Ass'n of Retired Emps. of the City of Stockton, Corp. v. City of Stockton (In re City of Stockton), Bankruptcy No. 12–32118–C–9.

• Decision Date: 06 August 2012
• Docket Number: Adversary No. 12–2302.,Bankruptcy No. 12–32118–C–9.
• Court: United States Bankruptcy Courts. Ninth Circuit. U.S. Bankruptcy Court — Eastern District of California
• Parties: In re CITY OF STOCKTON, CALIFORNIA, Debtor. Association of Retired Employees of the City of Stockton, a Nonprofit California Corporation, Shelley Green, Patricia Hernandez, Reed Hogan, Glenn E. Matthews, Patrick L. Samsell, Alfred J. Siebel, Brenda Jo Tubbs, Teri Williams, on Behalf of Themselves and Others Similarly Situated, Plaintiffs, v. City of Stockton, California, Defendant.

478 B.R. 8

56 Bankr.Ct.Dec. 250

In re CITY OF STOCKTON, CALIFORNIA, Debtor.

Association of Retired Employees of the City of Stockton, a Nonprofit California Corporation, Shelley Green, Patricia Hernandez, Reed Hogan, Glenn E. Matthews, Patrick L. Samsell, Alfred J. Siebel, Brenda Jo Tubbs, Teri Williams, on Behalf of Themselves and Others Similarly Situated, Plaintiffs,

v.City of Stockton, California, Defendant.

Bankruptcy No. 12–32118–C–9.

Adversary No. 12–2302.

United States Bankruptcy Court,

E.D. California.

Aug. 6, 2012.

G. Scott Emblidge (argued), Rachel J. Sater, Kathryn J. Zoglin, Moscone Emblidge & Sater LLP, San Francisco, CA, for Plaintiffs.

Marc A. Levinson (argued), Norman C. Hile, John W. Killeen, Orrick, Herrington & Sutcliffe LLP, Sacramento, CA, for Defendant.

OPINION

CHRISTOPHER M. KLEIN, Bankruptcy Judge.

The retired employees of the City of Stockton want this court to order the City to keep paying for their health benefits during this chapter 9 case. The difficulty is that 11 U.S.C. § 904 forbids the court from using any of its powers to “interfere with” property or revenues of a chapter 9 debtor. Accordingly, although the City's unilateral interim reduction of retiree health benefit payments may lead to tragic hardships for individuals in the interval before their claims are redressed in a chapter 9 plan of adjustment, the motion for injunctive relief must be DENIED. No relief being available and determining that this is an “arising in” core proceeding under 28 U.S.C. § 1334(b) and § 157(b)(2), the adversary proceeding will be DISMISSED.

Procedural Posture

This adversary proceeding was filed as a class action by the Association of Retired Employees of the City of Stockton (“ARECOS”) and eight retirees on July 10, 2012, together with an Application for Temporary Restraining Order (“TRO”) or Preliminary Injunction or in the Alternative Relief From Stay.

The retirees contend they have vested contractual rights that are protected from impairment by the Contracts Clause of the United States Constitution, a similar clause in the California Constitution, and by other provisions of California law.

The complaint, the application for injunctive relief, and the supporting papers conspicuously omit reference to § 904, which operates as an anti-injunction statute and bars the court, without the municipality's consent, from interfering with its political or governmental powers, property or revenues, and use or enjoyment of income-producing property.

The court set the TRO/preliminary injunction hearing for July 23, 2012, and ordered the parties to brief the question of the effect of § 904 on this adversary proceeding. It further ordered the City to state whether, as permitted by § 904, it consents to this court resolving the interim health benefit payment dispute. Notice was also given that the court might dismiss the adversary proceeding on its own motion if it concludes that § 904 prevents all of the relief being sought.

At the July 23 hearing, the parties addressed all facets of the adversary proceeding, questions of jurisdiction, and judicial authority. The City did not consent to permit this court to resolve the interim health benefit payment dispute. This decision announces and explains the court's ruling.

Facts

The City of Stockton filed this chapter 9 case on June 28, 2012. The questions of the City's eligibility for chapter 9 relief and whether to order relief are the subject of a separate process progressing under a schedule fixed by the court.

The Stockton City Council adopted a budget for the Fiscal Year commencing July 1, 2012, that, by state law, must be balanced. The required balance was achieved by cutting costs, including unilaterally reducing retiree health benefits.

This adversary proceeding seeks: an injunction prohibiting the City from implementing the retiree health benefit reduction; a declaration that the changes are unlawful; and an order compelling the City to pay for the retiree health benefit for all retirees entitled to it as of July 1, 2012; and attorney fees.¹

For purposes of the present analysis (but without deciding the question), the retiree health benefits are regarded as bargained-for and vested contractual rights.

Persons whose benefits have been reduced may file proofs of claim that must be addressed in a plan of adjustment under the standards prescribed in the Bankruptcy Code for confirming plans.

