The Uneasy Balance between Pension Obligations & Exiting Municipal Bankruptcy

November 19, 2014

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The Challenge of Inequality. U.S. Bankruptcy Judge Meredith Jury has ruled that the City of San Bernardino has until May 30, 2015 to put together its proposed plan of debt adjustment. Judge Jury’s order came just a day after the city and its largest creditor, the California Public Employees’ Retirement System or CalPERS, released details of an interim agreement under which the city would fully repay CalPERS and require the city to file its plan to exit bankruptcy by September 2015. That agreement, which had been kept under a gag order from the public and U.S. Bankruptcy Judge Meredith Jury until yesterday, was released by both sides in advance of yesterday’s hearing today at which creditors had successfully sought to convince Judge Jury to impose a deadline for the city’s proposed exit plan. According to city officials and CalPERS, mediator Gregg Zive, a retired bankruptcy judge, authorized the disclosure.

Under the agreement, San Bernardino will make repayment of the full amount San Bernardino owes to CalPERS, or approximately $14 million, by means of 24 equal installments beginning retroactively to last July 1st and ending June, 1, 2016, or when the city’s plan of debt adjustment is accepted by the federal court and its plan of adjustment becomes effective. According to CalPERS, the city has, to date, paid $4.5 million of the money it owes. Judge Jury noted at the hearing: “I don’t know what took nine months to agree to pay CalPERS in full.” Under the new agreement, according to both the city and CalPERS, the city will make up all payments missed since the bankruptcy declaration — about $13.5 million — plus interest and fees in 24 equal installments over two years. The CalPERS agreement, however, has other creditors worried, including Erste Europäische Pfandbrief- und Kommunalkreditbank AG, the Luxemburg-based holder of municipal bonds the city issued in 2005 to pay its pension obligations. Based on U.S. Bankruptcy Judge Christopher Klein’s approval of Stockton’s plan of debt adjustment last month in which CalPERS received full payment, but creditor Franklin Templeton Investments received pennies on the dollar (and has appealed Judge Klein’s decision), the Luxemburg bank representative described the agreement as a “deal [that] is really more of a surrender…At worst, the city will find there is no feasible plan that could incorporate the deal with CalPERS.” On the matter of the deadline Judge Jury set for the city to submit its final plan, the judge stated: “I’d rather say this is a hard, hard deadline, and the earth is going to have to move under San Bernardino (to get an extension) — which, by the way, is not impossible.” In her comments with regard to setting the final deadline, Judge Jury was critical of San Bernardino, noting that the city’s reliance on the recently voter rejected Measure Q—which the city had assumed would be passed and provide significant labor savings―“was never going to be enough…“Good heavens, the attorneys’ fees in this case were probably several years of what you were going to get by adjusting the safety salaries.” Nevertheless, Judge Jury granted more time than CalPERS and the city’s unions had sought, because she wanted to allow time for a plan to be developed by Management Partners, the firm San Bernardino hired at the beginning of this week (at a cost of $300,000) to help develop its plan. Management Partners, however, has some experience under their belts from their recent work in assisting the City of Stockton put together its recently approved plan of debt adjustment. Moreover, the city has previous—albeit unacted upon—experience with the group from seven years ago—but the city followed up only partially on its recommendations, or as Judge Jury said Tuesday: “What I remember from the reports is the city didn’t do anything that was recommended.” If San Bernardino is successful in complying with the federal court’s deadline, it will have been in municipal bankruptcy for just short of three years—more than twice as long as Stockton, and four times as long as Detroit, but within striking range of the 31 months it took Vallejo, California to exit from chapter 9.

