2013 Annual Meeting
Chapter 9: The Big Debates in The Brave New World
Moderators:
Jordan A. Kroop, Squire Sanders, Phoenix, AZ
Theodore B. Orson, Gibson Dunn, Washington, D.C
Panelists:
Hon. Frank Bailey, Chief Judge for the United States bankruptcy court,
District of Massachusetts
Hon. David H. Coar (Ret.), Mediator and Arbitrator, JAMS, former United
States District Judge for the Northern District of Illinois and former United
States Bankruptcy Judge, United States District Court for the Northern
District of Illinois
Hon. Christopher Klein, Chief U.S. Bankruptcy Judge, Eastern District of
California, Sacramento, CA
Ron Oliner, Duane Morris, San Francisco, California
Harriet M. Welch, Squire Sanders, Los Angeles, CA
August 8-11, 2013
Moscone Center West
San Francisco, CA
SPEAKERS
Frank J. Bailey
Massachusetts Federal Courts
5 Post Office Sq. Ste 1150
Boston, MA 02109-3945
Phone: 617-565-6065
[email protected]
David H. Coar
US District Court
219 S. Dearborn St, rm 1478
Chciago, IL 60601
Phone: 312-636-7022
[email protected]
Christopher Klein
Chief U.S. Bankruptcy Judge
Eastern District of California 501, 1st Street
Sacramento, CA
Phone: 916-930-4510
[email protected]
Jordan A. Kroop
Squire Sanders
30 Rockefeller Plaza
New York, NY 10112
Phone: 602-528-4024
[email protected]
Ron Oliner
Duane Morris LLP
One Marker Plaza, Ste 2200
San Francisco, CA 94105
Phone: 415-957-3104
Fax: 415-520-5308
[email protected]
Thoedore Orson
Orson and Brusini Ltd
144 Wayland Avenue
Providence, RI 02906
Phone: 401-861-0344
[email protected]
American Bar Association
Section of State and Local Government Law
2013 Annual Meeting
Chapter 9 Bankruptcy
Theodore Orson, Esq., Principal at Orson and Brusini Ltd.
Karen Grande, Esq., Partner at Edwards Wildman
Harmony Conti Bodurtha, Esq, Associate at Orson and Brusini Ltd.
August 8-11, 2013
Moscone Center West
San Francisco, CA
8/5/2013
CHAPTER 9: BIG DEBATES IN A
BRAVE NEW WORLD
American Bar Association Annual Meeting
San Francisco, California
August 10, 2013
Purpose of Panel
Since the filing of the Vallejo, California’s Chapter 9 case in May 2008, many of the country’s distressed municipalities have been considering Chapter 9 as a potential vehicle to help them return to fiscal stability. This new use of Chapter 9 has raised many questions currently being debated nationwide. The debates are both legal and political. This panel will explore five of the most controversial and timely issues.
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8/5/2013
Moderators
Ted Orson, Orson & Brusini, Ltd.
Providence, RI
Jordan Kroop, Squire Sanders LLP
Phoenix, AZ and New York, NY
Panelists
Hon. Frank J. Bailey, U.S. Bankruptcy Judge
D. Massachusetts
Hon. David Coar, U.S. District Judge (Ret.)
N.D. Illinois
Hon. Christopher M. Klein, Chief U.S. Bankruptcy Judge
E.D. California
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8/5/2013
Panelists
Ron Oliner, Duane Morris LLP
San Francisco, CA
Harriet Welch, Squire Sanders LLP
Los Angeles, CA
Are Bankruptcy Code § 109(c)’s Eligibility Requirements Too Strict?
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8/5/2013
Eligibility Requirements 1. “municipality”
2. State authorization
3. “insolvent”—sources of financial distress:





Unfunded liabilities
Unsustainable collective bargaining agreements
Other unsustainable contracts or leases
Unsustainable public debt
Tort or contract judgment—possible issuance of judgment bonds as alternative
 Insufficient revenues—political and legal impediments
Eligibility Requirements (cont.)
4. Desire to effect a plan of adjustment
5. Dealings with creditors—debtor has:
a) Obtained agreements from majorities of each impaired class of creditors; or
b) Negotiated in good faith but failed to obtain agreements; or
c) Not negotiated with creditors because it is impractical; or d) Come to believe that a creditor may attempt to obtain an avoidable preferential transfer
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Eligibility Requirements (cont.)
 The role of “eligibility” in Chapter 9 as compared with other Bankruptcy Code chapters
 Do the eligibility requirements limit or bar serial filings by a municipality?
 Why did Congress make the eligibility requirements so strict?
Should general obligation bonds, like special revenue bonds, be granted priority treatment under the Bankruptcy Code? 5
8/5/2013
Bond Priorities
 Treatment of special revenue bonds in Chapter 9 as compared with the treatment of general obligation bonds and other public bonds and financial obligations
 Compare treatment of bond obligations in the Chapter 9 cases of Stockton, California and Central Falls, Rhode Island (where bonds were subject to Rhode Island’s recently‐enacted statutory lien to secure general obligation bonds)
 Is the fear of “contagion” a real or imagined concern (i.e. greater difficulty in the capital markets to sell municipal bonds issued by municipalities neighboring another municipality that has defaulted on its bond obligations)?  Should Chapter 9 debtor municipalities care?  Should states care? Should pension obligations be treated the same as other general unsecured claims?
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8/5/2013
Pension Obligations
 The role of unfunded pension and retiree health care obligations in today’s municipal crisis  The role of the Contract Clause outside of bankruptcy in local governmental attempts to modify pension and retiree health insurance promises
 How are pension and retiree health claims classified in Chapter 9?
Should municipalities continue to be allowed to treat collective bargaining agreements as rejected on Day 1 of a Chapter 9 case?
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8/5/2013
Collective Bargaining Agreements
 Rejection of executory contracts generally under Bankruptcy Code § 365
 Compare different standards for rejecting collective bargaining agreements in Chapter 11 cases to the standard applied in Chapter 9 cases
 Compare timing of rejection of collective bargaining agreements under Bankruptcy Code § 1113(f) in Chapter 11 cases to the surviving and contrasting Bildisco rule in Chapter 9 cases
How does sovereign immunity
limit a Bankruptcy Court’s continuing jurisdiction under Bankruptcy Code § 945(a)?
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8/5/2013
Sovereign Immunity
 How does sovereign immunity and Bankruptcy Code §§ 903 and 904 limit a bankruptcy court’s powers and vastly increase a municipality’s powers in Chapter 9 cases?
 Bankruptcy Code § 945(a)’s granting of continuing jurisdiction “as is necessary for the successful implementation of the plan.”
 Does sovereign immunity limit a bankruptcy court’s power to order a municipality to provide post‐effective date reporting and otherwise to comply with affirmative obligations in a plan?
 Is a plan requiring reporting and/or affirmative actions by the debtor municipality during the plan term a waiver of sovereign immunity? Would a waiver of sovereign immunity, express or implied, be binding on subsequent administrations of that municipality?
9
CHAPTER 9 BANKRUPTCY
By Theodore Orson, Esq., Karen Grande, Esq., and Harmony Conti Bodurtha, Esq.1
America’s municipalities are suffering.
Cities and towns are struggling with
unsustainable structural deficits, as well as and unfunded pension and/or retiree health insurance
obligations that are spinning out of control. Others municipalities face the consequences of prior
devastatingly-bad financial events, such as the corruption and fraud in connection with the sewer
system project in Jefferson County, Alabama. Increasingly, American cities and towns hold the
short end of the stick: the federal government has cut its appropriations to states, and, thereupon,
states have cut appropriations to cities and towns.
Beginning with the Chapter 9 petitions for the City of Vallejo, California in 2008, and the
City of Central Falls, Rhode Island in 2011, several United States municipalities have sought
protection under Chapter 9 of the United States Bankruptcy Code. Many others have publicly
stated that Chapter 9 may be their only means for returning to fiscal stability. It is not yet clear
whether this wave of Chapter 9 filings will become a tsunami, or whether the threat that there
will be failing cities nationwide, is being overstated.
It is important for lawyers advising distressed municipalities to understand what can and
cannot be achieved through Chapter 9. A successful Chapter 9 bankruptcy case can help
municipalities:
•
Modify and/or reject collective bargaining agreements with their unions.
•
Modify and/or reject other executory contracts and unexpired leases.
•
Modify pension and retiree health insurance obligations.
•
Reduce and/or restructure debt owed to different classes of creditors.
On the other hand, a Chapter 9 case cannot help municipalities:
•
Circumvent state laws requiring timely payment of payroll.
•
Circumvent other legal obligations under state and federal law.
•
Replace incompetent, malfeasant, or even criminal officials with court-appointed
bankruptcy trustees.
1
Theodore Orson, Esq. is a principal of Orson and Brusini Ltd. in Providence, Rhode Island.
Karen Grande, Esq. is a partner in the Providence, Rhode Island office of Edwards Wildman.
Harmony Conti Bodurtha, Esq. is an associate of Orson and Brusini Ltd. Orson and Brusini
Ltd. was insolvency counsel and Edwards Wildman was public finance counsel to the State of
Rhode Island and the state-appointed receivers for the City of Central Falls in that city’s Chapter
9 case. The authors gratefully acknowledge the research assistance of Adelita Orefice. Ms.
Orefice is a former cabinet level official for the State of Rhode Island and is entering her third
year at Quinnipiac University School of Law.
Excerpted from Municipal Law Deskbook (William Scheiderich and Benjamin E. Griffith eds., forthcoming). Copyright © 2013 by the American Bar
Association. Reprinted by permission.
1
Each Chapter 9 case is unique as each distressed municipality has unique attributes based
on its particular demographics, local politics, state politics, degree of state assistance/control,
nature of financial distress (i.e. structural financial problems versus discrete bad financial
decision(s)), etc. However, while each Chapter 9 case presents its own unique struggles and
issues, nearly every Chapter 9 case includes three (3) seminal events which are key to the
success or failure of the case: (1) determination of eligibility, (2) rejection of collective
bargaining agreements, and (3) confirmation of a plan of debt adjustment. Each of Chapter 9
benchmarks is discussed below.
1.
DETERMINATION OF ELIGIBILITY.
The first seminal event in every Chapter 9 case is the determination whether the debtor is
“eligible” for Chapter 9 relief. Under Bankruptcy Code § 109(c), a municipality is “eligible” for
Chapter 9 relief “if and only if such entity”:
(1) is a municipality;
(2) is specifically authorized, in its capacity as a municipality to be a
debtor under such chapter by State law, or by a governmental officer or
organization empowered by State law to authorize such entity to be a
debtor under such chapter;
(3) is insolvent;
(4) desires to effect a plan to adjust its debts; and
(5) (A) has obtained the agreement of creditors holding at least a
majority in amount of the claims of each class that such entity intends to
impair under a plan;
(B) has negotiated in good faith with creditors and has failed to
obtain the agreement of creditors holding at least a majority in amount of
the claims of each class that such entity intends to impair under a plan;
(C) is unable to negotiate with creditors because such negotiation
would be impracticable; or
(D) reasonably believes that a creditor may attempt to obtain a
preference under § 547.
a.
Determination of Whether a Debtor is a “Municipality.”
Bankruptcy Code § 101(40) states, “[t]he term ‘municipality’ means political subdivision
or public agency or instrumentality of a state.” There is little guidance regarding this definition
within the Code. However, one court has held that a New York public benefit corporation is a
municipality within the Code’s definition because, while it is not a subdivision of the state, it is
"created by the State for the general purpose of performing functions essentially governmental in
2
nature." In re New York City Off-Track Betting Corp., 427 B.R. 256, 265 (Bankr. S.D.N.Y. 2010)
quoting Clark-Fitzpatrick, Inc. v. Long Island R. Co., 70 N.Y.2d 382, 386-87 (1987).
In perhaps the most important decision on “municipality” determination, In re Las Vegas
Monorail Corp., 429 B.R. 770, 788-89 (Bankr. D. Nev. 2010), the bankruptcy court recognized
Congress’ desire not to limit the definition in a manner that would restrict eligibility. The Las
Vegas Monorail Corp. (“LVMC”) was a non-profit entity created to operate a monorail system
for public use in the City of Las Vegas. LVMC sought financing through the issuance of
government bonds by agreement with the Director of the Nevada Department of Business and
Industry. The Governor of Nevada was granted considerable power over appointment and
removal of members of LVMC’s Board. In examining whether LVMC was a “municipality,” the
court examined three factors: (1) whether the entity had any of the powers typically associated
with sovereignty, (2) whether the entity had a public purpose and the level of state control over
the purpose (i.e., the more day-to-day control the more likely the entity is a municipality), and
(3) the effect of the state’s own designation and treatment of the entity. 429 B.R. 770 (Bankr. D.
Nev. 2010). The court concluded that LVMC was not a “municipality” because, among other
reasons, it had no power to tax, no power of eminent domain, its control over operations was
more akin to regulation, and there was no enabling legislation for its creation. Id.
b.
Determination of Whether a Municipality is Expressly Authorized by a State
to File a Chapter 9 Petition?
Under Section 109(c)(2), a municipality must have express authority from its state to file
a Chapter 9 petition. The following is table of states that have authorized or barred
municipalities from Chapter 9 relief on eligibility grounds. 2
2
Spiotto, James. “Primer on Municipal Debt Adjustment, Chapter 9: The Last Resort for Financially Distressed
Municipalities.” Chapman and Cutler, LLP. First Edition, 2012. Available at
http://www.afgi.org/resources/Bankruptcy_Primer.pdf
Eucalitto, Cory, Shannan Younger and Kristen De Peña. “Municipal Bankruptcy: An Overview for Local
Officials.” February 26, 2013. Available at
www.statebudgetsolutions.org/publications/detail/municipal-bankruptcy-an-overview-for-local-officials
3
12 States
Authorize
Municipal
Bankruptcy
•
•
•
•
•
•
•
•
•
•
•
•
Alabama
Arizona
Arkansas
Idaho
Minnesota
Missouri
Montana
Nebraska
Oklahoma
South
Carolina
Texas
Washington
c.
•
•
•
•
•
•
•
•
•
•
•
•
12 States
Conditionally
Authorize
Municipal
Bankruptcy
California
Connecticut
Florida
Kentucky
Louisiana
Michigan
New Jersey
North Carolina
New York
Ohio
Pennsylvania
Rhode Island
3 States Limit
2 States
Authorization
Prohibit
Only to Certain
Chapter 9
Types of
Filing
“Municipalities”
• Colorado
• Georgia
• Illinois
• Iowa
(with
• Oregon
exception)
21 States
Provide No
Authorization
for Chapter 9
Filing
• Alaska
• Delaware
• Hawaii
• Indiana
• Kansas
• Maine
• Maryland
• Massachusetts
• Mississippi
• Nevada
• New
Hampshire
• New Mexico
• North Dakota
• South Dakota
• Tennessee
• Utah
• Virginia
• Vermont
• West Virginia
• Wisconsin
• Wyoming
Determination of Whether a Municipality is “Insolvent”?
Under § 101(32)(C), a municipality is “insolvent” when it is:
(i) generally not paying its debts as they become due unless such debts are
the subject of a bona fide dispute; or
(ii) unable to pay its debts as they become due.
Three types of insolvency inform the § 109(c)(3) analysis: cash insolvency; budget
insolvency; and service delivery insolvency. In re City of Stockton, 2013 Bankr. LEXIS 2416
(Bankr. E.D. Cal. June 12, 2013) (Klein, J.). In Stockton, the city’s creditors argued that the city
had manipulated its budget to a “technical insolvency” to appear insolvent when it was not.
However, the court was not persuaded by this argument. It noted that the city was insolvent as of
4
February 28, 2012 and remained so through the date of the filing of its petition on June 28, 2012.
While the city had cash on hand at the time of filing, it was only due to the city’s decision to
default on bond payments and implementation of its “pendency plan” which slashed health care
benefits for employees and retirees. Implementing this plan allowed the city to adopt a balanced
budget for the year, however it hinged on confirmation of a plan that would discharge the
breached obligations. The court, in construing alternative definitions of insolvency, noted that
the insolvency must be real and “not likely to be resolved without use of the federal exclusive
bankruptcy power to impair contracts.” Id.
While cash insolvency -- the opposite of paying debts as they become due -- is the
controlling chapter 9 criterion under § 101(32)(C), longer-term budget imbalances
(budget insolvency) and the degree of inability to fund essential government
services (service delivery insolvency) also inform the trier of fact's assessment of
the relative degree and likely duration of cash insolvency.
Id.
Service delivery insolvency is defined as a “municipality's ability to pay for all the costs
of providing services at the level and quality that are required for the health, safety, and welfare
of the community.” Id. In Stockton, the police force had shrunk and crime rates had soared.
Because of budget cuts and fewer officers, police were only responding to calls of “crimes-inprogress.” Id. The Court found that this evidence established service delivery insolvency.
Budget insolvency looks at “the ability of a municipality to create a balanced budget that
provides sufficient revenues to pay for its expenses that occur within the budgeted period.
Relevant budgeted periods include future fiscal years.” Uncontested budget projections in
Stockton forecasted imbalances for decades without major changes. Id. All of these facts taken
together, satisfied the court that Stockton was “insolvent.”
In a contrasting decision, In re City of Bridgeport, 128 B.R. 30 (D. Conn. Bankr. 1991), a
bankruptcy court in Connecticut imposed a difficult burden on the City of Bridgeport to prove
that it could not pay its debts as they became due. Bridgeport faced a $16 million budget deficit
at the time that the mayor filed a petition under Chapter 9. The court made clear that Chapter 9
relief is not available to a city simply because it is financially distressed. Id at 336.
Bridgeport conceded that it was paying its debts when it filed its petition so in order to
prove “insolvency,” the city had to demonstrate that it would be “unable to pay debts as they
become due.” The court applied a prospective analysis using the petition date as the reference
point for the insolvency analysis. The court recognized that:
Cities cannot go out of business. Chapter 9 is intended to enable a financially
distressed city to “continue to provide its residents with essential services such as
police protection, fire protection, sewage and garbage removal, and schools…,”
while it works out a plan to adjust its debts and obligations. A construction of 11
U.S.C. § 101(32)(C) under which a city would not be able to seek Chapter 9
protection unless and until it was actually not paying its bills could defeat that
purpose, as actually not paying bills could lead to the non-delivery of services.
5
Id., 129 B.R. at 336-337.
The court determined that mere proof of a budget deficiency was insufficient to
demonstrate insolvency. On the date the petition was filed, Bridgeport had cash reserves of
nearly $28 million remaining from a recent bond sale. Bridgeport intended to use those funds to
pay for the current fiscal year’s operating deficit and the subsequent fiscal year’s operating
deficits, but the city argued that during the following year, it would run out of cash. Id. The
court held that in order to be “insolvent,” a city must prove that it will be unable to pay its debts
as they become due in its current fiscal year or, based on an adopted budget, or in its next fiscal
year. Accordingly, the court found that Bridgeport was not insolvent and the Chapter 9 petition
was dismissed. Accord In re Town of Westlake, 211 B.R. 860, 866 (Bankr. N.D. Tex. 1997) and
In re Pierce County Hous. Auth., 414 B.R. 702 (Bankr. W.D. Wash. 2009).
The bankruptcy court in In re New York City Off-Track Betting Corp., 427 B.R. 256
(Bankr. S.D.N.Y. 2010) took a less stringent view of a municipality’s burden to prove
“insolvency.” New York City Off-Track Betting Corporation (“NYC OTB”), a public entity,
filed a Chapter 9 petition. Despite instituting cost-cutting measures, it operated at a loss for
many years, including 17 months of state-controlled operations, just prior to filing the Chapter 9
petition on December 3, 2009. In its petition, NYC OTB estimated that it would run out of cash
by the end of 2009.
The court stated that “[b]ankruptcy courts should review Chapter 9 petitions with a jaded
eye” because principles of dual sovereignty severely curtail the power of bankruptcy courts to
compel municipalities to act once a petition is approved. Id at 264. “In light of these concerns,
Bankruptcy Courts scrutinize petitions for relief under Chapter 9.” Id. citing In re Sullivan
County Regional Refuse Disposal Dist., 165 B.R. 60, 82 (Bankr. D.N.H. 1994). It determined
that Congress intended that the eligibility requirements under Chapter 9 should be broadly
construed to provide access to relief in furtherance of the Code’s underlying policies. So
“[d]espite the scrutiny required due to federalism issues, Bankruptcy Courts must balance
constitutional concerns with congressional intent.” In re New York City Off-Track Betting Corp.,
427 B.R. 256 (Bankr. S.D.N.Y. 2010) citing Hamilton Creek Metro. Dist. V. Bondholders Colo.
Bondshares (In re Hamilton Creek Metro. Dist.), 143 F.3d 1381, 1384 (10th Cir. 1998).
The court found that NYC OTB was insolvent when it filed its petition. Although it was
delaying payments to creditors as a benefit of the automatic stay and maintaining funds for
operating expenses, the court found that having that cash on hand did not render it solvent
because it was still likely to run out of funds for operations by March 2010. In re New York City
Off-Track Betting Corp., 427 B.R. at 271-272.
d.
Determination of Whether a Municipality Desires to Effect a Plan to
Adjust its Debts.
“The cases equate ‘desire’ with ‘intent’ and make clear that this element is highly
subjective.” In re City of Stockton, 2013 Bankr. LEXIS 2416 (Bankr. E.D. Cal. June 12, 2013)
citing In re City of Vallejo, 408 B.R. 280, 295 (9th Cir. BAP 2009). According to Collier on
Bankruptcy, the eligibility requirement in Section 109(c)(4) that the debtor must “desire[] to
6
effect a plan to adjust [its] debts” is “an element of the ‘good faith’ requirement of section
921(c). It simply requires that the purpose of the filing of the chapter 9 petition not simply be to
buy time or to evade creditors. The chapter 9 petition must be designed to result in a plan of
adjustment of debts by which creditors' claims will be satisfied or discharged.” 2-109 Collier on
Bankruptcy P. 109.04.
In In re City of Stockton, the court found that the city’s unilateral contract impairments as
part of its pendency plan at the outset of the Chapter 9 filing gave the city little choice but to
effect a plan of debt adjustment, and the city satisfied, by a preponderance of the evidence, the
requisite “desire” under Section 109(c)(4). 2013 Bankr. LEXIS 2416 (Bankr. E.D. Cal. June 12,
2013).
E.
Determination of Whether a Municipality Made a Good Faith Effort to
Negotiate Resolutions with its Creditor Constituencies.
Under § 109(c)(5), in order to be “eligible” for Chapter 9 relief, the debtor must also
demonstrate satisfaction of one of the following four (4) criteria:
(A) [it] has obtained the agreement of creditors holding at least a majority in
amount of the claims of each class that such entity intends to impair under a plan
in a case under such chapter;
(B) [it] has negotiated in good faith with creditors and has failed to obtain the
agreement of creditors holding at least a majority in amount of the claims of each
class that such entity intends to impair under a plan in a case under such chapter;
(C) [it] is unable to negotiate with creditors because such negotiation is
impracticable; or
(D) [it] reasonably believes that a creditor may attempt to obtain a transfer that is
avoidable under section 547 of this title.
i.
Successfully-Negotiated Plan.
Subsection A provides the only § 109(c)(5) test which is objective and clear-cut. It
requires a municipality to demonstrate that it “has obtained the agreement of creditors holding at
least a majority in amount of the claims of each class that such entity intends to impair under a
plan in a case under such chapter.”
ii.
Unsuccessfully-Negotiated Plan.
A municipality can also satisfy its §109(c)(5) test by demonstrating that it “negotiated in
good faith with creditors [but] failed to obtain the agreement of creditors holding at least a
majority in amount of the claims of each class that such entity intends to impair under a plan in a
case under such chapter.”
This raises several sub-issues. For example, what is the requisite amount of negotiation
required? Is it sufficient to give creditors a “take it or leave it” offer based upon a demonstration
7
that the plan utilizes all projected revenue and a plan providing for more generous distributions
to creditors would not be feasible?
One court has held that § 109(c)(5)(b) requires the debtor to present to creditors a
comprehensive plan that can be implemented in a Chapter 9 case. Collier on Bankruptcy at §
900.02[2][e] citing In re Sullivan County Regional Refuse Disposal District, 165 B.R. 60, 78
(Bankr. D.N.H. 1994). Id. However, this can be contrasted with In re McCurtain Municipal
Authority, 2007 WL 4287604 (Bankr. E.D. Okla. 2007), wherein the court held that the debtor
had satisfied the good faith negotiation test because of prepetition offers to settle with the
creditor whose debt gave rise to the debtor’s financial difficulties. Collier on Bankruptcy §
900.02[2][e] citing 2007 Bankr. LEXIS 4160 (E.D. Okla. Dec. 4, 2007). "[W]hile a complete
plan is not required, some outline or term sheet of a plan which designates classes of creditors
and their treatment is necessary." Vallejo, 408 B.R. at 297.
The court in In re City of Stockton recently addressed reluctant creditors who refused to
take part in negotiations.
Just as it takes two dancers to tango, good faith negotiations contemplate
reciprocity. It is not possible to negotiate with a stone wall. It follows that, as a
matter of law, a municipality's § 109(c)(5)(B) good faith negotiation obligation is
satisfied with respect to any class of putatively impaired creditors that declines to
respond in good faith to a good faith proposal by the municipality.
2013 Bankr. LEXIS 2416 (Bankr. E.D. Cal. June 12, 2013).
iii.
When is it “Impracticable” to Negotiate a Plan?
A municipality may also satisfy its § 109(c)(5) requirement by demonstrating that it was
impracticable to engage in pre-petition negotiations with creditors. This requires a fact-driven
analysis.
"'Impracticable' means 'not practicable; incapable of being performed or accomplished by
the means employed or at command; infeasible.' In the legal context, 'impracticability' is defined
as 'a fact or circumstance that excuses a party from performing an act, esp. a contractual duty,
because (though possible) it would cause extreme and unreasonable difficulty.'" In re City of
Vallejo, 408 B.R. 280, 298 (B.A.P., 9th Cir. 208) citing Valley Health Sys., 383 B.R. at 163.
Impracticability often occurs when the debtor will have great difficulty identifying and
negotiating with all of its creditors. Impracticability also includes certain situations where assets
would be at risk if time is taken to negotiate with creditors. Furthermore, where a debtor has a
liquidity crisis and has not developed a plan upon which reasonable negotiations can take place,
prepetition negotiations may be impracticable. Collier on Bankruptcy § 900.02[2][e] (15 Ed.
Matthew Bender and Company, Inc. 2010).
In Stockton, the court found that the city had satisfied this requirement. There were
approximately 2,400 retirees and the court recognized that it would have been impracticable to
8
negotiate with each retiree individually, and there were no natural representatives who could
have negotiated on their behalf. In a scathing condemnation of the capital markets creditors, the
court held:
Second, § 109(c)(5)(C) impracticability provides an adequate, independent reason
for concluding that the City has satisfied the fifth essential element for eligibility
to be a chapter 9 debtor with respect to the objecting capital markets creditors - it
is impracticable to negotiate with a stone wall.
2013 Bankr. LEXIS 2416 (Bankr. E.D. Cal. June 12, 2013).
iv.
Preferences.
Finally, a municipality can satisfy § 109(c)(5) by demonstrating that an immediate
bankruptcy filing was necessary in order to capture a significant preference under Bankruptcy
Code § 547(b).
F.
Why are the Eligibility Requirements so Strict?
“Eligibility” is arguably the single most difficult hurdle for a municipality to achieve a
successful Chapter 9 case. Many Chapter 9 cases, including most notably Bridgeport,
Connecticut, and more recently, Harrisburg, Pennsylvania, have been terminated on eligibility
grounds.
The authors believe that Congress envisioned Chapter 9 as the last stop for cities and
towns before they drive off the fiscal cliff. There is a critical distinction between Chapters 9 and
11: unlike private debtors that can fail and be liquidated, cities and towns cannot be liquidated as
they must always be able to continue to provide social services, public safety services, and other
critical services for their residents. Thus, we believe that Congress granted municipalities the
enormous powers in Chapter 9 in order to ensure that each distressed municipality’s Chapter 9
case is successful. On the other hand, we also believe that Congress established the Section
109(c) strict eligibility standards to create a check and balance to ensure that these enormous
powers will only become available to those municipalities truly utilizing them as the only
alternative to financial ruin.
2.
REJECTION OF COLLECTIVE BARGAINING AGREEMENTS
Subject to certain limitations, Section 365(a) of the Bankruptcy Code authorizes a debtor
to assume or reject executory contracts. It provides:
Except as provided in sections 765 and 766 of this title and in subsections (b), (c),
and (d) of this section, the trustee, subject to the court’s approval, may assume or
reject any executory contract or unexpired lease of the debtor.
11 U.S.C. § 365(a). Bankruptcy Code § 365 is incorporated into Chapter 9 under § 901(a). In
the landmark decision, NLRB v. Bildisco & Bildisco, 465 U.S. 513 (1984) (“Bildisco”), the
9
United States Supreme Court held that Congress intended that 11 U.S.C. § 365(a) apply to all
collective bargaining agreements (“CBAs”). 465 U.S. at 524. It further held that a CBA “is an
executory contract.” Id. at 521-23 & n.6 (“We reject the argument of amicus United Mine
Workers of America that a collective-bargaining agreement is not an executory contract within
the meaning of § 365(a).”).
The Bildisco court addressed the issue whether a bankruptcy court considering rejection
of a CBAs should be governed by a higher standard than the “business judgment” standard
which is the ordinarily applied in consideration of contract rejection. 465 U.S. at 524. After
reviewing various lower court decisions, the Court concluded that a “somewhat stricter standard”
than the “business judgment” standard should govern the determination of whether or not a
debtor should be authorize to reject a CBA. Id.
In determining the appropriate standard, the Court rejected the more stringent standard
under a line of cases which held that a debtor should only be authorized to reject a CBA if it can
prove that its reorganization would fail without permission to reject. See id. at 524-25. Instead,
the Court adopted a more liberal test, namely that rejection of a CBA should be authorized under
§ 365(a) if: (1) the debtor can show that the CBA burdens the estate3 ; (2) after careful scrutiny,
the equities balance in favor of rejecting the CBA; and (3) “reasonable efforts to negotiate a
voluntary modification have been made, and are not likely to produce a prompt and satisfactory
solution.” See In re City of Vallejo, 403 B.R. 72, 78 (Bankr. E.D. Cal. 2009) (citing Bildisco,
465 U.S. at 526).
Labor unions reacted strongly against Bildisco. See In re County of Orange, 179 B.R.
177, 182-83 (Bankr. C.D. Cal. 1995). Within months after Bildisco was decided, Congress
enacted § 1113 of the Bankruptcy Code which, among other things, “applies in chapter 11 cases
and imposes on chapter 11 debtors procedural and substantive requirements that must be met
prior to rejection of collective bargaining agreements.” 11 U.S.C. § 1113(f); see City of Vallejo,
403 B.R. at 77. However, Congress did not amend § 901 to incorporate new § 1113.
Municipalities typically file their motions to reject CBAs on the first day of a Chapter 9
case so that they can immediately treat the CBAs as terminated. In cases filed under Chapter 11,
a debtor cannot treat a CBA as rejected until the bankruptcy court grants a motion to reject.
In Bildisco, supra, 465 U.S. 513, the United States Supreme Court determined that “the
filing of the petition in bankruptcy means that the collective-bargaining agreement is no longer
immediately enforceable, and may never be enforceable again.” 465 U.S. at 531. Because the
CBA in Bildisco was rendered unenforceable by filing the bankruptcy petition, unilateral
rejection of the contract was proper within the bankruptcy case.
The bankruptcy court in In re City of Vallejo followed Bildisco and held that a CBA may
be unilaterally modified by a Chapter 9 debtor. In re City of Vallejo, Findings of Fact and
3
“In a Chapter 9 case there is no ‘estate.’ Thus, a municipal debtor must demonstrate that the collective bargaining
agreement burdens its ability to reorganize by proposing and implementing a viable plan of debt adjustment.” In re
City of Vallejo, 403 B.R. 72, 78 n.2 (Bankr. E.D. Cal. 2009) (citing Bildisco, 465 U.S. at 525-26).
10
Conclusions of Law, Case No. 08-26813-A-9 (U.S. Bankr. Ct., E.D. Ca., August 31, 2009) citing
Bildisco at 531 and In re S.A. Mechanical, Inc., 51 B.R. 130 (Bankr. D. Ariz. 1985). 4
3.
CONFIRMATION OF A PLAN OF DEBT ADJUSTMENT
A third seminal event in any Chapter 9 case is the filing and confirmation of a plan of
debt adjustment.
A “plan of debt adjustment” is the term used in Chapter 9 for the restructure plan. It is
comparable and similar to a “plan of reorganization” in a Chapter 11 case. However, unlike
under Chapter 11, only the municipality is authorized to file a plan of debt adjustment; there is
no provision under Chapter 9 which authorizes creditors or other parties in interest to file a plan.
Bankruptcy Code § 941 states that “[t]he debtor shall file a plan for the adjustment of the
debtor's debts. If such a plan is not filed with the petition, the debtor shall file such a plan at such
later time as the court fixes.” The section logically assumes that a debtor will ordinarily file its
plan of adjustment simultaneous with its petition because in order to be “eligible,” under §
109(c)(5), the debtor usually is required to have formulated and negotiated its plan with creditors
prior to filing its petition.
If a plan is not filed with the petition, the court may set the time for filing either on its
own motion or at the request of the petitioner. 941-2 Collier on Bankruptcy P 941.04.
A.
CONTENTS OF A PLAN OF DEBT ADJUSTMENT.
1.
Plan Provisions: 11 U.S.C. § 1123 (a).
Section 1123(a) identifies which provisions must be included in a Chapter 9 plan of debt
adjustment. For example, a plan must designate classes of claims. The plan must specify which
of these classes are “impaired” under the plan. A claim is “impaired” if its legal, equitable or
contractual rights are altered. The plan must also be “fair and reasonable” which means that
each claim in a class must receive the same treatment, unless the holder of a particular claim
agrees to less favorable treatment. 901-46 Collier on Bankruptcy P 901.04 [36][a].
Section 1123(a)(5) provides a nonexclusive list of which provisions may be included in a
Chapter 9 plan.
4
The court in Vallejo and Collier made particular note that Vallejo filed its motion to modify and/or reject
the collective bargaining agreement prior to making any unilateral modifications. While the court did not
specifically state that the filing of the motion to reject was a necessary step, it would appear to be prudent for a
municipality to do so prior to treating the collective bargaining agreement as modified or rejected. This can be done
on Day 1 of the case.
11
2.
Acceptance of Plan – 11 U.S.C. § 1126.
In order for a plan of debt adjustment to be confirmed, it must either be “accepted” by
each class of creditors or it must satisfy the so-called “cram down” rules. A plan is deemed
“accepted” by a class when the creditors in the class holding at least two-thirds in amount and
more than one-half in number of the allowed claims for that class have voted to accept the
plan. Only creditors actually voting are counted in determining the vote. Subsection (f) obviates
the need for acceptance by a class of creditors whose claims are not “impaired” by the plan (i.e.
claims that will be paid in cash in full on the effective date of the plan). 901-51 Collier on
Bankruptcy P 901.04 [39]. Acceptances obtained before the commencement of a Chapter 9 case
are valid if adequate disclosures were made at the time of solicitation of the acceptance.
3.
Confirmation.
a.
Compliance with Ch. 9: 11 U.S.C. § 943.
11 U.S.C.S. § 943(b) sets forth seven (7) requirements for confirmation of a plan. 5 If
these standards are met, the bankruptcy court must confirm the plan. In re Pierce County
Hous. Auth., 414 B.R. 702 (Bankr. D. Wash. 2009) citing Collier P 943.01, at 943-4. Section
943(b)(1) also requires that a plan comply with certain other provisions of Title 11 made
applicable by § 103(e) and § 901. Section 901 makes applicable many of the plan
confirmation requirements contained in Chapter 11 including § 1129(a)(2), (3), (6), (8) and
5
The court shall confirm the plan if—
(1) the plan complies with the provisions of this title made applicable by sections 103(e) and 901
of this title;
(2) the plan complies with the provisions of this chapter;
(3) all amounts to be paid by the debtor or by any person for services or expenses in the case or
incident to the plan have been fully disclosed and are reasonable;
(4) the debtor is not prohibited by law from taking any action necessary to carry out the plan;
(5) except to the extent that the holder of a particular claim has agreed to a different treatment of
such claim, the plan provides that on the effective date of the plan each holder of a claim of a kind
specified in section 507(a)(2) of this title will receive on account of such claim cash equal to the
allowed amount of such claim;
(6) any regulatory or electoral approval necessary under applicable nonbankruptcy law in order
to carry out any provision of the plan has been obtained, or such provision is expressly
conditioned on such approval; and
(7) the plan is in the best interests of creditors and is feasible.
12
(10). 6 The debtor bears the burden of satisfying the confirmation requirements of § 943(b) by
a preponderance of the evidence. In re Pierce County Hous. Auth., 414 B.R. 702 (Bankr. D.
Wash. 2009) citing In re Mount Carbon Metro. Dist., 242 B.R. 18, 31 (Bankr. D. Colo. 1999).
Several of the more important requirements for confirmation are discussed below.
i.
A Plan Must be Proposed in “Good Faith.”
Section 1129(a)(3) requires that the plan be proposed in “good faith.” Although the term
"good faith" is not defined in the Bankruptcy Code, and there is not significant case law in the
context of a Chapter 9 plan, courts have looked to cases under Chapter 11 and Chapter 13 for
guidance. See § 1129(a)(3); § 1325(a)(3). In re Pierce County Hous. Auth., 414 B.R. 702, 719720 (Bankr. D. Wash. 2009).
Most courts agree that the determination of whether a plan has been proposed in good faith
"requires a factual inquiry of the totality of the circumstances." Id at 720 citing Mount Carbon,
242 B.R. at 39. Factors a court should examine include: "(1) whether a plan comports with the
provisions and purpose of the Code and the chapter under which it is proposed, (2) whether a
plan is feasible, (3) whether a plan is proposed with honesty and sincerity, and (4) whether a
plan's terms or the process used to seek its confirmation was fundamentally fair." In re Pierce
County Hous. Auth., 414 B.R. at 720 citing Mount Carbon, 242 B.R. at 40-41.
ii.
A Plan Must be Accepted by Each Class of Impaired Claims.
Unless a plan satisfies the so-called “cram down” rules, it must be “accepted” by all
classes of impaired claims. A class is deemed to have accepted a plan if holders of at least twothirds in amount and a majority in number of impaired claims have accepted the plan. A class is
not impaired under § 1124 if the legal, equitable, and contractual rights of the creditor are either
left completely unaltered, or are altered only by reversal of an acceleration clause and curing of
default and reinstatement of maturity. 943-11 Collier on Bankruptcy P 943.03[1][d].
6
Bankruptcy Code §§ 1129(a)(2), (3), (6), (8) and (10) provide:
(2) The proponent of the plan complies with the applicable provisions of this title.
(3) The plan has been proposed in good faith and not by any means forbidden by law.
(6) Any governmental regulatory commission with jurisdiction, after confirmation of the plan,
over the rates of the debtor has approved any rate change provided for in the plan, or such rate
change is expressly conditioned on such approval.
(8) With respect to each class of claims or interests—
(A) such class has accepted the plan; or
(B) such class is not impaired under the plan.
(10) If a class of claims is impaired under the plan, at least one class of claims that is impaired
under the plan has accepted the plan, determined without including any acceptance of the plan by
any insider.
13
iii.
A Plan Must Be Fair and Equitable.
A court may confirm a plan that is not accepted by all classes of claims if at least one
impaired class 7 has accepted the plan, and the plan otherwise satisfies the so-called “Fair and
Equitable Rule.” This is generally known as a “cram down.”
The Fair and Equitable Rule requires that the plan protect the interests, claims, or liens of
the creditors to whom it applies. The general rule of “equality between creditors” is applicable
in Chapter 9 as it is in all bankruptcy proceedings. American United Mut. Life Ins. Co. v. Avon
Park, 311 U.S. 138, 147 (U.S. 1940). Thus, a plan will not be confirmed if it unfairly
discriminates between creditors within the same class.
The Fair and Equitable Rule also incorporates the Absolute Priority Rule which requires
that senior creditors be paid in full before any creditor junior to them is paid anything on account
of its claim.
Fair and Equitable also includes the feasibility standard. In order to meet the “feasibility”
standard, the debtor must demonstrate its ability to make the payments required under the plan
and still maintain its operations at the level that it determines is necessary to continue the
viability of the municipality. The court’s role will be limited to determining whether the revenue
and expense projections that the debtor submits are reasonable forecasts and whether the debtor
will be able to make the payments called for under the plan. 943-32 Collier on Bankruptcy P
943.03[7][b].
iv.
A Plan must be in the Best Interests of Creditors.
The "best interest of creditors" requirement of § 943(b)(7) is "generally regarded as
requiring that a proposed plan provide a better alternative for creditors than what they already
have." 6-943 Collier on Bankruptcy P 943.03. The "best interest" test has been described as a
"floor requiring a reasonable effort at payment of creditors by the municipal debtor" and the
"feasibility" requirement as a "corresponding ceiling which prevents the Chapter 9 debtor from
promising more than it can deliver." In re Pierce County Hous. Auth., 414 B.R. 702 (Bankr. D.
Wash. 2009) quoting Mount Carbon, 242 B.R. at 34.
4.
SOVEREIGN IMMUNITY LIMITATIONS ON A BANKRUPTCY COURT’S
POWERS
Because of sovereign immunity, a bankruptcy court’s authority in a Chapter 9 case is
significantly more limited than a bankruptcy court’s authority in cases under Chapters 7, 11 or
13.
7
This excludes the claims of any insiders. An insider is defined in a municipal case as an elected official of the
debtor or a relative.
14
a.
Constitutional Basis for Sovereign Immunity Limitation.
The Tenth Amendment 8 is a significant factor in shaping Chapter 9 of the Bankruptcy
Code. Furthermore, courts, in upholding municipal bankruptcy legislation, have been careful to
recognize the delicate balance that is necessary between the Code and the Tenth Amendment.
