Calpers pits state court vs federal in San Bernardino bankruptcy

SAN FRANCISCO Tue Dec 18, 2012 4:46pm EST

SAN FRANCISCO Dec 18 (Reuters) - The biggest U.S. pension fund argued in a court filing that its status as a state agency gave it sweeping powers in the San Bernardino, California bankruptcy case and that the federal jurisdiction that applies in bankruptcy should be overridden by the state's rights.

San Bernardino is emerging as a precedent-setting case in determining how creditors, including Wall Street bondholders and retirees, are treated in a municipal bankruptcy.

The California Public Employees' Retirement System latest legal argument, filed late on Monday, contends that bond insurers who are opposing Calpers in San Bernardino are actually supporting its legal position in another big municipal bankruptcy in Alabama.

San Bernardino, a city of 210,000 about 60 miles east of Los Angeles, filed for bankruptcy protection on Aug. 1. Since then, it has halted its bi-weekly, $1.2 million payment to Calpers, saying it wants to defer any payments to the fund until fiscal year 2013-2014.

Calpers says the city is already millions of dollars in arrears, and wants a federal bankruptcy judge to let it sue San Bernardino in state court. No other city in bankruptcy has stopped payments to Calpers, and the courts will eventually have to determine whether pension payments take precedence over other debts in a municipal bankruptcy.

The main question is whether a state maintains elements of financial control over a city or county, once the municipality enters federal bankruptcy court.

Calpers says it is an arm of the state and aims to enforce state law, which requires municipalities that use Calpers as a pension system make payments to the fund. Federal bankruptcy code lets the state enforce its own laws, and Calpers argues that its ongoing payments to retirees since the city declared bankruptcy give it special 'post-petition' rights.

Lawyers for bond insurers in the case want to treat Calpers as a creditor, though. "All that they are raising are claims," said Lawrence Larose, who represents bond insurer National Public Finance Guarantee Corp, a wholly owned subsidiary of MBIA Inc. Because the issue is claims, the federal court should keep control of the process, he said in an interview.

Section 903 of federal bankruptcy code, which sets the limits on court powers, is key. In a municipal bankruptcy case in Jefferson County, Alabama, Larose argued that the limits on court power applied even after bankruptcy was declared.

"In order to protect a state's right to control its municipalities, 903 must be applied to post-petition acts, including bankruptcy court orders," he argued in a Jefferson filing cited by Calpers. Calpers said that argument dovetailed with its own.

"It's a complete red herring," Larose said. Jefferson county involved control of the local sewer system, not a financial claim, he said. In San Bernardino, Calpers is acting as a creditor, not as an arm of the state, he said.

The case is In re City of San Bernardino, U.S. Bankruptcy Court Central District of California, Riverside Division, 12-bk-28006.