Ky. Emps. Ret. Sys. v. Seven Counties Servs., Inc., s. 16-5569/5644

Citation901 F.3d 718
Decision Date24 August 2018
Docket NumberNos. 16-5569/5644,s. 16-5569/5644
Parties KENTUCKY EMPLOYEES RETIREMENT SYSTEM ; Board of Trustees of Kentucky Retirement Systems, Appellants/Cross-Appellees, v. SEVEN COUNTIES SERVICES, INC., Appellee/Cross-Appellant.
CourtUnited States Courts of Appeals. United States Court of Appeals (6th Circuit)

ARGUED: Tyson A. Crist, ICE MILLER LLP, Columbus, Ohio, for Appellants/Cross-Appellees. G. Eric Brunstad, Jr., DECHERT LLP, Hartford, Connecticut, for Appellee/Cross-Appellant. ON BRIEF: Tyson A. Crist, Daniel R. Swetnam, Victoria E. Powers, ICE MILLER LLP, Columbus, Ohio, for Appellants/Cross-Appellees. G. Eric Brunstad, Jr., DECHERT LLP, Hartford, Connecticut, David M. Cantor, SEILLER WATERMAN LLC, Louisville, Kentucky, Paul Hershberg, GRAY & WHITE, Louisville, Kentucky, for Appellee/Cross-Appellant.

Before: COLE, Chief Judge; McKEAGUE and STRANCH, Circuit Judges.

STRANCH, J., delivered the opinion of the court, in which COLE, C.J., joined. McKEAGUE, J. (pp. 732–46), delivered a separate dissenting opinion.

JANE B. STRANCH, Circuit Judge.

This case arises out of an attempt by Seven Counties Services, Inc., a nonprofit provider of mental health services, to rehabilitate its finances by filing for reorganization under Chapter 11 of the Bankruptcy Code. For decades, Seven Counties has participated in Kentucky’s public pension plan, the Kentucky Employees Retirement System (KERS or the System). But because the rate set for employer contributions has drastically increased in recent years, Seven Counties now seeks to use these proceedings to reject its relationship with KERS. The bankruptcy court and the district court both held that Seven Counties is eligible to file under Chapter 11 and that the relationship between Seven Counties and KERS is based on an executory contract that can be rejected in bankruptcy. Because the Commonwealth of Kentucky does not exercise the necessary forms of control over Seven Counties, we AFFIRM the conclusion that Seven Counties is eligible to file. But, lacking guidance from the Kentucky state courts, we CERTIFY the question of the nature of the relationship to the Kentucky Supreme Court.

I. BACKGROUND

Seven Counties is a Kentucky nonprofit that has provided mental health services in the area surrounding Louisville, Kentucky since 1978. In its role as a community mental health center (CMHC), Seven Counties provides services to approximately 33,000 people, serving as a safety net for adults and children with mental illnesses, emotional or behavioral disorders

, developmental or intellectual disabilities, and alcohol or drug addictions.

CMHCs like Seven Counties have provided mental health services in Kentucky since the 1960s. In 1963, Congress passed the Mental Retardation Facilities and Community Mental Health Centers Construction Act, which provided federal funding to establish CMHCs. Pub. L. No. 88-164, 77 Stat. 282 (1963). Before that time, mental health services in Kentucky, like in most states, were largely provided by the state government. With the newly available federal funding, Kentucky embarked on a plan to provide services through CMHCs, including by passing laws that enabled their creation and regulation. Seven Counties' predecessor in the Louisville area, a nonprofit that eventually became known as River Region Mental Health-Mental Retardation Board, was founded at that time.

When River Region and the other new CMHCs formed in 1966, they began providing local services that had previously been provided by the Kentucky Department of Mental Health. Many of the CMHCs' new employees had previously been Department employees. Those employees were reluctant to leave the state system and thereby give up the retirement benefits they had been accruing in the state public pension system, KERS.1 In response to the employees' dilemma, the Governor issued an executive order declaring that "community mental health boards are permitted to become and are participating agencies in the Kentucky Employe[e]s Retirement System." Ky. Exec. Order No. 66-378 (June 23, 1966). The order did not distinguish between newly hired employees and those who were transitioning from state employment. Three CMHCs declined to participate; the remainder became part of KERS.

In 1978, River Region filed for reorganization and then for bankruptcy under Chapter XI of the Bankruptcy Act of 1898. That same year, Seven Counties was incorporated and became the designated CMHC for the area formerly served by River Region. As the bankruptcy court concluded, "[e]xcept for adopting its separate corporate identity and not assuming debt, Seven Counties was the direct successor to River Region for all business and regulatory purposes." In re Seven Ctys. Servs., Inc. (Ky. Emps. Ret. Sys. v. Seven Ctys. Servs., Inc. ), 511 B.R. 431, 443 (Bankr. W.D. Ky. 2014), aff'd in part, rev'd in part , 550 B.R. 741 (W.D. Ky. 2016).