“As the court stated in In re Willacy County Water Control & Improvement District No. 1:
The Bankruptcy Act limits the power of the court to the composition of
indebtedness and to the carrying on of the usual business transactions, which
includes the making of necessary expenditures in connection therewith.
Jurisdiction over the governmental affairs of the municipality, or of its property, is
limited to such purposes. The court is merely authorized to determine insolvency,
or inability to meet debts as they mature, and whether the plan proposed is in
accordance with the provisions of the statute, and whether it has been accepted by
the number of creditors provided, and whether the petitioner is in a position to
carry out the terms of the plan, and whether it is equitable, for the best interests of
the creditors, and nondiscriminatory. Those questions are the limit of jurisdiction,
and upon their determination follows either confirmation or dismissal.”
6-900 Collier on Bankruptcy P 900.01.
b.
Bankruptcy Code Bases for Sovereign Immunity Limitations.
Section 903 of the Code recognizes the State’s power to control municipalities
and states:
This chapter does not limit or impair the power of a State to control, by legislation
or otherwise, a municipality of or in such State in the exercise of the political or
governmental powers of such municipality, including expenditures for such
exercise, but—
(1) a State law prescribing a method of composition of indebtedness of such
municipality may not bind any creditor that does not consent to such composition;
and
(2) a judgment entered under such a law may not bind a creditor that does not
consent to such composition.
Section 904 recognizes the power of the chapter 9 debtor to manage the municipality and
its property:
8
The powers not delegated to the United States by the Constitution, nor prohibited by it to the states, are reserved to
the states respectively, or to the people.
15
Notwithstanding any power of the court, unless the debtor consents or the plan so
provides, the court may not, by any stay, order, or decree, in the case or
otherwise, interfere with—
(1) any of the political or governmental powers of the debtor;
(2) any of the property or revenues of the debtor; or
(3) the debtor's use or enjoyment of any income-producing property.
c.
Examples of Limitations Imposed by Sovereign Immunity:
i.
In Chapter 9 there is no bankruptcy estate.
ii.
The bankruptcy court has no fiscal oversight powers, cannot order tax
levies, and cannot order liquidation of assets.
iii.
A Chapter 9 municipality has complete authority to make all business
decisions without court approval including paying pre-petition claims, provided that they do not
violate applicable non-bankruptcy law.
iv.
A bankruptcy court cannot appoint a trustee for the municipality even in
the event of fraud and other attributes normally authorizing a bankruptcy court to appoint a
trustee in Chapter 11. 9
v.
A bankruptcy court cannot order municipality to pay the administrative
fees of a creditors’ committee’s professionals.
5.
THE ROLE OF PUBLIC-FINANCED DEBT.
a.
Treatment of special revenue bonds vs. general obligation bonds.
General obligation bonds are debt obligations secured by the full faith and credit and
taxing power of a governmental issuer. In most states, general obligation bonds represent a
promise by the governmental unit to levy and assess taxes in order to pay debt service.
Generally, this promise can be enforced by court order. Outside of the context of a Chapter 9
bankruptcy, general obligation bonds are considered the highest, most secure pledge of credit a
municipal issuer can grant.
In contrast, special revenue bonds are limited obligations which provide for a security
interest in a specified revenue stream, usually revenues of a project being financed by the bonds
(i.e. a toll might be create the revenue stream for the cost of a bridge). If the revenues are
inadequate to pay the revenue bonds, the municipal issuer has no further obligation to pay the
bonds. This is an application of the “special fund doctrine,” which provides that if a particular
9
A bankruptcy court does have the power to appoint a special purpose trustee for such matters as pursuing voidable
transfers that a debtor municipality cannot or will not pursue.
16
fund is pledged as the source of payment for a debt without additional security, then payment of
the debt is limited to monies in that fund. If the fund is depleted, the debtor has no additional
obligation to pay. McQuillin, Municipal Corporations § 41.30.
Outside of a Chapter 9 bankruptcy, revenue bonds are viewed by investors as a less
secure investment than general obligation bonds. However, once a municipality has filed under
Chapter 9, the relative priority positions of the obligations flip. Section 928 of the Bankruptcy
Code provides that in the case of special revenue bonds, a security interest in special revenues
remains valid and enforceable during the pendency of the Chapter 9 bankruptcy case.
Therefore, although outside of a Chapter 9 bankruptcy, general obligation bonds are
considered the more secure investment; inside a Chapter 9 case, special revenue bonds have
secured creditor status while general obligation bondholders are relegated to the status general
unsecured creditors. Special revenue bonds will continue to be paid, at least to the extent of
available pledged revenues, while general obligation bondholders will share in what is left over
(assuming anything is left over) with other unsecured creditors, which may include municipal
employees under collective bargaining agreements and retirees.
b.
Statutory Liens.
In Chapter 9, a bankruptcy court generally must honor statutory liens created by state
statute. 11 U.S.C. Section 545. The 2001 Amendments to the Uniform Commercial Code (the
“UCC”) recognized statutory liens, and the UCC provides an exception to the requirement of
filing UCC-1 Financing Statements in order to perfect such liens. In many states, it is quite
common to find statutory liens for revenue bonds, but it is much less common to find statutory
liens for municipal general obligation bonds. See e.g. Cal. Educ. Code §15250 (provides tax
pledge to bondholders of general obligation bonds issued for schools), Colo. Rev. Stat §32-11555 (statutory lien granted for bonds issued by Urban Drainage and Flood Control District
Bonds); Fla. Stat. §132.43 (providing for statutory lien on proceeds of refunding bonds for
payment of refunded bonds). See also Moody’s Investor Service, Special Comment, Key Credit
Considerations for Municipal Governments in Bankruptcy, dated January 19, 2012 updated on
May 2, 2012.
Probably the most far-reaching lien statute for general obligation bonds is found in the
State of Rhode Island. The law was drafted in 2011 in advance of the City of Central Falls'
Chapter 9 bankruptcy filing. Section 45-12-2 of the Rhode Island General Laws provides a first
priority lien on a city’s or town’s taxes and general fund revenues to secure general obligation
bonds. This lien has priority over all other obligations, including collective bargaining
agreements and pension obligations.
c.
Debate regarding whether impaired treatment of General Obligation
Bonds in Chapter 9 will lead to "contagion.”
The Rhode Island lien statute was enacted in order to preserve Central Falls' access to
capital and also to prevent "contagion" which might otherwise prejudice the capital markets
against other Rhode Island municipal issuers, precluding access to capital or making credit more
expensive to compensate for risk. The existence of a "contagion effect" within the entire
17
municipal bond market, within states, or within neighboring communities is currently being
debated.
In Rhode Island, there was anecdotal evidence that Central Falls' financial woes were
having an adverse effect on some of Rhode Island's financially weaker municipalities. Likewise,
when the City of Harrisburg, Pennsylvania attempted to file for bankruptcy, there were concerns
that municipalities surrounding Harrisburg would have difficulty with market access or be
required to pay higher interest rates. See Forbes, “Behind Those Scary Municipal Bond
Headlines”
http://www.forbes.com/greggfisher/2011/11/21/behind-those-scary\municipalbondheadlines, and
Joe Deaux, The Street, No Contagion Seen from Harrisburg Bankruptcy,
http://www.thestreet.com/story/11275-203/1/Harrisburg-files-chapter-9-bankruptcy.htm
With the announcement of the proposal of Detroit's state-appointed emergency manager
to pay general obligation bondholders 10 cents on the dollar, commentators again have suggested
that Detroit's actions could impair market access, or at least increase borrowing costs for the
State of Michigan and its municipalities. B. Chappatta and M. Brown, "Detroit Recovery Plan
Threatens Muni-Market Underpinnings," http://mobile.bloomberg.com/news/2013-06-17/detroitrecovery-plan-threatens-muni-market-underpinnings.html
c.
Lessons Learned from Five Post-2000 Chapter 9 Cases.
One of the difficulties in providing good legal advice to financially distressed municipal
clients is the dearth of Chapter 9 bankruptcy case law. Since 2000, the significant Chapter 9
cases include Vallejo, California; Central Falls, Rhode Island; Jefferson County, Alabama;
Stockton, California; and San Bernardino, California. Each of these bankruptcy cases has been
instructive in its own way.
i.
Vallejo, California.
Vallejo, California filed for Chapter 9 bankruptcy in May, 2008, and as of that date, it
was the largest Chapter 9 case in United States history. Vallejo’s plan of debt adjustment, which
was confirmed on July 28, 2011, substantially cut labor contracts, debt service payments and
post-employment health care benefits. The Plan did not, however, address significant retiree
pensions. The Vallejo bankruptcy cost more than $9 million dollars and took 3 years to
complete. Since emerging from bankruptcy in 2011, Vallejo still has not balanced its budget and
its infrastructure is crumbling. H. Dreier, "Vallejo, California Bankruptcy offers 'Opportunity’
Even as City Goes in the Red." http://www.huffingtonpost.com/2012/07/22/in-ca-city-mixedpicture_n_1692924.html. The city has not been able to issue debt since before it filed for
bankruptcy, due largely to its inability to access the debt markets. Standard & Poor's Ratings
Service "Case Study: The Vallejo California Bankruptcy” http://www.standardandpoors.com/
spf/upload/Events US/US_PF_Event_MunicipalArticle2.pdf.
ii.
Central Falls, Rhode Island.
In contrast, the tiny City of Central Falls, Rhode Island, filed for Chapter 9 bankruptcy on
August 1, 2011 and had its plan of debt adjustment confirmed just 13 months later, on September
18
11, 2012. Central Falls’ confirmed plan provides for five years of balanced budgets enforceable
by court order. The Plan was consented to by substantially all of the city's creditors, including
labor unions and retirees. The city's general obligation bondholders were not impaired and all
debt service payments have been made timely. The receivership and bankruptcy were both
completed at a cost of approximately $3 million, which was initially paid for by the State of
Rhode Island, but requires the city to repay over a period of 10 years. The city's credit rating,
which had been downgraded to a Caa1 level by Moody's Investors Service, was upgraded to a B2
on the effective date of the plan. Participants in the bankruptcy proceedings stated that the keys
to the success of the bankruptcy case were the (i) state involvement, both legislatively and
operationally, and (2) complete transparency in the sharing of information with creditors,
stakeholders, and particularly the retirees who agreed to very significant reductions in their
pensions.
iii.
Jefferson County, Alabama.
When Jefferson County ("JeffCo") filed for bankruptcy in November, 2011, it
displaced Vallejo as the largest municipal bankruptcy in United States history.
Among the causes of the Jefferson County bankruptcy were corruption and fraud in
connection with the sewer system project financed with special revenue bonds. More than 20
people including politicians and vendors were convicted. Investment bankers also induced the
County to enter into complex derivative transactions which cost the County dearly during the
collapse of financial institutions in 2008. No criminal liability was imposed on the lead
investment banking firm, however, the Securities and Exchange Commission assessed penalties
against the firm for paying bribes. "J.P. Morgan Settles SEC Changes in Jefferson County,
Alabama Illegal Payments Scheme" http://www.sec.gov/news/press/2009/2009-232.htm. The
county and its creditors litigated, first over control of the system, and then over which expenses
could be treated as operating expenses, payable prior to debt service.
JeffCo's had not filed its plan of debt adjustment as of June 30, 2013. JeffCo Bankruptcy
Information, http://www.kccllc.net/jeffersoncounty. The underwriting firm that underwrote most
of the County's bonds and which had been engaged in the derivative transactions with the
County, is expected to take taking the largest loss of all creditors. In addition, it is expected that
the plan will provide for the financing of some of the County's bonds. It will be interesting to
see what reception the County's refunding bonds receive. The lessons learned from JeffCo
include: (1) a municipality should generally avoid exotic financial products such as variable rate
debt and derivative transactions which require high levels of sophistication to understand, (2) a
municipality should adhere strictly to procurement statutes, and (3) it may be possible to resolve
a bankruptcy through refinancing under certain circumstances.
iv.
Stockton, California.
Stockton, California is another municipality whose financial woes, at least in part, were
caused by labor costs and unfunded pension obligations. "Stockton Bankruptcy the Result of 15Year
Spending
Binge."
http://www.huffingtonpost.com/2012/07/04/stocktonbankruptcy_n_1648634.html. Stockton's pension and benefit liabilities exceeded $800 million.
Due to the difficulty of obtaining legal authority to issue general obligation bonds, the City of
19
Stockton issued appropriation obligations. Appropriation obligations are not considered legal
"debt." They are obligations payable, subject to annual appropriation of funds by the
municipality. The municipality does not enter into any long-term unconditional obligation to
pay, but rather, has the legal right to refuse to make appropriations to pay the current year's debt
service. The consequence of a failure to appropriate funds for debt service is typically loss of the
asset financed. Therefore, Stockton has determined not to appropriate funds for those
appropriation obligations which are not secured by buildings or facilities that the city intends to
continue to use. The Stockton bankruptcy remains pending at the time of this writing, but the
lessons to be learned, include that municipalities should (1) get control over unsustainable labor
costs, pension obligations and other post-employment benefits, and (2) be strategic about what
obligations to continue paying.
6.
COMPARATIVE STATE APPROACHES TO MUNICIPAL DISTRESS.
Municipalities derive all of their powers from the sovereign – the State. McQuillin
Municipal Corporation § 10.12. When it comes to addressing fiscal health and operations of
their municipalities, States have adopted various approaches. These approaches range from a
"hands off" approach, to provision of assistance upon request, to state takeover over the
objection of the municipality. Substantially different approaches are represented by California,
Pennsylvania, Rhode Island, and Massachusetts, each summarized below.
a.
California – No Intervention
An example of a state which has adopted a "hands off" approach is the State of
California. California has no formal oversight mechanism, other than for school districts.
https://www.pfm.com/uploadedFiles/Content/Knowledge_Center/Whitepapers,_Articles,_Comm
entary/Whitepapers/State%20Programs%20for%20Municipal%20Financial%20Recovery.pdf.
The State legislature, in 2011, passed California Assembly Bill 506 ("AB 506"), which requires a
60-day mediation process in advance of a bankruptcy filing. One of the eligibility requirements
for bankruptcy is that the debtor negotiate in good faith with creditors so all AB506 adds is a
required duration for the mediation. Use of AB 506 has not yet prevented any municipal
bankruptcy filings in California. So effectively, California leaves its municipalities "on their
own," perhaps because the State government is worried that by stepping in, cities, towns and
counties might not give their full effort to manage their finances because of the expectation that
the State will step in to bail them out.
b.
Pennsylvania – Moderate Intervention.
An example of a state system with moderate levels of State involvement with distressed
communities is the Commonwealth of Pennsylvania. The Commonwealth has an early
intervention program which provides state monitoring and planning assistance, but entrance into
the program is only upon the request of a municipality; it is not imposed by the Commonwealth.
In the case of larger cities (over 250,000 in population), state law provides for the
creation of Intergovernmental Authorities. Intergovernmental Authorities have been established
for Philadelphia and Pittsburgh. Any city with a population below 250,000 people is a City of
the Third Class and must petition under Act 47.
20
The Commonwealth's "fiscal stability act", Act of 1987, P.L. 246, No. 47, known as "Act
47," was adopted in the 1980s and provides a blended approach of assistance and oversight, but
like the early intervention program, there are no automatic triggers that subject a municipality to
State oversight. Id. §202. . The local officials or other interested parties must petition to the
State Department of Community and Economic Development (the "DCED") to be subject to Act
47. If the State DCED approves the petition, it will appoint a coordinator to develop a multi-year
management and financial plan. The municipality's chief executive officer and governing body
may also develop and propose plans. § 247. Act 47 provides a "carrot and a stick," as failure to
approve the plan may result in loss of state aid to the municipality and approval results in priority
for receiving state loans and grants. The State, however, has no power to impose the plan.
Cities which have petitioned for oversight under Act 47, and then refuse to approve the
Plan developed by the coordinator, may be placed into receivership. Act 47 also permits Cities
of the Third Class to file for Chapter 9 bankruptcy; however, a recent amendment prohibited
Third Class cities from filing until after June 30, 2012. This amendment was enacted to prohibit
the City of Harrisburg from filing a Chapter 9 petition.
c.
Rhode Island – Multi-level Intervention.
An example of a state with legislation providing incrementally increasing levels of
oversight and state control, commensurate with the depth of the crisis, is Rhode Island. Rhode
Island's legislation, known as the “Fiscal Stability Act,” was adopted in response to the decision
by Central Falls elected officials to file a petition with the Rhode Island Superior Court for the
appointment of a receiver for the city.
Under the Fiscal Stability Act, triggers imposing state oversight are automatic if stated
criteria demonstrating fiscal stress are met. R.I. Gen. Laws §45-9-3. When the triggers are met,
the first level of state support is a fiscal overseer. Although the fiscal overseer has certain
financial powers, his or her role is more advisory in nature.
If it is determined that the level of oversight provided by a fiscal overseer is insufficient
to return the city or town to fiscal stability, the Director of Revenue can appoint a budget
commission in order to take over control of municipal finances. R.I. Gen. Laws §45-9-5. The
budget commission is vested with all of the powers of the city or town’s elected officials.
If that level of oversight is not sufficient to return the city or town to fiscal stability, the
Director of Revenue can appoint a state receiver who is vested with the powers of the city or
town’s elected officials, and the power to file a Chapter 9 petition on behalf of the city or town.
R.I. Gen. Laws §45-9-7. In addition, upon the receiver’s appointment, the status of elected
officials is reduced to “advisory capacity.” Id.
d.
Massachusetts – Case-by-Case Intervention.
Massachusetts does not have a general law of applicability to all cities and towns
providing for municipal oversight. Instead, the Commonwealth has adopted special acts which
21
apply to individual municipalities, upon request of those municipalities to the state legislature.
In 1991, the State legislature passed an act authorizing the appointment of a receiver for the City
of Chelsea. Mass. Statute 1991, Ch. 200.
This act and similar legislation for the Cities of
Springfield and Lawrence have authorized state loans to these municipalities. See Mass. Statute
2004, Ch. 169 (An Act Relative to the Financial Stability in the City of Springfield). The Chelsea
and Springfield acts also permitted the receiver to file for chapter 9 Bankruptcy, but only with
the consent of the Commonwealth’s Secretary of the Executive Office for Administration and
Finance. For further discussion of various state approaches, see "State Programs for Municipal
Financial Recovery – An Overview." https://www.pfm.com/uploadedFiles/Content/
Knowledge_Center/Whitepapers,_Articles,_Commentary/Whitepapers/State%20Programs%20fo
r%20Municipal%20Financial%20Recovery.pdf
Conclusion
Historically, municipal bankruptcy has been extremely rare in the United States. The
economic downturn of 2008-2012, coupled with spiraling labor and retiree costs, have
increasingly pushed government units to the brink of bankruptcy. In advising governmental
clients, lawyers should follow recent events and study current chapter 9 bankruptcy cases, as
municipal bankruptcy is a rapidly evolving area of the law. The legal ability to invoke chapter 9
and the evolution of State fiscal oversight laws have a significant effect on the ability of
municipalities to find their way back to fiscal stability. In addition, state and municipal officials
and their counsel will likely find that decisive state leadership and involvement bring about
better results than letting local governments attempt to handle fiscal crises alone.
22
American Bar Association
Section of State and Local Government Law
2013 Annual Meeting
Order Confirming Fourth Amended Plan For The
Adjustment Of Debts Of City Of Central Falls,
Rhode Island, Dated July 27, 2012
UNITED STATES BANKRUPTCY COURT
DISTRICT OF RHODE ISLAND
In re CITY OF CENTRAL FALLS, RHODE ISLAND,
Case No. 11-13105
Debtor
Chapter 9
ORDER CONFIRMING FOURTH AMENDED PLAN FOR THE
ADJUSTMENT OF DEBTS OF CITY OF CENTRAL FALLS,
RHODE ISLAND, DATED JULY 27, 2012
After hearing and consideration of the memorandum of the City of Central Falls,
Rhode Island (the "City”) in support of confirmation of the Fourth Amended Plan for the
Adjustment of Debts of the City of Central Falls, Rhode Island dated July 27, 2012 [doc.
#479] (the “Plan”), a copy of which Plan is attached hereto as Exhibit 1; the Declaration
of Gayle Corrigan and exhibits thereto; the Declaration of Tracey Pecchia and exhibits
thereto; the Declaration of William Dolan, Esq.; and the evidence, representations, and
arguments adduced at the confirmation hearing, the Court now makes the findings and
determinations set forth below. Any capitalized terms not defined in this Order shall
have the meanings ascribed to them in the Plan.
1.
The City’s Plan has been accepted in writing by the creditors whose
acceptances are required by law;
2.
At least one class of claims that is impaired under the Plan has accepted
the Plan; in fact, all impaired classes of claimants have accepted the Plan.
3.
The Plan complies with the provisions of Title 11 of the United States
Bankruptcy Code made applicable by Section 901 to Chapter 9 plans;
4.
The City has proposed the Plan in good faith and not by any means
forbidden by law in compliance with Section 1129(a)(3);
5.
The Plan complies with the provisions of Chapter 9, Section 943(b)(2);
6.
All amounts to be paid by the City or by any person for services or
expenses in the case have been fully disclosed and are reasonable in accordance with
Section 943(b)(3);
7.
The Plan provides for payment of administrative claims in accordance
with Section 943(b)(5);
8.
The Plan is in the best interests of the City’s creditors; and
9.
The Plan is feasible.
Based upon these findings and determinations the Court hereby ORDERS,
ADJUDGES, AND DECREES that:
1.
The City’s Plan is CONFIRMED;
2.
Within seven (7) days of the entry of this Order, the City shall serve by
mail a Notice of Entry of this Order, with a copy of this Order, on all creditors, parties in
interest (including the City’s elected officials), and all parties to the City’s executory
contracts and unexpired leases. The Notice of Entry need not include a copy of the Plan
but shall direct recipients to the City’s website and indicate that copies of the Plan will be
provided at no cost upon written request.
2.1
Within the term of the Plan, if and when the current elected officials of the
City are replaced with new elected officials, and if and when a new fiduciary is appointed
for the City under the Act Relating to Cities and Towns – Providing Financial Stability,
Rhode Island General Laws § 45-9-1 et seq., and when a new Administrative and Finance
Page 2 of 8
Officer is appointed for the City under R.I. Gen. Laws § 45-9-10, it shall be the
obligation of the State of Rhode Island, by and through its Director of Revenue, promptly
to effect service of this confirmation order on the newly-elected official or the newly
appointed fiduciary or Administrative and Finance Officer, as the case may be, and to
file a certificate of such service.
3.
The Effective Date of the Plan shall be thirty (30) days from the expiration
of the appeal period with regard to this Order.
4.
On the Effective Date, a trust (the “Trust”) shall be deemed created for the
benefit of the State, and all of the City’s claims against Elected Officials shall be deemed
transferred into the Trust including, without limitation, the City’s claims against Elected
Officials under any Final Order in Flanders vs. Moreau et al., P.B. No 10-5615
(“Flanders vs. Moreau”).
5.
On the Effective Date, Allan M. Shine shall be deemed appointed as
“Trustee” of the Trust in accordance with the terms of the Plan. The Trustee (and
successor Trustees, if any), shall be impressed with the duty to make a good faith effort to
collect the maximum amount reasonably attainable from any Final Order against Elected
Officials, including a Final Order in Flanders vs. Moreau.
6.
Any holder of Class 1 $12,000,000 General Obligation School Bonds
Claims, Class 2 $8,700,000 General Obligation Municipal Facility Bonds Claims, Class 3
$1,300,000 General Obligation School Bonds Claims, Class 4 $750,000 General
Obligation School Bonds, of Class 5 $4,250,000 General Obligation School Bonds, that
seeks allowance of a Class 16 General Unsecured Claim or a Class 17 General Unsecured
Convenience Claim for attorney fees, shall file a Proof of Claim with the Court no later
Page 3 of 8
than thirty (30) days after entry of this Order or shall be deemed forever barred from
doing so.
7.
Notwithstanding the longer time period set forth in Section IX A of the
Plan, the City, or any other creditor, shall file and serve any objections to Claims by no
later than sixty (60) days after the Effective Date (or, in the case of Claims lawfully filed
or amended after the Effective Date, by no later than sixty (60) days after the date of
filing of such Claims or amended Claims).
8.
Any creditor under the Plan, including the State of Rhode Island, and the
City’s other major stakeholders, including its labor unions and its retirees, are hereby
granted standing to seek specific enforcement and other appropriate relief from the
Bankruptcy Court to enforce compliance with the Plan terms if the City or any other
person or entity takes, or seeks to take, any action(s) which makes or would make the
Plan not in Material Conformity with the Plan terms, as that term is defined in Section
VII B.2 of the Plan.
9.
Further, the retirees of the City are hereby granted standing to have this
Court interpret, apply, and enforce the terms of the Settlement and Release Agreement
approved by the Court by Order entered January 9, 2012 (the Settlement Agreement”), as
provided by the Settlement Agreement, which has been incorporated into the Plan.
10.
In the event that the Rhode Island Director of Revenue terminates the
Receiver in conformity with the terms of the Fiscal Stability Act, R.I. Gen. Laws § 45-91 et seq., the rights and obligations of the Receiver under the Plan and this Confirmation
Order shall transfer to the appropriate Central Falls officials as authorized under Rhode
Island General Laws, the Central Falls Charter, and Central Falls ordinances.
Page 4 of 8
11.
Following the Effective Date, this case will remain open during the term
of the Plan. This Court will hold annual status conferences with the City and other
parties in interest during the term of the Plan to be scheduled after passage of the budget
for each fiscal year. The City shall file and serve on parties in interest or their
representatives a status report regarding the City’s performance under the Plan and
compliance with the Six-Year Financial Projection within thirty (30) days of the passage
of the budget, after which time this Court may schedule a status conference with the City
and any interested parties.
12.
Following the Effective Date, the Bankruptcy Court shall retain and have
exclusive jurisdiction over any matter arising under the Bankruptcy Code and relating to
the City, arising in or related to the Chapter 9 Case, the Plan or the Settlement Agreement
as set forth specifically in Section XI, paragraphs 1-15 of the Plan, subject to this Court’s
exercise of its mandatory and discretionary abstention powers. The Bankruptcy Court
shall not exercise jurisdiction over labor disputes that may arise under the collective
bargaining agreements or other day-to-day disputes that may arise within the City, and
with respect to labor disputes, nothing in the Plan shall impair the rights that the parties
have under the collective bargaining agreements or under state law.
13.
Discharge and Discharge Injunction: In accordance with 11 U.S.C.
944(b), the City will be and hereby is discharged from all debts upon the entry of this
Order. All entities who have held, hold or may hold pre-Effective Date Claims are
hereby permanently enjoined from and after the Effective Date from: (a) commencing or
continuing in any manner any action or other proceeding of any kind with respect to any
such pre-Effective Date Claim against the City or its property; (b) enforcing, attaching,
Page 5 of 8
collecting, or recovering by any manner or means any judgment, award, decree or order
against the City or its property with respect to such pre-Effective Date Claims; (c)
creating, perfecting, or enforcing any lien or encumbrance of any kind against the City or
its property; and (d) asserting any right of setoff, subrogation or recoupment of any kind
against any obligation due to the City with respect to any such pre-Effective Date Claim,
except as otherwise permitted by § 553 of the Bankruptcy Code.
14.
The City shall be the disbursing agent for all amounts to be distributed
under the Plan.
15.
Nothing in the Plan or this Order will be construed to impair the rights of
the State of Rhode Island and/or the Rhode Island Director of Revenue under the Fiscal
Stability Act, R.I. Gen. Laws § 45-9-1 et seq., in accordance with the Tenth Amendment
to the United States Constitution.
16.
Budgetary and Disclosure Injunctions: In accordance with Section
VII(B) of the Plan, the Court hereby ORDERS as follows:
a.
Obligation to Keep Budget in Balance: The City’s elected officials, and
any fiduciary acting with the powers of elected officials under the Act
Relating to Cities and Towns – Providing Financial Stability, Rhode
Island General Laws § 45-9-1 et seq., shall keep the City’s budget in
balance through June 30, 2017, the term of the Plan. b.
Annual Attestation Forms: Within thirty (30) days after the City enacts
any budget or amended budget before the term of the Plan, each person
acting with the powers of an elected official (i.e. the Mayor and each City
Council member or a state-appointed fiduciary, as the case may be) shall
sign an “Annual Attestation Form,” in the form set forth in Exhibit S to
the Plan, attesting, under oath either (i) that to the best of his or her
knowledge and belief, the budget is in “Material Conformity” with the
terms of the Six-Year Financial Projection, Exhibit X, or (ii) that to the
best of his or her knowledge and belief, the budget is not in “Material
Conformity” with the terms of the Six-Year Financial Projection, and, if
the latter, identifying the specific line items in the budget that are not in
Material Conformity with the Six-Year Financial Projection. “Material
Conformity” shall mean that the budget is consistent with the Six-Year
Page 6 of 8
Financial Projection and/or that any increase in expenditures in any line
item is offset by increases in revenues based upon additional revenues
and/or decreases in expenditures. Any assumptions regarding any such
additional revenues and/or decreases in expenditures must be reasonable.
Each Annual Attestation Form shall be electronically filed with the
Bankruptcy Court, and a copy shall be sent by first class mail to the Rhode
Island Director of Revenue at Rosemary Booth Gallogly, Director of
Revenue, State of Rhode Island, Department of Revenue, One Capitol
Hill, Providence, Rhode Island 02908. c. Annual Administrative and Finance Officer Statements: Within
fourteen (14) days after the filing of each Annual Attestation Form, the
Administrative and Finance Officer appointed under R.I. Gen. Laws § 459-10 shall file an “Annual Administrative and Finance Officer Statement”
in the form set forth in Exhibit S to the Plan, stating whether he or she
agrees or disagrees with the attestations therein. If the Administrative and
Finance Officer disagrees with the attestations, he or she shall explain
why. Each Annual Administrative and Finance Officer Statement shall be
filed with the Bankruptcy Court, and a copy shall be sent by first class
mail to the Rhode Island Director of Revenue at Rosemary Booth
Gallogly, Director of Revenue, State of Rhode Island, Department of
Revenue, One Capitol Hill, Providence, Rhode Island 02908.
d. Quarterly Attestation Forms: Within thirty (30) days after the end of
each fiscal quarter before the term of the Plan, each person acting with the
powers of an elected official (i.e. the Mayor and each City Council
member or a state-appointed fiduciary, as the case may be) shall sign a
“Quarterly Attestation Form” in the form set forth in Exhibit S to the
Plan, stating under oath and to the best of his or her knowledge and belief
whether or not actual performance by the City during the prior quarter and
year-to-date remains in Material Conformity with the terms of the SixYear Financial Projection. To the extent that an elected official states that
actual performance by the City during the prior quarter and year-to-date
does not remain in Material Conformity with the terms of the Six-Year
Financial Projection, the elected official shall also identify the specific line
items that do not remain in Material Conformity with the Six-Year
Financial Projection. Each Quarterly Attestation Form shall be
electronically filed with the Bankruptcy Court, and a copy shall be sent by
first class mail to the Rhode Island Director of Revenue at Rosemary
Booth Gallogly, Director of Revenue, State of Rhode Island, Department
of Revenue, One Capitol Hill, Providence, Rhode Island 02908.
e. Quarterly Administrative and Finance Officer Statements: Within
fourteen (14) days after the filing of each Quarterly Attestation Form, the
Administrative and Finance Officer shall file a “Quarterly Administrative
and Finance Officer Statement” in the form set forth in Exhibit S to the
Plan, stating whether he or she agrees or disagrees with the attestations
Page 7 of 8
therein. If the Administrative and Finance Officer disagrees with the
attestations, he or she shall explain why. Each Quarterly Administrative
and Finance Officer Statement shall be filed with the Bankruptcy Court,
and a copy shall be sent by first class mail to the Rhode Island Director of
Revenue at Rosemary Booth Gallogly, Director of Revenue, State of
Rhode Island, Department of Revenue, One Capitol Hill, Providence,
Rhode Island 02908.
Dated: September 11, 2012
____________________________________
Frank J. Bailey
United States Bankruptcy Judge
Sitting by designation in the
District of Rhode Island
Page 8 of 8
American Bar Association
Section of State and Local Government Law
2013 Annual Meeting
In re CITY OF CENTRAL FALLS,
RHODE ISLAND, Debtor.
City of Central Falls, Rhode
Island, Plaintiff
v.
Central Falls Teachers’ Union, Rhode
Island Council 94, AFSCME, AFL–
CIO Local 1627, et al., Defendants.
36
468 BANKRUPTCY REPORTER
bility as may exist under the tax laws in
effect at that time, the presence of any
such liability at the end of one’s working
life would be a tremendous undue hardship
incurred as the result of the student loan.’’
356 B.R. at 580–81. In Brunell, the court
held that ‘‘[t]o the extent that the Debtor
satisfies the requirements for participation
in the Ford Program, any tax liability
based on the forgiven balance at that time
is discharged.’’ Id. at 581. See also Fahrenz v. Educ. Credit Mgmt. Corp. (In re
Fahrenz), No. 05–1657, 2008 WL 4330312
(Bankr.D.Mass.2008).
[4, 5] As noted in Stevenson, the Court
agrees with those courts which have ruled
that § 105(a) gives the bankruptcy court
authority to fashion equitable relief in appropriate circumstances in student loan
discharge cases. Like the Stevenson case,
this case cries for a form of equitable
relief. Accordingly, the Court shall enter
an order discharging any student loan debt
Mr. Ayele is unable to repay following his
participation in the Ford Program. If Mr.
Ayele were to participate in the Ford Program and so inform the Court, and if he
faithfully abides by the terms and provisions of either the IBR program or an ICR
Plan, then the Court prospectively discharges any student loan debt which he
may have at the expiration of the plan
period so as to avoid any negative tax
consequences.
V.
CONCLUSION
For the foregoing reasons, the Court
shall enter a judgment in favor of the
Defendant and against the Plaintiff with
the proviso that if Mr. Ayele informs the
Court within 14 days of the date of this
decision that he will participate in the
Ford Program and, if he represents that
he in good faith will abide by the provisions of the IBR program option or the
ICR Plan option, then the Court shall en-
ter a judgment partially discharging his
student loan debt to the extent any remains at the expiration of the repayment
plan.
,
In re CITY OF CENTRAL FALLS,
RHODE ISLAND, Debtor.
City of Central Falls, Rhode
Island, Plaintiff
v.
Central Falls Teachers’ Union, Rhode
Island Council 94, AFSCME, AFL–
CIO Local 1627, et al., Defendants.
Bankruptcy No. 11–13105–FJB.
Adversary No. 11–1094.
United States Bankruptcy Court,
D. Rhode Island.
March 23, 2012.
Background: State-appointed receiver for
Chapter 9 debtor-city brought adversary
proceeding for declaratory judgment
against, inter alia, two unions that were
parties to collective bargaining agreements
(CBAs) with school district that operated
city’s public schools, seeking determinations that school district was part of city,
such that its debts and contract obligations
were subject to adjustment in city’s case,
and that receiver, acting on city’s behalf,
had power under Rhode Island’s fiscal stability laws to bargain collectively with unions. Receiver moved for summary judgment, and one union moved to dismiss for
lack of subject matter jurisdiction or to
abstain.
Holdings: The Bankruptcy Court, Frank
J. Bailey, J., held that:
IN RE CITY OF CENT. FALLS, R.I.
Cite as 468 B.R. 36 (Bkrtcy.D.R.I. 2012)
(1) claims for declaratory relief presented
requisite actual controversy;
(2) claims for declaratory relief were noncore proceedings;
(3) mandatory abstention did not apply;
(4) permissive abstention was not warranted; and
(5) amendments to city charter disestablished school committee and left no
board or agency through which city
could control schools.
Ordered accordingly.
1. Declaratory Judgment O3
Bankruptcy courts are among the federal courts that may grant declaratory relief under Declaratory Judgment Act. 28
U.S.C.A. § 2201(a).
2. Declaratory Judgment O61, 62, 65
Despite the availability of declaratory
relief before a party is injured or aggrieved, court may enter declaratory relief
only in a case of ‘‘actual controversy’’ in
the constitutional sense, which requires a
real and substantial controversy admitting
of specific relief through a decree of a
conclusive character, as distinguished from
an opinion advising what the law would be
upon a hypothetical state of facts.
U.S.C.A. Const. Art. 3, § 2, cl. 1; 28
U.S.C.A. § 2201(a).
See publication Words and Phrases for other judicial constructions
and definitions.
3. Declaratory Judgment O5.1
Even where an actual controversy is
presented, court retains discretion to deny
declaratory relief for prudential reasons.
28 U.S.C.A. § 2201(a).
4. Bankruptcy O3102.1, 3481
Powers of a municipality in a Chapter
9 case include the power to reject executory contracts. 11 U.S.C.A. §§ 365(a), 901,
902(5).
37
5. Bankruptcy O3106
As a general rule, a contract is ‘‘executory,’’ within meaning of trustee’s power
to assume or reject debtor’s executory contracts, when performance remains due to
some extent on both sides. 11 U.S.C.A.
§ 365(a).
See publication Words and Phrases for other judicial constructions
and definitions.
6. Bankruptcy O2834, 3115.1
Rejection of executory contract has
the effect of freeing debtor from the obligation to perform contract and leaves nondebtor party with a claim for breach that
is deemed to have arisen immediately before the date of filing of the bankruptcy
petition. 11 U.S.C.A. § 365(g)(1).
7. Bankruptcy O3108
Provided certain conditions are satisfied, trustee’s power to reject debtor’s executory contracts extends to collective bargaining agreements (CBAs). 11 U.S.C.A.
§ 365(a).
8. Declaratory Judgment O210
Declaratory judgment claim asserted
by state-appointed receiver for Chapter 9
debtor-city, seeking determination that
school district that operated city’s public
schools was part of city, such that receiver
had power to reject union’s collective bargaining agreement (CBA) with school district, presented requisite actual controversy; decision on claim would establish
whether receiver could reject CBA as contract with city, or could establish cause for
receiver to object to union’s claim against
city, and adjudication of claim, by establishing whether rejection was possibility,
would hasten receivers’ contract negotiations and settlement of school district’s
budget, thereby shortening debt adjustment process and duration of city’s time in
receivership. U.S.C.A. Const. Art. 3, § 2,
38
468 BANKRUPTCY REPORTER
cl. 1; 11 U.S.C.A. §§ 365(a), 901, 902(5); 28
U.S.C.A. § 2201(a).
U.S.C.A. §§ 365(a),
U.S.C.A. § 2201(a).
9. Declaratory Judgment O210
11. Declaratory Judgment O272
Claim for declaratory judgment asserted by state-appointed receiver for
Chapter 9 debtor-city, which sought determination that school district was part of
city, such that receiver had power to reject
collective bargaining agreement (CBA) between teachers’ union and school district
that operated city’s public schools, presented requisite actual controversy, even
though CBA, which had expired but continued to be governing, might not be executory and union had not filed proof of
claim against city; reasonable possibility
existed that CBA, if deemed to be a contract with city, would be ruled executory
and subject to rejection, union still could
file proof of claim if school district was
determined to be part of city and CBA was
rejected, and receiver needed to resolve
issues surrounding CBA in light of its
impact on city’s budget. U.S.C.A. Const.
Art. 3, § 2, cl. 1; 11 U.S.C.A. §§ 365(a),
901, 902(5); 28 U.S.C.A. § 2201(a).
Declaratory Judgment Act does not
itself confer subject matter jurisdiction,
but instead makes available a declaratory
remedy for disputes that come within the
court’s jurisdiction on some other basis.
28 U.S.C.A. § 2201(a).
10. Declaratory Judgment O210
Contingent claim for declaratory relief
asserted by state-appointed receiver for
Chapter 9 debtor-city presented requisite
actual controversy in seeking, upon court’s
determination that school district was part
of city, rather than separate entity, additional declaration that receiver had power
under Rhode Island’s fiscal stability laws,
pursuant to which he was appointed, to
bargain collectively, on city’s behalf, with
unions that had collective bargaining
agreements (CBAs) with school district; if
school district was part of city, then both
CBAs would have to be renegotiated, and
declaration that receiver could act for city
would advance such negotiations and reorganization process in city’s bankruptcy
case. U.S.C.A. Const. Art. 3, § 2, cl. 1; 11
901,
902(5);
28
12. Bankruptcy O2043(1, 2), 2058.1
As to all core proceedings arising under Bankruptcy Code or arising in a case
under Code, bankruptcy judge has authority, regardless of the consent of the parties,
to hear and determine and enter appropriate orders and judgments, but as to all
other referred matters, bankruptcy judge
may not, without the consent of the parties, determine such matters and enter
final orders or judgments. 28 U.S.C.A.
§ 157(b)(1), (c).
13. Bankruptcy O2043(2, 3), 2104
So long as non-core matter is related
to bankruptcy case, it remains within
bankruptcy court’s subject matter jurisdiction, and court retains authority to hear
and enter proposed findings and conclusions in the matter, with judgment to enter
finally in the district court. 28 U.S.C.A.
§§ 157(a), 1334.
14. Bankruptcy O2045
In addressing whether state-appointed receiver’s requests for declaratory relief in city’s Chapter 9 case were core
proceedings, bankruptcy court had to
make determination as to each request for
declaratory
relief.
28
U.S.C.A.
§ 157(b)(2).
15. Bankruptcy O2043(2)
Term ‘‘core proceeding,’’ as used in
statute, refers to those matters that a
bankruptcy judge may hear, determine,
and dispose of by appropriate orders and
IN RE CITY OF CENT. FALLS, R.I.
Cite as 468 B.R. 36 (Bkrtcy.D.R.I. 2012)
judgments, subject only to appellate review. 28 U.S.C.A. § 157(b).
See publication Words and Phrases for other judicial constructions
and definitions.
16. Bankruptcy O2047, 3481
Provision of statute which treats as
core proceeding ‘‘matters concerning the
administration of the estate,’’ cannot apply
in Chapter 9 case, which involves no estate. 11 U.S.C.A. §§ 103(f), 541(a), 901(a);
28 U.S.C.A. § 157(b)(2)(A).
17. Bankruptcy O2043(2)
It is the nature of the proceeding,
meaning its relation to the basic function
of the bankruptcy court, and not the state
or federal basis for the claim, that determines whether proceeding is a ‘‘core proceeding.’’ 28 U.S.C.A. § 157(b)(3).
