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State Supreme Courts Decide Vested Rights State Supreme Courts Decide Vested Rights

State Supreme Courts Decide Vested Rights

Two recent state supreme court cases considered whether public pension participants are entitled to a particular benefit once offered through their public pension that, due to a plan amendment, is no longer available. In Eddington et al. v. Dallas Police and Fire Pension System, et al., (available here) the Supreme Court of Texas considered whether plan participants were entitled to a once-guaranteed interest rate on a Deferred Retirement Option Plan ("DROP") account, and in Cal Fire Local 2881 et al. v. Cal. Pub. Employees' Retirement Sys., (available here) the Supreme Court of California considered whether plan participants were entitled to an option to purchase "airtime" that was available under a former pension statute. Eddington v. Dallas Police and Fire Pension System, No. 17-0058 (Tex. Mar. 8, 2019); Cal Fire Local 2881 v. Cal. Pub. Employees' Ret. Sys., No. S239958 (Cal. Mar. 4, 2019). In both cases, petitioners argued that they held a vested right to a benefit no longer available under the plan. See Eddington, No. 17-0058 at 2; Cal Fire, No. S239958 at 2; see also Cal Fire, No. S239958, at 5 n.3 (explaining that a vested right is "a benefit of public employment whose repeal or other divestment is constrained by the constitutional contract clause. Public employees acquire a vested right in their pension at the inception of employment, even though they generally do not become vested with respect to its receipt until after five years of employment."). However, both state supreme courts held that these benefits were not part of the participants' accrued benefits under the plan, and therefore, the participants did not have any entitlement or right to receive them. See Eddington, No. 17-0058 at 13; Cal Fire, No. S239958 at 3. Broadly, the cases demonstrate a reluctance by state courts to expand the understanding of participants' vested rights in public pension systems beyond annuity payments.

In Eddington, the Supreme Court of Texas considered whether the Dallas Police and Fire Pension System's reduction and subsequent removal of a guaranteed interest rate paid on its DROP accounts violated the Texas Constitution's prohibition on the reduction or impairment of benefits under public local retirement systems. See Eddington, No. 17-0058 at 2. Although the Plan at one point guaranteed an interest rate of "not less than 8% nor more than 10%" for its DROP accounts, an amendment required the Plan to begin gradually decreasing the guaranteed interest rate in 2015 and eventually allowed it to fluctuate between 7% and 0% depending on investment performance. Id. at 3. Petitioners in the case argued that this change constituted a reduction in retirement benefits "granted or accrued," thereby violating their rights under the Texas Constitution. Specifically, the Petitioners relied on Article XVI, Section 66 of the Texas Constitution, which provides that "[b]enefits granted to a retiree or other annuitant before the effective date of this section and in effect on that date may not be reduced or otherwise impaired." Id. at 6.

The court found that the Texas Constitution protected a pensioner's annuity rather than a certain rate of interest on that annuity. In regards to the Texas Constitution provision at issue, the court held that it "protects only accrued benefits based on service rendered and not benefits expected but as-yet unearned for future service." Id. at 9. Acknowledging that the Texas Constitution does not expressly define "benefit," the court interpreted the term to mean "the pensioner's annuity payments." Id. at 11. While the court did not conclude that the Constitution only protected annuity payments, it did hold that the petitioner's failed to show that all retirement terms are protected. Id. In this case, the changes in retirement terms at issue were prospective only and allowed pensioners a one-time opportunity to revoke their decision to enter the DROP option. Id. at 13. Ultimately, such a change in the DROP interest rate did not affect the pensioners' accrued benefit and, therefore, did not give rise to any protection under the vested rights doctrine. Id. It is worth noting that the Eddington decision was the first Texas Supreme Court case to reconsider the court's decision in the City of Dallas v. Trammell case (a 1937 decision based on a Depression-era change to the amount of a retiree's current pension interest).

Considering a similar challenge under the U.S. Constitution, the Supreme Court of California in Cal Fire considered whether a statutory change that eliminated an option allowing employees to purchase up to five years of airtime violated the Contract Clause of the U.S. Constitution. Id. at 2. Petitioners are participants in the California Public Employees Retirement System, in which participating state employees become eligible to receive a pension after working for the state of California for at least five years and reaching at least age 50. Id. at 4-5. Prior to the enactment of the California Public Employees' Pension Reform Act of 2013 ("PEPRA"), employees with at least five years of public employment could make a one-time election to purchase up to five years of additional retirement service credit. Id. at 8. As pensioners no longer had access to a pension benefit once available to them, petitioners argued that the removal of that benefit violated pensioners' contractual rights to it. Id. at 2.

The court held that employees who had not yet utilized the option to purchase airtime had no contractual right to the benefit; therefore, the change in law eliminating that option did not violate the Contract Clause. Id. at 3. The court explained that the vested rights doctrine is a relatively unique example of the Constitution protecting the terms and conditions of public employment. Id. at 13-14. First, the court determined the California legislature had no express legislative intent to grant pensioners a protected right to airtime, rather it was previously available only as an optional election for pensioners to use. Id. at 23-24. In this regard, the court cautioned that the protection of pension rights does not extend to all benefits of employment. Id. at 25. Second, the court considered whether the legislature implied contractual protection of airtime, noting that the vested rights doctrine typically arises on the basis of an implied contract basis, where services have been rendered under a pension statute. Id. at 26-29. While the vested rights doctrine has been used to protect deferred compensation as an implied contractual right, such protection does not extend to an "additional component" such as airtime. Id. at 29-32. The court likened airtime to optional benefits such as a choice between various health benefits or the opportunity to purchase life insurance or long-term disability insurance, none of which have been historically protected. Id. at 32. Without an express or implied intent by the legislature to protect the right of pensioners to airtime, the court found the petitioners had no constitutional basis for their claim that airtime was a vested right. Id. at 33-44 (eliminating additional arguments such as a unilateral contract theory as a basis to a contractual right to airtime). Ultimately, finding that the Contract Clause did not apply to airtime, the court declined to re-examine the so-called "California Rule," the "doctrine developed in [the court's] prior decisions defining the scope of constitutional protection afforded pension rights." Id. at 44.

In sum, both decisions suggest that a participant's interest in a public pension system is generally limited to the participant's annuity benefit. See Eddington, No. 17-0058 at 10; Cal Fire, No. S239958 at 29-32. Benefits which may indirectly impact the amount of the pensioner's annuity, such as a guaranteed interest rate on a DROP account or the opportunity to purchase airtime, are not part of the participant's protected benefit. According to the analysis in these cases, such additional benefits can be limited without violating a participant's vested benefits.

Should you have questions about governmental plan status or the IRS' proposed rules concerning this status, please contact Audra Ferguson-AllenRobert GaussLisa HarrisonLindsay KnowlesTara SciscoeChris Sears, or the Ice Miller LLP Employee Benefits attorney with whom you most closely work.

This publication is intended for general information purposes only and does not and is not intended to constitute legal advice. The reader should consult with legal counsel to determine how laws or decisions discussed herein apply to the reader’s specific circumstances.
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