But Seven Counties was not automatically pulled into KERS. Approximately six months after Seven Counties formed, its executive director sent a letter to the Kentucky Retirement Systems—the body that administers KERS—about Seven Counties' participation in KERS. Seven Counties then sent a letter to the Attorney General asking whether it was eligible to participate in KERS. The Attorney General’s response cited the provision in Kentucky law that allows an entity to become a participating "department" in KERS upon issuance of an executive order, Ky. Rev. Stat. § 61.510(3), and concluded that because Seven Counties "appears to be [River Region’s] newly created successor, it is our opinion that [Seven Counties] employe[e]s may begin to participate in the KERS upon the issuance of an Executive Order from the Governor to that effect." Ky. Op. Att'y Gen. No. 78-685, 1978 WL 26239 (Oct. 4, 1978). According to the minutes from a Seven Counties board meeting the following month, Seven Counties then "petition[ed] ... the Governor to sign an Executive Order to allow [Seven Counties] to join KERS." In January, the Governor issued an executive order "designat[ing] Seven Counties Services, Inc. as a participating department in the Kentucky Employe[e]s Retirement System." Ky. Exec. Order No. 79-78 (Jan. 24, 1979).2

In recent years, participation in KERS has become a heavy financial burden for Seven Counties. A brief summary suffices to explain the nature of a complex problem. KERS is a defined benefit plan. Participating employers and their employees pay into the System at a set rate and then, upon retirement, the System pays out the defined benefit at a rate determined by multiplying the employee’s final compensation, the "benefit factor," and the number of years of service credit. If the rates at which employees and employers pay into the System are not set appropriately, KERS can become underfunded. The subset of KERS in which Seven Counties participates (known as the "non-hazardous plan") was fully funded as recently as 2000. But as of 2013, when Seven Counties' petition was filed, the General Assembly had failed for years to budget sufficient funds to make the actuarially required contribution that would ensure the financial health of KERS. To make the situation worse, KERS’s assets declined substantially in value during market downturns in 2000–01 and 2008–09, and the legislature approved but did not fund cost-of-living adjustments to respond to inflation. The burden of this shortfall falls on the employers participating in KERS. (Employee contribution rates, KERS’s other source of income aside from investment returns, are capped by statute. See Ky. Rev. Stat. § 61.560(1).)

Recognizing the funding crisis in its public pension system, Kentucky’s General Assembly phased in increased employer contribution rates starting in 2008, and then, in 2013, began requiring employers participating in KERS—including the State itself—to contribute at the full, actuarially required rate going forward. See Ky. Rev. Stat. § 61.565. Aware of the burden this placed on some participating employers, the legislature provided assistance to CMHCs, keeping their rates somewhat lower than those of other employers in the System. Nonetheless, Seven Counties' contribution rates rose well above their historic single-digit range. By the time Seven Counties filed its petition in April 2013, its contribution rate was just under 24% of wages—and was set to increase to almost 27% in a few months.

According to the bankruptcy court, at an employer contribution rate of 24%, "Seven Counties can perform its charitable mission or pay System contributions that will force it to terminate operations. It cannot do both." In re Seven Ctys. Servs. , 511 B.R. at 453. And as of 2013, there was no statutory mechanism by which Seven Counties could withdraw from KERS.3 So Seven Counties filed a Chapter 11 petition, seeking a way to shed its ongoing obligation to participate in KERS. If Seven Counties is permitted to withdraw, KERS estimates that it will leave behind a shortfall of over $90 million to be picked up by other employers in the System—and, ultimately, Kentucky taxpayers.

The proceedings since filing have been lengthy and convoluted. In the instant matter, KERS appeals the dismissal of its complaint in an adversary proceeding. In that complaint, KERS made two basic arguments: (1) that Seven Counties is a "governmental unit" and therefore ineligible to file under Chapter 11, and (2) that Seven Counties should be required to comply with its statutory obligations to make contributions and reports to KERS during the pendency of bankruptcy proceedings. In the same proceeding—and addressed by the bankruptcy court in the same ruling—Seven Counties filed a motion seeking to reject its obligation to contribute to KERS as an executory contract. The bankruptcy court found in favor of Seven Counties on all counts. See In re Seven Ctys. Servs. , 511 B.R. at 437. The district court affirmed.

II. ANALYSIS

This court reviews the bankruptcy court’s decision directly, affording no...

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