Retired police and firefighters from Central Falls, R.I., have agreed to sharp pension cuts, a step thought to be unprecedented in municipal bankruptcy and one that could prompt similar attempts by other distressed governments.
If approved by the bankruptcy court, the agreement could be groundbreaking, said Matthew J. McGowan, the lawyer representing the retirees.
“This is the first time there’s been an agreement of the police and firefighters of any city or town to take the cut,” he said, referring to those already retired, who are typically spared when union contracts change. “I’ve told these guys they’re like the canary in the coal mine. I know that there are other places watching this.”
As cities, towns and counties struggle with fiscal pain, there has been speculation that they could shed their pension obligations in bankruptcy. Some have said it might, in fact, be easier for local governments to drop those obligations than it is for companies, which use a different chapter of the bankruptcy code. Large steel companies, airlines and auto suppliers like Delphi have terminated pension plans in bankruptcy.
“But it’s a fight that municipalities haven’t been willing to fight,” said David Skeel, a law professor at the University of Pennsylvania who writes frequently on bankruptcy.
Municipalities have been reluctant because public pensions are protected by statutes and constitutional provisions meant to make them nearly airtight. And even if the rules could be broken in bankruptcy, that would present a different problem. Local officials who want to cut pensions do not, as a rule, want to shortchange their bondholders for fear of not being able to borrow in the future — yet bankruptcy law requires that both types of creditors be treated equitably.
Rhode Island sought to sidestep the issue with a law that gave bondholders more protections than retirees. Central Falls’s retirees used that issue to gain some bargaining power, extracting a commitment from the state to seek extra money for the next five years. The extra money is not a sure thing, though, and would not cover all the cuts to the retirees over those years.
The last American city to work its way through Chapter 9 bankruptcy was Vallejo, Calif., which finished the process this year. It had to navigate similar stumbling blocks. Initially, it planned to cut its workers’ and retirees’ pensions, but it changed course when California’s giant state pension system, which administered Vallejo’s plan, threatened a costly and debilitating court battle.
Vallejo instead cut pay, health care and other benefits, as well as city services and payments to its bondholders, and left the pensions intact. Even though the bondholders faced a loss, all parties eventually agreed they had been treated equitably, and the state passed a law making it easier for Vallejo to continue borrowing.
The episode strengthened the perception that public retirement plans were unalterable, even in bankruptcy.
“Central Falls is undermining that,” said Mr. Skeel, who wrote about Vallejo’s bankruptcy for a coming issue of The University of Chicago Law Review.
Central Falls had little choice. For years, its government failed to contribute enough to its police and firefighters’ pension fund, and the fund effectively ran out of money this fall. The city, which had also promised the retirees comprehensive health benefits, could not cover the pension and health payments out of its general revenue.
The police and firefighters have known for months that drastic cuts were looming. Last month, the unions representing active workers negotiated new contracts, which called for workers to complete at least 25 years to receive pensions, instead of 20. Workers will also have to meet much more rigorous standards to qualify for disability pensions.
Until now, 60 percent of Central Falls police officers and firefighters have retired on full disability pensions, drawing the inflation-protected and tax-free payments even when they embarked on new careers. One of them, at 43, has become a prominent personal-injury lawyer and can be seen in television ads shooting baskets and pretending to fall down a manhole. That retiree, Robert Levine, a former police officer, said his disability was the result of an on-duty car crash where he was not at fault, and that his pension had been granted lawfully after his condition was certified by three different doctors.
The retirees, who are not represented by the unions, voted in favor of their pension reductions last week. The cuts would be up to 55 percent of each retiree’s benefits, which now vary widely, from about $4,000 to $46,000 a year, depending on final salary, years of service and other factors. A few retirees would give up more than $25,000 a year. Central Falls’s police and firefighters do not participate in Social Security .
The new agreement also reduces the annual cost-of-living adjustments and requires retirees to start contributing toward the cost of their health benefits. But it does not take disability pensions away from retirees — something that could become a sticking point.
In the negotiations, the state’s revenue director promised to seek money from the state — enough to pay most retirees a supplement of several thousand dollars a year for five years.
Having recently enacted a big and painful package of pension cuts for state workers and teachers, Rhode Island legislators say they are in no mood to help a city’s retirees who stripped their own pension fund, often collecting disability pensions when they were well enough to work.
The retirees’ lawyer, Mr. McGowan, won support for the state money by threatening to challenge a state law enacted just before Central Falls declared bankruptcy last summer. The law protects holders of general-obligation bonds issued by Rhode Island and its municipalities by giving them priority in bankruptcy. Without the law, investors could find themselves subject to the same losses as the retirees.
The state law was intended to prevent a contagion effect, in which Central Falls’s bankruptcy would frighten investors away from other cities’ bonds, driving up borrowing costs across the state.
The idea of shielding municipal bondholders during bankruptcy is controversial, however.
“It’s not clear to me that you ought to be protecting bondholders,” said Mr. Skeel. “It seems unfair to me that you’re singling out one type of creditor to bear the burden, and another type not to.”
Mr. McGowan, the retirees’ lawyer, said he had threatened to sue Central Falls’s bondholders on the argument that the state law had given them a “voidable fraudulent transfer”— an abusive deal that could be undone by a bankruptcy court. He said the state did not want such a challenge, so it agreed to push for pension supplements.
Theodore Orson, who represents Central Falls’s state-appointed receiver in the bankruptcy, said negotiations would have been impossible without the law. He said he thought Chapter 9 should be amended to give cities the ability to shield their bondholders if they could show a compelling need to do so. But that would take an act of Congress, and federal lawmakers, at odds over their own debt and deficit, show no interest in taking on the cities’ fiscal woes.
“One thing I think we’ve demonstrated in Rhode Island is, we really have a functional state government,” Mr. Orson said. “We are pulling together and making what we believe to be difficult decisions that you don’t see Congress making right now.”