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Will the California Supreme Court Reform the “California Rule?” – Latest Update

Most pension experts believe that without additional reform, pension payments are destined to put an unsustainable burden on California’s state and local governments. Even if pension fund investments meet their performance objectives over the next several years, California’s major pension funds have already announced that payments required from participating agencies are going to roughly double in the next six years. This is a best-case scenario, and it is already more than many cities and counties are going to be able to afford.

California’s first major statewide attempt to reform pensions was the PEPRA (Public Employee Pension Reform Act) legislation, which took effect on January 1st, 2013. This legislation reduced pension benefit formulas and increased required employee contributions, but for the most part only affected employees hired after January 1st, 2013.

The reason PEPRA didn’t significantly affect current employees was due to the so-called “California Rule,” a legal argument that interprets state and federal constitutional law to, in effect, prohibit changes to pension benefits for employees already working. The legal precedent for what is now called the California Rule was set in 1955, when the California Supreme Court ruled on a challenge to a 1951 city charter amendment in Allen v. City of of Long Beach. The operative language in that ruling was the following: “changes in a pension plan which result in disadvantage to employees should be accompanied by comparable new advantages.

To learn more about the origin of the California Rule, how it has set a legal precedent not only in California but in dozens of other states, two authoritative sources are “Overprotecting Public Employee Pensions: The Contract Clause and the California Rule,” written by Alexander Volokh in 2014 for the Reason Foundation, and “Statutes as Contracts? The ‘California Rule’ and Its Impact on Public Pension Reform,” written by Amy B. Monahan, a professor at the University of Minnesota Law School, published in the Iowa Law Review in 2012.

Pension benefits, most simply stated, are based on a formula: Years worked times a “multiplier,” times final salary. Thus for each year a public employee works, the eventual pension they will earn upon retirement gets bigger. Starting back in 1999, California’s public sector employee unions successfully negotiated to increase their multiplier, which greatly increased the value of their pensions. In the case of the California Highway Patrol, for example, the multiplier went from 2% to 3%. But in nearly all cases, these increases to the multiplier didn’t simply apply to years of employment going forward. Instead, they were applied retroactively. For example, in a typical hypothetical case, an employee who had been employed for 29 years and was to retire one year hence would not get a pension equivalent to [ 29 x 2% + 1 x 3% ] x final salary. Instead, now they would get a pension equivalent to 30 x 3% x final salary.

Needless to say this significantly changed the size of the future pension liability. For years the impact of this change was smoothed over using creative accounting. But now it has come back to haunt California’s cities and counties.

Amazingly, the California rule doesn’t just prevent retroactive reductions to the pension benefit formula. Reducing formulas retroactively might seem to be reasonable, since formulas were increased retroactively. But the California rule, as it is interpreted by attorneys representing public employee unions, also prevents reductions to pension benefit accruals from now on. And on that question, in the case CalFire vs CalPERS, the California Supreme Court has an opportunity this year to make history.

Ironically, the active cases currently pending at the California Supreme Court were initiated by the unions themselves. In particular, they have challenged the PEPRA reform that prohibits what is known as “pension spiking,” where at the end of a public employee’s career they take steps to increase their pension. Spiking can take the form of increasing final pension eligible salary – which can be accomplished in various ways including a final year promotion or transfer that results in a much higher final salary. Another form of spiking is to increase the total number of pension eligible years worked, and the most common way to accomplish this is through the purchase of what is called “air time.”

Based on fuzzy math, the pension systems have offered retiring employees the opportunity to pay a lump sum into the pension system in exchange for more “service credits.” Someone with, say, ten years of service, upon retirement could pay (often the payment that would be financed, requiring no actual payment) to acquire five additional years of service credits. This would increase the amount of their pension by 50%, since their pension would now be based on fifteen years x 3% x final salary, instead of 10 years x 3% x final salary. To say this is a prized perk would be an understatement. How it became standard operating procedure, much less how the payments made were calculated to somehow justify such a major increase to pension benefits, is inexplicable. But when PEPRA included in its reform package an end to spiking, even for veteran employees, the unions went to court.

The spiking case that has wound its way to the California Supreme Court with the most disruptive potential started in Alameda County, then was appealed to California’s First Appellate Court District Three. The original parties to the lawsuit were the plaintiffs, Cal Fire Local 2881, vs CalPERS (Appellate Court case). On December 30, 2016, the appellate court ruled that PEPRA’s ban on pension spiking via purchases of airtime would stand. The union then appealed to the California Supreme Court.

An excellent compilation of the ongoing chronology of the California Supreme Court case Cal Fire Local 2881 v. CalPERS (CA Supreme Court case) can be found on the website of the law firm Messing, Adam and Jasmine. It will show that by February 2017 the unions filed a petition for review by the California Supreme Court, and that the court granted review in April 2017. In November 2017, Governor Brown got involved in the case, citing a compelling state interest in the outcome. Apparently not trusting his attorney general nor CalPERS to adequately defend PEPRA, the Governor’s office joined the case as an “intervener” in opposition to Cal Fire Local 2881. For nearly a year, both petitioners and respondents to the case have been filing briefs.

This case, which informed observers believe could be ruled on by the end of 2018, is not just about airtime. Because whether or not purchasing airtime is protected by the California Rule requires clarification of the California Rule. The ruling could be narrow, simply affirming or rejecting the ability of public employees to purchase airtime. Or the ruling could be quite broad, asserting that the California Rule does not entitle public employees to irreducible pension benefits, of any kind, to apply for work not yet performed.

One of many reviews of the legal issues confronting the California Supreme Court in this case is found in the amicus brief prepared by the California Business Roundtable in support of the respondents. A summary of the points raised in the California Business Roundtable’s amicus brief is available on the website of the Retirement Security Initiative, an advocacy organization focused on protecting and ensuring the fairness and sustainability of public sector retirement plans. An excerpt from that summary:

“The Roundtable brief asserts the California Rule has numerous legal flaws:

(1) It violates the bedrock principle that statutes create contractual rights only when the Legislature clearly intended to do so.

(2) It violates black-letter contract law by creating contractual rights that violate the reasonable expectations of the parties.

(3) It violates longstanding constitutional law by assuming that every contractual impairment automatically violates the California and Federal Contract Clauses.

(4) It lacks persuasive or precedential value. The Rule was initially adopted without anything resembling a full consideration of the relevant issues.

(5) It has been almost uniformly rejected by federal and state courts—including by several courts that previously accepted it.

(6) It has had—and will continue to have—devastating economic consequences on California’s public employers.”

Pension reform, and pension reformers, have often been characterized as “right-wing puppets of billionaires” by the people and organizations that disagree. The fact that one of the most liberal governors in the nation, Jerry Brown, actively intervened in this case in support of the respondent and in opposition to the unions, should put that characterization to rest.

If the California Supreme Court does dramatically clarify the California Rule, enabling pension benefit formulas to be altered for future work, it will only adjust the legal parameters in the fight over pensions in favor of reformers. After such a ruling there would still be a need for follow on legislation or ballot initiatives to actually make those changes.

What California’s elected officials and union leadership, for the most part, are belatedly realizing, is that without more pension reform, the entire institution of defined benefit pensions is imperiled. Hopefully California’s Supreme Court will soon make it easier for them all to make hard choices, to prevent such a dire outcome.

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Edward Ring co-founded the California Policy Center in 2010 and served as its president through 2016. He is a prolific writer on the topics of political reform and sustainable economic development.

REFERENCES

California Government Pension Contributions Required to Double by 2024 – Best Case
– California Policy Center

California Public Employees’ Pension Reform Act (PEPRA): Summary And Comment
– Employee Benefits Law Group

Allen v. City of of Long Beach
– Stanford University Law Library

Overprotecting Public Employee Pensions: The Contract Clause and the California Rule
– Alexander Volokh, Reason Foundation

Statutes as Contracts? The ‘California Rule’ and Its Impact on Public Pension Reform
– Amy Monahan, Iowa Law Review

Did CalPERS Use Accounting “Gimmicks” to Enable Financially Unsustainable Pensions?
– California Policy Center

Cal Fire Local 2881, vs CalPERS (Appellate Court case)
– JUSTIA US Law Archive

Cal Fire Local 2881 v. CalPERS, California Supreme Court, Case No. S239958 – Case Review
– Messing, Adams and Jasmine

Intervener and Respondent State of California’s Answer Brief on the Merits
– Amicus Brief, Governor’s Office, State of California

Amicus Brief of the California Business Roundtable in Support of Respondents
– Amicus Brief, California Business Roundtable (CBR)

RSI Supports California Business Roundtable Amicus Brief
– Summary of CBR Amicus Brief by Retirement Security Initiative

Resources for California’s Pension Reformers
– California Policy Center

 

 

 

California Court Ruling Allows Pension Changes

On August 17, 2016 the First Appellate District Court ruled on the lawsuit brought by the Marin Association of Public Employees against the Marin County Employees’ Retirement Association (MCERA) and State of California. The case was brought after MCERA eliminated pay items considered pensionable following the States enactment of the California Public Employees’ Pension Reform Act of 2013.

The Act mostly just enacted lower benefit formulas for employees hired after 2013. For existing employees, the Act did little of substance other than attempting to eliminate pension spiking, which is the practice of increasing an employee’s retirement allowance by increasing final compensation and including various non-salary items such as unused vacation pay, pay for uniform allowances, pay for equipment or vehicle use, and adding service credit for unused sick time, vacation time or leave time.

The Marin County Employees Association sued claiming they were entitled to those benefits because they were a “vested right” based on the legal theory that once a pension benefit is enhanced it can never be taken away, something commonly referred to as the “California Rule”.

The California Rule has been used for years to prevent the state, cities and counties from modifying pension formulas for existing employees.

The conclusion of the Appellate Court was that the only constitutional protection provided to employees was for a “reasonable” pension and that until the employee retires, their pension benefits are subject to change to keep the plan flexible and that this flexibility is necessary to permit adjustments in accord with changing conditions and at the same time maintain the integrity of the system and carry out its beneficent policy.

BACKGROUND

Each county plan is administered by a retirement board, which is required to determine whether items of remuneration paid to employees qualify as ‘compensation’ and therefore must be included as part of a retiring employee’s ‘final compensation’ for purposes of calculating the amount of a pension.

In the aftermath of the severe economic downturn of 2008–2009, public attention across the nation began to focus on the alarming state of unfunded public pension liabilities. Pension funds for state and local government workers throughout the country are underfunded by approximately a trillion dollars according to their actuaries and by as much as $3 trillion or more if more conservative investment assumptions are used. The Federal government also has $3.5 trillion in unfunded pension liabilities.

The Growing Pension Crisis

The Court in their ruling stated the depth of the pension crisis in California quoting the results of the  Stanford Institute for Economic Policy Research which calculated the total unfunded liability for all pension systems in California.

The Institute determined the California Public Employees’ Retirement System, the California State Teachers’ Retirement System, and the University of California Retirement System, and County systems throughout California had $281 billion in unfunded liabilities assuming a 7.5% rate of investment return. This amounts to $22,000 worth of unfunded liabilities per California household. They also calculated the liability using the same rate of return CalPERS uses if an agency wants to leave their system, which is a 3.7% rate of investment return. This increased the total unfunded liability to $946 billion or $75,000 per household.

It is also important to note that as staggering and unaffordable as these numbers are they do not include the past 2 years of lower than assumed investment earnings. In addition, this debt is interest bearing because it is money that is not in the system earning investment returns. And since there is no money available to pay down the debt (if required to be paid right away it would bankrupt most municipalities) it will be paid back over the next 20 to 30 years at 7.5% interest which will double or triple the actual cost to taxpayers and move hundreds of billions of dollars from taxpayer services to pension costs.

The Little Hoover Commission Report Cited

The court in their ruling also cited the 2011 Little Hoover Commission report which advised the Governor and the Legislature that California’s pension plans are dangerously underfunded, the result of overly generous benefit promises, wishful thinking and an unwillingness to plan prudently and stated unless aggressive reforms are implemented now, the problem will get far worse, forcing counties and cities to severely reduce services and lay off employees to meet pension obligations.

The Commission urged a number of structural changes that realign pension costs and expectations of employees, employers and taxpayers.  The situation was described as “dire,” “unmanageable,” a “crisis” that “will take a generation to untangle,” and “a harsh reality” that could no longer be ignored.

According to the Commission the money coming into the pension funds is nowhere near enough to keep up with the money that will need to go out and stated that the state must “exercise its authority—and establish the legal authority—to reset overly generous and unsustainable pension formulas for both current and future workers.”

To provide immediate savings of the scope needed the Commission stated “state and local governments must have the flexibility to alter future, unearned retirement benefits for current workers.”

One feature of the system that drew the Commission’s critical attention was “pension spiking,” which the Commission defined as the practice of increasing an employee’s retirement allowance by increasing final compensation or including various non-salary items (such as unused vacation pay) in the final compensation figure used in the employee’s retirement benefit calculations, and which has not been considered in prefunding of the benefits. The commission found the practice had become “widespread throughout local government,” and had generated “public outrage that cannot continue to be ignored and pensions must be based only on actual base salary, not padded with other pay for clothing, equipment or vehicle use, or enhanced by adding service credit for unused sick time vacation time or other leave time.

THE LAWSUIT

Reaction to MCERA’s change in policy was almost immediate.  On January 18, 2013, less than three weeks after the Pension Reform Act took effect, five recognized employee organizations and four individuals commenced a legal action against their retirement association MCERA.  Plaintiffs alleged that on December 18, 2012: The MCERA board voted to implement AB 197 effective January 1, 2013 and announced a new policy for the calculation of retirement benefits.

Under the new policy, MCERA would begin excluding standby pay, administrative response pay, callback pay, cash payments for waiving health insurance, and other pay items from the calculation of members’ final compensation for all compensation earned after January 1, 2013.

Plaintiffs prayed for declaratory and injunctive relief that AB 197 and MCERA’s “actions are unconstitutional impairments of vested rights and therefore unenforceable.”

The State of California was granted leave to intervene, as expressly directed by the governor, in order that it could defend the constitutionality of AB 197.

THE PLANTIFFS ARGUEMENTS

The crux of this appeal is whether MCERA may eliminate benefits previously treated as compensation earnable from the calculation of the pension formula for what plaintiff’s term “legacy members”—employees who were hired prior to January 1, 2013.

The second ground for reversal advanced by plaintiffs is that MCERA did not follow the correct procedural requirements of AB 197 for excluding payments made to ‘enhance a member’s retirement benefit.

