A promise is a promise…unless it’s inconvenient

Paul Secunda, an associate professor at Marquette University Law School, explained that until the early 20th century, courts had treated public pensions not as contracts or promises but as “gratuities,” more akin to gifts or tips than to salaries or wages.

“It was accepted that employees didn’t have any rights to their pensions and that the employers could change them at any time, almost on a whim,” he said. “People could work their whole lives and then, just before they were going to retire, the employer could pull the rug out from under them.”

Since the middle of the century, however, courts have generally acknowledged that states cannot promise pension benefits to their employees as an inducement to get them to work for the state and then renege on those promises. The large majority of states have protected pensions under the theory that the promise of a pension represents a form of contract, though there is some variation (see bottom box entitled “A variety of legal protections”).

“We moved from a place where pensions were thought of as being like tips to a place where it was understood that they were part of the compensation that employees had earned,” Stein said. “The legal understanding has been, ‘That is your money, and the state can’t take it away.’”

“A radical shift”

According to Secunda, the lawsuits that are moving through the courts in Rhode Island and other states gain added significance when seen within the context of the historical evolution away from a gratuity model.

“We’re at an inflection point,” Secunda said. “We’re poised between these two possibilities: will the court uphold the contract model and find that public pensions are entitled to legal protections, or will they move back toward the gratuity model, where the legislature can change benefits on a whim?”

The majority of pension lawsuits are still pending in state courts, but the decisions that have come down have gone both ways. In April, for example, a South Dakota judge ruled that cost-of-living adjustments the state had promised to retirees were not contractually protected, while in October, the Colorado Court of Appeals ruled that they were.

Michael Yelnosky, a professor of law at Roger Williams University in Bristol, Rhode Island, said that, “[i]n other rulings, courts have just chipped away at the contractual protection, and have generally upheld some limits on what the state can do,” he said.  “But here the state is saying, ‘Just throw the contract stuff out the window and give us free reign.’”

A variety of legal protections

Though every state except for Texas and Indiana extends some form legal protection to the pension rights of their employees, the legal basis for these protections varies from state to state.

The vast majority of states — 41 — apply a contract theory to their employees’ pension rights. All of these states have consitution provisions that — mirroring the contract clause of the federal Constitution — prohibit the passage of any law that impairs the obligation of contracts. In the constitutions of seven of these states, there is a clause explicitly preventing the state from reducing the pension benefits its employees have earned. In the remaining 34, statutes and judicial decisions have found that the promise made by the state to pay a specified amount to the employee in pension benefits constitutes a contract and is entitled to constitutional protection.

Six states have adopted a property-based model of protecting pensions, meaning that the promised benefits are legally considered to be the property of the employee who has earned them. Thus, according to the Fifth and Fourteenth amendments of the federal Constitution, promised benefits cannot be “taken for public use, without just compensation.”

The Second Judicial District Court of Minnesota recently applied a third model of legal protection to the state’s pension obligations. Under this model, known as “promissory estoppel,” the state must live up to the promises it has made — even if those promises did not form contracts — if the promises have been reasonably relied upon by another party and if breaking the promises would cause an injustice.

Finally, Texas and Indiana apply a “gratuity” model to state pension promises. Under this theory,  benefits are considered more akin to gifts or tips than to salary or wages, and can be unilaterally modifed by the state at any time.

Additionally, there is variation from state to state as to the point at which these legal pension protections for state workers apply. Pension benefits are earned, or “accrued,” over time. In 21 states, the protections apply both to the benefits that have accrued and to future promised benefits. In 16 states, the protections apply to accrued benefits only. In 11 states, it is unclear whether the protections apply to past and future benefits or only to past benefits.

Source for table: Center for Retirement Research at Boston College