City of San José v. How. Jarvis Taxpayers Ass'n

320 Cal.Rptr.3d 589

CITY OF SAN JOSÉ, Plaintiff and Respondent,

v.HOWARD JARVIS TAXPAYERS ASSOCIATION et al., Defendants and Appellants.

H050889

Court of Appeal, Sixth District.

Filed April 29, 2024

Trial Court:Santa Clara County Superior Court, Trial Judge: Hon. Sunil R. Kulkarni (Santa Clara County Super. Ct. No. 21CV391517)

Counsel for Defendants and Appellants Howard Jarvis Taxpayers, Association, Citizens for Fiscal, Responsibility and Pat Waite: Jonathan M. Coupal, Sacramento, Timothy A. Bittle, Laura E. Dougherty, Howard Jarvis Taxpayers Foundation

Counsel for Plaintiff and Respondent The City of San Jose: Allison E. Burns, Brian P. Forbath, Gregory J. Maestri, Newport Beach, Stradling Yocca Carlson & Rauth

Danner, J.

In this appeal, we consider the application of the constitutional debt limitation to a municipality’s constitutional obligation to its employees to make promised pension payments and its duty to ensure pension plans have sufficient assets to be actuarially sound.

Article XVI, section 18, subdivision (a) of the California Constitution sets forth the constitutional debt limitation applicable to cities. It states in relevant part: "No … city … shall incur any indebtedness or liability in any manner or for any purpose exceeding in any year the income and revenue provided for such year, without the assent of two-thirds of the voters of the public entity voting at an election to be held for that purpose." (Cal. Const., art. XVI, § 18, subd. (a).)

This provision, which "mandat[es] balanced budgets" (Rider v. City of San Diego (1998) 18 Cal.4th 1035, 1045, 77 Cal. Rptr.2d 189, 959 P.2d 347 (Rider)), has been part of the California Constitution since 1879. It was enacted in response to "municipal extravagance" (San Francisco Gas Co. v. Brickwedel (1882) 62 Cal. 641, 642 (San Francisco Gas)) by local governments making large capital investments and thereby "creating huge long term debts." (Compton Community College etc. Teachers v. Comptan Community College Dist. (1985) 165 Cal.App.3d 82, 88, 211 Cal.Rptr. 231 (Compton Community College).)

Courts have identified exceptions to the constitutional debt limitation, including the "special fund doctrine" (City of Oxnard v. Dale (1955) 45 Cal.2d 729, 733, 290 P.2d 859 [debt limitation not violated by obligations payable solely from a special fund]), obligations imposed by law (City of Lang Beach v. Lisenby (1919) 180 Cal. 52, 57, 179 P. 198 (Lisenby) [debt limitation has "no application to cases of indebtedness or liability imposed by law or arising out of tort"]), and contingent obligations (Rider, supra, 18 Cal.4th at p. 1047, 77 Cal.Rptr.2d 189, 959 P.2d 347 [debt limitation inapplicable to "multiyear contracts in which the local government agrees to pay in each successive year for land, goods, or services provided during that year" because each payment is a contemporaneous payment for the property, goods, or services rather than an installment payment on a long-term debt]; see also Taxpayers for Improving Public Safety v. Schwarzenegger (2009) 172 Cal.App.4th 749, 763, 91 Cal.Rptr.3d 370).

Howard Jarvis Taxpayers Association, Citizens for Fiscal Responsibility, and Pat Waite (collectively, HJTA) argue that the City of San José (city) violated the constitutional debt limitation when its city council adopted a resolution authorizing the issuance and sale of bonds, on the condition they result in a savings to the city, to address a shortfall in the city’s pension plans. In validation proceedings, the trial court upheld the city’s actions against a challenge by HJTA, deciding that the bond issuance falls under the obligation imposed by law exception to the debt limitation. HJTA appeals the judgment, contending the city’s actions violate the constitutional debt limitation and lack statutory authority.

We affirm the judgment, but our reasoning differs from that of the trial court. We decide that under the terms of the challenged resolution, the city has not "incur[red] any indebtedness or liability in any manner or for any purpose exceeding in any year the income and revenue provided for such year." (Cal. Const., art. XVI, § 18, subd. (a).) Because the city’s actions do not trigger the constitutional debt limitation, we need not consider the applicability of its exceptions. We further- more conclude the city has the authority under state law to issue the bonds.