Retirees & Muni Bondholders. Notwithstanding the provisions in the Michigan and California constitutions protecting the pension contracts of municipal retirees in Detroit, San Bernardino, and Stockton; U.S. Bankruptcy Judges Steven Rhodes and Christopher Klein had each been clear that the federal chapter 9 municipal bankruptcy law trumped the respective state constitutional protections. Indeed, with appeals on the question filed with both the U.S. 6th and 9th U.S. Circuits Courts of Appeal—and with appeals pending in both Stockton and Detroit (please see below), it appeared we were on the road to a fundamental federalism challenge at the U.S. Supreme Court. That titanic, potential clash, however, has faded: In the Motor City, the “grand bargain” appeared to successfully garner the strong support of the city’s unions and retirees to support the acceptance of modest reductions in their pension benefits—especially compared to the cuts of some of the other financial creditors of the city; and in neither Stockton, nor, so far, in San Bernardino has there been any effort to seek cuts: first Stockton, and now San Bernardino have agreed to pay CalPERS in full and to keep their retirement plans intact, notwithstanding U.S. Judge Christopher Klein’s oral ruling last month. Had Stockton taken Judge Klein’s offered route and reduced payments to CalPERS, it would have triggered a mechanism that would have cut retirement benefits by as much as 60 percent—any amount that Stockton leaders feared would have led key employees to quit in droves, and, more importantly, maybe, rendered the city far less competitive in its ability to hire new employees. Stockton’s federally approved plan of debt adjustment fully protects its public pension obligations; San Bernardino’s filing with the U.S. Bankruptcy Court this week fully protects what Paul Glassman, an attorney for the city, this week said was the “800-pound gorilla in the case: CalPERS,” according to a report by Bloomberg. Nevertheless, the issue will not be over until it’s over; so that with both Judge Klein’s and Judge Rhodes’ decisions on the record, the possibility of the issue coming back in appeals to the respective U.S. Bankruptcy court decisions, the final balance might yet remain to be assessed. Indeed, Franklin Templeton has already appealed Judge Klein’s decision.  Or, as Dave Low of Californians for Retirement Security puts it: “I don’t think that we’re out of the woods.”

It Ain’t Over ‘til It’s Over. In approving Detroit’s modest reductions under its plan of adjustment to most city pensions earlier this month, U.S. Bankruptcy Judge Steven Rhodes said there was a 25 percent chance his ruling could be overturned on appeal. Detroit, being a casino city, might well have figured into the thinking of 133 holdout pensioners-creditors who are rolling the dice that they may be able to gain full restitution. This week they requested that U.S. Bankruptcy Judge Steven Rhodes halt the implementation of Detroit’s pension cuts approved under its approved plan of debt adjustment pending resolution of their appeal of his decision approving the Motor City’s plan of debt adjustment. Indeed, in their filing, the group of retirees, survivors and city workers cited the 4-to-1 odds the Denver Broncos will win Super Bowl XLIX next February 1st as part of their justification for time to appeal: “Therefore, there is a reasonable likelihood of prevailing on the merits,” retired Detroit police officer and attorney Jamie S. Fields wrote in a court motion for a limited stay of U.S. Bankruptcy Judge Steven Rhodes’ ruling. Their motion requested a limited stay that would not impact other settlements tied to Detroit’s plan to reinvest $1.7 billion in municipal improvements and eliminate close to $7 billion in debt, but argued that Detroit should not be able “to avoid any meaningful appellate review of the unprecedented approach” used to forge settlements with labor unions, retiree groups, the city’s pension funds, or its financial creditors. While Judge Rhodes has not yet set a date for Detroit’s plan of adjustment to become effective, Mayor Duggan and city leaders anticipate he will do so by the middle of next month—at which point the city can begin imposing its plan to reduce general retiree pensions by about 4.5 percent and modifying cost-of-living or COLA adjustments for retired police officers and firefighters from 2.25 percent down to about 1 percent. Under the so-called grand bargain, the State of Michigan and major foundations agreed to provide $816 million towards offsetting the pension reductions—especially for retirees who might otherwise fall below the federal poverty level over the next two decades, as well as to keep the world famous Detroit Institute of Art from being auctioned off—an action that led Detroit’s pension members and retirees in both the General Retirement System and Police and Fire Retirement System to vote overwhelmingly in favor of the city’s plan of debt adjustment, which includes deeper cuts for some GRS members who received excess interest earnings on an optional savings account. Nevertheless, in Judge Rhodes’s ruling approving Detroit’s plan of debt adjustment earlier this month, the federal bankruptcy judge acknowledged the pension reductions could be a “real hardship” for some retirees, although he reminded the court: “The pension reductions in the pension settlement are minor compared to any reasonably foreseeable outcome for these creditors without the pension settlement and the grand bargain.”

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