18. Bankruptcy O2048.2
Proceedings to assume or reject executory contracts, arising as they do under the Bankruptcy Code and being unavailable outside of bankruptcy, affect the
adjustment of the debtor-creditor relationship within the meaning of statute
identifying categories of core proceedings,
and therefore are ‘‘core proceedings.’’ 11
U.S.C.A.
§ 365(a);
28
U.S.C.A.
§ 157(b)(2)(O).
19. Bankruptcy O2045
Receiver’s claim for declaratory judgment that school district which operated
city’s public schools was part of city arose
entirely under state law, rather than
Bankruptcy Code, would not decide any
core matter, and, although it arose in city’s
Chapter 9 case, could have arisen and been
brought other than in bankruptcy court,
and therefore claim was ‘‘non-core proceeding’’ and was merely ‘‘related to’’
bankruptcy case, even though requested
declaration could be useful in structuring
negotiations with unions with which school
district had collective bargaining agree-
39
ments (CBAs) and could have consequence
for core matters in case, including rejection of CBAs, litigation and adjustment of
claims, and extent of automatic stay. 11
U.S.C.A. §§ 362, 365(a); 28 U.S.C.A.
§ 157(c)(1).
See publication Words and Phrases for other judicial constructions
and definitions.
20. Bankruptcy O2045
Claim for declaratory judgment
brought by receiver for Chapter 9 debtorcity, which sought determination as to receiver’s authority under Rhode Island’s fiscal stability laws pursuant to which he was
appointed, arose entirely under state law,
and could have arisen and been brought
other than in bankruptcy court had city
not sought bankruptcy relief, and therefore claim was ‘‘related to’’ bankruptcy
case, but was ‘‘non-core proceeding.’’ 28
U.S.C.A. § 157(c)(1).
21. Bankruptcy O2045, 2104
Bankruptcy judge could hear stateappointed receiver’s declaratory judgment
complaint in city’s Chapter 9 case and
propose findings of facts and conclusions of
law for entry of final judgment by district
court on receiver’s two non-core claims for
declaratory
relief.
28
U.S.C.A.
§§ 157(c)(1), 2201(a).
22. Federal Courts O47.5
Bankruptcy jurisdiction statute’s mandatory abstention provision mandates that
court abstain if five conditions are satisfied: (1) the proceeding is based on a state
law claim or cause of action, (2) the claim
or cause of action is related to a case
under Bankruptcy Code but does not arise
under Code and does not arise in a case
under Code, (3) federal courts would not
have jurisdiction over the claim but for its
relation to a bankruptcy case, (4) an action
‘‘is commenced’’ in a state forum of appro-
40
468 BANKRUPTCY REPORTER
priate jurisdiction, and (5) the action can
be timely adjudicated in that state forum.
28 U.S.C.A. § 1334(c)(2).
23. Federal Courts O47.5
Claims for declaratory relief asserted
by state-appointed receiver in Chapter 9
case of debtor-city could not be timely
adjudicated in another forum, and therefore mandatory abstention did not apply,
even though adversary proceeding sought
declaration of rights and relations under
state law and federal jurisdiction would not
have existed over receiver’s claims but for
bankruptcy case, given urgency of matters
to be decided within the context of reorganization process, which needed to occur
within weeks, rather than months or years.
28 U.S.C.A. § 1334(c)(2).
24. Federal Courts O47.5
Relevant considerations in deciding
whether permissive abstention is warranted include (1) effect or lack thereof on
efficient administration of estate if court
recommends abstention, (2) extent to
which state law issues predominate over
bankruptcy issues, (3) difficulty or unsettled nature of applicable law, (4) presence
of related proceeding commenced in state
court or other nonbankruptcy court, (5)
jurisdictional basis, if any, other than
bankruptcy jurisdiction statute, (6) degree
of relatedness or remoteness of proceeding
to main bankruptcy case, (7) substance
rather than form of asserted core proceeding, (8) feasibility of severing state law
claims from core bankruptcy matters to
allow judgments to be entered in state
court with enforcement left to bankruptcy
court, (9) burden of bankruptcy court’s
docket, (10) likelihood that commencement
of proceeding in bankruptcy court involves
forum shopping by one of the parties, (11)
existence of a right to a jury trial, and (12)
presence in proceeding of nondebtor parties. 28 U.S.C.A. § 1334(c)(1).
25. Federal Courts O47.5
Permissive abstention was not warranted in adversary proceeding in which
state-appointed receiver for Chapter 9
debtor-city sought declaration that school
district was part of city, such that unions’
collective bargaining agreements (CBAs)
with school district were subject to adjustment in city’s case; although state-law issues predominated, and issues were unusual and of special concern to state, its
municipalities, and its various authorities,
issues did not come to bankruptcy court
without determinative signposts in state
law, answers to declaratory requests could
be narrowly framed, issues were of fundamental importance to bankruptcy case,
and need for expedition warranted resolving issues in bankruptcy court.
28
U.S.C.A. § 1334(c)(1).
26. Statutes O176
Questions of statutory interpretation
are questions of law.
27. Bankruptcy O2232
Only a ‘‘municipality,’’ as that term is
defined in the Bankruptcy Code, may be a
debtor under Chapter 9 of the Bankruptcy
Code. 11 U.S.C.A. §§ 101(40), 109(c)(1).
28. Bankruptcy O2232
Exercise of bankruptcy jurisdiction
over city, including its school district, if
school district was part of city rather than
separate entity, did not offend Tenth
Amendment where city voluntarily petitioned for Chapter 9 relief and did so with
proper state authorization.
U.S.C.A.
Const.Amend. 10; 11 U.S.C.A. § 109(c)(1).
29. Bankruptcy O2156
Union’s argument that school district
that operated public schools of Chapter 9
debtor-city qualified as municipality under
Bankruptcy Code and so had to be treated
as separate and distinct entity for Chapter
9 purposes, even if school district was part
IN RE CITY OF CENT. FALLS, R.I.
Cite as 468 B.R. 36 (Bkrtcy.D.R.I. 2012)
of city under state law, raised issue collateral to claims for declaratory judgment
that were subject of adversary complaint
to determine whether school district was
part of city, making its debts and contract
obligations subject to adjustment in city’s
case, and in substance sought dismissal as
to portion of city’s case, and therefore
issue had to be brought as motion filed in
main case, with notice to all creditors, and
was not properly raised in adversary proceeding. 11 U.S.C.A. § 101(40).
30. Bankruptcy O2232, 3481
School district that was part of Chapter 9 debtor-municipality, under state law
of which it was a creature, could not be
excluded from bankruptcy relief afforded
to municipality even if school district itself
qualified as ‘‘municipality’’ as defined by
Bankruptcy Code and was thus eligible to
be Chapter 9 debtor.
11 U.S.C.A.
§§ 101(40), 109(c)(1).
31. Bankruptcy O3481
State law governed issue of whether
school district that operated public schools
of Chapter 9 debtor-city was part of debtor-city, such that school district’s debts
and obligations were subject to adjustment
in debtor-city’s case.
32. Bankruptcy O2002
41
34. Federal Courts O386
Where issue of state law being decided by federal court is one of statutory
construction, court should follow state’s
rules of statutory construction.
35. Municipal Corporations O54
Municipalities are creatures of state
law and subject to the power of the state,
as limited by its constitution, to create,
divide, and even abolish them.
36. Bankruptcy O2104
Schools O44
Bankruptcy court would recommend
that district court find that, under Rhode
Island law, amendment to city charter that
deleted words ‘‘school committee’’ from
provision of charter which had created
school committee and indicated that city’s
executive and administrative work would
be performed in part through that committee disestablished school committee and
left no board or agency through which city
could control schools, effectively severing
city’s constitutional connection to school
district under state law and removing
school district from city. 28 U.S.C.A.
§ 157(c)(1); R.I.Const. Art. 13, § 8;
R.I.Gen.Laws 1956, § 16–2–9(a).
West Codenotes
Recognized as Unconstitutional
28 U.S.C.A. § 157(b)
Federal Courts O390
When ruling on an issue of state law,
a federal court exercising bankruptcy jurisdiction, like a federal court sitting in
diversity, must rule as it believes the highest court of the state would rule.
33. Federal Courts O382.1, 386
Christine M. Curley, Christine M. Curley, Esq., North Kingstown, RI, Theodore
Orson, Orson and Brusini Ltd., Providence, RI, for Plaintiff.
In deciding issue of state law, federal
court should employ the method and approach announced by the state’s highest
court.
Curtis C. Mechling, Stroock & Stroock
& Lavan LLP, Hanan B. Kolko, Meyer,
Suozzi, English & Klein, P.C., New York,
NY, Marc B. Gursky, Gursky Law Associ-
42
468 BANKRUPTCY REPORTER
ates, North Kingstown, RI, William J. Delaney, Delaney DeMerchant & Heitke
LLC, Forrest L. Avila, RI Department of
Education, Michael R. McElroy, Schacht &
McElroy, Claire J.V. Richards, State of
Rhode Island, Providence, RI, Girard A.
Galvin, Corcoran, Peckham, Hayes & Galvin, P.C., Newport, RI, for Defendant.
MEMORANDUM OF DECISION ON
CITY’S MOTION FOR SUMMARY
JUDGMENT AND ON TEACHERS’
UNION’S MOTION TO DISMISS OR
ABSTAIN
FRANK J. BAILEY, Bankruptcy
Judge.
This adversary proceeding arises in the
bankruptcy case of the City of Central
Falls, Rhode Island (the ‘‘City’’), a proceeding for adjustment of debts of a municipality under chapter 9 of the Bankruptcy Code. The plaintiff is Robert G.
Flanders, Jr. (the ‘‘Receiver’’) in his capacity as the state-appointed receiver of the
City. The principal defendants are two labor unions, the Central Falls Teachers
Union, Local 1657 of the American Federation of Teachers (the ‘‘Teachers’ Union’’)
and Local 1627, Rhode Island Council 94,
AFSCME, AFL–CIO (‘‘Council 94’’) (jointly, the ‘‘Unions’’). Each is party to a
collective bargaining agreement with the
Central Falls School District (the ‘‘School
District’’), which—suffice it to say for
now—runs the public schools in Central
Falls. As part of his efforts to fashion a
feasible and comprehensive plan of debt
adjustment in this bankruptcy case, the
Receiver has been renegotiating the CBAs
with the Unions, but his efforts have been
impeded by uncertainty over two issues:
(i) whether the School District is part of
1.
The Receiver has previously reported to the
Court that he has successfully negotiated new
collective bargaining agreements with the
City’s police, firefighter, and municipal work-
the City, such that the debts and contract
obligations of the School District are obligations of the City and therefore subject
to adjustment in this bankruptcy case;
and (ii) whether the Receiver, acting on
behalf of the City, has the power under
Rhode Island’s Fiscal Stability Act, the
statute defining his powers as receiver, to
collectively bargain with the Unions. By
his complaint in this adversary proceeding,
the Receiver seeks a declaratory judgment
resolving both issues in the affirmative,
and he has now moved for summary judgment to that effect. In response, the
Teachers’ Union has moved to dismiss for
lack of subject matter jurisdiction or to
abstain; and, on the merits, both Unions
have opposed summary judgment and
urged resolution of the Receiver’s issues in
the negative. In view of the need to avoid
significant delays in the reorganization
process, the Court heard both motions on
an expedited basis and now addresses
them in this memorandum of decision.
PROCEDURAL HISTORY
On August 1, 2011, the City, by and
through the Receiver, filed a voluntary
petition under Chapter 9 of the Bankruptcy Code, commencing the Chapter 9 case
in which this adversary proceeding arises.
On December 1, 2011, the Court entered
an Order for Relief in the Chapter 9 case.
In the first five months of the case, the
Receiver negotiated agreements with three
unions with whom the City had collective
bargaining agreements and a further
agreement with the City’s retirees.1 The
court approved these agreements, each a
major step toward a confirmable plan of
debt adjustment.
er unions; in each instance the new agreement was part of a consensual resolution of a
motion by the Receiver to reject earlier collective bargaining agreements with these unions.
IN RE CITY OF CENT. FALLS, R.I.
Cite as 468 B.R. 36 (Bkrtcy.D.R.I. 2012)
In the meantime, the Receiver had also
begun negotiations with the defendant Unions, the Teachers’ Union and Council 94.
Each is a party to a collective bargaining
agreement with the Central Falls School
District. The Teachers’ Union’s contract
expired on August 31, 2011, but under
state law, its terms continue to govern for
a time, the extent of which is uncertain.2
Council 94’s contract expires on June 30,
2013. Though negotiations have continued, each defendant Union expressly has
reserved the right to argue (i) that the
School District is not part of the City and
therefore the collective bargaining process
is not within the Bankruptcy Court’s subject-matter jurisdiction and (ii) that the
Receiver does not have the power to act on
behalf of the City relative to collective
bargaining with the defendant Unions.
On December 30, 2011, the Receiver
filed the complaint commencing this adversary proceeding, a complaint seeking only
declaratory relief and naming only the
Teachers’ Union as a defendant. It requested two declarations: in Count One,
‘‘that the School District is part of the City
and therefore, ipso facto, the collective
bargaining process is within the Bankruptcy Court’s subject-matter jurisdiction’’;
and in Count Two, ‘‘that the Receiver has
the power under the Fiscal Stability Act to
2.
At the hearing, counsel for the Teachers’
Union indicated that Rhode Island law was
unclear, that the contract’s terms will govern
until a new agreement is reached or perhaps
until impasse resolution procedures are at an
end. I express no opinion on the issue. The
parties agree that the contract’s terms continued to govern as of the date of the hearing.
3.
The Governmental Defendants are the State
of Rhode Island; the Rhode Island Department of Elementary and Secondary Education and Debora Gist as the Department’s
Commissioner; the Rhode Island Board of
Regents for Elementary and Secondary Education and George Carullo, Patrick A. Guida,
Colleen Callahan, Lorne A. Adrian, Carolina
43
act on behalf of the City relative to collective bargaining with the Union.’’ By a
first amendment to the complaint, the Receiver added Council 94 as a defendant.
By a second amendment, the Receiver
added numerous related governmental
parties (the ‘‘Governmental Defendants’’)
as nominal defendants, the court having
determined that these were necessary parties.3 These amendments notwithstanding, the complaint’s demand for declaratory relief is unchanged. At the Receiver’s
request, the court established an expedited
schedule for adjudication of the adversary
proceeding.
Before the time to answer the Second
Amended Complaint, the Receiver filed the
present motion for summary judgment.
The Teachers’ Union filed an opposition to
the motion for summary judgment and a
‘‘cross-motion’’ to dismiss for lack of subject matter jurisdiction or to abstain.4
Having moved under Fed.R.Civ.P. 12(b)(1)
to dismiss or abstain, the Teachers’ Union
has not yet filed an answer, and its answer
has not come due. In a separate opposition to the motion for summary judgment,
Council 94 indicated that it was relying on
the opposition filed by the Teachers’ Union
and has submitted no separate argument
of its own. Council 94 has filed an answer
opposing the Receiver’s demands for deB. Bernal, Dr. Robert Carothers, Karin
Forbes, Matthew Santos, and Betsy Shimberg
as members of the Board; the Central Falls
School District; Frances Gallo, as Superintendent of the Central Falls Schools; and the
Central Falls Board of Trustees and Anna
Cano Morales, Sonia Rodrigues, Stephanie
Gonzalez, Cheryl LaFond, Brian Keith Nordin, and Ana Cecilia Rosado as members of
the Board of Trustees.
4.
Though the Teachers’ Union has argued that
it would be appropriate, on the Receiver’s
motion for summary judgment, to enter judgment against the Receiver, it has not filed a
cross-motion for summary judgment.
44
468 BANKRUPTCY REPORTER
claratory relief.5 Each of the Governmental Defendants has answered the Second
Amended Complaint and, without articulating a position on the two main issues,
has simply requested the judgment of the
court; none has opposed the motion for
summary judgment.
By order of August 5, 2011 in the Chapter 9 case, the court established October 4,
2011 as the deadline for filing proofs of
claim, but the order also provided that ‘‘a
claim arising from the rejection of an executory contract TTT of the debtor may be
filed within such time as the court later
directs.’’ The Teachers’ Union has not
filed a proof of claim. On October 3, 2011,
Council 94 filed a proof of claim in an
amount stated as ‘‘unknown,’’ in part on
the basis of its collective bargaining agreement with the School District.6
As of the date of the hearing on the
present motions, negotiations between the
Receiver and the Unions were continuing
but remained in preliminary stages. In a
recent status report in the Chapter 9 case,
the Receiver indicated that he expects to
make a financial offer to the Unions on or
before March 21, 2012, and that he expects
to know within three weeks thereafter
whether he will have reached new and
modified collective bargaining agreements
with the Unions. In his complaint in this
adversary proceeding, the Receiver stated
that if he is unable to negotiate collective
bargaining agreements with the Unions
that would enable the City to operate with
5.
Council 94’s answer is to the Amended
Complaint; it has not answered the Second
Amended Complaint, but the operative allegations and demands are the same.
6.
Proofs of claim nos. 20–1, 20–2, 21–1, and
21–2.
7.
8.
28 U.S.C. § 2201(a).
Nipon v. Leslie Fay Co. Inc. (In re Leslie Fay
Co. Inc.), 216 B.R. 117, 134 (Bankr.S.D.N.Y.
1997); Downington Industrial and Agricultur-
balanced budgets for a period of five years,
he will move to reject their collective bargaining agreements. He has not yet
moved to reject either agreement. The
Receiver maintains that before he can file
a confirmable plan in this case, the court
must resolve the issues as to which he now
seeks declaratory relief.
DECLARATORY RELIEF
The Court must first determine its subject matter jurisdiction and therefore will
address the Motion to Dismiss or Abstain
before the Motion for Summary Judgment.
However, in order to address the issues of
jurisdiction, authority, and abstention that
are presented by the former motion, it
would help first to clarify the relief being
demanded and establish whether declaratory relief is appropriate and warranted.
[1] The Declaratory Judgment Act
states that ‘‘[i]n a case of actual controversy within its jurisdiction TTT any court of
the United States, upon the filing of an
appropriate pleading, may declare the
rights and other legal relations of any
interested party seeking such declaration,
whether or not further relief is or could be
sought.’’ 7 Bankruptcy courts are among
the federal courts that may grant declaratory relief under this statute.8 And, notwithstanding the inapplicability of Fed.
R.Civ.P. 57 to adversary proceedings, the
Bankruptcy Rules make provision for entertainment of complaints for declaratory
relief in bankruptcy cases.9
al School v. Commonwealth of Pennsylvania
Dept. of Ed. (In re Downington Industrial and
Agricultural School), 172 B.R. 813, 819
(Bankr.E.D.Pa.1994).
9.
Fed. R. Bankr.P. 7001(9) (adversary proceedings include certain proceedings to obtain a declaratory judgment). The fact that
the rules so provide is not a basis for concluding that a bankruptcy court has authority to
enter a declaratory judgment, and I do not
suggest otherwise.
No bankruptcy rule
IN RE CITY OF CENT. FALLS, R.I.
Cite as 468 B.R. 36 (Bkrtcy.D.R.I. 2012)
[2, 3] The Declaratory Judgment Act is
designed to enable litigants to clarify legal
rights and obligations before acting upon
them, ‘‘whether or not further relief is or
could be sought.’’ 10 Despite the availability of this relief before a party is injured or
aggrieved, a court may enter declaratory
relief only ‘‘in a case of actual controversy.’’ 11 An actual controversy is ‘‘a case
and controversy in the constitutional
senseTTTT It must be a real and substantial controversy admitting of specific relief
through a decree of a conclusive character,
as distinguished from an opinion advising
what the law would be upon a hypothetical
state of facts.’’ 12 But even where an actual controversy is presented, the court retains discretion to deny declaratory relief
for prudential reasons.13
The Receiver contends without elaboration that there exists an actual controversy
as to both issues on which he seeks declaratory relief, and the Unions neither contend otherwise nor expressly address the
issue. Though the Unions oppose summary judgment, neither has done so on the
basis that there does not exist an actual
controversy or that declaratory relief is
not otherwise appropriate. And, although
the Teachers’ Union has moved to dismiss
for lack of subject matter jurisdiction, and
lack of an actual controversy would be a
defect in subject matter jurisdiction, the
Teachers Union does not contend in its
makes Fed.R.Civ.P. 57 applicable in bankruptcy cases or adversary proceedings.
10. 28 U.S.C. § 2201(a); Ernst & Young v.
Depositors Economic Protection Corp., 45 F.3d
530, 534 (1st Cir.1995).
11.
28 U.S.C. § 2201(a).
12. Public Service Com. v. Wycoff Co., 344 U.S.
237, 242–243, 73 S.Ct. 236, 97 L.Ed. 291
(1952) (internal quotation marks omitted).
13. Diaz–Fonseca v. Puerto Rico, 451 F.3d 13,
27 (1st Cir.2006) and cases cited.
45
motion to dismiss that this adversary proceeding suffers from that particular jurisdictional defect.
Still, the court must satisfy itself that
there exists an actual controversy with
respect to each question presented and not
merely a difference of opinion over hypothetical facts. This in turn requires an
understanding of precisely what each
question asks and how it affects the rights
and legal relations between the Receiver
and each Union.
a.
Declaratory Relief as to Count I
[4–7] In his first count, the Receiver
seeks a declaration ‘‘that the School District is part of the City and therefore, ipso
facto, the collective bargaining process is
within the Bankruptcy Court’s subjectmatter jurisdiction.’’ By this language, I
understand the Receiver to seek a determination in two parts: (i) that the School
District is not a separate entity from the
City but merely a part or department of
the City, and (ii) that because the School
District is a part of the City, the debts and
contractual obligations of the School District to the Unions are debts and contractual obligations of the City and therefore
subject to possible adjustment, especially
by rejection, in the City’s bankruptcy case.
The powers of a municipality in a Chapter
9 case include the power to reject executory contracts.14 Provided certain conditions
14. 11 U.S.C. § 365(a) (subject to certain exceptions, ‘‘the trustee, subject to the court’s
approval, may assume or reject any executory
contract TTT of the debtor’’), 901 (section 365
of the Bankruptcy Code applies in a case
under Chapter 9), and 902(5) (‘‘ ‘trustee,’
when used in a section that is made applicable in a case under this chapter by section TTT
901 of this title, means debtor’’). As a general rule, a contract is ‘‘executory’’ when performance remains due to some extent on both
sides. 3 Collier on Bankruptcy ¶ 365.02 (16th
ed. 2011); Ready Prod., Inc. v. Jarvis (In re
Jarvis), 2005 Bankr.LEXIS 536, 2005 WL
46
468 BANKRUPTCY REPORTER
are satisfied, this power of rejection extends to collective bargaining agreements.15 By seeking a declaration that
‘‘the collective bargaining process is within
the Bankruptcy Court’s subject-matter jurisdiction,’’ the Receiver is not so much
interested in the extent of the court’s jurisdiction or authority as in the reach of the
City’s power to reject. Does it extend to
the Unions’ contracts with the School District?
The Receiver’s first count is no broader
than this. The Receiver does not in this
proceeding move to reject the collective
bargaining agreement of either Union; he
indicates that he may in the near future
move to reject one or both, but in view of
the early stage of negotiations with the
Unions, he believes that a motion to reject
would at present be premature, and the
Teachers’ Union concurs. (Council 94 has
voiced no position on the issue.) Nor does
the Receiver seek a declaration that either
agreement is executory within the meaning of § 365(a). His interest in this proceeding is simply in establishing that rejection is a possibility, because the Unions’
agreements are with the debtor City.
As to both Unions, this controversy and
that presented by Count Two are purely
legal. The material ‘‘facts’’ are almost all
758805, *2 (Bankr.D.N.H.2005) (surveying
state of law in First Circuit). Rejection has
the effect of freeing the debtor from the obligation to perform the contract and leaves the
nondebtor party with a claim for breach that
is deemed to have arisen immediately before
the date of filing of the bankruptcy petition.
11 U.S.C. § 365(g)(1).
15. NLRB v. Bildisco & Bildisco, 465 U.S. 513,
104 S.Ct. 1188, 79 L.Ed.2d 482 (1984) (holding, in a chapter 11 case, that collective bargaining agreements are subject to rejection
under § 365(a), but the standard of rejection
is stricter than the ordinary business judgment standard and requires a showing of reasonable efforts to negotiate a voluntary modification). See also IBEW, Local 2376 v. City
of a legislative nature, and the few remaining material facts that are not of this
nature are neither controverted nor developing.
[8] With respect to Council 94, the
first count presents an actual controversy
for three reasons. First, it will determine
the possibility of rejection. Council 94’s
collective bargaining agreement is unexpired and appears to be an executory contract.16 If it is a contract with the City,
not with an independent entity, it would be
subject to possible rejection in this case;
but if it is not a contract with the City,
then rejection under the Bankruptcy Code
would not be an option. Second, if Council
94’s contract is not with the City, the
Receiver will have cause to object to the
contract claim asserted by Council 94:
that the School District’s obligations under
the contract are not obligations of the City.
Third, in order to formulate a plan of debt
adjustment in this case and to understand
the feasibility of any plan he does formulate, the Receiver must determine the
School District’s budget for the projected
five-year term of the plan. Under recent
amendments to Rhode Island law, the City
will, during the term of the plan, be responsible for a small fraction of the School
District’s budget.17 The Unions’ contracts
of Vallejo (In re City of Vallejo), 432 B.R. 262,
272 (E.D.Cal.2010) (a municipality operating
under Chapter 9 may utilize 11 U.S.C.
§ 365(a) to reject a collective bargaining
agreement if the municipality can show that
the requirements of Bildisco are met). I
make no ruling at this time as to the specific
requirements for rejection in a Chapter 9
case.
16. I need not and do not make a final ruling
on that issue in this adversary proceeding.
17. Over the last 20 years, the State has funded the entire operational budget. Though the
fraction for which the City will be responsible
is small, the School District’s budget is much
larger than the City’s budget, and even a
IN RE CITY OF CENT. FALLS, R.I.
Cite as 468 B.R. 36 (Bkrtcy.D.R.I. 2012)
together constitute the vast majority of
that budget. By determining whether rejection is a possibility, adjudication of the
Receiver’s first count would hasten the
negotiation of the Unions’ contracts and
the settlement of the School District’s budget, and it would thereby shorten the debt
adjustment process in bankruptcy and the
duration of the City’s time in receivership.
For each of these reasons, I am satisfied
that the first count presents an actual
controversy with Council 94 that warrants
declaratory relief.
[9] As against the Teachers’ Union, the
existence of an actual controversy is for
two reasons less certain: its contract may
not be executory, and it has not filed a
proof of claim. There is a dispute as to
whether the Teachers’ contract remains
executory—on the one hand the contract
has expired, on the other it continues to
govern, and the issue has not been raised
or briefed. And the Teachers’ Union has
not filed a proof of claim. Still, there
exists at least a reasonable possibility that
the contract, if it is deemed a contract with
the City, would be deemed executory and
subject to rejection. And the Teachers’
Union may yet file a proof of claim if the
School District is part of the City and its
collective bargaining agreement is executory and ultimately rejected. With respect
to budgetary concerns, the existence of an
actual controversy is more certain: the
Receiver’s need to move ahead on the
Teachers’ Union’s contract is even more
urgent than on Council 94’s contract. As
the Teachers’ Union explained at the hearing, its budget is by far the larger of the
two and the most significant item in the
School District budget. In addition, where
the court has already determined that an
small fraction of the schools’ budget could
have an appreciable effect on the City’s already-stretched finances and may have a material impact on confirmation.
47
actual controversy exists as to Council 94,
there is good cause to consider the same
issue as to the Teachers’ Union at the
same time—the Teachers’ Union has
shown every indication of wanting to be
heard on the issue. The Court therefore
concludes that the first count presents an
actual controversy with the Unions that
warrants declaratory relief.
b.
Declaratory Relief as to Count II
[10] By his second count, the Receiver
seeks a declaration ‘‘that the Receiver has
the power under the Fiscal Stability Act to
act on behalf of the City relative to collective bargaining with the Unions.’’ As the
Receiver himself states, the need for this
declaration is contingent on the court’s
first declaring that the School District is
part of the City.18 By this count, the Receiver seeks a declaration of the scope of
his power under Rhode Island’s Fiscal Stability Act, pursuant to which he was appointed receiver and by which his powers
are established and defined. The Unions
have taken the position that the Fiscal
Stability Act does not empower the Receiver to collectively bargain with the Unions on the City’s behalf. The Receiver
contends that the Act does so empower
him and that a declaration on this issue is
needed so that the parties can proceed
with a full understanding of their respective rights.
The court concludes that this count
presents an actual controversy as to both
Unions. If the School District is part of
the City, then both contracts will require
renegotiation. Indeed the expiration of
the Teachers’ Union contract last August
would require negotiation of a new agree18. Upon a determination that the School District is not part of the City, this second count
would become moot.
48
468 BANKRUPTCY REPORTER
ment even if the City were not in bankruptcy. A declaration that the Receiver
may act for the City in those negotiations
plainly will advance the negotiations and
the reorganization process in bankruptcy.
This controversy, too, warrants declaratory relief.
MOTION TO DISMISS OR ABSTAIN
[11] The Declaratory Judgment Act
does not itself confer subject-matter jurisdiction. Rather, it makes available a declaratory remedy for disputes that come
within the court’s jurisdiction on some other basis.19 The determination that declaratory relief is appropriate does not obviate
the need to address the Teachers’ Motion
to Dismiss or Abstain.
In that motion, the Teachers’ Union
makes the following four arguments.
First, the court’s subject-matter jurisdiction is limited to core proceedings, but the
Receiver’s requests for declaratory relief
are not core proceedings within the meaning of 28 U.S.C. § 157(b) (enumerating
core proceedings and authorizing bankruptcy judges to hear and determine and
enter appropriate orders and judgments in
them). Second, even if they are core proceedings, they arise under state law and
therefore are not matters on which a bankruptcy judge, lacking life tenure and protection against reduction of salary, may
constitutionally enter judgment, a proposition for which the Teachers’ Union relies
on Stern v. Marshall, ––– U.S. ––––, 131
S.Ct. 2594, 180 L.Ed.2d 475 (2011). Third,
even if the court does have subject-matter
jurisdiction, the court must, under 28
U.S.C. § 1334(c)(2), abstain from adjudicating the adversary proceeding because it
arises under state law and can be timely
adjudicated in a state forum. And fourth,
19. Ernst & Young v. Depositors Economic Protection Corp., 45 F.3d at 534.
20.
28 U.S.C. § 1334(a), (b), and (e).
even if § 1334(c)(2) does not mandate abstention, the court may and should abstain
under § 1334(c)(1) out of respect for state
law and for the numerous state parties and
state interests in this matter. The Receiver opposes the Union’s position at each
turn. The court will address the arguments in order.
a.
Core Status and Subject–Matter
Jurisdiction
The Teachers’ first argument has two
parts: (i) the court’s subject-matter jurisdiction is limited to core proceedings, (ii)
but the Receiver’s requests for declaratory
relief are not core proceedings. For the
reasons set forth below, the court agrees
that the Receiver’s requests are not core
and that this renders the bankruptcy court
unable to enter a final judgment in the
matter but not that subject-matter jurisdiction is lacking.
I begin with the argument that the
bankruptcy court’s subject-matter jurisdiction is limited to core proceedings. The
Teachers’ argue without elaboration:
‘‘[t]he Court’s subject-matter jurisdiction
in an adversary proceeding is limited to
‘core proceedings arising under title 11, or
arising in a case under title 11TTTT’ 28
U.S.C. § 157(b)(1).’’ The Receiver does
not answer this part of the Union’s argument.
[12, 13] Bankruptcy jurisdiction is
vested in the first instance in the district
courts.20 The district courts are empowered by 28 U.S.C. § 157(a) to provide ‘‘that
any or all cases under title 11 and any or
all proceedings arising under title 11 or
arising in or related to a case under title
11 shall be referred to the bankruptcy
judges for the district.’’ 21 The district
21.
28 U.S.C. § 157(a).
IN RE CITY OF CENT. FALLS, R.I.
Cite as 468 B.R. 36 (Bkrtcy.D.R.I. 2012)
court for the District of Rhode Island has
done just that.22 A bankruptcy judge’s
authority over the matters so referred is
not uniform. As to ‘‘all core proceedings
arising under title 11 or arising in a case
under title 11,’’ a bankruptcy judge has
authority, regardless of the consent of the
parties, to hear and determine and enter
appropriate orders and judgments.23 As
to all other referred matters, however, a
bankruptcy judge may not, without the
consent of the parties—the Unions have
indicated that they do not consent—determine such matters and enter final orders
or judgments.24 Still, a bankruptcy judge
is expressly permitted to hear these noncore matters.25 However, when a bankruptcy judge does hear such a matter, he
or she ‘‘shall submit proposed findings of
fact and conclusions of law to the district
court, and any final order or judgment
shall be entered by the district judge after
considering the bankruptcy judge’s proposed findings and conclusions and after
reviewing de novo those matters to which
any party has timely and specifically objected.’’ 26 Therefore, it is inaccurate to
state that outside of core proceedings, a
bankruptcy judge lacks subject-matter jurisdiction. Neither Congress by statute
nor the Supreme Court in Stern v. Marshall or otherwise has so limited the jurisdiction of a bankruptcy judge. Provided
the matter in question is related to a bankruptcy case—the present matters unques22. DRI LR Gen 109(a) (‘‘All cases arising
under Title 11 shall be referred automatically
to the bankruptcy judge(s) of this District.’’).
Though I am a bankruptcy judge of the District of Massachusetts, by designation under
11 U.S.C. § 921(b), I am a bankruptcy judge
of the District of Rhode Island for this bankruptcy case. See Designation Order, Case
No. 11–13105 (Bankr.D. R.I.), Doc. # 2.
23. 28 U.S.C. § 157(b)(1) (‘‘Bankruptcy judges
may hear and determine all cases under title
11 and all core proceedings arising under title
11, or arising in a case under title 11, referred
49
tionably are—it remains within the subject-matter jurisdiction created in § 1334
and referred to the bankruptcy court under § 157(a). The bankruptcy judge retains authority to hear and enter proposed
findings and conclusions in the matter,
with judgment to enter finally in the district court.
[14] The next issue is whether the Receiver’s requests for declaratory relief are
core. The Court must make this determination for each request for declaratory
relief. The Teachers’ Union argues that
the requests for declaratory relief are not
core because they are not among the core
proceedings that are enumerated in 28
U.S.C. § 157(b)(2), do not invoke a substantive right created by federal bankruptcy law, arise entirely under state law,
could exist independently outside of bankruptcy, and could proceed in another court
in the absence of a bankruptcy case. The
Receiver contends that both declaratory
requests are core for the following reasons: they fall within two of the enumerated categories of core proceedings—‘‘matters concerning the administration of the
estate’’ § 157(b)(2)(A), and ‘‘other proceedings affecting TTT the adjustment of the
debtor-creditor
TTT
relationship,’’
§ 157(b)(2)(O)—because they are related
to the rejection of executory contracts;
they will ‘‘determine who the debtor is’’
under subsection (a) of this section, and may
enter appropriate orders and judgments, subject to review under section 158 of this title.’’).
24.
28 U.S.C. § 157(b)(1) and (c).
25. 28 U.S.C. § 157(c)(1) (‘‘A bankruptcy
judge may hear a proceeding that is not a
core proceeding but that is otherwise related
to a case under title 11.’’).
26. 28 U.S.C. § 157(c)(1). See also Fed. R.
Bankr.P. 9033 and DRI LR Gen 109(d).
50
468 BANKRUPTCY REPORTER
and thereby determine the extent of the
bankruptcy court’s subject matter jurisdiction in this bankruptcy case, an issue a
bankruptcy court always has jurisdiction to
determine; they will affect various core
matters, including especially by determining whether creditors of the School District are creditors of the City; and they
will clarify whether the City may move to
reject the collective bargaining agreement
with the School District.27
[15–18] The term ‘‘core proceeding’’ is
used in 28 U.S.C. § 157(b) to refer to those
matters a bankruptcy judge may hear, determine, and dispose of by appropriate
orders and judgments, subject only to appellate review. Subsection 157(b) provides
a nonexhaustive list of core proceedings,
including two catch-all categories on which
the Receiver relies: ‘‘matters concerning
the administration of the estate,’’
§ 157(b)(2)(A), and ‘‘other proceedings affecting TTT the adjustment of the debtorcreditor TTT relationship,’’ § 157(b)(2)(O).
The first of these, ‘‘matters concerning the
administration of the estate,’’ cannot apply
in a Chapter 9 case because Chapter 9
cases involve no estate.28 Section 157 does
not otherwise define ‘‘core proceeding’’ except by dictating that ‘‘[a] determination
that a proceeding is not a core proceeding
shall not be made solely on the basis that
its resolution may be affected by State
law.’’ 28 U.S.C. § 157(b)(3). ‘‘It is the
nature of the proceeding—its relation to
27. The Receiver’s position on this issue is set
forth not only in his brief in opposition to the
Motion to Dismiss or Abstain but also in his
brief in support of his Motion for Summary
Judgment.
28. The section of the Bankruptcy Code that
creates a bankruptcy estate is § 541(a), but
that section does not apply in cases under
Chapter 9. 11 U.S.C. § 901(a) (listing Code
sections that apply in a chapter 9 case); 11
U.S.C. § 103(f) (‘‘Except as provided in section 901 of this title, only chapters 1 and 9 of
the basic function of the bankruptcy
court—not the state or federal basis for
the claim, that makes the difference
here.’’ 29 The legislative history of 28
U.S.C. § 157 indicates that ‘‘Congress intended that ‘core proceedings’ would be
interpreted broadly, close to or congruent
with constitutional limits.’’ 30 Proceedings
under 11 U.S.C. § 365(a) to assume or
reject executory contracts, arising as they
do under the Bankruptcy Code and being
unavailable outside of bankruptcy, ‘‘affect
the adjustment of the debtor-creditor relationship’’
within
the
meaning
of
§ 157(b)(2)(O) and therefore are undisputedly core proceedings.31
[19] As the Teachers’ Union rightly
points out, however, the Receiver’s demands for relief include no motion under
§ 365(a) of the Bankruptcy Code to reject
an executory contract. Nor do they seek a
determination that the Unions’ collective
bargaining agreements are executory or
even that they are contracts with the City.
The Receiver’s first count—for a declaration that the School District is part of the
City—stops short of putting the Unions’
collective bargaining agreements in controversy at all. It follows that, however useful the requested declaration may be, both
in structuring negotiations and possibly in
narrowing issues in future litigation, this
adversary proceeding cannot itself definitively determine any consequence of the
requested declaration for the relationship
this title apply in a case under such chapter
9.’’).
29. Arnold Print Works v. Apkin (In re Arnold
Print Works), 815 F.2d 165, 169 (1st Cir.
1987).
30.
Id. at 168–69.
31. In re Texaco, Inc., 77 B.R. 433, 437
(Bankr.S.D.N.Y.1987); In re UAL Corp., 293
B.R. 183, 184 (Bankr.N.D.Ill.2003).
IN RE CITY OF CENT. FALLS, R.I.
Cite as 468 B.R. 36 (Bkrtcy.D.R.I. 2012)
between the City and the Unions. In addition, the first count arises entirely under
state law, not under the Bankruptcy Code;
and though it arises in a bankruptcy case,
it could as easily have arisen, and been
brought elsewhere, had the City not commenced this bankruptcy case. The Receiver is correct in stating that Count One
may have consequences for numerous core
matters in this case, including the rejection
of contracts, the litigation and adjustment
of claims, and the extent of the automatic
stay. Still, it is not enough that the declarations he requests may affect these.
What is dispositive here is that the declarations would not themselves determine
any core matter.32
The Receiver has characterized his first
count as one to determine who is the
debtor and, consequently, to determine
the extent of the bankruptcy court’s subject matter jurisdiction. This characterization is not quite apt. The debtor in
this case is the City of Central Falls, and
‘‘the court’s jurisdiction’’—by which the
Receiver means the City’s power in bankruptcy, subject to court approval, to adjust debts and contractual obligations—
extends to all contractual obligations and
other debts of the City. That much is
clear and undisputed. The real issue in
dispute, which Count One bears upon but
would not actually determine, is whether
the Unions’ collective bargaining agreements are executory contracts with the
City, in which case those contracts would
be subject to adjustment under § 365.
Were this a proceeding to determine that
the contractual obligations of the School
District to the Unions are obligations of
the City under executory contracts, it
would have a much stronger claim to core
32. To be sure, it likely would bear upon, even
have issue-preclusive effect in, certain core
proceedings, such as a motion to reject the
Unions’ collective bargaining agreement or an
objection to the claim of Council 94. But its
preclusion would go only to discrete issues,
51
status. This would then be a proceeding
to determine that certain obligations are
subject to adjustment in the bankruptcy
case. But the Receiver’s first count stops
short of this and therefore is non-core. It
is merely ‘‘related to’’ this bankruptcy
case within the meaning of 28 U.S.C.
§ 157(c)(1), and the bankruptcy judge’s
authority over it is therefore limited to
that in § 157(c)(1).
[20] The second count’s claim to core
status is no stronger than the first’s. The
second count seeks a determination of the
authority of the Receiver under the Fiscal
Recovery Act, the state statute that delimits his authority. Like the first it arises
entirely under state law and, though it
arises in this bankruptcy case, could have
arisen and been brought elsewhere had the
City not sought bankruptcy relief. It too
is related to this case, and its determination is important to the progress of this
case, but it is not core.
b. Stern v. Marshall
The Teachers’ Union next argues that
even if the declaratory judgment counts
are core, the Supreme Court’s recent decision in Stern v. Marshall, ––– U.S. ––––,
131 S.Ct. 2594, 180 L.Ed.2d 475 (2011),
precludes the bankruptcy court from entering final judgment on them. In Stern,
the Supreme Court held that Congress
violated Article III of the United States
Constitution in 28 U.S.C. § 157(b) by assigning to bankruptcy judges—judges
lacking life tenure and protection against
diminution of salary—for final adjudication
as a core proceeding a counterclaim by the
bankruptcy estate against a creditor who
asserted a claim against the estate where
not to the core matter itself: collateral estoppel but not res judicata. Moreover, until a
core proceeding is commenced, the Court
cannot know the full range of issues that can
and will be raised or the importance of this
one issue to resolution of the core proceeding.