The court ruled that Section 31542 of the County Employee Retirement Law (CERL) is clearly intended to serve as the mechanism for calculating the pension of an employee about to retire and there is nothing to indicate the statute was intended to govern the situation here—a shift in policy by the retirement board in compliance with a new command from the Legislature, clearly intended to be applied in the future to plaintiffs’ so-called employees when they put in for retirement.

Plaintiffs’ essential position is clearly set out in their opening brief: Public employees earn a vested right to their pension benefits immediately upon acceptance of employment and such benefits cannot be reduced without a comparable advantage being provided.

A corollary of this approach was the employee’s argument that they are entitled to any increase in benefits conferred during their employment, beyond the pension benefit in place when they began and since they are performing work under the improved pension system, the terms of that system become an integral part of their compensation, and therefore immediately become vested in the improved benefit.

Plaintiffs candidly admitted in practice, this means that for existing employees, any changes must generally be neutral with regard to the overall benefit provided and cannot represent a net decrease in the pension benefit.  Less ambiguously, they assert neither MCERA nor the Legislature can now curtail those benefits.

Plaintiffs insist that if their position was not vindicated on this appeal, California will have returned to the view that public employee pensions are mere ‘gratuities’ to be granted or taken away at the whim of the employer.

But the Appellate Court provided a review of principles governing public employee pensions that showed that much of plaintiffs’ reasoning is not controversial, but their ultimate conclusion cannot be sustained. 

 THE APPELLATE COURTS RESPONSE

Some General Law of Pensions States are prohibited by the United States Constitution from passing a law “impairing the obligation of contracts.”  (U.S. Const., art. I, § 10.)  Article I, section 9 of the California Constitution states a parallel proscription: “A law impairing the obligation of contracts may not be passed.”   Public employment gives rise to certain obligations which are protected by the contract clause of the Constitution, including the right to the payment of salary which has been earned. The court ruled that “Earned” in this context obviously means in exchange for services ALREADY performed. In accordance with this view, a pension is treated as a form of deferred salary that the employee earns prior to it being paid following retirement.

The court concluded that an employee does NOT earn the right to a full pension until he has completed the prescribed period of service and although vested prior to the time when the obligation to pay matures, pension rights are not immutable.  For example, the government entity providing the pension may make reasonable modifications and changes in the pension system.  This flexibility is necessary to permit adjustments in accord with changing conditions and at the same time maintain the integrity of the system and carry out its beneficent policy.

REVIEW OF PREVIOUS SUPREME COURT RULINGS

The Supreme Court stated in the Kern v City of Long Beach case (supra, 29 Cal.2d 848, 854.) “the rule permitting modification of pensions is a necessary one since pension systems must be kept flexible to permit adjustments in accord with changing conditions and at the same time maintain the integrity of the system and carry out its beneficent policy.” Thus the Appellate Court ruled it appears that an employee may acquire a vested contractual right to a pension, but that this right is not rigidly fixed by the specific terms of the legislation in effect during any particular period in which he serves.  The statutory language is subject to the implied qualification that the governing body may make modifications and changes in the system and that the employee does not have a right to any fixed or definite benefits, but only to a ‘substantial’ or ‘reasonable’ pension.  There is no inconsistency therefore in holding that he has a vested right to a pension, but that the amount, terms and conditions of the benefits may be altered.”

The Appellate Court also cited Casserly v. City of Oakland (1936) 6 Cal.2d 64 as one of the authorities for the proposition that “it has also been held that a pension could be reduced prior to retirement from two-thirds to one-half of the employee’s salary, and modifications have been approved in some cases when made after the happening of the contingencies upon which the payments were to commence.”

The “Must” versus “Should” Debate

With respect to active employees in the Allen v Board of Administration case the Supreme Court held that any modification of vested pension rights must be reasonable, must bear a material relation to the theory and successful operation of a pension system, and, when resulting in disadvantage to employees, must be accompanied by comparable new advantages.

However, the First District Appellate Court stated they did not believe the word “must” was intended to be given the literal and inflexible meaning attributed to it by plaintiffs.   The Supreme Court in the 1983 Allen opinion cited three decisions as support for the quoted proposition.  The two Supreme Court decisions cited employed the word “should” be accompanied by comparable new advantages; Abbott v. City of Los Angeles, supra 50 Cal.2d 438, 449. It is only a 1969 Court of Appeal decision, which cites the same two Supreme Court decisions that use “must.”

The Appellate Court stated “only the least authoritative of the three sources cited supports the word ‘must,’ while the two Supreme Court decisions employ ‘should.’  Second, barely a month later, the Supreme Court—speaking though the same justice—filed another decision which used the ‘should’ formulation from the 1955 Allen decision as quoted in Abbott.”

The Court went on to say “there is nothing in the opinion linking the reduction to provision of some new compensating benefit.  If the court intended ‘must’ to have a literal meaning, the retirees would have won.  They lost.  In light of the foregoing, the Appellate Court could not conclude that Allen v. Board of Administration in 1983 was meant to introduce an inflexible hardening of the traditional formula for public employee pension modification.”

A New Benefit WAS Provided

The court also determined there was a new benefit provided because MCERA’s change in policy resulted in each of those employees’ paychecks no longer being reduced by deductions to cover those sums in funding the employee’s retirement.  Put simply, the new benefit is an increase in the employee’s net monthly compensation.  Put even more simply, it is more cash in hand every month.

APPELLATE COURT’S CLARIFICATION OF THE “CONTRACTS CLAUSE” OR “CALIFORNIA RULE”

Plaintiffs’ initial premise, and the centerpiece of their oral argument, is that the moment each individual plaintiff commenced working for a public agency in Marin County, that person acceded to a “vested right” to a pension.  To a large extent, that premise is correct.  As already established by Miller, the “right” to a pension “vests” when the first portion of wages or salary already earned is deferred by being withheld for a future pension.  But to call a pension right “vested” is to state a truism.  As one Court of Appeal sensibly noted, “ALL pension rights are vested” in the sense they cannot be destroyed. However, until retirement, an employee’s entitlement to a pension is subject to change short of actual destruction. 

That same Court of Appeal characterized that entitlement as only “a limited vested right” and not every change in a retirement law constitutes an impairment of the obligations of contracts.  Nor does every impairment run afoul of the contract clause.  The United States Supreme Court has observed, although the Contract Clause appears literally to proscribe any impairment, the prohibition is not an absolute one and is not to be read with literal exactness like a mathematical formula.  Thus, a finding that there has been a technical impairment is merely a preliminary step in resolving the more difficult question, whether that impairment is permitted under the Constitution.

Courts Must Determine What is a Reasonable Change

Modifications to pension benefits the court stated must be reasonable, and it is for the courts to determine upon the facts of each case what constitutes a permissible change.  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.

Past court rulings have found that “Reasonable” modifications for future benefits eared can encompass reductions in promised benefits.  These include:

  1. A change of retirement age
  2. A reduction of maximum possible pension
  3. The repeal of cost of living adjustments
  4. A reduction of the pension cap
  5. Changes in the number of years of service required to qualify for a pension
  6. A reasonable increase in the employee’s contributions
  7. A reasonable change in what is considered pensionable compensation

The Court’s ruling stated “thus, short of actual abolition, a radical reduction of benefits, or a fiscally justifiable increase in employee contributions is allowed 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.”

THE COURT’S CONCLUSIONS

The Appellate Court stated that it is without dispute that (1) up to January 1, 2013, there was a contract between MCERA and certain public employees concerning how those employees would be compensated, and (2) that after January 1, 2013, under compulsion of the Pension Reform Act, the agreement was unilaterally altered by MCERA to reduce the scope of compensation that had been accounted as “compensation earnable.”  The issue here is whether the amendment of section 31461—of CERL, the only part of AB 197 challenged by plaintiffs and addressed here—qualifies as an “unreasonable” change, a “substantial” impairment, and thus a violation of the state and federal constitutions. We conclude the dual answer is NO:  MCERA’s implementation of the amended version of section 31461 does not qualify as a substantial impairment of plaintiffs’ contracts of employment with its right to a “reasonable” and “substantial” pension.  Thus there is no violation of the state and federal constitutions.

The Ventura Decision and Changing Pensionable Compensation Post PEPRA

The Supreme Court’s Ventura Decision in 1997 added items to what was considered pensionable pay for counties makes clear that before the Pension Reform Act that compensation paid in cash and which was not overtime was required to be included as compensation earnable.  And while it is true that the retirement boards have some discretion to interpret and apply CERL—this discretion is limited by the contours of the statute and the constitution, including the Contracts Clause.

However, the Appellate Court stated that the “Supreme Court’s discussion of compensation earnable in Ventura County would appear to have little, if any, relevance to the scope and meaning of the subsequently amended language of section 31461 we are considering here.  The utility of Ventura County is also weakened because none of the words ‘constitution,’ ‘contract,’ or ‘impair’ were used in the opinion, so it is no authority for an unchanging constitutional dimension to a statute as substantially amended as was section 31461.  The permanence plaintiffs attribute to MCERA’s exercise of discretion in allowing certain payments to be included in compensation earnable is troubling because it seems to deny MCERA the discretion to change that decision.”

They also stated that “Plaintiffs’ insistence on retaining their claimed ‘vested rights’ measured by the former version of section 31461 and Ventura County has hindered their appreciation of how that right is only to a ‘reasonable’ pension, that the public employee does not have a right to any fixed or definite benefits that may be fixed by the specific terms of the legislation during any particular period.”

“The qualification is a necessary one since pension systems must be kept flexible to permit adjustments in accord with changing conditions and at the same time maintain the integrity of the system. Restricting their unyielding focus to only their “vested rights” has led plaintiffs to pay insufficient attention to the ever-present possibility of legislative involvement, one of the essential attributes of sovereign power that is always to be consulted.”

The Appellate Court thus ruled that an employee does not have a right to any fixed or definite benefits, which can mean that any one or more of the various benefits may be wholly eliminated prior to the time they become payable, so long as the employee retains the right to a substantial pension. 

They went on to say that “plaintiffs have failed to make out a clear case, free from all reasonable ambiguity and reasonable doubt, that they are the victims of a constitutional violation. Put another way, after January 1, 2013, payment of any of the items specified in section 31461, subdivision (b), could not be deemed salary already earned pursuant to a contract that enjoyed constitutional protection.” 

Pension Changes Must Be Prospective

The Appellate Court emphasized the limited nature of their holding stating “the Legislature’s change to the definition of compensation earnable was expressly made purely prospective by the Pension Reform Act and MCERA’s responsive implementation was also explicitly made prospective only and nothing altered the status of compensation or payments accrued prior to January 1, 2013.”

THE BOTTOM LINE

The Appellate Court ruled that as long as they are prospective and reasonable and do not destroy the pension system, the pension changes that can be considered and implemented by governmental agencies may include:

Increasing the minimum retirement age,

Increasing the number of years of service required to qualify for a pension,

Reducing the pension cap as a percentage of salary,

Eliminating retiree cost of living adjustments (COLA),

increasing employee contributions,

Lowering the maximum pension dollar amount; and

Changing what is considered pensionable pay.

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About the author:  Ken Churchill is the author of numerous studies on the pension crisis in California and is also the Director of New Sonoma, a pension reform group.

Court Pension Decision Weakens ‘California Rule’

The one thing some pension reformers say is needed to cut the cost of unaffordable public pensions: give current workers a less costly retirement benefit for work done in the future, while protecting pension amounts already earned.

It’s allowed in the remaining private-sector pensions. But California is one of about a dozen states that have what has become known as the “California rule,” which is based on a series of state court decisions, a key one in 1955.

The pension offered at hire becomes a “vested right,” protected by contract law, that cannot be cut, unless offset by a new benefit of comparable value. The pension can be increased, however, even retroactively for past work as happened for state workers under landmark legislation, SB 400 in 1999. 

Last week, an appeals court issued a ruling in a Marin County case that is a “game changer” if upheld by the state Supreme Court, said a news release from former San Jose Mayor Chuck Reed, who wants to put a pension reform initiative on the 2018 ballot.

Mayor Chuck Reed considered it a “game-changer” when a Marin County Court rejected the rigid interpretation of the California Rule of vested rights, ruling that although an employee has a vested right to a pension, their only right is to a ‘reasonable pension,’ one without benefit spiking

 

Justice James Richman of the First District Court of Appeal wrote that “while 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.

“And the Legislature may, prior to the employee’s retirement, alter the formula, thereby reducing the anticipated pension. So long as the Legislature’s modifications do not deprive the employee of a ‘reasonable’ pension, there is no constitutional violation.”

The ruling came in a suit by Marin County employee unions contending their vested rights were violated by a pension reform enacted in 2012 that prevents pension boosts from unused vacation and leave, bonuses, terminal pay and other things.

These “anti-spiking” provisions apply to current workers. The major part of the reform legislation, including lower pension formulas and a cap, only apply to new employees hired after Jan. 1, 2013, who have not yet attained vested rights.

The California Public Employees Retirement System expects the reform pushed through the Legislature by Gov. Brown to save $29 billion to $38 billion over 30 years, not a major impact on a current CalPERS shortfall or “unfunded liability” of $139 billion.

Similarly, legislation two years ago will increase the rate paid to school districts to the California State Teachers Retirement System from 8.25 percent of pay to 19.1 percent, while the rate paid by teachers increases from 8 percent of pay to 10.25 percent.

The limited teacher rate increase followed the California rule. The new benefit offsetting the 2.5 percent rate hike vests a routine annual 2 percent cost-of-living adjustment, which previously could have been suspended, though that rarely if ever happened.

While mayor of San Jose four years ago, Reed got approval from 69 percent of voters for a broad reform to cut retirement costs that were taking 20 percent of the city general fund. A superior court approved a number of the measure’s provisions.

But a plan to cut the cost of pensions current workers earn in the future by giving them an option (contribute up to an additional 16 percent of pay to continue the current pension or switch to a lower pension) was rejected by the court, citing the California rule.

In a settlement of union lawsuits, Reed’s successor locked in some retirement savings but dropped an appeal of the option. Reed, a lawyer, thinks the California rule is ill-founded and likely to be overturned if revisited by the state supreme court.

He has pointed to the work of a legal scholar, Amy Monahan, who argued that by imposing a restrictive rule without finding clear evidence of legislative intent to create a contract, California courts broke with traditional contract analysis and infringed on legislative power.

“California courts have held that even though the state can terminate a worker, lower her salary, or reduce her other benefits, the state cannot decrease the worker’s rate of pension accrual as long as she is employed,” Monahan wrote.

