Stockton filed for bankruptcy at the end of June. San Bernardino followed on Aug. 1. Both blamed the slowdown in the economy, which pushed down tax revenue, and rising costs for pensions, retiree health care and wages, especially for police officers and firefighters.

In the San Bernardino case, Calpers asked a judge to waive a restriction preventing the fund from suing the city in state court, where it would have the chance to force payment.

“The city’s failure to make these contributions is a violation of state law,” Calpers said in court papers.

Seizing Assets
While a city is in Chapter 9, creditors are barred from seizing assets or suing. One exception is for government agencies that are enforcing a law using their police or regulatory powers.

“Simply put, if the city is forced to pay Calpers, the city’s ability to continue to function would be seriously threatened,” San Bernardino officials said in court papers.

In Stockton, Calpers General Council Peter Mixon issued a statement arguing that pensions and other public employee benefits are protected by the California Constitution and have priority over other creditors.

Stockton has an unfunded pension liability of $147.5 million owed to Calpers, according to the city’s bankruptcy petition. The city also owes $124.3 million on pension obligation bonds and about $142 million for various public projects.

Unfunded Pension
San Bernardino, about 60 miles east of Los Angeles, has an unfunded pension liability of about $143 million and is in default on $50.4 million in bonds issued in 2005 to help cover pension obligations, according to court documents and the city budget.
Central Falls, Rhode Island, exited bankruptcy earlier this year after cutting pensions and health-care benefits for retirees. The state sided with bondholders in that case, passing a law that allowed them to put a lien on city tax revenue. The city’s bondholders were paid in full, according to court documents.

Municipal bond investors are watching San Bernardino’s fight with Calpers, partly because so much of the city’s debt is tied to pensions, said Richard P. Larkin, director of credit analysis for Herbert J. Sims & Co., a municipal-bond underwriter in Iselin, New Jersey.

“If Calpers wins, I think people are going to look at bankruptcies for municipalities much more negatively,” Larkin said by telephone. “This is a precedent-setting case, not just in California but nationally.”