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U.S. District Court Holds That An Eight Percent Wage Reduction Impairing Existing MOUs Did Not Violate The U.S. Constitution’s Contract Clause

On March 29, 2012, the Federal District Court of the Virgin Islands rejected a Contract-Clause challenge to the Virgin Islands Economic Stability Act (“VIESA”), which provided that all executive and legislative branch employees making more than $26,000 would receive an eight percent (8%) wage reduction.  United Steel, Paper & Forestry, Rubber, Manufacturing, Allied Industrial and Service Workers International Union AFL-CIO-CLC v. Government of the United States Virgin Islands et al.  (D.V.I. March 29, 2012, Civ. No. 2011-76 et al.) 2012 U.S. Dist. Lexis 43461 (hereafter “United Steel Workers v. Virgin Islands”).

The facts in the Court’s opinion paint a picture that is all too familiar to California public agencies.  Between fiscal year 2008 and 2010, the Virgin Islands’ tax revenue plunged by $250 million.  During this same period, the government’s predicted fiscal year deficits ballooned to $300 million.  To reduce the deficit, it borrowed $500 million. 

In Fall 2010, salary increases required by several MOUs were projected to cost $31 million.  Salaries and benefits of government employees accounted for seventy percent (70%) of all government expenditures.  In early 2011, the fiscal year 2011 budget was estimated to run a deficit of $75 million. 

In response to the projected deficits, the Virgin Islands in the first half of 2011 imposed a new marine terminal user’s tax, reduced appropriations for the executive and judicial branches, and increased taxes, court filing fees, and traffic fines.  It also maintained a limited hiring freeze, sought to reduce energy consumption, and reduced training and travel expenditures. 

Despite the government’s actions, the deficit for fiscal year 2011 was still projected to be $17 million and was projected to rise to $50 million for fiscal year 2013.

In June 2011, the Virgin Islands considered several cost-cutting measures including the lay off of 600 employees, furloughs, workweek reductions, the elimination of paid holiday leaves, and a gross-receipts tax increase from 4.5% to 5%.  By late June 2011, the Governor had exhausted his $500 million statutory borrowing authorization.

The Passage of the Virgin Islands Economic Stability Act

On June 22, 2011, the Legislature passed the Virgin Islands Economic Stability Act (“VIESA”).  VIESA provided that all executive and legislative employee salaries would be reduced by eight percent (8%), subject to a $26,000 salary floor, a July 2013 expiration date, and exemptions for retiring employees.  It was projected that the eight percent wage reduction would save $28 million.

In VIESA’s preamble, the Legislature declared that the Virgin Islands was in a “precarious financial condition” because of the “current global economic crisis.”  The Legislature further declared that the “Government Operating budget is overwhelming and unsupportable for much longer….” 

Following the Legislature’s adoption of the VIESA, a collection of unions challenged the legislation as violating the U.S. Constitution’s Contract Clause.[1]

The Court’s Analysis

The Court acknowledged that VIESA substantially impaired existing MOUs insofar as they contained agreements pertaining to the wages and salaries of union-member employees.  The Court then analyzed whether this impairment was legally permissible under the circmstances.

            ●   Important Public Interest

The Court first considered whether VIESA was intended to serve an important public interest, rather than a special interest.  Relying on the Supreme Court’s decision in Home Bldg. & Loan Ass’n v. Blaisdell (1934) 290 U.S. 398, 444-48, the Court noted that “addressing a fiscal emergency is an important public interest.”

VIESA had been passed to address a $17 million deficit at a time when “employee compensation is the single largest expenditure of the Government, accounting for approximately seventy percent of the annual budget.”  Thus, the Court held that the Act was intended “simply to reduce overall expenditures” and thus “was supported by an important and legitimate state interest.” 

            ●   Reasonableness and Necessity of VIESA

The Court next addressed whether VIESA was reasonable and necessary.  The Court held that under U.S. Trust Co. v. New Jersey (1977) 431 U.S. 1, 23, 26, it would not afford substantial deference to the government because the state was itself a party to the contracts at issue.  Under the less-deferential standard, the Court required the government to establish that:

(1)        It did not consider impairing the contract on par with other policy alternatives; 

(2)        It did not impose a drastic impairment when an evident and more moderate course would have served its purpose equally well; and 

(3)        It did not act unreasonably.

The Court held that VIESA did none of these things.

Specifically, VIESA was enacted only “after a series of alternative measures were first considered and tried.”  Yet, despite these alternate measures, the Virgin Islands by June 2011 was still facing substantial deficits.  The Court held that

[W]ith personnel costs accounting for nearly seventy percent of all Government expenditures, it cannot be said it was unreasonable or inappropriate for the Government to look to reduce its employees’ wages and salaries as an emergency cost-cutting measure.

