A federal judge ruled Wednesday that U.S. bankruptcy law allows Stockton, California, to treat public pension fund obligations like other debts, meaning the city could trim its pension obligations.
Stockton argued that it must make its pension contributions for public employees before its creditors are paid the entire amount they are owned.
The case is being closely watched because it could answer the significant question of who gets paid first by financially strapped cities around the nation — retirement funds or creditors.
The ruling was prompted by a key creditor's contention that pension obligations should be treated like other debts. The judge has not yet ruled on the city's overall plan for exiting bankruptcy, which includes continued payment of its pension obligations.
In its case against the city, Franklin Templeton Investments says the pension payments are fair game as it tries to collect on an unsecured $32.5 million claim against the city.
Stockton city Manager Kurt Wilson and its attorney Marc Levinson declined immediate comment on the pension ruling as the city prepared to present its overall bankruptcy exit plan later in the day.
In making the ruling, U.S. Bankruptcy Judge Christopher Klein said, "California public employee retirement law ... is simply invalid in the face of the supremacy clause of the United States Constitution."
That means federal bankruptcy and contract law applies to the pension fund, "just like anybody else," Klein said.
Earlier in the proceedings, Levinson said employees of Stockton could be forced to take a 60 percent pension "haircut" if a federal judge rejects its overall reorganization plan.
The judge spent much of the morning questioning whether CalPERS and its members enjoy a protected status under federal and state laws.
"One can't mess with CalPERS, that's the vernacular way of putting it," the judge said at one point, summarizing the view of CalPERS and Stockton officials.
"Is CalPERS a state unto itself?" Klein mused later.
Stockton, an inland port city, became the largest city in the country in 2012 to file for Chapter 9 protection before Detroit made the move last year.
Before the recession, Stockton leaders spent millions of dollars revitalizing the downtown area with a new City Hall and building a marina, sports arena and ballpark. The city issued about 3,000 permits annually to build new homes, and it paid police premium wages and health benefits.
With the recession, building dried up, and Stockton became ground zero for home foreclosures.
Like many residents, City Hall couldn't pay its bills. The city slashed its budget by millions of dollars and laid off 25 percent of its police officers. Crime soared.
The city about 80 miles east of San Francisco wants Judge Klein to approve its plan for reorganizing more than $900 million in long-term debt, while Franklin Templeton Investments wants the judge to reject the proposal.
The city has reached deals with all of its major creditors, except for Franklin, which took Stockton to trial.
Franklin Templeton Investments attorney James Johnston said during opening trial statements in May that it is being offered 1 cent on each dollar for a $35 million loan given to Stockton in 2009 to build firehouses and parks, and to move its police dispatch center.
Johnston told the judge that Stockton struck much more favorable deals with other creditors. The attorney said the city is making a meager comeback, allowing it to pay its debts to the firm.