Retirement Sign.jpgThe vested nature of public employee retirement benefits is a hot topic. On the one hand, there are municipalities dealing with increasing pension costs and unfunded liabilities. On the other hand, there are often times a vested right to future pension benefits for employees and retirees cannot be impaired except under very limited circumstances.  Most recently, the California Court of Appeal examined a public employer’s ability to take away promised pension benefits retroactively, after the Internal Revenue Service found that the pension benefits violated federal tax law.  (San Diego City Firefighters, Local 145 v. Board of Administration of the San Diego City Employees’ Retirement System, et. al.)

The San Diego City Employees’ Retirement System (SDCERS) operates the defined benefit pension system for the City, the San Diego Unified Port District, and the San Diego Regional Airport Authority. SDCERS is a qualified public pension plan under Internal Revenue Code section 401(a).  In 2007, the IRS issued a compliance statement under a voluntary audit of SDCERS which stated that two aspects of SDCERS did not comply with IRC section 401(a).

First, by a 2002 resolution, as well as a separate agreement with an employee, the City agreed to an “incumbent president program” which allowed three incumbent union presidents’ retirement allowances to be based on the highest one-year combined salaries from both City employment and union employment. The IRS held this was not permitted under a qualified plan and that the retirement allowance may only be based on salary from City employment.

Second, the City had entered into a memorandum of understanding (“MOU”) in 2002 with the City’s fire fighters union which permitted employees to convert their annual leave cash equivalent to retirement service credit on a pre-tax basis.  Pursuant to City Charter, an election of the SDCERS membership voted to approve the annual leave conversion and it was later adopted by City ordinance.  This, too, the IRS held violated section 401(a) as an impermissible cash or deferred arrangement in a qualified plan.

The City and SDCERS signed an agreement with the IRS promising to remove the infracting provisions retroactively within 150 days. The IRS in return would not pursue the sanction of disqualification of the SDCERS.  The City passed ordinances retroactively terminating the incumbent president program and repealing the prior ordinance permitting the annual leave conversion.

The union and individual plaintiffs impacted by the retroactive repeals filed lawsuits against the City and the SDCERS Board asserting claims including breach of contract, unconstitutional impairment of contractual rights, negligence, declaratory relief and promissory estoppel, as well as petitioning for writs of mandate.  The cases were consolidated and the superior court sustained demurrers filed by the City and SDCERS on all causes of action without leave to amend and dismissed the lawsuits.  The plaintiffs appealed and the Court of Appeal affirmed on all counts.

First, the Court held that there was no valid contract requiring the City or SDCERS to base the incumbent union presidents’ retirement allowance on both their salaries from the City and union employment.  The City Charter stated that changes and amendments to the SDCERS could only be made by: (1) a majority vote of the SDCERS membership; and (2) by a subsequent ordinance of the City Council.  The incumbent president program was implemented merely by City Council resolution. No vote of the SDCERS membership was held, nor was an ordinance enacted.   The resolution of the City Council was therefore void.

The enactment of the annual leave conversion, however, complied with the City Charter. Nonetheless, the Court held that the annual leave conversion provision was “suspended and superseded” by federal law.  The MOU that promised the benefit contained a “savings clause” which provided that the MOU was subject to all current and future applicable federal, state and local laws, regulations and the City Charter.  If any part or provision of the MOU was found in conflict or inconsistent with the law, that provision would be suspended and superseded by that applicable law or regulation with the remainder of the MOU preserved.

As the annual leave program violated section 401(a) it was “suspended and superseded” by operation of the savings clause in the applicable MOU.  As the ensuing ordinance and municipal code section were part and parcel of the same transaction as the MOU provision, the savings clause similarly applied to void the ordinance and municipal code section, as well. 

Therefore, no valid and enforceable contract existed pertaining to the annual leave conversion.

Second, the doctrine of promissory estoppel could not act to impose a contractual right to either the incumbent president program or the annual leave conversion.  Promissory estoppel is an equitable doctrine that acts to bar a promisor from refusing to give a promised for exchange due to the lack of a valid contract where the other party has already acted in reliance on that promise, the promisor should have known the action would occur, and where denying the promised for exchange would now be unjust.  The Court held that:

‘“[N]either the doctrine of estoppel nor any other equitable principle may be invoked against a governmental body where it would operate to defeat the effective operation of a policy adopted to protect the public.’”

Here, the policy adopted was that of the City Charter that required any changes or amendments to the SDCERS be made by both a majority vote of the membership and then by ordinance.  Promissory estoppel, therefore, could not be used to require the City to continue the incumbent president program because to do so would run afoul of the mandate in the City Charter.

Similarly, promissory estoppel failed as a matter of law as to the annual leave conversion because the City did not promise plaintiffs they could participate in the annual leave conversion if that program was found to be noncompliant with the law.  The MOU’s savings clause of the MOU expressly provided that it was subject to all current and future applicable laws and regulations and that if any provision of the MOU was found to be in conflict with or be inconsistent with applicable law, the provision would be suspended and superseded.

Justice Irion dissented from the majority decision, however, opining, in part, that because the annual leave conversion program was adopted in the appropriate manner under the City Charter, it gave rise to contractual obligations that could only be modified if the modifications were reasonable to preserve the integrity of the pension system and any resulting disadvantages to affected employees were accompanied by comparable new advantages. (Betts v. Board of Administration)

This case may have implications for all public employers providing benefits through a defined benefit pension system, not only for those that maintain their own pension system, but in some cases for those who provide benefits under the County Employees’ Retirement Law (“ ’37 Act”), PERS or STRS.  This decision also has implications for any employer that provides other defined post-employment benefits, such as retiree health insurance.  Public employers are cautioned to ensure that any changes or modifications in pension benefits comply not only with the requisite retirement law (e.g. ’37 Act, PERL, etc.), but also with the employer’s own charter, municipal code or other governing laws. Public employers are also encouraged to include savings clauses in MOUs in the event any provision of the MOU is held to be unlawful.

Pension benefits and other post-employment benefits often involve vested rights that may not be impaired except in limited circumstances and any modifications that may be made will always depend on the circumstances of the individual employer, governing documents, and applicable pension system laws.  Employers are advised to seek legal counsel before making any changes to pension or other post-employment benefits.