Is the California Rule in jeopardy after Alameda County?

In a 90-page opinion issued on July 30, a unanimous California Supreme Court looked deep into the abyss of pension rights and by the end, actually decided very little. To understand the court's decision in Alameda County Deputy Sheriff's Association v. Alameda County Employees' Retirement Association, 2020 DJDAR 7952, the small exception it established, and what may lie ahead, we have to define some terms. Up first is what is referred to as the "California Rule," which, in its simplest terms, requires the vesting of public employee pension benefits at the beginning of employment. That means benefits, even those related to future service, can only be reduced under very limited circumstances. Next comes the California Public Employees' Pension Reform Act of 2013, or PEPRA. In the narrow context of this case, PEPRA amended the County Employees Retirement Law of 1937, aka CERL. The PEPRA amendment restricts the scope of an employee's compensation utilized to calculate the retirement benefit to prevent "pension spiking." Pension spiking occurs when an employee's pay is manipulated to inflate what is known as "compensation earnable," an amount used to calculate the retirement benefit. No longer includable in the compensation earnable calculus are: (1) compensation determined by a local retirement board as paid to enhance the retirement benefit; (2) compensation for services rendered outside of normal working hours; and (3) unused paid time off accrued outside of the year of retirement.

The first issue reviewed by the court was whether the PEPRA amendment violates prior, now conflicting settlement agreements between county employees and the county retirement board. This question was examined under contract law and a claim of estoppel. The court stated that like any other administrative body, a county retirement board's rulemaking power prohibits the agency from acting outside the scope of the enabling law. Under CERL, a country retirement board's function is to implement or administer the pension plan as designed by the legislative enactment. A county retirement board lacks any authority to circumvent applicable law as it is the Legislature that has final authority governing pension benefits under CERL. Given that, a county retirement board cannot act inconsistently with CERL or any CERL legislative amendments. Any provision to a settlement agreement requiring a county retirement board to act in a manner contrary to subsequent CERL amendments is void. As such, the court interpreted the settlement agreements as requiring the county retirement boards to classify compensation consistent with the prevailing law. The court then rejected the plaintiffs' equitable estoppel claim finding that absent from the settlement agreements was any representation that the CERL provisions relating to compensation calculations would not be amended.

The court then turned to plaintiffs' claims that the PEPRA amendment violates the rights of pre-existing county employees under the contract clause found at Article I, Section 9 of the California Constitution. The contract clause prohibits only substantial impairment of a contract. After a review of its prior decisions, the court summed up the analysis applicable to the California Rule as determining if the modification imposes disadvantages on the employees, and if so, are those disadvantages offset or accompanied comparable advantages. In the absence of any such offset, the Legislature's purpose in changing the preexisting law is examined to determine if that purpose serves as a sufficient justification for the impairment of pension rights. A public employee pension system may be modified in order to keep the system flexible enough to allow for adjustments to changing conditions while maintaining system integrity. However, such changes only survive a contract clause challenge if the alterations have a material relationship to the theory of a pension system and its successful operation. Thus, legislatively enacted financial disadvantages without suitable offsets only pass constitutional scrutiny if providing the offsetting advantages undermine, or are inconsistent with, the purpose of the modification.

Applying this analytical framework, the court found that the PEPRA amendment reduces county employee pension rights in the absence of any comparable new advantages, as the amendment excludes previously included compensation from the retirement benefit calculation. The court then noted three examples where it previously held political reasons attempting to justify diminishing benefit modifications without an offset were rejected: shrinking the benefits of more senior employees to equalize the benefits with more recent hires in a less generous plan; stripping retirees of benefits upon conviction of a felony to satisfy taxpayer objections; and stemming rising costs that speculatively threatened the system. By comparison, the compensation exclusions in the PEPRA amendment serve to prevent pension spiking, which the court viewed as a distortion of the pension benefit calculation. Thus, the amendment has a material relationship to theory of the pension system and its successful operation.

Having determined that the amendment was enacted for a constitutionally permissible purpose, the court moved to the final question: Would providing comparable new advantages as an offset undermine, or be inconsistent with, the constitutionally permissible purpose for the modification? In concluding an offset would undermine the basis for the amendment, the court reasoned that the purpose of the PEPRA amendment was to prevent the practice of pension spiking by closing loopholes that previously were the subject of manipulation and abuse. While such abuse was not illegal, closing the loopholes imposes uniformity on the calculation process consistent with intent of the Legislature.

The court expressly limits the scope of its decision to county employees who were employed prior to PEPRA's effective date by those counties that have elected to participate in CERL. Thus, the immediate net result here is relatively small. The court also made it clear that, despite urging by the State and the California Business Roundtable, the California Rule remains intact. The question looking forward is will Alameda County be the proverbial first crack in the dam that continues to expand to such a degree that the California Rule itself is in jeopardy? Tune in to future litigation to find out. 