Stockton bankruptcy judge’s pedigree, history offer hope

March 27, 2013

By Chris Reed

The stakes are immense in the four-day trial in Sacramento’s federal bankruptcy court this week. The New York Times frames the issue well:

“Wall Street is taking America’s biggest pension fund to court this week, for a long-awaited battle over who takes the losses when a city goes bust — workers and retirees, municipal bondholders, or both.

“Stockton, Calif., declared Chapter 9 bankruptcy last year after suffering one of the country’s sharpest riches-to-rags swings when the mortgage bubble burst. Struggling to stay afloat, Stockton has slashed tens of millions of dollars’ worth of city services — firefighters, senior centers, library programs for at-risk children — and said it would cut its municipal bond repayments to a degree never seen before in a municipal bankruptcy.

“But it has drawn the line at slowing down its current workers’ pension accrual, or cutting the benefits its retirees now receive.”

If judges pay attention to current events and tailor their opinions accordingly — as many legal scholars believe — then Judge Christopher M. Klein could strike a huge blow for pension sanity and for local and state governments avoiding catastrophe. The present status quo of services being scrapped and roads falling apart because of excessive government pension benefits isn’t just unsustainable. It’s horrible governance.

So how will Klein rule? He’s got a J.D. and M.B.A. from the University of Chicago, which is about the best possible pedigree for those hoping he strikes a blow for pension sanity. There’s no university in the nation more known for advocating economically rational, evidence-driven public policy.

And a commercial law expert’s analysis of an early Klein ruling in the Stockton case suggests he doesn’t believe municipal contracts are inviolate at all.

“Like many municipalities (and states, for that matter) Stockton owes its retired employees far more in pensions than it can hope to pay.  …  

“Stockton filed bankruptcy to avoid paying the benefits it had contracted to pay but could no longer afford. But wait, the retirees argued, Stockton is an instrumentality of the State of California and, as we have seen, the U.S. Const. Art. 1, Sec. 10 specifically prohibits the states from messing around with contracts. While admitting that the federal government’s constitutional bankruptcy power can discharge most contractual obligations, the retirees asserted that it cannot be permitted to do so in Stockton’s case without contradicting the constitutional text. The irresistible force meets the immovable object.

“An ingenious argument but Bankruptcy Judge Christopher Klein didn’t buy it. (Judge Klein’s lengthy opinion, Assoc. of Retired Employees, et al. v. City of Stockton (In re City of Stockton) can be found at 2012 WL 3193588.) First, he observed that § 904 of the Bankruptcy Code clearly prohibits the court from granting any interim relief to the retirees. Second, and much more fully reasoned (in anticipation of an appeal, one suspects), Judge Klein concluded that the Bankruptcy Clause in effect trumps the Contracts Clause, at least in this case. In short, the City of Stockton can ‘interfere’ with its ‘Obligation of Contracts'” because the State of California has permitted it to file for relief under Chapter 9 of the Bankruptcy Code.”

Pretty promising. Go, Judge Klein, go.