From top: Jon Holtzman, Ryan McGinley-Stempel, Steve Cikes
by Parter Jon Holtzman, Senior Associate Ryan McGinley-Stempel and Of Counsel Steve Cikes.
Jon Holtzman and others in Renne Public Law Group have deep experience helping local agencies to navigate fiscal emergencies, including Stockton, Vallejo, Fresno and others.
Declaring a fiscal emergency, and implementing appropriate remedial measures, may be an unfortunate reality for some local agencies in light of the COVID-19 epidemic. If implemented properly, with good faith labor and creditor negotiations and adequate factual support, as well as legal guidance, legislative fiscal emergency declarations can be a viable stop-gap measure in times such as these. They are, however, subject to a high degree of judicial scrutiny to the extent a fiscal emergency is employed as a basis for altering contractual obligations. This article describes the state of the law on fiscal emergencies and how the facts of the current crisis may fit within that legal framework.
Many local public agencies across the state—including the state itself—have already issued emergency declarations in response to the coronavirus. These emergency declarations will give public agencies much-needed breathing room in the short run with respect to their procedural obligations under the Meyers-Milias-Brown Act (“MMBA”)1 and to implement emergency actions driven by public health concerns. However, in order to maintain public service levels, limit the need for layoffs, and avoid municipal insolvency through bankruptcy, some public agencies will need to consider a variety of other options to control costs in response to the economic consequences that flow from this public health emergency, including declaring fiscal emergencies.
To be clear at the outset, fiscal emergencies and bankruptcy are last resort options. Our experience has been that, faced with clear evidence of an emergency, unions and creditors both should and will reach compromises that avoid the need for unilateral action by a public agency. Notably, for example in Stockton, stakeholders participated in a pre-bankruptcy mediation process involving all major creditors and unions under A.B. 506.2 While the bankruptcy was ultimately necessitated by self-serving positions taken by capital market creditors, all of the unions reached voluntary agreements to trim OPEB benefits and other contractual costs. Hopefully, given the significant price the capital market creditors ultimately paid there, they will take more considered positions in the future.
The COVID-19 Emergency Allows Local Public Agencies Increased Flexibility With Respect to Labor Negotiations
Local public employers reacting to the coronavirus crisis should be mindful of their obligations under the MMBA, but the nature of this public health emergency should shield public agencies from unfair practice charges stemming from their implementation of emergency measures in response to the crisis. Among other things, the MMBA requires local public employers to: (1) “meet and confer in good faith regarding wages, hours, and other terms and conditions of employment with” union representatives before “arriving at a determination of policy or course of action” and (2) give reasonable written notice to unions and the opportunity to meet and confer regarding any “ordinance, rule, resolution, or regulation directly relating to matters within the scope of representation proposed to be adopted by the” agency’s governing body or designated boards and commissions.3 However, in cases of emergency, this duty is suspended until “the earliest practicable time following the adoption of the ordinance, rule, resolution, or regulation.”4
Although the MMBA leaves “unexplained” exactly “what shall constitute an emergency,” the Court of Appeal has noted that this “omission is of no moment, given that emergency has long been accepted in California as an unforeseen situation calling for immediate action.”5 Indeed, PERB—whose interpretation of the MMBA is entitled to deference—has “recognized that under exceptionally limited circumstances, an employer may be excused from negotiating on the basis of true emergency that provides a basis for claiming that a business necessity excused a unilateral change.”6 In order to “establish ‘operational necessity’ or ‘business necessity’ as a defense to a unilateral charge, the employer must establish an actual financial or other emergency that leaves no alternative to the action taken and allows no time for meaningful negotiations before taking action.”7 The “alleged necessity must be the unavoidable result of a sudden change in circumstance beyond the employer’s control.”8
Thus, as PERB has recently explained, “a unilateral change was permitted in Sonoma County Organization, Etc. Employees v. County of Sonoma (1991) 1 Cal.App.4th 267, where a strike created an unforeseen situation calling for immediate action with an imminent and substantial threat to public health or safety.”9
