LOS ANGELES – California’s legal process is slouching toward a series of decisions that could give state and local governments leeway to alter their public pension systems.

Lawyers are preparing briefs in the first of what could be a series of high-profile cases that could endanger California’s “vested rights” doctrine.

The lead plaintiff, Cal Fire Local 2881, after losing at the appellate level, has taken its case to the state Supreme Court, arguing that California violated rights guaranteed to its members in the state constitution when it enacted the Public Employees’ Pension Reform Act of 2013. The union represents firefighters employed by the California Department of Forestry and Fire Protection.

The outcome of the court’s decision in this and another group of local cases will determine the trajectory of pension reform efforts in the Golden State.

Tani Cantil-Sakauye, chief justice of the California Supreme Court, in April 2017
California Chief Justice Tani Cantil-Sakauye. The state Supreme Court has several momentous pension cases on its docket. California Courts

PEPRA was enacted in an effort to curb what many saw as abuses of the pension systems, such as the practice of “spiking” in which extra benefits are calculated into an employee’s pay at the end of his or her career, resulting in a larger pension payout. The crux of the Cal Fire case is whether or not PEPRA’s elimination of the ability of both future and current employees to purchase additional years of service time violates the so-called “California Rule.”

The California Rule arose from a 60-year-old state Supreme Court ruling generally interpreted to mean that existing employees' benefits cannot be reduced, even for formulas in future years of employment, without offering pension plan participants a comparable advantage in turn. The rule has been influential not only in California but also nationally, with courts in several other states sometimes citing California’s legal precedent in their own rulings.

Pension underfunding, modification, and reform is a hot topic among municipal bond analysts and investors, who are increasingly concerned that pensioners are paid out of the same pools of money as bondholders and have won out over investors in major bankruptcy cases such as Detroit and Stockton.

Straggling investment returns and high unfunded pension liabilities have created credit pain points for state and local governments. Moody’s Investors Service has said that rulings which clear the path for governments to modify their pension systems would likely be viewed as good for their credits.

The Cal Fire case differs from the other cases pending before the court even though all of the cases get to the heart of the California Rule.

The other cases, Marin Association of Public Employees v. Marin County Employees’ Retirement Association, and Alameda County Deputy Sheriffs’ Association et al. v. Alameda County Employees’ Retirement Association, are related to the anti-spiking provisions of PEPRA. The plaintiffs there argue that the government can’t legally alter the future pension calculation formula for current employees, because that removes an existing benefit without offering them a new one.

An appeals court made waves last year when it ruled in the Marin County case that the benefits could be altered, and that employees are entitled only to a “reasonable” pension benefit, a theory that could upend the "California Rule."

The Cal Fire case, by contrast, deals not with spiking but rather with a legislatively-granted ability for employees to purchase so-called “air time” to count towards their years of service and eventual pension benefit. Originally granted by the legislature in 2004, this benefit allowed employees who had worked at least five years to purchase between one and five of additional years of service time at any time prior to retirement.

This allowed CalPERS participants to leave work to pursue additional education, or to stay at home with children, and then to eventually return to work then retire at the normal retirement age with a larger pension benefit. The union argued in its Supreme Court filing that the right was a clear benefit to employees and came at no cost to taxpayers because the cost was borne by the employees themselves.

The lawsuit further alleges that not only did CalPERS recognize the purchase system as a right, but that the legislature also made no effort to explain in PEPRA why removing the right to purchase service time was necessary to preserve the integrity of the pension system.

The state of California, intervening in the case to defend the law, successfully argued at both the trial and appellate levels that there was nothing in the statute indicating it intended to create a vested pension right, and that the legislature could therefore make reasonable modifications to those benefits.

In their own new brief, the firefighters argue that the Court of Appeals was mistaken in its analysis and point out that public employers and CalPERS itself have consistently pointed to rights like the air time purchase benefit as protected and have used such arguments to advantage public employers over the private sector.

“Public employers have induced employees to stay or become employed and leave the private sector for better benefits – particularly retirement benefits,” Cal Fire’s attorneys wrote. “Public employees have entered public service in the belief that their pension benefits are guaranteed once they vest.”

Pension expert James Spiotto, a managing director at Chapman Strategic Advisors in Chicago, said that the court could go a variety of different ways in its rulings on these cases, either tailoring them narrowly to avoid tackling the broader California Rule question, or issuing a more sweeping opinion that could have more wide-ranging repercussions. The Cal Fire decision, assuming it comes first as the court has indicated it will, could therefore be an influence or indication of the court’s stance on the other cases, he said.

“I think generally since they are raising some of the same issues, a decision in Cal Fire, depending on how far the court goes, could be at least influential if not determinative,” said Spiotto.

Marc Levinson, a partner at Orrick, Herrington & Sutcliffe in Sacramento, said that judges in California’s top court as well as in others around the country sometimes view lead cases as an opportunity to avoid having to reconsider the same issues in the other pending cases. The court could rule in Cal Fire, and then remand the others back to the Court of Appeals for a decision “consistent with the ruling in Cal Fire,” Levinson said.

Nationally, most states have modified their versions of the California Rule to be more flexible and court decisions nationwide are trending toward allowing reasonable modifications to pension benefits, Spiotto said.

Spiotto and other sources following the case said that due to the state’s request for an extension to file its reply brief, the court should be fully briefed by September and prepared to set a date for oral argument for some time after that.

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