On March 4, 2019, the California Supreme Court, in Cal Fire Local 2881 v. California Public Employees’ Retirement System,[1] affirmed the lower courts’ determinations that the opportunity to purchase additional retirement service (ARS) credit, also known as “air time” credit, was not a benefit of employment protected by the constitutional contract clause. Therefore, the Court held, the opportunity to purchase ARS credit could be altered or eliminated at the discretion of the Legislature. Because the Court concluded there was no constitutional protection of the opportunity to purchase ARS credit, it did not address whether the elimination of the opportunity to purchase ARS credit was an unconstitutional impairment of public employees’ vested rights.

Background

As outlined in our March 2017[2] and January 2018[3] Client Alerts, this case involved a challenge to the constitutionality of the California Public Employees’ Pension Reform Act of 2013’s[4] (PEPRA) elimination of the opportunity for public employees to purchase ARS credit.  From 2003 until the end of 2012, State employees and other CalPERS members with at least five years of public employment were granted the opportunity to, at any time prior to his or her retirement, make a one-time election to purchase from one to five years of ARS credit.  To acquire ARS credit, the member was required to pay CalPERS an amount equal to the increase in employer liability, to the extent the increase could be estimated from circumstances prevailing at the time the employee exercised the opportunity to purchase the ARS credit. ARS credit gave public employees the ability to acquire “nonqualified” service credit, meaning service credit that did not reflect any type of service.  Therefore, public employees that exercised the option to purchase the ARS credit were able to receive pension benefits calculated on the basis of up to five years more public employment than they actually worked. PEPRA eliminated the purchase of ARS credit by public employees after December 31, 2012.

Plaintiffs, which included Cal Fire Local 2881, a labor association whose members are employees of the California Department of Forestry and Fire Protection (“Cal Fire”), and four individual Cal Fire employees, challenged the elimination of ARS credit, arguing that the opportunity to purchase ARS credit was a vested right protected by the contract clause of the California Constitution. The trial court ruled that the opportunity to purchase ARS credit was not protected by the Constitution and, even if it were, elimination of the opportunity was a permissible modification to the pension plan because it was “materially related to the theory and successful operation of a pension system.” The Court of Appeal affirmed, concluding that the opportunity to purchase ARS credit was not constitutionally protected given the absence of any indication of legislative intent to create a contractual right. It also held that, even if it was constitutionally protected, it was properly eliminated. The California Supreme Court granted review.

Discussion

In reaching its decision, the Supreme Court explained that contract clause protection of the terms and conditions of public employment has historically been the exception, rather than the rule. The Court explained that terms and conditions of public employment are generally established by statute or other similar legislative enactment rather than by contract and, therefore, public employees have generally been held to possess no constitutionally protected rights in the terms and conditions of their employment. Accordingly, the terms and conditions of public employment are generally subject to repeal or revision at the discretion of the legislative body.

The Court explained there are two exceptions to this general rule: (1) contract clause protection applies to statutory terms and conditions of employment when the statute or ordinance establishing the benefit and circumstances of its enactment “clearly evince a legislative intent to create contractual rights,” and (2) protection of certain benefits of public employment by implication.

Looking at the first exception, the Court concluded there was no indication that the Legislature intended to create a contractual right to purchase ARS credit. Plaintiffs argued there was a vested right in the opportunity to purchase ARS credit, and characterized previous case law as finding a contractual right if the “benefits were promised when employees provided service.”  Plaintiffs argued that the language in the statute that stated a member could elect to receive the additional ARS credit at any time prior to retirement by making the required contributions manifested legislative intent to permit existing employees to exercise the opportunity to purchase ARS credit at any point prior to their retirement by (1) working for the five-year period and (2) making the required payments to CalPERS.

The Court rejected Plaintiffs’ argument. It explained that the language, read in the context of the remainder of the statute, simply established that the one-time election to purchase ARS credit could be made at any point during the employee’s career, and that the election to purchase ARS credit was not complete until the required payments to the pension system had been made. Based on this reading, the Court found the language of the statute did not “clearly evince a legislative intent to create private rights of a contractual nature.” The Court also noted that Plaintiffs pointed to no text, legislative history, or other evidence suggesting that the Legislature intended to make ARS credit an irrevocable feature of employment of then-existing public employees.

The Court then turned to the second exception to assess whether there were any implied contractual rights, and concluded there were no implied contractual rights. The Court explained that the Constitution protects an implied contractual right for public employees to receive statutory pension benefits because such benefits constitute deferred compensation.  However, the Court determined that the opportunity to purchase ARS credit was not a form of deferred compensation.  The Court explained that pension benefits flow directly from a public employee’s service, and the magnitude of such benefits are proportionate to the time of that service.  The Court distinguished the opportunity to purchase ARS credit.  It noted that ARS credit was available at the option of each individual employee, and that it expired upon an employee’s retirement if not taken advantage of. It also noted the amount of service was not relevant to the exercise of the opportunity, and that service beyond the five-year period required to be eligible did not increase or otherwise affect the opportunity to purchase ARS credit.  Unlike pension benefits, “in which a critical determinant is an employee’s term of public employment,” the factor that determined the benefit received was the number of years of ARS credit the employee purchased.  The Court also noted that the opportunity to purchase ARS credit was not different in form than a variety of other optional benefits offered to public employees, such as the option to purchase different types of health insurance, to purchase life and long-term disability insurance, and to create a flexible spending account.  The Court observed that it had never suggested that this type of benefit is entitled to contract clause protection.