The Court rejected the unions’ argument that VIESA was unreasonable because the government could have obtained saving though other means, such as tax increases or borrowing.  The Court noted that the government had already tried both of those options and was still facing a deficit. 

Simply borrowing more is not a readily available solution, as the Government was already required to leverage significant future income streams from excise taxes in order to secure financing of the $500 million in loans.  Moreover, as with raising taxes, it simply cannot be reasoned that the Government could have borrowed more.  If this were the criteria, “no impairment of a government contract could ever survive constitutional scrutiny.”

The Court rejected the idea that furloughs or layoffs would have been preferable.  The Court stated that “furloughs would have resulted in greater net reduction in pay for Government employees while also reducing the Government’s ability to provide basic services.”  In addition, layoffs were not preferable given that the government would have to lay off 600 employees to equal the savings resulting from VIESA.  The Court concluded that “VIESA was an act of last resort” (italics added).

Finally, the Court held that VIESA was narrowly tailored.  The wage reduction was set to expire on July 3, 2013 and had several exemptions for low-wage earners and retiring employees. 

As such, the Court held that “in light of the economic necessity, the lack of viable alternatives, and its narrow tailoring, VIESA cannot be said to be unreasonable or inappropriate.”

Lessons from United Steel Workers v. Virgin Islands

We must caution that United Steel Workers v. Virgin Islands is a recent District Court Memorandum Opinion, and as such, is of limited use as a citable authority in a legal action.  However, the opinion is valuable as an instructional tool and provides an example of how a court might analyze a public agency’s impairment of a contract in light of a fiscal emergency. 

In response to Constitutional Contact-Clause challenges, public agencies may rely on federal case law permitting limited contract impairment during fiscal emergencies.  In addition, agencies should be aware of the seminal California case applying this law, Sonoma County Org. of Public Employees v. County of Sonoma (1979) 23 Cal.3d 296 (“Sonoma County”). 

In Sonoma County, the California Supreme Court outlined similar factors as considered by the District Court in United Steel Workers v. Virgin Islands to find unconstitutional legislation passed in the aftermath of Proposition 13.  The legislation had declared void any local agency agreement containing a cost-of-living increase in excess of that granted to state employees.  The California Supreme Court held that a true emergency did not exist because the underlying fiscal emergency, local agencies’ anticipated property tax losses, had been offset by redistributed state surplus funds.

The issue for California agencies defending against a Contract-Clause challenge likely will be whether a true fiscal emergency exists (such as in Sonoma County) and whether an MOU impairment is reasonable and necessary. 

United Steel Workers v. Virgin Islands is highly relevant to today’s public agencies.  Many of the economic factors present in the Virgin Islands (mounting deficits, limited options for increasing tax revenues, personnel costs as a high percentage of operating expenses) are current realities for California public agencies.  Importantly, the District Court was willing to treat these factors as signaling a true fiscal emergency meriting the use of a government’s “police powers.”

Furthermore, in United Steel Workers v. Virgin Islands, the Court emphasized that the Virgin Islands had already borrowed $500 million to continue meeting expenses and, only after incurring such debt, considered a wage reduction.

Indeed, it is difficult to construe the borrowing of half a billion dollars for operating expenses as anything other than portending a Virgin Islands economy that subsists on shaky financial ground.  Given that circumstance, and the numerous other obligations of government, the Constitution does not require a specific solution, nor does it foreclose the solution chosen by the Government.  Rather, the Contract-Clause jurisprudence has long recognized that while an impairment of contract may be a part of a government’s financial measures, that impairment is not necessarily constitutionally infirm.  What is required to pass conditional muster is a legally deliberated approach prior to the abrogation of any contract.  The evidence adduced at trial demonstrates that, prior to the enactment of VIESA, the government undertook precisely such an approach.

Any entity considering impairing contracts is cautioned that the ability of a public agency to impair a contract remains a developing area of law, may well result in a legal challenge, and would require a significant factual showing of a true fiscal emergency.  However, United Steel Workers v. Virgin Islands provides another example in this expanding line of contract impairment cases suggesting that, at least in cases of true fiscal emergency when an agency has already exhausted other reasonable options, impairment may be a viable option.

We will continue to monitor the development of United Steel Workers v. Virgin Islands and other cases concerning the impairment of contract doctrine.

 [1]The unions also alleged violations of the Constitution’s “takings” clause and “due process” clause.