I. Summary
On March 27, 2015, the California Court of Appeal ruled that a city cannot retroactively cut pension benefits. In Protect our Benefits v. City & County of San Francisco , the Court decided that a voter approved initiative to amend the charter of the City and County of San Francisco to only pay a supplemental cost of living increase to retirees if the pension system was fully funded during the previous year impaired vested contractual rights and largely violated the Contracts Clause of the California and United States Constitutions. Those employees who retired before the supplemental cost of living increases became an effective part of the pension system were, however, subject to the voter approved initiative because the Court held these retirees did not have a vested contractual right to the supplemental increases. In other words, while the charter amendment was meant to apply to all retirees to prohibit a supplemental cost of living increase unless the retirement system was fully funded, the Court held that the amendment could only be applied to those who retired before the supplemental cost of living increases became a benefit under the pension plan.
II. Discussion
In the case of Protect our Benefits v. City & County of San Francisco, 2015 Cal. App. LEXIS 269 (1st Dist. Mar. 27, 2015), the Court of Appeal evaluated the constitutionality of an initiative measure that amended the charter of the City and County of San Francisco to only pay supplemental cost of living increases to retirees when the retirement system was fully funded during the preceding year. The Court held that, with respect to employees who worked after 1996 when the supplemental cost of living increases were effective, the initiative unconstitutionally impaired a vested contractual right to the increases. However, with respect to those employees who retired before 1996 and never worked while the increases were part of the pension plan, the Court held that these retirees had no vested contractual right to the increases and the initiative was valid as to them.
Background
In 1996, voters in the City and County of San Francisco passed a measure that created a supplemental cost of living increase for retired city employees. In 2002, voters passed another measure that provided that the amount of the cost of living increase could not be reduced. However, due to the financial crisis in fiscal year 2008-2009, the retirement fund lost about 25% of its value. In 2011 voters passed an initiative measure that amended the charter to prohibit paying retirees the supplemental cost of living increase unless the retirement system was fully funded for the previous year. Since the retirement system was not fully funded, retirees’ benefits were decreased because supplemental cost of living increases were not paid.
“Protect our Benefits,” a political action committee representing retired employees, filed a petition to overturn the initiative, arguing that the initiative impairs a vested contractual right to the supplemental cost of living increases and therefore violates the Contracts Clause of the California and United States Constitutions. The trial court upheld the validity of the initiative, finding that the purpose of the 1996 supplemental increase was to permit retirees to share in surpluses, but only when the fund could afford to do so. The trial court held that while the “full funding” requirement did technically alter the City’s contractual obligation, the 2011 initiative was nonetheless “consistent with the spirit or basic theory” of the prior enactments on when supplemental increases should be paid.
The Court’s Decision
In finding the 2011 initiative largely invalid, the Court of Appeal rejected the City’s argument that the initiative did not decrease pension benefits because it merely clarified the prior voter-approved measures that implicitly required “full funding” of the retirement system before the supplemental cost of living increase could be paid. The Court found that there was no indication that the prior voter-approved measures contained an implied requirement that the supplemental cost of living increases would only be paid if the retirement system was fully funded for the previous year. While the purpose of the prior measures may have been enacted so retirees could share in surpluses, the measures did not expressly condition supplemental cost of living increases upon the retirement system being fully funded. Thus, without a comparable advantage that the City gave pensioners in return for the decrease in pension benefits, the City impaired a vested contractual right in violation of the state and federal constitutions.
The Court also held that the 2011 initiative did not impair the vested contractual rights of employees who retired before 1996 when the supplemental cost of living increase became part of the retirement plan since these retirees did not work to earn this form of deferred compensation. Only employees who provided employment services to the City after the supplemental cost of living increases were put in place in 1996 received a vested right to supplemental increases after retirement.
III. Conclusion
It’s worth noting that the 1996 measure could have specified that supplemental cost of living increases would only be paid when the retirement system is fully funded, but since it didn’t, the 2011 measure could not do so without violating the contractual rights of those who worked after passage of the 1996 measure. This case illustrates the limitation on a city’s ability to decrease vested pension benefits to those employees who worked for the city when the benefits were effective, even when the limitation is proposed and approved by the voters. As the Court noted, cities can diminish vested contractual rights without offending the Contracts Clause but only if a comparable benefit is offered in return. This case also illustrates that cities can limit pension benefit increases to years when there is a surplus so long as this limitation is clearly spelled out in the pension plan.
Finally, the court currently adjudicating the City of Stockton’s bankruptcy recently held that “vested rights” under California law remain subject to impairment under Chapter 9 bankruptcy due to the supremacy of federal laws over state laws [In re City of Stockton, 526 B.R. 35, 56 (Bankr. E.D. Cal. 2015)]. Thus, bankruptcy may provide a means whereby a city may avoid its obligations to fund a pension plan without impairing the vested rights of its current and former employees.
The above information is for general use and is not legal advice. This J&M Legal Alert is not intended to create, and receipt of it does not constitute an attorney – client relationship.Should you have any questions or require further clarification of the above, please contact Keith F. Collins at (714) 446-1400 or kfc@jones-mayer.com