Stockton, Calif., has been allowed into Chapter 9 bankruptcy.
Bondholders - or, more aptly, monoline insurance companies - facing what seems to be certain pain, are looking for someone to share in the fun. They believe they have found their victim in the form of Calpers.
Easier said than done.
Calpers is the California Public Employees’ Retirement System, but municipalities can join up and have the state pension fund run their retirement system. While Los Angeles County and other larger municipalities have their own retirement systems, many like Stockton decided long ago to outsource the work to Calpers.
When a municipality joins Calpers, it does  so by way of a contract. It is Stockton’s obligations under this contract that put Calpers right at the head of the list of unsecured creditors, with a claim for more than $147 million.
Bondholders would like that claim to suffer the same fate that they face.
The fight over that would seem likely to arise at the point when Stockton decides to assume its contract with Calpers. If a debtor assumes a contract, it must cure all past defaults, and if that happens, Calpers is happy.
Thus, the bondholders will fight any move to assume.
And indeed, we can expect the bondholders to argue that the contract should instead be rejected and Calpers left to collect its claim for damages for breach of the contract.
That might treat Calpers like the bondholders, although I would note that the pension fund’s claim will be quite large.
As I understand it, termination of the contract simply caps the pension at the point of termination. But the municipality is obligated to make Calpers whole for all pension claims it will have to pay to employees who are in the plan at that point.
Termination basically accelerates the previously amortized payment of the pension obligations. Upon rejection, Stockton would get to pay the Calpers claim in itty-bitty bankruptcy dollars (worth the proverbial 10 cents on the dollar, or whatever the debtor pays its unsecured creditors), but the claim would still be a big number.
That would tend to reduce the bondholders’ recovery further. Presumably they have thought of that. Right
There is a California statute that says that a municipality in Chapter 9 can’t reject its contract with Calpers and can only assume the contract with Calpers consent. But I think we can presume that this is not enforceable.
Why then did I say that the bondholders’ plan might lead to a big Calpers claim
First, California law provides that a municipality’s liability for withdrawing from Calpers is secured by all of the municipal assets. If that lien holds up - the best I can tell, there is essentially no case law on how this lien works - Calpers suddenly jumps ahead of the bondholders.
And then there is the question of sovereign immunity. While the Supreme Court’s case law is a bit unclear on this point, it is not certain that Calpers is bound by the bankruptcy court’s decision anyway, which leads to further imponderable questions centering on the question of whether a plan that Calpers didn’t like would be binding on Calpers.
All of which supposes that Stockton wants to reject the contract and leave Calpers.
It probably doesn’t, because doing so would create a lot of strife with its employees, who are probably already a bit testy. After all, Stockton has already eliminated retiree health benefits and cut employee salaries. Then it has to assume the Calpers contract - or do nothing, which itself raises some more mind-bending questions I’ll save for another day.
The crucial question is whether the bondholders can get the bankruptcy court to force Stockton out of Calpers, perhaps as the price for continuing its Chapter 9 case.
I’d be hesitant to go that route. On a basic level, it would undermine the ability to assume and reject contracts under the Bankruptcy Code. Sure, the Calpers contract involves big dollars, but if the debtor has a good reason to assume a contract, should a judge say “no†simply because without assumption the counterparty would be treated just a poorly as other unsecured creditors That starts to look like the judge is taking over the assumption and rejection power.
Stephen J. Lubben is the Harvey Washington Wiley Chair in corporate governance and business ethics at Seton Hall Law School and an expert on bankruptcy.
