(Adds comment from plaintiffs; background)
NEW YORK, April 11 (Reuters) - Talks to end a legal challenge to Rhode Island's public pension reform failed on Friday, both sides said, putting the state on track for a potentially costly trial against labor unions in a closely watched battle over public-sector retirement benefits.
Firefighters, teachers and retirees involved in the lawsuit had all agreed to a settlement. But police union members rejected the agreement, prompting the state judge overseeing the litigation to order the parties back to mediation on Monday.
"Due to a small group of union members, the settlement agreement has failed and the mediation process has ended," Governor Lincoln Chafee and General Treasurer Gina Raimondo said in a statement.
Rhode Island's overhaul of its public pension system has been used by other state and local governments across the United States as a model to rein in the ballooning cost of retirement benefits for public-sector workers.
Rhode Island lawmakers and officials began making changes several years ago. The biggest overhaul in 2011 suspended cost-of-living adjustments, raised the retirement age, moved workers onto a hybrid pension plan and reduced future benefits for current employees. Those changes went into effect in July 2012.
But the moves led to lawsuits in 2009, 2010 and 2011 that challenged the constitutionality of some changes. The settlement was supposed to end all the litigation, while also preserving more than 94 percent of the reduction in the pensions' unfunded liabilities, according to Fitch Ratings.
Plaintiffs were notified on Friday morning that the state had ended mediation, according to Ray Sullivan, a spokesman for the plaintiffs, about 25,000 current and former public employees.
"We have ... talked about the fundamental strength of our legal argument and are now prepared to take the necessary steps to proceed to trial," Sullivan said.
Confidentiality agreements constrained him from providing details about which specific issues were sticking points in mediation, he said.
"We entertained a path towards settlement because it provided stability and predictability. We think that's something our members deserve," Sullivan said.
State officials also said they would now prepare for trial, which is set to begin Sept. 15.
"While we are disappointed this settlement was not ultimately able to come to fruition, we continue to believe that the pension changes enacted by our General Assembly are constitutional," the governor and treasurer said in their statement.
(Reporting by Hilary Russ; Editing by Meredith Mazzilli and Jonathan Oatis)