In a blow to CalPERS, a federal bankruptcy judge has ruled that Stockton may reduce its pension payments to California's massive public pension system and use the money to pay other creditors.
It is a landmark finding that could resonate in bankrupt San Bernardino and in other debt-stressed California cities, prompting them to look to the bankruptcy courts to reduce pension obligations.
Bankruptcy Court Judge Christopher Klein ruled Wednesday that federal bankruptcy law permitted Stockton to reduce the $29 million Stockton pays each year to the California Public Employees Retirement System and use part of that money to pay other creditors.
At the heart of the debate is whether a city's promise to pay a pension to a public employee has a greater legal protection than any other contract a city might enter. Klein's ruling appeared to put pension administrators like CalPERS on an equal footing with other creditors.
CalPERS spokeswoman Rosanna Westmoreland said the ruling was not legally binding on the parties in the Stockton bankruptcy case.
"What's important to keep in mind is what the city of Stockton stated in court today: that they can't function as a city if their pensions are impaired," Westmoreland said.
An attorney for the city warned that if the court rejected Stockton's bankruptcy plan, pensions could be cut up to 60 percent, prompting many city workers to quit, undermining public safety and quality of life for residents.
Stockton, an inland port city east of San Francisco, declared bankruptcy in 2012 to restructure some $900 million in debts. In its plan to emerge from bankruptcy, the city did not propose cutting the $29 million it pays each year to CalPERS.
But Franklin Templeton Investments, another creditor, protested Stockton's bankruptcy exit plan. Over a four-month trial, the firm argued that the city could not settle its $32.5 million debt to the investment firm for pennies on the dollar while continuing to pay millions of dollars in full retirement benefits to former workers.
CalPERS argued that the state constitution prevents Stockton from cutting city pension payments. It said CalPERS is a state agency and immune to cuts. It is the nation's largest pension agency, serving Stockton's employees and some 1.6 million other public workers.
Pension guarantees had long been seen as untouchable, even when cities run into financial trouble. Several states, including California and Michigan, have laws protecting public employee pensions from reductions. But those protections appear to be crumbling.
A bankruptcy judge in December ruled that Detroit -- the nation's largest city to declare bankruptcy -- could reduce what the city owed in pensions even though the Michigan state constitution expressly protects pension payments. In June, employees voted their approval of pension benefit cuts.
San Bernardino declared bankruptcy in 2012, soon after Stockton. It is unclear how the ruling will affect its emergence from bankruptcy. In June, San Bernardino and CalPERS reached an interim agreement over the city's $16.5 million debt to the pension administrator, the San Bernardino Sun reported, however, details have not been made public.
San Bernardino's city attorney and other officials were in a bankruptcy mediation meeting Wednesday and not available to comment how the judge's ruling might change their financial plans, said spokeswoman Samantha MacDonald. Stockton city officials were not immediately available for comment.