In the ruling last week, Justice Richman describes the setting for the reform legislation: soaring pension debt after the financial crisis in 2008-09 and a Little Hoover Commission report in 2011 urging cuts in pensions current workers earn in the future.

He cites several court rulings in the past that conclude cuts in pensions earned by current workers are allowed to give the pension system the flexibility needed to adjust to changing conditions and preserve “reasonable” pensions in the future.

Some of the court rulings cited allowed changes in retirement ages, reductions of maximum possible pensions, repeals of cost-of-living adjustments, changes in required service years, pensions reduced from two-thirds to one-half of salary, and a reasonable increase in pension contributions.

“Thus,” Richman wrote, “short of actual abolition, a radical reduction of benefits, or a fiscally unjustifiable increase in employee contributions, the guiding principle is still the one identified by Miller in 1977: ‘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.’”

Richman’s ruling makes several references to a unanimous state Supreme Court decision in 1977 in Miller v. State of California. He said the foundation of the unions’ constitutional appeal is a “onetime variation” in one word in another ruling.

“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 state Supreme Court said in Allen v. City of Long Beach (1955).

Richman said a 1983 state Supreme Court decision (Allen v. Board of Administration) changed “should” have a comparable new advantage to “must,” citing two other State Supreme Court decisions that said “should” and an appeals court decision that said “must.”

In a decision a month later, he said, the Supreme Court used “should” while referring to a comparable new benefit and has continued to use “should” in all rulings since then.

“It thus appears unlikely that the Supreme Court’s use of ‘must’ in the 1983 Allen decision was intended to herald a fundamental doctrinal shift,” Richman said, citing two rulings that “should” is advisory or a recommendation not compulsory.

The 39-page decision written by Richman and concurred in by Justices J. Anthony Kline and Maria Miller makes other points in its rejection of a rigid view of the California rule and pension vested rights.

“The big question for pension reformers is whether or not the California Supreme Court will agree,” Reed said in a news release from the Retirement Security Initiative. “If it does, the legal door will be open for Californians to begin to take reasonable actions to save pension systems and local governments from fiscal disaster.”

There was no immediate word from the Marin Association of Public Employees and other county employee unions last week about whether the appeals court decision will be appealed to the Supreme Court.

About the Author: Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. He is currently a Publisher for CalPensions.com.

The Mechanics of Pension Reform – Local Actions

Part 2 of 2…

Introduction

In Part One, I enumerated reforms needed at the state level. That list was in part plugging up the “cheats” used to run up the statewide pension deficit of about a trillion dollars. Employee unions control the state legislature, the attorney general, all executive offices and all retirement administrators; therefore I prefaced Part One with an opinion that reform at the state level was and is basically a pipe dream.

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Picturesque Pacific Grove is being destroyed by government unions.

This part will discuss reform at the county and city level only, simply because I have not researched education and special districts sufficiently to include them.

Premise

This analysis is based on the conclusion that current local government defined benefit pension plans are under 50% funded based on market analysis.

The common lament about pension deficits is that it was caused by the 2008-09 investment crash. But most PERL Agencies were under water after the 2001-02 high tech stock market crash. Most pension bonds were issued in exchange for pre 2008 pension unfunded deficits or to fund pension enhancements (Marin and Sonoma counties, for example).

Vallejo filed for Chapter 9 in 2008, before the crash with a market pension deficit of about $400M.

Pacific Grove went from a zero deficit in fiscal 2001 to 2002, to a nineteen million dollar deficit in 2004 to 2005. About 50% of the pension deficit was in the 2%@55 plan for non safety employees and the other 50% for the 3%@50 safety employees. Non-safety 2%@55 plans suffered substantial pension deficits again after the 2008-to 2009 crash and all PERL plans had an additional deficit from poor results in 2013-14. It had a good return for fiscal year 2014 to 2015, but recent results (June 2015 to date) are catastrophic. Based on the size of the 2%@55 deficits, that level of benefits is unsustainable and if it was the highest level of benefits, it would still break all but the very richest agencies.

Contribution rates have doubled and tripled; yet the PERS estimate of the funding level for PERL plans as of fiscal year end 2012-13 is 70.5%, using its assumptions. But financial experts using fair market assumptions – those used competitively – estimate the funded level at well less than 50%, a funded level that PERS has stated was beyond saving.

Based on the above, it is mathematically probable that PEPRA which grants a defined benefit as high as 2.7% at various ages of eligibility will go down like the Titanic, in spite of its prospective limits on the size of maximum benefits. If 2%@55 plans are under water; it means that 2.7% at age 57 plans must fail. PEPRA is a palliative measure that has delayed curative reform.

In CERL agencies, much of its pension debt, including pension bonds, was created between 2002-07, after it had incurred a deficit in 2001-02. In Sonoma county a phony lawsuit about calculating pensionable salary was created. Plaintiffs and defendants then contrived a settlement of the lawsuit that circumvented the public notices of CERL and Govt. code 7507, to grant every full time employee a 3% benefit at some age (between 50 and 60). The reason it was important for the staff to avoid the notice statutes was because compliance would have shown that the increased annual budget costs of the pension enhancements would have violated Article XVI, section 18 of the state constitution, which required a 2/3 vote of the people to approve the enhancements. (The Orange county debt limitation case did not involve the issue of increased annual budget costs, and that is why it lost).

Marin had a similar experience as documented in a precise 2015 grand jury report. The pension deficits in Marin and Sonoma are about a billion dollars each. In each county, the agency lawyers, the supervisors, the unions and staff, the sheriff, DA, et al took no action on the grand jury reports. They had a duty to set aside the illegally adopted pension increases, but did not. The ratification of the illegal pensions was unanimous.

Except for a chapter 9 that modifies pensions and other post-retirement benefits, there is no way out of the financial demise of Sonoma and Marin county and all but the very richest local entities.

Chapter Nine is a Game Changer

Until Judge Klein (in the Stockton Chapter 9) produced a total analysis that showed that employee’s pensions are modifiable in a chapter 9, PERS and the unions claimed pensions were untouchable for a variety of tenuous reasons.

Article I. Section 8 of the U.S. Constitution says “The Congress shall have the power…To establish uniform Rules of Naturalization, and uniform Laws on the subject of Bankruptcies throughout the United States;.” Judge Klein went on to clearly define how pursuant to a Plan of Adjustment in a Chapter 9, pension contracts could be rejected and the obligations modified in a fair and equitable manner along with all of the creditors. Judge Rhodes in the Detroit bankruptcy agreed . The Supremacy clause applies to a chapter 9 and is still the law per the two judges and all neutral experts on the matter. Pensions do not have a special status in a Chapter 9.

In his decision, Judge Klein said: “..it is doubtful that CaLPERS even has standing to defend the City pensions from modifications. CaLPERS has bullied its way about in this case with an iron fist insisting that it and municipal pensions it services are inviable. The bully may have an iron fist, but it turns out to have a glass jaw.”

Karol Denniston, a bankruptcy attorney and chapter 9 expert (SQUIRE Patton Boggs), who followed the Stockton bankruptcy carefully, in one of her several writings about the Stockton decision said: “Klein’s opinion provides a handy road map of how to put pensions on the bargaining table thus creating a more balanced approach to restructuring. That means pensions get talked about at the front end of a case and not at the back end. It also means a city can tackle its restructuring plan by looking at all of the significant liabilities, including a plan that really works.”

“..including a plan that really works.” The elements totally lacking in the Vallejo, Stockton and San Bernardino bankruptcies. Those chapter 9’s were union controlled political bankruptcies that intentionally used all of the available assets to pay for a bankruptcy, while protecting its employee’s million dollar pensions. As of 6/30/2013, San Bernardino had a fair market unfunded pension liability of about $1.05B and was 43.4% funded; Vallejo a $650M unfunded pension liability and 45% funded, and Stockton a $1.3B pension liability. The new losses for the succeeding two years will be daunting. Imagine another recession!

The Political Landscape for Chapter 9 Filings

In all cities and counties you hear the refrain: “another loss like that one and the city or county will be bankrupt.” Therein lies the problem; taxpayers view a chapter nine as worse than slashing services, raising taxes and fees, with a future doomed to more cuts, taxes and fees. Because the three municipal bankruptcies to date were “rigged” in favor of city staff and the unions, the public lacks an example of a successful chapter 9.

Therefore, the first bona-fide chapter nine will be critical so that it will encourage other agencies to negotiate from a position of strength. Cities and counties must comply with Myers, Milias and Brown, but any deal that leaves the agency in a defined benefit plan is off the table. If that goal is achieved, there is much to talk about.

The key issue is the level of adjustment to be made to pensions so that employees and retirees will receive a reasonable pension? Unless the taxpayers are convinced that retirees and employees are not taken advantage of, it will not support a bona-fide chapter 9 in bankruptcy.

Pension Adjustments in a Pre-chapter 9 Settlement or in a Plan of Adjustment Must Be Fair and Equitable

Government agencies usually do not belong to the Social Security system. Additionally, PERS and CERL systems do not have an insured component to fill in for pensions modified in a bankruptcy. In chapter 11’s and 7s, canceled pension benefits are often replaced by the federal pension insurance system. So modifying pensions in a chapter 9 is a serious business and must not only appear to be fair, but in fact be fair.

On the one-hand an egregious PERL and CERL system has already caused massive tax increases and prop. 218 fees with a dramatic drop in the number of employees and service levels. As a game-wrecker, prop. XIII dwarfs it by comparison. On the other hand, retirees are not entitled to million dollar annuities, but should receive reasonable pensions for their service. Mathematically, the status quo is not an option. Convincing taxpayers that the modifications are essential but fair is the key to electing a legislative majority with the support to negotiate pension reform from a position of strength. That strength is the right to modify pensions in a chapter 9.

The opposition to a chapter 9 will be massive. In addition to PERL and CERL, the unions will invest millions in opposition. More importantly, the agency lawyers, managers and administrators will use agency monies for store-bought legal opinions that pretend that modifying pensions along with other debt is illegal and bad (like Pacific Grove, Sonoma and Marin county regarding illegal pension adoptions). So if a reform majority is elected, it must replace those who fight for the status quo no matter what. Current attorneys, managers/administrators must go to be replaced by contract experts during the financial emergency.

In order to elect a legislative majority of pension reformers, a lengthy public relations plan is an absolute prerequisite. That program must analyze the outstanding liability for pensions, including pension bonds, and then postulate reasonable modifications for the affected retirees and employees.

Older retirees with lower pensions should not suffer modifications. The younger retirees with massive retirements should be cut to as much as 2 times the social security maximum (about $60,000 per year). The goal is to provide a reasonable retirement for those affected, and to arrive at a plan of adjustment that permits a city or county to repair its roads, sewers, water systems, etc. while providing amenities for every age group (senior, recreational, library, etc) without a separate levy or fee in addition to property, sales and franchise taxes.

In cities like Pacific Grove and counties like Marin and Sonoma, the press is a huge problem. In Monterey County no news source understands the magnitude of the pension conundrum.

In Marin and Sonoma, the issue is treated superficially by the press, but the news media does not portray the magnitude of the deficits together with the illegality of it all so that the reader understands that taxpayers have been defrauded to the tune of a billion dollars. Without a chapter 9 the pension deficits will grow in Sonoma and Marin to one and a half and then two billion dollars and so on. Only chaos can follow such incredible juvenile behavior by all involved. Even reform groups fail to shout out the critical nature of the problem. If the ordinary taxpayer understood the situation, electing competent legislative majorities and reform would follow.

In Monterey County, if you asked a city council member about the size of the city pension deficit, it would be confused. In Pacific Grove they would admit that it was bad, but believe it is curable. But if you told a member of the Carmel council that the city pension debt per household was $24,000, it would be curious about whether that was good or bad. Carmel has so much revenue, it does not concern itself about whether it gets its money worth. My point is that the prospect for pension reform varies from agency to agency, but there is NO avenue to inform the citizens of Seaside, Salinas, Pacific Grove and other communities of the continuing decline in the quality of life in their community; and that a bona fide chapter 9 could make them free. Therefore Reform groups must educate the press, but also provide bi-weekly or monthly pamphlets by mail to citizens so that they can use their vote to defend against the pension tsunami by electing bona fide pension reformers to their city council (or board of supervisors in counties). It will require a sizeable flow of cash.

Paying For a Chapter 9

According to a reliable source, the legal costs in the Stockton chapter 9 exceeded $15M. Costs for experts added a significant sum. For a residential entity like Pacific Grove (15,599 residents) it could be as much as $6M. If a city has pension and other bonds that will be modified in the bankruptcy, the annual payments may be a source of funds to pay for the bankruptcy. Because a modification of pensions or OPEB is contemplated, cash from those sources may be available.

There has not been a bona fide chapter 9 in California; therefore, a material modification of pensions lacks guidelines; but it will be based on federal bankruptcy principles, not state law. According to one highly qualified chapter 9 expert it is important that the PERL or CERL contracts NOT be terminated until after the 9 filing in order to prevent a lien claim by the pension plans.

Qualifying For a Chapter 9

In California, a municipality, like a city or county, is qualified for chapter 9 treatment if it is “insolvent” and “desires to effect a plan to adjust such debts” and has complied with Government code section 53760 et seq. That section provides for a choice to pursue a neutral evaluation process in an attempt to obtain a compromise, or, the local public entity may declare a state of emergency pursuant to Government code Section 53760.5.

Generally, the local agency will qualify if it can show it is “unable to pay its debts, or unable to pay its debts as they come do” (cash insolvency). Cash insolvency may include charges that are not immediately due, but are imminent, such as increases in annual pension contributions and annual pension bond payments, sewer debts, etc. Unfunded pension liabilities will probably not carry the day, except to the extent they will become cash obligations through rate increases. This is a complex area, beyond the scope of this article, except to again make the point that local entities need experts that are not subject to the bias and influence of staff; otherwise, the advice from staff will be, “you can’t touch our pensions” and it will advise a “rigged” chapter 9 like Vallejo, Stockton and San Bernardino.

Alternatives to a Bona fide Chapter 9

Insolvency may be delayed by massive salary reduction, staff and service cuts, new taxes and fees and so on; but such a process cannot promote sufficient financial healing to permit a reasonable level of services at a reasonable cost, or avoid massive deficits. Stockton had a $7M deficit for 2014. So much for its chapter 9.

The “police power” rule of contract law is theoretically available. That rule provides that the state police powers allow modification of contracts when it is necessary to protect the general public welfare. And if that power is extant, does it extend to local agencies? I don’t have the answer, except to note that the California government as now constituted would never use the power, and if attempted by a local agency, the cost for legal representation by reformers is too great.

