CHICAGO – As Illinois girds for the promised legal challenge to its newly minted pension overhaul, backers say the restructuring can pass constitutional muster because of what it offers public sector workers in exchange for benefit cuts.

Unions disagree and say they will file a complaint in the next few weeks arguing that the legislation which Gov. Pat Quinn signed Dec. 5 violates the state constitution’s contract and pension clauses.

“Senate Bill 1 is attempted pension theft, and it’s illegal,” the We Are One Illinois coalition of unions said in a statement last week. “Our coalition has been consistently in contact with our attorneys, and today we directed them to prepare to file suit. We will challenge SB 1 as violating the constitution and ask for a stay of the legislation’s implementation pending a ruling on its constitutionality.”

The Illinois Supreme Court ultimately will have the final say on the legislation slated to take effect next June, although the unions could also pursue a federal challenge. Union officials said they are still considering their options.

The state’s strong constitutional protections that safeguard the benefits of participants in the state retirement system have played a central role in the debate over pension reform and driven political divisions that resulted in a two-year impasse before the overhaul was approved.

During that time, the state’s unfunded liabilities continued to grow, reaching $100.5 billion at the close of fiscal 2013, while the state’s general obligation bond rating sunk to A-minus levels across the board, the weakest among states. All three rating agencies affirmed the ratings this week; Fitch Ratings and Moody’s Investors Service retained negative outlooks on the credit as they sort of the impact of the changes, while Standard & Poor’s changed its outlook to “developing” from negative.

The legal arguments will center on whether the changes run afoul of state contract law and pension clauses in the constitution and whether sufficient buffers are built into the legislation offering annuitants “consideration” for reduced benefits.

At the heart of the debate is Article XIII, Section 5 of the Illinois Constitution which reads: “Membership in any pension or retirement system of the state, any unit of local government or school district, or any agency or instrumentality thereof, shall be an enforceable contractual relationship, the benefits of which shall not be diminished or impaired.”

Legal experts are divided over whether the entirety of the new law, or portions of it, can withstand the impending challenge.

Union lawyers will argue that the changes are a clear cut violation of the language and the intent of the provisions by participants in the 1970 state constitutional convention. The state will argue that contract law allows for modifications when accepted by the parties or if some consideration is offered as compensation.

The state will be represented by Illinois Attorney General Lisa Madigan.

“The attorney general’s office has been thoroughly researching and analyzing all possible issues as the legislature has worked toward a final agreement, so if and when litigation is filed, we will be prepared to defend the state,” said AG spokeswoman Maura Possley.

Court tests on pension changes across the country offer a mixed bag and don’t necessarily provide a road map given the variances of individual state and constitutional law.

Some rulings have granted stronger status solely to accrued benefits. In a Minnesota case, COLA changes were upheld. Lower courts in Arizona have struck down pension cuts imposed by lawmakers, but a final ruling from the state’s high court is still pending.

Union representatives last week made clear their position that the so-called items of consideration in the bill don’t make up for the cuts imposed by the legislation.

House Speaker Michael Madigan, D-Chicago, in providing an overview of the bill ahead of the vote last week pointed out the “items of consideration” in the legislation aimed at supporting the state’s legal arguments.

They include a state pension funding guarantee, a paring back of employee payments, and a shift to an actuarially sound funding scheme all aimed at stabilizing the faltering system that is just 39.3% funded.

“We’ve been concerned from day one that before the Supreme Court the argument would be that it just hurts workers,” Madigan said. “The reduction in employee’s contribution has been put in the bill for the purpose of showing consideration before the court.”

A lengthy preamble to the legislation offers another legal avenue for state lawyers to pursue – that fiscal doom lies ahead for the state and the pension system without reforms. The legislation’s introduction outlines the dire status of the state’s pension system and its drain on state coffers, the spending cuts and tax increases already implemented to help shore up the state’s books, and the state’s sharp credit deterioration.

“Already, Illinois has the lowest credit rating of any state, and it faces the prospect of future credit downgrades that will further increase the high cost of borrowing,” the preamble reads. “The General Assembly recognizes that without significant pension reform, the unfunded liability and the state’s pension contribution will continue to grow, and further burden the fiscal stability of both the state and its retirement systems.

“Having considered other alternatives that would not involve changes to the retirement systems, the General Assembly has determined that the fiscal problems facing the state and its retirement systems cannot be solved without making some changes to the structure of the retirement systems,” it concludes.

Under the new law, the state will shift to an actuarially based method that moves the state’s system to full funding by 2044. State contributions are guaranteed and pension funds could ask the courts to compel the state to make the payments although lawmakers can vote to change them.

Cost-of-living adjustments will grow at a slow rate on most portions of an annuitant’s pension, up to five COLAs adjustments will be skipped, pensionable salaries will be capped, and retirement ages raised for some. The legislation also creates an optional 401(k)-style defined contribution plan although participation is limited. Employee contributions will drop by 1 % and the state will make supplemental contributions in future years.

Sponsors say if all pieces are upheld, the overhaul will shave $160 billion off scheduled payments to the system, pare about $21 billion off the state’s $100.5 billion of unfunded liabilities, and $1.5 billion off upcoming annual state contributions.

A supplement posted to the state’s offering statement on Thursday’s scheduled competitive $350 million bond sale informs potential investors that debt repayment retains its priority position over the pension guarantee. “Senate Bill 1 provides that enforcement of these payments to the Retirement Systems is expressly subordinate to the payment of the principal, interest and premium” on any bonded debt obligation of the state, it says.

The supplement does not offer any figures on the prospective savings as they have yet to be finalized based on an actuarial review and simple estimate could prompt regulatory scrutiny.

“Should SB 1 be declared unconstitutional or otherwise invalid, the state’s financial condition would be materially worse than the state’s anticipated financial condition if SB 1 is upheld and its reforms implemented,” the supplement posting warned.

Passage of the plan ended the political stalemate which most recently had centered on the constitutional question. Madigan earlier this year pressed for a plan that would impose direct cuts and result in savings of more than $180 billion.

Senate President John Cullerton, D-Chicago, pushed his own plan with more modest savings but one he believed could better withstand a legal fight. His plan asked employees and retirees to “accept” benefit changes in exchange for preserving their retiree healthcare subsidies.

Cullerton lobbied his members to support the new legislation and voted in its favor but later said he believes it has “serious constitutional problems.”

Cullerton’s previous plan was based on the contract principle of acceptance. His legal counsel Eric Madiar has written of the strength of the constitutional language that protects benefits granted at the time of employment and future enhancements as well as the case law that supports the provisions and the intent of those participating in the 1970 constitutional convention.

In his overview, he writes that while the General Assembly cannot adversely change the benefit rights of current employees via unilateral action, they are “contractual” in nature and may be modified through contractual principles. “In sum, while welching on public pension promises is not an option for Illinois as some legal and civic commentators have suggested, legitimate contract principles provide a solution to mitigate this crisis,” the piece read.

The question on the new plan is whether its provisions of “consideration” will sway judges. The changes apply to four of the state’s five pension funds as lawmakers purposely left the judges’ retirement fund out of the mix to avoid a conflict of interest as the courts decide the legality of the legislation.

In addition to upholding or overturning the entirety of the law, the courts could cherry pick what pieces of the legislation are constitution, providing a roadmap if new legislation is needed, lawmakers said.

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