S. Inyo Healthcare Dist. v. Optum Bank, Inc. (In re S. Inyo Healthcare Dist.)

• Decision Date: 10 February 2020
• Docket Number: Adv. No. 17-01077-A,Case No. 16-10015-A-9
• Citation: 612 B.R. 750
• Court: U.S. Bankruptcy Court — Eastern District of California
• Parties: IN RE: SOUTHERN INYO HEALTHCARE DISTRICT, Debtor. Southern Inyo Healthcare District, Plaintiff, v. Optum Bank, Inc., Defendant.

612 B.R. 750

IN RE: SOUTHERN INYO HEALTHCARE DISTRICT, Debtor.

Southern Inyo Healthcare District, Plaintiff,

v.Optum Bank, Inc., Defendant.

Case No. 16-10015-A-9

Adv. No. 17-01077-A

United States Bankruptcy Court, E.D. California.

Argued and submitted on May 22, 2019 at Fresno, California

Signed February 10, 2020

Jeffrey I. Golden, Weiland Golden Goodrich LLP for Southern Inyo Healthcare District;

Ashley M. McDow, Foley & Lardner LLP for Southern Inyo Healthcare District;

Latonia C. Williams, Shipman & Goodwin LLP for Optum Bank, Inc.;

Gerald N. Sims, Pyle Sims Duncan & Stevenson, P.C. for Optum Bank, Inc.

MEMORANDUM

Honorable Fredrick E. Clement, Bankruptcy Judge Presiding

Hospital districts may issue promissory notes for "equipment or items which have a useful life equal to, or longer than, the term of the notes, as determined by the board of directors." Cal. Health & Safety Code § 32130.2. Longer loans are unenforceable. Apparently without considering the length of the loan vis-à-vis asset life, a hospital district financed, and then refinanced, the purchase of equipment and software. Is the refinance loan enforceable?

I. FACTS

A. About the Debtor

Southern Inyo Healthcare District ("Southern Inyo" or "the district") is a rural healthcare district founded under the California Local Health Care District Law. Cal. Health & Safety Code § 32000 et seq. It operates a hospital, skilled nursing facility and medical clinic in Inyo County, California. Its principal office is in Lone Pine, California. Southern Inyo is governed by its Board of Directors.

B. The El Dorado Line of Credit

From time to time in the past, Southern Inyo experienced cash flow difficulties. In 2007, as a means to address short-term cashflow shortfalls, Southern Inyo took out a $250,000 equity line of credit from El Dorado Bank ("El Dorado loan"). It bore interest at 8.25% and was secured by a deed of trust against Southern Inyo's Lone Pine office property. The line of credit matured in 2012, and having been unpaid, converted to a 15-year promissory note with monthly principal and interest payments.

C. The UHC of California Equipment and Software Purchase Loan

In 2011, Southern Inyo wanted to purchase Health Information Technology/Electronic Health Records equipment and software for use in its facilities. Unable to pay cash for these items, the district arranged financing with UHC of California. At a special meeting held in 2011, Southern Inyo's Board of Directors authorized the issuance of promissory notes to UHC of California for purchase of the equipment and software. The Board of Directors memorialized its decision in Resolution 11-06. Resolution 11-06 contained no findings as to the useful life of the equipment and/or software for which the promissory notes were issued. It also did not reflect whether the Board considered useful life spans of these items vis-à-vis the length of the UHC of California loan.

Thereafter, the District purchased the equipment and software, and executed a promissory note for $1.7 million in favor of UHC of California ("UHC loan"). The loan was secured by an Indenture of Trust. It bore interest at 3.75% per annum and matured in late 2016. The note required annual principal reductions in excess of $500,000, which were to be paid starting December 2014. It also required semiannual interest payments. The loan offered Southern Inyo a sliding scale prepayment incentive, e.g., 10% reduction in principal if the note was paid in full within 36 months of inception, and 7.5% reduction in principal if paid in full in 42 months.

D. Southern Inyo's Revenues Decline

Starting in 2012, after it executed the loan in favor of UHC of California, Southern Inyo's revenues fell.

Rather than cutting expenses, in 2013 and 2014 Southern Inyo increased staffing. Predictably, those changes resulted in increased operating expenses and further pinched Southern Inyo's already tight cash flow. By June 2013, the District had only four days' operating cash; by June 2014 it had less than two days' operating capital; and by late 2014, its financial situation was "day to day" and "precarious."¹ As a result, the district was unable to make the first principal reduction in December 2014 on the UHC loan or to take advantage of the prepayment incentives offered as a part of that loan.

