CalPERS may have legal edge in fight with San Bernardino

RIVERSIDE — A federal judge last week rejected a CalPERS request to sue bankrupt San Bernardino for a growing unpaid bill, but gave preliminary support to the argument that the bill must be paid in full before the city can leave bankruptcy.

The widely watched question of whether the bankruptcy will reduce pensions promised retirees or payments made by the city to CalPERS may now turn on the ability of the city to pay.

U.S. Bankruptcy Judge Meredith Jury agreed to a 60-day discovery period sought by CalPERS to probe city finances. City officials said they plan to hire a half-dozen persons to help a skeleton staff provide information to the big pension system.

The judge rejected a CalPERS motion to lift the automatic stay on debt collection imposed when San Bernardino filed for bankruptcy Aug. 1. She said employee pay would be threatened and the attempt to reorganize under bankruptcy law undercut.

Jury said she would be “highly disappointed” if CalPERS sued the city in state court, citing an appeals court decision giving bankruptcy court precedence. A CalPERS lawyer replied that an “end run” is unlikely but left the option open.

The judge indefinitely delayed a ruling on whether San Bernardino is eligible for bankruptcy, a step that would give the city more leverage in negotiations with creditors. She urged the city to begin thinking about an “end game” plan now.

In an emergency filing for bankruptcy, the city said debt deferral was needed to continue meeting payroll. Unlike in the Stockton and Vallejo bankruptcies, San Bernardino stopped making payments to CalPERS.

The city’s unpaid bill to CalPERS, growing at $1.7 million a month, is now more than $8 million. The debt is expected to reach $13 million to $19 million by the end of the fiscal year in June, depending on whether unions agree to pay more toward pensions.

San Bernardino contends that a new city manager and finance officer hired last spring discovered a $19 million general fund cash deficit. The city blames years of overspending, faulty bookkeeping, a weak local economy and the housing bust.

A CalPERS attorney, Michael Gearin, told the court Friday the city has an unexplained $14.7 million cash surplus. He argued that the city could pay its CalPERS bill if ordered to do so by a state court.

In the Vallejo bankruptcy, unions waged a lengthy and unsuccessful court battle to dip into restricted special funds to help close a general fund deficit. San Bernardino already has borrowed $15 million from special funds and is proposing to defer repayment.

The judge told an attorney for the city, Paul Glassman, during a four-hour hearing that CalPERS apparently hopes to discover a “pot of gold” stashed among the city special funds.

Glassman said all of the special fund information is on the city website, except for limited access to the water department. He said the city has borrowed from special funds to survive but cannot simply “raid” them.

CalPERS said the city only produced about a dozen of the more than 50 financial documents requested. During a hearing recess, CalPERS and the city were unable to agree on a discovery plan. They will try again before the next court hearing Jan. 22.

Two other points raised by CalPERS attorneys may have helped persuade the judge, initially concerned about delaying tactics, to agree to a 60-day discovery period for records going back about one year.

A San Bernardino consultant e-mailed a Stockton official about the 90-day mediation with creditors used by Stockton under a new state law before filing for bankruptcy, versus the emergency bypass of mediation chosen by San Bernardino.

A Reuters news story said the city paid $2 million for unused vacation and sick leave shortly before filing for bankruptcy, an action CalPERS said was preferential to insiders. The city said it followed the law as its plight caused a wave of retirements.

In a typical bankruptcy, negotiations with creditors reduce debt. Bond insurers are opposing Stockton’s eligibility for bankruptcy, arguing among other things they are being treated unfairly because the city is not trying to reduce its large CalPERS debt.

CalPERS is contending in the San Bernardino case that the unpaid pension bill is not typical debt because it’s being run up after the city filed a petition for bankruptcy, protected by the automatic stay on debt collection.

The pension bill should be treated as an operating or “administrative” expense that must be paid in full before exiting bankruptcy, CalPERS argues, similar to a requirement in the private sector aimed at preventing erosion of the value of properties in bankruptcy.

The judge said the “800-pound gorilla in the room” is whether there are priority administrative expenses (in this case the pension bill) in a municipal bankruptcy that must be paid in full before the city leaves bankruptcy.

“My preliminary thoughts on that matter is that there are and they do,” said Jury.

The judge said it’s a “staggering concept” if the city is eligible for bankruptcy and tries to put together a plan to emerge. She said it would mean that CalPERS, even if the city debt is deferred, would not be treated as just another creditor.

Before making a decision on the administrative expenses issue, the judge said she wants briefs from both sides. Given a choice by the judge, the city said it preferred to delay setting a briefing schedule.

Glassman said the city is unclear about why legally the unpaid pension bill should be regarded as an administrative expense. He also said part of the pension bill is for debt or “unfunded liability” incurred before the bankruptcy petition was filed.

“It’s a case of be careful what you ask for,” said Glassman. If CalPERS forces a payment the city can’t make, he said, the city might have to reject its CalPERS contract, triggering a debt adjustment and a “catastrophic result” that no one wants.

The judge said the issue of whether some of the unpaid bill was incurred before the bankruptcy petition was filed will have to be sorted later. Earlier in the hearing, she grilled the CalPERS attorney, Gearin, about the unfunded liability.

The attorney had said that if other employers followed San Bernardino and stopped making pension payments questions would be raised about the “soundness” of the pension system.

“Is it ever, quote, ‘sound?’” asked the judge. With or without San Bernardino’s pension payments, she said, CalPERS is “hardly sound” because of huge investment losses during the economic downturn.

The judge said CalPERS seems to have a “continuing uphill battle” to become sound. At the last actuarial valuation, CalPERS had about 70 percent of the assets projected to be needed for full funding over 30 years.

Jury said assuming investment returns averaging 8 percent may be “conservative” over the last century, but over the last four years 8 percent is “optimistic.” CalPERS lowered its earnings forecast from 7.75 percent to 7.5 percent earlier this year.

Gearin said the funding level is a “snapshot” in time that tends to move up and down with the economy, producing a surplus about a decade ago. He said any “pension reform” should be done through the Legislature not the bankruptcy process.

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Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at http://calpensions.com/