52
468 BANKRUPTCY REPORTER
resolution of the counterclaim was not necessarily resolved in the process of adjudicating the creditor’s proof of claim. In the
discussion above, this court has already
decided that the declaratory judgment
counts are not core and therefore that,
lacking the Unions’ consent, the bankruptcy court may not enter final judgment but
is limited to hearing the matter and submitting proposed findings and rulings to
the district court, with judgment to be
entered by the district court. When asked
at hearing whether such a conclusion—
specifically, a determination that the
claims at issue are merely ‘‘related to’’ and
not core—would render the present argument moot, the Teachers’ Union said it
would not; but counsel could not explain
why, except to state that, in Stern, the
Supreme Court signaled that ‘‘the bankruptcy courts need to carefully consider
whether they should be deciding certain
types of purely state law questions.’’ 33
[21] I understand the Teachers’ Union
to be arguing that Stern somehow invalidates the procedure prescribed in 28
U.S.C. § 157(c)(1) for a matter that is not
a core proceeding but that is otherwise
related to a bankruptcy case and that
arises entirely under state law. Stern provides no support for this reading. Stern
concerned only the authority of a bankruptcy court, as a court whose judges lack
the full protections of Article III, to enter
33. Nowhere does the Teachers’ Union specify
precisely what type of state law question its
argument is concerned with.
34.
35.
Stern v. Marshall, 131 S.Ct. at 2620.
Id. The court stated:
As described above, the current bankruptcy
system also requires the district court to
review de novo and enter final judgment on
any matters that are ‘‘related to’’ the bankruptcy proceedings, § 157(c)(1), and permits the district court to withdraw from the
bankruptcy court any referred case, proceeding, or part thereof, § 157(d). Pierce
certain final judgments, and it rested exclusively on a separation-of-powers rationale. It did not address the validity of a
judgment entered by the district court,
whose Article III credentials the Teachers’
Union does not dispute, pursuant to the
process set forth in 28 U.S.C. § 157(c)(1).
Nor did it address concerns of federalism;
although the counterclaim at issue in Stern
arose under state law, the determinative
feature of that counterclaim was that it did
not arise under the Bankruptcy Code. The
operative dichotomy was not federal versus state, but bankruptcy versus nonbankruptcy. The Teachers’ Union has offered
no reason why Stern should affect the
validity of § 157(c)(1) procedures and
judgments. In Stern itself, the Supreme
Court indicated that the fault it found was
limited to ‘‘one isolated respect’’ of the
bankruptcy jurisdictional scheme in
§ 157 34 and that its decision did not meaningfully change the division of labor in the
statute.35 I am satisfied that Stern had no
effect on § 157(c)(1) and that a bankruptcy
judge may hear the Receiver’s declaratory
judgment complaint and propose findings
of facts and conclusions of law on its two
counts.
c.
Mandatory Abstention, 28 U.S.C.
§ 1334(c)(2)
[22] In the alternative, the Teachers’
Union argues that 28 U.S.C. § 1334(c)(2)
has not argued that the bankruptcy courts
‘‘are barred from ‘hearing’ all counterclaims’’ or proposing findings of fact and
conclusions of law on those matters, but
rather that it must be the district court that
‘‘finally decide[s]’’ them. We do not think
the removal of counterclaims such as Vickie’s from core bankruptcy jurisdiction
meaningfully changes the division of labor
in the current statute; we agree with the
United States that the question presented
here is a ‘‘narrow’’ one.
Stern v. Marshall, 131 S.Ct. at 2620 (internal
citations omitted).
IN RE CITY OF CENT. FALLS, R.I.
Cite as 468 B.R. 36 (Bkrtcy.D.R.I. 2012)
requires that the court abstain from adjudicating the Receiver’s complaint. Section
1334(c)(2) states:
Upon timely motion of a party in a
proceeding based upon a State law claim
or State law cause of action, related to a
case under title 11 but not arising under
title 11 or arising in a case under title
11, with respect to which an action could
not have been commenced in a court of
the United States absent jurisdiction under this section, the district court shall
abstain from hearing such proceeding if
an action is commenced, and can be
timely adjudicated, in a State forum of
appropriate jurisdiction.36
This subsection applies by its terms to a
district court exercising bankruptcy jurisdiction under § 1334 and, by operation of
28 U.S.C. §§ 151 and 157(a), to a bankruptcy court acting upon a bankruptcy
matter by reference under § 157(a).37
Section 1334(c)(2) mandates that a court
abstain if five conditions are satisfied: (1)
the proceeding is based on a state law
claim or cause of action; (2) the claim or
cause of action is related to a case under
title 11 but does not arise under title 11
and does not arise in a case under title 11;
(3) federal courts would not have jurisdiction over the claim but for its relation to a
bankruptcy case; (4) an action ‘‘is commenced’’ in a state forum of appropriate
jurisdiction; and (5) the action can be
timely adjudicated in that state forum.38
The Teachers’ Union contends all five are
satisfied. The Receiver opposes abstention, contending principally that timely adjudication cannot be had in another forum.
36.
28 U.S.C. § 1334(c)(2).
37. The bankruptcy judges in a federal judicial
district ‘‘constitute a unit of the district court’’
for that district. 28 U.S.C. § 151.
38. Stoe v. Flaherty, 436 F.3d 209, 213 (3d
Cir.2006).
53
[23] Two of the five conditions appear
to be satisfied here: the proceeding is
based on a state law claim or cause of
action—it seeks a declaration of rights and
relations under Rhode Island law; and the
federal courts would not have jurisdiction
over the claim but for its relation to a
bankruptcy case. However, at least one
other, timely adjudication, is not satisfied,
and therefore abstention is not mandatory.39
The matters cannot be ‘‘timely’’ adjudicated in a state forum of appropriate jurisdiction. What constitutes ‘‘timely’’ adjudication is a function of the needs of the
reorganization process. Here, the Receiver expects to be in a position to complete
negotiations with the Unions before midApril. The completion of these negotiations, and the resolution of the status of
the City’s obligations to the Unions (if
any), are the last matters he must address
before submitting an amended plan of reorganization on which the Receiver hopes
to proceed to confirmation. The Receiver’s goals, shared by the court, are to
resolve the bankruptcy process and then
complete his receivership in a much shorter time than the usual span of litigation
outside of bankruptcy and, indeed, in other
Chapter 9 adjustment cases. This goal is
driven in part by the cost of the reorganization process, which increases with its
length and at some point jeopardizes the
reorganization itself. It is also driven by
the need to complete the receivership process and return the City to municipal normalcy. The Rhode Island Supreme Court
39. The court also questions whether this matter ‘‘does not arise in a case under title 11’’
and that a matter ‘‘is commenced’’ when it
has not already been commenced. Where the
timeliness requirement is not satisfied, these
concerns are academic and need not be addressed.
54
468 BANKRUPTCY REPORTER
has itself recognized this imperative with
respect to the receivership of Central
Falls.40 The Receiver filed his complaint
in this adversary proceeding on December
30, 2011, and asked for disposition of the
matter by March 2, 2012. After hearing
from the Unions, and at their request, I
enlarged that time by approximately a
month but generally agreed with the Receiver’s appraisal of the matter’s urgency
and with the timeline on which it should be
decided.
The matter would not likely be adjudicated in the state courts within the time
that this bankruptcy case requires. The
bankruptcy courts are designed and intended to handle all matters in a bankruptcy case precisely to make reorganization
more feasible and to advance matters
whose adjudication is critical to the progress of the case. A state court would be
receiving this matter without the bankruptcy court’s sense of the whole case in
which it is situated, on a docket already
crowded with other matters. And it takes
nothing away from the state courts to observe that the usual course of civil litigation is vastly longer in duration than this
matter requires: weeks, not months or
years.41
I am mindful that the bankruptcy court
itself cannot finally decide this matter.
Under § 157(c)(1), further process will be
required in the district court before final
40. See Moreau v. Flanders, 15 A.3d 565, 576–
79 (R.I.2011) (indicating concern about the
absence of an explicit sunset provision in the
framework of Rhode Island’s municipal receivership statute and stating that ‘‘it would
seem that a period of oversight that exceeds
two years from the appointment of a receiver
might be unreasonable’’).
41. At the hearing on this motion, the court
explored with the parties the possibility of
certifying key questions in this adversary proceeding to the Rhode Island Supreme Court,
an unusual procedure. The court did this in
judgment can enter. Even so, I find and
conclude that adjudication of this matter in
the bankruptcy court pursuant § 157(c)(1)
is the option most likely to result in a
timely adjudication. For these reasons,
abstention is not mandatory.
d.
Discretionary
Abstention,
U.S.C. § 1334(c)(1)
28
In the alternative, the Teachers’ Union
argues that the bankruptcy court may and
should, in the interest of respect for state
law, abstain under § 1334(c)(1) from adjudicating this matter. The Union argues
that the court should abstain because the
issues presented arise entirely under state
law and are of particular importance to the
state but will have little or no consequence
in this bankruptcy case. The Receiver
opposes discretionary abstention, arguing
that abstention is disfavored and would
impede the efficient administration of the
case, that the issue presented is important
to the bankruptcy case, and that although
the questions arise under state law, established Rhode Island law already answers
the questions.
[24] Where abstention is not mandatory under § 1334(c)(2), subsection (c)(1)
nonetheless permits a court to abstain
from hearing a matter related to a bankruptcy case in the ‘‘interest of justice’’ or
‘‘in the interest of comity with State courts
or respect for State law.’’ 28 U.S.C.
part because the Unions cited the speed with
which that court heard and decided other
litigation concerning the City’s receivership.
By the end of the hearing, however, it was
clear that even that pace, which is veritable
alacrity at the appellate level, would not meet
the needs of this case. And this court cannot
know in advance whether the Supreme Court
would even agree to address the question and,
if so, how soon. Where the Supreme Court’s
calendar is closed for this term, it is unclear
that the matter could even be heard before
October.
IN RE CITY OF CENT. FALLS, R.I.
Cite as 468 B.R. 36 (Bkrtcy.D.R.I. 2012)
§ 1334(c)(1). Courts have developed a
comprehensive list of the relevant considerations:
(1) the effect or lack thereof on the efficient administration of the estate if a
Court recommends abstention, (2) the
extent to which state law issues predominate over bankruptcy issues, (3) the difficulty or unsettled nature of the applicable law, (4) the presence of a related
proceeding commenced in state court or
other nonbankruptcy court, (5) the jurisdictional basis, if any, other than 28
U.S.C. § 1334, (6) the degree of relatedness or remoteness of the proceeding to
the main bankruptcy case, (7) the substance rather than form of an asserted
‘‘core’’ proceeding, (8) the feasibility of
severing state law claims from core
bankruptcy matters to allow judgments
to be entered in state court with enforcement left to the bankruptcy court,
(9) the burden of [the bankruptcy
court’s] docket, (10) the likelihood that
the commencement of the proceeding in
bankruptcy court involves forum shopping by one of the parties, (11) the existence of a right to a jury trial, and (12)
the presence in the proceeding of nondebtor parties.42
‘‘Courts should apply these factors flexibly,
for their relevance and importance will
vary with the particular circumstances of
each case, and no one factor is necessarily
determinative.’’ 43
[25] Several of these factors undisputedly weigh heavily in favor of abstention.
First, the state issues predominate; both
parties do also advance arguments under
federal law, but at bottom both declarato42. In re Chicago, M. & St. P. & Pac. R.R., 6
F.3d 1184, 1189 (7th Cir.1993); see also In re
Middlesex Power Equip. & Marine, Inc., 292
F.3d 61, 69 (1st Cir.Mass.2002) (citing court’s
‘‘broad discretion to abstain’’ and citing to
lists of factors employed in other circuits).
55
ry requests are about state law. Second,
unlike many state law issues that are routinely litigated in bankruptcy court—regarding contracts, security interests, exemptions, property rights, and the like—
the issues presented here are unusual and
not well-trodden. Third, the issues concern the structure of state and municipal
government and its financing and are thus
of special concern to the State of Rhode
Island, its municipalities, and its various
authorities. And fourth, those authorities
are necessary parties in this proceeding.
Respect for state law is therefore of greater than usual importance here, a significant concern.44
The force of this concern is blunted by
other factors. Though the state issues are
not well-settled, they do not come to this
court without determinative signposts in
state law; this court would not be making
state law out of whole cloth. In addition,
answers to declaratory requests can and
would be framed narrowly. And, though
the Governmental Defendants are present
in this proceeding as necessary third parties, they have taken no position on the
substantive issues and have not requested
dismissal or abstention but rather, in each
of their answers, have requested the judgment of this court.
Moreover, there are two countervailing
concerns. The first is the importance of
these issues to the bankruptcy case. If
the School District is part of the City, then
its contracts may be subject to adjustment
in this case. The Teachers’ Union argues
that ‘‘the City is not a party to the Unions’
contracts and cannot reject them,’’ and
43. In re Middlesex Power Equip. & Marine,
Inc., 292 F.3d 61, 69.
44. Id. (‘‘because section 1334(c)(1) is concerned with comity and respect for state law,
whether a case involves unsettled issues of
state law is always significant’’).
56
468 BANKRUPTCY REPORTER
therefore that the declaratory judgment
issues cannot have a meaningful impact on
the bankruptcy case. This argument puts
the cart before the horse. The purpose of
this adversary proceeding is, in effect, to
determine whether the City is a party to
the contracts. The Receiver’s ability to
reject those contracts, and by extension to
negotiate with authority concerning them,
is hardly settled. The Teachers’ Union
also contends that the issues presented
cannot meaningfully affect the City’s bankruptcy case for the further reason that the
net effect of rejection of the Unions’ contracts on the City would be negligible because the State will still fund over 95% of
the School District’s operating costs over
the next five years.45 But the Teachers’
Union concedes that the School District
budget dwarf’s the balance of the City’s
budget—the figures cited to the court
were $44 million for the School District
and $17.5 million for the balance of the
City. It follows that even a small fraction
of the School budget can have a significant
effect on the City’s overall ability to make
ends meet and to propose a feasible plan.
But even this point misses the big picture:
the City’s receipt of budgetary assistance
from the State is not a reason the City
should not use the resources at its disposal
in this case to get its budget under control.
Control of the budget is self-justifying,
even for those portions of the budget that
the State has and may in the future subsidize in part or even in full. The availability of life-support is not justification for not
curing the disease that necessitates it.
The City has every reason to diminish the
extent of its necessity, and that in itself is
a legitimate goal in this case. Therefore,
the issues presented are of fundamental
importance in this bankruptcy case.
45. Five years is the term of the plan of debt
adjustment the City contemplates filing in this
case.
cially when there exists a forum that can
accomplish that.
46. Compromise is part of bankruptcy, and
there has been a fair measure of it in this case
already, but it should not be necessitated by
inability to timely adjudicate a matter, espe-
The second countervailing concern is the
need for expedition. For reasons explained above, sending this matter to state
court would likely delay this case for much
longer than the reorganization effort can
tolerate or, more likely, force the Receiver
to proceed without a resolution of this
issue, which would effectively compromise
some or all of his legitimate objectives in
this case, or both.46 In short, determination of these issues by the state courts is
not a realistic option. The real options are
determination in the present proceeding or
not at all. For all these reasons, the better course is not to abstain. The Court
therefore turns to the Motion for Summary Judgment.
MOTION
MENT
FOR
SUMMARY
JUDG-
Standard of Review
[26] Summary judgment is appropriate
when there is no genuine issue of material
fact and, on the uncontroverted facts, the
moving party is entitled to judgment as a
matter of law.47 Where, as here, the burden of proof at trial would fall on the party
seeking summary judgment, that party
must support its motion with evidence—in
the form of affidavits, admissions, depositions, answers to interrogatories, and the
like—as to each essential element of its
cause of action. The evidence must be
such as would permit the movant at trial to
withstand a motion for directed verdict
47. Fed.R.Civ.P. 56, made applicable by Fed.
R. Bankr.P. 7056; Desmond v. Varrasso (In re
Varrasso), 37 F.3d 760, 763 (1st Cir.1994).
IN RE CITY OF CENT. FALLS, R.I.
Cite as 468 B.R. 36 (Bkrtcy.D.R.I. 2012)
under Fed.R.Civ.P. 50(a).48 Provided it
does so, the burden then shifts to the
opposing party to adduce evidence that
establishes a genuine issue of material fact
as to at least one essential element of the
moving party’s case. The Court must view
all evidence in the light most favorable to
the nonmoving party and indulge all inferences favorable to that party.49 The ultimate burden of proving the absence of a
genuine issue of material fact remains at
all times on the moving party. ‘‘Only disputes over facts that might affect the outcome of the suit under the governing law
will properly preclude the entry of summary judgment.’’ 50 Absent a genuine dispute of material fact, questions of law are
appropriate for resolution on summary
judgment.51 Questions of statutory interpretation are questions of law.52
The court adjudicates this motion for
summary judgment in a proceeding in
which it must make ‘‘proposed findings of
fact.’’ To be clear, a motion for summary
judgment involves no findings of fact,
merely (insofar as facts are concerned)
48. Anderson v. Liberty Lobby, Inc., 477 U.S.
242, 250, 106 S.Ct. 2505, 91 L.Ed.2d 202
(1986).
49. Daury v. Smith, 842 F.2d 9, 11 (1st Cir.
1988).
50. Martinez–Rodriguez v. Guevara, 597 F.3d
414, 419 (1st Cir.2010), quoting from
Anderson v. Liberty Lobby, Inc., 477 U.S. 242,
248, 106 S.Ct. 2505, 91 L.Ed.2d 202 (1986).
51. Zehner v. Central Berkshire Regional School
Dist., 921 F.Supp. 850, 857 (D.Mass.1995)
(citing to Jimenez v. Peninsular & Oriental
Steam Nav. Co., 974 F.2d 221, 223 (1st Cir.
1992)).
52. See Hernandez–Miranda v. Empresas Diaz
Masso, Inc., 651 F.3d 167, 170 (1st Cir.2011);
Simmons v. Galvin, 575 F.3d 24, 30 (1st Cir.
2009) (‘‘questions of statutory interpretation
are questions of law ripe for resolution at the
pleadings stage’’).
57
rulings of law as to whether there exist
genuine issues as to the material facts.
The following facts are not findings of the
court.
Facts
The facts as the court must construe
them are as follows. Except where otherwise indicated, they are either admitted or
otherwise uncontroverted.53
1. The plaintiff City is a municipality of
the State of Rhode Island (the ‘‘State’’)
and a political subdivision thereof.
2. On August 1, 2011, the City filed a
voluntary petition under Chapter 9 of the
Bankruptcy Code with the United States
Bankruptcy Court for the District of
Rhode Island, commencing the Chapter 9
case in which this adversary proceeding
arises.
3. On December 1, 2011, the Court entered an order for relief in the Chapter 9
case.
4. Defendant Central Falls Teachers’
Union (the ‘‘Teachers’ Union’’) is a labor
53. The parties followed the procedure set
forth on DRI LR Cv 56(a), made applicable to
this proceeding by R.I. LBR 1001–1(b). Accordingly, the City filed a Statement of Undisputed Facts with its motion for summary
judgment. The Teachers’ Union responded
with a Statement of Disputed Facts and also
filed a further Amended Statement of Undisputed Facts, to which the City responded with
a Statement of Disputed Facts. Except as
otherwise noted, the numeration through ¶ 43
corresponds to that in the City’s Statement of
Undisputed Facts. Council 94, which on the
whole relies on the Teachers’ Union’s response to the Motion for Summary Judgment,
nonetheless filed a short separate response
from that of the Teachers’ Union to the City’s
Statement of Undisputed Facts. It states only
that ‘‘[Council 94] has reviewed the Statement and disagrees that Paragraphs 22, 42
and 43.(sic) In addition, [Council 94] defers to
the pleadings filed by the [Teachers’ Union].’’
Council 94 cited no evidentiary basis for controverting paragraphs 22, 42, and 43.
58
468 BANKRUPTCY REPORTER
union that, at present and since 1967, is
and has been the exclusive bargaining
agent for all classroom teachers and eligible certified personnel of the Central Falls
School District (the ‘‘School District’’).
The Teachers Union has approximately
287 members, who include prekindergarten through grade 12 teachers, certified
school nurse teachers, deans, guidance
counselors, school librarians, department
chairs, temporary certified employees,
speech pathologists, coaches, social workers, school psychologists, and certain parttime certified district staff. The principal
office of the Teachers’ Union is located in
Lincoln, Rhode Island.54
5. Defendant Rhode Island Council 94,
AFSCME, AFL–CIO Local 1627 (‘‘Council
94’’), a labor union, is the bargaining unit
for certain Central Falls non-teacher, noncertified school employees. Its principal
place of business is in North Providence,
Rhode Island.55
10. On March 26, 1991, the governor of
Rhode Island and the State commissioner
of elementary and secondary education entered into a Memorandum of Understanding with the mayor of Central Falls and
the chairmen of the Central Falls City
Council, the Central Falls School Committee, and the Central Falls Review Commission. The Memorandum of Understanding
contemplated a full state administrative
and financial takeover of the Central Falls
school system, beginning on July 1, 1992.
11. The Memorandum of Understanding set forth that the Proposed Agreement
was expressly subject to certain terms and
conditions, one of which was General Assembly approval.
9. In 1952, the City adopted a homerule charter that designated the City’s
school committee as one of the independent boards and commissions responsible
for performing the executive and administrative work of the city.
12. In 1991, the Rhode Island General
Assembly (the ‘‘General Assembly’’)
passed legislation, 1991 R.I. Pub. Laws ch.
312 (the ‘‘1991 Act’’). The 1991 Act provided for (i) shared funding of the School
District by the State and the City for fiscal
year ending June 30, 1992, and (ii) a shifting of the administration of the City’s
schools to a state administrator who was
granted the same powers and duties afforded to the school committee. Specifically, the 1991 Act provided as follows:
Section 2. State Administrative Takeover of Central Falls School District
July 1, 1991. The state administrative
takeover of the Central Falls school system, to begin on July 1, 1991, shall be
accomplished in the following manner:
(a) the governor, in consultation with
the commissioner of elementary and
secondary education, shall appoint a
special state administrator for the
Central Falls school system.
(b) The special state administrator shall
have all the rights, responsibilities,
54. The facts in this paragraph include the
uncontroverted facts from the Teachers’ Unions Statement of Undisputed Facts, ¶ 1.
55. The facts in this paragraph include the
uncontroverted facts from the Teachers’ Unions Statement of Undisputed Facts, ¶ 2.
6. The Council 94 employees participate in the Rhode Island Municipal Employees’ Retirement System.
7. All state employees and teachers are
required under Rhode Island law, R.I.
Gen. Laws § 36–9–2, to participate in the
Employees Retirement System of the
State of Rhode Island (‘‘ERSRI’’).
8. Non-state employees and non-teachers are not permitted to be members of
the ERSRI.
IN RE CITY OF CENT. FALLS, R.I.
Cite as 468 B.R. 36 (Bkrtcy.D.R.I. 2012)
59
duties and obligations afforded to
school committees under the applicable law and regulation of the state.
(c) The special state administrator will
report to the commissioner, seek community input from a nine (9) member
Central Falls advisory group, and
shall provide regular briefings to the
mayor of Central Falls.
(d) The special state administrator shall
plan a complete state financial and
administrative takeover of the Central
Falls school system, commencing July
1, 1992.
Section 3. Central Falls School District Advisory Group. The commissioner of elementary and secondary education is hereby directed to solicit
nominations for persons to serve on the
Central Falls advisory group for the
period July 1, 1991 to June 30, 2002.
All persons except the special state administrator shall serve without compensation. The board of regents shall appoint the members of the advisory
group from nominations made by the
commissioner.
The advisory group
shall meet monthly, shall select a chairman, and shall advise and assist the
special state administrator on matters
relating to the complete takeover of the
Central Falls school district. The special state administrator and the superintendent of schools shall serve as exofficio, non-voting members of this advisory group.
Section 4. Administrative plan of the
Central Falls School District period of
July 1, 1991 to June 30, 1992.
(a) During the fiscal year 1992, the operation of the Central Falls school
12.1 The School District has been overseen by the Rhode Island Department of
Education since July 1, 1991.56
56. Teachers’ Union’s Statement of Undisputed Facts, ¶ 3. The Teachers’ Union’s evidence,
consisting of a portion of the Report of Receiver Mark A. Pfeiffer (predecessor to Robert
Flanders in the Central Falls Receivership),
does not indicate the manner or capacity the
School District was overseen by RIDE in this
period. RIDE has oversight responsibilities
for all school districts and presumably did so
even before this period began. The evidence
district shall continue in the same
manner as in prior fiscal years except
as herein provided.
(b) The special state administrator shall
replace the school committee as provided in this act.
(c) Collective bargaining agreements
currently in force shall remain in effect through June 30, 1992.
(d) The city of Central Falls shall continue to be responsible for payment of
all bond principal and interest.
(e) The city of Central Falls shall continue to be the fiscal agent for the
Central Falls school district, except
that a separate interest-bearing
checking account shall be established
for the school district. Only expenses
incurred after July 1, 1991 shall be
paid from this account; provided, further, the incurring and payment of
expenses shall be subject to the prior
approval of the special state administrator or his/her designee. The account shall contain the revenues to be
provided in accordance with section 1
of this act. In accordance with federal
regulations, federal funds shall be deposited in a non-interest bearing
checking account, and shall be subject
to the conditions set forth in this act.
Section 5. Nothing contained in this
act shall be interpreted to restrict the
commissioner or the special state administrator from fulfilling their duties
regarding the Central Falls school
system.
60
468 BANKRUPTCY REPORTER
13. Under the 1991 Act, the City retained the legal obligation to pay debt
service on bonds for school buildings.
14. Section 4 of the 1991 Act set forth
an administrative plan for the School District for the period of July 1, 1991, to June
30, 1992. It stated that ‘‘the city of Central Falls shall continue to be the fiscal
agent for the Central Falls school district,
except that a separate interest-bearing
checking account shall be established for
the school district.’’ 1991 R.I. Pub. Laws
ch. 312, § 4(e).
point the members of the board of
trustees from nominations made by
the commissioner of elementary and
secondary education. The chairperson shall also be selected in this
manner. The board of regents shall
determine the number, qualifications, and terms of office of members of the board of trustees, provided however, that at least four (4) of
the members shall be residents of
the city and parents of current or
former Central Falls public school
students. The remaining three (3)
shall be appointed at large.
15. In 2002, the General Assembly
passed an act, 2002 R.I. Pub. Laws ch. 204
(the ‘‘2002 Act’’), codified at R.I. Gen.
Laws § 16–2–34. The 2002 Act replaced
the state administrator created by the
1991 Act with a board of trustees appointed by the commissioner of the department
of elementary and secondary education,
subject to the approval of the Rhode Island board of regents for elementary and
secondary education. In part, § 16–2–34
states:
(a) There is hereby established a seven
(7) member board of trustees, which
shall govern the Central Falls School
District. With the exception of
those powers and duties reserved by
the commissioner of elementary and
secondary education, and the board
of regents for elementary and secondary education, the board of trustees shall have the powers and
duties of school committees.
(j) The appointment of the special state
administrator for the Central Falls
School District and the Central Falls
School District Advisory Group, created by chapter 312 of the Rhode
Island Public Laws of 1991, will no
longer be in effect upon the selection
and appointment of the board of
trustees created in this section. All
powers and duties of the special state
administrator and the Central Falls
School District Advisory Group are
hereby transferred and assigned to
the board of trustees created in this
section, upon the selection and appointment of that board.
(b) The board of regents for elementary
and secondary education shall ap-
R.I. Gen. Laws § 16–2–34(a), (b), (f), and
(j).57
does not indicate whether and how this oversight differed from its oversight of this and
other school districts before and after the
1991 Act. It appears from the Report that
Receiver Pfeiffer was referring special oversight authority put in place by the 1991 Act,
and continued thereafter in succeeding legislation, and I construe this evidence to refer to
those changes, the details of which are specified in the 1991 Act.
(f) [ ]The board of trustees shall have
TTT the following powers and duties:
TTT (3) to appoint a superintendent
to serve as its chief executive officer[.] TTT
57. The Receiver contends that it is established
and uncontroverted that the members of the
board of trustee are not subject to removal by
the commissioner. The Teachers’ Union admits this but contends that neither are the
members of the board of trustees subject to
IN RE CITY OF CENT. FALLS, R.I.
Cite as 468 B.R. 36 (Bkrtcy.D.R.I. 2012)
15.1 Effective July 1, 2003, the Board
of Regents approved the School District’s
first Board of Trustees. Since then, all
members of the Board of Trustees have
been appointed pursuant to § 16–2–34(b).
This system of State control makes the
School District unique in all of Rhode Island.58
15.2 Whereas, under the revised City
Charter currently in effect, the Mayor and
the City Council members must be legal
residents of the City ‘‘for at least two
years’’ § 16–2–34(b) as amended by the
2002 Act requires that only four of the
seven members of the Board of Trustees
must be City residents. Of the six current
members of the Board of Trustees, only
three are City residents.59
15.3 The Teachers’ Union states that it
is established and uncontroverted that
§ 16–2–34, as amended by the 2002 Act,
was not repealed by the 2007 amendment
to the City Charter and has not been
subsequently repealed.60 The City responds that this is not an appropriate
statement of fact but a disputed conclusion
of law for the court to determine. The
court agrees with the City.
15.4 The Board of Trustees continues
to operate the School District pursuant to
§ 16–2–34.61
61
tee has ceased to exist since 1991, but the
evidence is a statement in the affidavit of
Jane Sessums, who makes the statement
on the basis of the 1991 Act, and therefore
this is merely a legal conclusion, and a
disputed one.62
16. The 2002 Act did not alter the provisions of P.L. 1991, ch. 312 regarding the
City’s obligation to pay debt service on
bonds or the City’s status as fiscal agent.
17. The City remains obligated to pay
debt service on bonds for school buildings.
There is evidence in the record that the
State reimburses the City for 97 percent of
the principal and interest the City must
pay on school bonds and school construction bonds. There is also evidence in the
record that the amount the Receiver expects the City to pay in connection with
principal and interest on bonds from fiscal
year 2012 to fiscal year 2016 will be offset
by between 70% and 80% per year by
State reimbursement.
18. Payments for the debt service on
bonds for school buildings were accounted
for in the City’s initial Plan of Debt Adjustment filed with the bankruptcy court
on September 22, 2011.
15.5 The Teachers’ Union states that
there is evidence that the School Commit-
19. In November 2006, the electors of
the City approved amendments to its
home-rule charter that had been proposed
by the City Council.63 The amendments
deleted certain sections of the pre-amend-
removal by the City. Both positions are conclusions of law, not statements of fact.
62. Teachers’ Union’s Statement of Uncontested Facts, ¶ 14.
58. Teachers’ Union’s Statement of Uncontested Facts, ¶ 9.
63. In conjunction with the motion for summary judgment, the Receiver and Teachers’
Union each originally submitted isolated excerpts from published editions of the original
and amended charters. The Court then ordered the parties to submit full copies of both
the original charter and the amended, and the
Receiver and both Unions did so in a single
document entitled Collective Submission of
City Charters. Facts ¶ 19 is a description of
the relevant portions of the texts so produced.
59. Teachers’ Union’s Statement of Uncontested Facts, ¶¶ 11 and 12.
60. Teachers’ Union’s Statement of Uncontested Facts, ¶ 13.
61. Teachers’ Union’s Statement of Uncontested Facts, ¶ 14.
62
468 BANKRUPTCY REPORTER
ment charter (which had itself been
adopted in 1952): § 3–608(1), which had
addressed the composition of the school
committee 64; § 3–608(2), which had addressed the filling of vacancies on the
school committee 65; and § 3–608(3), which
had addressed the qualifications of school
committee members.66 In the amended
charter, § 3–608 was simply marked ‘‘reserved,’’ without specific content. The
amendments also redacted § 3–100(c), the
section that created certain independent
boards and commissions, by deleting the
school committee from that list.67 They
also deleted in its entirety Chapter 14 of
Article IV; Article IV is entitled Executive
and Administrative Branch Powers and
Duties, and Chapter 14 had been the chapter (comprising seven sections) that governed the school board. In the amended
charter, Chapter 14 is now marked ‘‘reserved.’’ However, the amendments left
in place §§ 6–107 and 6–108, both of which
appear in Article VI of the Charter, entitled ‘‘Municipal Elections.’’ 68 Section 6–
64. Section 3–608(1), entitled ‘‘The school
committee,’’ stated:
The school committee shall consist of five
members, one of whom shall be elected
from each of the five wards as the same are
now constituted. The terms of members of
the school committee shall begin on the
first Monday of January following the year
in which they were elected, except that a
member elected to fill a vacancy shall serve
for the balance of the unexpired term. At
the municipal election in 1953, a member
from the first ward shall be elected for a
term of two years, a member from the second ward and a member from the third
ward for a term of four years, a member
from the fourth ward and a member from
the fifth ward for a term of six years. At
each municipal election thereafter, there
shall be elected for a term of six years a
member of the school committee to replace
the one whose term shall be expiring.
66. Section 3–608(3), entitled ‘‘Qualifications
of members of the school committee,’’ stated
in its entirety: ‘‘Members of the school committee, at the time of their elections, shall be
qualified electors of and residents of the respective ward from which they are elected.’’
65. Section 3–608(2), entitled ‘‘Vacancies,’’
stated:
In case of death, resignation, or inability to
serve, or removal from the ward from
which he was elected, of any member of the
school committee, of if for any other cause
there shall be a vacancy in the membership
of the committee, a majority of the members of the school committee may appoint,
as a member of said committee, a person
who at the time of his appointment shall be
a qualified elector in the ward where such
vacancy occurs. Such persons shall hold
office as a member of the school committee
until the first Monday in January, succeeding the municipal election, next following
his appointment, at which election the
unexpired term shall be filled by the
electors of the ward so affected.
67. Section 3–100(c) stated: ‘‘The executive
and administrative work of the city shall be
performed by: TTT (c) The following independent boards and commissions which are hereby created: TTT School committee.’’ No other entity listed in § 3–100(c) was deleted from
the list, but three were added (the Zoning
Board, Detention Facility Board, and Planning Board), and the Board of Pensions and
Retirement was changed to the Board of Retirement.
68. An editor’s note appearing in the texts of
both the original and the amended charters,
at the start of Article VI, which includes section 6–107 and 6–108, indicates that the text
of this article does not derive from the 1952
original but from a 1953 corrective amendment to it: ‘‘Article VI of the original Home
Rule Charter was declared unconstitutional in
State ex rel Messier v. Turrow et al., 81 R.I.
149, 99 A.2d 484. Subsequently, the Legislature, in a Special November Session, 1953,
enacted chapter 3239 entitled as follows: ‘An
Act pertaining to municipal primaries and
elections in the City of Central Falls, and
validating certain provision in the City of Central Falls Home Rule Charter.’ This Act is set
out herein, in place of the original Article VI.’’
(Emphasis added.) If this note is to be credited (I make no determination on that issue),
then (i) the 1952 charter did not include this
Article VI, (ii) the 2007 amended charter may
not have included it either, and (iii) Article VI
IN RE CITY OF CENT. FALLS, R.I.
Cite as 468 B.R. 36 (Bkrtcy.D.R.I. 2012)
63
107,69 though not identical to deleted § 3–
608(1), is very similar to it: like the deleted section, it specifies that the school committee shall consist of five members, one
from each of the City’s five wards, and it
further specifies when their terms shall
begin and when elections shall be held.
Section 6–108 70 is virtually identical to deleted § 3–608(2). Deleted § 3–608(3) has
no remaining parallel or equivalent in the
charter as amended. The original charter
also included mention of school committee
members in §§ 6–109 and 6–110, both of
which were carried over unmodified into
the amended charter. Section 6–109 specifies when general elections for city officers, expressly ‘‘including members of the
school committee,’’ shall be held. Section
6–110 deals with signature requirements
on petitions for city officers, ‘‘including
members of the school committee,’’ to be
elected. Also, the amended charter, at
¶ 4–1500, carries over from the original a
reference to a school department: ‘‘The
board of recreation shall TTT cooperate
with the school department in coordinating
its activities with the recreation program
conducted by the school department.’’
This appears to be the only mention of a
school ‘‘department’’ in the charters, old
and new.
may be a legislative fix that the editors reproduced as if it were part of the charter because
it was designed to fill a gap left by the invalidation of the original Article VI. This leaves
much uncertainty about Article VI.
every odd year thereafter, there shall be
elected for a term of six years commencing
with the first Monday in January then next
succeeding a member of the school committee to replace the one whose term shall be
expiring.
In the language of the amended charter, this
section is modified only by the replacement of
‘‘the 1st day of February’’ each time it occurs
with ‘‘February 1.’’
69. Section 6–107, entitled ‘‘Election of members of school committee,’’ states:
The school committee shall consist of five
members, one of whom shall be elected
from each of the five wards as the same are
now constituted. The terms of members of
the school committee shall begin on the
first Monday of January following the year
in which they were elected, except that at
the election held on January 19, 1954, a
member from the first ward shall be elected
to serve from the 1st day of February, 1954
until the first Monday of January, 1956, a
member from the second ward and a member from the third ward to serve from the
1st day of February, 1954, until the first
Monday of January, 1958, and a member
from the fourth ward and a member from
the fifth ward to serve from the 1st day of
February, 1954, until the first Monday of
January, 1960 and until their successors are
elected and qualified. A member elected to
fill a vacancy shall serve for the balance of
the unexpired term. At each municipal
election to be held on the first Tuesday after
the first Monday in November, 1955 and in
20. In 2007, the General Assembly ratified the city charter as amended.
21. The General Assembly has never
authorized the Central Falls Board of
Trustees or the state administrator to exercise any sovereign power in the areas of
taxation, eminent domain, or the police
power other than the enforcement of com-
70. Section 6–108, entitled ‘‘Vacancies in
membership of school committee,’’ stated:
In case of death, resignation, or inability to
serve, or removal from the ward from
which he was elected, of any member of the
school committee, of if for any other cause
there shall be a vacancy in the membership
of the committee, a majority of the members of the school committee may appoint,
as a member of said committee, a person
who at the time of his appointment shall be
a qualified elector in the ward where such
vacancy occurs. Such person shall hold
office as a member of the school committee
until the first Monday in January, succeeding the municipal election next following
his appointment, at which election the
unexpired term shall be filled by the
electors of the ward so affected.
In the amended charter, the language of this
section is identical.
64
468 BANKRUPTCY REPORTER
pulsory attendance laws by the Superintendent of Schools.
new funding formula for public education
in Rhode Island (the ‘‘Funding Formula’’).
22. From 1991 to the present, the City
has provided services to the School District without invoicing or otherwise charging the School District for said services,
including, but not limited to, police programs in the schools, fire department safety programs in the schools, maintenance of
school athletic facilities, purchasing of
sports equipment, maintenance of school
parking lots, trash removal for the schools,
fire alarm and sprinkler systems in the
schools, and maintenance, repairs, and upgrades to various school buildings. There
is evidence that ‘‘historically, the City has
not budgeted funds specifically for the purpose of maintaining the school buildings.’’
25. In support of the legislation, Deborah Gist, the Commissioner of the Department of Elementary and Secondary Education, submitted a report to the General
Assembly on the Funding Formula, dated
November 15, 2010.
22.1 Since 1991, the operational costs
for the Central Falls public schools have
been paid for by the State of Rhode Island. Between fiscal year 1992 and fiscal
year 2011, the State provided $604 million
for the operation of the School District.71
Between 2007 and 2011, and aside from
any federal funding the City may have
received for its schools, the School District
has been entirely funded by the State. No
other municipal school district in Rhode
Island is funded entirely by the state.72
26. Under the Funding Formula, commencing Fiscal Year ending June 30, 2013,
the City will be required to make contributions to the cost of operating the City’s
schools by paying funds into the Central
Falls Stabilization Fund. There is evidence
that the City would be required to fund
barely five percent of the School District’s
total operating costs, while the remaining
funding required will continue to come
from the State, and that the State has
acknowledged that ‘‘it is unlikely that the
city will be able to fund education in the
immediate future’’ and has begun to explore possible ways it could ‘‘allow for
100% funding if the city cannot afford to
pay its local contribution.’’
27. The City’s contribution to the Central Falls Stabilization Fund was included
in the City’s initial Plan of Debt Adjustment filed with the bankruptcy court on
September 22, 2011.
24. In 2010, the General Assembly
passed legislation which provided for a
28. Under a proposed legislative
change to R.I. Gen. Laws § 16–7.2–6, the
City’s contribution to the Central Falls
Stabilization Fund would be increased.
There is evidence that the City would be
required to fund barely five percent of the
School District’s total operating costs,
while the remaining funding required will
continue to come from the State, and that
the State has acknowledged that ‘‘it is
unlikely that the city will be able to fund
education in the immediate future’’ and has
begun to explore possible ways it could
71. Teachers’ Union’s Statement of Uncontested Facts, ¶¶ 16–17.
72. Teachers’ Union’s Statement of Uncontested Facts, ¶ 18.
23. The Rhode Island Department of
Elementary and Secondary Education
(‘‘RIDE’’) completed a full program and
finance review of the School District on
October 31, 2011 and issued a Final Program Review Determination Letter on November 14, 2011. RIDE anticipates a
$256,432 deficit in the School District Unrestricted Fund at the conclusion of fiscal
year ending June 30, 2012.
IN RE CITY OF CENT. FALLS, R.I.
Cite as 468 B.R. 36 (Bkrtcy.D.R.I. 2012)
‘‘allow for 100% funding if the city cannot
afford to pay its local contribution.’’
29. The Funding Formula funds staterun schools, such as charter public schools,
the William M. Davies, Jr. Career and
Technical High School, and the Metropolitan Regional Career and Technical Center,
differently from its funding of local school
districts.
30. Given changes in the school Funding Formula based, in part, on declining
enrollments, RIDE forecasts a decline in
the School District’s state revenue, unrestricted state aid, of $1,688,271 each year
for eight years starting in fiscal year ending 2014. The cumulative impact of this
decrease over the five-year period from
fiscal year ending 2012 to fiscal year ending 2016 is $4,783,465. There is evidence
that the State has acknowledged that ‘‘it is
unlikely that the city will be able to fund
education in the immediate future’’ and has
begun to explore possible ways it could
‘‘allow for 100% funding if the city cannot
afford to pay its local contribution.’’
