Courtesy of James R. Touchstone, Esq., and Brittany E. Roberto, Esq.

On January 8, 2018, Division Four of the First District Court of Appeal, in Alameda County Deputy Sheriff’s Association et al. v. Alameda County Employees’ Retirement Association et al.,[1] concluded that because the California Public Employees’ Pension Reform Act of 2013 (“PEPRA” or “AB 197”) effected substantive changes to the County Employees Retirement Law of 1937 (“CERL”) law with respect to on-call payments and so-called pension enhancements, a vested rights analysis is required.  The Court remanded the case for determinations, in accordance with its analysis, as to the reasonableness of PEPRA’s detrimental changes when applied to the vested rights of “legacy members” (members hired before January 1, 2013).

Background

As detailed in our March 2017 Client Alert relating to the California Supreme Court granting review in another pension case,[2] this case involved consolidated challenges to amendments made to CERL law by PEPRA. Appellants in the case include Alameda County and Contra Costa County and their respective Deputy Sheriffs’ Associations, as well as the Merced County Sheriffs’ Association.  The parties challenged their respective county employee retirement associations’ ability to implement AB 197 as to legacy members.

Among other things, the parties sought a declaration that the county employee retirement associations’ actions in implementing AB 197 as to legacy members was an unconstitutional impairment of a vested contractual right to have “the value of accrued leave cash-outs exceeding the amount that was both earned and payable during their ‘final compensation’ period” included in their “compensation earnable.”  The parties also sought a writ of mandate directing the employee retirement associations to calculate legacy members’ retirement allowance in accordance with their policies and procedures in place prior to the implementation of AB 197 and also sought injunctive relief prohibiting the associations from further implementing AB 197.

The Contra Costa Superior Court judge that heard the consolidated matters denied the request that the court declare the associations’ actions unconstitutional impairments of vested contractual rights and also declined to issue a writ of mandate or grant declaratory or injunctive relief on the issue of leave cash-outs to be included in “compensation earnable” and “final compensation.”  The deputy sheriffs’ associations appealed.

Discussion

Division Four of the First District Court of Appeal began its analysis by briefly discussing the history of CERL and California Government Code section 31461.[3]  It then discussed the changes to CERL effected by PEPRA, the actions taken by the retirement boards in each of the three counties to conform their systems to PEPRA, and the litigation initiated by appellants challenging the boards’ implementation actions as an unlawful impairment of legacy members’ constitutionally protected pension rights.  It then outlined the trial court’s analysis and judgments denying petitioners’ request to have Section 31461 declared an unconstitutional impairment of the vested rights of legacy members, except to the extent the revised statute excluded the value of certain types of on-call payments from such members’ “compensation earnable.”

Before addressing the challenges to the trial court’s decision, Division Four addressed “Guelfi[4] discretion,” which derives from a footnote from the Guelfi decision that has been interpreted as standing for the proposition that Section 31461 merely identifies the minimum pay items that must be included in compensation earnable, but it does not otherwise limit the discretion of CERL boards to include additional pay items in the calculation of pension benefits if they choose to do so.  The Court rejected the argument that the boards have Guelfi discretion—the discretion to include additional pay items in compensation earnable without being bound by the language of CERL.  The Court explained that if an item is not compensation, compensation earnable, or final compensation under CERL statutes, it cannot be included in a member’s pensionable compensation under CERL.

The Court next addressed the impacts of each of the challenged amendments to Section 31461.

Leave Cash-Outs Under Subdivision (b)(2)

First, the Court reviewed PEPRA’s treatment of in-service leave cash-outs as a component of compensation earnable.  It explained that under the amended version of Section 31461, compensation earnable expressly excludes “[p]ayments for unused vacation, annual leave, personal leave, sick leave, or compensatory time off, however denominated, whether paid in a lump sum or otherwise, in an amount that exceeds that which may be earned and payable in each 12-month period during the final average salary period, regardless of when reported or paid.”  The Court, citing prior versions of Section 31641 and its definition of compensation earnable, adopted the position that compensation must be earned in the final compensation period in order to be pensionable.

Next, the Court addressed whether in-service leave cash-outs are earned when the leave at issue is accrued or when the employee earns the right to sell that leave in cash.  Citing Ventura County Deputy Sheriffs’ Assn v. Board of Retirement[5] and In re Retirement Cases,[6] the Court determined that an employee’s election to turn an otherwise in-kind benefit into cash, either through a leave cash-out or by choosing to take vacation pay without working, creates “remuneration in cash” that is pensionable compensation under CERL.  Accordingly, the Court supported the trial court’s conclusion that the new subdivision (b)(2) of Section 31461 does not change existing law with respect to in-service leave cash-outs.  However, the Court rejected the trial court’s determination of when such cash-outs are earned for purposes of CERL. The Court held that leave cash-outs must be included in a member’s pensionable compensation to the extent the member exercises his or her option to convert the leave into cash during the final compensation period, regardless of when that leave time was accrued.

