Ky. Emps. Ret. Sys. v. Seven Counties Servs., Inc.

• Citation: 580 S.W.3d 530
• Decision Date: 29 August 2019
• Docket Number: 2018-SC-000461-CL
• Parties: In re: KENTUCKY EMPLOYEES RETIREMENT SYSTEM and Board of Trustees of Kentucky Retirement Systems v. SEVEN COUNTIES SERVICES, INC.
• Court: United States State Supreme Court — District of Kentucky

580 S.W.3d 530

In re: KENTUCKY EMPLOYEES RETIREMENT SYSTEM and Board of Trustees of Kentucky Retirement Systems

v.SEVEN COUNTIES SERVICES, INC.

2018-SC-000461-CL

Supreme Court of Kentucky.

AUGUST 29, 2019

COUNSEL FOR KENTUCKY EMPLOYEES RETIREMENT SYSTEM AND BOARD OF TRUSTEES OF KENTUCKY RETIREMENT SYSTEMS: Mark C. Blackwell, Katherine I. Rupinen, Joseph Patrick Bowman, KENTUCKY RETIREMENT SYSTEMS, Daniel R. Swetnam, Victoria E. Powers, Tyson A. Crist, ICE MILLER LLP.

COUNSEL FOR SEVEN COUNTIES SERVICES, INC.: David Marcus Cantor, Louisville, SEILLER WATERMAN LLC, Paul Joseph Hershberg, Louisville, PAUL HERSHBERG LAW, PLLC, G. Eric Brunstad, Jr., DECHERT LLP.

COUNSEL FOR AMICUS CURIAE, COMMUNITY CARE AND DEVELOPMENT MANAGEMENT, INC.: Douglas L. McSwain, Courtney Ross Samford, Thomas Travis, WYATT, TARRANT & COMBS, LLP, Lexington.

COUNSEL FOR AMICUS CURIAE, THE COMMONWEALTH OF KENTUCKY, EX REL. MATTHEW G. BEVIN, GOVERNOR: Mark Stephen Pitt, Stephen Chad Meredith, Matthew Kuhn, OFFICE OF THE GOVERNOR.

COUNSEL FOR AMICUS CURIAE, ROBERT STIVERS, PRESIDENT OF THE SENATE; DAVID OSBORNE, SPEAKER PRO TEMPORE OF THE HOUSE OF REPRESENTATIVES; MORGAN MCGARVEY, SENATE MINORITY FLOOR LEADER; AND ROCKY ADKINS, HOUSE OF REPRESENTATIVES MINORITY FLOOR LEADER: David E. Fleenor, General Counsel, OFFICE OF THE SENATE PRESIDENT, R. Vaughn Murphy, Deputy General Counsel, OFFICE OF THE SENATE PRESIDENT, Rebecca Rudd Barnes, OFFICE OF THE SENATE MINORITY FLOOR LEADER, Joanna Poole Decker, OFFICE OF THE HOUSE MINORITY FLOOR LEADER, Tyler Peavler, OFFICE OF THE SPEAKER OF THE HOUSE OF REPRESENTATIVES, Deborah S. Hunt, Clerk of Court, UNITED STATES COURT OF APPEALS, SIXTH CIRCUIT.

OPINION OF THE COURT BY JUSTICE HUGHES

By order entered November 1, 2018, this Court granted the United States Court of Appeals for the Sixth Circuit’s request for certification of law on the following issue:

Whether Seven Counties Services, Inc.’s participation as a department in and its contributions to the Kentucky Employees Retirement System are based on a contractual or a statutory obligation.

After careful consideration, we hold that Seven Counties Services, Inc.’s participation in and its contributions to the Kentucky Employees Retirement System (KERS) are based on a statutory obligation.

FACTS AND PROCEDURAL HISTORY

This case arises from the efforts of Seven Counties, a non-profit provider of mental health services, to reorganize and rehabilitate its finances under Chapter 11 of the Bankruptcy Code. At its request, in 1979 Governor Julian Carroll designated Seven Counties a "department" for purposes of participating in KERS, a public pension system. Subsequently Seven Counties paid into KERS to secure retirement benefits for its employees. Because the rate of required employer contributions has increased dramatically in recent years, Seven Counties initiated bankruptcy proceedings in April 2013, primarily to reject its relationship with KERS as an executory contract. With KERS maintaining that Seven Counties has statutory as opposed to contractual obligations to KERS, the nature of the parties' relationship is central to a pending appeal in the Sixth Circuit. To address adequately the question certified to this Court, a brief history of both Seven Counties and KERS is necessary.