A better choice is “The Kern Doctrine.” In Kern v City of Long Beach and later in Allen v City of Long Beach, the California supreme court determined that a Charter provision granted employees a vested pension right and in Allen, concluded that the right extended to “work not yet performed.” But in doing so, especially in Kern it noted its second rule, that in a case where the pension system was financially broken, the local entity could make reasonable modifications to vested rights and no off-set was required. In Kern it noted several examples that it had permitted; in one case it allowed a benefits reduction from 2/3 of salary to 1/2 for all employees who had not yet retired. In Allen, the court noted that in that case the financial integrity of the pension system was not in question, so any reductions in pensions required a corresponding off-set. Then it immediately noted again that it was NOT a case where integrity of the system was in issue, thereby reaffirming the Kern doctrine that vested rights could be modified without off-set to save the pension plan..

Hundreds of local entities now have pension plans that are broken with no chance to pay the benefits promised. In 2014, Moody’s released a statement that Vallejo was again insolvent because of pension promises and needed to go into a new chapter 9 to shed pension obligations. It warned that Stockton and San Bernardino needed to shed pension obligations or would again become insolvent after its chapter 9.

There is now a “perfect storm “ for pension reduction under the “Kern Doctrine,” but most lawyers simply do not understand it because they read Allen, without reading Kern. Kern gives an example of the exercise of the police powers by a local entity to protect the public welfare. Entities with impossible pension deficits, like Oakland, San Jose, Pacific Grove, Salinas, King City, Marin and Sonoma counties, etc., etc. could modify pensions for employees to save their plans from insolvency. Read Kern!

Anticipating the Opposition’s Tactics

The gimmick used by Stockton to justify not modifying pensions in its Chapter 9 bankruptcy was a claim that it would be unable to recruit and retain safety and other experts, particularly police; and it already had a raging crime fest on its hands. In fact, it had depleted its police department because of raging pension costs arising from excessive million dollar pensions and the 2008 to 2009 financial crash. Ironically, its manager spread the theme that Stockton could not hire and retain qualified people across the board without the million dollar pensions; then he retired? He was hired by San Bernardino to spread the same theme for its bankruptcy.

Despite claims that police departments cannot recruit new officers without 3%@50 pension benefits, there are over 150 local entities in California with police receiving a 2%@50 pension and they fill positions readily. Until about 2003, almost all local agencies were 2%@50 and there was an overflow of qualified applicants. The age 50 level is much too low, but it is there, created by greed. The claimed shortage arose because of the fraudulent adoption of 3%@50 in 1999; now they naturally seek a 3%@50 annuity and refuse to believe that it has destroyed representative government.

More troubling about the claimed police shortage are allegations that police departments like San Jose discourage applicants and certification schools to create a shortage. But the critical component of the police shortage theme is the inability to gain the truth about the number of applicants for open positions. Somehow it was learned that Stockton had numerous applications for its police force. To counter, its manager wrote a guest editorial in the Sac Bee and said only one in a hundred certificated police applicants could qualify as a Stockton police officer (Yes,he really said that!).

Additionally thousands of police officers were laid off after the financial crisis. Where are they? If you make a records request about applications for open positions, you will feel you are on a railroad by the response. The key is to make the staff produce its evidence of a shortage and that objection should go away. If not, can they really argue that the entity must go broke to maintain the status quo! No. To the extent that high crime cities have a genuine component to its shortage, it will need an on-the-job training plan to fill vacancies at an affordable cost. Ex MPs are a good source for the program.

The other response to pension modification goes to the heart of the public reluctance and lack of information about the issue. The benefits were promised and now they are to be reduced. There are many arguments that should mitigate that reluctance:

(1)  The assets in the DB plan belong to the employees and will not be used except to pay pensions. If a plan is 30% unfunded, the 70% will provide a reasonable retirement if the defined benefit plan is eliminated going forward;

(2)  Pensions exceeding 2%@55 and 2%@50 for safety, were obtained by PERS and local entity fraud;

(3)  Compared to social security, the pensions are much too high, by three to four times;

(4)  Compared to the private sector, the pensions are too high;

(5)  The pension promises were based on unrealistic market returns;

(6)  Each employees union representative was part of the pension scam and unions control PERS;

(7)  Per the California Supreme court employees are only entitled to a “reasonable” pension, not a specific formula;

(8)  Spiking and other illegal activities contributed to the crisis;

(9)  The cost of pensions has curtailed government services, contribute to rising crime and is a dagger to education. Even community colleges can no longer meet demand;

(10)  Deficits compound at 7.5% a year. There is no revenue defense to that fact, so services will continue to suffer due to a lack of funds because of increased pension costs;

(11)  After the defined benefit plan is discontinued in whole or part, employees will be part of the social security system, plus a defined contribution plan, a hybrid system providing fair and financially sustainable retirement security;

(12)  Thanks to the work of Dr. Joe Nation, director of The Stanford Institute For Economic Policy Research and the financial reporting of David Crane of “Govern for California,” reformers have two sources of accurate information about the true state of the pension crisis; impeaching charts used by PERS to mislead the public about the irremediable nature of the pension deficits.

Opponents of reform may respond that Prop. 13 contributed to the crisis. But since prop. 13, sales taxes have increased by 6% and income taxes by 5% and more than make up for lost revenue. If we assume that without Prop. 13 property taxes would be 2% rather than the 1% limit (a doubling), property values would drop proportionally because the higher tax eliminates purchase money. If opponents blame Prop. 13, and they will, polls indicate that voters oppose repealing Prop. 13. Given a choice they will cancel the defined benefit plans and save their communities.

Would a bona fide Chapter 9 that eliminated the entity defined benefit plan reduce its borrowing power going forward? Pension bonds and unfunded pension deficits would be reduced and deficits eliminated, providing cash flow going forward. Entities could fix infrastructure with bond money and the bondholders would have confidence in re-payment because of the improved balance sheet. Using Sonoma County as an example: would bond issuers rather lend to it with its billion dollar pension deficit, or with much of that deficit eliminated?

SUMMARY

(1)  Defined benefit pension plans for government employees are mathematically destined to fail;

(2)  The three chapter 9’s to date did not modify pensions and according to Moody’s, Vallejo is once again insolvent and Stockton and San Bernardino will suffer the same fate for failing to modify pensions in its chapter 9 cases;

(3)  The law is clear that California local entities may modify pensions and other post employment benefits in a chapter 9 plan of adjustment;

(4)  If a local entity has great voter support for pension reform, it may reduce pensions pursuant to the supreme court’s “Kern Doctrine” in order to restore some vital services without a chapter 9; but PERL and CERL administrators may oppose such a plan, forcing a chapter 9.

(5)  Because there has not been a chapter 9 in California wherein a local entity has requested pension modification, there is new legal ground that must be covered, but that is the nature of legal solutions. In the case of pension deficits, a chapter 9 in bankruptcy modifying pensions as part of a plan of adjustment is the only solution. There is no other conceivable reform that can scratch the surface of the problem.

(6)  Modifications to pensions must be fair, taking into account that SB 400 was adopted based on fraudulent representations about its cost.

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Read part one “The Mechanics of Pension Reform – State Actions,” December 22, 2015

Read Kern v City of Long Beach, and Allen v City of Long Beach.

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About the Author:  John M. Moore is a resident of Pacific Grove, Ca. He is a licensed member of the California State Bar (#34749) and a member of the “Public Law” section of the State Bar. He is retired and no longer practices law, but has Lexis/Nexis for research. John graduated from San Jose State College with majors in Political Science and Economics (summa cum laude). He then received a JD from The Stanford School of Law and practiced business and trial law for 40 years before retiring. In 1987, he was the founding partner of a Sacramento law firm that he formed in 1987 to take advantage of the increased bankruptcies brought about by the Tax Act of 1986. Although he did not file and manage bankruptcy cases, he represented clients in numerous litigation matters before the bankruptcy court, including several cases before judge Klein, the current judge of the Stockton bankruptcy case. He is an admirer of Judge Klein, for his ability and accuracy on the law. As managing partner, he understood the goals of bankruptcy filings and its benefits and limitations.

Note to readers:  During 2012 author John Moore published the “final” chapter of “The Fall of Pacific Grove” in an four part series published between October 20th and November 9th:

The Fall of Pacific Grove – A Primer on Vested Rights
 – The Final Chapter, Part 1, October 20, 2015

The Fall of Pacific Grove – The City’s Tepid Defense of the Vested Rights Lawsuit
– The Final Chapter, Part 2, October 27, 2015

The Fall of Pacific Grove – The Judge’s Ruling
– The Final Chapter, Part 3, November 2, 2015

The Fall of Pacific Grove – The Immediate Future
– The Final Chapter, Part 4, November 9, 2015

During 2014 author John Moore published the first chapter of “The Fall of Pacific Grove” in an eight part series published between January 7th and February 24th. For a more complete understanding of the history, read the entire earlier series:

The Fall of Pacific Grove – How it Began, and How City Officials Fought Reform
 – Part 1, January 7, 2014

The Fall of Pacific Grove – How City Thwarted Reform, and CalPERS Squandered Surpluses
 – Part 2, January 14, 2014

The Fall of Pacific Grove – CalPERS Begins Calling Deficits “Side Funds,” Raises Annual Contributions
 – Part 3, January 21, 2014

The Fall of Pacific Grove – Outsourcing of Safety Services Causes Increased Pension Deficits
 – Part 4, January 28, 2014

The Fall of Pacific Grove – Anti-Pension Reform Mayor Claims to Favor Reed Pension Reform
 – Part 5, February 3, 2014

The Fall of Pacific Grove – Privately Owned Real Property are the Only Assets to Pay for Pensions
 – Part 6, February 11, 2014

The Fall of Pacific Grove – The Cover-Up by the City After the Hidden Actuarial Report Surfaced in 2009
 – Part 7, February 18, 2014

The Fall of Pacific Grove – Conclusion: The “California Rule” Cannot Stand

The Fall of Pacific Grove – The Immediate Future

The Final Chapter, Part 4 of 4

The facts and law indicate that the lawyers defending the city in the POA pension reform law suit, directed by the city attorney, and supported by a city council majority, consciously and intentionally failed to uphold two legal ordinances which could have prevented the financial “Fall of Pacific Grove.”

Current annual pension costs for Pacific Grove, including the pension bonds and a new $625,000-per-year charge are about $4 million, soon to increase to $5 million, then $6 million, and increasing forever. Its unfunded deficit grows at about $3 million per year, and in 9.2 years will grow at $6 million per year. Average revenues are about $17 million. The current unfunded deficit (based on a 3.5% income rate) is about $90 million; it will double every 9.2 years. Pacific Grove is upside-down financially.

It is important for pension reformers to understand that a legislative body, after negotiating with the unions, and after impasse, can reduce salaries under California law. Currently salary reduction is the only leverage for pension reform, but it will require the election of a majority loyal to the salary reduction plan to save cities and counties like Marin and Sonoma.

An alternative for Pacific Grove would be to terminate with CalPERS and modify pensions and salaries in a chapter 9 bankruptcy. Bonds like pension bonds get reduced dramatically in bankruptcy, and pay for the bankruptcy.

Neither of the two alternatives will happen in Pacific Grove, because it is impossible to apprise the voters of the impending peril. The local press does not have forensic capabilities in law and accounting, so it refuses to acknowledge the serious financial plight of Pacific Grove and surrounding cities.

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Pacific Grove’s current commercial district contributes insufficient tax revenue to fund
six-figure pensions for the city’s retirees. Time to rezone and sell public assets!

 

The current Pacific Grove (union controlled) council majority plans to pay for pensions by attacking the current zoning laws and thereby build three large hotels and permit several bars in the downtown area. Pacific Grove is fully built out and has a dearth of parking spaces; it has one-way streets each way, so its current residential culture will disappear with such development. A second plan of the unions and the council is to sell off city property, like the recreation field and center. So far they have granted a long-term lease of its 18-hole municipal golf course. Tennis courts and parks will be sold off for development. There is no alternative without pension reform.

Lack of Impartial Lawyers and Financial Experts

Recent grand jury findings in Marin and Sonoma counties document corrupt pension enhancements since 2002, benefiting all unions, staff, the board of supervisors and the local pension administrators. Marin just announced that next year’s pension contribution cost for each supervisor is $54,000. The Marin county counsel receives an annual retirement payment and a salary that total about $475,000 a year. He was county counsel in Sonoma at the time the corrupt pension enhancements were adopted there.

In both Marin and Sonoma, the agents who planned the illegal pension enhancements were experts in the laws mandated for pension enhancement. The law mandated an actuarial declaration of the yearly cost of the proposed benefit. The lawyers, actuaries and financial experts in both counties had to knowingly and covertly by-pass the law. Including interest on pension bonds, each county now has about $1.5 billion in pension debt (up from almost zero).

Each county hired outside lawyers to respond to the grand jury reports. Each outside law firm treated the beneficiaries and the perpetrators of the wrong-doing documented in the grand jury reports as the client, and wrote astounding mythical legal opinions saying that everything was fine with the law. There were no lawyers in the system to protect the voters and the integrity of the grand jury findings. Where were the district attorneys? Evidently they intend to keep every penny of the illegal pensions.

The State Bar must enter this fray and set forth rules for public agency lawyers that provide legal representation to the voters and protect them from the insidious practices that occurred in Marin County, Sonoma County, Pacific Grove, and cities that went through bankruptcy without modifying pensions.

A Surprise Ending

In the game of golf, there is a saying, “Don’t ever say that things can’t get worse.” They can and do.

Take the POA v. Pacific Grove pension reform law suit as an example:

  1. As referenced above, the law firm of Liebert Cassidy Whitmore (LCW) sponsored a CEB-approved course about the acquisition of vested rights. The course was accurate and faithfully laid out the rules to establish a vested pension or OPEB in California: A+
  2. A partner from LCW applied the referenced principles to convince the trial and appellate court that the South Pasadena POA did not have vested rights based upon years of MOUs and reliance by employees, providing a medical benefit that had been reduced going forward: A+
  3. Pacific Grove was represented by LCW in the POA law suit discussed at length herein. The lead attorney in that defense was the same LCW partner who led the defense in the South Pasadena law suit, and totally failed to explain the principles set forth in the CEB course and in the South Pasadena law suit to Judge Wills, the voters, and the city were defrauded by their lawyers. F-

Conclusion

As demonstrated by this case study, also by the response to the grand jury reports in Marin and Sonoma counties, the current agencies of state and local government are opposite to the interests of its citizens.