E. The Optum Bank Loan

Driven by constricted cashflow, the district explored refinancing its short-term debt into longer-term obligations with lower monthly payments. Among the interested lenders was Optum Bank. Optum Bank submitted a Confidential Letter of Interest for a loan to refinance the El Dorado line of credit and the UHC loan. The bank proposed a loan ("Optum Bank loan") of approximately $1.5 million with a 10-year maturity. The interest rate was fixed for the first 5 years of the loan at 5.25% per annum and thereafter adjusted the interest rate to the Federal Home Loan Bank of Seattle's 5-year rate plus 3.59%. But to accommodate the district's cash flow needs the bank suggested two key provisions: (1) though due and payable in 10 years, the proposed loan was amortized over 20 years, which provided the district with a lower debt service payment; and (2) the repayment was timed to Southern Inyo's annual cash flow cycle; between January and June of each year, Southern Inyo was to make monthly payments of principal and interest, estimated to be $20,200. Between July and December of each year, Southern Inyo benefitted from a debt service hiatus. The loan was to be secured by a first deed of trust against the district's Lone Pine, California, real property and against other tangible and intangible personal property.

Optum Bank's loan proposal was presented at a special meeting in October 2014. The agenda described Optum Bank's proposal as "refinancing long term debt." Present at the meeting were the members of the Southern Inyo Healthcare District's Board of Directors (Dick Gering ("Gering"), president; Drew Wickman; and Jack Berry), the District's Chief Executive and Financial Officer, Lee Barron ("Barron"), and Recording Secretary, Mary Gonzales. Barron summarized the terms of Optum Bank's proposal. The Board found that "In the long run [the loan] benefits the District as it allows for more reasonable payment options," and approved Optum Bank's "mortgage loan."² Even though 85% of the Optum Bank loan would be used to refinance the UHC loan, the minutes of the October 2014 meeting do not reflect discussion of the useful life of the equipment and software.

Thereafter, on behalf of the District, Barron accepted Optum Bank's proposal by signing the Confidential Letter of Interest. The District then submitted to Optum Bank a Business Credit Application, which was signed by CEO/CFO Barron, President Gering and Secretary Mary Kemp.

The Optum Bank loan closed late February 2015. As a part of finalizing the loan, President Gering and Secretary Kemp signed three species of documents: (1) confirmation of authorization to incur debt, called a "Governmental Certificate;" (2) promissory note; and (3) security interest agreements to create and perfect security interests in favor of Optum Bank. The Governmental Certificate purported to authorize a 10-year $1.767 million loan, secured by Southern Inyo's real and personal property. The certificate recited that on the date of signing the Board of Directors approved a $1.676 million dollar loan, secured by the District's real and personal property, with a maturity in February 2025. The promissory note memorialized the loan from Optum Bank in the amount of $1.676 million. The note provided for an initial fixed interest rate of 5.25% for the first five years, but provided that the interest rate thereafter would increase to the Federal Home Loan Bank of Seattle's 5-year loan rate plus 3.680% (rather than 3.59% as stated in the Confidential Letter of Interest). The note also provided for year-round monthly payments to Optum Bank, rather than the six months on and six months off payment schedule proposed in the Confidential Letter of Interest. The note contained a severability clause. The security interest agreements and deeds of trust encumbered the district's Lone Pine office building and all, or nearly all, of its personal property.

At closing, Optum Bank paid off the El Dorado line of credit ($226,700) and UHC of California equipment and software loan ($1,423,300). The remainder of the loan amount was absorbed by transactional costs or was remitted to the district.

II. PROCEDURE

A. Southern Inyo Files for Chapter 9 Protection

In early 2016, Southern Inyo filed for Chapter 9 protection and this court ordered relief.

Optum Bank filed a Proof of Claim for $1.17 million. Optum Bank contended its loan was secured by a deed of trust against Southern Inyo's real property, i.e., 501 E. Locust Street, Lone Pine, California, and by equipment, inventory, rents, monies, payments, health-care insurance receivables, chattel paper, general intangibles, fixtures, documents, records, instructions and accessions, accessories, replacements, proceeds and other rights.

Southern Inyo has proposed, but not yet confirmed, a plan of reorganization.

B. Southern Inyo Files an Adversary Proceeding

The district filed this adversary proceeding in 2017. It prays for disallowance of Optum Bank's Proof of Claim and for declaratory relief as to the invalidity of the bank's deed of trust against its real property and the bank's security interest against its personal property. Southern Inyo contends that the Optum Bank loan was made contrary to applicable state law, Cal. Health & Safety Code §§ 32130, 32130.2, that the loan is unenforceable, and that any security interest supporting the unlawful loan is invalid.

Optum Bank answered and filed a counterclaim for restitution.

The parties have filed cross-motions for summary judgment. Southern Inyo advances two primary arguments in favor of its position: (1) Southern Inyo was mistaken to authorize a loan that is unenforceable under California Health & Safety...