DON THOMPSON
Associated Press

SACRAMENTO, Calif. (AP) — U.S. bankruptcy law allows the California city of Stockton to cut pension benefits because it can treat its obligations to the public retirement fund like other debts, a federal judge said in a ruling that could help clarify who gets paid first by financially strapped cities around the nation — pension funds or creditors.

Stockton argued that it must make its pension contributions for public employees before its creditors are paid the entire amount they are owned.

U.S. Bankruptcy Judge Christopher Klein ruled Wednesday that federal law and the U.S. Constitution trump special protections that attorneys had argued protects the inland California city’s contract with the nation’s largest state pension fund, the California Public Employees’ Retirement System.

The ruling, which is likely to be appealed, was prompted by a key creditor’s contention that pension obligations should be treated like other debts. Franklin Templeton Investments said the pension payments are fair game as it tries to collect on an unsecured $32.5 million claim against the city, which is about 80 miles east of San Francisco.

Klein said he would announce his decision Oct. 30 on the city’s overall plan to leave bankruptcy and the contention by the investment firm.

If the judge rules against the city’s reorganization plan and forces the city to end its CalPERS contract, Stockton bankruptcy attorney Marc Levinson said employees of Stockton could be forced to take a 60 percent pension “haircut.”

The city’s plan calls for continuing full payments to the state’s pension giant. If the plan is approved by Klein, his ruling on treating pension payments like other debts would have no practical effect, CalPERS attorney Michael Gearin told reporters.

Stockton can afford to pay Franklin Templeton in full over 30 years even if it also keeps making its pension payments, Franklin Templeton Investments attorney James Johnston told Klein.

Stockton, an inland port city of about 300,000 people, became the largest city in the country in 2012 to file for Chapter 9 protection before Detroit made the move last year.

City manager Kurt Wilson said after the hearing that another month’s delay in a final ruling on the city’s future won’t matter as Stockton fights for revival.

Before the recession, Stockton leaders spent millions of dollars revitalizing the downtown area with a new City Hall and building a marina, sports arena and ballpark. The city issued about 3,000 permits annually to build new homes, and it paid police officers premium wages and health benefits.

With the recession, building dried up, and Stockton became ground zero for home foreclosures. Like many residents, City Hall couldn’t pay its bills. The city slashed its budget by millions of dollars and laid off 25 percent of its police officers. Crime soared.

The city wants Judge Klein to approve its plan for reorganizing more than $900 million in long-term debt. Franklin Templeton Investments wants the judge to reject the proposal.

Franklin attorney Johnston said the company is being offered 1 cent on each dollar for a loan given to Stockton in 2009 to build firehouses and parks, and to move its police dispatch center.

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