Stockton Tests Legalities of City Bankruptcies

By Dennis Cauchon and Judy Keen, USA TODAY

The bankruptcy of Stockton, Calif., could be the crucial test case that determines whether local governments can use the federal courts to shed burdensome retirement benefits in a way that corporations often do.

The struggling city of 291,000 has been firing police, firefighters and other workers for several years to reduce payroll costs so it can pay retirement benefits and debt. The City Council and city manager decided Tuesday — with regret but little disagreement — that it cannot cut more and, instead, the knife must be taken to pension and health care benefits of former workers.

“We have used every tool in our toolkit to try to resolve our financial situation without going into Chapter 9 (bankruptcy),” says Mayor Ann Johnston. “It truly is bad that we’re in this position, but it’s good that we have a way to resolve our financial situation.”

What’s significant about the Stockton bankruptcy is that a substantial-sized city is confronting head-on a multitrillion-dollar problem facing states, cities and school districts nationwide: unfunded promises for pensions and retiree health care. With unusual frankness, City Manager Bob Deis compares Stockton’s strategy with that of General Motors and American Airlines, recent examples of a decades-old business technique to abandon costly retirement promises by filing for bankruptcy.

“This is a big test case,” says University of Pennsylvania law professor David Skeel. “The conventional wisdom has been until very recently that you can’t touch retirement benefits or labor contracts in bankruptcy court. That conventional wisdom has been rapidly eroding because of the horrendous financial conditions of some cities and the role pensions are playing in the trouble.”

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