31. In addition, the School District received over $10 million in federal grant
fund revenues from the 2009 American
Recovery
and
Reinvestment
Act
(‘‘ARRA’’). These monies, used to support
school programming and other initiatives,
will not be replaced once spent: $4.3 million in ending fiscal year 2012, $2.9 million
in fiscal year ending 2013, $.9 million in
fiscal year ending 2014, $.1 million in fiscal
year ending 2015, and no funds in fiscal
year ending 2016. The cumulative impact
73. The School District admits the first sentence of this paragraph but, without citing
controverting evidence, denies the second
‘‘because it is impossible to know with certainty what the School District’s costs and
revenues will be during that time frame.’’ I
deem the second sentence uncontroverted
subject to the unremarkable caveat that it is
impossible to know the future and that bud-
65
of this decrease over the five-year period
from fiscal year ending 2012 to fiscal year
ending 2016 is $4,324,259.
32. Additionally, RIDE estimates that
the School District will face slight declines
in non-ARRA federal grant fund revenues
over the five-year period. The cumulative
impact of this decrease over the five-year
period from fiscal year ending 2012 to
fiscal year ending 2016 is $555,122.
33. At the time the City filed its initial
Plan of Debt Adjustment, the School District’s operating costs were fully funded by
the State, and the financial information
available at the time indicated that the
School District had a funding surplus for
Fiscal Year ending June 30, 2012.
34. Based upon the RIDE forecasts,
the School District is facing a significant
drop in revenue sources of approximately
$8.5 million over the five-year period. Given the starting deficit at the end of fiscal
year ending 2012 and increasing cost
trends, without significant cuts to expenses, the School District will have a
cumulative deficit well in excess of $10
million by the end of fiscal year ending
2016.73
35. As a result of the RIDE Program
Review and RIDE revenue forecasts, the
City needs to develop an amended Plan of
Debt Adjustment to fund the Fiscal Year
ending 2012 deficit as well as the projected
deficits for the remaining years of the fiveyear term of the Plan of Debt Adjustment.74
getary projections are projections, not statements of fact about the future.
74. The Teachers’ Union denies this fact only
on the basis that ‘‘it is the State, not the City,
which funds the School District and negotiates collective bargaining agreements with
the Unions. Accordingly, an adjustment of
the School District’s finances would have no
impact on the City’s finances.’’ I therefore
66
468 BANKRUPTCY REPORTER
36. The most recent collective bargaining agreement between the School District
and the Teachers’ Union expired on August 31, 2011.
37. Negotiations on a new collective
bargaining agreement were conducted between negotiating teams from the School
District and the Teachers’ Union prior to
the filing of the bankruptcy petition.
These negotiations did not yield a new
collective bargaining agreement.
38. Soon after the commencement of
the bankruptcy case, the Receiver replaced
the negotiating team that had been acting
on behalf of the School District and continued negotiating a collective bargaining
agreement between the City and the
Teachers’ Union. The Teachers’ Union
reserved its right to argue that the School
District is not subject to the City’s bankruptcy proceeding and that the Receiver is
without authority to execute a collective
bargaining agreement.
39. On July 29, 2011, the Receiver issued an order to the School District directing that the Board of Trustees not to enter
into or to amend any collective bargaining
agreements or to approve expenditures or
contracts in excess of $25,000 without the
Receiver’s prior written approval.
accept ¶ 35 subject to the caveat that any
deficit in the School District’s budget does not
affect the City’s budget if the School District
is not part of the City.
75. Citing to the two statutory provisions reproduced in this paragraph, the City states
that it is established and uncontroverted that
‘‘the City will be liable for any difference
between any appropriation by the state government or the federal government and the
costs arising from any collective bargaining
agreement commencing in Fiscal Year ending
2012.’’ The Teachers’ Union denies this,
states that § 16–1–11 and § 16–7.2–6(d)
speak for themselves, and, on the basis of a
RIDE 2010 Report (Teachers Exhibit 29, at
40. The City and Council 94 have a
collective bargaining agreement which expires on June 30, 2013.
41. The City and Council 94 began discussions to open up and amend their collective bargaining agreement in December
2011.
42.
R.I. Gen. Laws § 16–1–11 states: 75
For the purposes of this section and
§§ 16–1–10 and 16–5–22, the department
of elementary and secondary education
shall be subrogated to all the powers
and functions of the city or town school
committee, including the right to draw
orders upon the city or town treasurer
for the payment for the support of the
public schools of the city or town of any
money in the city or town treasury required by law to be accredited to the
public school account. The department
of elementary and secondary education
may also apportion to or expend for the
support of the public schools of the city
or town any part of the annual appropriation for public schools provided by
§ 16–4–5 as shall not be apportioned for
other purposes, or the whole, or any
part of the annual appropriation as the
general assembly shall make for the
purposes of this section and §§ 16–1–10
and 16–5–22.
pp. 8–9), states (i) that the State continues to
fully fund the School District and (ii) that the
State has acknowledged that ‘‘it is unlikely
that the City will be able to fund education in
the immediate future’’ and has begun to explore possible ways it could ‘‘allow for 100%
funding if the city cannot afford to pay its
local contribution.’’
Because the City’s
‘‘fact’’ is not a fact but a conclusion of law
based on the cited statutes, it suffices to reproduce the statutory language in question.
The Court further notes that the Union’s evidence that the State may find a way to avert a
shortfall does not controvert the proposition
that the City will be liable for any shortfall
that the State does not avert.
IN RE CITY OF CENT. FALLS, R.I.
Cite as 468 B.R. 36 (Bkrtcy.D.R.I. 2012)
67
And R.I. Gen. Laws § 16–7.2–6(d)
states:
Central Falls Stabilization Fund is established to assure that appropriate
funding is available to support the community, including students from the
community that attend the charter
schools, Davies, and the Met Center
pursuant to § 16–7.2–5, due to concerns
regarding the city’s capacity to meet the
local share of education costs. This
fund requires that the difference between education aid calculated pursuant
to § 16–7.2–3 and education aid, as of
the effective date of the formula, shall
be shared between the state and the city
of Central Falls. The state’s share of
the fund will be paid directly to the
Central Falls school district upon verification that the city has transferred its
share of the local contribution for education. At the end of the transition
period defined in § 16–7.2–7, the municipality will continue its contribution pursuant to § 16–7–24.
the absence of a substantial infusion of
state or federal funds.76
43. Based upon preliminary financial
model projections prepared by the City,
and in particular the sharp decrease in
projected revenues from state and federal
sources over the term of the City’s fiveyear plan of debt adjustment, without substantial changes to the structure and delivery of educational services within the
School District, the City will not be able to
propose a plan with balanced budgets in
47. Except insofar as (i) the School
District is part of the City (which is a
question of law to be decided in this case)
and (ii) members of the Board of Trustees
are residents of Central Falls, the School
District establishes its annual budget with
no City involvement.
76. The facts in this paragraph are established
by averments in the affidavit of Gayle Corrigan. The Teachers’ Union denies this paragraph and cites as controverting evidence
only the RIDE 2010 Report (Teachers Exhibit
29, at pp. 8–9), which, the Union says, stands
for the proposition ‘‘that the State continues
to fully fund the School District and has begun to explore possible ways it could ‘allow
for 100% funding if the city cannot afford to
pay its local contribution.’ ’’ This evidence
does not controvert the City’s fact in evidence
because that evidence already states that the
City ‘‘will not be able to propose a plan with
balanced budgets in the absence of a substantial infusion of state or federal funds.’’
44. The Rhode Island State Fiscal
Year 2012 Supplemental Appropriations
Act, Article 1, has a separate line item for
the School District. No other school district in Rhode Island has a similar line
item entry in this document. The only
other schools to have such separate State
budget allocations are State schools such
as Rhode Island School for the Deaf and
Davies Vocational.77
45. Rhode Island Education Aid, an
October 2010 report of the Rhode Island
House Fiscal Advisory Staff, shows State
aid to Central Falls as a separate budgetary line item.78
46. The Fiscal Year 2010, 2009, and
2008 Personnel Supplements for the State
Department for Elementary and Secondary Education show State aid to the School
District as a separate budget line item.
No other school district has a similar line
item entity in these documents.79
48. Under § 16–2–34, the Superintendent must ‘‘prepare a budget and otherwise participate in budget development as
77. Teachers’ Union’s Statement of Uncontested Facts, ¶ 19.
78. Teachers’ Union’s Statement of Uncontested Facts, ¶ 20.
79. Teachers’ Union’s Statement of Uncontested Facts, ¶ 21.
68
468 BANKRUPTCY REPORTER
required,’’ R.I. Gen. Laws § 16–2–34(h)(6),
and the Board of Regents provides ‘‘parameters for overall budget requests, approve[s] the budget, and otherwise participate[s] in budget development,’’ and the
Commissioner recommends ‘‘parameters
for overall budget requests, recommend[s]
a budget, and otherwise participate[s] in
budget development,’’ R.I. Gen. Laws
§ 16–2–34(c), (d).80
49. The historic practice has been for
the superintendent to prepare the budget.
Except insofar as the School District is a
part of the City, in which case the superintendent would be a City official, no City
official has had responsibility for preparing
or approving the School District’s budget
since 2005.81
50. The City and the School District
issue separate annual financial statements.
In each year starting with the year ending
June 30, 2003, the financial statements
prepared for the City were prepared by
different auditors than the financial statements prepared for the School District.82
51. In each year starting with the year
ended June 30, 2002, Note 1 to the City’s
financial statements state:
Reporting Entity: In evaluating how to
define the City, for financial reporting
purposes, management [i.e., the City]
has considered all potential component
units. The decision to include a potential component unit in the reporting entity was made by applying the criteria
set forth in GASB Statement No. 14.
Under GASB Statement No. 14, the financial reporting entity includes both
the primary government and all of its
component units. Component units are
80. Teachers’ Union’s Statement of Uncontested Facts, ¶ 23.
81. Teachers’ Union’s Statement of Uncontested Facts, ¶ 24. The term ‘‘historic practice’’
here is undefined. And the significance (if
legally separate entities that meet any of
the following three tests:
Test 1—The primary government appoints the voting majority of the
board of the potential component unit
and
1 Is able to impose its will on the
potential component unit and/or
1 Is in a relationship of financial
benefit or burden with the potential
component unit;
Test 2—The potential component unit
is fiscally dependent upon the primary
government; or
Test 3—The financial statements
would be misleading if data from the
potential component unit were not included.
The following entities were considered
for classification as a component unit for
fiscal year 2003:
1 Central Falls Redevelopment Agency
Although this entity meets certain
criteria of the tests previously listed, it is deemed not to have separate legal status apart for the City.
As a result, the financial data of the
above entity has been included as a
non-major special revenue fund
within the City’s financial statements.
1 Central Falls Housing Authority
1 Central Falls Community Center
1 Central Falls School District
1 Central Falls Detention Facility
Corporation
Since these entities do not meet any
of the above three tests, they have
any) of 2005 is not evident from the deposition testimony submitted in support of this
paragraph.
82. Teachers’ Union’s Statement of Uncontested Facts, ¶ 25.
IN RE CITY OF CENT. FALLS, R.I.
Cite as 468 B.R. 36 (Bkrtcy.D.R.I. 2012)
not been included in the financial
reporting entity.83
52. The covers of the eight annual financial statements for the School District
for the years ended June 30, 2003 through
June 30, 2010, describe the School District
as ‘‘a component unit of the State of Rhode
Island.’’ 84
53. The School District has its own
bank accounts that are maintained for the
benefit of the School District. It is the
responsibility of the Superintendent to
maintain those accounts; the Superintendent has authority over those accounts and
uses them for ‘‘school related purposes.’’
Except insofar as the School District may
be deemed a unit of the City (a contested
issue of law which it is the purpose of this
adversary proceeding to decide), and
therefore the Superintendent a City official, no City official has authority over
those accounts.85
69
55. To obtain insurance, the School
District participates in ‘‘a non-profit, public
entity risk pool (Rhode Island Inter–Local
Risk Management Trust, Inc.), which provides coverage for property/liability claims
and workers compensation claims.’’ The
City, too, participates in the risk pool, but
it signed a participation agreement with
the risk pool separate and apart from the
participation agreement the School District executed with the risk pool. The
School District pays its own premiums to
the risk pool for coverage, separate from
any premiums paid by the City for coverage for the City.88
56. The Superintendent answers to the
Board of Trustees, and the Board of Trustees answers to the Board of Regents and
the Commissioner. The School District
has its own Finance Department, HR Department, Building and Maintenance Department, and IT system separate from
the City.89
54. School District employees currently
receive paychecks issued by the School
District payroll department.86 Before the
1991 State takeover, payroll checks for
School District employees were issued by
the ‘‘City of Central Falls.’’ After the
takeover, those checks were issued by the
‘‘Central Falls School District.’’ 87
57. The School District maintains its
own business records, which the Superintendent is responsible for maintaining.90
83. Teachers’ Union’s Statement of Uncontested Facts, ¶ 26.
90. Teachers’ Union’s Statement of Uncontested Facts, ¶ 35. The Teachers’ Union also
contends that it is established and uncontroverted that ‘‘the School District can sue and
be sued in its own name,’’ but the Receiver
disputes this, saying that although the School
District has sued and been sued in its own
name, the General Assembly has not granted
this power under R.I. Gen. Laws §§ 16–2–9
and 16–2–34. The court concludes that this
‘‘fact’’ is a conclusion of law.
84. Teachers’ Union’s Statement of Uncontested Facts, ¶ 27.
85. Teachers’ Union’s Statement of Uncontested Facts, ¶ 28.
86. Teachers’ Union’s Statement of Uncontested Facts, ¶ 29.
87. Teachers’ Union’s Statement of Uncontested Facts, ¶ 30.
88. Teachers’ Union’s Statement of Uncontested Facts, ¶¶ 31–33.
89. Teachers’ Union’s Statement of Uncontested Facts, ¶ 34.
58. The School District enters into ordinary course commercial contracts in its
own name, including on at least one occasion with the City itself (through the Receiver).91
91. Teachers’ Union’s Statement of Uncontested Facts, ¶ 36.
70
468 BANKRUPTCY REPORTER
59. With the exception of contracts for
buildings and maintenance, since 2005,
there have been no City officials (other
than the Superintendent, if the School District is part of the City) whose job it is to
approve ordinary course goods and services contracts entered into by the School
District.92
60. Section 16–2–34 provides that the
superintendent, along with the chair of the
Board of Trustees, must ‘‘negotiate TTT all
district employment contracts, which contract shall be subject to the approval of the
commissioner of elementary and secondary
education with the concurrence of the
board of regents.’’ R.I. Gen. Laws § 16–
2–34(h)(10).93
61. The Chair of the Board of Trustees
and the Superintendent, along with additional designees, have negotiated collective
bargaining agreements on behalf of the
School District. Since the advent of the
Board of Trustees in 2002, all School District contracts with the Teachers’ Union
have been approved by the Board of Trustees with the concurrence of the Commissioner and Board of Regents. The Superintendent and the Chair of the Board of
Trustees submitted the most recent collective bargaining agreement between the
Teachers’ Union and the School District to
the Commissioner and the Board of Regents for their approval. The Commissioner approved the agreement and the
Board of Regents concurred with the Commissioner’s approval.94
62. Since 1992, no City official (except
for the Superintendent and the Board of
Trustees to the extent they are deemed
City officials) has participated in negotiations between the School District and its
unions.95
63. The School District enters into collective bargaining agreements its own
name and has done so since 1992.96
64. The School District has its own formal personnel policies, set by the Superintendent in consultation with and subject to
the approval of the Board of Trustees.
Except to the extent that the School District is part of the City and the Superintendent is therefore a City official, no City
official has any role in setting these policies.97
65. The Superintendent is ultimately
responsible for hiring and firing employees
(except that there is a question of law as to
whether terminated employees have a
right of appeal to the Board of Trustees).98
66. Elected City officials have had no
input on employment decisions that were
made by Superintendent Gallo or any other superintendent from 2005 to the present.99
67. The pay of most School District
employees is set by their collective bargaining agreements, which are negotiated
by the Superintendent and subject to the
approval of the Commissioner of Education and the Board of Regents. R.I.
Gen. Laws § 16–2–34(h)(10). Except to
92. Teachers’ Union’s Statement of Uncontested Facts, ¶ 37.
96. Teachers’ Union’s Statement of Uncontested Facts, ¶ 42.
93. Teachers’ Union’s Statement of Uncontested Facts, ¶ 38.
97. Teachers’ Union’s Statement of Uncontested Facts, ¶ 43.
94. Teachers’ Union’s Statement of Uncontested Facts, ¶¶ 39–40.
98. Teachers’ Union’s Statement of Uncontested Facts, ¶ 44.
95. Teachers’ Union’s Statement of Uncontested Facts, ¶ 41.
99. Teachers’ Union’s Statement of Uncontested Facts, ¶ 45.
IN RE CITY OF CENT. FALLS, R.I.
Cite as 468 B.R. 36 (Bkrtcy.D.R.I. 2012)
the extent that the School District is part
of the City and the Superintendent is
therefore a City official, no City official is
responsible for deciding how much any
employee of the School District gets
paid.100
Count I: Whether the School District Is
Part of the City
a.
Arguments of the Parties
The parties’ arguments are numerous
and extensive. I summarize here only
their overall structure.
The Receiver’s position is as follows.
Rhode Island law governs the question of
whether the School District is part of the
City. Case law in Rhode Island recognizes
that education is in the first instance a
state-level concern, but one that the General Assembly has delegated to or vested
in the school committees of the various
municipalities. The Central Falls home
rule charter of 1952 created a school committee and gave to it the basic governance
of the City’s schools, collectively known as
the School District. The School District is
not a separate entity from the City: it
lacks incidents of municipal sovereignty,
such as police powers and powers of taxation and eminent domain; it cannot hold
property in its own name; though it may
contract in its own name, the City is liable
for its contracts; it cannot be sued in its
own name; and prior to 1991, it was controlled by the City’s school committee.
The 1991 and 2002 Acts did not change
the School District’s status as a department of the City. The plain language of
those acts confirms that the City remained
the fiscal agent for the School District,
100. Teachers’ Union’s Statement of Uncontested Facts, ¶ 46.
101. Anticipating that the Teachers’ Union
would make an ‘‘arm of the state’’ argument,
the Receiver also made extensive arguments
on that subject. The Teachers’ Union did not
71
that governing case law was not abrogated, that the City remained liable for
debt service on school bonds, and that the
City continued to own and maintain the
school buildings and adjacent property.
More importantly, the Acts cannot have
divested the City of the School District
because that would have altered the City’s
form of government, which, by the State
constitution, would have required passage
by the City’s electorate. Though the City
has no active school committee, the City
Charter, amended in 2007, continues to
provide for the election of a school committee.
Nor does the extent of the School District’s reliance on State funding change its
status. Many municipalities receive State
funding to aid the operation of their
schools. Central Falls differs only in degree and has continued to fund the schools,
albeit minimally. And the State, by recent
legislation, is requiring the City to fund a
larger portion of the School District’s budget in coming years.101
The Teachers’ Union responds in the
first instance with arguments under federal law. The School District is not a debtor
in this Chapter 9 case. It is a separate
and distinct governmental entity. Under
federal law, the School District must be
treated as a separate entity for Chapter 9
purposes and is not authorized to be a
debtor in its own right. The exercise of
bankruptcy jurisdiction over it would violate the Tenth Amendment.
In the alternative, the Teachers’ Union
argues that, under Rhode Island law, the
School District is not part of the City.
Before 1991, it fit the paradigm of a muin fact make the anticipated argument, and
therefore I need not set forth the Receiver’s
position on it. I agree with the Receiver and
the Teachers’ Union that the arm of the state
theory is irrelevant.
72
468 BANKRUPTCY REPORTER
nicipally-run school district. That changed
with the 1991 and 2002 Acts, which together removed the schools from City control.
These changes were sealed by amendments to the City’s charter in 2007, which
terminated the City’s school committee.
The State’s control and funding of the
School District is not just extensive, but
complete and unique in the State. It must
be seen as a difference in kind. Any argument that these changes are ‘‘only temporary’’ ignores their 21–year duration and
modifications to the City charter. And the
cases on which the Receiver relies are
inapposite: they are limited to circumstances where the school district is funded
by the municipality and controlled by its
school committee, neither of which is true
in Central Falls. The State has the power
to create a school district that is independent of a municipality and, by virtue of the
1991 and 2002 Acts and the amendment to
the City charter, has done so here.
In its reply brief and at oral argument,
the Receiver added a further argument,
this one under federal law: that under the
definition of municipality in the Bankruptcy Code, the School District would not
qualify as a municipality in its own right,
and therefore it should not now be viewed
as a separate entity.
b.
Overview of Analysis
The debtor in this chapter 9 case is the
City of Central Falls, and the question
presented by Count One is simply whether, under Rhode Island law, the School
District is part of the City.102 Under Rhode
Island law, the crucial factors are not the
extent of state funding or the duration of
state intervention. Rhode Island law begins with the act by which the School
District was created, the adoption of the
102. If not, the court need not determine what
else the School District might be: a standalone entity, an agency of the State, or some-
City Charter of 1952. The Charter created a municipally-elected school committee
to govern the City’s schools, collectively
known as the School District. Until 1991,
the School District fit the paradigm of a
municipally-run school district, one which,
under Rhode Island case law, would have
been viewed and treated as part of the
City. The 1991 and 2002 Acts transferred
political control over the School District
from the City, through its school committee, to a state administrator and then to
the state-appointed Board of Trustees. It
may well be, as the Receiver argues, that
these Acts cannot by themselves have removed the School District from the City.
The Receiver contends that under the
Rhode Island constitution, removal would
have required an amendment to the City’s
Charter, itself requiring a vote of the
City’s electors. In 2007, however, the City
did, by the vote of its electors approving
amendments to the City’s charter and the
State legislature’s ratification, disestablish
its school committee and with it any remaining political control over and constitutional connection to the School District.
The City’s remaining obligations to and
interests in the School District—that the
District serves the City’s children, uses the
City’s school properties, requires City
funding, is governed in part by trustees
who are City residents—do not make it
part of the City. However provisional this
arrangement may be, the status quo is
separation.
c.
Governing Law
For jurisdictional purposes, the Teachers’ Union insisted that the issues presented in this proceeding were exclusively of
state law, yet it now leads with three
arguments under federal law: (i) the
thing else. That issue is not presented here
or within this court’s jurisdiction to decide.
IN RE CITY OF CENT. FALLS, R.I.
Cite as 468 B.R. 36 (Bkrtcy.D.R.I. 2012)
School District is not eligible to be a debtor under Chapter 9, both because it has
not been authorized by the State to file a
bankruptcy petition and because the Receiver himself has not been authorized by
the State to file a Chapter 9 petition on its
behalf; (ii) exercise of bankruptcy jurisdiction over the School District would violate
the Tenth Amendment to the U.S. Constitution; and (iii) the School District would
qualify as a municipality under the Bankruptcy Code and therefore, even if under
state law it is part of the City, it must be
treated as a separate and distinct entity
for purposes of Chapter 9. The Receiver
responds that the first and second arguments are moot and irrelevant but answers
the third at some length, arguing that the
School District is not a municipality within
the meaning of § 101(40) of the Bankruptcy Code and therefore should not be
deemed a separate entity from the City.
These arguments require that the court
determine their relevance and whether the
question presented by Count One is, at
bottom, one of federal law or state.
[27] Only a ‘‘municipality,’’ as that
term is defined in the Bankruptcy Code,
may be a debtor under Chapter 9 of the
Bankruptcy Code.103 The debtor in this
case is the City of Central Falls—and only
the City of Central Falls. The City is
undisputedly a municipality, and its eligibility to be a debtor has already been
determined, as reflected by entry of an
order for relief.104 As the Receiver points
out, he has not sought, and does not in this
proceeding seek, Chapter 9 relief for the
School District. Accordingly, I conclude
that the Teachers’ Union’s arguments
103. 11 U.S.C. § 109(c)(1) (‘‘an entity may be
a debtor under chapter 9 of this title if and
only if such entity—(1) is a municipality’’); 11
U.S.C. § 101(40) (in title 11, ‘‘ ‘municipality’
means political subdivision or public agency
or instrumentality of a state’’).
73
about eligibility—that, for lack of State
authorization, the School District is not
eligible to be a debtor under Chapter 9,
and that the Receiver is not authorized to
file a Chapter 9 petition on its behalf—are
moot and irrelevant.
[28] In Count One, the Receiver seeks
only a determination that the School District is part of the City. A judgment in his
favor on this count would not add a debtor
to this case but merely define the scope of
the existing debtor. That debtor, the City,
has voluntarily petitioned the court for
bankruptcy relief and has done so with
proper state authorization; the Teachers’
Union does not contend otherwise. Consequently, the resulting exercise of bankruptcy jurisdiction over the City, whether
it includes the School District or not,
would not offend the Tenth Amendment.
The Teachers’ Union appears to concede
this, too, because it argues that the offense
against the Tenth Amendment would occur
if (i) the court exercised jurisdiction over
the School District (ii) notwithstanding
that it is a separate entity from the City.
But this cannot occur. If the School District is deemed a separate entity, there will
be no exercise of jurisdiction over it, either
as part of the debtor or as a separate
debtor. The Tenth Amendment argument
is therefore moot, of no consequence.
[29] This leaves only the Teachers’ Union’s third argument: that the School District would qualify as a municipality under
the Bankruptcy Code and therefore, even
if under state law it is part of the City, it
must be treated as a separate and distinct
entity for purposes of Chapter 9. In restated form, the Union is arguing that
104. The court established a deadline for filing
objections to the eligibility of the City to be a
debtor and for filing motions to dismiss. All
filed objections to eligibility were withdrawn,
whereupon the court entered an order for
relief. See 11 U.S.C. § 921(c) and (d).
74
468 BANKRUPTCY REPORTER
even if, under Rhode Island law, the
School District is a part of the debtor City,
the Bankruptcy Code requires that it be
treated otherwise. The court need not
address this issue unless it first determines that, under state law, the School
District is part of the City; otherwise, it is
moot. Even if the court were to determine that the School District is part of the
City, the issue would be collateral to the
declaratory counts that are the subject of
the Receiver’s complaint. In substance
this argument is a motion to dismiss the
bankruptcy case as to a portion of the
debtor. Such a motion must be filed in the
bankruptcy case itself, with notice to all
creditors. It is not properly brought in this
adversary proceeding, much less (in the
first instance) by argument in response to
a motion for summary judgment, and is in
fact untimely.
[30] In the interest of completeness,
however, I address the merits here. The
Union rests this argument on five cases in
which a school district, utility district, water district, or housing authority has been
deemed a municipality that is eligible to be
chapter 9 debtor in its own right, separate
from the municipality in which it is located.
I need not parse the cases in any depth; at
best, they stand for the proposition that a
school district may, in some instances, be a
municipality and an eligible Chapter 9
debtor.
This is very different from saying that
Chapter 9 authorizes a bankruptcy court
to exclude from bankruptcy relief a school
105.
11 U.S.C. § 109(c)(1).
106. See, e.g., 11 U.S.C. § 101(5) (definition of
claim).
107. See Butner v. United States, 440 U.S. 48,
54–55, 99 S.Ct. 914, 918, 59 L.Ed.2d 136
(1979) (‘‘Congress has generally left the determination of property rights in the assets of a
bankrupt’s estate to state law.’’ ‘‘Property
district or other portion of an eligible debtor municipality, notwithstanding that the
school district is, under the law of the state
of which it is a creature, part of the debtor
municipality. I am aware of no authority
for that practice and find none in Chapter
9. ‘‘[A]n entity may be a debtor under
chapter 9 TTT if TTT such entity is a municipality.’’ 105 A municipality, if it is eligible
at all, is eligible as it exists in state law.
The Bankruptcy Code neither creates nor
redefines it and makes no provision for
limiting eligibility to portions of otherwise
eligible municipalities. This proposal has
no parallel in other chapters of the Code.
What the Teacher’s Union is proposing
finds no basis in the Bankruptcy Code.
In addition, it would be antithetical to
the principles of the Bankruptcy Code,
which is informed by an intent to bring all
of a debtor’s debts and contracts into the
case, in order to provide the most comprehensive relief possible.106 Were the court
to exclude from a municipality’s bankruptcy case significant financial obligations of
the debtor, the utility of its bankruptcy
relief would be severely compromised.
For all these reasons, the court rejects this
argument.
[31] This leaves only Count One as
framed by the Receiver. It asks not
whether the School District is a municipality but whether it is part of the City of
Central Falls. As the City is a creature of
Rhode Island law, so must the answer to
this question be.107 This matter is therefore governed by Rhode Island law.
interests are created and defined by state law.
Unless some federal interest requires a different result, there is no reason why such interests should be analyzed differently simply because an interested party is involved in a
bankruptcy proceeding.’’). Butner involved
property rights, not the relation of a municipality to its school district, but the principle is
the same: unless Congress has altered the
governing considerations, a question of state
IN RE CITY OF CENT. FALLS, R.I.
Cite as 468 B.R. 36 (Bkrtcy.D.R.I. 2012)
[32–34] When ruling on an issue of
state law, a federal court exercising bankruptcy jurisdiction, like a federal court sitting in diversity, must rule as it believes
the highest court of the state would rule.108
To that end, the federal court should employ the method and approach announced
by the state’s highest court.109 Where the
issue is one of statutory construction, the
court should follow the state’s rules of
statutory construction.110
d.
The City Charter of 1952
[35] Municipalities are creatures of
state law and subject to the power of the
State, as limited by its constitution, to
create, divide, and even abolish them.111
The issue of whether the School District is
part of the City turns on how the City and
its relation to the School District are defined and constituted by state law.
In this instance, the originating act—
that is, the act by which the School District was formed—is the adoption by the
City and ratification by the State of the
City’s home-rule charter of 1952. The
parties have cited to the court no other act
of the State by which the School District
was established,112 and I am aware of no
other. The City of Central Falls is a duly
law should be determined in the usual manner, unaffected by the bankruptcy context in
which the question arises.
108. In re Miller, 113 B.R. 98, 101 (Bankr.
D.Mass.1990).
109. Cahoon v. Shelton, 647 F.3d 18, 22 (1st
Cir.2011).
110. Woods v. Friction Materials, Inc., 30 F.3d
255, 263 (1st Cir.1994); Huguenin v. Ponte,
29 F.Supp.2d 57, 63 (D.R.I., 1998).
111. Kennedy v. Mayor of Pawtucket, 24 R.I.
461, 53 A. 317, 320 (1902), citing Laramie Co.
v. Albany Co., 92 U.S. 307, 310, 23 L.Ed. 552
(1875) (‘‘Corporations of the kind are properly denominated public corporations, for the
reason that they are but parts of the machinery employed in carrying on the affairs of the
75
authorized municipal corporation that has
a home-rule charter adopted in accordance
with Article 13 of the Rhode Island Constitution.113 The City’s charter, first adopted
in 1952 and amended in 2007, in large
measure defines the form and constitution
of the City as a body politic.
In relevant part, § 3–100 of the 1952
charter specified the authorities through
which the executive and administrative
work of the City would be performed and
also created certain of those authorities,
including a school committee. It stated:
‘‘The executive and administrative work of
the city shall be performed by: TTT (c) The
following independent boards and commissions which are hereby created: TTT School
committee.’’ 114 By this act the Central
Falls School District was constituted as a
part of the City of Central Falls. The
nomenclature ‘‘school district’’ appears to
be simply the term by which the State
refers to the collection of elementary and
secondary schools that are operated by the
school committee of a particular city or
town. The charter essentially creates the
school district as a department of the City,
under the control of the City’s elected
school committee, one of the City’s independent boards.115
State; and it is well-settled law, that the charters under which such corporations are created may be changed, modified, or repealed, as
the exigencies of the public service or the
public welfare may demand.’’).
112. I set aside for the time being any later
changes or reconstitutions, including those
effected by the 1991 and 2002 Acts and the
2007 changes to the city charter.
113.
Moreau v. Flanders, 15 A.3d at 569.
114. 1952 Charter of the City of Central Falls,
§ 3–100(c) (emphasis added).
115. In other sections of Article III of the
Charter, entitled ‘‘Executive and Administrative Branch–Organization,’’ the 1952 charter
76
468 BANKRUPTCY REPORTER
The Receiver has succinctly and accurately summarized Rhode Island law on
the relation of a school committee to its
municipality on the one hand and the State
on the other. The Rhode Island Constitution grants the General Assembly plenary
power over education.116 The General Assembly has exercised this power generally
by statutorily vesting power over education in local school committees:
The entire care, control, and management of all public school interests of the
several cities and towns shall be vested
in the school committees of the several
cities and towns.117
On the basis of this delegation, the Rhode
Island Supreme Court has held, in Cummings v. Godin and repeatedly thereafter,
that school committees are ‘‘agencies of
the state’’ in that they carry out by delegation the educational mission that resides in
the first instance in the General Assembly;
but in the same cases the court has further
held that school committees ‘‘are not ‘state
specified how many members the committee
would have and when their terms would commence, § 3–608(1), the manner of filling of
vacancies on the school committee, § 3–
608(2), and the qualifications of school committee members. § 3–608(3). And in Article
VI, entitled ‘‘Municipal Elections,’’ the 1952
charter contained two further sections, §§ 6–
107 and 6–108, that dealt exclusively with
school committee members and that were essentially duplicative §§ 3–608(1) and 3–
608(2). See Facts ¶ 19 above.
116. City of Pawtucket v. Sundlun, 662 A.2d
40, 56–57 (R.I.1995) (citing R.I. Const. art.
XII, § 1); see also Nat’l Educ. Ass’n of R.I. v.
Garrahy, 598 F.Supp. 1374, 1387 (D.R.I.1984)
(‘‘it is beyond gainsaying that under [Rhode
Island] state law, the state exercises supreme
responsibility in the arena of education’’).
117. R.I. Gen. Laws § 16–2–9(a); see also
East Providence School Committee v. Smith,
896 A.2d 49, 53 n. 4 (‘‘the General Assembly
has delegated its constitutional responsibilities for public education to [school committees]’’). General Laws 1938, ch. 178, § 22
agencies’ because their duties are limited
to matters of local rather than statewide
concern.’’ 118 It follows, Cummings concluded, that ‘‘a school committee is a municipal body and all of its employees, city
employees.’’ 119
Accordingly, in Cummings, the court held that an employee of
the Woonsocket public schools was an employee of the City of Woonsocket and subject to a provision in the Woonsocket city
charter applicable to city employees.120
And in Peters v. Jim Walter Door Sales of
Tampa, Inc., the court ruled that the City
of East Providence, and not the East Providence School Committee, was the proper
party defendant in a suit for the death of a
student from injuries he incurred in
school.121
In view of (i) the creation of the Central
Falls school committee by the 1952 city
charter, (ii) the General Assembly’s delegation of authority over education to the
various school committees, and (iii) the
was a precursor to G.L1956 § 16–2–9, which,
like the current version of the statute, vested
school committees with ‘‘the entire care, control, and management’’ of schools. East Providence School Committee v. Smith, 896 A.2d at
53 n. 3.
118. Cummings v. Godin, 119 R.I. 325, 377
A.2d 1071, 1073 (1977); Coventry School
Committee v. Richtarik, 122 R.I. 707, 411 A.2d
912, 915 (1980); Peters v. Jim Walter Door
Sales of Tampa, Inc., 525 A.2d 46, 47 (R.I.
1987); East Providence School Committee v.
Smith, 896 A.2d 49, 53 (R.I.2006); accord
Casey v. Newport School Committee, 13
F.Supp.2d 242 (D.R.I.1998) (applying Rhode
Island law and holding city, rather than
school committee, was proper defendant).
119. Cummings v. Godin, 377 A.2d at 1074;
Peters v. Jim Walter Door Sales of Tampa, Inc.,
525 A.2d at 47.
120.
Id.
121. Peters v. Jim Walter Door Sales of Tampa,
Inc., 525 A.2d at 47.
IN RE CITY OF CENT. FALLS, R.I.
Cite as 468 B.R. 36 (Bkrtcy.D.R.I. 2012)
Rhode Island Supreme Court’s holding
that a school committee, notwithstanding
its role as an agency of the state, is a
department of its municipality, I am satisfied that, at least until 1991 and the
changes that ensued, the School District
was part of the City.122
e.
The 1991 and 2002 Acts and the
Charter Amendment
Have subsequent events changed this
essentially constitutional relationship of
the City to its school district? The Receiver argues that notwithstanding the 1991
and 2002 Acts, which removed control of
the School District from the Central Falls
School Committee and placed it first in a
state administrator and then in the stateappointed Board of Trustees that continues to govern the School District, the essential relation of the City to the School
District remains unaffected. It must remain unaffected, the Receiver argues, because the 1991 and 2002 Acts were both
unilateral acts of the General Assembly,
but a permanent modification of the City’s
form of government would have required
an amendment to its charter, and, by constitutional requirement, R.I. Const. Art.
13, § 8 (procedure for amendments to
charters), that in turn would have required
a vote of the City’s electorate.123 Neither
Act was voted on by the City’s electorate.
The Receiver further contends that the
amendments to the City’s charter in 2007
essentially changed nothing and preserved
provisions for election of a school commit122. The Teachers’ Union appears to agree.
‘‘Over twenty years ago, the Central Falls
School District fit into the paradigm of a
municipally controlled school system that,
through its School Committee, administered
the State function of education within the
borders of its home municipality.’’ Teachers’
Unions Amended Memorandum, p. 37.
123. Viveiros v. Town of Middletown, 973 A.2d
607, 614 (R.I.2009) (‘‘once a town or city has
77
tee. Accordingly, despite the City’s longstanding lack of political control over the
School District, the School District’s inclusion in the City is unchanged. The arrangements effected by the 1991 and 2002
Acts must be viewed as temporary and
provisional. The Acts effected no permanent change in the form, structure, or
reach of City government. So argues the
Receiver.
The Teachers’ Union disagrees. I need
not set forth its arguments in full. It
suffices to note the Union’s position on the
2007 amendment to the city charter, which
is that the amendment terminated the
City’s school committee altogether.
[36] The court agrees. The critical
amendment was the deletion of the words
‘‘school committee’’ from § 3–100(c) of the
City’s charter.124 By virtue of those
words, § 3–100 had created a school committee and had indicated that the City’s
executive and administrative work would
be performed in part through that committee. The deletion disestablished the school
committee and left no board or agency
through which the City might control the
schools. Insofar as the State’s grant of
‘‘the care, control, and management’’ of the
schools in R.I. Gen. Laws § 16–2–9(a) is a
grant specifically to ‘‘the school committees
of the several cities and towns,’’ that
amendment effectively severed the City’s
constitutional connection to the School District. That action was undertaken in full
compliance with the legal procedures that
adopted a charter pursuant to the home rule
provisions of article 13 of the Rhode Island
Constitution, the charter can be modified only
by amendment pursuant to section 8’’).
124. It is undisputed that the amendment was
passed by the electorate and ratified by the
General Assembly, and satisfies the procedural requirement in R.I. Const. Art. 13, § 8 for
amendment of the charter.
78
468 BANKRUPTCY REPORTER
Rhode Island has established for self-governance. The electorate voted for the
change and the state legislature ratified it.
It can no longer be said that the structure
of the City’s government includes the care,
control, and management of the schools,
which is precisely the business of the
School District.
It is true, as the Receiver points out,
that the charter appears to have retained
provisions for election of a school committee, §§ 6–107 and 6–108. It is also true
that the deletion of §§ 3–608(1) and 3–
608(2) is, in itself, inconsequential, those
sections having been essentially duplicative of retained sections 6–107 and 6–108.
Likewise, the deletion of § 3–608(3) is in
itself of no real relevance, as it only removed certain limitations on school committee membership. Still, it is undisputed
(i) that the school committee itself was
deleted from the list in § 3–100 of the
independent boards and commissions by
which the City’s executive and administrative work would be performed and (ii) that
Chapter 14 of Article IV, which had set
forth the powers and duties of the school
committee, was also deleted. The deletions of §§ 3–608(1), 3–608(2), and 3–608(3)
are consistent with and confirmatory of
the deletion of school committee in § 3–
100. The deletion of the school committee
from § 3–100 must be given effect no less
125. Retirement Bd. of Employees’ Retirement
System of State v. DiPrete, 845 A.2d 270, 297
(R.I.2004) (‘‘We shall not interpret a statute to
include a matter omitted unless the clear purpose of the legislation would fail without the
implication.’’).
126. From the editor’s note, it appears that
Article VI of the charter, including §§ 6–107
and 6–108, may not in fact be part of the
amended charter at all but an editorial interjection of a 1953 legislative ‘‘fix’’ into the
published text of the amended charter. See
Facts ¶ 19, fn. 66 above. I need not make a
final determination of that issue because there
is no ambiguity in the critical deletions.
than the inclusion of ‘‘school committee’’ in
§ 3–100(c) was given effect before the deletion.125 The purpose of the surviving
provisions for electing school committee
members is unclear, and, aside from the
‘‘editor’s note’’ appearing in the volumes
setting forth the texts of the original and
amended charters, the parties have offered
no legislative history on the subject.126
Whatever their purpose, however, there is
nothing ambiguous about the deletion in
§ 3–100. There remains no charter-authorized school committee to which members might be elected.127
In view of this change to the charter and
the resulting disestablishment of the Central Falls school committee, it is unnecessary to determine whether the 1991 Act or
the 2002 Act effectively removed the
School District from the City. The deed
has in any event been done by other, more
fundamental, means.
As it stands, the Central Falls School
District has been assigned by the 2002 Act
and R.I. Gen. Laws § 16–2–34 to the control of the state-appointed Board of Trustees. The Board has been given ‘‘the powers and duties of a school committee.’’
The Board is independent of the City and
not mentioned in the City’s charter. Its
members are not elected by City voters,
appointed by City officials, or answerable
127. It is not clear whether the Receiver attaches significance to the fact that, at § 3–608
of the charter, where three deleted school
committee provisions previously resided, the
charter now says ‘‘reserved.’’ The word reserved in that place merely reserves the section number for possible future use. It does
not in any sense reserve the deleted provisions that had previously been codified at that
section number. In any event, the word reserved appears only in § 3–608 and not also
in § 3–100, the place of the deletion of real
consequence.
