Type of reform:
PEPRA amended Government Code section 31461, a provision of the County Employees Retirement Law to fundamentally change the manner in which public pensions are calculated. PEPRA reduced employer contributions, increased employee contributions, and restricted final pay to wages—excluding in-kind payments, accrued unused vacation, and overtime. Specifically, the legislation prohibited the use of standby pay, administrative response pay, callback pay, cash payments for waiving health insurance, vacation, and other pay items from the calculation of members’ final compensation for the purposes of calculating pensions.
Status of litigation:
The cases were filed by employee unions and associations who sought to have the new legislation deemed inapplicable to legacy employees. The plaintiffs asserted that non-wage compensation had always been considered in the calculation of retirement benefits and could not be excluded without violating the plaintiffs’ constitutional rights to vested benefits.
The cases were initially consolidated before Judge David Flinn in the Contra Costa Superior Court in May 2013 under case no. N12-1870. However, Judge Flinn later became aware that the judge in the Marin County case had already indicated his intent to sustain a demurrer to the petition in that action, and the petitioners had sought a writ from the First Court of Appeal. Accordingly, Judge Flinn’s decisions did not apply to the Marin County case.
In Dec. 2013, Judge Flinn preliminarily ruled that payment of unused vacation, personal holidays, and holiday compensation are not to be included in the retirement law’s definition of what compensation is considered for calculating an employee’s pension. But Judge Flinn held that workers who had expected to receive these benefits would be allowed to receive them. Thus, employees who accumulated unused vacation before the law went into effect on Jan. 1, 2013, may be permitted to apply it in calculating their pensions. But going forward, employees cannot apply the terminal pay to their pensions and must use vacation, starting with the oldest accrued unused days first.
On March 7, 2014, Judge Flinn made a final determination that public employees were never entitled to count as income compensation received at termination for unused leave time. On March 18, 2014, Judge Flinn issued a statement of decision to that effect.
On May 12, 2014, Judge Flinn issued a final judgment and stayed the effect of the legislation for 60 days. The plaintiffs appealed in the California Courts of Appeal and sought a further stay pending the appeal. On June 30, 2014, the appeals court denied the further stay. The law went into effect on July 11, 2014.
The appeal proceeded to the California First Court of Appeals, docketed as Case No. A141913. The appeal was fully briefed as of Jan. 22, 2016. The parties requested oral argument in March.
Oral argument was heard on Dec. 12, 2017.
In June 2013, the trial court in the Marin County case sustained the demurrer filed by the Marin County Employees’ Retirement Association (MCERA) without leave to amend and entered judgment against the plaintiffs. The plaintiffs appealed to the First District Court of Appeals, case number A139610.
On Aug. 17, 2016, the Court of Appeals issued a decision affirming the decision of the trial court and finding that “the Legislature did not act impermissibly” when it chose to “exclude specified items and categories of compensation from the calculation of pensions for current employees.” The court held that the legislature had the right to modify the formula for calculating current employees’ pensions:
[W]hile a public employee does have a ‘vested right’ to a pension, that right is only to a ‘reasonable’ pension—not an immutable entitlement to the most optimal formula of calculating the pension . . . So long as the Legislature’s modifications do not deprive the employee of a ‘reasonable’ pension, there is no constitutional violation.
Decision, p. 2.
While the court noted that it was well accepted that a vested pension cannot be impaired, “the governing body may make reasonable modifications and changes before the pension becomes payable and that until that time the employee does not have a right to any fixed or definite benefits but only to a substantial or reasonable pension.” Decision, at 30 (citing with emphasis added Miller v. State of California (1977) 18 Cal.3d 808, 816). Accordingly, the legislature reserved power to make reasonable modifications and changes before the pension has become payable. MCERA’s implementation of CALPRA does not qualify as an unconstitutional impairment of the plaintiff’s contracts of employment and expectation of a “reasonable” and “substantial” pension. The court found there was no violation of the federal and state constitutions.
Yet, the court did note that CALPRA, and MCERA’s implementation of its reforms, were prospective in nature and did not alter the status of compensation or payments accrued prior to Jan. 1, 2013.
On Sept. 26, 2016, four plaintiff labor groups—Marin Association of Public Employees (MAPE), the Marin County Management Employees Association, Service Employees International Union 1021, and the Marin County Department Firefighters’ Association—filed a petition for review of the 1st District Court of Appeals decision to the California Supreme Court. The petition posits that the court of appeals decision was a “frontal assault on a doctrine so well established that it is known throughout the nation as the ‘California Rule’.” (Pet. at 6.) The appellants seek two issues for review: (i) whether a modification resulting in disadvantages for employees be accompanied by an offsetting comparable new advantage; and (ii) whether the petitioners stated a claim for impairment of vested rights in violation of the Contract Clause based upon PEPRA’s reductions to their pension benefits.
