by Partners Linda Ross and Jon Holtzman
The long-awaited Alameda County Deputy Sheriff’s case has now been decided by the California Supreme Court. The case is the second of two cases the Court agreed to hear addressing changes to pensions made by the Legislature through the Public Employees’ Pension Reform Act (PEPRA), which became effective in 2013. PEPRA spawned numerous lawsuits asserting that various of its provisions violated the “vested rights” of active employees. On March 4, 2019, the Supreme Court decided the first of the cases, Cal Fire, in which the Court held the ability to purchase credit for service not rendered (“air time”) in the CalPERS system was not a vested benefit. That decision was based, in large part, on a determination that the legislation originally authorizing air time did not give CalPERS members a contractual right to the benefit. The Court did not reach the issue of whether the so-called California Rule – the controversial rule that unions argued meant that the future benefits of current employees cannot be changed – in fact protected future not-yet-earned benefits.
In the Alameda County case decided on July 30, 2020, the California Supreme Court upheld the sections of PEPRA that outlawed forms of pension “spiking” in county pension systems regulated by the ’37 Act (CERL). In the process, the Court limited the California Rule in a variety of helpful ways, but ultimately found that the case did not present an opportunity to “revisit” the California Rule itself. This has left pension reformers and unions scouring the Court’s nearly 100-page decision for clues as to how it would rule if, for example, the legislature reduced benefit formulas of current employees because they could no longer be supported economically due to a major recession. Much of the Court’s discussion, which in legal terms is referred to as “dicta,” may or may not guide a future court the next time it rules on a vested rights challenge involving pensions. However, as a practical matter, with this decision, it is likely the Supreme Court is done with the California rule in the context of pensions until the next major pension reform comes from the Legislature or the voters. Although the Court has “held” two decisions addressing forfeiture of pensions by felons, those cases are likely to be sent back to lower courts to resolve. In short, we could be waiting a long time for a case that brings further clarity about the continuing vitality and scope of the California Rule.
The “Spiking” Practices at Issue
The Court addressed a number of different practices that were banned by PEPRA, all of which have the effect of increasing pensionable compensation:
Termination pay – one-time cash payments of unused leave time, paid upon retirement, beyond amounts that would otherwise be earned and payable in the final compensation period. The Court held that CERL had never permitted this type of pay to be pensionable, and thus there was never a vested right to it.
Cash outs of vacation or sick pay – beyond the amounts earned and payable in the final compensation period. The Court held that under the Supreme Court’s 1997 opinion in the Ventura case, this type of pay, because paid in cash, was pensionable under CERL, and thus a vested right. However, the Court also held that the state legislature had the authority to modify this vested right, and prohibit the inclusion of this pay in pensionable compensation, “for the constitutionally permissible purpose of closing loopholes and preventing abuse of the pension system ….” The Court also held that the PEPRA amendments prevent the practice of “straddling” under which an employee chooses a final compensation period that straddles two calendar years to obtain credit for two cash outs.
On call pay – pay for additional services performed outside normal working hours. Similarly, the Court held that on call pay was pensionable under Ventura, and thus a vested right, but again that the state legislature had the authority to modify CERL and prohibit its inclusion for the permissible purpose of closing loopholes and prevent abuse.
Pension enhancements. The Court also upheld the elimination of pay made to “enhance a member’s retirement benefit, such as cash paid in lieu of an in kind benefit, one time or ad hoc payments, and payments paid solely due to termination of employment. Again, the Court found that this section “is intended to prevent various forms of manipulation.”
Limits on the California Rule:
Comparable advantage. Historically, public employee unions have argued that any attempt at pension reform had to provide a comparable advantage to offset any disadvantage. The Court rejected this argument, holding that the law “requires the level of pension benefits to be preserved if it is feasible to do so without undermining the Legislature’s permissible purpose in enacting the pension modification.” In this case, the Court held that providing a comparable advantage was not required because it would eliminate the Legislature’s permissible purpose — to end loopholes that were distorting the pension system. This holding is a major victory against a rule that unions had illogically argued would require public agencies to compensate employees for pension changes that were designed to stop employees from being unjustly enriched.
Permissible modifications. For the first time, the Court provided substance to the long standing rule that pension modifications are permissible if they “bear [a] material relation to the theory of a pension system and its successful operation.” The Court stated that the legislative amendments at issue were “designed to limit pension spiking, the manipulation of compensation to artificially increase a pension benefit.” The Court held that this legislative action, which was intended “to align the express language of a pension statute more closely with its intended manner of functioning directly relates to both the theory of a pension system and its successful operation.” This holding may have other future applications.
Cost considerations. Many have read prior Supreme Court opinions to reject the argument that the financial burden of pensions on public entities can be a legitimate reason to reform pensions. However, in this case, the Court did not foreclose that argument. The Court described one of its prior opinions as simply rejecting, as “speculative,” a City’s “hypothetical prediction of costs so great as to lead to the pension system’s abolition.” And importantly, the Court identified, as a reason to uphold the anti-spiking law, that “it serves to maintain the system’s financial integrity and discourage gamesmanship in the management of compensation practices.” (Emphasis added.) Bottom line – financial considerations may not be automatically foreclosed and may be a factor in the future.
Prospective changes. Although the Court rejected the argument that “prospective” changes in pension benefit formulas were immune from contracts clause protection, the Court suggested that a truly “prospective” modification would be one “that applies only to pension rights accrued after its effective date while preserving unchanged the law applicable to pension rights accrued prior to that date.” Although the Court also stated, in a footnote, that it did not mean to suggest that such a change automatically would be lawful, this may be an open issue. This is potentially important because all of the debate over vested rights has been focused on “prospective benefits” – benefits of current employees that have not yet been earned through service. Depending on how the Court views what constitutes a truly prospective benefit, this dicta could provide an opening in the future.
On the surface, this decision, like the Cal Fire decision before it, is a victory for modest pension reform. After CalFire, in truth, few pension insiders expected the Court to take on the California Rule wholesale. But, taken together, Cal Fire and Alameda all but guarantee that any future pension reform that affects current employees will be on legally uncertain ground – ground that will not be solidified until, many years after the reform, the Supreme Court once again considers this issue. If pension plans, and the agencies that contribute to these plans remain solvent, that may be all we need. But, if, as some have predicted, pension plans start losing money, or, as we have already seen due to Covid, public agency revenues dry up, the uncertainty left by the Supreme Court means any potential voices of reform will be proceeding at their own risk with little guidance they can “take to the bank.” If the economy turns bad, it will be hard enough for reform advocates to talk about touching pensions.