On July 30, 2020, the California Supreme Court issued its long-awaited decision In Alameda County Deputy Sheriff’s Assn. v. Alameda County Employees’ Retirement Association (Alameda County). The Court’s decision provides important clarification of the so-called “California Rule,” which governs the analysis of public employees’ vested rights to pension benefits.
The Alameda County case involved a challenge to changes to the County Employees Retirement Law of 1937 (“CERL”) enacted as part of the California Public Employees’ Pension Reform Act of 2013 (“PEPRA”). One of PEPRA’s significant changes to CERL was a limitation on “compensation earnable,” i.e., those elements of a public employee’s compensation that could be included in the calculation of pensionable income. Specifically, PEPRA excluded from compensation earnable, any compensation determined by the local retirement board to have been paid to enhance a member’s retirement benefit (known as “spiking”) and any compensation for services rendered outside normal working hours. In addition, unused paid time off, such as vacation and sick leave, and payments made at termination of employment, which often also constitute compensation for unused leave time, can be included in compensation earnable only to the extent the leave time was “earned and payable” in any 12-month period during a final compensation year.
Plaintiffs in the Alameda County case were organizations representing employees in Alameda, Contra Costa, and Merced Counties. They raised two separate challenges to PEPRA’s revision to the definition of compensation earnable.
First, the plaintiff associations argued that over the years various lawsuits brought against the defendant counties had resulted in settlement agreements that provided for a definition of compensation earnable more favorable than that contained in PEPRA. The plaintiff associations argued the counties were obligated to comply with those contractual obligations regardless of PEPRA’s new definition of compensation earnable. The Supreme Court disagreed. It held that county retirement boards are obligated to follow the terms of CERL, as modified by PEPRA, and that county employees had no express contractual right to demand the counties comply with contrary terms in a settlement agreement
Plaintiffs’ next challenged PEPRA’s definition of compensation earnable on the ground it was unconstitutional. The “Contracts Clauses” of the U.S. and California Constitutions prohibit the enactment of laws that result in a “substantial impairment” of contracts, including contracts of employment. As applied to public employees’ pension rights, the constitutional prohibition on impairments of contract rights has led to the formulation of the “California rule.” The origin of this rule dates back to the California Supreme Court’s 1947 decision in Kern v. City of Long Beach, but as noted by the Court in Alameda County, the definitive statement of the rule is set forth in Allen v. City of Long Beach (Allen I):
An employee’s vested contractual pension rights may be modified prior to retirement for the purpose of keeping a pension system flexible to permit adjustments in accord with changing conditions and at the same time maintain the integrity of the system. Such modifications must be reasonable …To be sustained as reasonable, alterations of employees’ pension rights must bear some material relation to the theory of a pension system and its successful operation, and changes in a pension plan which result in disadvantage to employees should be accompanied by comparable new advantages.”
The Court in Alameda County noted that the California rule, as articulated in Allen I, “requires a court first to determine whether the modifications impose an economic disadvantage on affected employees and, if so, whether those disadvantages are offset in some manner by comparable new advantages. The court must then determine whether the government’s articulated purpose in making the changes was sufficient, for constitutional purposes, to justify any impairment of pension rights. Although changes may be enacted ‘for the purpose of keeping the pension system flexible to permit adjustments in accord with changing conditions and at the same time maintain the integrity of the system,’ such changes ‘must bear some material relation to the theory of a pension system and its successful operation.’”
Utilizing this standard, the Court found that PEPRA’s change to CERL’s definition of compensation earnable altered the pre-PEPRA definition of that term. It further found that this change disadvantaged affected employees without providing them with a comparable new advantage. Nevertheless, the Court found PEPRA’s change to CERL’s definition of compensation earnable did not violate the California rule because,
- PEPRA was enacted for the constitutionally permissible purpose of conforming benefits more closely to the theory underlying CERL pension plans by closing loopholes and proscribing potentially abusive practices such as income spiking.
- Contrary to decisions subsequent to Allen I, the Court clarified that when a change to a pension system disadvantages employees, comparable new advantages should (but not must) be provided. It referred to the use of the word “must” in prior cases in conjunction with the provision of comparable new advantages as “inadvertent.”
- By its own acknowledgment, the Court addressed for the first time those circumstances in which a comparable new advantage does not have to be offered when altering pension benefits. The Court ruled that comparable new advantages do not have to be provided when to do so would undermine, or would otherwise be inconsistent with, the constitutionally permissible purpose underlying the modification. The Court found that PEPRA’s change to CERL’s definition of compensation earnable met this standard because it did not change in any fundamental way the implementation of the CERL pension system and it was not enacted to reduce the cost burden of the system on counties, other than incidentally. Rather, the purpose of the change was to define compensation earnable in a way more in alignment with the system’s underlying theory by excluding income designed to artificially inflate a pension benefit and limiting the inclusion of other types of compensation that were reasonably viewed as inconsistent with CERL’s general approach to pensionable compensation. The Court concluded the Legislature was attempting to reduce manipulation and abuse by closing loopholes created by the previous definition of compensation earnable.
The Alameda County decision provides important clarification of the California Rule governing vested rights analyses of modifications to pension benefits. For the first time, the California Supreme Court addressed the conditions under which such changes may be made that disadvantage affected employees without the requirement of offering a comparable new advantage. By so doing, the Court has provided public employers and public pension systems with important new tools to close loopholes within pension systems and, by so doing, reduce the costs of the system.
Questions
If you have any questions concerning this Legal Alert or this or any other labor or employment-related matter, please contact the following from our office or the attorney with whom you normally consult.
David Tyra
dtyra@kmtg.com | 916.321.4594