State court relaxes ‘California rule’ standard

A California Supreme Court case has relaxed a standard called the "California rule" also used by about a dozen other states to determine the degree to which public employee pension plans for existing employees can be changed, giving employers and states a little more wiggle room to close loopholes.

However, plaintiffs attorneys believe the new standard still will prevent modifications to address rising pension costs or revenue drops. Attorneys for the pension plan defendants, meanwhile, say the court upheld public retirement systems' authority to correct retirement system errors and improve retirement system operations.

Created by a series of California Supreme Court cases over 65 years, the so-called California rule provided that state agencies can change public pension plans to eliminate benefits from existing employees if the employees were provided comparable advantages.

In the latest case — involving the $7.4 billion Alameda County Employees' Retirement Association, Oakland; the $8.9 billion Contra Costa Employees' Retirement Association, Concord; and $896 million Merced County Employees' Retirement Association — California's highest court added a postscript to the rule.

In its July 30 opinion, the court ruled against plaintiffs' argument that the state's pension reform legislation, a law designed to eliminate so-called pension spiking — which is including extra pay elements such as voluntary on-call duty and cashing out unused leave time to compute pension benefits without offsetting advantages — violated the contract clause of the constitution. Public employee unions argued that employees have a right to the benefits that existed when they were hired.

The state supreme court disagreed. The California rule did not prevent the state Legislature from excluding or limiting the inclusion "of additional types of compensation in an effort to prevent perceived abuses of the pension system," the court said.

The California Legislature enacted pension reform laws in 2012 "for the constitutionally permissible purpose of closing loopholes and preventing abuse of the pension system," the court said. "It would defeat this proper objective to interpret the California Rule to require county pension plans either to maintain these loopholes for existing employees or to provide comparable new pension benefits that would perpetuate the unwarranted advantages provided by these loopholes."

The case is the second to come before the state's highest court involving the California rule in the past 18 months. On March 5, 2019, the court ruled against the union representing some California firefighters who wanted to retain the option allowing them to buy up to five years of additional service time, called airtime, to count toward earned retirement allowances. That option had existed before the pension reform law passed.

In that case, the court found the option to purchase airtime was not a protected pension right. However, it declined to rule on the continued application of the California rule.

The court sent the case back to the trial court.

Lawyers agree that the latest decision modified the California rule.

The court's decision "seems to add a little more flexibility to the California rule than we argued existed under the law prior to this decision," said Timothy K. Talbot, a principal at law firm Rains Lucia Stern St. Phalle & Silver PC who represents the Contra Costa County Deputy Sheriffs Association, in an email.

Steve M. Berliner, partner and chairman of the retirement, health and disability practice group at law firm Liebert Cassidy Whitmore, who is not involved in the case, said he sees the decision "as slightly softening the California rule."

The exception to the rule that any change to a vested retirement benefit needs to be accompanied by offsetting benefits "only applies with regard to those changes designed to eliminate loopholes that distort the system and where providing the offsetting benefit undermines the purpose of the change," Mr. Berliner said.

What's more, Mr. Berliner said he does not think this decision will increase efforts to rein in pension costs.

"Public employers have limited rights to make changes," he said. "It would require the state legislature and governor to take an expansive view of this decision and change the statutes to allow for benefit reductions."

The California rule stems from the idea that employees and their employers enter into a contract when they are hired and cutting benefits would violate the contract clause of the state's constitution. About 12 other states follow the California rule's legal approach.

Legal experts are mixed as to how the decision will affect other states that follow the rule.

David E. Mastagni, partner in law firm Mastagni Holstedt, which represents employee organizations and unions including the Alameda County Deputy Sheriffs' Association, wrote in an email: "The court is saying that the Legislature can address perceived abuses, even if it results in a net detriment to some pensioners, while upholding the California rule requirement that otherwise requires detrimental changes to be accompanied with offsetting new advantages."

While many states have adopted the theory that public employees have vested rights in their benefits, they do not necessarily apply the California rule in exactly the same way, Mr. Talbot said.

"I do not know what impact this decision may have on other states that follow the California rule, but presumably it will be considered when ruling on pension cases in their jurisdictions," he said.

Ashley Dunning and Peter Mixon, both partners at Nossaman LLP, a law firm that led representation of the Merced County Employees' Retirement Association and board in the case, said that the decision also affirmed retirement systems' authority to improve their operations.

"The California Constitution expressly affords public retirement boards 'plenary authority, consistent with their fiduciary responsibilities,' to administer the retirement systems they govern," Ms. Dunning and Mr. Mixon said in an emailed alert about the case. "The express grant of authority and discretion means that they may, and must, correct errors and improve operations within the retirement system, after a careful balancing of short and long-term interests of their members and beneficiaries."

Ms. Dunning, who worked on the case, declined to comment beyond the alert.

One of the pension systems involved in the case is waiting to see what happens in the trial court. The Contra Costa Employees' Retirement Association "does not anticipate implementing any changes until after the decision is thoroughly studied and the process continues, as ordered, at the trial court level, which may take several months," according to a statement on its website. Association officials declined further comment.

The case was remanded to the trial court for the court to vacate the judgments entered in each of the three consolidated cases and to conduct further proceedings consistent with the state Supreme Court's decision.

Mike Fara, Alameda County pension plan communications manager, said the fund "respects the California Supreme Court's decision, and we're pleased to have a resolution so the public employees who make up our membership can know what to expect for the retirement benefits they've contributed their pay towards and have earned through their hard work."

Plaintiffs and their lawyers said they are unhappy about the impact of the opinion on the workers involved but pleased that the court upheld the California rule.

"I am disappointed for my clients in this appeal, but thankful that the court upheld the efficacy of the California rule," Mr. Mastagni said. "In recounting and clarifying its prior jurisprudence, this decision in some ways strengthens the California rule."

Mr. Talbot said his client, Contra Costa County Deputy Sheriffs Association, plans to move forward on a separate 2015 lawsuit on the issue. The parties agreed to a suspend the case until a final resolution of the latest Supreme Court case.

Other employee organizations are also considering whether to file their own cases to recoup contributions made by or for the benefit of employees that were based on actuarial calculations that included the costs of benefits they won't be receiving. In a footnote, the California Supreme Court mentioned this argument by the plaintiffs but said it wasn't addressing whether employees might be entitled to a partial refund of their contributions.

"We do not believe the pension systems are entitled to a windfall of contributions and that the contributions should be returned to the employees," Mr. Talbot said in an email. "The Supreme Court acknowledged that such a remedy might be appropriate."