IN RE CITY OF CENT. FALLS, R.I.
Cite as 468 B.R. 36 (Bkrtcy.D.R.I. 2012)
to City authorities. Rather, they are appointed by the board of regents for elementary and secondary education from
nominations made by the commissioner of
elementary and secondary education.128
Four of its seven members ‘‘shall be residents of the city and parents of current or
former Central Falls public school students.’’ 129 But, as they do not hold their
positions by virtue of the charter and do
not answer to City electors or a City appointing officer, their City residency does
not make them City officials and does not
make the Board the City’s school committee. The political and constitutional separation of the School District from the City
is complete.130
I do not suggest that this state of affairs
is not temporary or provisional. Still, the
court cannot know the future and, in any
event, must judge this controversy according to present circumstances, not circumstances as they may yet develop.
f.
Facts Deemed Irrelevant
In making this determination, the court
has deemed certain facts to be of little or
no relevance, and these should be dealt
with expressly. First is the fact that the
City has been wholly dependent on outside
sources, mostly the State, for the funding
of its operating budget for over twenty
years. This fact is irrelevant because
there is no state law that makes it a factor
of significance to the continued relation of
128.
R.I. Gen. Laws § 16–2–34(b).
129.
Id.
130. This appears to be confirmed in the recent amendment of R.I. Gen. Laws § 16–2–
9(a)(18) by 2011 R.I. Pub. Laws ch. 11–265,
§ 1. Prior to the amendment, § 16–2–9(a)(18)
had simply indicated that ‘‘School committees
shall have TTT the following powers and
duties: TTT (18) To enter into contracts.’’ The
amendment added a proviso and an exception
to the proviso. The proviso is ‘‘that the pow-
79
this school district to this city. Municipalities routinely receive state funding, some
more than others. The Unions have cited
to me no feature of state law that might
alter the relation of a municipality to its
school district on the basis of the extent or
duration of its state funding. Much less
have they specified a legal tipping point.
Second is the duration of the period in
which the City has not had control of its
schools. Again, nothing in the governing
law states that after a certain number of
years in the care of a state administrator
or board of trustees, a city’s school district
ceases to be its school district. It is possible for the state to have stepped in as
caretaker for the City, even on an extended basis.
Third is the fact that state law may
require the City to contribute to the funding of its schools. Again, the court is
aware of no provision in the City’s charter
or in any state law that makes the School
District’s status—as part of the City or
not—dependent on the presence or absence of an obligation to fund.
Fourth, the Receiver has emphasized
that the School District lacks many of the
attributes of municipal sovereignty, such
as powers of taxation and eminent domain,
and therefore should not be deemed a
separate entity from the City. Under this
theory, the School District must be a dependency of some sort. Again, nothing in
the City’s charter or in any other state law
er and duty to enter into collective bargaining
agreements shall be vested in the chief executive officer of the municipality and not in the
school committee.’’ The exception expressly
excludes ‘‘the Central Falls school district
board of trustees established by § 16–2–34’’
from the application of the proviso, thus negating any implied power or duty of the
‘‘chief executive officer’’ of Central Falls to
enter into collective bargaining agreements
on behalf of the Central Falls School District.
80
468 BANKRUPTCY REPORTER
of which I am aware prohibits a city from
severing its relationship to its school district, however dependent, by a properly
approved and ratified amendment of its
charter that disestablishes its school committee, especially where the State has already provided other governance and support for the school district. States have
conjured all manner of entities and arrangements through which to fulfill their
objectives.
Fifth, the Receiver emphasizes that the
1991 Act, which replaced the City’s school
committee with a state administrator,
nonetheless expressly reserved for the
City the status of ‘‘fiscal agent.’’ It said:
‘‘The city of Central Falls shall continue to
be the fiscal agent for the Central Falls
school district, except that a separate interest-bearing checking account shall be
established for the school district.’’ 131 I
have attached little significance to this fact
for the following reasons. First, nowhere
in the record has the Receiver supplied
evidence of what it means to be the fiscal
agent. At least for lack of evidence establishing its import, the title ‘‘fiscal agent’’ is
wholly undefined and without significance.
Second, the title does not appear in the
City’s charter and therefore cannot constitute the basis for a continuing charterbased relationship between the City and
the School District. Third, the court is by
no means confident that the City’s status
as fiscal agent has survived the significant
changes to the relationship of the City to
the School District that occurred after the
1991 Act, especially the 2002 Act and the
amendment to the City’s charter.
and is a component unit of the State 132 are
essentially offered as opinions of law and
are therefore irrelevant. To the extent
that they are simply offered as accountants’ opinions, it suffices to note that accounting standards do not necessarily coincide with the law to be applied in this
proceeding and have no relevance.
Seventh, the evidence of the operational
independence of the School District from
the City—that it maintains separate bank
accounts and financial records, pays its
own payroll, purchases its own insurance,
enters into contracts, makes its own personnel policies and decisions, all independent of the City—is of little significance
for two reasons. First, it has no significance under Rhode Island law for the
charter-based relationship of the City to
the School District. Second, the Unions
have adduced no evidence that this practice differs from the practices of school
districts that are parts of their respective
municipalities.
g.
Conclusion as to Motion for Summary Judgment
Sixth, the labels and classifications in
the City’s and School District’s financial
statements to the effect that the School
District is not a component unit of the City
The material facts are not in controversy, but on the factual record established by
this motion, the Receiver is not entitled to
judgment as a matter of law. Rather, on
the governing law, it appears that judgment should enter against the Receiver
with a declaration that the School District
is not part of the City. Rule 56(f)(1) now
expressly permits a court to grant summary judgment for a nonmovant, but only
‘‘after giving notice and a reasonable time
to respond.’’ 133 The Court will hold a
status conference to determine whether
judgment should enter against the Receiver or, in the alternative, whether this adversary proceeding should proceed to trial,
131.
1991 R.I. Pub. Laws ch. 312, § 4(e).
133.
132.
See Facts ¶¶ 51–52.
Fed.R.Civ.P. 56(f)(1).
IN RE W.R. GRACE & CO.
Cite as 468 B.R. 81 (D.Del. 2012)
as provisionally scheduled. The Receiver’s
second count is dependent on the outcome
of the first. Upon a final determination
that the School District is not part of the
City, the second would be moot. Entry of
this decision should not be delayed for a
merely academic consideration of that issue. Therefore, as to Count Two, the
court will hold the Motion for Summary
Judgment in abeyance pending a determination as to whether summary judgment
will enter against the Receiver on Count
One. If that event, the court would enter
an order deeming Count Two moot.
ORDER
For the reasons set forth above, the
court hereby ORDERS as follows:
1. The Cross–Motion of the Teachers’
Union to Dismiss or Abstain is DENIED.
2. The two counts in this proceeding
are non-core matters that are otherwise
related to the City’s bankruptcy case. Under 28 U.S.C. § 157(c)(1), this court will
hear the adversary proceeding and, at the
conclusion, enter proposed findings of fact
and conclusions of law, subject to review
and entry of final judgment by the district
court as specified in § 157(c)(1) and related rules.
3. As to Count One, the Receiver’s Motion for Summary Judgment is DENIED,
and the court will schedule a hearing to
determine whether, under Fed.R.Civ.P.
56(f)(1), the court should grant summary
judgment for the Unions.
4. As to Count Two, decision on the
Motion for Summary Judgment is deferred.
5. Pursuant to Fed. R. Civ. P. 56(h),
the court hereby determines that the facts
in the Facts section of this memorandum,
except those enumerated below, are not
genuinely in dispute and are established in
this adversary proceeding. (This is not a
81
conclusion that every fact so established is
material.) The exceptions are the facts
appearing in (i) the footnote to ¶ 15, (ii)
¶ 15.3, (iii) ¶ 15.5, (iv) the second and third
sentences of ¶ 17, (v) the last sentence of
¶ 22, (vi) the last sentence of ¶ 26, (vii) the
last sentence of ¶ 28, (viii) the last sentence of ¶ 30, and (ix) the footnote to ¶ 57.
,
American Bar Association
Section of State and Local Government Law
2013 Annual Meeting
In re CITY OF STOCKTON,
CALIFORNIA,
Debtor(s)
720
475 BANKRUPTCY REPORTER
is no breakdown, the total fees and costs
requested appear to be reasonable for the
amount of work that was done. And these
are entitled to an administrative priority.
In re Multiple Allied Servs., 2010 WL
4505391, 2010 Bankr.LEXIS 3895 (Bankr.
N.D.Cal. Oct. 15, 2010).
SANCTIONS
[5] Although I am not happy about the
failure of Friedman to just admit that
there is little or no authority for its statement that many courts in the Ninth Circuit use the billing date approach, this is
not a frivolous motion, but rather it deals
with an unclear area of law, as can be seen
by my long analysis. Sanctions are denied.
CONCLUSION
HRI’s administrative claim is $70,558, its
claim for pre-petition arrearages is
$115,174 and its rejection claim under 11
U.S.C. § 502(b)(6) is $245,343. The security deposit is $24,000 and is to be applied to
the pre-petition arrearage claim, reducing
it to $91,174.
Varlow’s
administrative
claim
is
$45,236.85. This is calculated by apportioning the month of January 2006 between an administrative claim (though
January 8, 2006) and a rejection claim for
the balance of the month. As stated
above, Varlow appears to be entitled to an
administrative claim for the rent for the
full month of January 2006, but that has
not been requested.7 The Varlow unsecured claim of $98,108.64 is not affected by
this ruling.
,
7.
Doc. # 385.
In re CITY OF STOCKTON,
CALIFORNIA,
Debtor(s).
Nos. 12–32118–C–9.
United States Bankruptcy Court,
E.D. California.
July 13, 2012.
Background: Following conclusion of prefiling neutral evaluation required by newly-enacted California statute as a precondition for permitting a California municipality to file a Chapter 9 petition, city filed
emergency motion for leave to dispense
with confidentiality and introduce evidence
relating to the neutral evaluation process
so that it could establish its eligibility for
Chapter 9 relief.
Holdings: Addressing matters of first impression, the Bankruptcy Court, Christopher M. Klein, Chief Judge, held that:
(1) the California statutory confidentiality
requirement governing parties participating in the neutral evaluation process applies to determinations made
under the subsection of the Bankruptcy Code providing that, to be eligible
for Chapter 9, a municipality must be
specifically authorized, in its capacity
as a municipality or by name, to be a
debtor under Chapter 9 by state law,
or by a governmental officer or organization empowered by state law to authorize such entity to be a debtor under such chapter;
(2) once the neutral evaluation process
ended, the confidentiality requirement
ceased with respect to such information as the number and length of meetings between city and creditors, the
identity of meeting participants, the
IN RE CITY OF STOCKTON, CAL.
Cite as 475 B.R. 720 (Bkrtcy.E.D.Cal. 2012)
types of issues discussed, and the status of the parties’ negotiations;
(3) the financial and other information
shared, the offers exchanged, and the
discussions between the parties remained protected by the confidentiality
requirement, even after the neutral
evaluation process ended;
(4) the California neutral evaluation process is not protected by a federal privilege;
(5) it was appropriate to issue a limited
protective order to preserve the confidentiality of the statements made, information disclosed, or documents prepared or produced during the neutral
evaluation process; and
(6) city was authorized to release proposed
plan that formed basis for discussions
during the neutral evaluation process.
So ordered.
721
the municipality must satisfy a creditor
negotiation requirement, through one of
four enumerated alternatives, and (6) the
petition must have been filed in good faith.
11 U.S.C.A. §§ 109(c), 921(c).
3. Bankruptcy O2232, 3481
If the five essential elements to be a
Chapter 9 debtor set forth in the section of
the Bankruptcy Code governing who may
be a debtor are satisfied, then the court
must order relief unless the debtor did not
file the petition in good faith. 11 U.S.C.A.
§§ 109(c), 921(c).
4. Bankruptcy O2236
Burden of proof, at least as to the five
essential elements to be a Chapter 9 debtor set forth in the section of the Bankruptcy Code governing who may be a debtor, is
on the municipality as the proponent of
voluntary relief. 11 U.S.C.A. § 109(c).
5. Bankruptcy O2236
1. Bankruptcy O2232, 3481
Filing of a voluntary Chapter 9 petition does not constitute an order for relief;
rather, the municipality must be prepared
to litigate its way to an order for relief by
demonstrating its eligibility to be a Chapter 9 debtor and establishing that it filed
the petition in good faith. 11 U.S.C.A.
§§ 109(c), 921(c, d).
Quantum of proof as to the five essential elements to be a Chapter 9 debtor set
forth in the section of the Bankruptcy
Code governing who may be a debtor is
the familiar preponderance-of-evidence
standard of basic civil litigation, there being no contrary indication in statute or in
controlling decisional law. 11 U.S.C.A.
§ 109(c).
2. Bankruptcy O2232, 3481
Six essential elements for eligibility to
be a Chapter 9 debtor are as follows: (1)
there must be a ‘‘municipality,’’ (2) the
municipality must be specifically authorized, in its capacity as a municipality or by
name, to be a debtor under Chapter 9 by
state law, or by a governmental officer or
organization empowered by state law to
authorize such entity to be a debtor under
such chapter, (3) the municipality must be
‘‘insolvent,’’ (4) the municipality must desire to effect a plan to adjust the debts it is
generally not paying or unable to pay, (5)
6. Bankruptcy O2236, 3481
Procedure for resolving the Chapter 9
eligibility question resembles ordinary federal civil litigation: the petition and supporting materials function as the equivalent of a complaint and objections to the
petition as the answer, while material factual disputes will be resolved by way of
trial. 11 U.S.C.A. §§ 921, 923; Fed.Rules
Bankr.Proc.Rule 9014, 11 U.S.C.A.
7. Bankruptcy O2156
Procedure set forth in the bankruptcy
rule governing contested matters applies
722
475 BANKRUPTCY REPORTER
in Chapter 9. Fed.Rules Bankr.Proc.Rule
9014, 11 U.S.C.A.
8. Bankruptcy O3481
For a city to be entitled to an order
for relief under Chapter 9, at least a prima
facie case needs to be stated. 11 U.S.C.A.
§ 109(c); Fed.Rules Bankr.Proc.Rule 9014,
11 U.S.C.A.
9. Bankruptcy O3481
If there are no objections to a city’s
Chapter 9 petition, then the court will be
entitled, but not required, to rely on the
city’s prima facie case as a basis for ordering relief. 11 U.S.C.A. § 109(c); Fed.
Rules Bankr.Proc.Rule 9014, 11 U.S.C.A.
10. Bankruptcy O3481
If there are objections to a city’s
Chapter 9 petition, a trial will ensue. 11
U.S.C.A. § 109(c); Fed.Rules Bankr.Proc.
Rule 9014, 11 U.S.C.A.
11. Bankruptcy O2232
Under California law, any county, city,
district, public authority, public agency, or
entity that qualifies as a municipality under the federal Bankruptcy Code, other
than a school district, may be a debtor
under Chapter 9, provided that it satisfies
certain preconditions, namely, that the municipality either engages in a neutral evaluation process for a specified period, or
that its governing board declares a fiscal
emergency pursuant to specified procedures. 11 U.S.C.A. § 109(c)(2); West’s
Ann.Cal.Gov.Code § 53760.
12. Bankruptcy O2232
Under California law, if the neutral
evaluation process required before a municipality may seek Chapter 9 relief concludes without having resolved all pending
disputes with creditors, the municipality
may file a Chapter 9 petition. West’s Ann.
Cal.Gov.Code §§ 53760, 53760.3(u).
13. Bankruptcy O2232
Under California law, the municipality
and all interested parties participating in
the neutral evaluation process required before a municipality may seek Chapter 9
relief have a duty to negotiate in good
faith. West’s Ann.Cal.Gov.Code §§ 53760,
53760.3(o ).
14. Bankruptcy O2232
Under California law, the parties participating in the neutral evaluation process
required before a municipality may seek
Chapter 9 relief must maintain the confidentiality of the neutral evaluation process.
West’s
Ann.Cal.Gov.Code
§§ 53760,
53760.3(q).
15. Bankruptcy O3481
Because a Chapter 9 case is, by definition, a federal proceeding in a federal
court, the Federal Rules of Evidence, including the rule governing privilege, apply
to such a case. Fed.Rules Evid.Rule 501,
28 U.S.C.A.
16. Bankruptcy O3047(2)
Federal rules on privilege apply to all
stages of a Chapter 9 case. Fed.Rules
Evid.Rules 501, 1101(c), 28 U.S.C.A.
17. Bankruptcy O2232, 3047(2)
California statutory confidentiality requirement governing parties participating
in the neutral evaluation process required
before a municipality may seek Chapter 9
relief applies to determinations made under the subsection of the Bankruptcy Code
providing that, to be eligible for Chapter 9,
a municipality must be specifically authorized, in its capacity as a municipality or by
name, to be a debtor under Chapter 9 by
state law, or by a governmental officer or
organization empowered by state law to
authorize such entity to be a debtor under
such chapter; state law provides the rule of
decision for this eligibility question. 11
U.S.C.A. § 109(c)(2); West’s Ann.Cal.Gov.
IN RE CITY OF STOCKTON, CAL.
Cite as 475 B.R. 720 (Bkrtcy.E.D.Cal. 2012)
Code § 53760.3(q); Fed.Rules Evid.Rule
501, 28 U.S.C.A.
18. Bankruptcy O3047(2)
Phrase ‘‘maintain the confidentiality of
the neutral evaluation process,’’ as used in
the California statutory confidentiality requirement governing parties participating
in the neutral evaluation process required
before a municipality may seek Chapter 9
relief, functions to impose a shroud of secrecy only during the pendency of the
process.
West’s
Ann.Cal.Gov.Code
§ 53760.3(q).
See publication Words and Phrases for other judicial constructions
and definitions.
19. Bankruptcy O3047(2)
California statutory confidentiality
protection applicable to parties participating in the neutral evaluation process required before a municipality may seek
Chapter 9 relief ceased, once the evaluation process ended, with respect to (1) the
number and length of meetings between
city and its various creditors, (2) the identity of the participants at such meetings,
(3) the types of issues discussed, and (4)
the status of negotiations between city and
each interested party as of the petition
date; accordingly, such information could
be revealed by city to establish its eligibility for Chapter 9 relief. 11 U.S.C.A.
§ 109(c)(2);
West’s
Ann.Cal.Gov.Code
§ 53760.3(q).
20. Bankruptcy O3047(2)
California statutory confidentiality
protection applicable to parties participating in the neutral evaluation process required before a municipality may seek
Chapter 9 relief remained, even after completion of the evaluation process, with respect to financial and other information
shared, the offers exchanged, and the discussions between the parties; because the
court was not persuaded that any of the
723
statements made, information disclosed, or
documents prepared or produced during
the process were necessary to determine
eligibility, such information could not be
revealed by city to establish its eligibility
for Chapter 9 relief.
11 U.S.C.A.
§ 109(c)(2);
West’s
Ann.Cal.Gov.Code
§ 53760.3(q).
21. Bankruptcy O3047(2)
California neutral evaluation process
required before a municipality may seek
Chapter 9 relief is not protected by a
federal settlement negotiation privilege.
Fed.Rules Evid.Rule 501, 28 U.S.C.A.;
West’s Ann.Cal.Gov.Code § 53760.
22. Bankruptcy O3047(2)
In city’s Chapter 9 case, it was appropriate for the bankruptcy court to issue a
limited protective order to preserve confidentiality of the statements made, information disclosed, or documents prepared or
produced during the pre-filing neutral
evaluation process mandated by California
law for cities desiring Chapter 9 relief;
although the pre-filing discussions had
concluded, the settlement discussions were
not finished, and such discussions would be
vital to the formulation of a successful plan
for the adjustment of city’s debts. West’s
Ann.Cal.Gov.Code § 53760.
23. Bankruptcy O2232, 3047(2)
City was authorized to release the
proposed plan that formed the basis for
discussions during the pre-filing neutral
evaluation process mandated by California
law for cities desiring Chapter 9 relief;
disclosure of plan or ‘‘ask’’ that detailed
city’s current situation and laid out a proposed plan to address city’s financial shortfall was part of city’s prima facie case on
the issue of its eligibility for Chapter 9
protection. 11 U.S.C.A. § 109(c)(5)(B);
West’s Ann.Cal.Gov.Code § 53760.
724
475 BANKRUPTCY REPORTER
Marc A. Levinson (argued), Norman C.
Hile, John W. Killeen, Orrick, Herrington
& Sutcliffe LLP, Sacramento, CA, for
debtor.
OPINION ON MOTION FOR LEAVE
TO INTRODUCE EVIDENCE RELATING TO NEUTRAL EVALUATION PROCESS UNDER CALIFORNIA GOVERNMENT CODE
§ 53760.3(q)
CHRISTOPHER M. KLEIN, Chief
Judge.
This case of first impression involves the
boundaries, the interplay, and the common
ground between federal law and state law
in the context of the confidentiality requirement in California’s new statute channeling a municipality through a neutral
evaluation process before filing a chapter 9
case to adjust debts under the U.S. Bankruptcy Code.
Upon filing this chapter 9 case, the City
of Stockton filed the instant motion invoking the part of California Government
Code § 53760.3(q) that authorizes a bankruptcy judge to lift the shroud of confidentiality from the pre-filing neutral evaluation for the limited purpose of establishing
the City’s eligibility for chapter 9 relief.
This court accepts the invitation only with
respect to the one chapter 9 eligibility
element for which state law provides the
rule of decision and otherwise declines because state evidence law does not govern
evidence in federal court on issues when
federal law provides the rule of decision.
Nevertheless, federal policy encouraging settlement also favors preserving confidentiality of compromise discussions and
permits federal trial judges to ration the
disclosure of confidential settlement discussions on their own authority. Hence,
this court will impose a confidentiality
protective order and take an incremental
approach to disclosure as there is no indi-
cation in the case as yet that detailed evidence of confidential discussions will be
needed in order to determine chapter 9
eligibility.
Facts
The City of Stockton, California, filed
this chapter 9 case on June 28, 2012, following the conclusion of the newly-enacted
pre-filing neutral evaluation required by
California Government Code § 53760 as a
precondition for permitting a California
municipality to. file a chapter 9 case.
The next day, the City filed this Emergency Motion For Leave To Introduce Evidence Relating To Neutral Evaluation
Process
Under
Government
Code
§ 53760.3(q) seeking permission to introduce evidence as to: (1) the number and
length of meetings between the City and
its creditors; (2) the identity of the participants at such meetings; (3) the types of
issues discussed; (4) the financial and other information shared; (5) the offers exchanged and the discussions between the
parties; and (6) the status of negotiations
between the City and each interested party as of the petition date.
Oral argument was entertained in open
court on July 6, 2012. This decision memorializes the ruling made from the bench
at the end of that hearing.
Analysis
Context matters. Here, what is going
on is the process of determining whether
to enter an order for relief, which is the
initial judicial task in every chapter 9 case.
We begin with an inventory of the essential elements for chapter 9 eligibility and
how one goes about determining them,
before assessing the effect of Government
Code § 53760 on this chapter 9 case.
I
[1] Chapter 9 is peculiar in that the
filing of a voluntary petition does not con-
725
IN RE CITY OF STOCKTON, CAL.
Cite as 475 B.R. 720 (Bkrtcy.E.D.Cal. 2012)
stitute an order for relief. 11 U.S.C.
§ 921(d). Rather, the municipality must
be prepared to litigate its way to an order
for relief in its voluntary case by demonstrating its eligibility to be a chapter 9
debtor and establishing that it filed the
petition in good faith. 11 U.S.C. §§ 109(c)
& 921(c).
A
[2] Five essential elements for eligibility to be a chapter 9 debtor are set forth at
11 U.S.C. § 109(c), to which is appended a
good faith filing requirement by 11 U.S.C.
§ 921(c).
2 COLLIER ON BANKRUPTCY
¶ 109.04 (Alan N. Resnick & Henry J.
Sommer eds. 16th ed. 2011) (‘‘COLLIER’’).
First, there must be a ‘‘municipality,’’
which is defined as a ‘‘political subdivision
or public agency or instrumentality of a
State.’’ 11 U.S.C. §§ 101.(40) & 109(c)(1);
2 COLLIER ¶ 109.04[3][a].
Second, the municipality must be specifically authorized, in its capacity as a municipality or by name, to be a debtor under
chapter 9 by state law, or by a governmental officer or organization empowered by
state law to authorize such entity to be a
debtor under such chapter. 11 U.S.C.
§ 109(c)(2); 2 COLLIER ¶ 109.04[3][b].
Third, the municipality must be ‘‘insolvent,’’ which is specially defined for chapter 9 purposes as ‘‘(i) generally not paying
its debts as they become due unless such
debts are the subject of a bona fide dispute; or (ii) unable to pay its debts as they
become due.’’ 11 U.S.C. §§ 101(32)(C) &
109(c)(3); 2 COLLIER ¶ 109.04[3][c].
Fourth, the municipality must desire to
effect a plan to adjust the debts it is
generally not paying or unable to pay. 11
1.
Given that the City is relying in this instance
on the good-faith negotiation prong of
§ 109(c)(5)(B), debate about who has the
good-faith filing burden under § 921(c) can
U.S.C.
§ 109(c)(4);
¶ 109.04[3][d].
2
COLLIER
Fifth, a creditor negotiation requirement
may be satisfied by one of four alternatives. The municipality must have: (A)
obtained the agreement of creditors holding at least a majority in amount of the
claims of each class that it intends to impair under a chapter 9 plan; or (B) negotiated in good faith with creditors and have
failed to obtain the agreement of creditors
holding at least a majority in amount of
the claims of each class that it intends to
impair under a chapter 9 plan; or (C) be
unable to negotiate with creditors because
such negotiation is impracticable; or (D)
reasonably believe that a creditor may attempt to obtain a transfer that is avoidable
as a preference. 11 U.S.C. § 109(c)(5); 2
COLLIER ¶ 109.04[3][e].
Here, the City relies on the good-faith
negotiation prong at § 109(c)(5)(B) of the
creditor negotiation requirement.
[3] If the five essential elements are
satisfied, then the court must order relief
unless the debtor did not file the petition
in good faith. Thus, this latter ‘‘good faith
filing’’ element can be regarded as a sixth
essential element for chapter 9 relief in the
sense that relief will not be ordered if the
case was not filed in good faith. Compare
11 U.S.C. § 921(c), with id. § 921(d).
B
[4] The burden of proof, at least as to
the five § 109(c) elements, is on. the municipality as the proponent of voluntary
relief.1 Int’l Assn. of Firefighters, Local
1186 v. City of Vallejo (In re City of
Vallejo), 408 B.R. 280, 289 (9th Cir. BAP
2009) (‘‘Vallejo ’’); In re Valley Health
safely be left to another day as it seems improbable (but not impossible) that good-faith
negotiations would precede a filing that is
made not in good faith.
726
475 BANKRUPTCY REPORTER
Sys., 383 B.R. 156, 161 (Bankr.C.D.Cal.
2008) (‘‘Valley Health ’’); In re County of
Orange, 183 B.R. 594, 599 (Bankr.C.D.Cal.
1995) (‘‘Orange County ’’); 2 COLLIER
¶ 109.04[2].
[5] The quantum of proof, there being
no contrary indication in statute or in controlling decisional law, is the familiar preponderance-of-evidence standard of basic
civil litigation. Nothing suggests there
should be a higher burden. This conclusion comports with the argument by the
authors of the Collier treatise that the
burden should be liberally applied in favor
of granting relief. 2 COLLIER ¶ 109.04[3].
Clarifying that the quantum of the burden is preponderance of evidence matters
in the present instance because the logic
behind the breadth of the City’s request to
dispense with confidentiality of the prefiling neutral evaluation appears to rest on
the incorrect premise that the City will be
subjected to some higher standard of proof
than preponderance of evidence.
C
[6] The procedure for resolving the
eligibility question resembles ordinary
federal civil litigation. The petition and
supporting materials function as the
equivalent of a complaint and objections
to the petition as the answer. Material
factual disputes will be resolved by way
of trial.
Once the petition is filed, notice of commencement of the case must be published
for three consecutive weeks in a newspaper of general circulation within the district and a newspaper of general circulation among bond dealers and bondholders.
11 U.S.C. § 923. One purpose of such
notice is to alert parties in interest to the
opportunity to ‘‘object’’ to the petition.
The court resolves objections to the petition by following a notice and hearing procedure. 11 U.S.C. §§ 921(c)-(d).
[7] By process of elimination, the relevant procedure is the Rule 9014 ‘‘contested
matter.’’ Fed. R. Bankr.P. 9014. Although the notice-and-hearing requirement
of § 921(c) puts the question of the order
for relief into a litigation context, the Federal Rules of Civil Procedure do not directly specify a procedure for chapter 9 cases.
Neither the contested petition provisions
of Rules 1011 and 1018 nor the adversary
proceeding rule apply in chapter 9. What
remains is the Rule 9014 ‘‘contested matter’’ procedure.
Under Rule 9014, aside from the absence of formal pleadings, most of the
adversary proceeding rules apply. Fed. R.
Bankr.P. 9014(c). Testimony of witnesses
in any disputed material factual issue in a
contested matter must be taken in the
same manner as testimony in an adversary
proceeding—in other words, a fact-based
contest in a contested matter is to be
resolved by way of trial. Fed. R. Bankr.P.
9014(d).
[8] As the petition and supporting documents function as a complaint to place
before the court the allegations and factual
basis for relief, it is appropriate that facts
be alleged with respect to each essential
element sufficient to make plausible the
proposition that the City is entitled to an
order for relief. In other words, at least a
prima facie case needs to be stated.
Indeed, the City urges that its need to
assert a plausible case as to each essential
element for eligibility justifies dispensing
with all of the confidentiality protecting
the pre-filing neutral evaluation discussions. As will be explained, however, a
more incremental approach is appropriate.
[9, 10] The actual nature and extent of
the litigation and the increments of disclo-
727
IN RE CITY OF STOCKTON, CAL.
Cite as 475 B.R. 720 (Bkrtcy.E.D.Cal. 2012)
sure will depend upon the issues that are
actually joined by way of objection to the
petition. If there are no objections, then
the court will be entitled (but not required)
to rely on the prima facie case as a basis
for ordering relief. If there are objections, a trial will ensue, the complexion of
which will depend upon the nature of the
dispute and may trigger broader disclosure of pre-filing discussions.
II
The state is the chapter 9 gatekeeper by
virtue of § 109(c)(2). But that gatekeeping function ends once the. gate is opened
and a chapter 9 case is filed.
[11] California has engineered the parameters of its gate in California Government Code § 53760, which authorizes any
county, city, district, public authority, public agency, or entity that qualifies as a
municipality under the Federal Bankruptcy Code, other than a school district,2 to be
a debtor under chapter 9 but recently imposed preconditions for which this case
functions as the maiden voyage. The municipality must either engage in a neutral
evaluation process for a specified period or
its governing board must declare a fiscal
emergency pursuant to specified procedures. CAL. GOVT.CODE § 53760.3
A
B
The gate is the requirement that a municipality is eligible to be a debtor in a
chapter 9 case only if it is specifically
authorized by state law, or by a governmental officer or organization empowered
by state law to authorize the municipality
to be a debtor under chapter 9. 11 U.S.C.
§ 109(c)(2).
[12] If the neutral evaluation process
concludes without having resolved all
pending disputes with creditors, the municipality may file a chapter 9 petition.
CAL. GOVT.CODE § 53760.3(u).4
2.
The statute applies to any ‘‘local public entity,’’ which is defined as:
(f) ‘‘Local public entity’’ means any county, city, district, public authority, public
agency, or other entity, without limitation,
that is a municipality as defined in Section
101(40) of Title 11 of the United States
Code (bankruptcy), or that qualifies as a
debtor under any other federal bankruptcy
law applicable to local public entities. For
purposes of this article, ‘‘local public entity’’ does not include a school district.
CAL. GOVT.CODE § 53760.1(g).
3. The basic authorization is:
A local public entity in this state may file
a petition and exercise powers pursuant to
applicable federal bankruptcy law if either
of the following apply:
(a) The local public entity has participated in a neutral evaluation process pursuant
to Section 53760.3.
(b) The local public entity declares a fiscal emergency and adopts a resolution by a
[13] The municipality and all interested parties participating in the neutral evalmajority vote of the governing board pursuant to Section 53760.5.
CAL. GOVT.CODE § 53760, as amended by Assembly Bill 506, approved by Governor, October 9, 2011, effective January 1, 2012.
4.
The statute provides:
(u) If the 60–day time period for neutral
evaluation has expired, including any extension of the neutral evaluation past the
initial 60–day time period pursuant to subdivision (r), and the neutral evaluation is
complete with differences resolved, the neutral evaluation shall be concluded. If the
neutral evaluation process does not resolve
all pending disputes with creditors the local
public entity may file a petition and exercise powers pursuant to applicable federal
bankruptcy law if, in the opinion of the
governing board of the local public entity, a
bankruptcy filing is necessary.
CAL. GOVT.CODE § 53760.3(u).
728
475 BANKRUPTCY REPORTER
uation process have a duty to negotiate in
good faith. CAL. GOVT.CODE § 53760.3(o ).
[14] The parties must maintain the
confidentiality of the neutral evaluation
process and ‘‘not disclose statements
made, information disclosed, or documents
prepared or produced, during the neutral
evaluation process, at the conclusion of the
neutral evaluation process,’’ or during any
bankruptcy proceeding except upon agreement of all parties or, for the limited purpose of determining chapter 9 eligibility
under § 109(c), upon permission of the
bankruptcy judge.
CAL. GOVT.CODE
§ 53760.3(q).5
III
The question becomes the extent to
which the California confidentiality provision applies in the conduct of this chapter
9 case and, to the extent it does not apply,
how to deal with matters warranting confidentiality.
A
[15] A chapter 9 case is, by definition,
a federal proceeding in a federal court.
One particular consequence is that the
Federal Rules of Evidence apply to this
bankruptcy case.
E.g., Fed.R.Evid.
1101(b).
With respect to privileges—and California’s confidentiality requirement arguably
in the nature of a privilege under Califor5.
The precise statutory language is:
(q) The parties shall maintain the confidentiality of the neutral evaluation process
and shall not disclose statements made, information disclosed, or documents prepared or produced during the neutral evaluation process, at the conclusion of the
neutral evaluation process or during any
bankruptcy proceeding unless either of the
following occur:
(1) All persons that conduct or otherwise
participate in the neutral evaluation expressly agree in writing, or orally in accordance with Section 1118 of the Evidence
nia Evidence Code § 1119 6—the controlling federal provision is Federal Rule of
Evidence 501:
Rule 501.
Privilege in General
The common law—as interpreted by
United States courts in the light of reason and experience—governs a claim of
privilege unless any of the following provides otherwise:
1 the United States Constitution;
1 a federal statute; or
1 rules prescribed by the Supreme
Court.
But in a civil case, state law governs
privilege regarding a claim or defense
for which state law supplies the rule of
decision.
Fed.R.Evid. 501.
[16] The rules on privilege apply to all
stages of this chapter 9 case. Fed.R.Evid.
1101(c).
It follows that the confidentiality provision of California Government Code
§ 53760.3(q) apply only to the extent that
this bankruptcy court confronts a question
governed by a state rule of decision.
[17] In the context of chapter 9 eligibility, state law provides the rule of decision only for § 109(c)(2): whether the entity ‘‘is specifically authorized, in its capacity
as a municipality or by name, to be a
debtor under such chapter by State law, or
Code, to disclosure of the communication,
document, or writing.
(2) The information is deemed necessary
by a judge presiding over a bankruptcy proceeding pursuant to Chapter 9 of Title 11 of
the United States Code to determine eligibility of a municipality to proceed with a
bankruptcy proceeding pursuant to Section
109(c) of Title 11 of the United States Code.
CAL. GOVT.CODE § 53760.3(q).
6. Cf. Government Code § 53760.3(q) (specifically incorporating Cal. Evid.Code § 1118).
IN RE CITY OF STOCKTON, CAL.
Cite as 475 B.R. 720 (Bkrtcy.E.D.Cal. 2012)
by a governmental officer or organization
empowered by State law to authorize such
entity to be a debtor under such chapter;[.]’’
Indeed, § 109(c)(2) presents a question
of pure state law. Under that provision, it
has been determined as a matter of New
York State constitutional law that the Governor of New York had the authority to
authorize an entity to file a chapter 9 case.
In re N.Y.C. Off–Track Betting Corp., 427
B.R. 256, 264 (Bankr.S.D.N.Y.2010). By
the same token, nothing in New York law
empowered the Suffolk County (N.Y.) Legislature to authorize a chapter 9 filing. In
re Suffolk Regional Off–Track Betting
Corp., 462 B.R. 397, 414–21 (Bankr.
E.D.N.Y.2011).
Here, California constructed its own
gate at the entrance to the chapter 9 arena
and is entitled to have it construed as a
matter of state law.
All other eligibility questions under
§ 109(c)—§ 109(c)(1)
municipality;
§ 109(c)(3) insolvent; § 109(c)(4) desire to
effect plan of adjustment; and § 109(c)(5)
creditor negotiation—and the good faith
question under § 921(c) are federal questions based on, and created by, the federal
Bankruptcy Code and subject to a federal
rule of decision as to which the California
confidentiality provision does not control.
In short; the only portion of California
Government Code § 53760.3(q) that applies to the chapter 9 eligibility analysis in
this instance is the question whether the
City complied with the neutral evaluation
requirement.
B
Having concluded that the California
statutory confidentiality requirement applies to § 109(c)(2), but only to § 109(c)(2),
the focus shifts to what the City wants
permission to disclose, which begins with a
729
focus on the precise terms and meaning of
the confidentiality statute in order to ascertain what is and is not protected.
The terms of California Government
Code § 53760.3(q) provide (with the critical terms emphasized):
(q) The parties shall maintain the
confidentiality of the neutral evaluation
process and shall not disclose statements
made, information disclosed, or documents prepared or produced during the
neutral evaluation process, at the conclusion of the neutral evaluation process or
during any bankruptcy proceeding unless either of the following occur:
(1) All persons that conduct or otherwise participate in the neutral evaluation expressly agree in writing, or
orally in accordance with Section 1118
of the Evidence Code, to disclosure of
the communication, document, or
writing.
(2) The information is deemed necessary by a judge presiding over a
bankruptcy proceeding pursuant to
Chapter 9 of Title 11 of the United
States Code to determine eligibility of
a municipality to proceed with a bankruptcy proceeding pursuant to Section
109(c) of Title 11 of the United States
Code.
CAL. GOVT.CODE § 53760.3(q) (emphases
supplied).
The important question relates to the
meaning of the phrase ‘‘maintain the confidentiality of the neutral evaluation process.’’ It is noteworthy that the remainder
of the section refers only to specific categories of statements, communications, information, and documents and is followed
by a temporal clause extending the protection beyond the conclusion of the neutral
evaluation process. Further, the part that
provides that all parties can agree to disclosure of communications, documents, or
730
475 BANKRUPTCY REPORTER
writings says nothing about the process
itself. CAL. GOVT.CODE § 53760.3(q)(1).
The analysis is informed by two findings made by the California legislature in
Assembly Bill 506 (‘‘AB 506’’), which enacted the amendments to Government
Code § 53760 creating the neutral evaluation process. First, it found that ‘‘allowing the interested parties to exchange information in a confidential environment
with the assistance and supervision of a
neutral evaluator’’ assists in determining
whether obligations can be renegotiated
on a consensual basis.7 Second, it made
findings designed to excuse the neutral
evaluation process from open meeting
laws, which findings focused on the need
for ‘‘secure documents.’’
pendency of the process. During the
pendency of the process, it is not permissible to reveal the number and length of
meetings, the identity of the participants,
the types of issues discussed, and the status of negotiations because that information is part of the ‘‘confidentiality of the
neutral evaluation process.’’ While there
may be good reason to continue to protect
‘‘statements made,’’ ‘‘information disclosed,’’ and ‘‘documents prepared or produced’’ even after the neutral evaluation
process concludes, the justification is
weaker for protecting the number and
length of meetings, identity of participants, types of issues discussed, and status of negotiations when the process concludes.
The statute is not ambiguous on what
remains confidential after the neutral evaluation process is completed. What remains protected are the more specific
items listed in Government Code
§ 53760.3(q): ‘‘statements made,’’ ‘‘information disclosed,’’ and ‘‘documents prepared or produced’’ or, as listed later in
the provision, ‘‘communication,’’ ‘‘document,’’ and ‘‘writing.’’ This is generally
consistent with the ‘‘secure document’’
finding of § 7 of AB 506.
[19] This brings into focus the City’s
request that this court grant permission
under the authority conferred on a bankruptcy judge by Government Code
§ 53760.3(q)(2) to reveal: (1) the number
and length of meetings between the City
and its various creditors; (2) the identity
of the participants at such meetings; (3)
the types of issues discussed; and (4) the
status of negotiations between the City
and each interested party as of the petition
date.
[18] But the statute is ambiguous
about the temporal aspect of the meaning
of the phrase ‘‘maintain the confidentiality
of the neutral evaluation process’’ in Government Code § 53760.3(q). In context,
the court concludes that it is a reference
to the entire process that functions to impose a shroud of secrecy only during the
While this information was appropriately
embargoed during the conduct of the neutral evaluation process by virtue of the
‘‘maintain the confidentiality’’ clause, that
confidentiality protection ceased, as a matter of California law, once that process
ended. Accordingly, there is no present
impediment of California law to revelation
7.
The precise finding in AB 506 on this point
is:
(g) Through the neutral evaluation process, the neutral evaluator, a specially
trained, neutral third party, can assist the
municipality and its creditors and stakeholders to fully explore alternatives, while
allowing the interested parties to exchange
information in a confidential environment
with the assistance and supervision of a
neutral evaluator to determine whether the
municipality’s contractual and financial obligations can be renegotiated on a consensual basis.
Cal. Assembly Bill 506, § 1(g), enacted and
approved by Governor, Oct. 9, 2011.
731
IN RE CITY OF STOCKTON, CAL.
Cite as 475 B.R. 720 (Bkrtcy.E.D.Cal. 2012)
of that information in and during the chapter 9 case.
prejudice to being revisited in the event a
subsequent contest over § 109(c)(2) arises.