I believe there will always be collective bargaining in the agencies; talk of eliminating collective bargaining is a pipe dream.

The problem is that in the current system, the governor, city and county managers and administrators, lawyers, and financial experts are de facto union members. That must change. The executive staff of each agency, particularly the lawyers, administrators, and financial experts, must be removed from the collective bargaining process.

It is beyond the scope of this effort to provide the solution. But as shown in Pacific Grove, Marin, and Sonoma, the current system of de facto union membership will trash each and every pension reform.

Read the entire series:

The Fall of Pacific Grove – A Primer on Vested Rights
 – The Final Chapter, Part 1, October 20, 2015

The Fall of Pacific Grove – The City’s Tepid Defense of the Vested Rights Lawsuit
– The Final Chapter, Part 2, October 27, 2015

The Fall of Pacific Grove – The Judge’s Ruling
– The Final Chapter, Part 3, November 2, 2015

The Fall of Pacific Grove – The Immediate Future
– The Final Chapter, Part 4, November 9, 2015

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About the Author:  John M. Moore is a resident of Pacific Grove, Ca. He is a licensed member of the California State Bar (#34749) and a member of the “Public Law” section of the State Bar. He is retired and no longer practices law, but has Lexis/Nexis for research. John graduated from San Jose State College with majors in Political Science and Economics (summa cum laude). He then received a JD from The Stanford School of Law and practiced business and trial law for 40 years before retiring. In 1987, he was the founding partner of a Sacramento law firm that he formed in 1987 to take advantage of the increased bankruptcies brought about by the Tax Act of 1986. Although he did not file and manage bankruptcy cases, he represented clients in numerous litigation matters before the bankruptcy court, including several cases before judge Klein, the current judge of the Stockton bankruptcy case. He is an admirer of Judge Klein, for his ability and accuracy on the law. As managing partner, he understood the goals of bankruptcy filings and its benefits and limitations.

*   *   *

Note to readers:  During 2014 author John Moore published the first chapter of The Fall of Pacific Grove in an eight part series published between January 7th and February 24th. For a more complete understanding of the history, read the entire earlier series:

The Fall of Pacific Grove – How it Began, and How City Officials Fought Reform
 – Part 1, January 7, 2014

The Fall of Pacific Grove – How City Thwarted Reform, and CalPERS Squandered Surpluses
 – Part 2, January 14, 2014

The Fall of Pacific Grove – CalPERS Begins Calling Deficits “Side Funds,” Raises Annual Contributions
 – Part 3, January 21, 2014

The Fall of Pacific Grove – Outsourcing of Safety Services Causes Increased Pension Deficits
 – Part 4, January 28, 2014

The Fall of Pacific Grove – Anti-Pension Reform Mayor Claims to Favor Reed Pension Reform
 – Part 5, February 3, 2014

The Fall of Pacific Grove – Privately Owned Real Property are the Only Assets to Pay for Pensions
 – Part 6, February 11, 2014

The Fall of Pacific Grove – The Cover-Up by the City After the Hidden Actuarial Report Surfaced in 2009
 – Part 7, February 18, 2014

The Fall of Pacific Grove – Conclusion: The “California Rule” Cannot Stand
 – Conclusion, February 24, 2014

The Fall of Pacific Grove – The Judge's Ruling

The Final Chapter, Part 3 of 4

The parties to the law suit made final oral arguments, and on June 18, 2013, Judge Wills issued his Statement of Decision, setting forth his conclusions and the legal reasoning that led to his conclusions.

First, he found that because the charter stated that the city council was directed to set the compensation of all officers and employees, the people could not process an initiative that set compensation. Recall that the attorneys for the city did not cite the case of Spencer v. City of Alhambra (or any of the 122 cases in which it had been cited) which said that articles in a charter which direct the body that is to set compensation do not preclude an initiative that sets compensation.

The city failed to argue that the city council had in fact adopted the initiative ordinance as its own, thereby complying with the charter.

The city failed to inform Judge Wills that a legislative act, like setting compensation, could only preclude the right to petition a compensation ordinance via the initiative if the charter had expressly excluded that power from the initiative process; and there was no such exclusion in the Pacific Grove Charter.

20151019-UW-Moore3

The Pacific Coast shoreline – rezoning these areas for high-density luxury hotels will
bring tax revenue to the city so they can afford to pay their pension fund contributions.

Measure R was affirmed by a vote of 74% of the voters. It had clarified that Article 25 of the charter was amended (if necessary) to assure that the voters retained its initiative power to set compensation and affirmed that employees did not have vested pension rights. The POA argued that Measure R was too late, because it didn’t apply at the time the council adopted the initiative as its own. Incredibly, the city attorney had not submitted his declaration indicating that Measure R was to apply retroactively to supplement the pension reform ordinance. He could have pointed out that the video of the council meeting placing Measure R on the ballot would have clearly shown that Measure R was to apply retroactively. That was the only reason for Measure R. His failure to point out that he had drafted Measure R to concur in time with the earlier adoption of the retirement reform ordinance was an omission much more serious than malpractice, it was a breach of his fiduciary duty to uphold the ordinance and to act with his singular fidelity to the city and its laws.

Second: Finding that employees had a vested pension right, Judge Wills said:

“The Retirement Contribution Ordinance is invalid in violation of Article 1, Section 9 of the California Constitution, the Contracts Clause. The employees were told that they were to receive retirement benefits under a CaLPERS administered plan with an employee cost set at a fixed percentage of their salary. The fluctuating portion would be borne by the employer.”

“Upon entering employment with such a promise, the employee has a vested right to earn a pension on those terms and conditions.”

“Measure R Resolution 10-055 violates the Contract Clause of the California Constitution for the same reasons.”

“Again, the Court reiterates that what is vested in the employee is a right to earn a pension on the terms promised him or her upon employment. That right commences when the promise is made and the employee then commences or resumes work.”

Based on the facts and the law, the judge was in error on every point he made to justify his conclusion:

  1. Per the city charter, compensation must be set forth in an ordinance. There was no ordinance that promised employees a vested pension right (ever).
  2. Prior to the trial, the court had ruled that the MOU (contract between labor and the city) did not grant a vested right.
  3. Prior to the trial, the court had ruled that the contract to administer pensions between the city and CaLPERS did not grant a vested pension right:
  4. As set forth in the LCW CEB course on vested rights, an “implied” vested right can only be implied from the legislative intent.
  5. Legislative intent by implication looks to evidence that showed the intent of the legislative body at the time of adopting an ordinance or adopting a contract (County of Orange case, South Pasadena case, and other cases). There are no appellate cases contra to this principle.
  6. An “implied” vested right can only flow from a statute or contract that created the benefit, in this case a pension. The issue was not whether a pension benefit was granted, but whether the council adopted an ordinance or contract that promised the benefit for life. The POA did not even argue that there was a statute that granted a vested right, and the only documents it had included in its complaint were stricken from the evidence. The city did not inform the court that a statute or contract was essential to the analysis.
  7. The opinion makes it clear that Judge Wills was unaware that the law presumes that an instrument does NOT create a vested right. He was not even aware that a statute or contract granting a benefit was a precondition to determining whether the benefit was vested (for life). So he hung his decision on alleged oral promises, promises which had not been made by the legislative body.
  8. Only the police unions sued, but the court invalidated the ordinances totally, thereby giving all of the unions not before the court and the non-union staff a gratuitous judgment. Each union negotiated most MOUs separately from other unions. There was no evidence related to their rights.
  9. If there had been a basis for invalidating the ordinances, it certainly was still valid for new hires. New hires had no right to an expectation of any kind. The ordinances would have limited the new hires to a pension whereby the city could pay no more than 10% of salary. Over time, if the city could survive through the cost of current employees’ pensions, Pacific Grove could have been saved by applying the ordinances to new hires. In fairness to the judge, the attorneys for the city did not even request that if all else failed, the ordinances clearly applied to new hires. In the San Jose pension reform law suit, defendant unions stipulated that the contested reform ordinance applied to new hires.
  10. The most critical flaw in the judge’s decision was his failure to apply the two-step process described in the LCW State Bar seminar: was there a benefit? Yes. Was it granted for life, or only for the term of the MOU? Only for the term of the MOU.

Read the entire series:

The Fall of Pacific Grove – A Primer on Vested Rights
 – The Final Chapter, Part 1, October 20, 2015

The Fall of Pacific Grove – The City’s Tepid Defense of the Vested Rights Lawsuit
– The Final Chapter, Part 2, October 27, 2015

The Fall of Pacific Grove – The Judge’s Ruling
– The Final Chapter, Part 3, November 2, 2015

The Fall of Pacific Grove – The Immediate Future
– The Final Chapter, Part 4, November 9, 2015

*   *   *

About the Author:  John M. Moore is a resident of Pacific Grove, Ca. He is a licensed member of the California State Bar (#34749) and a member of the “Public Law” section of the State Bar. He is retired and no longer practices law, but has Lexis/Nexis for research. John graduated from San Jose State College with majors in Political Science and Economics (summa cum laude). He then received a JD from The Stanford School of Law and practiced business and trial law for 40 years before retiring. In 1987, he was the founding partner of a Sacramento law firm that he formed in 1987 to take advantage of the increased bankruptcies brought about by the Tax Act of 1986. Although he did not file and manage bankruptcy cases, he represented clients in numerous litigation matters before the bankruptcy court, including several cases before judge Klein, the current judge of the Stockton bankruptcy case. He is an admirer of Judge Klein, for his ability and accuracy on the law. As managing partner, he understood the goals of bankruptcy filings and its benefits and limitations.

*   *   *

Note to readers:  During 2014 author John Moore published the first chapter of The Fall of Pacific Grove in an eight part series published between January 7th and February 24th. For a more complete understanding of the history, read the entire earlier series:

The Fall of Pacific Grove – How it Began, and How City Officials Fought Reform
 – Part 1, January 7, 2014

The Fall of Pacific Grove – How City Thwarted Reform, and CalPERS Squandered Surpluses
 – Part 2, January 14, 2014

The Fall of Pacific Grove – CalPERS Begins Calling Deficits “Side Funds,” Raises Annual Contributions
 – Part 3, January 21, 2014

The Fall of Pacific Grove – Outsourcing of Safety Services Causes Increased Pension Deficits
 – Part 4, January 28, 2014

The Fall of Pacific Grove – Anti-Pension Reform Mayor Claims to Favor Reed Pension Reform
 – Part 5, February 3, 2014

The Fall of Pacific Grove – Privately Owned Real Property are the Only Assets to Pay for Pensions
 – Part 6, February 11, 2014

The Fall of Pacific Grove – The Cover-Up by the City After the Hidden Actuarial Report Surfaced in 2009
 – Part 7, February 18, 2014

The Fall of Pacific Grove – Conclusion: The “California Rule” Cannot Stand
 – Conclusion, February 24, 2014

The Fall of Pacific Grove – The City's Tepid Defense of the Vested Rights Lawsuit

The Final Chapter, Part 2 of 4

In June of 2010, the City of Pacific Grove (City) received an initiative petition from a citizen’s group containing the requisite number of signatures. Thereafter the city adopted the petition as an ordinance. The ordinance limited the city’s obligation to pay for employee pensions for work not yet performed to 10% of salary. Employees retained full credit for work already performed. At that time, the city attorney and city manager openly and intensely opposed the adoption on political grounds. In an attempt to raise a legal objection, the city attorney referred to Article 25 of the city charter, which indicated that compensation should be set by the city council. He argued that it could not be set by initiative.

There were two problems with the city attorney’s legal point: first, the council was in fact adopting the ordinance as its own, and second, because setting salaries was a legislative act, it was subject to the citizens’ power of initiative regardless of the gratuitous charter directive that the council should set salaries; that point had been held in the case of M.R. Spencer v. City of Alhambra (as of this writing it is good law and has been cited in 122 appellate cases). The only way that the people could have excluded “compensation” from the initiative power was to set forth the exclusion in the charter, and it had not.

The council approved the ordinance 6-1; the current mayor who was and is against any pension reform for Pacific Grove was the lone dissenter. He was elected mayor in November 2012 (along with two other pro-union anti-pension reformers), and that became important in allowing the unions, the city attorney, and city manager  to ultimately defeat the pension reform measure by throwing the law suit challenging the ordinances. What follows is a description of how they pulled it off.

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The Monarch Butterfly’s Pacific Grove Sanctuary – selling this to developers might
pay for one year of employer pension fund contributions! Maybe even two years!

When I first learned of the pension reform initiative, I had the three legal sponsors of the initiative delay obtaining signatures until I had researched whether PG city employees had vested contract rights by actual contracts or by a statute or the charter. Through public record requests, I reviewed the original charter (1927) and every change going forward. Until 1955, the charter expressly prohibited a pension. In 1955, the charter was amended to allow the council to enroll the city in a pension plan where the sole obligation of the city was to pay premiums. Another part of that charter provision allowed a “complete” (vested) pension plan by a vote of the people. In 1957 the council, without a vote of the people, authorized the city to join CaLPERS. Thereafter, there were no further amendments to the city charter dealing with pension rights.

I reviewed all of the resolutions, codes, and ordinances, together with all MOUs (contracts between the city and labor) and the contract and all amendments thereto between the city and CaLPERS from 1957 to date.

There was no document that even hinted that the pension rights were vested. To the contrary, because there was no vote of the people approving a “complete” pension it was clear that if it was claimed that joining CaLPERS created a vested pension right, it was void because of the absence of a vote of the electorate. As noted, in the POA case, the court had made a pre-trial ruling that there were no documents that created a vested pension right.

Article 16 of the city charter states: “The right of initiative and referendum is hereby preserved to the citizens of the City to be exercised in accordance with procedures proscribed by the Constitution and General Laws of this State.”  If the citizens wanted to prevent initiatives about compensation, then it needed to say so in Article 16, but did not. Otherwise, as a legislative act, fixing salaries and compensation was reserved to the people in the initiative power (Spencer). And of course, the council did in fact adopt the pension reform ordinance as its own.

As a safety measure, at the time that the council adopted the pension reform ordinance, it had the city attorney prepare a council-sponsored ballot measure that simply clarified that the people had the authority to sponsor an initiative about compensation regardless of Article 25. It also reaffirmed that employees did not have and never had vested pension rights The measure became Measure R on the ballot. Because it was sponsored as part of the pension reform ordinance, it was clearly intended to be retroactive to protect the ordinance from any claim that it could not save the ordinance because it came after adoption of the ordinance. The city attorney was clear that the measure was timely to protect the reform ordinance. Otherwise, why bother? And of course it was unnecessary because the law was so clear that the people retained the legislative power to set salaries and compensation. You can probably guess how the city attorney and SF counsel took a dive on this issue in the trial.

