Tim Reid and Jim Christie, Reuters
Posted: 12/16/2012 03:31:33 PM PST

Special Section: San Bernardino

A high-stakes legal battle has intensified as the largest U.S. pension fund filed court papers denouncing the financially troubled city of San Bernardino for what it called a “sham” bankruptcy and accused the city of “criminal behavior” in withholding payments to the pension plan.

The filing on Friday by the California Public Employees’ Retirement System, or CalPERS, came 10 days after San Bernardino officials traveled to Sacramento to plead with top CalPERS executives for more time to make payments.

At issue is whether the pensions of government workers take precedence over other payments in a municipal bankruptcy – which could have ramifications for municipal creditors, including Wall Street bondholders, as more cities and towns have trouble meeting their obligations.

No agreement was reached at the CalPERS-San Bernardino meeting, and CalPERS officials told Reuters they have little latitude to allow San Bernardino – or any other city that pays into its pension fund – to alter the payment schedule.

San Bernardino officials, for their part, say they also have no alternative – and sorely wish they did.

“Why would anyone put themselves through this level of pain – daily, recurring pain – to perpetrate a sham?” asked City Attorney James F. Penman. “You couldn’t do that and be in good control of your mental faculties.”

Penman said he hadn’t yet seen CalPERS’ most recent filing, but the bankruptcy is filling the minds of city officials.

“For CalPERS, it may be just another issue – we’re one of hundreds of cities they have – but for us, every day that we go into work, every night that we’re sitting at home thinking…there’s an umbrella of sadness over us,” he said, noting he met to discuss the bankruptcy Saturday with two City Council members and planned to meet Sunday night with Mayor Pat Morris. “These decisions are made after a lot of thought and usually a lot of dialogue, and for some of us a lot of prayer.”

In a closely related action, bond insurers who are responsible for the debt of Stockton filed papers in that city’s bankruptcy case denouncing CalPERS’ efforts to be treated differently from other creditors. Stockton has continued to make payments to CalPERS while halting payments to some bondholders.

Both cities filed for bankruptcy in the wake of the housing market bust and years of financial mismanagement, and the two comparatively rare municipal bankruptcy cases are expected to set important precedents as to who gets paid when a government goes broke.

But while Stockton was well prepared when it filed for bankruptcy protection in June, San Bernardino’s finances and government operations are in deep disarray as political factions battle one another, according to an ongoing Reuters investigation. The city filed for bankruptcy on Aug. 1 with no plans as to how it would meet its obligations.

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