Dentist surgeryBankruptcy Judge Chris Klein recently issued his formal confirmation opinion in Stockton’s Chapter 9 bankruptcy case. While there were no real surprises, the opinion makes for entertaining reading given the Court’s more than serious conclusion that:

…it is doubtful that CalPERS even has standing to defend the City pensions from modification, CalPERS has bullied its way about in this case with an iron fist insisting that it and the municipal pensions it services are inviolable. The bully may have an iron fist, but it also turns out to have a glass jaw.

Colorful language to be sure, but critical for every municipality in California and here’s why. Next time we see a Chapter 9 bankruptcy filing, pensions will be up for negotiation just like every other creditor. No longer will cities be able to avoid dealing with pensions in California out of a fear of facing off with CalPERS and its massive bank account. Judge Klein found that CalPERS, as a pension fund administrator, likely does not have standing to object to or intervene in a Chapter 9 bankruptcy case. This means that pensions are now on the restructuring table, for real. And it also means that the conversation between a municipality and its creditors, employees and retirees just got a whole lot more interesting.

As a result of Judge Klein’s opinion, those cities facing no other option but bankruptcy are in a position to fully negotiate their obligations with all of their creditors and consider whether and what changes need to be made to their pension obligations. Cities now know that CalPERS cannot easily run interference and, as a result, cities can negotiate pension obligations directly with employees and retirees without objections from CalPERS. The bully with the glass jaw lost its seat at the table, to the extent it ever had one.

Judge Klein also shoots down CalPERS assertions regarding its “termination lien” finding that the Bankruptcy Code authorizes the avoidance of statutory liens that are not perfected or enforced at the time of the commencement of the case. So, if a city needs to restructure its pension obligations and does so post-filing, CalPERS’ termination lien becomes a “springing lien”, which cannot be enforced. The key point for municipalities is that the lien can only be avoided if the termination of the CalPERS’ agreements occurs after a bankruptcy filing.

Of course no one wants to impair pensions or any other creditor in a municipal restructuring and we all appreciate that Chapter 9 is not a panacea. It is a process to deal with the challenges of municipal restructuring. Nonetheless, where resources are scarce and there is no way through other than a restructuring in bankruptcy court, Judge Klein’s opinion provides a handy road map of how to put pensions on the bargaining table thus creating a more balanced approach to restructuring. That means pensions get talked about at the front end of the case and not at the back end. It also means a city can tackle its restructuring plan by looking at all of its significant liabilities, including pensions, and develop a plan that really works. This is good news for all creditors because essential parties to a restructuring conversation are now playing with a full deck. Before, pensions were off the table because of a fear of taking on CalPERS on top of all the other challenges being addressed.

It also means that employees and retirees can and should have a seat at California’s pre-bankruptcy negotiating table under AB 506, which provides for neutral evaluation before a bankruptcy filing. As a result, a city considering bankruptcy now has a decent shot of negotiating with all of its critical creditors during the AB 506 process and maybe even a better shot at reaching consensual deals. And AB 506 is now more valuable, thanks to Judge Klein holding early on that creditors, along with the city, have an obligation to negotiate in good faith before filing. Not to mention that a bankruptcy avoids CalPERS’ long feared termination lien.

Now that the impediment of CalPERS has been lifted, all of the parties are free to talk about pensions, along with a city’s other liabilities, early in the process. That levels the playing field for all involved and eliminates what has been a distorted process due to CalPERS’ running interference and refusal to negotiate on behalf of its beneficiaries. Now we know that CalPERS likely does not have standing and that those who are directly impacted by the bankruptcy filing do.  Employees and retirees are represented by their collective bargaining units and there is a long history of retiree committees. If there ever was a hope for reducing the restructuring costs in California, getting everyone to the table early is going to be a big help for cities and for the taxpayers footing most of the bill.