In November 2010, the Pacific Grove Police Officers Association et. al. (POA) sued the city, alleging that the new ordinances breached vested pension rights as set forth in MOUs and the contract with CaLPERS; that only the council could set compensation and setting compensation was not subject to the initiative (Article 25 of charter); and that plaintiffs had an “implied vested pension right” based on hiring advertisements and oral statements made by a city administrator to new hires.

During 2011 through November 2012, the law suit was processed on normal punch and counter punch practices. The city initially had notable success. On July 27, 2011, the court (not by the trial judge) made its order granting the city judgment on both POA claims that it had vested pension rights arising out of the MOUs between the city and the unions and arising out of the contract between the city and CaLPERS. The POA had not referred to any statute, code, resolution, or charter provision as the basis for a vested pension right, so that left the unlikely claim of a vested pension right by implication. But the law is clear, as set forth in the CEB seminar and the cases, that even such a claim must have its genesis in a legislatively adopted contract or a statute, and there was none. The trial court was not informed of this by Pacific Grove’s attorneys, who as experts in the legal issue, knew this requirement beyond all doubt.

In November 2012, Bill Kampe, a dyed-in-the-wool union backer was elected mayor, replacing then-mayor Carmelita Garcia. Garcia was a determined pension reformer whose love of the city was like a tattoo on her forehead.  After Kampe’s election, defense of the POA case by the city deteriorated from winning to lost; based on its attitude and statements, it became clear that the Kampe council majority hoped that the city would lose the law suit. Per the charter, the council, the city attorney, and the city manager all had an unqualified duty to enforce the pension reform ordinance. Measure R passed by a vote of 74% of the voters and thereby created a second pension reform ordinance that was challenged in the POA law suit.

I was concerned because it was clear that neither the city attorney, nor the San Francisco law firm defending the city, was aware of the content of my research of the charter, codes, resolutions, ordinances, MOUs, and other contracts. The history about the prohibition in granting a vested pension in the charter at the time PG joined CaLPERS would have defeated any claim of a vested pension right. And in particular, the CA Supreme Court had stated that there could be no implied vested right if it violated a legal prohibition. The vote requirement of the charter was such a prohibition.

When the POA sued, I protested to the council and the city attorney about the city attorney’s bias as openly displayed by him at the time the city adopted the pension reform ordinance. I, joined by the sponsors of the initiative, demanded that he not be involved in defense of the POA law suit. Regardless, he was allowed to choose and to supervise the lawyer selected to defend the case. In doing so, he restricted the lawyers from interviewing Dr. Daniel Davis and me.

Dr. Davis was the author and one of the three sponsors of the initiative adopted by the council. He had served for years on the city planning commission and two terms as a member of the city council. He was a practicing mathematician, with graduate degrees from Georgia Tech and a Ph.d. in math from Cal Tech. He had worked as a scientist at the Monterey Bay Aquarium Research Institute (MBARI) for 18 years, interfacing with David Packard. He was the key representative of the thousands of citizens favoring the pension reform (74%). He was ably qualified, and in 2008 wrote an academic-quality article about the risks arising from defined benefit pension plans. How could he not be allowed to participate in the defense of the law suit? Unless, of course, the mayor and the attorneys wanted to lose the law suit (at a defense cost of hundreds of thousands of dollars).

After the 2012 holidays I became very concerned that the city was not prepared for the trial of the POA law suit. I had made numerous e-mail requests to the city council and the SF attorneys demanding that Dr. Davis and I be allowed to participate in the defense of the vested rights case. Trial of the case was set for March 21, 2013. I met with Mayor Kampe and councilmen Cuneo and Huitt on March 13, 2013 and explained the need for our participation in the case. I received nothing in response, just blank looks. No “Yes,” no “No,” just “This meeting is over.”

On February 22, 2013, each side in the law suit filed its trial brief. I read both briefs and concluded that the city attorney and the SF lawyer wanted the city to lose the case. Why did I believe that? Most importantly, the city brief did not inform the judge about the law and evidence necessary for the POA to prove a vested right. The judge should have at a minimum been provided the six points listed in Part One from the LCW CEB seminar.

As set forth in the CEB seminar, when analyzing whether a pension or other benefit is vested, the beginning point is the language of the document conferring the benefit; and that vesting is a two-step process: is there a valid contract conferring the benefit, and if so does the contract contain an express or implied term that the benefit is not just for a limited term, but vested for life? Most importantly: there is a presumption that a vested right has not been created and the POA had the burden of producing evidence (the burden of proof) to overcome the presumption. The judge was not even informed of this basic principle.

The law in the case was so basic. The attorney for the city, supervised by the city attorney, did not inform the trial judge of the simple rules for determining the existence of a vested contract right. The omission concerning the presumption against creation of vested right, that put the burden of proof on the back of the POA, was well beyond legal malpractice.

As I have demonstrated, the judge assigned to the case had no understanding of the city’s defenses because the trial brief did not inform him of the basic law of vested contracts. I attended the first day of the trial. It was assigned to Judge Wills. By agreement, the case was submitted on declarations, documents, and judicial notice of documents. There was no testimony.

Judge Wills acknowledged that he had never seen the file until that moment and that he would review the file and the trial briefs and decide the matter. The city had turned a case that could not possibly be lost into a certain loser. I wrote several e-mails to the council and the press explaining how the case had been intentionally thrown.

Was there a statute, charter provision, code, ordinance, or resolution that provided for a vested pension benefit? No. To this day, none has been asserted by the city or the unions. There is none.

Was there an implied term in any of the statutes, charters, codes, ordinances, resolutions, or contracts that created an implied vested contract right? As set forth in numerous cases like Retired Employees of Orange Co., Inc. v. County of Orange, the implied vested right must flow from concurrent evidence surrounding the time of adoption of the contract or statute (minutes, agenda reports, etc.), not an oral utterance or publication for new hires years later. Attorneys reading this must be thinking, “How in hell could the court admit a hearsay statement made 50 or more years after adoption of the benefit? How could one witness be allowed to testify in a declaration that all new hires were told they had a fixed-cost pension benefit?” Even the declaration of the witness was not so raw as to say that they had been promised the benefit for life. Both the city and SF attorney understood that for the last 40-50 years, retirement benefits for new hires were set forth in a writing, an MOU agreed to after collective bargaining; the best-evidence rule required that the writing, not an oral comment of one union member to another, was the best evidence of what employees were to receive as pensions. And the court had already ruled that the MOUs did not create vested contract rights. But the attorneys for the city could have, but did not, object to the hearsay declaration of the union witness. In my view, a failure of that magnitude could only be intentional. Both the city an SF attorneys were experts in this area of the law.

According to the Pacific Grove Charter, “The compensation of all officers and employees shall be fixed by Ordinance.” Under the law there are no exceptions to such a provision. In June 2012, LCW in its California Public Agency Labor and Employment Blog discussed the case of San Diego Firefighters, Local 145 v. Board of Administration of the San Diego City Employees Retirement Board. In the case, the appellate court held that because the benefit in question had only been approved by a resolution and not an ordinance as required by the city charter, the contract granting the benefit was void. So clearly, oral statements by administrators describing compensation as asserted by the POA could not possibly grant a vested right. Only an ordinance could do that. The case also held that there was no estoppel based upon the employees’ reliance on the contract. The case was not cited in the city brief.

As set forth in the LCW CEB seminar outline, it is “legislative intent” expressed at the time of the adoption of a contract or statute granting the pension benefit that is critical to establishing an implied vested pension right. Why? Because, by law, the only intent that could create a vested contract right is the legislative intent (the city council); after it adopts a contract or statute, the only type of evidence that supports an implied claim is evidence “concurrent with the adoption,” but not set forth in the document.

An administrator informing a new hire of the current pension plan orally or in a publication of any kind 50 years later cannot prove the required legislative intent.  LCW proved that beyond all doubt in its defense of the city in the South Pasadena case discussed above. To date, all of the appellate cases that dealt with a claim of an implied vested right have been lost by the claimants. In every case, like the Orange County case and the South Pasadena case, claimants argued that decades of  MOUs proved a vested benefit right. They lost because they could not show legislative intent by evidence concurrent with the time of adoption of the benefit.

What evidence would provide the legislative intent to grant a vested right although the contract or statutes did not? I believe a concurrent agenda report or benefit committee report that made it clear that the adopted benefit was intended to be for life would do the trick. But that is just my opinion.

After reviewing the trial briefs, Dr. Davis and I independently did what we could. Dr. Davis wrote a letter to the council indicating that the city’s brief did not set forth even a token defense, let alone the clear winning evidence. Dr. Davis said: “We have repeatedly pointed out that the City Attorney’s opinions . . . created a conflict of interest with regards to a defense of the 2010 initiative. . . . Now that the City has utterly failed to defend the fundamental basis of pension reform in the POA law suit the City has proven that our fears were justified.”

I wrote several e-mails to the city council, the SF attorney defending the case, and even met with the pro-union mayor and two of his council yes-men prior to trial. I expressed that based on the city trial brief, the case was not ready to be tried, would be lost, and that it was imperative that Dr. Davis and I be allowed to participate in defense of the city’s case. It did not happen. The Kampe council majority, the city attorney, city manager, and the unions made sure that the city lost the pension reform law suit.

Read the entire series:

The Fall of Pacific Grove – A Primer on Vested Rights
 – The Final Chapter, Part 1, October 20, 2015

The Fall of Pacific Grove – The City’s Tepid Defense of the Vested Rights Lawsuit
– The Final Chapter, Part 2, October 27, 2015

The Fall of Pacific Grove – The Judge’s Ruling
– The Final Chapter, Part 3, November 2, 2015

The Fall of Pacific Grove – The Immediate Future
– The Final Chapter, Part 4, November 9, 2015

*   *   *

About the Author:  John M. Moore is a resident of Pacific Grove, Ca. He is a licensed member of the California State Bar (#34749) and a member of the “Public Law” section of the State Bar. He is retired and no longer practices law, but has Lexis/Nexis for research. John graduated from San Jose State College with majors in Political Science and Economics (summa cum laude). He then received a JD from The Stanford School of Law and practiced business and trial law for 40 years before retiring. In 1987, he was the founding partner of a Sacramento law firm that he formed in 1987 to take advantage of the increased bankruptcies brought about by the Tax Act of 1986. Although he did not file and manage bankruptcy cases, he represented clients in numerous litigation matters before the bankruptcy court, including several cases before judge Klein, the current judge of the Stockton bankruptcy case. He is an admirer of Judge Klein, for his ability and accuracy on the law. As managing partner, he understood the goals of bankruptcy filings and its benefits and limitations.

*   *   *

Note to readers:  During 2014 author John Moore published the first chapter of The Fall of Pacific Grove in an eight part series published between January 7th and February 24th. For a more complete understanding of the history, read the entire earlier series:

The Fall of Pacific Grove – How it Began, and How City Officials Fought Reform
 – Part 1, January 7, 2014

The Fall of Pacific Grove – How City Thwarted Reform, and CalPERS Squandered Surpluses
 – Part 2, January 14, 2014

The Fall of Pacific Grove – CalPERS Begins Calling Deficits “Side Funds,” Raises Annual Contributions
 – Part 3, January 21, 2014

The Fall of Pacific Grove – Outsourcing of Safety Services Causes Increased Pension Deficits
 – Part 4, January 28, 2014

The Fall of Pacific Grove – Anti-Pension Reform Mayor Claims to Favor Reed Pension Reform
 – Part 5, February 3, 2014

The Fall of Pacific Grove – Privately Owned Real Property are the Only Assets to Pay for Pensions
 – Part 6, February 11, 2014

The Fall of Pacific Grove – The Cover-Up by the City After the Hidden Actuarial Report Surfaced in 2009
 – Part 7, February 18, 2014

The Fall of Pacific Grove – Conclusion: The “California Rule” Cannot Stand
 – Conclusion, February 24, 2014

The Fall of Pacific Grove – A Primer on Vested Rights

The Final Chapter, Part 1 of 4

Editor’s Note:  In early 2014 we published a eight part series, “The Fall of Pacific Grove,” written by retired attorney and Pacific Grove resident John Moore. It describes in detail how this small coastal city slid inexorably towards insolvency by yielding, again and again, year after year, to pressure from local government unions to award unaffordable pension benefits to city employees. Pacific Grove’s challenges are a textbook case of how there is simply no interest group, anywhere, currently capable of standing up to the political power of government unions. This small city now faces the possibility of selling off every asset they’ve got, primarily real estate, to private developers to raise cash for the city’s perpetually escalating annual pension contributions. They face the possibility of rezoning to allow construction of huge tourist hotels that will destroy the quality of life for residents, in order to enable new tax revenue producing assets to help pay the city’s required pension contributions. Anyone familiar with local politics knows that one of the only special interests with the financial strength to oppose government unions are major developers. This end-game, where public assets are sold to developers to generate cash for pension contributions ought to put to rest any remaining debate as to who runs our cities and counties. Of course developers aren’t going to oppose government unions. By extension, and in a tragic twist of irony, why should any libertarian leaning private sector special interest oppose government unions? As these unions drive our public institutions into bankruptcy, private sector investors buy the assets of our hollowed out public institutions at fire sale prices.

In this new four part series, author John Moore challenges the so called “California Rule” that supposedly makes pension modifications – even prospectively – legally impossible. But he also summarizes another legal approach to reform, one that takes into account the lack of due process and the ignorance of specific commitments made in the original granting of financially unsustainable pension benefit enhancements. It is an approach that has many facets and can be utilized in many California cities and counties. Sadly, Moore also exposes why this approach to reform, while viable, was only tepidly attempted in Pacific Grove. Regardless of how Pacific Grove’s situation evolves, what Moore has come up with here offers insights to anyone serious about pension reform in California.

The California State Bar governs the practice of law in California. Licensed active attorneys must continue their education by attending Continuing Education of the Bar (CEB) courses on a wide variety of subjects. Recently the law firm of Liebert Cassidy Whitmore (LCW), a large multi-office law firm emphasizing public law, was authorized by the State Bar to present a CEB course entitled Understanding “Vested” and Other Post-Employment Benefits. In order to understand precisely how the city government of Pacific Grove (city attorney, city manager, unions, and a union-backed council majority) defeated citizen pension reform, I can now, for the first time, with reliance on the course materials and the seminar, set forth important established principles of vested pension rights in California government agencies without being subjected to the retort that my assertions are only my opinions. The LCW seminar materials provide ample gravitas to my assertions. But first, here are some general principles that limit the applicability of vested right determinations.