In Sonoma County, county employees undertook “a series of unpredictable rolling sickouts and strikes occurring on a sporadic and erratic basis” that significantly impacted the County’s “public health facilities,” requiring the county’s community hospital to “evacuat[e] patients and clos[e] down certain areas of the Hospital.”10 In response, the county adopted an emergency ordinance vesting department heads with the authority to place employees participating in an intermittent work stoppage on administrative unpaid absence in order “to protect the public health and safety” and “to prevent the substantial impairment of County department operations.”11
The employee union brought an action against the county, asserting that the emergency ordinance adopted by the county “implicated ‘matters relating to employment’ within the scope of its representation, thus activating the County’s obligation to meet and confer with [the union] about the Ordinance prior to its adoption.”12 The county responded that it “had no such obligation because the Ordinance dealt with subjects outside the ambit of [the union’s] representation.”13 The Court of Appeal declined to decide whether the ordinance fell within the scope of representation because “[e]ven if it was concluded that the Ordinance was a matter within the meet and confer requirement, that conclusion would be merely a preliminary step toward the real issue of whether the County’s noncompliance was excused by an emergency as expressly contemplated by the MMBA.”14
The Court of Appeal then concluded that the county’s noncompliance with the MMBA was excused by an emergency. Although the court explained that “peril to public health” was “the most obvious factor justifying the County’s determination that there was a substantial likelihood that serious harm would be experienced if it took no action,” the court noted that “the fact that [the union’s] ‘sickouts’ had adverse consequences in other areas can only have added to the County’s concern.”15 Accordingly, the court held that in light of “these manifold consequences, the County was amply justified in concluding that it confronted emergency of grave character and serious moment demanding immediate action.”16
Although the circumstances in which public agencies may rely on this emergency exception are “exceptionally limited”—and PERB itself has yet to apply the exception in any reported decision the authors could locate—even the notoriously biased PERB will be hard-pressed to deny that the novel coronavirus pandemic qualifies. Similar to the “peril to public health” posed by the rolling sickouts in Sonoma County, the COVID-19 disease creates “an unforeseen situation calling for immediate action” from public agencies.17 Indeed, as the dramatic nationwide response to the virus illustrates, there is a “substantial likelihood that serious harm would be experienced if [public employers] took no action” in response to the coronavirus. Because the coronavirus poses “an imminent and substantial threat to public health or safety,”18 public agencies should be able to undertake emergency responses to the crisis without first meeting and conferring under the MMBA.
Taking emergency actions under the MMBA based upon the secondary effects of the COVID-19 crisis poses a slightly more difficult issue. Generally, there is an argument that economic downturns are foreseeable and relatively slow moving, allowing time for negotiation. However, the immediate revenue losses due to the COVID-19 shutdown were certainly not reasonably foreseeable. There is certainly sufficient time to begin negotiations with unions and to partially satisfy the MMBA. But prior to making changes in the terms and conditions of employment, the MMBA requires that all impasse procedures be completed. This process can easily span six months—which may well be longer than public agencies can reasonably withstand. We do not believe it is necessary for a public agency to exhaust all of its reserves before declaring an MMBA emergency. Due to the particular nature of this crisis, and the likelihood of a sustained downturn, if reserves are being exhausted quickly, immediate action may be warranted. In such circumstances, public agencies should do their best to meet their bargaining obligations, but an emergency may well preclude completing impasse procedures.
The issue of whether emergency excuses completion of impasse procedures under the MMBA has not been specifically tested. And, again, PERB may well attempt to second guess. However, we are firmly of the belief that, if quick agreement cannot be reached with unions on cost-cutting measures, and the rate that reserves are being diminished is unsustainable in light of a reasonable assessment of future needs, emergency should excuse completion of the impasse procedures before taking emergency actions. Of course, in such cases, the public agency should continue with impasse procedures after taking emergency action.
