Baltimore Pension Reforms Do Not Violate U.S. Contract Clause

August 11, 2014 ( – A federal appellate court has found reforms made to the pension plan covering public safety workers in Baltimore, Maryland, did not violate the Contract Clause of the U.S. Constitution.

Reversing a district court decision, the 4th U.S. Circuit Court of Appeals concluded that the members’ rights under the Contract Clause were not impaired, because the members retained a state law remedy for breach of contract. The plaintiffs—active and retired members of the police and firefighters pension fund as well as unions representing them—contend that the city extinguished any state law remedy for breach of contract, because the city has not waived all available defenses based on its enactment of the ordinance reforming benefits. They also maintain that, by relying on its reserved legislative power to modify the retirement plan, the city has refused to pay damages for breach of contract and has deprived the plaintiffs of a remedy under state law.

According to the court opinion, prior to financial hardships of the plan in 2008, retirees were entitled to receive a benefit increase if the investments earned more than 7.5% in the prior fiscal year—called the Variable Benefit. Beginning in 2008, the city encountered substantial budget deficits that it was obligated to eliminate. The city implemented several measures to reduce these deficits that were unrelated to the plan, while at about the same time, the plan’s actuary determined that certain actuarial adjustments should be made to the plan to improve the plan’s financial stability. To accomplish this objective, the city would be required to pay annually an additional $64 million into the plan.

In light of these financial difficulties, the city began to consider alternatives to the Variable Benefit that would not require the city both to bear the burden of poor investment performance and to forego some of the investment gains in years of strong performance. The ordinance established a “Tiered COLA” under which retirees age 65 and older would receive an annual cost-of-living adjustment (COLA) of 2%, retirees age 55 to 64 would receive an annual COLA of 1%, and retirees younger than age 55 would not receive any COLA benefit.  The ordinance also instituted other changes to the plan, including increasing the retirement age, service, and member contribution requirements (see “Baltimore Takes a Bold Step Towards Pension Reform”).

A federal district court held that by establishing the Tiered COLA, the ordinance violated the Contract Clause of the U.S. Constitution. The court explained that the Tiered COLA system treated younger retirees more harshly than older retirees, and that the impairment was not necessary to achieve an important public purpose. The district court therefore declared invalid and unenforceable the portion of the Ordinance eliminating the Variable Benefit and instituting the Tiered COLA.

Because it determined the pension reform violated the Contract Clause, it dismissed a claim that the reform violated the Takings Clause of the U.S. Constitution as moot.

The 4th Circuit noted that its task was not to decide whether a breach of contract has occurred, but to determine whether the city erected a legal barrier that has prevented the plaintiffs from obtaining damages, or some equivalent remedy, for any breach. If the plaintiffs retain the right to recover damages for breach of contract, there is no impairment of contract under the Contract Clause.

The 4th Circuit pointed out that under Maryland law, the city is allowed to make reasonable modifications to its pension plans and is required to provide members with a substantially similar program after such modifications. To qualify as a “reasonable modification,” a revised plan must provide the employees with “substantially the program [they] bargained for and any diminution thereof must be balanced by other benefits or justified by countervailing equities for the public’s welfare.”

The appellate court said that by articulating this rule, the Court of Special Appeals of Maryland recognized that the needs of the government may change over time as new employees draw on pension funds, requiring modifications to ensure the “soundness of the fund.” However, the reasonable modification principle articulated by Maryland’s courts verifies that the plaintiffs have an opportunity to litigate a breach of contract claim under state law. If the city’s defense is unsuccessful and a court determines that the city has a contractual duty to the members and that the modification of the plan is unreasonable under Maryland law, the plaintiffs may be entitled to relief.

The 4th Circuit concluded that the because the ordinance does not foreclose any such claim by the plaintiffs, the city has not extinguished the plaintiffs’ remedy under state law by enacting the ordinance, and accordingly, the plaintiffs do not have a viable Contract Clause claim.

The court remanded the case back to the district court for review, noting that since it decided there was no viable Contract Clause claim, then the Takings Clause claim was no longer moot. The Takings Clause of the U.S. Constitution prohibits the taking of private property for public use, without just compensation. In their complaint, the plaintiffs assert that by eliminating the Variable Benefit, the city has effected a per se taking of the members’ property without just compensation in violation of the Takings Clause.

The 4th Circuit’s opinion is here.