordinary powers and one of them is the ability to obliterate legal contracts. But their rulings don’t set precedence for other jurisdictions.

California’s Stockton and San Bernardino don’t have multi-billion-dollar art collections at risk, but the two bankrupt cities do have a lot of workers and retirees with pensions. Stockton is further ahead in its proceedings and reached agreement on a plan that raises taxes, hacks municipal services, dings bondholders and whacks retiree health care but essentially leaves the pensions intact. Critics say the city inadvisably caved to the California Public Employees’ Retirement System (CalPERS) and will have trouble in the future without reducing pensions.

San Bernardino did not cave, at first, withholding some of its monthly payments while it struggled to pay employees and creditors. Then it did cave, but refused to make good on the missed back payments. Judge Meredith Jury said in August that the city would have a hard time not going after the pension fund.   

“If CalPERS gets all the money they want, under what they say is their statutory right, who isn't going to get paid? All the employees? How is that going to help CalPERS?” Judge Jury said.

CalPERS, trying to avoid that fate, asked the judge to let them appeal her decision to grant San Bernardino bankruptcy protection directly to the U.S. Ninth Circuit Court of Appeals. She denied the motion in mid-November, saying it would undermine negotiations already underway, and suggested they appeal to the U.S. District Court and ask them for a direct appellate court hearing.

But the San Bernardino Sun said Judge Jury, in making her ruling, expressed a longing for guidance from higher courts which has been lacking in municipal bankruptcy cases:

“There is a side of me that could support the 9th Circuit weighing in on these tricky questions of desire and good faith. If there were some definitive rulings, it would give direction to some potential debtor cities as well as creditors in those proceedings, perhaps changing the landscape of how the eligibility battle has become the war that it is.”

–Ken Broder

To Learn More:

California City’s Return to Solvency, With Pension Problem Unsolved (by Rick Lyman and Mary Williams Walsh, New York Times)

Ruling in Detroit Could Affect San Bernardino Bankruptcy Case (by Ryan Hagen, San Bernardino Sun)

Pension Ruling in Detroit Echoes West to California (by Mary Williams Walsh, New York Times)

Bankrupt Detroit Can Cut Pensions; Implications Big for California (by Dale Kasler, Sacramento Bee)

Judge Gives San Bernardino Bankruptcy Protection, then Takes Aim at Pension Fund (by Ken Broder, AllGov California)