[20] The remainder of the City’s request—to reveal ‘‘financial and other information shared, the offers exchanged and
the discussions between the parties’’—does
remain protected by § 53760.3(q). because
those categories fit within the statutory
categories ‘‘statements made, information
disclosed, or documents prepared or produced’’ for which protection unambiguously survives after completion of the neutral
evaluation process.
C
This court is not presently persuaded
that any of the statements made, information disclosed, or documents prepared or
produced during the neutral evaluation
process, all of which remain protected under the California confidentiality requirement, are ‘‘necessary TTT to determine eligibility’’ under § 109(c)(2). CAL. GOVT.
CODE § 53760.3(q)(2). As to eligibility issues under §§ 109(c)(1) and (c)(3), (c)(4),
and (c)(5), those are federal issues that will
be addressed in the next section.
As to the state law issue under
§ 109(c)(2), the information that either is
not, or is no longer, protected (i.e. number
and length of meetings, identity of participants, types of issues discussed, and status
of negotiations as of petition date) is eligible to be used without restriction and
ought to suffice to establish at least a
prima facie case that § 109(c)(2) has been
satisfied and that, as a matter of California
law, the City is permitted to file a chapter
9 case. Indeed, as to status of negotiations, counsel for the City announced during the hearing on the motion that agreements had been reached with two unions
to amend collective bargaining agreements.
Accordingly, the City’s request under
California
Government
Code
§ 53760.3(q)(1) will be denied, without
The analysis now shifts to the federal
law facet of the confidentiality issue. All
chapter 9 eligibility issues except
§ 109(c)(2) are creatures of federal law,
and federal law provides the rule of decision.
Federal policy is as encouraging of settlements as is state law, but it takes the
different tack of preferring such tools as
limiting admissibility in evidence and the
protective order as being able to be fashioned to particular situations with more
precision than a blanket privilege.
1
[21] We begin by dispensing with the
issue of privilege. Federal Rule of Evidence 501 controls privileges in federal
litigation and, as relevant to settlement
and mediation discussions, relies on federal
common law.
As no settlement discussion privilege or
mediation privilege is recognized in either
the U.S. Constitution, or a federal statute,
or rules prescribed by the Supreme Court,
the question becomes whether there is a
common-law privilege that has been judicially recognized ‘‘in the light of reason
and experience.’’ Fed.R.Evid. 501.
There is an ongoing debate over whether there should be a federal common law
settlement negotiation privilege. In re
MSTG, Inc., 675 F.3d 1337, 1342 (Fed.Cir.
2012) (‘‘MSTG’’). The circuits that have
addressed the question are divided. The
Sixth Circuit recognizes such a privilege;
the Seventh Circuit and the Federal Circuit do not. Goodyear Tire & Rubber Co.
v. Chiles Power Supply, Inc., 332 F.3d 976,
979–83 (6th Cir.2003) (privilege recognized); In re Gen. Motors Corp. Engine
Interchange Litigation, 594 F.2d 1106,
1124 n. 20 (7th Cir.1979) (no privilege);
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475 BANKRUPTCY REPORTER
MSTG, 675 F.3d at 1343–48 (no privilege).
Although the Ninth Circuit does not appear to have taken a position, district
courts within the Ninth Circuit are divided
on the question. Matsushita Elec. Indus.
Co. v. Mediatek, Inc., 2007 WL 963975
(N.D.Cal.2007) (no privilege); California v.
Kinder Morgan Energy Partners, L.P.,
2010 WL 3988448 (privilege recognized).
For purposes of the present situation,
this court is persuaded by the Federal
Circuit’s comprehensive analysis that a
settlement negotiation privilege is not necessary. In particular, other tools in the
toolbox—especially the protective order—
are adequate to protect confidentiality of
settlement discussions where necessary to
promote settlement. See MSTG, 675 F.3d
at 1346–47. Since neither the Ninth Circuit nor the Supreme Court has recognized
a settlement negotiation privilege as a
matter of federal common law, this court
holds that the California neutral evaluation
process is not protected by a privilege.
2
The lack of privilege is not the end of
the matter. Federal policy favors settlement and disfavors undermining settlement discussions in a manner that could
chill the productivity of such discussions in
future situations.
a
Federal Rule of Evidence 408 prohibits
admission into evidence in civil litigation of
compromise offers and statements made in
negotiations to prove or disprove the validity or amount of a disputed claim or to
impeach by prior inconsistent statement or
contradiction. Fed.R.Evid. 408.
An objection to the proffer of any evidence in this case of statements made,
information disclosed, or documents prepared or produced during the pre-filing
neutral evaluation process, either during a
hearing or in motion papers and declara-
tions, will have a sympathetic reception in
the eyes of the court.
b
[22] A protective order issued under
the court’s inherent authority is also appropriate to preserve confidentiality in this
chapter 9 proceeding of the statements
made, information disclosed, or documents
prepared or produced during the pre-filing
neutral evaluation process.
Although those pre-filing discussions
concluded, the settlement discussions are
not finished. Experience of cases such as
Vallejo in this judicial district teaches that
fashioning a successful plan of adjustment
is more of an exercise in negotiation and
compromise than a litigation exercise.
Accordingly, a sitting bankruptcy judge
from another district has been appointed
as Judicial Mediator to be available to
serve the needs of this case, without prejudice to the ability of the parties also to
employ private persons to facilitate discussions. This measure is consistent with the
policy inherent in the alternative dispute
resolution provisions in the Federal Judicial Code. 28 U.S.C. §§ 651–53. Confidentiality is expressly contemplated. 28
U.S.C. § 652(d).
Whatever goodwill, confidence, and lines
of communication that may have been established during the pre-filing neutral
evaluation process deserve to be fostered
with the certainty that will be useful in the
discussions during this case. Such discussions will be vital to the formulation of a
successful plan of arrangement.
In issuing such a protective order, this
court is taking an incremental approach.
As the case develops, it may become appropriate to relax the protective order in
various respects so that the rights of all
parties can be fully examined.
[23] As a first increment of disclosure,
it is appropriate (and ‘‘necessary’’ if an
733
IN RE RHODES COMPANIES, LLC
Cite as 475 B.R. 733 (D.Nev. 2012)
appellate court were to hold that the California statute applies to all eligibility questions) to authorize the City to release its.
‘‘790–page ‘ask’ created by the City that
details the City’s current situation and lays
out a proposed plan—equivalent to a chapter 9 plan—to address the City’s financial
shortfall.’’
This limited disclosure is necessary in
light of the ruling by the Bankruptcy Appellate Panel of the Ninth Circuit in Vallejo that § 109(c)(5)(B), upon which the City
relies for eligibility, ‘‘requires negotiations
with creditors revolving around a proposed
plan, at least in concept.’’ Vallejo, 408
B.R. at 297. Disclosure of the proposed
plan that formed the basis for discussions
during the pre-filing early neutral evaluation is part of the City’s prima facie case
on the issue of eligibility.
evaluation process, they are not privileged
but shall be protected from disclosure by a
protective order issued by this court forbidding disclosure, which protective order
may be adjusted from time to time. The
protective order shall not apply to the
‘‘790–page ‘ask’ created by the City that
details the City’s current situation and lays
out a proposed plan—equivalent to a chapter 9 plan—to address the City’s financial
shortfall.’’
A separate order will issue.
,
As noted, if objections to the petition are
made that place various elements of eligibility in actual dispute, then further relaxations of the protective order will be appropriate.
In re The RHODES COMPANIES,
LLC, aka ‘‘Rhodes Home,’’ et
al., Reorganized Debtors.
Conclusion
v.
With respect to the question of eligibility
under 11 U.S.C. § 109(c)(2), the City’s motion will be denied as unnecessary to the
extent that it seeks permission to dispense
with confidentiality of the California prefiling neutral evaluation process with respect to the number and length of meetings between the City and its creditors,
the identity of the participants at such
meetings, the types of issues discussed,
and the status of negotiations between the
City and each interested party as of the
petition date. Those matters are no longer confidential under California law. The
remainder of the motion, insofar as it is
based on California Government Code
§ 53760.3(q), is denied, without prejudice.
The Litigation Trust of the Rhodes
Companies, LLC, et al.,
Appellee.
With respect to statements made, information disclosed, or documents prepared
or produced during the pre-filing neutral
James M. Rhodes, Appellant,
No. 2:11–CV–01705–PMP–GWF.
United States District Court,
D. Nevada.
April 30, 2012.
Background: Founder and president of
Chapter 11 debtors moved to quash orders
granting examinations of third parties and
corresponding subpoenas, which were obtained by litigation trust created pursuant
to debtors’ confirmed plan. The United
States Bankruptcy Court for the District
of Nevada denied motion. Founder-president appealed.
Holdings: The District Court, Philip M.
Pro, J., held that:
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(Cite as: 2013 WL 2629129 (Bkrtcy.E.D.Cal.))
United States Bankruptcy Court,
E.D. California.
In re CITY OF STOCKTON, CALIFORNIA, Debtor.
(7) city acted in “good faith” in filing for Chapter 9
relief, and case could not be dismissed as “bad
faith” filing.
Objections overruled; order for relief entered.
West Headnotes
No. 12–32118–C–9.
June 12, 2013.
Background: Capital market creditors objected to
Chapter 9 petition filed by city, based not only on
city's alleged ineligibility for Chapter 9 relief, but
on its alleged lack of good faith in filing petition.
Holdings: The Bankruptcy Court, Klein, J., held
that:
(1) city's serious and productive negotiations with
category of claimants whose claims represented
more than two-thirds of its annual budget independently sufficed to satisfy California statutory requirement that, in neutral evaluation process initiated by municipality as prerequisite to filing for
bankruptcy, city must negotiate in good faith;
(2) capital market creditors, by refusing to negotiate, waived right to object to city's good faith during evaluation process;
(3) city's inability to formulate a balanced budget
without impairing its contractual obligations
provided independent basis, even apart from its dire
financial projections, to find that it was “insolvent”
on petition date;
(4) city had necessary “desire to effect a plan to adjust its debts,” as required for it to be eligible for
Chapter 9 relief;
(5) city “negotiated in good faith with creditors,”
and satisfied one of four alternative prerequisites to
eligibility for Chapter 9 relief;
(6) negotiation with stonewalling capital market
creditors and with the 2,400 retirees who lack any
natural representative capable of bargaining on
their behalf was “impracticable,” thereby satisfying
one of other alternative prerequisites to eligibility
for Chapter 9 relief; and
[1] Bankruptcy 51
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California statute providing that, in the neutral
evaluation process which public entity may initiate
in order to obtain necessary authorization to file
bankruptcy petition, local public entity “and all interested parties” participating in evaluation process
must negotiate in good faith, dictates that evaluation process be a two-way street, by imposing
good faith negotiation requirement on all interested
parties,
including
the
objectors.
West's
Ann.Cal.Gov. Code § 53760.3(o).
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California city's serious and productive negotiations with category of claimants whose claims represented more than two-thirds of its annual budget
independently sufficed to satisfy California statutory requirement that, in neutral evaluation process initiated by municipality as prerequisite to filing for bankruptcy, city must negotiate in good
faith. West's Ann.Cal.Gov. Code § 53760.3(o).
[3] Bankruptcy 51
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Objectors, having adopted position in neutral
evaluation process initiated by municipality as prerequisite to filing for bankruptcy that they had nothing to negotiate about until municipality first
sought significant concessions from its 2,400 retirees, retirees who had no natural representative capable of bargaining on their behalf, and who would
have no such representative until after entry of order for relief, waived right to challenge municipality's good faith in the evaluation process, or whether municipality had satisfied this California statutory prerequisite to obtaining necessary authorization for its Chapter 9 filing. 11 U.S.C.A. §
109(c)(2); West's Ann.Cal.Gov. Code § 53760.3(o).
[4] Bankruptcy 51
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California statute specifying that, in neutral
evaluation process initiated by local public entity as
prerequisite to filing for bankruptcy, public entity
must pay only half of the costs of evaluation process, and that creditors participating in process
must shoulder any remaining expenses unless otherwise agreed by parties, indicated public policy decision by California legislature to trump contractual
fee-shifting provisions in order to promote incentives to negotiate and prevented bondholders participating in evaluation process from relying on boilerplate language in bonds to disclaim any responsibility for costs of evaluation process, such that
bondholders' refusal to pay any portion of these
costs was independent reason for finding that they
had waived right to object to public entity's good
faith in evaluation process. West's Ann.Cal.Gov.
Code § 53760.3(o).
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51k2234 k. Insolvency; Current Payment
of Debts. Most Cited Cases
Theme underlying the two alternative definitions of municipal “insolvency,” such as municipality must exhibit to be eligible for Chapter 9 relief,
is that municipality must be in bona fide financial
distress that is not likely to be resolved without use
of federal bankruptcy power to impair contracts;
financial distress must be real and not transitory. 11
U.S.C.A. §§ 101(32)(C), 109(c)(3).
[6] Bankruptcy 51
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51k2234 k. Insolvency; Current Payment
of Debts. Most Cited Cases
Under two-headed definition of municipal
“insolvency,” as denoting condition in which municipality is generally not paying its debts not subject
to bona fide dispute or, in alternative, is “unable to
pay its debts,” the alternative language “unable to
pay as they become due” implicates notions of time
and projections about the future, and indicates that
municipality need not actually be out of cash before
it is “insolvent” and satisfies this statutory requirement for eligibility for Chapter 9 relief. 11
U.S.C.A. §§ 101(32)(C), 109(c)(3).
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City's inability to formulate a balanced budget
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without impairing its contractual obligations
provided independent basis, even apart from its dire
financial projections, to find that it was “insolvent”
on petition date, and indeed for some time prior
thereto, as required for it to be eligible for Chapter
9 relief. 11 U.S.C.A. §§ 101(32)(C), 109(c)(3).
[8] Bankruptcy 51
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of Debts. Most Cited Cases
When municipality lacks the funds to pay its
contractual obligations within the current or next
succeeding fiscal year, it is “unable to pay its debts
as they become due” and satisfies “insolvency” requirement for eligibility for Chapter 9 relief. 11
U.S.C.A. §§ 101(32)(C), 109(c)(3).
[9] Bankruptcy 51
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of Debts. Most Cited Cases
While “cash insolvency,” the opposite of paying one's debts as they become due, is controlling
criterion in deciding whether municipality satisfies
“insolvency” requirement for eligibility for Chapter
9 relief, longer-term budget imbalances, i.e.,
“budget insolvency,” and degree of inability to fund
essential government services, i.e., “service delivery insolvency,” also inform any assessment of relative degree and likely duration of municipality's
cash insolvency. 11 U.S.C.A. §§ 101(32)(C),
109(c)(3).
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of Debts. Most Cited Cases
City's failure to go to the people for tax increase prior to filing for Chapter 9 relief did not
mean that its “insolvency” was self-generated, and
that it did not satisfy one of statutory requirements
to eligibility for Chapter 9 relief, given evidence
that, in California, successful local tax measures for
general-purpose revenue occurred in atmosphere in
which predicate message to electorate was that public entity's fiscal house was already in order, and
that putting its fiscal house in order so that voters
might be willing to entertain tax increases was reason that city had filed for Chapter 9 relief. 11
U.S.C.A. §§ 101(32)(C), 109(c)(3).
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“Desire to effect a plan to adjust its debts,”
such as municipality must have to be eligible for
Chapter 9 relief, may be equated with an intent to
effect such a plan, and is a highly subjective requirement. 11 U.S.C.A. § 109(c)(4).
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Initial question for court, in deciding whether
municipality has “desire to effect a plan to adjust its
debts,” as required to be eligible for Chapter 9 relief, is whether Chapter 9 case was filed for some
ulterior motive. 11 U.S.C.A. § 109(c)(4).
[13] Bankruptcy 51
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Evidence probative of municipality's “desire to
effect a plan to adjust its debts,” as required to be
eligible for Chapter 9 relief, includes its attempts to
resolve claims, submission of draft plan, and other
circumstantial evidence. 11 U.S.C.A. § 109(c)(4).
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Fact that city, at outset of its Chapter 9 case,
had unilaterally implemented cost-cutting measures
that committed it, at risk of having these costcutting measures reversed and obligation imposed
for damages to affected parties, to either confirming
a Chapter 9 plan or achieving agreements sufficient
to constitute de facto plan with respect to victims of
these cost-cutting measures showed that city had
necessary “desire to effect a plan to adjust its
debts,” as required for it to be eligible for Chapter 9
relief. 11 U.S.C.A. § 109(c)(4).
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“Desire to effect a plan to adjust its debts,”
such as municipality must have to be eligible for
Chapter 9 relief, does not necessarily require that a
confirmed or confirmable Chapter 9 plan be actually intended; phrase also subsumes a de facto plan
in which a sufficient number of affected parties voluntarily revise their contracts with municipality in
face of alternative of potential compulsion of confirmed plan of debt adjustment. 11 U.S.C.A. §
109(c)(4).
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Municipality “negotiated in good faith with
creditors,” and satisfied one of four alternative prerequisites to eligibility for Chapter 9 relief, by entering into serious and productive negotiations with
category of claimants whose claims represented
more than two-thirds of its annual budget and, with
respect to other capital market creditors challenging
its eligibility for Chapter 9 relief, by making serious proposal to temporarily suspend interest and
other payments to such creditors, for which it proposed to compensate creditors by extending time
for payment, increased interest, or other adjustments, where capital market creditors, acting as
unified block, refused to respond to municipality's
proposal on theory that there was nothing to negotiate until municipality first obtained significant concessions from its 2,400 retirees, retirees who had no
natural representative capable of bargaining on
their behalf, and who would have no such representative until after entry of order for relief. 11
U.S.C.A. § 109(c)(5)(B).
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Requirement that municipality must have negotiated in good faith with creditors, in order to satisfy one of four alternative prerequisites to eligibility
for Chapter 9 relief, is satisfied with respect to any
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class of putatively impaired creditors that declines
to respond in good faith to a good faith proposal by
municipality. 11 U.S.C.A. § 109(c)(5)(B).
[18] Bankruptcy 51
2232
51 Bankruptcy
51III The Case
51III(B) Debtors
51k2222 Who May Be a Debtor
51k2232 k. Municipalities. Most Cited
Cases
Lack of any natural representative capable of
bargaining on behalf of city's 2,400 retirees and
capital market creditors' stonewall attitude in refusing to negotiate until after city had first obtained
concessions from retirees, made negotiation with
both groups of creditors “impracticable,” thereby
satisfying one of four alternative prerequisites for
city's eligibility for Chapter 9 relief. 11 U.S.C.A. §
109(c)(5)(C).
[19] Bankruptcy 51
3481
51 Bankruptcy
51XIII Adjustment of Debts of a Municipality
51k3481 k. In General. Most Cited Cases
Statute authorizing bankruptcy court to dismiss
Chapter 9 case if it finds that debtor did not act in
“good faith” in filing petition serves policy objective of assuring that Chapter 9 process is being used
in manner consistent with reorganization purposes
of the Bankruptcy Code. 11 U.S.C.A. § 921(c).
[20] Bankruptcy 51
3481
51 Bankruptcy
51XIII Adjustment of Debts of a Municipality
51k3481 k. In General. Most Cited Cases
Whether debtor acted in “good faith” in filing
for Chapter 9 relief, as required by bankruptcy statute, is assessed on case-by-case basis in light of all
the facts, which must be balanced against broad remedial purpose of Chapter 9. 11 U.S.C.A. § 921(c).
[21] Bankruptcy 51
3481
51 Bankruptcy
51XIII Adjustment of Debts of a Municipality
51k3481 k. In General. Most Cited Cases
Relevant considerations for court in deciding
whether debtor acted in “good faith” in filing for
Chapter 9 relief, as required by bankruptcy statute,
include whether debtor's financial problems are of a
nature contemplated by Chapter 9, whether reasons
for debtor's bankruptcy filing are consistent with
Chapter 9, extent of debtor's prepetition efforts to
address its financial issues, extent that alternatives
to Chapter 9 were considered, and whether debtor's
residents would be prejudiced by denying Chapter 9
relief. 11 U.S.C.A. § 921(c).
[22] Bankruptcy 51
3481
51 Bankruptcy
51XIII Adjustment of Debts of a Municipality
51k3481 k. In General. Most Cited Cases
City's proof of statutory elements required to
establish its eligibility of Chapter 9 relief operated
to create a rebuttable presumption that it filed its
Chapter 9 petition in good faith, such that initial
burden was on objectors challenging its good faith
to rebut this presumption, before burden would
shift back to city to carry its ultimate burden of persuasion. 11 U.S.C.A. §§ 109(c), 921(c).
[23] Bankruptcy 51
3481
51 Bankruptcy
51XIII Adjustment of Debts of a Municipality
51k3481 k. In General. Most Cited Cases
City acted in “good faith” in filing for Chapter
9 relief, and case could not be dismissed as “bad
faith” filing, as demonstrated by its multi-year effort to ratchet down expenses, during which it reduced its work force and reduced employee compensation, its cash insolvency, its service insolvency, its good faith negotiations or efforts to negotiate with creditors, and its inability to achieve significant further reductions without being able to
compel impairment of contracts. 11 U.S.C.A. §
921(c).
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[24] Bankruptcy 51
2232
51 Bankruptcy
51III The Case
51III(B) Debtors
51k2222 Who May Be a Debtor
51k2232 k. Municipalities. Most Cited
Cases
California statute specifying that, in neutral
evaluation process initiated by local public entity as
prerequisite to filing for bankruptcy, public entity
must pay only half of the costs of evaluation process, and that creditors participating in process
must shoulder any remaining expenses unless otherwise agreed by parties, was intended to be selfexecuting and imposed on other parties to evaluation process, not an obligation to reimburse city
for costs of process, but a direct obligation to pay
share of costs. West's Ann.Cal.Gov. Code §
53760.3(o).
Marc A. Levinson, Norman Hile, Jonathan Riddell,
John W. Killeen, Orrick, Herrington & Sutcliffe
LLP, Sacramento, California, for Debtor.
Nicholas De Lancie, Jeffer Mangels Butler &
Mitchell LLP, San Francisco, California, for Union
Bank, N.A.
Michael S. Gardener, Boston, Massachusetts, for
Wells Fargo Bank, National Association.
James O. Johnston, Joshua D. Morse, Jones Day,
Los Angeles, California, for Franklin High Yield
Tax Free Income Fund and Franklin California
High Yield Municipal Fund.
Lawrence A. Larose, Winston & Strawn LLP, New
York City, New York, for National Public Finance
Guarantee Corporation.
Guy S. Neal, Sidney Austin, LLP, Washington, DC,
for Assured Guaranty Corporation and Assured
Guaranty Municipal Corporation.
Michael Ryan, K & L Gates, Seattle, Washington,
for California Public Employees' Retirement Sys-
tem.
Michael J. Gearin, K & L Gates LLP, Los Angeles,
California, for California Public Employees' Retirement System.
Matthew M. Walsh, Winston & Strawn LLP, Los
Angeles, California, for National Public Finance
Guarantee Corporation.
OPINION REGARDING CHAPTER 9 ORDER
FOR RELIEF
KLEIN, Bankruptcy Judge.
*1 Chapter 9 is unique among voluntary Bankruptcy Code cases in that a municipality must litigate its way to the order for relief before restructuring its debt. Capital markets creditors of the City of
Stockton have required the City to prove its eligibility for chapter 9 relief under 11 U.S.C. §§ 109(c)
and 921(c). Such a proceeding is like a qualifying
round in a competition; success leads only to the
main event—the process of achieving a viable plan
of adjustment. Without a confirmed plan, a municipality lacks constitutional authority to compel
impairment of contracts.
This opinion addresses chapter 9 eligibility issues that arose during the three-day trial on the
question whether to order relief and the post-trial
motion to alter or amend the findings regarding the
strategy adopted by certain creditors. The focus is
on pre-filing obligations of the municipality in
dealing with creditors and stakeholders. Concluding
that the City carried its burden to establish the elements required for an order for relief and concluding that the objectors inappropriately used an issue
relating to plan confirmation, but that is irrelevant
to eligibility, as a pretext to decline to negotiate in
good faith and to force a trial that should not have
FN1
been necessary, relief will be ordered.
STATUTORY REQUIREMENTS
As chapter 9 eligibility is governed by Bankruptcy Code §§ 101(32)(C), 101(40), 109(c), and
921(c) and (d), it is appropriate to situate those stat-
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utes front and center:
§ 101(32). The term “insolvent” means—
...
(C) with reference to a municipality, financial
condition such that the municipality is—
(i) generally not paying its debts as they become due unless such debts are the subject of a
bona fide dispute; or
(ii) unable to pay its debts as they become due.
creditors holding at least a majority in amount
of the claims of each class that such entity intends to impair under a plan in a case under
such chapter;
(C) is unable to negotiate with creditors because such negotiation is impracticable; or
*2 (D) reasonably believes that a creditor
may attempt to obtain a transfer that is avoidable under section 547 [preferences] of this
title.
11 U.S.C. § 109(c).
11 U.S.C. § 101(32).
***
***
§ 101(40). The term “municipality” means
political subdivision or public agency or instrumentality of a State.
11 U.S.C. § 101(40).
***
§ 109(c). An entity may be a debtor under
chapter 9 of this title if and only if such entity—
(1) is a municipality;
(2) is specifically authorized, in its capacity as
a municipality or by name, to be a debtor under
such chapter by State law, or by a governmental
officer or organization empowered by State law
to authorize such entity to be a debtor under such
chapter;
(3) is insolvent;
§ 921
(c) After any objection to the petition, the
court, after notice and a hearing, may dismiss the
petition if the debtor did not file the petition in
good faith or if the petition does not meet the requirements of this title.
(d) If the petition is not dismissed under subsection (c) of this section, the court shall order
relief under this chapter notwithstanding section
301(b).
11 U.S.C. § 921(c)-(d).
***
Relevant parts of California's gateway statute,
Government Code §§ 53760, 53760.1, and 53760.3,
FN2
also deserve a billing:
(4) desires to effect a plan to adjust such debts;
and
§ 53760. A local public entity in this state may
file a petition and exercise powers pursuant to applicable federal bankruptcy law if either of the
following apply:
(5) (A) has obtained the agreement of creditors
holding at least a majority in amount of the
claims of each class that such entity intends to
impair under a plan in a case under such chapter;
(a) The local public entity has participated in a
neutral evaluation process pursuant to Section
53760.3.
(B) has negotiated in good faith with creditors and has failed to obtain the agreement of
(b) The local public entity declares a fiscal
emergency and adopts a resolution by a majority
vote of the governing board pursuant to Section
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53760.5.
CAL. GOV'T CODE § 53760.
***
§ 53760.1(d). “Good faith” means participation
by a party in the neutral evaluation process with
the intent to negotiate toward a resolution of the
issues that are the subject of the neutral evaluation process, including the timely provision of
complete and accurate information to provide the
relevant parties through the neutral evaluation
process with sufficient information, in a confidential manner, to negotiate the readjustment of
the municipality's debt.
CAL. GOV'T CODE § 53760.1(d).
***
§ 53760.3(o ). The local public entity and all interested parties participating in the neutral evaluation process shall negotiate in good faith.
CAL. GOV'T CODE § 53760.3(o ).
§ 53760.3(s). The local public entity shall pay 50
percent of the costs of neutral evaluation, including, but not limited to, the fees of the evaluator,
and the creditors shall pay the balance, unless
otherwise agreed to by the parties.
CAL. GOV'T CODE § 53760.3(s).
FACTS
When Bob Deis became City Manager for the
City of Stockton on July 1, 2010, the first day of its
fiscal year, he encountered a municipality in financial distress. In a progression beginning in 2008,
the City Council had declared fiscal emergencies
and imposed certain unilateral actions in an effort
to staunch the hemorrhage. On June 22, 2010, the
Council adopted an “Action Plan For Fiscal Sustainability' “ that it hired Deis to implement.
Some of the problems were due to the state of
the economy in the Great Recession. Stockton was
ground zero for the subprime mortgage crisis. Unemployment was 22 percent; median income for a
family of four was about $63,000. Property values,
both commercial and residential, had declined by
FN3
50 percent.
Stockton had one of the highest
foreclosure rates in the nation, a fact of which this
court is painfully aware from the ordeal of presiding over the tragedy of bankruptcies of literally
thousands of individual Stockton citizens who had
done nothing wrong other than be seduced by easy
credit when purchasing a home in a housing bubble
before being slammed by unexpected loss of income when laid off or furloughed. Property tax,
sales tax, and other public revenues characteristic
of a functioning municipal economy had
plummeted. For example, sales tax revenue declined from $47.0 million in fiscal year 2006 to
FN4
$32.7 million in fiscal year 2010.
Recovery
was far over the horizon.
*3 Some problems were due to excessive optimism. In better times, Stockton committed its general fund to back long-term bonds to finance development projects based on an overly-sanguine
“if-you-build-it-they-will-come” mentality. They
did not come. Hence, project revenues were insufficient to pay project bills.
Some problems were due to encrustation of a
creeping multi-decade, opaque pattern of abovemarket compensation of employees. /Among other
things, the City paid for generous health care benefits to which employees did not contribute, including lifetime health care regardless of length of service. It permitted, to an unusual degree, so-called
“add-pays” for tasks that allowed nominal salaries
to be increased to totals greater than those prevailing for other municipalities. And there were predetermined automatic annual cost-of-living pay increases not tied to the state of the economy or local
finances.
The submerged compensation problems included surprisingly generous retirement practices.
Pensions were allowed to be based on the final year
of compensation, which compensation could include essentially-unlimited accrued vacation and
sick leave. This led to a phenomenon of so-called
“pension-spiking” in which a pension could be sub-
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stantially greater than the retiree's actual final
salary. Nor were individual employees required to
contribute to their pensions. In consequence, projected pension expenses were soaring.
City management before the Great Recession
deserves some of the blame. City accounts were in
such disarray that it has taken literally years to unscramble them. Various work rules were contractually agreed upon, often without approval in public
view by the City Council, that left little latitude for
exercise of managerial supervision. And one wonders about what prior City Councils had been doing.
In each fiscal year during Deis' tenure, fiscal
emergencies have continued to be, declared, which
have enabled some limitation of the adverse effects
of some collective bargaining agreements.
In the fiscal year beginning July 1, 2010, unrepresented employees suffered: furloughs of 96
hours; new medical premiums; and increased health
plan deductibles and co-pays. Similar concessions
FN5
were obtained from collective bargaining units.
In the fiscal year beginning July 1, 2011, the
economy measures were racheted up. For unrepresented employees: 96–hour furloughs continued;
medical benefits were eliminated for new hires;
sick leave accruals were reduced, and limits imposed on sick leave cash-outs at retirement; vacation leave accruals were reduced, and limits imposed on vacation sell-back and accrual maximums;
extra salary above Workers' Compensation ceased;
longevity “add-pay” was eliminated for certain employees; educational incentive pay was eliminated;
employees were required to contribute 7 percent toward their retirement plan; the maximum City contribution to the health plan was decreased. Similar
concessions were obtained from collective bargaining units.
*4 Of particular significance to the City's pension expense, age limits were raised, which had the
effect of requiring longer service before being able
to collect a pension, and the pension calculation
was revised to be based on income during the final
three years of service, instead of one year of service. The final-three-year provision, coupled with
the limits on additives, dampened opportunities for
“pension spiking.”
Councilmember Kathy Miller testified credibly
about the extent of the corrective measures that
have been taken since she joined the City Council
in January 2009 and about the painful toll inflicted
on the City workforce at the cost of impairing basic
public services as the Council sought to regain control of the budget and the trust of the people.
In sum, the City workforce decreased by 25
percent from 1,886 on July 1, 2008, to 1,420 on
December 31, 2011. This included a 20 percent reduction for police, 30 percent for fire, 38 percent
for public works, 46 percent for library, and 56 percent for recreation.
In the middle of the 2012– 2013 fiscal year, it
was apparent that, despite the four-year struggle to
tame the City's finances, its general fund would
reach June 30, 2012, with a projected deficit of
$8,652,768 unless drastic action was taken.
Accordingly, Deis and his management team,
supported by the independent analysis of the consulting firm Management Partners, concluded that it
was time to ask the City Council to initiate the
neutral evaluation process under California Government Code §§ 53760(a) and 53760.3 that is one of
two alternatives preliminary to filing a municipal
debt adjustment case under chapter 9 of the Bankruptcy Code.
A 54–page memorandum dated February 28,
FN6
2012,
from Deis to the City Council projected a
$8,652,768 deficit on expenditures of $166,655,282
as of the fiscal year end on June 30 and projected a
deficit for the fiscal year commencing July 1, 2012,
ranging from $20,207,540 to $38,182,873.
Deis reviewed the present and future options
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for closing the gaps. He noted that more service reductions were an easy target as 71 percent of general fund expenses are devoted to labor, or viewed by
function, 77 percent relates to public safety-police
and fire. But, although a further 15 percent cut
would save about $20 million, staffing had already
been slashed during the three previous years to
close gaps of $37 million, $23 million, and $28 million, respectively. The consequences were worrisome.
Public safety was a particular concern. In 2010,
Stockton's violent crime rate bucked a nationwide
drop and rose to rank it 10th nationally, with 13.81
violent crimes per 1,000 residents. Homicides were
at an all-time record. Aggravated Assaults with a
Firearm rose from 99 in 2009 to 196 in 2011, and
another 30 percent in 2012.
A 15 percent reduction in the police budget
would eliminate all 30 community service officers
and 64 of about 323 sworn officers. The same reduction in the fire budget would eliminate 41 sworn
fire positions, 3 fire engines, and 1 fire truck.
*5 The' Police Chief pointed out that, even
without a 15 percent cut, the Police Department had
about 1.10 officers per 1,000 residents, compared to
FN7
a national standard of 2.7 per 1,000 residents.
The police, during peak activity, respond only to
crimes-in-progress. Ending the School Resource
Officer program was followed by a rise in juvenile
crime, gang membership, and a 575 percent jump in
gang-related homicides, from 4 to 27. Abolishing
the Narcotics Enforcement Team led to more drug
traffic and fewer asset forfeiture proceeds. Reducing security camera monitoring from full-time to
part-time impaired the ability to spot crimes or follow pursuits.
Deis concluded that these “kind of cuts simply
FN8
pose too much of a safety risk to our citizens.”
This was consistent with the conclusion of the
City's consultant, Management Partners, that, as of
February 2012, the City was, first, in a state of
“service delivery insolvency,” which is a municipality's inability to pay for all the costs of providing
services at the level and quality required for the
health, safety, and welfare of the community, and,
second, was in a state of “budget insolvency,”
which is the inability to create a balanced budget
that provides sufficient revenues to pay expenses
occurring within the budgeted period. Management
Partners also opined that the City was on the verge
of “cash insolvency,” which is inability to generate
and maintain cash balances to pay expenditures as
FN9
they come due.
The City Council accepted the Deis recommendation on February 28, 2012, and authorized
initiation of the neutral evaluation process that
California prescribes under Government Code §§
53760 and 53760.3 as a prerequisite to permission
to file a chapter 9 case under the Bankruptcy Code.
The City Council also authorized diversion of
various earmarked funds to meet the projected
$8,652,768 budget shortfall. Hence, the City suspended payments from the general fund on the 2004
Lease Revenue Bond (Parking), the 2009 Lease
Revenue Bonds (Public Facilities Fees), and the
2007 Variable Rate Bonds (City Hall), for which
the expected general fund payments due before
June 30, 2012, totaled $2,048,658. In the next fiscal
year beginning July 1, 2012, general fund payments
to service those, and other, bonds were projected at
$11,787,182.
As a result of measures authorized by the City
Council on February 28, 2012, including not paying
$2,048,658 on the bonds, the general fund finished
the fiscal year with about $1.3 million on hand.
FN10
Without the intentional bond default, it
would have ended the fiscal year with a deficit exceeding $700,000.
The bond default led Wells Fargo, as bond
trustee acting at the behest of National Public Finance Guarantee Corporation and Assured Guaranty
Municipal Corp., to have receivers appointed to
take over and operate three parking garages
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(National Public Finance) and the building at 400
E. Main Street intended to serve as the new city
hall (Assured Guaranty). Those receivers remain in
place and are collecting project revenues.
City did not intend to reestablish a possessory interest or to pay any debt service going forward.
FN12
The receiver would collect parking revenues
until the bonds are paid in full.
*6 National Public Finance responded to the
notice of the initiation of the neutral evaluation process with notice of intent to participate as an
“interested party” under California Government
Code § 53760 by letter dated March 15, 2012, from
Matthew Cohn, Director.
As to 2006 Lease Revenue Bonds on the socalled Stewart–Eberhart Building and adjacent
parking facility, for which the insurer is National
Public Finance, the City proposed debt service relief of five years, followed by five years of interestonly payments, and substituting a pledge of parking
district revenues and public facilities fees in place
FN13
of the backstop of the general fund.
The
bonds would eventually be paid in full.
But, although § 53760.3(s) requires creditors to
pay half of the costs of neutral evaluation unless
otherwise agreed, Cohn stated: “National expressly
disclaims any obligation or liability for the payment
of any costs or expenses under Section 53760.3(s)
of the Act or otherwise in connection with the 506
Notice, the Act or pursuant to the 506 Process or
FN11
otherwise.”
Neither National Public Finance, nor Assured
Guaranty, nor Franklin Advisors, nor Wells Fargo
paid any of the costs or expenses allocated to them
by Government Code § 53760.3(s). The City did
not agree to pay their share.
Former Bankruptcy Judge Ralph Mabey was
selected as the neutral evaluator.
The neutral evaluation process continued for 90
days, having been extended for the additional 30
days permitted by Government Code §
53760.3(t)(3).
The City began by presenting a proposed plan
of adjustment in the form of what was termed an
“Ask” in which it described how it proposed to deal
with the affected parties. The City intended the
“Ask” as the opening proposal in a negotiation.
Several examples of the proposed treatment of
bonds follow.
As to the three parking garages covered by the
2004 Lease Revenue Bond (Parking) and in the
hands of a receiver appointed at the behest of National Public Finance Guarantee Corporation, the
As to the issue of 2007 Variable Rate Demand
Lease Revenue Bonds, insured by Assured Guaranty, for the intended city hall at 400 E. Main
Street, the City proposed debt service relief for five
years, followed by five years of interest-only payments, and thirty years of full amortization. The
City would pledge all net revenues of the building
unto the amount of the originally scheduled debt
service, to be backstopped by the general fund up to
FN14
the amount of restructured debt service.
The
bonds eventually would be paid in full.
National Public Finance and Assured Guaranty
each took the position that there was nothing to talk
about unless and until the City also proposed to impair its pension obligation to the California Public
Employees' Retirement System (“CalPERS”).
When the City declined to do so after the second
neutral evaluation meeting with the bondholders,
they absented themselves from all further discussions. They did not thereafter indicate a desire to
meet again with Judge Mabey.
*7 Objector Franklin Advisors did make a
counterproposal regarding a different bond issue,
which the City concedes was made in good faith
but which was too far removed from the relief the
City needed on that bond issue to open a path for
exploration. Neither Franklin Advisors, nor Wells
Fargo as indenture trustee, pursued further discussions with Judge Mabey.
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The neutral evaluation process conducted by
Judge Mabey achieved agreements to adjust all unexpired collective bargaining agreements and
achieved substantial progress in discussions with
other stakeholders. The court is persuaded that
Judge Mabey would have worked further with the
capital market creditors if they had expressed interest. None was expressed.
This case was filed on June 28, 2012, and assigned to the undersigned judge by the chief judge
of the court of appeals.
National Public Finance, Assured Guaranty,
Franklin Advisors, and Wells Fargo objected to an
order for relief.
This litigation ensued. The interval since filing
has been consumed, first, by court-ordered mediation with the Hon. Elizabeth Perris, U.S. Bankruptcy Judge, District of Oregon, it being this
court's experience that successful reorganizations
entail substantial agreement among most of the
parties. Second, during that mediation process, time
has been consumed developing and exchanging information essential to understanding the City's finances and to the negotiation of a plan of adjustment.
JURISDICTION
Federal subject-matter jurisdiction is founded
upon 28 U.S.C. § 1334. This is a core proceeding
that a bankruptcy judge may hear and determine. 28
U.S.C. § 158(d)(1). The chief judge of the court of
appeals has designated this bankruptcy judge to
conduct the case. 11 U.S.C. § 921(b).
DISCUSSION
Since the guestion of whether to order relief is
governed by six essential elements prescribed by
statute, the analysis will use those elements as an
outline.
I
The first essential element is that the debtor
must be a “municipality” as defined in the Bank-
ruptcy Code. 11 U.S.C. § 109(c)(1). A
“municipality” is a political subdivision or public
agency or instrumentality of a state. 11 U.S.C. §
101(40). The objectors concede that Stockton is a
municipality for these purposes.
II
The second essential element for chapter 9 eligibility is that the municipality must be specifically
authorized in its capacity as a municipality or by
name, to be a chapter 9 debtor by state law, or by a
governmental officer or organization empowered
by state law to make such authorization. 11 U.S.C.
§ 109(c)(2). This element is contested.
As explained in an earlier decision, the initial
gateway into chapter 9 is under the control of the
state. Stockton I, 475 B.R. at 727–28. Hence, California law governs the question whether the City is
authorized to be a chapter 9 debtor.
A
California has enacted a standing authorization
for its municipalities to be chapter 9 debtors if they
comply with the California Government Code §
53760 by either pursuing a neutral evaluation process or declaring a fiscal emergency. CAL. GOV'T
CODE § 53760.
*8 As the City pursued California's neutral
evaluation route, our focus is on the terms that govern that process.
B
The course of the neutral evaluation conducted
by former Bankruptcy Judge Mabey is detailed in
the evidence. The City presented a tentative plan in
the form of a 790–page “Ask” for the purposes of
discussions. The evaluation lasted the maximum
ninety days permitted by statute, having been extended by the City and a majority of the participating parties. There were more than forty sessions
with various interested parties, in the course of
which the evaluator engaged in shuttle diplomacy.
The neutral evaluation produced agreements
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with some of the participating parties, including all
unions with unexpired collective bargaining agreements. No agreement was reached with the 2,400
retired employees, there being no common representative with whom to negotiate.