I. Seven Counties Services, Inc.

Historically, states were responsible for treating the mentally ill, and this often resulted in their institutionalization. In 1963 Congress passed the Community Mental Health Act which provided federal funding to establish Community-Based Mental Health Centers (CMHCs) designed to begin the privatization of mental health services. Using the federal funding, Kentucky chose to provide services through CMHCs, passing laws that enabled their creation and regulation. To become a CMHC in Kentucky, an entity first has to be a non-profit organization and receive designation from the Kentucky Cabinet for Health and Family Services.¹

One of the first CMHCs to incorporate in the state was River Region Mental Health-Mental Retardation Board, Inc.² Most River Region employees were former employees of the Kentucky Department of Mental Health, and reluctant to leave the state system and give up retirement benefits accrued through KERS. In response, Governor Edward Breathitt issued an executive order in 1966 declaring that CMHCs "are permitted to become and are participating agencies" in KERS.³ Executive Order 66-378. This expansion applied to all CMHC employees, not just those transitioning from state employment. River Region became a participating department in KERS by an August 6, 1974 executive order. Executive Order 74-587.

In 1978, River Region filed a petition for Chapter 11 bankruptcy.⁴ The Kentucky Department of Human Resources intervened, urging the Bankruptcy Court not to immediately declare River Region bankrupt, as termination of its business would cut off mental health services in the region it serviced. Soon thereafter, Seven Counties, a newly-formed entity, purchased the assets of River Region through the bankruptcy process and agreed to assume responsibility for providing services in the areas formerly served by River Region. Even though Seven Counties is the direct successor of River Region, it was not automatically drawn into KERS.

In 1978, Seven Counties sought an Attorney General Opinion that it could qualify as a "department" capable of participating in KERS. The Attorney General acknowledged Seven Counties' eligibility pursuant to KRS 61.510(3) : "Any other body, entity or instrumentality designated by Executive Order by the Governor, shall be deemed to be a department [for purposes of KERS] notwithstanding whether said body, entity or instrumentality is an integral part of state government." Subsequently, Governor Carroll entered Executive Order 79-78 allowing Seven Counties to participate in KERS.

Today, Seven Counties is a Kentucky non-profit organization that has provided mental health services in Louisville, Kentucky, and surrounding areas for over 30 years. In its role as a CMHC, Seven Counties provides services to approximately 33,000 people annually, including adults and children with mental illnesses, emotional or behavioral disorders

, disabilities, and alcohol or drug addictions.

II. The Kentucky Employees Retirement System (KERS)

In 1956, the Kentucky General Assembly established KERS and a board of trustees to administer the system. 1956 Ky. Acts ch. 35. Today, Kentucky Retirement Systems (Systems)⁵ is a statutorily-created agency of Kentucky’s executive branch that, through its board of trustees, administers three of Kentucky’s retirement systems—the County Employees Retirement System, the State Police Retirement System, and KERS. KRS 61.645. The goal of KERS is to provide a secure means of retirement savings for the employees of the Commonwealth, its departments, agencies and instrumentalities. KERS is a cost-sharing, multiple-employer, defined-benefit retirement plan. Participating employers and employees pay into KERS at a set rate and, upon retirement, KERS pays out the employee’s defined benefit based on the number of years served, a "benefit factor," and an employee’s final compensation. See KRS 61.510 et seq.

KERS implements two plans: hazardous and non-hazardous plans that are best described as different tiers within a single defined benefit plan.⁶ Generally, employees contribute 5% of their compensation.⁷ The employer contribution consists of the cost of funding the benefit earned that year, plus the amount needed to fund the actuarially accrued liability.⁸ This actuarially required contribution rate is known as the ARC and is a payment made by employers toward past unfunded liability in order to ensure KERS has the resources needed to pay benefits. The ARC is important because the solvency of KERS to meet future payment obligations depends on consistent payment of the ARC. Ky. Emp. Ret. Sys. v. Seven Ctys. Serv., Inc., 550 B.R. 741, 749 (W.D. Ky. 2016). As the District Court pointed out in its opinion in this case, "[i]t does not take an expert to conclude that KERS’s non-hazardous plan is in poor shape." Id.

In the early 2000s, KERS became underfunded for three primary reasons: (1) market losses in 2000-01 and 2008-09 diminished the fund’s asset values by 17%; (2) the General Assembly approved increased retirement benefits to keep up with inflation without providing additional appropriations to fund the increase; and (3) the General Assembly consistently failed to require contribution rates commensurate with the ARC.⁹ Seven Ctys. , 550 B.R. at 749-50. The burden of this shortfall in funding falls on the employers participating in KERS.¹⁰

Kentucky’s General Assembly responded to the funding crisis by increasing employer contribution rates in 2008 and in 2013 it required employers participating in KERS—including the State itself—to contribute at the full, actuarially required rate going forward. Recognizing 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 KERS and capping the contribution rate at 24%. Nevertheless, as of April 2013, Seven Counties' contribution rate rose well above its historic single-digit rate. The Bankruptcy Court noted that with the required contribution rate of 24% of wages, Seven Counties could either perform work in furtherance of its charitable mission or pay its KERS contributions and be forced to terminate operations.¹¹ KERS estimates that if Seven Counties is permitted to withdraw from the pension system, it will leave behind a shortfall of over $90 million, to be picked up by other employers in the pension system and, ultimately, Kentucky taxpayers.

III. Procedural History of the Parties' Litigation

On April 4, 2013, Seven Counties filed a Chapter 11 bankruptcy petition seeking to reject its obligation to participate in KERS. As the Bankruptcy Court noted, the procedural history of ...