Discussion

Since the complaint relies on the supposed inability of the City to impair contracts, we begin with basic points of constitutional law and history that give context to the § 904 limitation on the court's authority. Then the focus shifts to how the plaintiffs' due process rights are protected, and thence to the jurisdictional and procedural status of this proceeding.

I

This adversary proceeding is premised at bottom on the Contracts Clause of the United States Constitution: “No State shall ... pass any ... Law impairing the Obligation of Contracts.” U.S. Const., art. I, § 10, cl. 1.

Counsel clarified in open court that an immutable Contracts Clause is the centerpiece of plaintiffs' case. The first cause of action is: “Impairment of Contract—U.S. Constitution” and alleges that in “unilaterally changing the terms of the Retiree Health Benefit, the City impaired contractual obligations, in violation of Article I section [10] of the United States Constitution and 42 U.S.C. § 1983.” Complaint, ¶ 56. The other causes of action flow from that premise.² The premise is flawed.

While the Contracts Clause is a key navigational star in the firmament of our Constitution and economic universe, it is subject to being eclipsed by the Bankruptcy Clause: “The Congress shall have Power to ... establish ... uniform Laws on the subject of Bankruptcies throughout the United States.” U.S. Const., art. I, § 8, cl. 4.

Significantly, the Contracts Clause bans a state from making a law impairing the obligation of contract; it does not ban Congress from making a law impairing the obligation of contract. This asymmetry is no accident.

The Bankruptcy Clause necessarily authorizes Congress to make laws that would impair contracts. It long has been understood that bankruptcy law entails impairment of contracts. Sturges v. Crowninshield, 17 U.S.(4 Wheat.) 122, 191, 4 L.Ed. 529 (1819).

In Sturges, the Supreme Court reasoned that Congress “is expressly vested with the power of passing bankrupt laws, and is not prohibited from passing laws impairing the obligation of contracts, and may, consequently, pass a bankrupt law which does impair it; whilst the states have not reserved the power of bankrupt laws, and are expressly prohibited from passing laws impairing the obligation of contracts.” Id.

In 1936, the Supreme Court noted that the “especial purpose of all bankruptcy legislation is to interfere with the relations between the parties concerned—to change, modify, or impair the obligation of their contracts.” Ashton v. Cameron Cnty. Water Improvement Dist. No. 1, 298 U.S. 513, 530, 56 S.Ct. 892, 80 L.Ed. 1309 (1936).

Again, in its 1938 decision validating the second municipal insolvency statute, the Court explained that the “natural and reasonable remedy through composition” is not available under state law “by reason of the restriction imposed by the Federal Constitution upon the impairment of contracts by state legislation” but the “bankruptcy power is competent to give relief.” Hence, a state, by authorizing a municipality to file a case, legitimately “invites the intervention of the bankruptcy power to save its agency which the State itself is powerless to rescue.” United States v. Bekins, 304 U.S. 27, 54, 58 S.Ct. 811, 82 L.Ed. 1137 (1938).

In other words, while a state cannot make a law impairing the obligation of contract, Congress can do so. The goal of the Bankruptcy Code is adjusting the debtor-creditor relationship. Every discharge impairs contracts. While bankruptcy law endeavors to provide a system of orderly, predictable rules for treatment of parties whose contracts are impaired, that does not change the starring role of contract impairment in bankruptcy.

It follows, then, that contracts may be impaired in this chapter 9 case without offending the Constitution. The Bankruptcy Clause gives Congress express power to legislate uniform laws of bankruptcy that result in impairment of contract; and Congress is not subject to the restriction that the Contracts Clause places on states. CompareU.S. Const. art. I, § 8, cl. 4, with§ 10, cl. 1. Hence, the key premise of the centerpiece of this lawsuit rests on infirm constitutional ground.

The federal bankruptcy power also, by operation of the Supremacy Clause, trumps the similar contracts clause in the California state constitution. U.S. Const. Art. VI, cl. 2; Cal. Const. Art. I, § 9 (“A bill of attainder, ex post facto law, or law impairing the obligation of contracts may not be passed.”); Int'l Bhd. of Elec. Workers, Local 2376 v. City of Vallejo (In re City of Vallejo), 432 B.R. 262, 268–70 (E.D.Cal.2010), aff'g,403 B.R. 72, 76–77 (Bankr.E.D.Cal.2009). For the same reason, the plaintiffs' other theories also fall.

In sum, even if the plaintiffs' benefits are vested property interests, the shield of the Contracts Clause crumbles in the bankruptcy arena.

II

A delicate state-federal relationship of mutual sovereigns in which the Tenth Amendment looms large provides the framework for municipal bankruptcy and gives context to this dispute.

A

A pair of chapter 9 provisions honors state-federal balance by reserving certain state powers and by correlatively limiting the powers of the federal court: 11 U.S.C. §§ 903 and 904.

Section 903 reserves to the state the power to control political and governmental powers, as well as expenditures:

§ 903. Reservation of State power to control municipalities

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...