In re City of San Bernardino

Decision Date07 March 2017
Docket NumberCase No. 6:12–bk–28006–MJ
Citation566 B.R. 46
Parties IN RE: CITY OF SAN BERNARDINO, CALIFORNIA, Debtor.
CourtU.S. Bankruptcy Court — Central District of California

Laura L. Buchanan, Paul R. Glassman, Fred Neufeld, Stradling Yocca Carlson & Rauth, P.C., Santa Monica, CA, for Debtor.

Michael J. Bujold, U.S. Department of Justice, Everett L. Green, Office of the U.S. Trustee, Mohammad Tehrani, Riverside, CA, for U.S. Trustee.

Anthony Bisconti, Steven J. Katzman, Bienert, Miller & Katzman, PLC, San Clemente, CA, for Creditor Committee.

MEMORANDUM OF DECISION RE ISSUANCE OF THIRD PARTY INJUNCTION IN CONJUNCTION WITH CONFIRMATION OF CHAPTER 9 PLAN

Meredith A. Jury, United States Bankruptcy Judge

Facing a cash flow crisis of significant magnitude in the summer of 2012 with no end in sight, the City of San Bernardino ("City") declared an emergency under state law and filed a petition under Chapter 91 in the Bankruptcy Court on August 1, 2012. After a hard-fought battle over eligibility which resulted in this court finding the City was eligible because it had filed its chapter 9 petition in good faith and desired to propose a plan to adjust its debt2 , the City set about to propose such a plan. It began by shoring up its financial records so that its income and expense projections were reliable. This gave it an accurate picture of how it must impair its creditor body in order to achieve restructuring of its debt and revitalization of City services. It mediated where possible and litigated where necessary to eventually be able to propose its Third Amended Plan of Adjustment ("Plan") which was by and large a consensual plan. After multiple confirmation hearings to resolve the few but significant objections to the Plan, on December 6, 2016, this court overruled the remaining objections and confirmed the Plan.

A lynchpin of the Plan was payment of 1% on the dollar on the allowed claims in Class 13, the class of general unsecured creditors. In support of confirmation, the City presented substantial unrefuted evidence which justified the necessity of such a low percentage payment to this creditor body so that the City could move forward with its 20 year Financial Model, which over time would bolster City services, revitalize the aging infrastructure, and substantially improve safety, in particular police services. A significant component of Class 13 were litigation claimants ("Claimants"), who had either filed suit or made claims against the City based on its alleged wrongdoings, including Civil Rights Claimants who alleged claims under the Civil Rights Act.3 Many of these Claimants asserted litigation claims not only against the City but also against it employees acting in the normal course of their employment, in particular members of the Police Department. Under California law, the City is obligated to indemnify its employees for claims against them for acts arising within the scope of their employment. Unless the claims against these employees were addressed in the Plan, the indemnification requirement made the City face significant risk of an obligation to pay damages awarded against these employees at 100% on the dollar, payments which the City could not afford and still be able to perform under its Financial Model, its roadmap to revitalization.

The City addressed this risk by including in the Plan an injunction ("Plan Injunction") which would prevent Claimants from collecting damages awarded against certain Indemnified Parties4 from those parties' assets or earnings, thereby insulating the City from the uncapped indemnification claims which would arise under California law. Certain Claimants objected to inclusion of the Plan Injunction in the confirmed Plan; such objections were argued and overruled when the court confirmed the Plan. The court found that the Plan Injunction was a critical and essential element in the revitalization efforts of the City and that, without such, the City's opportunity to reorganize would be severely impacted. This Memorandum of Decision explains why the Plan Injunction is vital to the City's reorganization and proper under the law.5

I. BACKGROUND

The Plan at Section XI.C provides injunctive relief which prevents pre-confirmation creditors from pursuing debt collection activities after confirmation not only against the City but also against "Indemnified Parties", defined in the Plan as "the current and former officers and employees of the City who are entitled to Indemnification"6 (the "Plan Injunction"). Specifically, the Plan provided in pertinent part:

Except as otherwise expressly provided in this Plan, all Entities who have held, hold, or may hold Pre-Confirmation Date Claims shall be permanently enjoined from and after the Confirmation Date, with respect to such Pre-Confirmation Date Claims, from: (i) commencing or continuing in any manner, directly or indirectly, any suit, action or other proceeding of any kind against the City or its property or any or all of the Indemnified parties or any of their property ....7

