IOUs for State Workers Broke Law, Judge Says : Budget: U.S. District Court finds that California violated Depression-era regulation requiring employees to be paid in ‘cash or its equivalent.’ A spokesman says Gov. Wilson may seek an appeal.

SACRAMENTO â€”  A federal judge ruled Wednesday that California acted illegally last summer when it paid about 100,000 state employees with IOUs instead of cash during the long budget deadlock.

State Controller Gray Davis immediately said that the decision by U.S. District Judge Garland Burrell Jr. of Sacramento sets a precedent and that it could prevent the state from ever issuing IOUs.

He said it means that state employees are in a “protected category� and cannot be paid with IOUs even if dwindling tax revenues leave the state without enough cash to pay its bills.

In a 12-page opinion, Burrell said the state violated the requirements of the Federal Fair Labor Standards Act, a Depression-era law that established minimum wages and overtime pay for employees. Burrell said federal regulations implementing the act mandate that workers must be paid in “cash or its equivalent.�

For a record 63 days, Gov. Pete Wilson and the Legislature failed to reach an agreement on a new state budget. The absence of a state budget prevented the state from borrowing funds to cover a cash crunch, forcing it to issue registered warrants--commonly referred to as IOUs--to pay most employees, suppliers and private contractors for goods and services. During that time, Davis said, the state paid an estimated $340 million in payroll IOUs.

“They may not pay these wages in scrip or a similar medium,� Burrell ruled.

A spokesman for Wilson said the Administration disagreed with the ruling and would explore the possibility of an appeal with Atty. Gen. Dan Lungren. Wilson has been blamed by many state employees for precipitating the issuance of IOUs.

“It’s our opinion that registered warrants are and have been negotiable instruments of currency,� communications director Dan Schnur said.

Asked if the Administration foresaw issuing IOUs if a similar budget impasse occurs, Schnur said, “We would like to avoid it and will do everything in our power to avoid it, but it is a very real possibility.�

The state had contended during a court hearing that its actions were legal because paying cash would have made the state insolvent. It had said the IOUs were negotiable because most major financial institutions had agreed to honor them.

On Wednesday, Burrell ruled otherwise. He wrote that IOUs were not immediately negotiable as required by the federal law, because “not all financial institutions cashed or accepted the registered warrants. Some financial institutions conditionally accepted or refused to accept them.�

He also said state officials knew before issuing them that they would not be universally honored.

Gary Messing, a Sacramento attorney who filed the lawsuit on behalf of the workers, said Burrell’s ruling entitles him to seek damages against the state.

Messing and Davis said the potential judgment against the state could be as high as $680 million, but Davis quickly added that he did not expect the judge to be that punitive. As punishment for violating the law, the act says employers can be required to pay damages that are double the amount of the illegal payment.

“I believe the decision is good news. It means employees will not be trifled with again,� said Davis, who was named as the chief defendant in the lawsuit because he is the state’s paymaster. “However, I don’t want to see the state’s resources unduly drained. It’s my hope the court will not sock it to the state.�

Davis opposed the use of IOUs and encouraged Wilson and the Legislature to find an alternative.