Yes, we can break public-employee pensions

First on a series on public pensions.

Sept. 20, 2012

By Mark Cabaniss

The politicians in charge of “doing something” about the ongoing California pension debacle like to play a little game. It goes like this:  They decry the high costs of pensions that have already been granted, pretend to want to do something to rein in future pension obligations, and then turn their hands up and shrug that there is really nothing they can do about current pensions (including, cough cough, their own) — since, after all, pensions are contracts, and therefore they are protected by the Constitution.

But there is a problem with this self-serving assertion:  Even if politicians’ pensions are contracts protected by the Constitution, they are still breakable.  In pretending otherwise, the politicians are lying.  In other words, merely noting that pensions are contracts protected by the Constitution is not the end of analysis, but only the beginning, for all contracts are breakable, and all constitutional rights are subject to limits.

When, not if, state and local governments begin dishonoring the highest public pensions, there will be, obviously, a huge blizzard of litigation.  And when those cases are heard, some of the following basic concepts of contract law may be applicable.  (Note: My purpose here is not to write a treatise on contract law, nor to predict the course and outcome of future litigation.  My purpose is simply to show the lay person that there are several possible theories under contract law under which governments might be able to reduce the highest existing pensions rather than go bankrupt.).

All contracts are breakable, if you have a legally valid reason for breaking them.  For example, if a used-car salesman sells a car to a 10-year-old, the contract can be broken on the basis that the 10-year-old didn’t have the legal capacity (age) to sign a binding contract in the first place.  And all constitutionally protected rights, including contract rights, are nonetheless limited by finite resources. For example, your right to a fair trial does not mean that the government has to hire the entire Harvard Law School faculty to defend you in your shoplifting case. Society can’t afford it.

Regarding public pensions, the best and most obvious legal ground under contract law to get out of onerous pension obligation may be mistake of fact.  The legal rule goes like this: If you make a contract while holding a belief that isn’t true, you can get out of the contract.  For example, you make a deal to buy a Picasso for a million dollars, but it turns out that the painting is not a Picasso.  You can get out of the deal.  (Under the mistake doctrine, both sides have to be making the same mistake.  If only one side is mistaken and the other side knows the truth, you may still be able to get out of the contract under a different theory, such as fraud; more below.)

Pension spiking

Regarding high public pensions, the mistake that was made was simple, fundamental, and huge:  the supersize pensions that began to appear in the 1990s were justified on the grounds that pension funds “would” generate average annual returns of 7.5 to 8 percent or more into the future, forever.  This has turned out to be, ahem, not true.

The infamous SB 400, that then-Gov. Gray Davis signed into law in 1999, and which gave retroactive pension raises to state employees, including already-retired state employees, was sold by the California Public Employee Retirement System to the Legislature with lie after lie after lie — or “mistake” after “mistake” after “mistake,” if you prefer.  The CalPERS “analysis” that was “presented to” (perpetrated on?) the Legislature implicitly assumed that the Dow Jones Industrial Average would be at 25,000 by 2009, and 28,000,000 by 2099.  On the morning of Sept. 20, it is at 13,556.

Proving the existence of and reliance on the mistake(s) ought to be a lark. After all, a great deal of time, money, and work went into creating the rosy projections that were used to bamboozle government into granting the unsustainable pensions.  Were the mistakes made regarding future stock market returns mutual?  Well, the government certainly made a mistake on behalf of the taxpayers.  How about the public employees?  Who knows?  However, as a practical matter it is very hard to see how they would go in to court and say, “We were not mistaken as to future stock market returns.  We knew full well that the projections were a joke and that CalPERS was lying.”

Performance

The second big legal ground to get out of pensions is impossibility of performance.  If events make it impossible for you to perform the contract, then you can get out of it.  For example, you contract to sell your car, but before you deliver, it is destroyed by lightning.  Regarding pensions, the argument would be simply that the state and local governments have gone bankrupt since the pensions were granted.  In that event, the pensions could be modified to match the ability of government to pay them.

The third possibly applicable doctrine is known in contract law as consideration:  for a contract to be legally binding, there has to be something of value promised, on both sides.  For example, if I promise to give you a million dollars, and you promise to take three breaths between the hours of 1:00 p.m. and 2:00 p.m. next Tuesday, there is no mutuality of consideration, since I am giving something up and you are not.  The contract is voidable.

In the public pension realm, one obvious place where the consideration doctrine would come into play would be SB 400, the 1999 retroactive pension increase.  Since some of the workers who received retroactive pension increases were already retired, they obviously could not promise or give anything at all in exchange for the money, and indeed they did not.  Therefore, at least in regard to these already retired workers, there was a complete absence of consideration.  (A similar argument can be made not on contract law, but on Article 16 Section 6 of the California Constitution, prohibiting the giving away of public funds.)

A fourth possible ground for breaking managements’ pensions is fraud: If CalPERS or any of the other groups pushing big pensions knew that the pensions would not be self-funding and would require massive infusions of taxpayer cash, and they did not divulge that information, then any such pensions obtained on the basis of such fraudulent disinformation would be voidable.  Moreover, widespread and undisclosed self-dealing might qualify as fraud. For example, CalPERS officials, as public employees, themselves benefitted from the huge pension increases granted in 1999, and they did not disclose to the legislature that they would benefit.

Unconscionability

Another contract doctrine which might be used to break onerous pensions is “unconscionability,” which means simply that a contract is so one-sided that it is just unfair to enforce it against the disadvantaged party.  While normally this doctrine is applied to consumer contracts, some of the factors courts look to in weighing claims of unconscionability — such as whether the parties had equal bargaining power, whether the contract makes a one-sided allocation of risk (for example, where the taxpayers have to pick up the tab, all the tab, in the event that the Dow does not hit 25,000 by 2009, ha-ha) — are applicable to public employee pensions, as well.

Finally, one more area of contract law might be used to break the pensions: lack of capacity to contract.  If you are drunk or insane, for example, you cannot sign a contract to buy a house.  In the public pension context, the lack of capacity would be a little more subtle (maybe; hopefully).  For example, if you are under duress, being threatened to get you to sign a contract, that could qualify as a lack of capacity, since you lack free will.

Steven Greenhut and others have written recently about bullying tactics, including the attempt to frame a city councilman for DUI, being used in Costa Mesa to get local officials to see things the public employees’ way.  Testimony about such incidents could nullify the contracts obtained thereby.

Similarly, if you were being bribed to sign a contract, that too would qualify as a lack of capacity, since you would not be acting in your capacity as a fiduciary to the public, but rather in your private capacity as a criminal.  Another way to look at it is that if you are a manager sitting at a table “negotiating” a pension increase that will benefit not just the parties across the table but yourself as well, you may not be acting within the scope of your employment as a public official, but instead acting on your own behalf.  Therefore, you do not have the legal capacity to act to bind the public to pay for your self-dealing little scheme, since you are not at that moment acting as a public official.   Needless to say, were the courts to start taking bribery and self-dealing seriously, they could nullify a lot of contracts.

To sum up: There are a great many helpful doctrines under contract law that could be used to break onerous public pensions.  These legal arguments are strongest against the very top pensions, because they are the most unconscionable, they are the least possible to continue to pay, and they are the most likely to have been the result of self-dealing or bribery.

Therefore, the legal grounds for attacking the biggest pensions, managements’ pensions, coincide nicely with the public policy grounds of wanting to go after only the largest, most abusive pensions, and not the pensions of the retired school teacher or janitor.

Next article in this series: Breaking public employee pensions: The political path.

Mark Cabaniss is an attorney from Kelseyville. He has worked as a prosecutor and public defender.



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