The COVID-19 Emergency May Also Permit Public Agencies to Impair Existing Contractual Obligations
Even though local public agencies clearly have some breathing room to respond to the COVID-19 emergency in the short term without violating the MMBA’s procedural meet-and-confer obligations, their power to respond to the virus’s inevitable economic fallout in ways that could impair existing contractual obligations in MOUs is a different matter.19
Fiscal Emergencies May Justify Impairing Contractual Obligations
Although both the United States and California Constitutions prohibit government from enacting legislation that impairs contracts,20 courts have long recognized that this prohibition is subservient to the government’s power “to protect the lives, health, morals, comfort and general welfare of the public.”21 For example, in the landmark case of Home Building and Loan Association v. Blaisdell,22 the United States Supreme Court upheld the constitutionality of a Minnesota law that restricted foreclosures on mortgages during the Great Depression. In doing so, the Court recognized that certain conditions may arise “in which a temporary restraint of enforcement [of contractual obligations] may be consistent with the spirit and purpose of the [Contract Clause] and thus be found to be within the range of reserved power to the state to protect the vital interests of the community.”23 And in Veix v. Sixth Ward Building and Loan Association,24 the U.S. Supreme Court recognized that under the Contract Clause, a state’s authority to protect its citizens through statutory enactments affecting contract rights “is not limited to” situations in which the public’s “health, morals and safety” are at risk, but “extends to economic needs as well.”25
Test for Determining Whether an Emergency Justifies Impairing Contractual Obligations
In Sonoma County Organization of Public Employees v. County of Sonoma,26 the California Supreme Court, following Blaisdell, identified four factors for courts to use in determining whether a legislative impairment of a contract will be upheld in the face of a Contract Clause challenge. First, the contract modification must arise out an actual emergency. Second, relief from the contract must be necessary to protect a basic societal interest rather than for the benefit of a particular group of individuals. Third, the modification or relief must be appropriately tailored to the emergency it was designed to address, and the conditions that result must be reasonable. And finally, the modification imposed must be temporary and limited to the exigency that prompted the legislative response.27
These factors are not necessarily absolute. Since Blaisdell, the U.S. Supreme Court has in some cases upheld contractual impairments without some of these factors.28 In United States Trust Company of New York v. New Jersey,29 the U.S. Supreme Court acknowledged this shift and stated that while “the existence of an emergency and the limited duration of a relief measure are factors to be assessed in determining the reasonableness of an impairment, . . . they cannot be regarded as essential in every case.” The Court established a new standard to evaluate whether a contract impairment is constitutional, holding that “an impairment may be constitutional if it is reasonable and necessary to serve an important public purpose.”30
Generally, a public agency’s finding of an emergency necessitating the impairment of contracts will be afforded some deference. Needless to say, however, courts will be less deferential to the decision when it considers a public entity’s impairment of its own contractual obligations.31 As one court decision explained, for an impairment to be considered reasonable and necessary in such cases, the public entity must show that it did not “(1) ‘consider impairing the contracts on par with other policy alternatives’ or (2) ‘impose a drastic impairment when an evident and more moderate course would serve its purpose equally well,’ nor (3) act unreasonably ‘in light of the surrounding circumstances.’”32 That said, “less deference does not imply no deference,” and “even when the state impairs its own contractual obligations, the state’s judgment that the impairment was justified is afforded meaningful deference.”33
How Courts Have Responded to Recent Declarations of Fiscal Emergency
Several decisions handed down in response to declarations of fiscal emergencies in the wake of the Great Recession shed some light on how courts might approach similar declarations in response to the COVID-19 pandemic.
