California Supreme Court Finds Modifications to CERL Constitutional, But Leaves “California Rule” Intact

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Modifications Are Permissible Under the California Rule

In a unanimous decision, the California Supreme Court held that changes made to the County Employees’ Retirement Law, known as CERL, by pension reform measures that went into effect in 2013 are constitutionally permissible under the California Rule. The reform measures at issue in the decision impact pension benefit calculations for both new and legacy members – generally those establishing membership in a county public retirement system prior to Jan. 1, 2013.

The closely watched and long-awaited decision in the case consolidating actions in Alameda, Contra Costa and Merced counties that challenged implementation of AB 340 – Alameda County Deputy Sheriff’s Association v. Alameda County Employees’ Retirement Association, et al. – was issued Thursday.

The California Rule, historically known as the vested rights doctrine, is a doctrine developed over decades of California case law. It provides that a public employee’s right to accrue a pension on the same, or subsequently improved, terms as were offered to induce the employee to accept public employment becomes vested at the start of employment. Such pension benefits cannot be impaired, except for constitutionally permissible purposes. This principle is rooted in the understanding that the pension benefit constitutes deferred compensation, provided in exchange for services rendered.

Modifications to CERL
The Alameda case arises from one of the few pension reform measures in AB 340 that applies to all members of county retirement systems, including those members who established membership prior to Jan. 1, 2013, or “legacy members.” AB 340, as later clarified by AB 197 (collectively referred to here as “AB 340”), amended Government Code section 31461, a provision of the CERL that applies only to county retirement systems. As amended, section 31461 excludes numerous items of compensation from “compensation earnable” – i.e., compensation used to determine pension benefits – which were previously deemed includable under the holding in the 1997 California Appellate Court decision in Ventura County Deputy Sheriffs’ Association v. Board of Retirement. Specifically, section 31461 excludes the following: compensation deemed to be paid to enhance retirement benefits (e.g., in kind benefits converted to cash, termination pay received prior to separation, and one time payments not made to all similarly situated employees), the cash value of accrued leave except that earned and payable during the final compensation period, payments for services rendered outside normal working hours (e.g., standby pay) and amounts paid after employment termination.

Legacy Member Challenges
In challenging the modifications made by AB 340, the legacy members argued that they had a contractual and equitable right to have the compensation items excluded by AB 340 included in their pension benefit calculations based on settlement agreements entered into with their respective retirement boards prior to AB 340’s enactment. The settlement agreements were made to settle lawsuits brought in the wake of the Ventura decision that challenged the manner in which pension benefits were calculated based on pre-Ventura law. In accordance with the settlement agreements, the retirement systems involved in the Alameda litigation agreed to include previously excluded items in pension benefit calculations. In the alternative, the legacy members argued that they had a constitutional right to receive pension benefits calculated in accordance with the law in effect prior to AB 340.

Court’s Analysis and Holdings
On the contract claim, the Court held that the legacy members have no express contractual right to pension benefit calculations in a manner that is inconsistent with AB 340’s terms. The opinion further indicates that retirement boards are obligated to implement changes in the law enacted by the Legislature. Importantly, the Court states that settlement agreements conferring pension benefits on employees must be interpreted to allow modifications based on statutory changes in the applicable law. Thus, even if the settlement agreements had expressly contemplated their enforcement despite conflicting statutory provisions, the Court indicated that such a provision would have been void. The Court also found that the legacy members failed to establish the elements of an equitable claim, noting that the retirement boards made no representations that the settlement agreements would be enforced even in the case of subsequent statutory amendments that conflicted with the terms of the settlement agreements.

On the constitutional claim, the Court determined that the modifications made to CERL by AB 340 were constitutionally permissible.

First, the Court evaluated whether the modifications imposed an economic disadvantage on legacy members and, if so, whether such disadvantages were offset by a comparable new advantage. On this element, the Court found that, while the pre-AB 340 version of section 31461 was ambiguous, such ambiguity had been resolved by the Ventura decision, which held that compensation earnable includes all non-excluded cash compensation. Thus, the modifications enacted by AB 340 to the CERL would, in fact, result in a decrease in pension benefits for legacy members. As such, the modifications did result in an economic disadvantage to legacy members with no comparable new advantage offered in its place. Finding an economic disadvantage with no comparable new advantage, the Court moved on to the next step of its analysis.

Next, the Court considered whether the modifications were enacted for a constitutionally permissible purpose. In this regard, the Court reiterated that, to be constitutionally permissible, the modification must meet a two-part test. That is, not only must it be for the purpose of keeping the pension system flexible in the face of changing conditions and to maintain the integrity of the system, but it must also be consistent with the intent of the pension system and its successful operation. Here, the Court found that the Legislature’s purpose of preventing pension spiking – the practice of inflating compensation prior to retirement to increase pension benefits – was constitutionally permissible. The Legislature’s purpose was to ensure that pension benefits are earned on the basis of compensation received in the regular course of their employment as intended by the CERL, rather than on the basis of anomalies that result in more generous pension benefits than would have otherwise been earned. Further, the Court found that such modifications had a “material relation to the theory of a pension system” as the Legislature sought to bring a key element of pension benefit calculations – compensation earnable – into alignment with the intent of the CERL.

Finally, the Court noted that a constitutionally permissible purpose alone is insufficient to uphold modifications to a pension benefit. Rather, modifications will be upheld only if it can also be shown that providing a comparable new advantage would undermine, or be inconsistent with, the constitutionally permissible purpose. The Court observed that, while providing a comparable new advantage was not required as a matter of law, the offsetting of a disadvantage by a comparable new advantage is more than optional. In fact, such an exchange is necessary unless providing it would defeat the purpose of the modifications. Here, the Court concluded that providing a comparable new advantage was not required, as doing so would be incompatible with the Legislature’s intent of excluding amounts from pension benefit calculations that were never intended to be included.

The California Rule and What’s Next
While the Court was urged to reconsider the scope of the California Rule, it concluded that it was unnecessary because the changes made by AB 340 to the CERL were consistent with the California Rule.

Looking ahead, the Court’s opinion on four other cases challenging the constitutionality of AB 340 (Marin Association of Public Employees et al. v. Marin County Employees’ Retirement Association et al., Hipsher v. Los Angeles County Employees Retirement Association et al., McGlynn v. State of California et al., Wilmot v. Contra Costa County Employees’ Retirement Association et. al.) remains outstanding. As of now, oral arguments are not scheduled for any of these cases. However, it would be surprising if any of these cases results in a reconsideration of the California Rule, as each is likely to be resolved within the analytical framework applied by the Court in Alameda.

Alameda’s implications for county retirement systems governed by the CERL, its participating employers and its members are certainly significant. However, it has no direct impact on other systems, such as CalPERS, since the challenged provisions are applicable only to systems governed by the CERL. Nonetheless, the Court’s careful analysis and clarification of the comparable new advantage element provide us with further insight on how the Court may rule when it finally takes on the California Rule. For now, public employers should consult with their benefits counsel before considering any changes to pension benefits.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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