By Tim Reid
RIVERSIDE, California (Reuters) - The bankrupt city of San Bernardino and its largest creditor, the California Public Employees' Retirement System (Calpers), are set for a showdown over the city's $17 million in pension arrears, a important milestone in a case the bankruptcy judge says could set a national precedent.
After a Tuesday hearing in the case, an attorney for the Calpers - America's largest public pension fund with assets of $277 billion - said San Bernardino cannot be allowed to get away with failing to pay the pension fund for an entire year.
San Bernardino stopped paying Calpers its $1.2 million bimonthly employer's contribution for 12 months after it declared bankruptcy in August 2012. Calpers says the city in Southern California owes $17 million, plus growing interest, late fees and penalty payments.
"Calpers can't have cities financing their bankruptcy cases by just stopping making payments," Michael Lubic, an attorney for Calpers, told Reuters. "You can't make not paying Calpers cheap and easy, because then it creates this tremendous incentive for other cities to file for bankruptcy and stop meeting their obligations."
Lubic's comments came as San Bernardino's bankruptcy entered a critical phase: three days of closed-door negotiations with creditors next month, and local elections next week in which two council members and the city attorney, a pivotal figure in the bankruptcy, face recalls.
On October 7, San Bernardino officials handed the federal bankruptcy judge, Meredith Jury, a short "term sheet" containing a draft proposal of how it intends to deal with its creditors.
The judge has ordered all parties to keep contents of the term sheet secret, although it is believed the city's proposals for addressing the arrears to Calpers form a significant element of the plan. Three days of mediation are set for next month in Reno.
The San Bernardino case is taking a much different course than that of Stockton, another California city that filed for bankruptcy last year. San Bernardino stopped paying Calpers, while Stockton has kept current on all payments to the fund.
In its draft bankruptcy plan, Stockton is seeking to lower payments to some bondholders, while maintaining all obligations to Calpers. The fund has supported the city's bankruptcy.
In San Bernardino, the pension fund has fought the city's quest for bankruptcy protection at every turn.
On Tuesday, the judge refused a request by Calpers to appeal her August decision to grant San Bernardino bankruptcy protection directly to the federal Circuit Court of Appeals. But she invited Calpers to appeal the so-called eligibility ruling to the federal District Court.
"I fully understand the importance of this case goes far beyond the city of San Bernardino," Jury said.
Jury said she and other bankruptcy judges were "floundering around" when it came to their eligibility rulings, and she said some clarification of the municipal bankruptcy law - for which there is little precedent - would be welcome.
"It would be useful for the state, and the whole country, if the issue of eligibility goes to an appellate court," Jury said.
In the city of Detroit's bankruptcy case, the question of whether pension benefits can be cut is also a central issue in an ongoing eligibility proceeding.
Calpers administers benefits for over 3,000 city, state and local agencies, or nearly 3 million people. Many California cities are struggling to meet soaring pension costs.
Any final bankruptcy plan for San Bernardino will have to be backed by the city council, but who will be in office when it is finally presented is anybody's guess.
On October 17 two council members were criminally indicted in separate cases. One has since quit, although his name remains on the ballot for mayor next week.
Along with recall petitions against the city attorney and two other council members, three others are in re-election battles and 11 candidates are vying to replace the outgoing mayor.
(Reporting by Tim Reid; Editing by Jonathan Weber and Lisa Shumaker)