On the one hand, several courts found that a sharp decline in revenues and the concurrent inability to provide essential services constituted a fiscal emergency sufficient to allow a public entity to impair its own contractual obligations. For example, in United Auto., Aerospace, Agr. Implement Workers of America International Union v. Fortuño,34 the First Circuit upheld Puerto Rico’s adoption of a bill that established voluntary workday reductions for senior employees, involuntary seniority-based layoffs, and a two-year suspension of “a plethora of statutory, contractual, and other provisions governing the conditions of employment for the remaining affected public employees” where Puerto Rico faced a $3.2 billion structural deficit and included numerous new taxes in the legislation “to spread the burden of restoring Puerto Rico’s fiscal health across various sectors of society.”35
Similarly, in Cranston Police Retirees Action Committee v. City of Cranston by and through Strom,36 the Supreme Court of Rhode Island upheld city ordinances suspending cost-of-living adjustments for 10 years for retired members of the city’s police and fire departments where the Great Recession triggered “far reaching and devastating economic and general social consequences for the City,” the city adequately considered other policy alternatives—including “raising taxes, making more cuts to city personnel, and drastically reducing city services”—and the ordinances did not eliminate the COLA benefit altogether and only affected COLAs not yet made available to retirees.37
Likewise, in Barr v. City of White Plains,38 the Second Circuit held that a city did not violate the contracts clause when it enacted an ordinance “to address a serious budget shortfall and impending credit downgrade caused by the global financial crisis that started in 2008” that terminated the city’s payment of 100 percent of health insurance premiums for retired police officers and required officers to contribute the difference, if any, between 85 percent of the cost of the premium for a state insurance program and the full premium cost of the health insurance plans in which they were enrolled.39 The court noted that the city “presented ample evidence that it passed the 2010 Ordinance only after pursuing a range of measures to increase revenue and cut expenses.”40 The court relied heavily on its prior decision in Buffalo Teachers Federation v. Tobe,41 where the court held that the City of Buffalo acted lawfully in imposing a wage freeze on employees after forecasting an increase in its budget deficit from $7.5 million to $93-127 million in a manner of three years and after the city had already laid off 800 teachers and 250 assistant teachers in the preceding four years.42
By contrast, cases rejecting a declaration of emergency in the wake of the Great Recession have tended to do so on the grounds the public agency could have anticipated the crisis or failed to fully explore other, less intrusive cost saving measures. For example, in United Steel Paper & Forestry Rubber Manufacturing Allied Industrial and Service Workers Int’l Union AFL-CIO-CLC v. Gov’t of Virgin Islands,43 the Third Circuit concluded that the Virgin Islands Economic Stability Act of 2011, which reduced most government employees’ salaries by 8%, impermissibly impaired the government’s contractual obligations set forth in collective bargaining agreements even though the government “faced an immediate fiscal problem that needed to be addressed.”44 In the immediate wake of the financial crisis, the government projected budget deficits of $300 million for 2009, $275 million for 2010, $75.1 million for 2011, and $131.5 million for 2012.45 The government lowered these projected deficits through borrowing $500 million; imposing a marine terminal user’s tax of $1 per cruise ship passenger; reducing appropriations to the executive and judicial branches by 3%; increasing the tax on gross receipts from 4% to 4.5%; increasing the hotel tax from 8% to 10%; increasing marriage licensing fees, liquor licensing fees, court filing fees, fines for traffic violations, and motor-vehicle rental surcharges; limiting energy consumption; freezing all hires and cutting back on employee training and travel.46 Despite these efforts, the government still projected deficits of $17.4 million, $90.1 million, and $49.9 million for 2011, 2012, and 2013, respectively.47 The government considered implementing further cost-cutting measures, including laying off 600 government employees, eliminating government holidays, instituting furloughs and workweek reductions for government employees, and increasing the gross-receipts tax.48 Instead of pursuing these cost-cutting measures, the government imposed a two-year 8% reduction of employee salaries that exceeded $26,000.49
Although the Third Circuit agreed that the government had a “significant and legitimate public purpose” in pursuing this salary reduction, the court nevertheless concluded that reducing salaries violated the Contract Clause.50 The court explained it was a “close case as to the necessity” of the salary reduction because the government “did not place impairment of the agreements in a category separate from other policy options,” and failed to explore renegotiation of the collective bargaining agreements or conduct a feasibility study showing that the salary reductions were not “a more drastic remedy than was necessary.”51 Without deciding whether the government’s actions were necessary, the court concluded that they were unreasonable because “the Government knew of the economic crisis facing the Virgin Islands at the time it was negotiating with the Unions and when it concluded the collective bargaining agreements with [them].”52 The government had agreed to a salary increase with one union in October 2010, more than a year after the government had projected significant budget deficits.53 And the government had signed the collective bargaining agreements with another union in May 2009, when “the economic recession was in full swing.”54