The Court further determined there was no other basis for finding implied contract clause protection for the opportunity to purchase ARS credit, and explained that, even if, as Plaintiffs’ argued, the opportunity to purchase ARS credit constituted an offer of a unilateral contract, the Legislature was entitled to revoke that offer as to all employees that had not yet made a written election and made the required payments.

Citing its precedent, the Court also explained that a term and condition of employment that is not otherwise entitled to contract clause protection does not become entitled to such protection simply because it affects the amount of an employee’s pension benefit. While the purchase of ARS credit increased the amount of a pension benefit, it did not affect the amount of the pension that represented deferred compensation.  It was not compensation for public employment.  The increase in pension benefits was a return of the funds used to make the purchase.

Finally, the Court indicated that its determination that the opportunity to purchase ARS credit is not a vested right precluded a re-examination of the “California Rule.”[5]

HOW THIS AFFECTS YOUR AGENCY

This case addressed the limited issue of whether there was a contractual right to purchase ARS credit that was protected by the California Constitution. The Supreme Court found there was no such contractual right.  In addition to finding no indication that the Legislature intended to create a contractual right to purchase ARS credit, the Court’s decision largely focused on the fact that, unlike core pension rights, the opportunity to purchase ARS credit was not granted to public employees as deferred compensation for their work.  Thus, to the extent a pension benefit is not a form of deferred compensation for actual work performed by a public employee, and in the absence of a clear legislative intent to create a contractual right to such benefit, such benefit may be subject to modification or elimination by legislative bodies.

However, as noted, the Court expressly declined to re-examine the California Rule, which generally requires that elimination or reduction of an anticipated retirement benefit must be counterbalanced by a comparable new benefit.

As outlined in previous Client Alerts, there are two other cases pending before the Supreme Court that similarly challenge changes effected by PEPRA. In Marin Assn. of Public Employees v. Marin County Employees’ Retirement Assn.,[6] Division Two of the First District Court of Appeal found that there is no absolute requirement that elimination or reduction of an anticipated retirement benefit “must” be counterbalanced by a comparable new benefit. On the other hand, in Alameda County Deputy Sheriff’s Association et al. v. Alameda County Employees’ Retirement Association et al.,[7] Division Four of the First District Court of Appeal, expressly declining to follow Marin, concluded, citing Allen, that alterations of pension rights, to be sustained as reasonable, must bear “some material relation to a 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 Supreme Court granted review in both Marin and Alameda County, but deferred action in Marin pending the decision in the Alameda County.  According to the Supreme Court’s docket, Marin is holding for the lead case, Alameda County.  The docket for Alameda County indicates that the issue presented is:  “Did statutory amendments to the County Employees’ Retirement Law (Gov. Code, § 31450 et seq.) made by the Public Employees’ Pension Reform Act of 2013 (Gov. Code, § 7522 et seq.) reduce the scope of the pre-existing definition of pensionable compensation and thereby impair employees’ vested rights protected by the contracts clauses of the state and federal Constitutions?” The case is fully briefed, but has not yet been scheduled for oral argument.  Based on the issue presented, the Alameda County case may give the Supreme Court the occasion to re-examine the scope of the California Rule.  If it does, such decision will likely provide guidance on the application of the California Rule going forward, and the extent to which the State and local governments may reduce or eliminate pension benefits.

Thus, until the Court renders a decision addressing the scope and application of the California Rule, the California Rule remains intact.

As in all matters involving interpretation of the law, it is important to secure advice and guidance from your agency’s legal counsel. As always, if you wish to discuss this matter in greater detail, please feel free to contact James R. Touchstone at (714) 446–1400 or via email at jrt@jones-mayer.com.

Information on www.jones-mayer.com is for general use and is not legal advice. The mailing of this Client Alert Memorandum is not intended to create, and receipt of it does not constitute, an attorney-client-relationship.

[1] 2019 Cal. LEXIS 1419 (Cal. Mar. 4, 2019).

[2] Client Alert Vol. 32, No. 7, California Supreme Court to Weigh in on Pension Formula Dispute (Mar. 8, 2017).

[3] Client Alert Vol. 33, No. 1, Panel of First District Court of Appeal Declines to Follow Fellow Panel’s Analysis in Pension Formula Case (Jan. 19, 2018).

[4] Cal. Gov’t Code §§ 7522 et seq.

[5] The “California Rule” refers to the scope of constitutional protections afforded public pension rights by prior Supreme Court decisions, beginning with Allen v. City of Long Beach, 45 Cal. 2d 128 (1955). Generally, the “California Rule” is that public employees enter into a contract with their employers on the day they begin work, and the pension benefits they are offered as part of that contract cannot be diminished, unless replaced with similar benefits.

[6] 2 Cal. App. 5th 674 (1st Dist. 2016).

[7] 19 Cal. App. 5th 61 (1st Dist. 2018).