October 12, 2012 3:25 pm
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Stockton’s attempt to avoid impairing the California Public Employees Retirement System (CalPERS) in bankruptcy may well make its way to the Supreme Court, and in the process, set some much-needed case law, experts told Debtwire Municipals.
“This is a weighty enough issue that I don’t think Judge (Christopher) Klein’s determination is going to be the last word,” said Michael Sweet, a partner with Fox Rothschild. “Whether CalPERS can be impaired is the kind of thing that doesn’t stop at the trial level, no matter which side comes out on top.”
“Law is going to be made here,” Sweet added.
CalPERS is being challenged by bond insurers of Stockton’s debt, who are upset that the city has asked them to take haircuts on its USD 285m of unsecured debt, even as CalPERS avoids the scalpel. Attorneys for National Public Finance Guarantee and Assured Guaranty filed objections to Stockton’s Chapter 9 filing, saying that because the city had not negotiated in good faith with creditors, it was not eligible for bankruptcy.
“There is no case law out there to give guidance,” said Mark Berman, a partner with Nixon Peabody. “People are trying to figure out what the rules are.”
CalPERS’ claim rests on section 903 of the bankruptcy code, Berman said, which says Chapter 9 cannot limit the political or governmental powers of a municipality. What’s not clear, he added, is whether the court will interpret “political and governmental powers” to include the state statute and the provision in the state constitution which protect the CalPERS obligations. California may provide the best test run for establishing whether pensions can be impaired, Berman said, because the obligations are enshrined in not only in statute, which can be changed by the legislature, but also in the constitution, which is more difficult to change.
But most attorneys watching the case believe federal bankruptcy law supersedes state law. “Not much trumps federal bankruptcy law when federal bankruptcy law applies,” said William Rhodes, a partner with Ballard Spahr. Rhodes pointed out that a municipality that chooses to file for federal bankruptcy protection cannot “pick and choose” provisions of bankruptcy in order to elevate state-level obligations.
“I look forward to resolution of that issue,” Rhodes said. “I’m hoping we get clarity from a court ruling on the fact that goes to the merits of the case. If it gets appealed, even better. It won’t stop at the trial level.”
Sweet noted that Judge Klein’s recent public remarks seemed to indicate he was wrestling with the issue of federal and state sovereignty. Speaking at a conference at the University of California, Berkeley, Klein noted that the Constitution’s contracts clause says no state may make a law impairing the obligation of a contract. “Notice it doesn’t say Congress may not,” he added. “There’s another clause in the Constitution called the bankruptcy clause which gives to the Congress the exclusive authority to legislate uniform law of bankruptcy in the United States.”
“Bankruptcy is all about impairing contracts,” Klein went on. “Not only is there the bankruptcy clause there as a balance with the contracts clause, I think you can see that asymmetry is absolutely intentional on the part of the drafters of the Constitution. There’s also the supremacy clause so once there is a case under the uniform laws created by the Congress, the supremacy clause winds up causing that law to trump state law to the contrary, or as I pointed out in one of the Stockton decisions, also trumps the state constitution on the same point.”
Girding for a fight
“I think that CalPERS are on unclear footing and are going to make the best argument they can and I expect they will lose,” Rhodes said. “If a municipality is going to be forced to go into Chapter 9, everything should be on the table – all obligations.”
But Berman pointed out that Section 903 exists only in Chapter 9 of the bankruptcy code. What’s more, he said, if Stockton’s case proceeds, any plan of reorganization must eventually be found to be “fair and equitable” in order to be approved by the court. “If they say under state law you have to pay the pension in full, how can a court determine that a plan that cuts benefits is in the best interest of pensioners?”
“CalPERS sees this as the first breach in the wall if it were to be decided against them even on a negotiated settled basis,” Berman said. “This would be appealed to the circuit court and the Supreme Court.”
CalPERS is “well-funded,” Berman added. “The people on the other side may not be as well-funded. They may feel that the cost of litigation puts them in a difficult position.”
But Sweet said the bond insurers may find allies if the case advances beyond Stockton. “Folks on Wall Street who have more resources will be looking for certainty. The financial markets rely on the fact that people can reasonably predict how one event will cause a particular outcome. And so I think that there are interests on Wall Street that could invest some money in this question.”
CalPERS did not immediately respond to a request for comment.
A USD 30,000 tranche of Stockton’s Series 2006A public financing authority revenue bonds maturing in 2037 last traded on 9 October at 69.75, yielding 8.092%, according to Electronic Municipal Market Access. Bondholders could not be immediately identified.
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