By Tim Reid and Peter Henderson
LOS ANGELES | Wed Nov 28, 2012 4:31am EST

(Reuters) – America’s biggest public pension moved aggressively against the bankrupt city of San Bernardino, California, on Tuesday night over the city’s decision to halt payments to the fund.

The move laid bare a high-stakes battle shaping up between Wall Street and state pension funds over how they are treated when cities run out of money.

The powerful California Public Employees’ Retirement System (Calpers) filed a legal motion declaring its intention to sue San Bernardino for millions of dollars in pension arrears, a move that the fund has never before had to make in a municipal bankruptcy.

San Bernardino, a city of 210,000 about 60 miles east of Los Angeles, filed for bankruptcy protection on August 1. Since then, it has halted its bi-weekly, $1.2 million payment to Calpers, saying it wants to defer any payments to the fund until fiscal year 2013-2014. Calpers says the city is already $6.9 million in arrears since August 1.

The San Bernardino bankruptcy is fast emerging as a precedent-setting case over how creditors, especially Wall Street bondholders and insurers, are treated in a municipal bankruptcy, because never before has a city seeking bankruptcy halted payments to Calpers or threatened its historical primacy as a creditor.

Under Californian state law, the contract between Calpers and debtor cities is viewed as inviolate and has been treated as such by state courts. Unlike Calpers, other creditors have historically been forced to renegotiate or forgive debt to debtor cities.

The Californian city of Stockton, also seeking bankruptcy protection, decided to keep current on all payments to Calpers, as did the city of Vallejo, which emerged from bankruptcy in 2011.

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