Nor was there agreement with the capital market creditors. They attended only two meetings with
the neutral evaluator and, having taken the position
that there was nothing to talk about, departed. That
the evaluator, who established a record demonstrating conscientious diligence in his mediation task,
elected not to attempt to work further with the capital markets creditors warrants the inference that he
saw little possibility of bridging their gap with the
City.
C The objectors contend that, as a matter of
state law, the City did not satisfy its good faith negotiation obligation during the California neutral
evaluation process. Their rationale is twofold. First,
they contend that any proposal that would impair
the rights of capital markets creditors without simultaneously impairing CalPERS is not made in
good faith. Second, they contend that the City's proposal was made on a take-it-or-leave-it basis
without the intention of actually negotiating.
1
The objectors' initial challenge to the City's
good faith is the first of at least four encounters
with the term “good faith” in this case. At the prefiling gateway, California requires good faith negotiations in its neutral evaluation process. CAL.
GOV'T CODE § 53760.3(o ).
The next three appearances of “good faith” are
Bankruptcy Code provisions. One of four alternatives for establishing the fifth element of § 109(c)
eligibility to be a chapter 9 debtor is good faith negotiation with parties who would be impaired under
a proposed plan. 11 U.S.C. § 109(c)(5)(B). Next,
even if a municipality is eligible under § 109(c), the
court may dismiss a case that is not filed in good
faith. 11 U.S.C. § 921(c). Finally, a plan of adjustment must be proposed in good faith. 11 U.S.C. §
1129(a)(3), incorporated by id., § 901(a).
As these various versions of good faith in
chapter 9 arise in different contexts, they may have
different meanings. Cf. United States v. Memphis
Cotton Oil Co., 288 U.S. 62, 67–68, 53 S.Ct. 278,
77 L.Ed. 619 (1933) (“ ‘cause of action’ may mean
one thing for one purpose and something different
for another.”) (Cardozo, J.). Those varying contexts
will be addressed in due course.
2
*9 This first of the good faith objections, relating to the California gateway neutral evaluation
process, is rejected as a matter of California law.
a
Black-letter California law requires the City
and all parties participating in the neutral evaluation process to negotiate in good faith:
The local public entity and all interested parties
participating in the neutral evaluation process
shall negotiate in good faith.
CAL. GOV'T CODE § 53760.3(o ).
[1] It follows that good faith negotiation in the
California neutral evaluation process is a two-way
street.
California defines “good faith” for purposes of
its chapter 9 gateway neutral evaluation process:
(d) “Good faith” means participation by a party
in the neutral evaluation process with the intent
to negotiate toward a resolution of the issues that
are the subject of the neutral evaluation process,
including the timely provision of complete and
accurate information to provide the relevant
parties through the neutral evaluation process
with sufficient information, in a confidential
manner, to negotiate the readjustment of the municipality's debt.
CAL. GOV'T CODE § 53760.1(d).
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With this duty and this definition in mind, it is
beyond cavil that the City negotiated with its various unions toward a resolution of the issues that
were the subject of the neutral evaluation process.
The fact that pre-filing agreements were reached to
modify all unexpired collective bargaining agreements, and that substantial progress was made regarding expired agreements that were resolved soon
after the chapter 9 case was filed, persuasively testifies to the City's good faith negotiations for purposes of § 53760(o ).
Nor were these union contracts trivial matters.
Labor comprised about 71 percent of the City's prefiling budget. The City's 790–page “Ask” included
painful cuts to organized labor. The City reports
achieving the majority of the concessions it sought
from the unions in its “Ask.” And, it is this court's
experience that organized labor ordinarily resists
efforts to reduce compensation and benefits.
Although the objectors complain bitterly that
the City was not proposing directly to impair the
rights of CalPERS, they do not address the obvious:
material reductions in compensation to employees
correlatively will tend to reduce the City's future
pension obligations. In other words, renegotiated
collective bargaining agreements providing for reduced compensation indirectly reduce the City's
CalPERS obligations.
[2] The question becomes whether good faith
renegotiation of collective bargaining agreements
where labor expenses exceed two-thirds of a municipality's budget constitutes sufficient good faith to
satisfy Government Code § 53760.3(o ). This entails a line-drawing exercise. While the question
may not be free from doubt, this court concludes
that, as a matter of California law, serious and productive negotiations with a category of claimants
who represent more than two-thirds of a municipality's annual budget independently suffices to satisfy
the good faith negotiation requirement of §
53760.3(o ).
b
*10 The objectors took the position that the
City was required by the California statute to negotiate with them in good faith but that, insofar as
they were concerned, the obligation was not reciprocal. That is, the objectors contended that they had
no correlative good faith negotiation obligation.
Not so.
As already noted, the California statute imposes the good faith negotiation requirement on all
interested parties, including the objectors. CAL.
GOV'T CODE § 53760.3(o ).
As a factual matter, this court is persuaded by a
preponderance of evidence that neither National
Public Finance nor Assured Guaranty negotiated in
good faith during the California neutral evaluation
process. Rather, they took the position that there
was nothing to talk about unless the City also proposed to impair a different creditor, which the City
declined to do.
[3] The objectors, having adopted the posture
of a stone wall by refusing seriously to negotiate,
will not now be heard to complain about the negotiating behavior of their counterparty.
While this court understands that a principled
impasse may underlie the objectors' stone wall, the
existence of impasse does not necessarily undermine the City's compliance with the good faith negotiation requirement of the California neutral evaluation process.
The City's dire financial circumstances must
have been apparent to the objectors by the time of
the trial on the question of the order for relief. Even
they conceded on the record that long-term structural budget imbalances exist that require radical surgery; this position also impeaches their contention,
to be addressed later, that the City is not insolvent.
Their complaint that the City should be more aggressively attacking its pensioners by way of CalPERS is a matter that relates to the structure of a
confirmable plan, but that is not relevant to the order for relief.
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Although the CalPERS issue will become an
important question if the objectors raise it in a challenge to confirmation of a plan of adjustment, their
dissatisfaction with the City's proposed manner of
dealing with another creditor is not relevant to the
order for relief. Rather, its use at this stage is a
mere pretext that is not a responsible litigation position.
The mentality of the macho manager that authorizes uneconomic litigation activity on the
premise that the opponent will pay the bills, which
is the dysfunctional contractual corollary of the socalled “American Rule” regarding fees that escalates legal expense, has been rejected as a matter of
California law in the difficult arena of municipal insolvency.
3
There is an adequate, independent reason for
rejecting the objectors' challenge to the City's compliance with the California neutral evaluation gateway: the objectors declined to pay their share of
costs of the California neutral evaluation process.
In other words, the decisionmakers for the capital markets creditors need to check their testosterone at the door, stop assuming that they are spending their opponent's money when they direct their
counsel to pursue wasteful legal tasks, and make
their litigation business decisions on the premise
that they will be responsible for every dollar of legal effort that they order. This merely reflects that
basic management principle that authority should
not be separated from responsibility.
California requires that the local public entity
pay half of the costs of neutral evaluation, including, but not limited to, the fees of the evaluator, and
that the creditors must pay the balance, unless otherwise agreed to by the parties. CAL. GOV'T
FN15
CODE § 53760.3(s).
The City did not agree
otherwise.
None of the objectors paid any part of the costs
of neutral evaluation as required by § 53760.3(s).
National Public Finance was refreshingly candid
when it wrote that it would participate in the neutral
evaluation but that: “National expressly disclaims
any obligation or liability for the payment of any
costs or expenses under Section 53760.3(s) of the
Act.” Although the other objectors were not so candid, they all concede that none of them paid any
portion of their § 53760.3(s) obligation. This evidences a pattern of conscious parallelism.
*11 [4] Nor is it an excuse that boilerplate provisions in the bond indenture contracts purport to
saddle the City with the objectors' legal expenses
incurred in this chapter 9 battle. The specificity of
the language of California's Government Code §
53760.3(s) indicates a public policy decision by the
California legislature to trump contractual feeshifting provisions in order to promote incentives to
negotiate.
Here, the objectors are not only pursuing a
wasteful strategy, they put themselves in the position of freeloaders who, as a matter of California
law, will not be heard to complain about the City's
performance of its obligations during the California
neutral evaluation process. They should not expect
that they can add their legal fees to the debt owed
by the City.
Arguably, the City being the prevailing party in
the order-for-relief dispute, the objectors could be
obliged to pay the City's expenses of litigating the
order for relief. Cal. Civ.Code § 1717. That question, however, can be left to another day.
D
In short, the court is persuaded that the City
has proved by a preponderance of evidence that it
honored the requirements of the California neutral
evaluation process and, in consequence, is authorized by California law to be a chapter 9 debtor. 11
U.S.C. § 109(c)(2).
Independently, as the objectors did not comply
with their obligations under California law to negotiate in good faith and to pay their allotted share of
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the neutral evaluation process, they waived the
right to complain about the City's performance during the California pre-filing negotiation process.
III
The third essential element for eligibility to be
a chapter 9 debtor is that the municipality must be
insolvent. 11 U.S.C. § 109(c)(3).
A municipality is “insolvent” for purposes of §
109(c)(3) if it either is generally not paying its
debts that are not the subject of a bona fide dispute
or is unable to pay its debts as they become due. 11
FN16
U.S.C. § 101(32)(c).
The City relies on the second prong of the municipal insolvency definition. It contends that, per §
101(32)(C)(ii), as of the filing of its chapter 9 case
on June 28, 2012, it was “unable to pay” its debts
as they became due. The objectors contend that the
City either was not insolvent or manipulated itself
into a technical insolvency that should be disregarded.
*12 This trier of fact is persuaded that, by all
relevant measures, the City is insolvent.
A
Three types of insolvency inform the §
109(c)(3) analysis: cash insolvency; budget insolvency; and service delivery insolvency.
[5] The theme underlying the two alternative
definitions of municipal insolvency in § 101(32)(C)
is that a municipality must be in bona fide financial
distress that is not likely to be resolved without use
of the federal exclusive bankruptcy power to impair
contracts. The insolvency must be real and not
transitory. This follows from the language of §
101(32)(C) and from other uses of insolvency in the
Bankruptcy Code.
1
Insight into the meaning of the special definition of “insolvent” for municipalities gains texture
by comparison with other forms of the term
“insolvent” in the Bankruptcy Code.
The primary use of “insolvent” in other
chapters of the Bankruptcy Code refers to what is
commonly described as “balance-sheet insolvency,”
which is a financial condition such that liabilities
exceed assets. See, e.g., 11 U.S.C. § 548(a)(1)(B).
In addition, for those involuntary bankruptcy
FN17
cases that are premised on financial condition,
the requirement for an order for relief is that the
debtor is “generally not paying such debtor's debts
as such debts become due unless such debts are the
subject of a bona fide dispute as to liability or
amount.” 11 U.S.C. § 303(h)(1). While § 303 does
not actually use the term “insolvent,” the language
of § 303(h)(1) focused on debts as they become due
is the same as the debts-as-they-become-due language in the definition of municipal insolvency. §
101(32)(C).
2
[6] The language “unable to pay as they become due” in the municipal insolvency definition
implicates the notions of time and projections about
the future.
Statutory construction rules likewise point to a
temporal aspect as the § 101(32)(C)(ii) phrase “as
they become due” must mean something different
than its § 101(32)(C)(i) partner “generally not paying its debts.” In re City of Bridgeport, 129 B.R.
332, 334–37 (Bankr.D.Conn.1991).
The consequence of the § 101(32)(C)(ii) temporal definition of insolvency is that a municipality
need not be actually out of cash before it is cash insolvent.
But how far one looks into the future to discern
insolvency has not been settled. Although the
Bridgeport court purported to announce a rule that
limited the analysis to the current and the next succeeding fiscal years, the putative rule in that decision reflects the unpersuasive state of the evidence before the court in that case, which it viewed
as too speculative to be reliable. Bridgeport, 129
B.R. at 337–38. The Bridgeport rule does not pur-
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port to be a rule for all cases.
In this instance, as the City would run out of
cash within a matter of weeks after the case was
filed, it is only necessary to posit for future situations that § 101(32)(C)(ii) potentially permits the
actual point of running out of cash to be after the
next succeeding fiscal year.
B
*13 The evidence establishes that as of February 28, 2012, the City was not able to pay its debts
as they became due and remained cash insolvent
through the date of filing the chapter 9 case on June
28, 2012.
1
[7] As of February 28, 2012, little guesswork
was needed to project insufficient cash to complete
the current fiscal year. Although cash insolvency
probably existed before February 28, it was by then
beyond cavil that the City was insolvent for purposes of § 101(32)(C).
The main reason that there was about $1.3 million on hand when the case was filed on June 28,
2012, was that the City had, by virtue of its February 28 decision, intentionally defaulted on
$2,048,658 in bond payments due to the objectors
before June 30, 2012. It suspended general fund
payments on the 2004 Lease Revenue Bond
(Parking), the 2009 Lease Revenue Bonds (Public
Facilities Fees), and the 2007 Variable Rate Bonds
(City Hall).
For the fiscal year scheduled to begin July 1,
2012, the City was unable to project a balanced
budget in compliance with California law. Rather, it
projected a deficit for the fiscal year commencing
July 1, 2012, ranging from $20,207,540 to
$38,182,873. Nor would the funds on hand, together with those anticipated to be received during July,
be sufficient for payments required to be made during July. Succeeding months looked similarly
bleak. General fund payments scheduled to service
were projected to total $11,787,182.
By filing the chapter 9 case, the City was able
to impose its so-called “pendency plan” according
to which, among other things, it unilaterally slashed
health care benefits for employees and its 2,400 retirees and suspended general fund payments on
bonds. The pendency plan reductions, the ultimate
effectiveness of which depends upon confirmation
of a plan of adjustment that discharges the breached
obligations, Stockton II, 478 B.R. at 24–25, enabled
the City to adopt a balanced budget. The February
28 projections that led the City to initiate the California neutral evaluation process also sufficed to
establish the requisite cash insolvency to file a
chapter 9 case.
But, even if the projections of February 28 did
not suffice to support a conclusion of cash insolvency per § 101(32)(C), the inability to formulate a
balanced budget for the fiscal year beginning July 1
without impairing contractual obligations independently supports the finding of insolvency.
[8] In other words, when a municipality lacks
the funds to pay its contractual obligations within
the current or the next succeeding fiscal year, it is
unable to pay its debts as they become due within
the meaning of § 101(32)(C).
2
The objectors contend that the City's insolvency was engineered and not genuine. This is where
concepts of service delivery insolvency and budget
insolvency become relevant.
[9] While cash insolvency—the opposite of
paying debts as they become due—is the controlling chapter 9 criterion under § 101(32)(C),
longer-term budget imbalances (budget insolvency)
and the degree of inability to fund essential government services (service delivery insolvency) also inform the trier of fact's assessment of the relative degree and likely duration of cash insolvency.
a
*14 Service delivery insolvency focuses on the
municipality's ability to pay for all the costs of
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providing services at the level and quality that are
required for the health, safety, and welfare of the
community.
The evidence demonstrates that the police department has been decimated. The crime rate has
soared. Homicides are at record levels. The City
has among the ten highest rates in the nation of aggravated assaults with a firearm. Police often respond only to crimes-in-progress.
That is a paradigm example of service delivery
insolvency that confirms that the cash insolvency is
no chimera.
b
Budget insolvency focuses on the ability of a
municipality to create a balanced budget that
provides sufficient revenues to pay for its expenses
that occur within the budgeted period. Relevant
budgeted periods include future fiscal years. The
projections in the February 28 memorandum, which
are not contested by the objectors, demonstrate imbalances that would persist for decades without
some radical surgery.
Nor do there appear to be untapped resources
that would make a material difference. Few fixed
assets are available to be sold or otherwise monetized. Sales tax revenues from an improving regional economy will not suffice because, first, the City's
insolvency is more profound and, second, it is too
speculative to assume that such revenues will rise at
the same or greater rate as the regional economy in
light of the City's service delivery insolvency.
Nor will normal property tax revenues improve
enough to make a material difference. California
property taxes are asymmetric: elastic on the downside because it is comparatively easy to obtain reductions in assessments; but inelastic on the upside
because increases in assessments and ad valorem
rates are restricted by the barriers erected by the
famous Proposition 13.
It follows that the extra revenues needed to
fund a plan of arrangement probably will have to
come from tax increases. The difficulty is that local
tax increases in California generally require a vote
of the people.
[10] The objectors' assertion that relief should
be rejected because the City did not go to the
people for a tax increase before filing a chapter 9
case is not persuasive. Evidence that a majority of
local tax measures on the November 2012 ballot in
California were passed is not probative of, and does
not warrant, a conclusion that Stockton voters
would have approved a tax increase. The objectors
did not point to a single local measure that was enacted amidst fiscal chaos.
To the contrary, Deis testified credibly that a
key lesson learned from his long-term career in
California local public administration is that successful local tax measures for general-purpose revenues occur in an atmosphere in which the predicate message is that the fiscal house is already in order. Putting the fiscal house in order so that voters
might be willing to entertain tax increases is the
whole point of chapter 9.
*15 To that end, the chapter 9 plan confirmation standards incorporate the potential need for
voter approval. A plan cannot be confirmed unless
“electoral approval necessary under applicable nonbankruptcy law in order to carry out any provision
of the plan has been obtained, or such provision is
expressly conditioned on such approval.” 11 U.S.C.
§ 943(b)(6).
Through that process, a budget can be returned
to solvency with a combination of debt adjustment
and revenue enhancement, as appropriate to the
particular situation.
3
The sum of the evidence establishes that the
City was insolvent by all available measures when
it filed its chapter 9 case. It was cash insolvent, unable to pay its debts as they came due as required
by § 101(32)(C) and § 109(c)(3). That it was ser-
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vice delivery insolvent confirms that the cash insolvency was not a mere technical insolvency. That
it was budget insolvent for the long term confirms
that the insolvency would persist without realignment of revenues and expenses. Hence, the City
satisfied the insolvency requirement of § 109(c)(3).
IV
The fourth essential element for chapter 9 eligibility of an insolvent municipality that is authorized under state law to be a chapter 9 debtor is that
it “desires to effect a plan to adjust such debts.” 11
U.S.C. § 109(c)(4).
[11] The cases equate “desire” with “intent”
and make clear that this element is highly subjective. E.g., In re City of Vallejo, 408 B.R. 280, 295
(9th Cir.BAP2009).
A
[12] At the first level, the question is whether
the chapter 9 case was filed for some ulterior
motive, such as to buy time or evade creditors,
rather than to restructure the City's finances. Valleio, 408 B.R. at 295; 2 Collier on Bankruptcy ¶
109.04[3][d], at p. 109–32 (Henry J. Sommer &
Alan N. Resnick eds. 16th ed.2011) (hereafter
“Collier”).
[13] Evidence probative of intent includes attempts to resolve claims, submitting a draft plan,
and other circumstantial evidence. Valleio, 408
B.R. at 295.
impending fiscal year without unilaterally imposing
a pendency plan impairing contracts. The City's
unilateral reductions at to the outset of the case created an imperative on the City either to have those
contract impairments excused by way of a bankruptcy discharge or to achieve agreement with the
affected parties.
The City's unilateral cut of retiree health benefits that this court declined to prevent in the Stockton II decision echoes the action of the general who
burns bridges behind his own troops to leave them
with no choice but to attack. Slashing retiree health
benefits at the outset of the chapter 9 case left the
City with little choice but to effect a plan unless the
retirees were to agree to the impairment of their
claimed contract rights. Without such agreement or
a confirmed plan validating the unilateral action,
the impaired rights could spring back into existence
in a manner that could be unfortunate for the City.
B
*16 [15] The § 109(c)(4) statutory phrase
“desires to effect a plan to adjust such debts” does
not necessarily require that a confirmed or confirmable chapter 9 plan be actually intended. The phrase
also subsumes a de facto plan in which a sufficient
number of affected parties voluntarily revise their
contracts with the municipality in the face of the alternative of the potential compulsion of a confirmed
plan of adjustment.
The City's Ask that was used as a basis for discussion during the prefiling discussion also functions as a draft plan for purposes of § 109(c)(4).
At first blush, chapter 9 has only two exits:
confirmed plan with attendant discharge or dismissal with no discharge. But there really are three
possible chapter 9 outcomes because dismissal subdivides into two alternatives. First, a dismissal in
which a sufficient number of affected parties voluntarily agree to modify their rights that the municipality does not actually need a confirmed plan operates as a de facto plan.
And there is powerful circumstantial evidence
of the City's desire to effect a plan. Evidence of intent to effect a plan includes the circumstance of
the inability to fashion a balanced budget for the
Indeed, a de facto plan attendant to dismissal
was the recent resolution in this judicial district of
the chapter 9 case of the Town of Mammoth Lakes.
That case was dismissed without discharge concur-
[14] In this instance, the City has engaged in
extensive efforts to resolve claims. One of the
byproducts of the California neutral evaluation process is evidence regarding efforts to resolve claims.
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rent with agreement among the key parties in interest to a series of contracts that resolved the
town's financial difficulties, the muscle of chapter 9
having been what forced everyone to take seriously
the need to bargain. Order Dismissing Case, In re
Town of Mammoth Lakes, No. 12–32463,
Bankr.E.D. Cal., Nov. 16, 2012.
While the first form of dismissal without a discharge—dismissal attendant to de facto plan that resolves the financial problem—is a chapter 9 success, the second form of dismissal without discharge bodes trouble.
If the City's case were to be dismissed without
a sufficient number of agreements to restore its
fiscal health, then even more financial trouble
would be in store. One of the consequences of such
a dismissal of this case would be revival of the retirees' claims that their health benefits are contracts
to be enforced, leaving the City exposed to demands for restoration of those benefits and claims
for damages. 11 U.S.C. § 349, incorporated by id. §
901(a). In other words, when the City implemented
unilateral cost-cutting measures at the outset of this
case, it committed itself to the goal of either confirming a chapter 9 plan or achieving agreements
sufficient to constitute a de facto plan with respect
to the victims of those measures. Any other outcome would be troublesome for the City.
Thus, the court is persuaded by a preponderance of the evidence that the City “desires to effect
a plan to adjust such debts” within the meaning of §
109(c)(4) and, in view of its unilateral contract
impairments imposed by way of its pendency plan,
has little choice but to effect a plan.
V
The fifth essential element for chapter 9 eligibility has four alternatives, three of which are focused on negotiations with creditors. 11 U.S.C. §
109(c)(5).
The first and fourth alternatives do not apply in
this case. The City has not obtained the agreement
of a majority in amount of each class of claims that
it intends to impair under a plan. 11 U.S.C. §
109(c)(5)(A). Nor is there any suggestion that there
was a creditor who was attempting to obtain a preference that would be avoidable under the bankruptcy avoidable preference statute. 11 U.S.C. §
109(c)(5)(D). The second and third alternatives do
apply.
*17 The City contends that it has negotiated in
good faith with creditors and has failed to obtain
agreement of creditors holding at least a majority in
amount of each class of claims that it intends to impair under a plan. 11 U.S.C. § 109(c)(5)(B).
And, it contends that negotiation is impracticable with others, including its 2,400 retirees. 11
U.S.C. § 109(c)(5)(C).
A
[16] The § 109(c)(5)(B) negotiations with each
class that the City would impair under a plan puts
the focus on organized labor and on the capital markets creditors.
As to labor, the court concludes for purposes of
eligibility that the City negotiated in good faith
with its unions. During the pre-filing neutral evaluation process, extensive discussions with the various unions have been documented and were followed by agreements to modify all unexpired collective bargaining agreements before the case was
filed. In addition, substantial progress was made towards agreement with the police regarding replacement of their expired collective bargaining agreement. Recalling that personnel costs comprise more
than two-thirds of the City's expenses, this is persuasive evidence of negotiation in good faith with a
substantial body of creditors.
The objecting capital markets creditors contend
that the City did not similarly negotiate in good
faith with them. Although they brand the City's proposal as a take-it-or-leave-it ultimatum that was not
made in good faith, the exchange of salvos in the
good faith barrage and counter-barrage leave the
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capital markets creditors in the weaker position.
The evidence is that the objecting capital markets creditors, led by Assured Guaranty and National Public Finance, chose to take a wehave-nothing-to-talk-about position once the City
indicated that it was not proposing to impair its obligations to CalPERS. In other words, the objecting
creditors created a dynamic in which they categorically would not talk about modifying their rights
unless and until the City attacked CalPERS. At trial, they expressly asserted that § 109(c)(5)(B) good
faith is a one-way obligation applicable to the City
but not to the objectors themselves.
[17] The objectors' salvos are off-target. Just as
it takes two dancers to tango, good faith negotiations contemplate reciprocity. It is not possible to
negotiate with a stone wall. It follows that, as a
matter of law, a municipality's § 109(c)(5)(B) good
faith negotiation obligation is satisfied with respect
to any class of putatively impaired creditors that declines to respond in good faith to a good faith proposal by the municipality.
Although the objectors' complain that the City
did not make a good faith proposal, that salvo also
misses the target. This court is persuaded, as a matter of fact, that the City's Ask with respect to the
capital markets creditors was made in good faith.
The court is also persuaded, as a matter of fact, that
the City did not adopt a take-it-or-leave-it posture.
Rather, the proposals it set forth in the Ask were
within the range of reasonable starting positions in
a negotiation of plan treatment.
*18 A fair reading of the City's proposals indicates that restoring the foundation of the City's
financial structure, and especially reinvigorating its
general fund, will necessitate substantial debt relief
for up to a decade. One facet of its proposal is a
five-year holiday on paying interest and a ten-year
holiday on paying principal. Another facet is eliminating the guaranty of general fund assets to back
up revenue shortfalls in bonds related to specific
projects. The City was willing to pay for both types
of accommodation-typically in the form of extended time for payment, increased interest, or other
adjustments yielding an appropriate value to the impaired party. In short, the City was making a conventional proposal about which there was much that
could have been the basis for bargaining if only the
capital markets creditors had been willing to talk.
It follows that the City performed its good faith
obligation in the negotiations with labor and with
the objecting creditors. The fact that the objectors
chose not to reciprocate does not count against the
eligibility of the City under § 109(c)(5)(B).
B
[18] Impracticability of negotiations per §
109(c)(5)(C) is also pertinent to the City's eligibility in two respects.
First, it is impracticable to negotiate with 2,400
retirees for whom there is no natural representative
capable of bargaining on their behalf. A retiree
committee to speak on behalf of the retirees can be
appointed by the United States trustee, but only
after entry of the order for relief. 11 U.S.C. § 1102,
incoporated by § 901(a).
Second, § 109(c)(5)(C) impracticability
provides an adequate, independent reason for concluding that the City has satisfied the fifth essential
element for eligibility to be a chapter 9 debtor with
respect to the objecting capital markets creditors-it
is impracticable to negotiate with a stone wall.
VI
The sixth preliminary to entry of an order for
chapter 9 relief is a wild card that comes in through
the back door. Even if a municipality satisfies the
eligibility requirements of § 109(c), the court
“may” dismiss the petition “if the debtor did not
file the petition in good faith.” 11 U.S.C. § 921(c).
This is another of four encounters with the
concept of “good faith” in chapter 9. As already explained, there is a reciprocal duty to participate in
good faith in California's gateway neutral evalu-
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ation process. CAL. GOV'T CODE § 53760.3(o).
Chapter 9 eligibility contemplates good faith negotiation with impaired classes that are willing to negotiate. 11 U.S.C. § 109(c)(5)(B). Nor can a plan of
adjustment be confirmed unless proposed in good
faith and not by any means forbidden by law. 11
U.S.C. § 1129(a)(3), incorporated by § 901(a).
A
[19][20] Section 921(c) “good faith” serves a
policy objective of assuring that the chapter 9 process is being used in a manner consistent with the
reorganization purposes of the Bankruptcy Code. It
is assessed on a case-by-case basis in light of all the
facts, which must be balanced against the broad remedial purpose of chapter 9. 2 Collier at
1921.04[2]. Indeed, if all of the eligibility criteria
set forth in § 109(c) as described above are satisfied, it follows that there should be a strong presumption in favor of chapter 9 relief.
*19 [21] Relevant considerations in the comprehensive analysis for § 921 good faith include
whether the City's financial problems are of a
nature contemplated by chapter 9, whether the reasons for filing are consistent with chapter 9, the extent of the City's prepetition efforts to address the
issues, the extent that alternatives to chapter 9 were
considered, and whether the City's residents would
be prejudiced by denying chapter 9 relief. 2 Collier
¶ 921.04[2].
B
Since neither the statute nor the cases are explicit about the burden of proof regarding § 921(c)
good faith, it is appropriate to address the question
through the matrix of trial procedure and the law of
evidence.
Although it is straightforward that the § 109(c)
eligibility elements are matters as to which the City
has the affirmative burden to establish in all respects by preponderance of evidence, the structure
of the language of § 921(c)—“if the debtor did not
file the petition in good faith”—presents a significant difference that implicates the distinction
between the burden of going forward and the burden of persuasion.
[22] The use in § 921(c) of the conditional “if
the debtor did not,” when contrasted against the
background of the direct language of § 109(c),
means that the City's proof of the § 109(c) elements
also operates to create a rebuttable presumption that
it filed the case in good faith for purposes of §
921(c).
This presumption of § 921(c) good faith is directed against the objectors, who thereby have the
burden of producing evidence to rebut the presumpFN18
tion. Fed.R.Evid. 301.
If the objectors produce evidence' to rebut the §
921(c) good faith presumption, then the City must
proceed to carry its ultimate burden of persuasion.
Fed.R.Evid. 301.
The quantum of evidence that must be produced to rebut the § 921(c) good faith presumption
is appropriately evaluated in light of, first, the
policy favoring the remedial purpose of chapter 9
for those entities that meet the eligibility requirements of § 109(c) and, second, the risk that City
residents will be prejudiced if relief nevertheless is
denied.
[23] In view of the multi-year effort to ratchet
down expenses during which the City reduced employees and reduced employee compensation, its
cash insolvency, its service insolvency, its good
faith negotiations or efforts to negotiate with creditors, and its inability to achieve significant further
reductions without being able to compel the impairment of contracts, the § 921(c) good faith presumption in this instance is strong.
The objectors' burden of going forward to produce evidence to call into question § 921(c) good
faith has not, in the judgment of this trier of fact,
been satisfied. The objectors have not, by a wide
margin, adduced evidence sufficient to rebut the
presumption that the case was filed in good faith.
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The presumption that the case was filed in
good faith not having been rebutted, it follows that
the City satisfied its burden to persuade this trier of
fact that it filed the case in good faith for purposes
of § 921(c).
VII
*20 Assured Guaranty made a timely motion
for amended findings under Federal Rule of Civil
Procedure 52(b) questioning the findings regarding
its lack of good faith. Fed.R.Civ.P. 52(b), incorporated by Fed. R. Bankr.P. 7052 & 9014. The effect
of this timely motion is to defer the deadline for appeal from the order for relief until after this court
disposes of the motion. Fed. R. Bankr.P. 8002(b).
It is contended that the evidence does not support a finding that Assured Guaranty did not negotiate in good faith, first, by voting with its feet and
acting as a stone wall in dealings with the City and,
second, by not paying its share of the California
neutral evaluation fees. The City has countered that
the findings are based on evidence in the record and
reasonable inferences drawn therefrom.
The gist of the motion is that the court is unfairly holding Assured Guaranty accountable for
the actions of National Public Finance of entering
the neutral evaluation process with a renunciation
of its obligation under California Government Code
§ 53760.3(s) to pay a portion of the neutral evaluation fees and for announcing to the neutral evaluator that there was nothing to discuss so long as the
City was declining to propose impairment of its obligations to CalPERS.
After careful reflection, this trial court is persuaded that its original findings are correct.
A
The premise of the Assured Guaranty motion is
that the court disregarded the direct evidence embodied in the declaration of Assured counsel that
was designed to explain and excuse the negotiating
conduct of Assured.
1
This requires clarity about the role of the trial
court when, as here, it acts as finder of fact without
a jury.
The basic role of the fact finder is to determine
credibility of witnesses, resolve evidentiary conflicts, and draw reasonable inferences from proven
facts. Fed.R.Civ.P. 52(a), incorporated by Fed. R.
Bankr.P. 7052 & 9014; cf., e.g., United States v.
Hubbard, 96 F.3d 1223, 1226 (9th Cir.1996).
Findings will not be set aside by an appellate
court unless clearly erroneous, with deference given
to the trial court's opportunity to judge witness
credibility. Fed.R.Civ.P. 52(a)(6), incorporated by
FN19
Fed. R. Bankr.P. 7052 & 9014.
As part of that process, the trier of fact is entitled to ascribe differing weights to admitted evidence. The trier of fact is also entitled to disbelieve
admitted evidence. Professor McCormack explains
in a passage invoked by Assured Guaranty that direct evidence “is evidence which, if believed, resolves a matter in issue.” McCormack on Evidence
§ 185 (emphasis supplied); Reply of Assured Guaranty Corp. & Assured Guaranty Municipal Corp. to
City of Stockton's Opposition to Motion Pursuant to
Rule 52(b), at 4.
The authority of the trier of fact to believe or
disbelieve and to ascribe weight to evidence looms
large in this motion.
2
The focus is on the Bjork declaration that was
admitted into evidence. It is contended that this
constitutes unrebutted evidence of Assured Guaranty's good faith conduct.
*21 First, as a basic matter of trial evidence,
this written declaration that was admitted into evidence by stipulation of the parties is merely testimony that this court, in its capacity as trier of fact,
is entitled to believe or to disbelieve regardless of
whether there is cross-examination or other forms
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of rebuttal.
This trier of fact does not give much weight to
the Bjork declaration for two distinct reasons. First,
there is the structural problem that Mr. Bjork is a
lawyer who represents one of the objectors. Indeed,
he is an excellent lawyer who can be counted on to
be careful to say nothing that might undermine his
client. Such testimony, especially written testimony
presented by agreement without cross-examination,
FN20
is not likely to be fully candid and complete.
In the judgment of this trier of fact, it came with
too much spin to be taken at face value.
The second reason for not giving much weight
to the Bjork declaration is that it is inconsistent
with the obstinate stance the objectors, including
Assured Guaranty, have taken in this case. The objectors' continued resistance to an order for relief
and insistence on a trial in the face of overwhelming financial evidence of insolvency that was developed before trial defies common sense. As trial
approached, they must have recognized that the
evidence would compel the conclusion that the City
is in desperate financial straits that likely could
only be solved by impairing contracts through the
chapter 9 process that follows after entry of an order for relief.
Nor is the obstinance about an order for relief
consistent with their posture regarding CalPERS. It
has long been evident that the objectors are itching
for a fight over pensions, to answer interesting
questions whether the City has an executory contract with CalPERS and whether liabilities to CalPERS might be dischargeable debts. And CalPERS
itself has been bellowing and pawing the sidelines
during the eligibility phase waiting for the main
event that will come only after relief is ordered.
In this context, the assertion by the City's counsel that the objectors' obstinacy actually is “all
about leverage” resonates. The objectors are trying
to get their way by forcing the City to incur
massive legal expenses that should not be necessary. An appropriate method for achieving their
goal of spreading the pain to CalPERS would be to
challenge CalPERS head-on in battle over an actual
plan filed after relief is ordered, in which battle the
City could watch from the sidelines.
This trier of fact is persuaded that the carefully-drawn declaration of a lawyer, and by a lawyer, and for a client reflects a party in interest going
through the motions without sincerely intending to
achieve a legitimate litigation goal.
2
The picture that emerged at trial at which Assured Guaranty and National Public Finance shared
the lead in contesting the order for relief was a picture of a group of similarly situated creditors that
had been marching in lockstep throughout the case.
Although there is nothing improper about related
litigants presenting a united front, each participant
assumes the risk of being tainted by one of its associates.
*22 National Public Finance may have been the
one who was so bold as to put in writing its defiance of the cost-sharing obligation imposed by
California Government Code § 53760.3(s). But Assured Guaranty made no effort to disagree and concedes that it paid nothing. The parallelism is eloquent.
[24] Assured Guaranty protests that the City
did not ask it to pay any portion of the Government
Code § 53760.3(s) obligation. But the obligation is
not an obligation to reimburse the City; rather, it is
a direct obligation imposed on parties in interest
that the California legislature intended to be selfexecuting. Assured Guaranty was obliged to be proactive about the bill.
Assured Guaranty protests that pre-existing
agreements in its contracts with the City obliged the
City to pay the Assured Guaranty portion of the
neutral evaluation obligation and that this satisfies
the “unless otherwise agreed by the parties” clause
of Government Code § 53760.3(s). As explained
above, this court is not persuaded that a cost-
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shifting clause in the underlying contract satisfies
the “otherwise agreed” clause. Rather, Government
FN21
Code § 53760.3(s), at a minimum,
indicates a
public policy decision by the California legislature
to trump contractual fee-shifting provisions.
The objectors' trial presentation was a coordinated effort that resembled close order drill. It is apparent that the objectors had been marching together throughout the case. National Public Finance
may have been calling cadence, but Assured Guaranty was keeping in step.
In short, the motion to amend the findings pursuant to Federal Rule of Civil Procedure 52(b) will
be denied. The court was required at trial to weigh
competing evidence, to make credibility determinations, and to draw reasonable inferences. After reflecting on the findings in light of the points raised
by Assured Guaranty, it remains confident that all
of the questioned findings are correct.
CONCLUSION
The City having prevailed on its contention
that chapter 9 relief is appropriate, a chapter 9 order
for relief will be entered.
The motion by Assured Guaranty to alter or
amend the court's oral findings of fact and conclusions of law pursuant to Federal Rule of Civil Procedure 52(b) will be denied.
Appropriate orders will issue.
FN1. This is the fifth formal opinion issued in the Stockton case. The first dealt
with California's chapter 9 gateway statute.
In re City of Stockton, Cal., 475 B.R. 720
(Bankr.E.D.Cal.2012) (“ Stockton I ”). The
second addressed the City's unilateral reduction of health care benefits for retirees.
Ass'n of Retired Employees v. City of
Stockton (In re City of Stockton, Cal.), 478
B.R. 8 (Bankr.E.D.Cal.2012) ( “Stockton II
”). The third involved the additional automatic stay imposed by 11 U.S.C. § 922(a).
In re City of Stockton, Cal., 484 B.R. 372
(Bankr.E.D.Cal.2012) (“ Stockton III ”).
The fourth determined that a municipality
may, but is not required to, obtain court
approval of compromises made during the
case. In re City of Stockton, Cal., 486 B.R.
194 (Bankr.E.D.Cal.2012) (“ Stockton IV
”).
FN2. A California patois employs the term
“AB 506” to refer to the California gateway statute. AB 506 was the bill that,
when passed by the legislature and signed
by the Governor, enacted the current version of Government Code § 53760.
FN3. Median home sales prices were
$422,000 in 2006 and $140,000 in 2012.
Declaration of Chief Financial Officer
Vanessa Burke, City Exhibit 1062, at page
91. Burke was a credible witness.
FN4. Declaration of Deputy City Manager
Laurie Montes, City Exhibit 1054, at page
22. Montes was a credible witness.
FN5. The belt-tightening for all fiscal
years beginning July 1, 2008, is documented at Objector's Exhibit 50, pages
70–79.
FN6. City Exhibit 1057; Objector's Exhibit
68.
FN7. If all authorized 343 sworn officer
positions were filled, the ratio would be
about 1.16 per 1,000 residents. Declaration
of Police Chief Eric Jones, Objector's Exhibit 38, City Exhibit 1061, at page 3. The
parties stipulated to introduction of this declaration into evidence without the need
for cross-examination.
FN8. City Exhibit 1057; Objector's Exhibit
68, at page 27.
FN9. City Exhibit 1056, at pages 2 and
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48–49.
FN18. Federal Rule of Evidence 301
provides:
FN10. City Exhibit 1062, at pages 5 &
27–28.
FN11. City Exhibit 1385, at page 175.
FN12. City Exhibit 1376; Objectors' Exhibit 50, at pages 756–58.
FN13. City Exhibit 1376; Objectors' Exhibit 50, at pages 762–67.
FN14. City Exhibit 1376; Objectors' Exhibit 50, at pages 774–79.
FN15. The precise allocation of costs is:
(s) The local public entity shall pay 50
percent of the costs of neutral evaluation, including, but not limited to, the
fees of the evaluator, and the creditors
shall pay the balance, unless otherwise
agreed to by the parties.
CAL. GOV'T CODE § 53760.3(s).
FN16. The precise definition of a municipal “insolvent” is:
(C) with reference to a municipality, financial condition such that the municipality is—
(i) generally not paying its debts as they
become due unlesssuch debts are the
subject of a bona fide dispute; or
(ii) unable to pay its debts as they become due.
11 U.S.C. § 101(32).
FN17. Control of the debtor's property in
some circumstances may warrant an involuntary order for relief, independent of the
debtor's financial condition. 11 U.S.C. §
303(h)(2).
In a civil case, unless a federal statute or
these rules provide otherwise, the party
against whom a presumption is directed
has the burden of producing evidence to
rebut the presumption. But this rule does
not shift the burden of persuasion, which
remains on the party who had it originally.
Fed.R.Evid. 301.
FN19. The rule provides:
(a) (6). Setting Aside the Findings. Findings of fact, whether based on oral or
other evidence, must not be set aside unless clearly erroneous, and the reviewing
court must give due regard to the trial
court's opportunity to judge the witnesses' credibility.
Fed.R.Civ.P. 52(a)(6), incorporated by
Fed. R. Bankr.P. 7052 & 9014.
FN20. Nor can the Bjork declaration be regarded as uncontested. The assertion that
the City's counsel provided a responsive
declaration that acknowledged that the
Bjork declaration was “largely accurate”
does not lead to a different conclusion. Mr.
Levinson, like Mr. Bjork, is an excellent
lawyer who can be counted on to be careful to say nothing that might undermine his
client. The word “largely” leaves room for
a great deal of disagreement about what
was and was not accurate and complete in
the Bjork declaration.
FN21. As noted above, there is also a theory that the objectors might be required to
pay the City's costs of litigating the order
for relief because the City was the prevailing party.
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Bkrtcy.E.D.Cal.,2013.
In re City of Stockton, Cal.
--- B.R. ----, 2013 WL 2629129 (Bkrtcy.E.D.Cal.),
58 Bankr.Ct.Dec. 20
END OF DOCUMENT
© 2013 Thomson Reuters. No Claim to Orig. US Gov. Works.