Similarly, in Welch v. Brown,55 the Sixth Circuit upheld a preliminary injunction preventing the City of Flint from modifying existing contracts and collective bargaining agreements with respect to healthcare benefits of municipal retirees.56 The court concluded that the City of Flint’s efforts to “avoid bankruptcy and to achieve a balanced budget” in the midst of “financial turmoil” caused by the Great Recession was a “legitimate public objective.”57 However, the court concluded that the plaintiffs had established a likelihood of success in showing that the city’s actions were not necessary and reasonable because the record did “not establish that bankruptcy was imminent,” that the city “contemplated filing for bankruptcy,” or that the city “considered alternative strategies before modifying retiree benefits.”58
Likewise, in University of Hawaii Professional Assembly v. Cayetano,59 which pre-dated the 2008 financial crisis, the Ninth Circuit invalidated a state “pay lag” law, enacted to address an estimated budget shortfall of $143 million. The court found that other, less intrusive options were available, including a project to obtain additional funding from the federal government, further budget restrictions, and the raising of taxes. Further, the court pointed out: “Defendants knew of the budgetary crisis at the time the collective bargaining agreement was negotiated and as the history of [the pay lag statute] shows, previously had attempted to implement a similar pay lag plan.”60
Key Takeaways for Public Agencies Grappling with the Severe Fiscal Consequences of the COVID-19 Pandemic
In light of this caselaw, public agencies have a strong argument that impairing contractual obligations in response to the economic fallout of the COVID-19 pandemic “serve[s] an important public purpose.”61 Public agencies are spending at an alarming rate in response to the crisis and are collecting significantly less revenue as a result of the social distancing and stay-at-home measures adopted to slow the spread of the virus. As a result, public agencies are likely to face significant budget deficits over the coming years.
Moreover, because the pandemic has thrown the stock market into a downward spiral, public pension funds across the state have suffered staggering losses—posing longer term fiscal threats to local agencies and likely increasing employer contribution rates in the near term. And while some federal funding may help stanch the bleeding, it is clear that the federal government will be of limited help, just as it was with the initial public health response to the crisis. Indeed, Senate Majority Leader Mitch McConnell has stubbornly opposed federal funding for state and local governments, characterizing such aid as a “blue state bailout” and suggesting that they should be made to declare bankruptcy instead.62
Public agencies need not wait until the brink of insolvency to take action. As the United States Supreme Court explained nearly seventy years ago in describing government responses to the Great Depression, “threatened insolvency demands legislation for its control in the same way that liquidation after insolvency does.”63
It will be more challenging, as the above cases addressing fiscal emergencies illustrate, for public agencies to persuade courts that impairing contractual obligations is both (1) “reasonable” and (2) “necessary” to serve this important public purpose.64 But public agencies should have strong arguments on this front as well.
First, even more so than the financial crisis that triggered the Great Recession, public employers could not have anticipated the pandemic or its economic impact at the time they entered into the collective bargaining agreements they may need to impair in the near future. As a result, as this crisis unfolds, public agencies in the midst of fiscal emergencies should have good arguments about the reasonableness of impairing obligations that they undertook before anyone could anticipate the COVID-19 pandemic or its attendant economic consequences.
Second, public agencies dealing with fiscal emergencies that give adequate consideration to, and undertake, other less drastic policy alternatives—such as tax increases, layoffs, and renegotiation of existing collective bargaining agreements—will have a better chance of persuading a court of the necessity of impairing contractual obligations in the event that those policy alternatives are not sufficient.
As the immediate public health crisis posed by the coronavirus begins to subside and the potentially devastating economic consequences become more apparent, local public agencies are giving serious consideration to declarations of fiscal emergency as a tool to maintain public service levels, limit or eliminate the need for layoffs and avoid municipal insolvency through bankruptcy. Although courts have historically been skeptical of declarations of fiscal emergency, such declarations received a warmer reception from the bench in the wake of the Great Recession. Given the unforeseen and unprecedented nature of the COVID-19 pandemic and its economic consequences, courts may be even more receptive to declarations of fiscal emergency in the coming years—at least when public agencies make a concerted effort to avoid impairing contractual obligations until after considering and implementing less drastic policy alternatives.
Actually declaring a fiscal emergency requires findings that many public agencies will be easily able to muster. The more complex question is, after declaring such an emergency, what actions can be taken under the emergency? Every case is different, but, in general, actions that temporarily delay wage increases, suspend cash-outs and other actions directed at the specific problem at hand are most likely to be upheld—especially if, for example, a delay in a wage increase is temporary. Again, mechanisms exist to foster mutual agreement on impairments that may obviate the need for emergency actions, and they should always be pursued first.