On July 30, 2020, 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. (“ACDSA“). The opinion permits the 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. Under the standard articulated by the Court, pension reforms advocated by former San Jose Mayor Chuck Reed to reduce pension costs would almost certainly be held unconstitutional.

Although the Court denied the pensioners’ claims by upholding PEPRA’s anti-spiking provisions, the ruling affirms and strengthens 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 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.

The 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 Court recognized PEPRA resulted in a detriment to the Plaintiffs in this case but held the Legislature’s purpose justified the modifications. In the unanimous ruling, Chief Justice Tani Cantil-Sakauye explained, 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 Court also resolved the confusion over whether plan modifications that that result in disadvantages to employees “must” or “should” be accompanied by new advantages. During oral arguments, David E. Mastagni asserted that the distinction made little difference. The Court largely agreed. “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 Court found PEPRA’s reforms pigeonholed this narrow exception. “The Legislature’s decision to impose financial disadvantages on public employees without providing comparable advantages will be upheld 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 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.

The 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 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.

In repudiating the State’s contention that PEPRA’s changes were only prospective, the Court agreed with Mr. Mastagni’s argument that PEPRA’s amendment applies to all pension rights, regardless of when they were accrued. 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 Opinion is nuanced and complicated. While the outcome is a disappointment to the plaintiffs, in this case, the standard upheld by the Court is a major win for all public employees in California. Any future pension modifications must be analyzed under the California Rule and the validity of the modifications will be determined based upon the facts of each case. Simply put, the employers and the state cannot terminate or modify your retirement plans to address increasing pension costs as Governor Brown stated that he had hoped to do.