By Laura Dougherty, Director of Legal Affairs
With limited exception, you have a constitutional right to vote if your city council or county board of supervisors wants to create a new debt in any year that can’t be repaid within that year. Since 1879, the state constitution has required two-thirds voter approval for local bonds that would do this, with one exception. In 2000, California voters approved Proposition 39, reducing that margin to 55% for school bonds only. (Proposition 5 on the November ballot proposed the same 55% margin for practically everything else.)
For several years now, HJTA has been answering city council lawsuits seeking court approval to issue pension obligation bonds (POBs) bypassing the constitutional voter approval requirement. About one dozen city councils rescinded their resolutions in response. The city councils of San Jose, Oxnard, and Escondido did not, so the lawsuits proceeded.
The lawsuits in San Jose, Oxnard, and Escondido have recently concluded at the Courts of Appeal. Because San Jose’s case was heard first, it took the analytical lead. The decision in that case was published, meaning it can be cited in other cases. The court decided against voter approval and gave cities the green light to issue bonds without it, but the cities haven’t won yet.
That’s because in August, the California Supreme Court granted review of the Sixth District Court of Appeal’s published decision in City of San Jose v. HJTA, denying the constitutional right to vote on a $3.5 billion POB. Yes, that’s a $3.5 billion bond. Meanwhile, those proposed in other cities tend to be in the hundreds of millions.
These numbers are indeed mindboggling. According to one source, San Jose’s unfunded pension liability is now estimated at $4 billion or $41,000 per San Jose resident. In Escondido, it has been reported at $100,000 per resident. But unfunded pension liability projections can fluctuate dramatically, in both directions, based on factors such as labor contracts and investment performance. In one year, Oxnard’s liability projection went down by $110 million when it had previously been at $330 million.
Because unfunded pension liability fluctuates so wildly, previous courts have never considered it “debt” subject to voter approval. In fact, when the County of Orange sought to enforce voter approval on a benefit increase that went into effect in 2001, the Second District Court of Appeal said not to worry about it. Using other case law and Attorney General opinions concerning unfunded pension liability, it likewise concluded that no debt is created until each pension obligation becomes due. Only then can the amount be known and only then can it be an enforceable obligation.
So, in 2011, the Second District Court of Appeal’s decision in County of Orange essentially told voters to be patient. Pension benefit increases might inflate unfunded pension liability projections, but they were not yet “debt” ready for constitutional voter approval. Then, as interest rates went down, cities became interested in POBs.
As a policy matter, the Government Finance Officers Association has been recommending against POBs consistently, even when interest rates are very low. As the POB trend grew, HJTA argued, what could more clearly be “new debt” if not these bonds?
If pension benefits and increases themselves don’t require voter approval, then, HJTA has argued, the voter approval “can” is being kicked down the road to the POB. But now the Sixth District Court of Appeal has decided voters don’t have a right to vote on a POB either.
Since voter approval hasn’t been enforced at any point on the continuum of pension liability development, it makes sense that the California Supreme Court granted review. The constitutional text liberally guarantees the two-thirds voter approval right as to “any indebtedness or liability in any manner or for any purpose exceeding in any year the income and revenue provided for such year.”
So, when exactly do the voters have their say?
Using the word “any” four times, the constitution’s voter approval requirement is the rule, not the exception. If a city council wants to avoid voter approval, they’re supposed to qualify for a judicial exception. A handful of exceptions have developed over the last century and a half. Until now, they were strict.
The exception the city councils of San Jose, Oxnard, and Escondido argued for here is called an “obligation imposed by law.” The “obligation imposed by law” exception excuses cities from voter approval when they have no choice but to pay the debt in the current year. In one famous case, the City of Long Beach found itself subject to a tort judgment because a public auditorium had collapsed, killing and injuring people. There was no choice but to pay the judgment and pay it right away. However, the city didn’t have enough money in the general fund. Thus, the court said no voter approval was required for a bond. But pensions and POBs are completely different from this type of judgment. They’re voluntary from start to finish. And future liabilities are never due in a current year.
Nevertheless, the trial courts agreed with the cities that the “obligation imposed by law” exception could be extended to them. Using accounting recommendations from a standards board in another state, they said that unfunded pension liability now is an enforceable and present “debt.” In fact, it “already” was debt and it already happened in the past. Therefore, a bond to essentially “convert” it is acceptable without voter approval. (Other case law has held that the recommendations of this same accounting board cannot create or direct California law. But never mind that, either.)
The Court of Appeal took another radical step. Instead of agreeing with the cities’ theory that future liabilities are now pre-existing debt and therefore applying the “obligation imposed by law” exception, it said that the state constitution never required voter approval in the first place. It found the pension liability “already incurred.” So voter approval is becoming the exception. Local governments could incur any contractual obligation and figure out how to pay for it later, without voter consent.
One would next think that if unfunded pension liability is debt, then the Courts of Appeal must have overruled that 2011 decision in County of Orange. They did not. Unless the California Supreme Court makes a change, voters are now stuck with no rights to approve or disapprove when benefits are created, increased, or reduced to a POB.
If that wasn’t enough, there’s yet more inconsistency for the Supreme Court to chew on. In 2007, the Third District Court of Appeal decided that when the State Legislature wanted to issue a $960 million POB to infuse cash into the state pension system, it needed voter approval. It needed voter approval because the same constitutional requirement applied, and the pension liability was not an “obligation imposed by law.” The State imposed it upon itself. It was “voluntarily undertaken.”
No state law has ever required cities to have pensions or to pre-fund them in amounts matching each year’s unfunded liability estimate. Having a pension system or issuing a POB is voluntary and discretionary action, exactly what our state constitution contemplated to require voter approval if going over budget.
Briefing on the merits is ongoing and we hope to have the Supreme Court’s analysis in 2025.