Terminal Pay Under Subdivision (b)(4)

The Court next addressed PEPRA’s exclusion of terminal pay from compensation earnable.  It explained that PEPRA added subdivision (b)(4) to Section 31461, which excludes from compensation earnable “[p]ayments made at the termination of employment, except those payments that do not exceed what is earned and payable in each 12-month period during the final average salary period, regardless of when reported or paid.”  The Court agreed with the trial court’s conclusion that subdivision (b)(4) did not result in a change to existing CERL law because CERL has always required that compensation be payable during the final compensation period in order to be included in compensation earnable.

Pay “Outside of Normal Working Hours” Under Subdivision (b)(3)

The Court next addressed the exclusion set forth in subdivision (b)(3) of Section 31641, which provides that “[p]ayments for additional services rendered outside of normal working hours, whether paid in a lump sum or otherwise” may not be included in compensation earnable.  The Court noted that no party argued that overtime pay was ever a permissible component of compensation earnable under CERL, but that the parties disputed whether on-call, standby and similar pay items should be included in pensionable compensation.

The Court first concluded that on-call, standby and similar payments were included in compensation earnable prior to PEPRA to the extent they constituted remuneration for on-call services provided by an employee as part of his or her regular work assignment.  Then, the Court addressed whether CERL permitted on-call payments to be pensionable only to the extent they were received by others in the same grade or class, concluding that any such pre-PEPRA right is not limited to on-call premiums received by employees in the same group or class.  Having concluded that legacy members were entitled to the inclusion of on-call pay in the calculation of their pension benefits to the extent that the on-call duty was part of their regular work assignments, the Court next addressed whether PEPRA’s addition of subdivision (b)(3) to Section 31461 changed the law.  The Court concluded that PEPRA meant to exclude from compensation earnable such on-call and standby payments, and therefore constituted a change to CERL law.

Enhancement Payments Under Subdivision (b)(1)

The Court next addressed the new subdivision (b)(1) of Section 31461, which excludes from compensation earnable “[a]ny compensation determined by the board to have been paid to enhance a member’s retirement benefit.”  The trial court refused to reach the merits of the vested rights issue relating to subdivision (b)(1), which appellants challenged on appeal.  The Court concluded that the addition of subdivision (b)(1) clearly effected a change in CERL law, noting that, prior to PEPRA, if an employee-member had the option of receiving an in-kind benefit in cash and chose to do so during the final compensation period, that benefit had to be included in compensation earnable, regardless of the intent of any party and also contrary to subdivision (b)(1).  Because the Court found that the addition of subdivision (b)(1) changed CERL law, it concluded that it must be subjected to a vested rights analysis to determine whether legacy members have the right to have their pensions calculated without reference to the new requirements of subdivision (b)(1).

Vested Rights

Because it concluded that PEPRA made substantive changes to CERL law with respect to on-call payments and so-called pension enhancements, the Court next addressed the question of whether those changes constituted a reasonable modification to prior CERL law or whether the effect of the changes is to impair vested contractual rights of legacy members. The Court reviewed California Supreme Court precedent relating to vested pension rights.  It then reviewed Division Two of the First District’s decision in Marin Assn. of Public Employees v. Marin County Employees’ Retirement Assn.,[7] wherein Division Two concluded that PEPRA’s changes to CERL’s definition of compensation earnable did not amount to an unconstitutional impairment of the vested pension rights of Marin County Employees’ Retirement Association legacy members.  The Court noted that Division Two in its opinion had noted that the changes to Section 31461 were “quite modest” while detailing the unfunded pension liability crisis.  Division Two, the Court explained, balanced the amendments to Section 31461 against the significance of the problem they were intended to address and concluded that, in light of the need for change, the change was reasonable.

The Court declined to follow Marin.  It noted its belief that the Marin court improperly relied on its “general sense” of what a reasonable pension might be rather than recognizing that the Supreme Court has expressly defined a reasonable pension as one which is subject only to reasonable modification.  The Court explained that an employee’s right to a reasonable pension can only be judged in the context of the balancing analysis established by Allen v. City of Long Beach,[8] wherein the Supreme Court held that, to be sustained as reasonable, “alterations of employees’ pension rights must bear some material relation to a theory of a pension system and its successful operation, and changes in a pension plan which result in disadvantage to employees should be accompanied by comparable new advantages.”

Applying the principles outlined in vested rights precedent to this case, the Court concluded that the reasonableness of the PEPRA amendments must be judged independently in each of the three counties.  Because the trial court did not conduct the required vested rights analysis and did not consider the impacts of the changes, the Court concluded it did not have sufficient information to resolve the vested rights disputes on appeal, and that remanding the case was necessary.

