State pension deficits, the recession, and a modern view of the contracts clause.

• Author: Cloud, Whitney

The District Court of the City and County of Denver, Colorado, will be the first of many courts to consider an upcoming state pension fund battle. In Justus v. State, the district court will hear a case brought by public employees who are suing the state and the Colorado Public Employees Retirement Association (PERA) for passing state legislation adjusting contractual pension benefits of retired, current, and future employees. (1) As one of the latest state courts to hear a unilateral pension modification suit, the district court will likely apply a Contracts Clause balancing test typical of pension benefit cases. (2) Despite near uniformity in utilizing the Contracts Clause in order to weigh legislative interference with pension rights, state courts vary widely in their analyses of whether the legislature's proposed purpose justifies infringing pension protections. (3) Two factors make this Contracts Clause battle more interesting in the Justus case: the text of Colorado's law and the context of the recent financial crisis.

This Comment will examine state courts' use of the Contracts Clause in pension benefit cases through the lens of the Colorado case. After evaluating the changes to the benefit system implemented by the Colorado General Assembly and briefly discussing the traditional parameters of Contracts Clause jurisprudence in benefit cases, the Comment argues that the recent financial crisis, or the "Recession," provides a reasonable and necessary state justification for amending public employment contracts. The viability of a reasonable and necessary state justification turns on a court's interpretation of the state's role: sovereign power or contracting party in breach. Given the financial crisis at hand, this Comment proposes viewing the state first and foremost as a sovereign power. The Comment concludes by situating Justus within the broader national context and predicting that use of the Recession to justify pension modification is an inevitable--and defensible--action by the states.

1. UNFAMILIAR TERRITORY: COLORADO'S CHANGES TO ITS PENSION SYSTEM

   1. Overview of Traditional Pension Benefits

      Prior to recent legislation, Colorado's state employee pension benefit guarantees and protections were fairly standard compared to those of other states. (4) Colorado primarily offers a defined benefit plan, calculating benefits based on years of service and highest average salary. (5) The benefits include cost-of-living adjustments (COLAs) that accrue automatically and are tied to the Consumer Price Index (CPI) for inflation. (6) COLAs are funded as part of the state's existing pension liability. (7) Pension benefits vest once employees meet the required service and age requirements. (8)

      The strong protection of pension benefits, particularly vested pension benefits, makes unilateral adjustment a difficult task for legislatures. However, in light of the Recession and the continued growth of pension liabilities, many state legislatures are challenging traditional benefit structures. (9) Colorado Senate Bill 10-001 is an example of one such challenge. (10)

   2. Senate Bill 10-001's Changes to Pension Benefits

      Recognizing the growing liabilities accruing under its traditional pension system, the Colorado General Assembly ordered the Colorado PERA to propose a solution to the state's pension deficit problem by November 1, 2009. (11) After careful consideration and deliberation, (12) PERA recommended a 2% cap on COLA benefits matched by 2% increases in scheduled employer contributions, known as the "2/2/2 Plus Package." (3) Colorado Senate Bill 10-001 incorporates PERA's 2/2/2 Plus Package by adjusting employee and employer contributions, age and service requirements, and the accounting of pension benefits. (14) The most significant adjustment in the law--and the one For an example of a typical benefits structure plan available to employees who meet the age and service requirements, see COLO. PERA, PERA BENEFIT STRUCTURE BENEFIT ESTIMATE FACT SHEET 5 (July 2010), available at http://www.copera.org/pdf/8/8-85a.pdf. garnering national attention (15)--is the provision reducing COLAs for all employees, including current retirees. (16)

      Colorado legislators recognized that decreasing future pension benefit rights would not adequately address present pension liabilities. Instead, the legislature alleviated some of the taxpayers' future burden by partially adjusting the benefits of current employees and retirees. This single action could help the state reduce the budget deficit by several billion dollars, (17) but it will require sacrifice from retired pensioners unprepared to risk reductions (to the tune of $165,000 per retiree (18)) of their pensions. Regardless of the merits of S.B. 10-001, the public employees' resistance is consistent with historic opposition to similar initiatives: few states have attempted to modify contractual provisions for retirees whose pension benefits have already vested. (19)

2. PROTECTING PENSION BENEFITS WITH THE CONTRACTS CLAUSE

   Pension benefits for public employees are protected through mechanisms that vary by state, (20) but the Contracts Clause of the Constitution applies throughout: "No State shall ... pass any Bill of Attainder, ex post facto Law, or Law impairing the Obligation of Contracts." (21) Like most states, Colorado has its own constitutional protection limiting impairment of contracts, (22) and Colorado courts have traditionally protected vested rights in the context of contracts with public employees. (23)

   1. The Contracts Clause and State Interpretations

      The Contracts Clause does not protect against all legislative contractual modifications. Generally, only retroactive modifications affecting already vested rights violate the Contracts Clause. (24) The Supreme Court established a three-part test to determine whether state legislative modifications unconstitutionally impair contracts. The test asks: (1) whether there is a contractual obligation; (2) if a contract exists, whether the legislation imposes a "substantial impairment"; and (3) if there is an impairment, whether the legislation is "reasonable and necessary to serve an important public purpose." (25) State courts have since adopted this test in adjudications involving state legislative modifications of contracts. (26)

      While state courts often show deference to state legislative assessments of reasonableness and necessity under state police powers, (27) this deference decreases in cases in which the state has self-interest at stake, (28) including disputes over state public employment contracts. A state court's decision upholding or rejecting a legislative modification in this context can be interpreted as reflecting the court's view of the state's primary role: sovereign or contracting party. This analysis will be explored further in Part III.

      Despite widespread acceptance of the three-part Contracts Clause test, the decisions of state courts applying this analysis to state pension contracts vary considerably. This variance is largely due to different assessments and standards for evaluating whether legislatures have presented reasonable and necessary justifications for altering pension contracts. Some state courts bar any modification to pensioners' contractual rights; (29) other state courts find that the rights of pensioners do not merit limits on legislative exercise of sovereignty; (30) and some state courts analyze whether the impairments to the pension system are accompanied by offsetting benefits. (31) This interpretive variation is not surprising as contract law is primarily a state domain; yet when deciding questions of Contracts Clause violations, courts often look to doctrinal developments in other states. (32) The district court in Denver will thus have a wider audience than just Colorado pensioners, particularly as other states face looming lawsuits of their own. (33)

   2. Justus and the Contracts Clause

      The court's result in Justus v. State will likely turn on the application of the Contracts Clause to Senate Bill 10-001. The court must consider (1) whether there is a contract, (2) whether the contract has been substantially impaired, and (3) whether the impairment is justified by a necessary and reasonable state purpose. The first two prongs of the court's test for contractual impairment are easily decided in the employees' favor. Colorado has contractual...