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Bankruptcy Law Trumps State Protection of Pensions in City Bankruptcy

Public pensions can be fair game when a city government declares bankruptcy under federal law, the federal judge overseeing Stockton, Calif.’s bankruptcy has ruled.

U.S. Bankruptcy Judge Christopher Klein on Oct. 8 ruled that the U.S. Constitution’s Supremacy Clause trumps California’s public employee retirement law, and that therefore federal bankruptcy and contract law applies to Stockton’s pension fund. That means that the city’s pension debt must be treated in the same way as any other debt and can be adjusted due to Stockton’s bankruptcy.

Klein is not the first to issue such a ruling. On Dec. 3, 2013, Bankruptcy Court Judge Steven W. Rhodes ruled that bankrupt Detroit did not have to honor its pension obligations, noting that Michigan could have guaranteed pension benefits, but did not. At the time, Harvey L. Leiderman, CalPERS’ counsel, argued that Detroit’s bankruptcy and the subsequent treatment of its pension obligations would not be a precedent for the treatment of any municipal bankruptcies in California.

Leiderman based this reasoning on the fact that Detroit city employees’ pensions were protected by a contract, while municipal pensions in California are protected by state law. Now Judge Klein has found that California law is not sufficient to safeguard Stockton’s pension obligations from the reach of federal bankruptcy law.