In the opening skirmish of a battle over how local governments deal with soaring pension costs, America's largest public employee retirement system made clear on Friday it would not tolerate a city deciding to miss a payment.
The California Public Employees' Retirement System (Calpers) told bankrupt San Bernardino it may take legal action to force the city of 210,000 to resume its pension payments. And the $243 billion Calpers even threatened to sever its ties with the city altogether if it continues to be in arrears.
San Bernardino, a city 60 miles east of Los Angeles that has roughly 3,300 of its workers and retired workers in Calpers, has failed to make payments of more than $6 million to the pension system since it declared bankruptcy on August 1.
Calpers, one of the biggest pension funds in the world, serves many Californian cities and counties and has long argued that pension contributions to its fund cannot be suspended, even if a municipal authority is in bankruptcy. The dispute could become a big test case for financially troubled cities and counties in California and other states as they try to curb surging pension costs.
"These payments are required to be made under California law," Calpers said in an e-mail to Reuters. "If Calpers and the city cannot resolve the missed payments, Calpers will assert its rights and remedies available under applicable law."
Calpers spokeswoman Amy Norris said in a telephone interview that if the payments were not made and continued to fall due, "we will pursue collection through legal action."
Ultimately, Norris said Calpers had the right to terminate the city's pension plan. Any assets already in the city's pension fund would be placed in a termination pool, "and retirees' benefits will be reduced."
San Bernardino, which got in financial trouble because of the impact of the housing bust and financial crisis on tax revenues combined with generous pledges to employees when times were good, said in bankruptcy filings that its unfunded pension obligations to Calpers total $143.3 million. Calpers says it uses a different calculation method and pegs the debt at $319.5 million. The debt to the pension fund dwarfs the scale of the city's obligations to other creditors.
San Bernardino is the first Californian authority to hold back payments from Calpers or indicate that it might treat the pension fund like other creditors, including bondholders and insurers, during a municipal bankruptcy process.
"This is what makes the San Bernardino bankruptcy so fascinating," said Karol Denniston, a San Francisco lawyer who helped draft California's bankruptcy process law.
If San Bernardino and Calpers cannot reach a deal on the city's obligations to the pension fund, the city might move to reject its contract with Calpers under the bankruptcy process and treat it as any other unsecured creditor, she said.
That could mean seeking to reduce its pension obligations to Calpers - a strategy that other cities struggling with pension debts could imitate, Denniston added.
"We don't have precedent here. But if we get precedent that Calpers can be impaired in Chapter 9 that's going to make municipal bankruptcy a very attractive business tool for any city that needs to restructure its debt," Denniston said.
Cities, counties and local governments seeking protection from creditors usually apply for Chapter 9, named for the section of federal bankruptcy law for local governments.
Many cities in California - and throughout the United States - face soaring pension costs. Many municipal workers earn less salary than those in the private sector but receive more lavish health-care and pension benefits. These rose during the years when the U.S. economy was growing at a faster pace, and home prices were booming, before the 2008 financial crash.
Gwen Waters, a San Bernardino spokeswoman, described the failed payments to Calpers as "deferred" and necessary to keep dwindling money available to finance the city's immediate priorities, such as payroll for its workers.
The missed payments could become part of a negotiated plan with Calpers that "can be added to future payments over an agreed-upon number of years," Waters said.
Two other Californian cities - Vallejo, which emerged from bankruptcy in 2011, and Stockton, which is seeking bankruptcy protection - decided to keep current on all payments to Calpers.
Vallejo asked other creditors to renegotiate or reduce their claims, while leaving Calpers untouched. Wall Street bondholders and insurers are already challenging Stockton's eligibility to file for Chapter 9 bankruptcy because it didn't treat Calpers like other creditors.
The case is number 6:12-bk-28006-MJ, United States Bankruptcy Court, Central Division of California, Riverside Division.
(Reporting By Tim Reid, Editing by Tiziana Barghini and Martin Howell and David Gregorio)