8/3/2019 Municipal Pensions at Risk in Chapter 9 Bankruptcy

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Nationwide, the Pew Center on the States estimates a $1.26 trillion funding gap, as of 2009, between the promises states have made for public employees’ retirement benefits and the money set aside to pay forthem. The situation is much worse for retiree health care benefits, since states have saved only about $31

billion, or 5 percent, toward these obligations. As is true for the private sector, public employee retireehealth benefits are “pay as you go” obligations of the employer. 

Municipal plan sponsors may take various steps to reduce this unfunded liability going forward withoutrequiring immediate additional employer contributions to the plan. Ultimately, however, if the plan doesnot have sufficient funds to fund pension benefits for current retirees, then the municipal plan sponsorwill have to raise revenues, cut spending, or face a default on its obligations to retired employees.Because Chapter 9 has been used so rarely, there are many unanswered questions about what can andcannot be achieved in a Chapter 9 bankruptcy.

Mark Johnson, Ph.D., J.D.817-909-0778

mark@erisa-benefits.com 

Consulting services in:

• Fiduciary liability 

• 401(k) and ESOPs 

• Pension benefits 

• Bankruptcy 

• Cash balance conversions 

• Group life & health plans

• Health plan reimbursement • Long term disability benefits 

• Retiree medical plans 

• Severance benefits 

• Survivor benefits 

• Third party administrators 

• VEBA plans 

Municipal Pension Holders at Risk as Chapter 9 BankruptcyFilings IncreaseBy Mark Johnson, Ph.D., J.D.

Jefferson County, Alabama filed the biggest Chapter 9 bankruptcyin United States history on November 9, 2011. The $4 billionfiling covering the city of Birmingham and 658,000 countyresidents far surpassed Orange County, California, the previousrecord holder, which filed for Chapter 9 bankruptcy in 1994 with$1.7 in debt.

The filing raises issues about a local government’s inherentobligation and guarantee to pay its creditors on time. As a resultof filing Chapter 9, Jefferson County was relieved at leasttemporarily from paying most debt obligations and in fact stoppedpaying general debt holders. This situation raises a new andgrave concern for public employees, mainly whether theirpensions are safe from Chapter 9 bankruptcy.

The purpose of Chapter 9 is to provide a financially distressedmunicipality with protection from its creditors while it developsand negotiates a plan for adjusting its debts.

Underfunded pension plans for firefighters, teachers, police, andother municipal employees are increasingly a major considerationin a municipality’s ability to repay its debt. Pensions areconsidered to be underfunded when the accrued liabilities of the

 plan exceed the actuarial value of the plan’s assets.

8/3/2019 Municipal Pensions at Risk in Chapter 9 Bankruptcy

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(Realizing the financial risk inherent in unfunded pension liabilities, many municipalities are moving asquickly as possible to adopt 401(k)-type defined contribution plans in place of traditional defined benefitplans that obligate the municipality to these high future payments.)

Chapter 9 offers a potentially powerful mechanism to assist municipalities in obtaining relief from

creditors and adjusting their debts. The commencement of a Chapter 9 bankruptcy case operates as astay, applicable to all creditors, of most efforts to collect prepetition claims, including attempts to gainpossession of property or enforce contractual rights.

Some jurisdictions view public employee retirement benefits as a property interest and some view them ascontractual rights, both of which may be constitutionally protected. Accordingly, while the automaticstay is in effect, a municipal debtor may assert that it cannot be compelled to honor its obligations toretirees. Finally, the stay may require that pensioners assert their rights in the bankruptcy forum, whichoften is perceived as more “debtor friendly.” 

In the Chapter 9 bankruptcy case commenced by the City of Prichard, Alabama, in October 2009, the stayinitially prohibited the pensioners from prosecuting their preexisting lawsuit that sought, among other

things, to hold certain of the City’s officials liable for breach of fiduciary duty for the poor f inancial performance of the City’s pension fund.

In the Chapter 9 case involving the City of Vallejo, California, the automatic stay allowed the City toreduce retiree health benefits. One of the City’s arguments was that retirees had no vested rights in thehealth benefits since they were negotiated as part of a collective bargaining agreement.

While Chapter 9 is somewhat similar to Chapters 7 and 11, it is significantly different in that there is noprovision for the liquidation of the assets of the municipality and distribution of the proceeds to creditors.

Of course, not all municipalities have the opportunity to avoid their pension obligations. Many statesrequire special authorization for a Chapter 9 filing. As a result, Chapter 9 will not be available to all

municipalities in all states. Even where it is available, Chapter 9 does not provide municipalities with allof the bankruptcy tools that practitioners are familiar with in corporate bankruptcies. When bankruptcy isan alternative, Chapter 9 does not necessarily provide a struggling municipality full immunity from itspension obligations. However, very little experience exists in this area. As a result, how effective these

 bankruptcy tools will be in addressing a municipality’s pension debt is far from clear.

ABOUT THE AUTHOR. Mark Johnson, Ph.D., J.D., is a highly experienced ERISA expert. As aformer ERISA Plan Managing Director and plan fiduciary for a Fortune 500 company, Dr. Johnson haspractical knowledge of plan documents as well as an in-depth understanding of ERISA obligations. Heworks as an expert consultant and witness on 401(k), ESOP and pension fiduciary liability; retireemedical benefit coverage; third party administrator disputes; individual benefit claims; pension benefits in

bankruptcy; long term disability benefits; and cash conversion balances. He can be reached at 817-909-0778 or www.erisa-benefits.com. 

 ERISA Benefits Consulting, Inc. by Mark Johnson provides benefit consulting and advisory services and 

does not engage in the practice of law. January, 2012