The ruling is based on the legal principle that the U.S. Constitution grants exclusive authority to Congress over bankruptcy matters and that federal bankruptcy laws preempt a state statute enacted in 1982 to prevent just this result.
Quoting the English idiom “in for a penny, in for a pound,” the Judge said while the state legislature could decide whether its local governments could seek Chapter 9 bankruptcy protection, but that once it allowed it the state could not condition that authorization as it had done in the 1982 statute to prevent the impairment of CalPERS contracts. The Court further said that the payments to CalPERS required by the contracts were “unsecured” obligations of the debtor (city of Stockton) and were therefore dischargeable in bankruptcy in the same manner as other similar unsecured obligations.
Enacted in 1982, Government Code Section 20487 reads as follows:
Notwithstanding any other provision of law, no contracting agency or public agency that becomes the subject of a case under the bankruptcy provisions of Chapter 9 (commencing with Section 901) of Title 11 of the United States Code shall reject any contract or agreement between that agency and the board pursuant to Section 365 of Title 11 of the United States Code or any similar provision of law; nor shall the agency, without the prior written consent of the board, assume or assign any contract or agreement between that agency and the board pursuant to Section 365 of Title 11 of the United States Code or any similar provision of law.
Judge Klein emphasized, in fact, that the provisions of Section 365 of Title 11 of the United States Code (or the Bankruptcy Code) referenced in the above state statute is the heart of the entire Bankruptcy Code, and it would be unconstitutional for the state legislature to restrict it.
The judge did not order the city to modify its plan of adjustment to reduce its payments to CalPERS but indicated he would decide on the merits of the city’s plan of adjustment in the bankruptcy proceeding on Oct. 30. He also stressed repeatedly the city could revise its proposed plan at any time before he issues his ruling, leaving the door open to continued negotiations by the parties if they so choose.
While Moody’s rating agency indicated today that Judge Klein’s ruling could, if upheld on appeal, “lead some other financially stressed municipalities to consider bankruptcy as a way of trimming unaffordable and growing pension burdens,” the League suspects the devastating effects of a mass exodus of talented city staff if a city is forced to impair their pension agreements may instead act as a deterrent to filing future Chapter 9 actions.