Questions linger after state high court upholds ‘California Rule’

Last year, the California Supreme Court issued its long-awaited ruling on the "California Rule" in Alameda County Deputy Sheriffs' Association, et al. v. Alameda County Employees' Retirement System, et al., 9 Cal. 5th 1032 (2020). The opinion permitted the California Legislature to address perceived pension abuses, even if the modification reduces some employee benefits, while upholding the requirement of the California Rule that detrimental changes otherwise must be accompanied by offsetting new advantages.

Although the court denied the pensioners' claims by upholding the Public Employees' Pension Reform Act's anti-spiking provisions, the ruling affirmed and strengthened the California Rule. Carving a narrow exception from the requirement to offset detrimental modifications of pension benefits with new advantages, the court held PEPRA's limitations on the inclusion of certain leave payments, on-call pay, and other payments to enhance pension benefits were "enacted for the constitutionally permissible purpose of closing loopholes and preventing abuse of the pension system." The Court also ruled that terminal pay was never includable. The court then declined to apply equitable estoppel to enforce the Ventura settlement agreements providing for the inclusion of the disputed items in pension benefits. See Ventura County Deputy Sheriffs' Assn. v. Board of Retirement, 16 Cal. 4th 483 (1997).

The Supreme Court articulated a two-part test for evaluating pension modifications under the California Rule. First, the court must determine whether the modifications impose an economic disadvantage and, if so, whether those disadvantages are offset in some manner by comparable new advantages. The court must then determine whether the government's articulated purpose was sufficient, for constitutional purposes, to justify any impairment of pension rights.

The Supreme Court recognized PEPRA resulted in a detriment to the petitioners in this case but held the Legislature's purpose justified the modifications. In the unanimous ruling, Chief Justice Tani Cantil-Sakauye explained that prior contracts clause jurisprudence delineated what is not a constitutionally permissible purpose, including modifications to address revenue shortfalls and rising pension costs. The chief justice noted, "we have never addressed the circumstances under which such advantages need not be provided."

The Supreme Court also resolved the confusion over whether plan modifications that that result in disadvantages to employees "must" or "should" be accompanied by new advantages. The court said "should" is the proper test, but "should" cannot "be disregarded as merely precatory" and generally, "modifications of public employee pension plans "should" preserve the value of plan participants' pension rights."

In short, the California Rule "requires the level of pension benefits to be preserved if it is feasible to do so without undermining the Legislature's permissible purpose in enacting the pension modification." Here, the Supreme Court found PEPRA's reforms fell within this narrow exception: "The Legislature's decision to impose financial disadvantages on public employees without providing comparable advantages

under the contract clause only if providing comparable advantages would undermine, or would otherwise be inconsistent with, the modification's constitutionally permissible purpose. We conclude that the PEPRA amendment survives this constitutional scrutiny." (Emphasis added.) "Given our past decisions, we have no difficulty finding that the PEPRA amendment was enacted to maintain the integrity of the pension system." The court further explained, "it would defeat this proper objective to interpret the California Rule to require county pension plans either to maintain these loopholes for existing employees or to provide comparable new pension benefits that would perpetuate the unwarranted advantages provided by these loopholes."

Additionally, the Supreme Court rejected the argument that the employees acquired a contractual right to the inclusion of the disputed pay items because their contributions to the county pension fund were based on an actuarial calculation that included the additional benefit costs attributable to the inclusion of the disputed items. However, in footnote 18, the court held that by paying for the inclusion of the disputed items, the employees might be entitled to a partial refund of their contributions.

Importantly, the Supreme Court severely limited the power to modify pension benefits in the future, expressly holding the California Rule "remains the law of California." Rejecting the state's contention that it possessed sweeping police powers to reduce pension benefits, the court upheld the long-standing principle that pension rights vest upon commencement of employment. The state attempted to evade contracts clause analysis by arguing the changes only operated prospectively. The court characterized the state's argument as "misguided" and explained that the law in effect at the end of an employee's career is used to determine all pension benefits, resulting in a "profoundly retroactive impact."

The 90-page decision left many questions unanswered regarding the implementation of PEPRA and the Alameda decision. In the past year, County Employee Retirement Law systems across the state have struggled with interpreting and implementing the decision. The majority of these disputes are a result of ambiguities in the statute which were not explicitly addressed by the court in Alameda. Areas of dispute include on-call/ stand-by pay that is a part of an employee's "normal working hours," "straddling" of vacation cash-outs to include an extra cash-out in the final compensation period, and reimbursing employees for contributions they made in anticipation of benefits they are no longer entitled to receive. Eight years after implementation of PEPRA, the litigation is still far from over as lawsuits continue in multiple CERL counties. 

David argued on behalf of the Alameda County Deputy Sheriffs' Association, and is involved in litigation in multiple CERL counties.