The Court directed the trial court to recognize that because no corresponding new advantages were provided with respect to the detrimental changes to compensation earnable effected by PEPRA, the application of the detrimental changes to legacy members “can only be justified by compelling evidence establishing that the required changes ‘bear a material relation to the theory . . . of a pension system’ and its successful operation.”  It further directed that the trial court’s analysis focus on the impacts of the disadvantages on legacy members and, if the justification for the changes is the financial stability of the specific CERL system, the court’s analysis must consider whether the exemption of legacy members from the changes would cause that particular system to have difficulty meeting its pension obligations with respect to those members.

The Court remanded the case for determinations, in accordance with its analysis, as to the reasonableness of PEPRA’s detrimental changes when applied to the vested rights of legacy members in the three counties.

HOW THIS AFFECTS YOUR AGENCY

This decision establishes a split among the divisions of the First District Court of Appeal. As discussed in our March 2017 Client Alert, Division Two in Marin found that there is no absolute requirement that elimination or reduction of an anticipated retirement benefit “must” be counterbalanced by a comparable new benefit.  Similarly, Division Three, in another pension-related case, Cal Fire Local 2881 v. California Public Employees’ Retirement System (“Cal Fire”)[9], concluded that public employees are entitled only to a “reasonable” pension, not one providing fixed or definite benefits immune from modification or elimination by the governing body.  In April 2017, the California Supreme Court granted review in the Cal Fire case.

Marin and Cal Fire appear to signal a shift in California pension law.  However, as detailed above, Division Four in the Alameda County case expressly declined to follow Marin, instead citing California Supreme Court precedent that requires that changes in a pension plan which result in disadvantage to employees be accompanied by comparable new advantages. The Court further instructed the lower court on remand to recognize that the application of the detrimental changes to legacy members can only be justified by compelling evidence establishing that the required changes bear a material relation to the theory of a pension system and its successful operation.

As explained in our March 2017 Client Alert, the California Supreme Court granted review in the Marin case and deferred action pending a decision in the Alameda County case.  Now that a decision has been rendered, and establishes a split among the divisions of the First District Court of Appeal, it is possible that the Supreme Court will review the Marin, Alameda County, and Cal Fire cases together, since the cases raise similar issues.  Whether or not the cases are reviewed together, the Supreme Court’s decisions in these cases will likely establish the extent to which local governments can modify employee pension benefits to combat unfunded pension liabilities.

It will likely be several months before the Supreme Court weighs in on these issues.

As always, if you wish to discuss this matter in greater detail, please feel free to contact me at (714) 446–1400 or via email at jrt@jones-mayer.com.

Information on www.jones-mayer.com is for general use and is not legal advice.  The mailing of this Client Alert Memorandum is not intended to create, and receipt of it does not constitute, an attorney-client-relationship.

[1] 2018 Cal. App. LEXIS 12 (1st Dist. Jan. 8, 2018).

[2] Client Alert Vol. 32, No. 7, California Supreme Court to Weigh in on Pension Formula Dispute (March 8, 2017).

[3] (a) “‘Compensation earnable’ by a member means the average compensation as determined by the board, for the period under consideration upon the basis of the average number of days ordinarily worked by persons in the same grade or class of positions during the period, and at the same rate of pay. The computation for any absence shall be based on the compensation of the position held by the member at the beginning of the absence. Compensation, as defined in Section 31460, that has been deferred shall be deemed ‘compensation earnable’ when earned, rather than when paid.

(b) ‘Compensation earnable’ does not include, in any case, the following:

(1) Any compensation determined by the board to have been paid to enhance a member’s retirement benefit under that system. That compensation may include:

(A) Compensation that had previously been provided in kind to the member by the employer or paid directly by the employer to a third party other than the retirement system for the benefit of the member, and which was converted to and received by the member in the form of a cash payment in the final average salary period.

(B) Any one-time or ad hoc payment made to a member, but not to all similarly situated members in the member’s grade or class.

(C) Any payment that is made solely due to the termination of the member’s employment, but is received by the member while employed, except those payments that do not exceed what is earned and payable in each 12-month period during the final average salary period regardless of when reported or paid.

(2) Payments for unused vacation, annual leave, personal leave, sick leave, or compensatory time off, however denominated, whether paid in a lump sum or otherwise, in an amount that exceeds that which may be earned and payable in each 12-month period during the final average salary period, regardless of when reported or paid.

(3) Payments for additional services rendered outside of normal working hours, whether paid in a lump sum or otherwise.

(4) Payments made at the termination of employment, except those payments that do not exceed what is earned and payable in each 12-month period during the final average salary period, regardless of when reported or paid.”

[4] Guelfi v. Marin County Employees’ Retirement Assn., 145 Cal. App. 3d 297 (1st Dist. 1983).

[5] 16 Cal. 4th 483 (1997).

[6] 110 Cal. App. 4th 426 (1st Dist. 2003).

[7] 2 Cal. App. 5th 674 (1st Dist. 2016).

[8] 45 Cal. 2d 128 (1955).

[9] 7 Cal. App. 5th 115 (1st Dist. 2016).