Principle One: As set forth in the CA Supreme Court case of Valdez v. Cory (1983), state employees have vested pension rights. The court found there was a statutory scheme that gave state employees a contract right that continued for the life of each affected employee and was protected by the state and federal contract clause. Cases discussing state employee pension rights are not germane to the issue of whether a local agency’s employees have a vested pension right, because the discussions in the state employee cases assume that the employees have vested rights, while in non-state cases the issue is whether the legislative body granted a vested right.

Principle Two: California Teachers Assn v. Cory (1984), like Valdez, grants teachers in the State Teachers Retirement System a vested pension right.

Principle Three: Certain counties and some other local public agencies provide pension benefits pursuant to the County Employee Retirement Law (CERL). There is no case holding such benefits as vested, but a government code provision provides that benefits cannot be reduced or eliminated without the consent of all agency unions. A trial judge in Ventura found that unlike CaLPERS, CERL agencies did not have the right to terminate its plan. Its pensions are clearly vested-like.

Principle Four:  The California Constitution grants plenary authority to charter cities to provide for compensation of officers and employees (Article XI, Section 5[b]).

20151019-UW-Moore1
Will Pacific Grove’s parks be sold to developers to fund pension contributions?

There is no sweeping principle that provides a vested-right litmus test for particular at-law cities, charter counties, charter cities, cities and counties in CaLPERS and other cities and local municipal agencies.

The LCW CEB seminar sets forth the general rules that govern the process to determine whether a governing body had granted a vested pension or other post-employment right. Here is a summary  of those rules, based on the seminar and CEB course documentation:

  1. Vested rights are created by contract (that contract is protected by the state and federal contract clause). Contracts can create vested rights, but also charters, ordinances, resolutions, codes, etc., dependent on the expressed intention of the legislative body.
  2. When analyzing whether a pension or other benefit is vested, the beginning point is the language of the document conferring the benefit.
  3. Vesting is a two-step process: Is there a valid contract conferring the benefit, and, critically, does that contract contain an express or implied term that the benefit is only for a limited term or is it vested for life?
  4. The established rule, supported by a legal presumption, is that a statute–like a charter, ordinance, resolution, or contract–does NOT create vested contractual rights. Employees have a heavy burden of proof to overcome the presumption.
  5. Written contracts like MOUs (contracts between labor and the employer) and contracts with a pension administrator like CaLPERS have the potential to contain contract language vesting a benefit, but rarely do. In the 2013 Pacific Grove vested rights law suit, the court, in a pre-trial ruling, held that neither the MOUs, nor the contract with CaLPERS, granted vested contract rights. Recently, the US. Supreme Court in M&G Polymers, Inc. v. Tacket (2015) held that benefits (medical) provided under a collective bargaining agreement are presumed to expire when the contract expires.
  6. The final area covered in the seminar dealt with implied vested contract rights. As an example, for analysis, LCW discussed the 2015 case of South Pasadena Police Officers Assn et al v. City of South Pasadena. LCW in fact defended that city against a claim that plaintiffs had a vested contract right to certain medical benefits at a fixed cost. To succeed in such a claim, the facts must show that the legislative body intended to grant the claimed benefit for life. Such claims are very difficult to prove, and the LCW attorney successfully and adeptly defeated the claim.

In the Pacific Grove case, the Pacific Grove POA argued that evidence set forth in the affidavit of a police officer and job advertisements indicated that new hires were entitled to a “fixed-cost pension benefit” and hence an implied vested pension right for all. That turned out to be the KEY issue in the law suit.

*   *   *

Why is there so much confusion about whether a government agency has granted a vested pension right? In my experience, the present confusion is caused by statements by commentators, CalPERS, city, county, and agency lawyers describing the law that applies IF it has been established that a vested contract right existed. Quotes from Allen v. City of Long Beach (1955) are consistently out of context.

Kern v. City of Long Beach and Allen, were the foundation of the California Rule, which holds that in California (and 12 other states), if employees have a vested pension, not only pensions earned are vested, but employees are entitled to the rate of the current benefit and any increases for life (a benefit for work not yet performed cannot be eliminated). Earlier, in Kern, the Supreme Court held that a certain pension right set forth in the Long Beach charter could not be unilaterally eliminated by the city because current employees had a vested contract right created by the charter. A later attempt by the city to increase the employees’ contribution rate from 2% to 10% was struck down in Allen as a violation of that charter-granted vested contract right.

The confusion arises because quotes from Kern and Allen are cited as if the state and federal contract clauses created a vested pension right upon the date of employment without first establishing that a contract or a statute (charter, ordinance, resolution) had created the vested contract right for work not yet performed. In Pacific Grove, there was never any such statute, or any vested right to any employment contract ever adopted by the city legislative body or the charter. In both Kern and Allen a charter provision created such a right. The federal and state constitution protected the contract right, but did not and could not create it for a charter city like Long Beach or Pacific Grove.

Part Two will discuss Pacific Grove’s unprecedented non-defense in opposing the POA claim that the Pacific Grove police had a vested pension right based NOT on a document indicating legislative intent, but  by a claimed instance of an oral contract between one administrative city agent, possibly the police chief, and one newly hired police officer, opining that all new hires had been told they had a fixed-cost retirement benefit.

Additionally, both Kern and Allen distinguished modifications by an agency when there is no financial threat of the pension system losing its integrity (the ability to pay pensions). If facts were presented showing that a pension system was flawed, e.g. that by mistake or fraud its cost was so great that all pensions were threatened, the system could be modified without off-setting benefits. The most oft-quoted misstatement of Allen is: “Reasonable alterations of pension rights must bear some reasonable 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.” The court went on to say (this is always omitted by commentators): “There is no evidence or claim that the changes enacted bear any material relation to the integrity or successful operation of the pension system.” Also in Allen (and earlier in Kern), the court said again: “The city does not claim (that changes) were necessary to preserve the pension program applicable to persons employed prior to March 29, 1945 (the date pensions were eliminated in Long Beach) and there is no indication that the city would have difficulty in meeting its obligations.” Several cases where pensions were reduced without off-setting benefits, because the integrity of the pension system was in peril, were cited in Kern and alluded to in Allen.

In other words, Kern and Allen dealt with a city where there was no threat to the ability of the system to pay pensions, but both cases made it clear that even agencies that have created vested pension rights may claim that the vested pension rights are unsustainable, but it must offer financial evidence that the system is failed. A court, pursuant to Kern and Allen, could find that the financial condition justified a reduction of vested benefits without off-setting benefits. No such evidence was offered in Kern or Allen, but it is maddening that pension reformers do not demand that legislative bodies reduce even vested benefits pursuant to the integrity doctrine of Kern and Allen. Almost all California pension systems are irrevocably under water financially. And the assertion that Allen stands for the proposition that vested pension rights have been created by the courts without the creation process described in the CEB LCW seminar is simply based on ignorance.

*   *   *

About the Author:  John M. Moore is a resident of Pacific Grove, Ca. He is a licensed member of the California State Bar (#34734) and a member of the “Public Law” section of the State Bar. He is retired and no longer practices law, but has Lexis/Nexis for research. John graduated from San Jose State College with majors in Political Science and Economics (summa cum laude). He then received a JD from The Stanford School of Law and practiced business and trial law for 40 years before retiring. In 1987, he was the founding partner of a Sacramento law firm that he formed in 1987 to take advantage of the increased bankruptcies brought about by the Tax Act of 1986. Although he did not file and manage bankruptcy cases, he represented clients in numerous litigation matters before the bankruptcy court, including several cases before judge Klein, the current judge of the Stockton bankruptcy case. He is an admirer of Judge Klein, for his ability and accuracy on the law. As managing partner, he understood the goals of bankruptcy filings and its benefits and limitations.

Read the entire series:

The Fall of Pacific Grove – A Primer on Vested Rights
 – The Final Chapter, Part 1, October 20, 2015

The Fall of Pacific Grove – The City’s Tepid Defense of the Vested Rights Lawsuit
– The Final Chapter, Part 2, October 27, 2015

The Fall of Pacific Grove – The Judge’s Ruling
– The Final Chapter, Part 3, November 2, 2015

The Fall of Pacific Grove – The Immediate Future
– The Final Chapter, Part 4, November 9, 2015

*   *   *

About the Author:  John M. Moore is a resident of Pacific Grove, Ca. He is a licensed member of the California State Bar (#34749) and a member of the “Public Law” section of the State Bar. He is retired and no longer practices law, but has Lexis/Nexis for research. John graduated from San Jose State College with majors in Political Science and Economics (summa cum laude). He then received a JD from The Stanford School of Law and practiced business and trial law for 40 years before retiring. In 1987, he was the founding partner of a Sacramento law firm that he formed in 1987 to take advantage of the increased bankruptcies brought about by the Tax Act of 1986. Although he did not file and manage bankruptcy cases, he represented clients in numerous litigation matters before the bankruptcy court, including several cases before judge Klein, the current judge of the Stockton bankruptcy case. He is an admirer of Judge Klein, for his ability and accuracy on the law. As managing partner, he understood the goals of bankruptcy filings and its benefits and limitations.

*   *   *

Note to readers:  During 2014 author John Moore published the first chapter of The Fall of Pacific Grove in an eight part series published between January 7th and February 24th. For a more complete understanding of the history, read the entire earlier series:

The Fall of Pacific Grove – How it Began, and How City Officials Fought Reform
 – Part 1, January 7, 2014

The Fall of Pacific Grove – How City Thwarted Reform, and CalPERS Squandered Surpluses
 – Part 2, January 14, 2014

The Fall of Pacific Grove – CalPERS Begins Calling Deficits “Side Funds,” Raises Annual Contributions
 – Part 3, January 21, 2014

The Fall of Pacific Grove – Outsourcing of Safety Services Causes Increased Pension Deficits
 – Part 4, January 28, 2014

The Fall of Pacific Grove – Anti-Pension Reform Mayor Claims to Favor Reed Pension Reform
 – Part 5, February 3, 2014

The Fall of Pacific Grove – Privately Owned Real Property are the Only Assets to Pay for Pensions
 – Part 6, February 11, 2014

The Fall of Pacific Grove – The Cover-Up by the City After the Hidden Actuarial Report Surfaced in 2009
 – Part 7, February 18, 2014

The Fall of Pacific Grove – Conclusion: The “California Rule” Cannot Stand
 – Conclusion, February 24, 2014

San Jose City Council Capitulates to Police Union Power

“He told the class to take advantage of the academy, and then find jobs elsewhere. The police union tries to get us to leave the department.”
–  Anonymous source to NBC Bay Area, television report “Another San Jose Police Recruit Says Union Tried to Get Cadets to ‘Find Jobs Elsewhere’,” Oct. 28, 2014 (excerpt begins at 1:38 in report).

A precedent setting new development in San Jose last week provides abundant evidence of just how powerful local government unions really are in California. As reported today in San Jose Inside and elsewhere, an embattled city council has tentatively approved a new contract with San Jose’s police union that awards them “a 5 percent ‘retention’ bonus and an 8 percent raise over the next 16 months. In addition, former officers who return to the force in the next year can claim a 5 percent signing bonus.”

More significantly, at the same time, the San Jose City Council has tentatively agreed to drop their appeal of a court ruling that overturned a key part of a San Jose pension reform, a reexamination of the so-called “California Rule.” As pension expert Ed Mendel reported yesterday in PublicCEO, “The “California rule” is a series of state court decisions widely believed to mean that the pension offered on the date of hire becomes a vested right, protected by contract law, that can only be cut if offset by a new benefit of comparable value.

In practical terms, this means that pension benefit formulas, according to the California Rule, cannot even be trimmed for future work performed by existing employees. San Jose’s pension reform Measure B, passed by 70% of voters in 2012, presented city employees with a choice – they could either contribute an additional 16% towards their pension benefits via payroll withholding, or they could accept lower pension benefit accruals from then on. Nothing they had earned to-date would have been taken away from them.

Despite legal opinions that claim the California Rule is not well established law, and despite that the California Rule is contrary to the law governing public sector pensions in most states, and contrary to all law governing private sector pensions everywhere, San Jose’s local elected officials have capitulated.

THE INHERENT HYPOCRISY OF THE ‘CALIFORNIA RULE’

It is difficult to overstate just how hypocritical the union’s position is on the issue of modifying pension benefit formulas. Because the problems with pensions began back in 1999, when SB 400 raised pension benefit accruals per year for the California Highway Patrol. Within a few years, most every agency in California followed suit. And these pension benefit enhancements were applied retroactively to the date of the employees’ hire.

That is, starting in 1999, agencies changed the pension benefit formula so that, for example, police and fire pension accruals were not just increasing from 2% to 3% per year from then on, but retroactively to the day each employee was hired. So someone who would have earned a pension equivalent to 2% of their final salary times the years they worked would now earn a pension equivalent to 3% of their salary times the years they worked, even if they were going to retire within the next year or two.

What San Jose Measure B tried to do was not roll back pension benefits from 3% per year to 2% per year for years already worked. It only tried to reduce the benefit accrual, prospectively, for years still to be worked. And even that was too much for these unions.

THE DEVASTATING COSTS OF SAN JOSE’S POLICE/FIRE RETIREMENT BENEFITS

If taxpayers could afford to pay these pension benefits, there might be a stronger argument to preserve them. But San Jose’s independent Police and Fire Department Retirement Plan, according to their most recent financial report, is not in great shape financially. Keeping it afloat requires staggering sums of money from taxpayers that are only going to increase each year. Here are highlights:

(1) The plan as of 6-30-2014 (most recent data available) was 77.5% funded (page 114). This means that instead of earning their officially projected annual return on investment of 7.125% per year, just to avoid becoming more underfunded, they will have to earn 9.2% per year. Just to stay even. That is their so-called “risk free” rate of return.

(2) The fund truly is “risk free” to participants, because the taxpayers pay most of the expense and cover the losses when the market fails. In FYE 6-30-2014, police and fire employees contributed $21.1 million into their retirement fund, and taxpayers (the City of San Jose) contributed $123.6 million (page 69), nearly six times as much. How many “six to one” matching contributions are out there for corporate 401K plans?

