Capitol recap: how would pensioners be treated in a municipal bankruptcy?

Short answer: it depends on the judge.

Some legal scholars have long held that a bankruptcy judge can cut pension benefits because that’s a debt adjustment—not a contract-impairing law, which is banned by the state constitution.  Case law has expanded that constitutional prohibition as one on “statue, ordinance or other, similar action” infringing on a contract.

But the question comes up again in Pennsylvania with the state Auditor General’s bankruptcy predictions for the city of Scranton, based on projected exhaustion of city pension funds within five years. Public officials facing rising pension costs—both short-term and long-term—say they fear more cities will follow. 

On the national stage, two recent municipal bankruptcy rulings approved pension cuts. There are appeals pending in Detroit, but retired city workers started getting smaller pension checks six weeks ago. If it remains in place, that’s the first pension reduction since Central Falls, R.I., in 2011, of nearly 600 municipal bankruptcies in U.S. history. The city of Stockton, Calif., cut health benefits to retirees, but opted to maintain cash payments despite court authorization – which was upheld in March – to reduce those as well.  

Pennsylvania precedent

Pennsylvania’s never had a municipality go through bankruptcy.

Three of four attempted filings have been rejected because the state didn’t give its requisite permission, and the other one was settled before the bankruptcy court decided whether to hear the case. State approval could come from the Department of Community & Economic Development, maybe based on the recommendation of the state-appointed official overseeing a cash-strapped community’s recovery through Pennsylvania’s Act 47 program intended to stabilize financially distressed municipalities.

State guidelines list a few other circumstances that justify a municipal bankruptcy filing, including the failure of elected officials to approve an Act 47 plan.

But that scenario didn’t hold up for Harrisburg, where City Council rejected proposed Act 47 plans and then filed a bankruptcy petition without a recommendation from then-coordinator David Unkovic, who later became the city’s first receiver.

The bankruptcy court declined to take the case, ruling that all branches of city government had to be on board  – and former Mayor Linda Thompson hadn’t signed on to council’s petition. The decision also upheld a state law passed earlier that year temporarily preventing cities of Harrisburg’s size from filing for bankruptcy.

Harrisburg ultimately devised an out-of-court restructuring of its nearly $600 million debt.

Scranton has since emerged as the state’s most likely candidate for bankruptcy.

Pennsylvania possibilities

Scranton’s non-uniform and police pension funds are expected to run out of money within three years; it’s firefighters’ retirement fund, within two years after that.   The city would then have to start paying pensions with money from the general fund.

That won’t last long, given the city’s financial situation, so the city’s considering selling assets. Pittsburgh got cash from a parking fund to avoid bankruptcy when its pensions obligations brought it to the brink in 2009; Allentown brokered a sewer system transfer last year to buoy its pension funds by $211 million. An asset sale would buy Scranton time. But the cash will run out eventually, and borrowing prospects are unclear at best, given the city’s market access has been worsening considerably since at least 2012.

Any implications?

Some argue the potential for considering pensioners as creditors has always been the same: possible, but a last resort for judges.  And the Detroit and Stockton cases don’t affect Pennsylvania cities any more than Central Falls might.

Well, not much more, at this juncture.

A Pennsylvania bankruptcy judge isn’t forced to do anything by either ruling, according to Juliet Moringiello, a bankruptcy law professor at Weidner Law School’s Harrisburg campus. Stockton’s ruling simply reinforced the supremacy of federal bankruptcy code to state law, Moringiello says.

So did the Detroit decision. Judge Steven Rhodes’ ruling also addresses the contract-protective provisions in Michigan’s constitution, similar to what Pennsylvania has.

Rhodes says this constitutional component indicates citizens’ will, so pensions should be give special consideration by the court.

Meaning, cutting them should be a last resort.