San Bernadino is Bankrupt ... The Fight Is On Between The State's Public Employees Pension Fund and Lenders ... Who Gets Paid First and Fully Is The Case Before the Bankruptcy Court

The city of San Bernadino, California in effect is bankrupt.

The city can't pay all of its bills, and two very important creditors are fighting it out asking a bankruptcy court to determine which has the higher claim on what money is available to pay the bills owed in the future -- (A) the bondholders who loaned the city money and are contractually entitled to repayment or (B) the California public employees' teachers fund, the pension fund that collects and invests city contributions in order to later pay retirement benefits promised to California's retired teachers. It's a big deal and may help provide answers with respect to where this whole unfunded public sector pension funding issue is going to end.

So let's take a look at what happens when $2 are owed by a city and there's only $1 to pay off the obligation. Which of the two creditors gets the $1, do they split it, or what? What will the court decide?

The city has too much debt, too many pension obligations, too few knowledgeable personnel, an unfriendly state of California state pension plan, upset creditors and a highly confusing bankruptcy situation, to say the least.

Budget Officials Flee San Bernadino Amid Bankruptcy Chaos contains the troubling details:

"Top budget officials in crisis-hit San Bernardino, California, are quitting the city at a crucial juncture in its quest to seek bankruptcy protection.

A rush to the doors in San Bernardino city hall threatens the city's ability to qualify for Chapter 9 bankruptcy protection by robbing it of the people with the experience to answer questions from the court and creditors. If those questions are not answered, the judge could deny bankruptcy protection, experts say.

 

San Bernardino's interim city manager . . . has quit and will start a new job on February 19. The city's finance chief . . . is also expected to leave soon, a source inside the city said. The city's head of human resources has also quit, as has its head of code enforcement. . . .  

 

There are few other, if any, officials with a deep understanding of the city's finances. Their loss calls into question whether San Bernardino has the ability to present a viable plan to satisfy creditors, and a bankruptcy court, that it should qualify for bankruptcy protection. All parties meet in court on February 12 to argue that issue.

 

The . . . officials have been the central figures in overseeing the city's finances since it filed for bankruptcy protection in August, citing a $46 million deficit for this fiscal year and little leeway to make day-to-day wage payments.

 

PENSION FUND FIGHTING BANKRUPTCY

 

The next major decision for the federal judge overseeing the case is whether the city should be granted bankruptcy protection. Such protection safeguards the city from creditor lawsuits until its finances are restructured under the auspices of the court.

 

The city's biggest creditor, California's public employee's pension fund, has opposed San Bernardino's quest to seek bankruptcy protection. Without it, the struggling city will likely face multiple lawsuits in state court for unpaid bills, at a time when its officials say it can barely make payroll. . . . 

 

San Bernardino, a city of 210,000 about 60 miles east of Los Angeles, avoided any discussions with creditors by declaring a fiscal emergency in July.

 

SITUATION A 'LEGAL DISASTER'

 

Losing its top two budget officials at such an important stage will only add to San Bernardino's difficulties to achieve bankruptcy protection, said Karol Denniston, a municipal bankruptcy expert with Schiff Hardin in San Francisco.

 

"This is a situation with all the makings of a legal disaster, because the expectations are that a judicial process can sort out the unsortable," Denniston said.

 

"The court cannot determine (bankruptcy) eligibility if creditors have not been given sufficient information. Now we have a lack of staff. There is insufficient money," Denniston said, adding that the city has so far failed to come up with a convincing bankruptcy plan.

 

Michael Sweet, an attorney with Fox Rothschild, said if there are not the people on the ground to provide information about the city's finances, then outside experts will have to be hired to tell the court exactly what the city's assets and liabilities are.

 

The case is emerging as a landmark legal battle because the city has taken the unprecedented step of halting payments to Calpers, America's biggest public pension fund.

 

Because of that move, San Bernardino is potentially testing whether the pensions of government workers take precedence over other payments in a municipal bankruptcy, which could have ramifications for other creditors, including Wall Street bondholders, as more cities and towns have trouble meeting their obligations.

 

The city has not made its $1.2 million twice monthly payments to Calpers since it filed for bankruptcy last August. It now owes at least $10 million to the pension system in addition to a long-term debt that the city pegs at $143 million."

 

Summing Up 

 

San Bernadino's bankruptcy filing may provide the answer to at least one very big question: Among a bankrupt city's equally placed general creditors, which creditors are in fact going to be treated as more equal than others, if any? Pension funds and pensioners, for instance.

 

In other words, who has the priority and will be paid when funds are limited --- will payments and available funds be used to pay pensioners or will the city's other general creditors and bondholders be prioritized over those pensioners?

 

Because if the pensions take priority, then cities in the future will be hard pressed to get anybody to loan them money at anything approaching reasonable interest rates.

 

If there's a risk of not being paid, future would-be creditors will simply decide not to take that risk.

 

So either way the case is resolved the good people of San Bernadino will lose. It's just a matter of which good people of the city will lose the most. That's what is yet to be determined.

 

The bankruptcy court will make that simple judgment call, and then all hell will break lose --- at least somewhere and perhaps in lots of places.

 

Stay tuned.

 

Thanks. Bob.