(3) The unfunded liability for the SJ Police and Fire Retirement Plan was $806 million (page 114) as of 6-30-2013 (most recent actuarial data), equal to 436% of payroll. Or looking at this another way, the city’s pension contribution was $123.6 million, whereas their “covered payroll” was $184.6 million. That is, for every dollar San Jose pays to put police and firefighters on the street, they have to pay 67 cents to the pension fund.

(4) It’s not just pensions. The SJ Police and Fire Retirement Plan includes city funded retirement health insurance benefits. How’s that fund doing? As of 6-30-2013 (most recent data), that plan was 11% (eleven percent) funded, with an unfunded liability of $625.5 million (page 65).

(5) If you consolidate the financial data for San Jose’s Police and Fire Retirement Plan’s pension and healthcare (OPEB) plans, the most recent statements indicate they are 67% funded, with a total unfunded liability of $1.4 billion. If San Jose were to responsibly reduce their total unfunded liability for public safety retirement benefits, they would be paying far more than 67 cents for every dollar of payroll.

THE MISLEADING EMPHASIS ON AN EXODUS OF OFFICERS

Throughout this battle between fiscal realists and the police union in San Jose, the police have maintained that officers were leaving the city to work elsewhere or to retire. There’s no question that their ranks have thinned, perhaps alarmingly. According to SJ Inside, “the agency [currently has] 943 sworn officers out of a budgeted 1,109 positions.” And historically San Jose’s police department has had as many as 1,400 officers. But is the union thwarting efforts to fill the ranks?

Several news reports suggest that could be the case – starting with the local NBC television affiliate’s report quoted earlier. That anonymous source corroborated what another person stated publicly. According to the San Jose Mercury guest column entitled “San Jose police recruit: Union told class to quit right away for good of the department,” former police academy cadet Elyse Rivas writes:

“On the first day of the academy, our orientation included the opportunity to meet Jim Unland, the Police Officers Association’s president. In no uncertain terms, he blamed Measure B for the departure of hundreds of officers — and he told us that it would be better for the department and for us if we would just quit, right then and there. He said that our employment with the department did not help the POA’s cause in proving Measure B was killing the department’s recruitment capabilities. He urged us to find jobs elsewhere.”

Reached for comment earlier today regarding developments in San Jose, former Mayor Chuck Reed agreed with the substance of these allegations. Not only did he confirm reports of union representatives discouraging academy recruits from taking jobs with the department, but he also described other ways they thwarted recruitment:

There were reports of recruiting events held in the San Jose police union offices where they invited police recruiters in from other cities to encourage active San Jose police officers to take these jobs in other cities.

Reed also said “when we were trying to hire officers, we wanted to bring in retired police officers in to do the background checks so we could keep our active officers on the beat – but the union urged retirees to refuse to accept the work.”

In any case, Reed pointed out that the city had determined to reduce the size of the police force back in 2010, well before voters approved Measure B, saying “the police department headcount went down from 1,400 to 1,100 before there was any pension reform.” Reed believes that an ideal headcount for the San Jose police department would not require returning to 1,400, and that getting to the budgeted 1,109 positions would be a good first step.

SO HOW MUCH DO SAN JOSE’S ‘UNDERPAID’ POLICE OFFICERS MAKE?

Getting timely and accurate information on public pay is difficult because financial reports from public entities take a long time to produce and often omit important data. The most recent payroll records publicly available for the city of San Jose are for 2013. According to a search on Transparent California of San Jose city employees with “Police” in their job title, in 2013 there were 260 of them who made over $250,000 in pay and benefits, and an astonishing 806 who made over $200,000 in pay and benefits. Here’s the link:  San Jose city employees, 2013, with “Police” in their job title.

Pension information for San Jose’s retired police officers is complicated by the fact that the data includes firefighters along with police officers. Moreover, the average full-career pension estimates are understated because a significant percentage of the current participants retired before pension benefits were enhanced in San Jose – a process of “continual enhancement” that continued up until 2008. Using 2014 data acquired by Transparent California, the estimated average full career pension for a San Jose police/fire retiree is $99,116 – with guaranteed 3% per year cost-of-living increases. The number for recent, post-2008, full-career retirees is undoubtedly much higher. Here is a 2014 roster of all of San Jose’s police/fire retirees – note that individual retirement health benefits (unfunded liability of $625 million) were not provided – certainly adding a value of at least another $10,000 per year.

Are San Jose’s police officers underpaid? The average veteran officer makes pay and benefits worth well over $200,000 per year. Add to that the likely 5% “retention bonus, and the 8% raise over the next sixteen months per the tentative new agreement. You decide.

The personal attacks and confrontational tactics employed by the San Jose police officers union against their political opponents do not reflect well on the fine men and women who staff that department, who perform work of vital importance to society. Whether or not they intentionally urged officers to quit (or never join) the San Jose police force is almost irrelevant, despite abundant evidence that suggests they did. Because their real transgression against the people of San Jose, the taxpayers, the elected officials, and public safety itself, is to insist on levels of pay and benefits for their officers that are far more than the city can afford.

*   *   *

Ed Ring is the executive director of the California Policy Center.

RELATED POSTS

Why Pension Reform is Inevitable, and How Reforms Can Benefit the Economy, July 21, 2015

Retiree with $183,690 Annual Pension Attacks Pension Critics, June 9, 2015

Pension Reform is Bad for Wall Street, and Good for California, April 14, 2015

Is Deficient Recruiting the Real Reason for Police Understaffing in San Diego?, January 20, 2015

Conservatives, Police Unions, and the Future of Law Enforcement, January 6, 2015

Police Unions in America, December 9, 2014

Government Employee Unions – The Root Cause of California’s Challenges, June 3, 2014

Conservative Politicians and Public Safety Unions, May 13, 2014

How Much Does Professionalism Cost?, March 11, 2014  (The Kelly Thomas Story)

How Public Sector Unions Skew America’s Public Safety and National Security Agenda, June 18, 2013

CALIFORNIA POLICY CENTER PENSION STUDIES

California City Pension Burdens, February 2015

Estimating America’s Total Unfunded State and Local Government Pension Liability, September 2014

Evaluating Total Unfunded Public Employee Retirement Liabilities in 20 California Counties, May 2014

Evaluating Public Safety Pensions in California, April 25, 2014

How Much Do CalSTRS Retirees Really Make?, March 2014

Comparing CalSTRS Pensions to Social Security Retirement Benefits, February 27, 2014

How Much Do CalPERS Retirees Really Make?, February 2014

Sonoma County’s Pension Crisis – Analysis and Recommendations, January 2014

Are Annual Contributions Into CalSTRS Adequate?, November 2013

Are Annual Contributions Into Orange County’s Employee Pension Plan Adequate?, August 2013

A Method to Estimate the Pension Contribution and Pension Liability for Your City or County, July 2013

Moody’s Final Adopted Adjustments of Government Pension Data, June 2013

How Lower Earnings Will Impact California’s Total Unfunded Pension Liability, February 2013

The Impact of Moody’s Proposed Changes in Analyzing Government Pension Data, January 2013

A Pension Analysis Tool for Everyone, April 2012

 

 

 

The Fall of Pacific Grove – Conclusion: The "California Rule" Cannot Stand

In this series, relying on official records of CalPERS and the City of Pacific Grove, I have shown how those two agencies and the unions worked as one to destroy the ability of cities like Pacific Grove from providing minimal government services. But the Supreme Court of California is the great enabler and protector of pension rights for public employees; rights that contradict a democratic form of government.

If there is not a change in the so-called “California Rule,” created by the Supreme Court of California and followed by 12 other states, most California cities and counties will become insolvent, like Pacific Grove and Sonoma County. How soon it happens to other public agencies (with defined benefit programs) depends on the relative viability of their tax base. Carmel can last for decades as long as it can tax tourists without a material decline in tourism. The city of Monterey is less viable, and cities like Marina and Seaside less viable still. Pacific Grove and Sonoma county have no chance to lift themselves out of insolvency unless the California Rule is changed by something like the Reed Initiative or a reversal by the California Supreme Court (the Florida Supreme Court reversed the rule in 2011).

What is the California Rule?

I believe that most states hold that government employees have a “vested right” in the pensions that have already been earned (subject to various emergency powers). Private employees and social security members do not even have that degree of vesting, but in the 12 states that follow the California Rule, a public agency cannot reduce the size of pensions for future pension accruals (accruals for work not yet performed).

The California Supreme court summarized the California Rule in the case of Betts v. Bd. of Admin….(1978), decided by the infamous Bird court. Several scholars have soundly criticized the opinion as nothing more than improper legislation by the court, but it is important to understand why that is true.

The California Rule is based on the legal theory that a statute, like an ordinance or a city charter, that has set out a pension right in the statute or charter, did so with the intention to create a vested right, not only as to pensions earned, but also as to future accruals. That “contract” is then said to be protected by the “contract clauses” of the State and Federal constitution.

But in every case where a California court has enunciated the California Rule, it has omitted any factual inquiry into legislative intent. No scholar has found a single California opinion applying the rule, where there was a showing that the legislation from which the contract was derived was based on a legislative history confirming that a vested right to future accruals was intended. The court just made it up. The Court was and is a major beneficiary of the Betts decision and the California Rule.

In establishing the rule, there was no inquiry by the court into the state “debt limit” set forth in Art. XVI, Sec. 18 of the Constitution. Nor was State Govt. Code 7507 requiring the legislative body to analyze the actuarial impact of a pension increase on the future costs of the new benefit applied. That was because the court is not a legislative body. But if it is going to legislate, it should act like a legislature and not destroy public agencies like Pacific Grove, without the consent of its citizens and without an inquiry into the factual basis and the consequences of its decisions. Citizens can trump legislative acts by its right to a referendum, but the California Rule deprived the citizens of that right. A courageous court would analyze the California Rule, make the legal inquiry of whether it is legally possible to create a vested right to future pension accruals (in a democracy), and if so, was that intent set forth in the legislation at issue.

Legislation by Collusive Law Suits

Public Agency attorneys, like city and county attorneys, can indirectly legislate pension and medical benefits by collusive or thrown law suits. In my opinion, that happened to Pacific Grove just last year. Citizens qualified an initiative to limit pension contributions by the city to 10% of salaries. The city attorney and the unions opposed the initiative, but the city council adopted it as its own ordinance. The police unions sued claiming it possessed a “vested right” to future pension accruals. Pacific Grove is a charter city. It did not have a provision in its charter, or a statute that created a pension, so there was no way that the California Rule could apply. But in its so-called defense of the law suit, the city simply raised no defense to the claimed vested right, so it lost by default. In Pacific Grove, the only pension rights ever granted were by term contracts, called MOUs. All scholars of the California Rule agree that vested rights to future accruals cannot be created by short-term contracts. The process of inadequately defending pension law suits occurs over and over in California and coincides with the purchase by public agencies of “as requested” legal and expert opinions.

Recently, the California Supreme Court held that it was possible for union employees to claim an “implied” contractual right to retiree health benefits arising from a county statute like an ordinance. The court said that the existence of such an implied right would be very difficult to prove. But within days, retirees filed law suits claiming such rights. The law suits were defended by public agency attorneys appointed by employees of public agencies who would themselves be entitled to the claimed implied benefits so long as the public agency lost the suit. And, lo and behold, they lost and the union employees won. Billions of dollars of new deficits will flow from the Supreme Court decision.

Creating new benefits by the failure to properly defend claims of vested pension and health benefits is only possible because of the California Rule as applied to both pension and health benefits.

A Final Thought

Historically, only dictators–including royalty and religious leaders–held unlimited vested rights that destroyed the rights of the majority of citizens. Such rights are inconsistent with a democracy. Because of the California Rule, unions, CalPERS, city and county managers and attorneys have the unfettered power to destroy the public agencies that they represent and deprive citizens of the right to the form of government that they would choose. Government unions, city managers, city attorneys, and municipal legislative bodies, empowered by the dictatorial California Rule have destroyed the once-excellent school system, our roads, parks, water supply, services for the poor and aged, cultural services, and safety services, and imposed a burden of out-of-control debt on citizens who were not even of an age to vote (even the unborn) at the time that the debts were created.

In every election for pension reform in the past decade, about 75% of voters have voted for pension reform. In most instances the courts then held the reform invalid as a violation of the California Rule. Municipal services have been and will continue to be demolished at a rapid rate. Blogs etc. about how unfair it all is don’t seem effective. Action is required. Bi-partisan single-issue pension reform PACs must be formed throughout the state for the election of legislators who will sponsor an initiative that reverses the California Rule, no matter what. The remedy of recall and even impeachment should be on the table. A democracy is at stake. It must be restored.

Read the entire series:

The Fall of Pacific Grove – How it Began, and How City Officials Fought Reform
 – Part 1, January 7, 2014

The Fall of Pacific Grove – How City Thwarted Reform, and CalPERS Squandered Surpluses
 – Part 2, January 14, 2014

The Fall of Pacific Grove – CalPERS Begins Calling Deficits “Side Funds,” Raises Annual Contributions
 – Part 3, January 21, 2014

The Fall of Pacific Grove – Outsourcing of Safety Services Causes Increased Pension Deficits
 – Part 4, January 28, 2014

The Fall of Pacific Grove – Anti-Pension Reform Mayor Claims to Favor Reed Pension Reform
 – Part 5, February 3, 2014

The Fall of Pacific Grove – Privately Owned Real Property are the Only Assets to Pay for Pensions
 – Part 6, February 11, 2014

The Fall of Pacific Grove – The Cover-Up by the City After the Hidden Actuarial Report Surfaced in 2009
 – Part 7, February 18, 2014

The Fall of Pacific Grove – Conclusion: The “California Rule” Cannot Stand
 – Conclusion, February 24, 2014

About the Author:  John M. Moore is a resident of Pacific Grove, Ca. He is a licensed member of the California State Bar (#34734) and a member of the “Public Law” section of the State Bar. He is retired and no longer practices law, but has Lexis/Nexis for research. John graduated from San Jose State College with majors in Political Science and Economics (summa cum laude). He then received a JD from The Stanford School of Law and practiced business and trial law for 40 years before retiring. In 1987, he was the founding partner of a Sacramento law firm that he formed in 1987 to take advantage of the increased bankruptcies brought about by the Tax Act of 1986. Although he did not file and manage bankruptcy cases, he represented clients in numerous litigation matters before the bankruptcy court, including several cases before judge Klein, the current judge of the Stockton bankruptcy case. He is an admirer of Judge Klein, for his ability and accuracy on the law. As managing partner, he understood the goals of bankruptcy filings and its benefits and limitations.