Since the unions’ filing of the petition, multiple labor councils and groups have filed amicus curiae letters in support of the petition for review. The case was docketed as case number S237460.
On Nov. 22, 2016, the California Supreme Court granted the Petition for Review. The Court deferred further briefing, however, pending the decision by the First Court of Appeals in Alameda County Deputy Sheriff’s Association et al. v. Alameda County Employees’ Retirement.
On Jan. 8, 2018, Division Four of the First Court of Appeals issued a decision affirming the lower court in part, reversing in part, and remanding for further proceedings with respect to the analysis regarding certain vested pension rights.
At issue in the appeal was whether the implementation of the provisions of the Pension Reform Act of 2013 (PEPRA) by the Alameda, Contra Costa and Merced county retirement boards unconstitutionally deprived public employees in those counties pension benefits to which they were entitled under the prior version of the California Employees’ Retirement Law of 1937 (CERL).
As explained by the Division Four Court, under the provisions of CERL, the administering retirement board must determine what items “of remuneration” paid to employees qualify as “compensation,” (under section 31460) and “compensation earnable” (under section 31461) in order to calculate an employee’s “final compensation” for purposes of his or her pension.
The definition of “compensation earnable,” under the pre-PEPRA version of section 31461 meant:
the average compensation as determined by the board, for the period under consideration upon the basis of the average number of days ordinarily worked by persons in the same grade or class of positions during the period, and at the same rate of pay. (Opinion, p. 3, citing CERL § 34161)
The employee’s “final compensation” is calculated as “the average annual compensation earnable by a member during any three years” prior to retirement. (Opinion, p. 4, citing § 31462).
Under PEPRA, the definition of “compensation earnable” was redefined to exclude various forms of alleged spiking. Thus, final compensation would now exclude unused vacation or other leave in an amount that exceeds the yearly average, payments made solely due to termination but received while employed (called “terminal pay”), overtime, and any payment made to enhance a benefit (including in-kind compensation converted to cash, and one-time or ad hoc payments, etc.).
The Appeals Court examined those four types of employee pay to determine if they had indeed been used prior to PEPRA to calculate final compensation. If not, PEPRA would not have eliminated or affected any pre-existing right to have such pay included in final compensation.
First was unused vacation and other types of leave. The court held that under prior law, the leave benefit was earned at the time it was converted into cash, not at some prior time of accrual. Thus, the PEPRA provision may have changed existing rights. (Opinion, p. 33).
Second was “terminal pay.” The court held that under prior precedent, such pay had never been part of final compensation. (Opinion, p. 35).
Third was overtime of various types. The court noted that overtime pay per se had never been part of final compensation, but other similar items such as on-call and standby pay may have been included as part of normal compensation. (Opinion, p. 42).
Fourth were enhancements to final pay such as one-time payments. The court agreed with the appellants that nothing in prior law allowed the pension board to look at the “employer’s subjective intent” as to whether the payment was made to “enhance” a pension benefit. (Opinion, p. 47). Thus, this new exclusion was a change in law and would have to be reconsidered in light of any potential vested rights to particular forms of payment.
Next, having determined that PERPA changed previous law with respect to on-call pay and alleged pension enhancements, the appellate court then addressed whether such modifications were “reasonable” or whether they unconstitutionally impaired the legacy members’ vested rights. The court reviewed some 60 years of jurisprudence on the scope of permissible modifications, in particular, the holding in Allen v. City of Long Beach (1955) (45 Cal. 2d 128 (Allen I) and the recent decision from Division Two in Marin Assn. of Public Employees v. Marin County Employees’ Retirement Assn. (2016) 2 Cal.App.5th 674, 680-683 (Marin).
Allen I had held that “[t]o 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 to a pension plan which result in disadvantage to employees should be accompanied by comparable new advantages.” (Opinion, p. 53 (citing Allen I at 131.). The Marin court had concluded that the use of the word “should” in Allen I was indicative and it was not mandatory that the reform be counterbalanced with an advantage. Under this theory, the Marin court had held that AB 197 did not unconstitutionally impair Marin County’s legacy members despite not offering a counterbalancing advantage. The appellate court agreed with the Division Two court in Marin on this point. However, it differed from Marin in that it found that, where there were no corresponding advantages offered, the pension modification must be justified under the remaining prongs of the Allen I test. (Opinion, p. 60.) “Thus, when no comparative new advantages are given, the corresponding burden to justify any changes with respect to legacy members will be substantive.’” (Opinion, p. 60 (internal citations omitted).)
Accordingly, the appellate court remanded for the trial court to consider whether the pension modifications were reasonable in light of the particular financial impact of those changes on the legacy members in each county.
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