I. FACTS AND PROCEDURAL BACKGROUND¹

San Jose is a charter city, whose current charter took effect on May 4, 1965. (City of San José City Charter, adopted 1965.)² The City Council established the city’s current Federated City Employees Retirement System (federated plan) in 1975 (San José Mun. Code, ch. 3.28, § 3.28.010) and its current Police and Fire Department Retirement Plan (police and fire plan) in 1961 (San José Mun. Code, ch. 3.36, § 3.36.010) (collectively, the retirement plans or pension plans), pursuant to the city’s authority under the charter. (Charter, art. XV, § 1500.)

Under the retirement plans, pension benefits for individual city employees vary based on factors such as age, final salary, years of service, type of retirement, and any cost of living adjustments (COLAs). According to the city’s actuarial expert, "[t]he exact amount of the pension benefit an active employee will receive upon retirement cannot be known until them retirement date, since it depends on their years of service and pensionable earnings. The current pension benefits of retirees are known, but their future benefits will depend on cost of living and on how long they and their beneficiaries live."

The city makes annual contributions (described in the record as the "normal cost" or "[c]urrent [o]bligation") to fund the retirement plans. If the normal cost does not cover the present value of providing vested retirement benefits, an unfunded liability arises. An unfunded liability is the difference between the present value of future retirement benefits that have been earned as of the valuation date and the assets the city has currently set aside to pay for them. (San Jose Mun. Code, ch. 3.28, § 3.28.960.) According to the city’s actuarial expert, an unfunded liability is "often large enough that it is not practical for the employer … to pay the entire amount all at once. Instead, it is paid over time" or amortized. While the city pays the "normal cost" on an annual basis, the "unfunded liability" can refer to either the liability for any particular year or the amount of liability accumulated over the years as of the valuation date. The "current plan assets" are those assets the city has set aside to pay for the retirement benefits as of a particular valuation date. The amount of the city’s unfunded liability is based in part on the discount rate, the current expected annual rate of return on the city’s investments—estimated in 2020 and 2021 to be 6.625 percent.

The city’s actuary calculates annually the amount of the unfunded liability for each retirement plan, taking into account a combination of factors, including the performance of the city’s investments, city employees’ actual retirement and mortality patterns, and changes in actuarial assumptions and methods. The city’s unfunded liability has grown not because of increases in promised benefits, but because declining interest rates on the expected rate of return on the city’s investments, as well as changes to certain assumptions about demographic factors, including mortality and retirement rates, have affected the present value of future pension payments. As of June 30, 2020, the total unfunded liability was approximately $1,383,387,000 for the police and fire plan and $2,099,614,000 for the federated plan.

In April 2021,³ the city considered options for paying the unfunded liability to return the retirement plans to actuarially sound footings. The city determined that it would seek approval by resolution of the issuance of pension obligation bonds. Under the plan selected by the city, the city council would not be obligated to issue the pension obligation bonds and the timing of any bond issuance would depend on prevailing market conditions.

On October 5, the city passed a resolution which authorized the issuance of pension obligation bonds pursuant to Government Code section 53570 et seq.⁴ "in a maximum principal amount not to exceed that required to refund [(i.e., repay)] the [u]nfunded [l]iability, to prepay all or a portion of the city’s annual required retirement contribution … (the ‘[c]urrent [o]bligation’), and to pay the costs of issuance of such [b]onds," subject to certain conditions. The resolution gave the city discretion to determine the final principal amount of the bonds, provided that the aggregate amount of the bonds "shall not be greater than the lesser of (a) $3.5 billion or (b) the sum of the [c]ity’s [u]nfunded [l]iability and [c]urrent [o]bligation … together with the costs of issuing the [b]onds" and the issuance of the bonds results in savings to the city. The bonds would be issued at a lower interest rate than the current expected 6.625 percent rate of return on the city’s investments. The resolution also authorized the issuance of additional bonds on similar terms and conditions, as long as they would result in savings to the city.

The resolution authorized the preparation and prosecution of validation proceedings⁵ pursuant to Code of Civil Procedure section 860 et seq. to determine the validity of the bonds and related agreements. On November 18, in accordance with the terms of the resolution, the city filed a complaint for validation with the trial court "to determine the validity of the proceedings and obligations relating to the [c]ity’s issuance of one or more series of pension obligation refunding bonds, execution of a trust agreement and a bond purchase agreement, and approving additional actions related thereto."

On December 9, pursuant to California Rules of Court, rules 3.1200 et seq. and Code of Civil Procedure sections 861 ...