Chicago mayor Rahm Emanuel says the city will ask unions to negotiate a new pension reform package.

CHICAGO – Chicago will return to the bargaining table with its unions to take a second stab at reforms aimed at passing state constitutional muster, Mayor Rahm Emanuel said.

The Illinois Supreme Court shot down the city's 2014 reforms to its municipal employees' and laborers' pension funds last week, declaring the package a violation of the constitution's pension clause that assigns contractual rights to fund membership and protects benefits from impairment or diminishment.

The 2014 package cut benefits, including the compounded annual cost-of-living adjustment, and raised city and employee contributions.

The court's 18-page opinion, which reinforced justices' previous rulings on state pension reforms and state retiree healthcare benefits, left the door open for local and state governments to pursue reforms through collective bargaining and through a "consideration" model. The latter is related to contract law and allows for modifications if mutually agreed to by the various parties when some benefit is offered to offset a negative change.

"They've given us two roads and we are going to take both to find a balanced approach that is consistent and fair to everybody," Emanuel said in an interview on WTTW's Chicago Tonight program Tuesday. "We will do it in a way that is fair to taxpayers and fair to people that work with the city" while also protecting the "financial health of the city."

The stakes are high as the municipal market awaits word from the city on its next steps.

The city is facing further credit erosion over the weight of its $20 billion unfunded pension tab. Fitch Ratings knocked its rating down two notches to the lowest investment grade level of BBB-minus and assigned a negative outlook Monday.

Moody's, which already has the city at junk, and Standard & Poor's have said since the ruling that the city needs to quickly offer a viable plan for stabilizing the two funds that account for half of the $20 billion tab and are projected to exhaust assets in the next decade.

In the opinion released last Thursday, justices rejected the city's argument that the reforms provided fund members with a "net benefit" by saving them from insolvency and guaranteeing annuities. The court said those are benefits already are enjoyed by members through the pension clause.

Justices also rejected the city's argument that the changes represented a "bargained for exchange" because a majority of impacted unions informally signed off. The court did not agree with that characterization. Justices concluded that it was "undisputed that the unions were not acting as authorized agents within a collective bargaining process" and so individuals had not waived their constitutional rights.

The openings seen as a guideline for future reforms that could withstand a legal test lie in the following language: "To be sure, ordinary contract principles allow for the modification of pension benefits in a bargained-for exchange for consideration….As we explained in Heaton [the state pension case], the pension protection clause was not intended to prohibit the legislature from providing 'additional benefits and requiring additional employee contributions or other consideration in exchange….likewise, nothing prohibits an employee from knowingly and voluntarily agreeing to modify pension benefits from an employer in exchange for valid consideration from the employer."

Prior court rulings found "the intention must be mutual," the ruling said.

While some believe individuals might have to consent to any choice, the court outlines its recognition of union representation.

"In the context of the collective bargaining process for public employees, employees designate a particular union as their exclusive agent for collective bargaining negotiations," its opinion said.

It’s unclear whether the city would seek to include retirees in any new reform plan as they would not be represented by collective bargaining. The negotiation could take some time, would require new state legislation, and could launch a new court review, raising questions over a whether a city plan that relies on negotiation alone can stave off further credit hits. Market participants have said the city also needs to outline a near-term funding plan that relies on spending cuts and new revenues.

"Delayed implementation of a clear plan to fund municipal and laborer pension plan liabilities will likely weaken Chicago's credit quality," Moody's wrote.

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