San Bernardino municipal officials and bondholders heaved a sigh of relief in bankruptcy court on Friday when Judge Meredith Jury blocked the California Public Employees’ Retirement System (CalPERS) from suing the city in state court for missed pension payments.

Jury said she was inclined to believe city officials who said they didn’t have the money, and critical daily operations would be compromised, if it were forced to pay its $1.7 million-per-month obligation to retired public workers. The city wants to defer payments until at least July 2013.

The immediate question was whether San Bernardino had the money to pay what it owed CalPERS, the nation’s largest public employee pension fund. CalPERS argued yes, that the city was exaggerating its distress and hiding information about its true financial situation. The city had responded to just 11 of 53 document requests from CalPERS, arguing that it was too poor to hire enough people in its Finance Department to do the work. 

The judge ruled for San Bernardino and cast aspersions on CalPERS’ powers of observation. “I don't think there's really anyone in the room who thinks the city isn't broke,” she said.  

The longer term question was whether CalPERS could get in line ahead of unsecured bondholders to collect its debt. Bondholders warned of serious problems if a precedent is set favoring the pension fund. “There’s an awful lot of unsecured bondholders in California,” Matt Fabian, managing director of Municipal Market Advisors, a research firm in Concord, Massachusetts, told BloombergBusinessweek. “If you put pension obligations to CalPERS as secured and senior to unsecured debt, in effect those bonds have been downgraded.”  

CalPERS expressed concern that other cash-strapped cities, including a few that have already declared bankruptcy, might be inspired to withhold payments too, endangering the pension giant’s $241 billion in assets. The judge found that argument reasonable, but not compelling.

However, the pension fund’s big argument was that it had a legal claim backed by state law, not just a contractual agreement with the city. The judge was open to considering that assertion and deferred a decision until later as to whether CalPERS could collect back pension payments.

In the end, CalPERS’ attorneys reserved the right to take that question outside the bankruptcy court if it did not get satisfaction, a prospect that did not please the judge. “I will be highly disappointed if you go to a state court,” she said.

–Ken Broder

To Learn More:  

San Bernardino Wins Partial Victory in Bankruptcy Court (by Ryan Hagen, San Bernardino Sun)

U.S. Judge Rules Against Calpers on San Bernardino (by Jonathan Weber and Tim Reid, Reuters)

CalPERS Not Allowed to Sue Bankrupt San Bernardino (by Phil Willon, Los Angeles Times)

Calpers Seeks to Sue San Bernardino Over Pension Payments (by Steven Church and James Nash, BloombergBusinessweek)