Plan, XI.C. On September 30, 2016, the City filed modifications to the Third Amended Plan, which were approved by the Court in the Confirmation Order, which limited the Plan Injunction such that it only enjoined enforcement, not liquidation of the Litigation Claims, and allowed Claimants to recover from any applicable insurer. New Section XI.G stated:

Litigation Claims means (a) those lawsuits against the City that are still pending as of the Confirmation Date, including those listed in Exhibit 6 to the Appendix; (b) those lawsuits against the City that are filed on or after the Confirmation Date based on acts, claims or omissions that occurred or arose prior to the Confirmation Date; and (c) those lawsuits against any of the Indemnified Parties, whether filed prior to the Confirmation Date or on or after the Confirmation Date based on acts, claims or omissions that occurred or arose prior to the Confirmation Date, as to which lawsuits the City has assumed or will assume the defense thereof and became or becomes obligated to pay any judgment arising therefrom pursuant to Cal. Government Code §§ 825, 970, 995 and 996 and any other applicable law or rule.

Plan, XI.G.

Although written in generic terms, the primary purpose of the Plan Injunction was to shield the City's employees, specifically its police officers, from litigation exposure and liability for damages of Claimants who alleged the officers had violated their civil rights, as protected by 42 U.S.C. § 1983. Under the California Government Code, all municipalities are obligated to indemnify their employees for claims against them arising from the scope of their employment, such indemnification to cover both the costs of defense and any damage award against the employee (" Section 825 indemnification"). See Cal. Gov't Code §§ 825, 970, 995, and 996. At the time of confirmation in this case, the City had approximately 115 lawsuits pending against it and more than 200 other Claimants who had given notice of a claim but had not yet initiated litigation. More than half of the lawsuits and many of the other Claimants asserted claims against the Indemnified Parties.

The Plan placed the Claimants in Class 13, a class comprised of all unsecured claims against the City that arose prior to confirmation of the Plan. Class 13 also included the claims of employees, retirees, and general trade creditors, among others, all of which totaled an estimated $200 million.8 The Plan proposed to pay 1% on the dollar to all allowed claims in Class 13. As discussed more thoroughly below, the City asserted in its Disclosure Statement and submitted evidence at confirmation which demonstrated that the City could not afford to pay more than the specified 1% and still be financially able to pay all other preconfirmation debts pursuant to terms in the Plan as well as provide an acceptable level of services to its citizens as outlined in the Financial Model.9

The obligation of the City to provide § 825 indemnification to its employees is not a discharged preconfirmation claim under the terms of the Plan. The settlements the City negotiated with its employee unions and the operative collective bargaining agreements required the City to reaffirm its obligation to indemnify the employees. The City honored this commitment by reaffirming the obligation in the Plan at Section VII.D.

During the course of the Plan confirmation process, several of the civil rights Claimants objected to confirmation on multiple grounds, including the provision calling for the Plan Injunction.10 They argued that they should be able to pursue their litigation claims against City employees, allowing them not only to obtain a judgment or mediated resolution, but also to exercise all enforcement and collection rights against such employees. The court entertained both written and oral argument on these objections on multiple dates, culminating at the final hearing on Plan confirmation on December 6, 2016. At the December 6 hearing, the court overruled all outstanding objections to confirmation, including those of the civil rights Claimants, and confirmed the Plan, including the requested Plan Injunction.11

II. DISCUSSION
A. Arguments against Plan Injunction

Citing Ninth Circuit cases and other authorities, the civil rights Claimants assert that the bankruptcy court has neither the jurisdiction nor the authority to control preconfirmation creditors' actions against third parties. They argue that in American Hardwoods, Inc. v. Deutsche Credit Corporation (In re American Hardwoods, Inc.) , 885 F.2d 621 (9th Cir. 1989) the court determined that § 105(a) did not provide jurisdiction to the court because such injunctive relief did not arise under Title 11, nor was it arising in or related to a case under Title 11, the parameters set for the bankruptcy courts' subject matter jurisdiction in 28 U.S.C. § 1334(b). Moreover, they assert that even if the court has jurisdiction, it lacks the...

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