Bankruptcy Court Rules that Stay Relief Was Not Required for Action Challenging City’s Proposed Tax Measure

Contributed by Marvin Mills
On September 27, 2013, the City of Stockton filed its proposed chapter 9 plan of adjustment and a draft disclosure statement. The plan of adjustment is conditioned upon the passage of a 3/4-cent sales tax increase that remains subject to voter approval on November 5, 2013. During the summer, a Stockton resident filed a motion for stay relief in the City’s pending bankruptcy case in order to file a petition in state court challenging the language in the tax measure. On September 18, 2013, the United States Bankruptcy Court for the Eastern District of California ruled that the automatic stays of sections 362(a) and 922(a) of the Bankruptcy Code did not affect the ability of the resident to bring litigation challenging the tax measure language so long as the resident made no effort in the litigation to obtain any monetary award against the City or any of the City’s officials or inhabitants.

In his stay relief motion, the Stockton resident asserted that the tax measure language was “misleading to the average voter” and sought to file a petition seeking a writ of mandate ordering the language to be altered. According to the resident, California law required that he name the City and the City Council as real parties in interest in the state action. The resident argued, however, that as part of the proposed action he was not seeking any assets of the debtor nor attempting to interfere directly with the City’s bankruptcy case or modify any orders of the bankruptcy court, and, therefore, stay relief was warranted.
The City countered that the proposed petition included unnamed parties as defendants, as well as a request for “such other and further relief as the court may deem just and equitable.” The City asserted that these elements of the petition could result in actions that would violate the automatic stay under section 922 of the Bankruptcy Code. In response, the resident represented to the court that he would neither permit the scope of the litigation to extend to city officers or inhabitants, nor assert any monetary claims.
In weighing the stay relief request, the court commented that a vague line exists between “litigation against a chapter 9 municipal debtor that does and does not offend the bankruptcy automatic stays of” sections 362(a) and 922(a). The court explained that, if the litigation were to implicate a “claim,” then the litigation might be subject to the stays under those sections. Recognizing that the meaning of claim varies in different legal contexts, the court explained that, for purposes of construing sections 362 and 922(a), claim means a right to payment as defined in section 101(5) of the Bankruptcy Code.
Turning to section 362(a), the court observed that, in chapter 9 cases, the references to “property of the estate” in that section must be construed as “property of the debtor” (in light of section 902(1) of the Bankruptcy Code). The court then explained why each of the eight subsections of 362(a) were inapplicable. According to the court, six of the eight subsections were “plainly” not implicated. The court ruled out subsections (1), (2), (5), (6) and (7) — all of which stay actions relating to the period “before the commencement date” — because the proposed ballot language litigation was based upon postpetition events. The court also ruled out subsection (8) — which only relates to debtors that are corporations — because the definition of corporation under section 101(9) of the Bankruptcy Code does not include a municipality.
As for section 362(a)(3), the court found that the purpose of the litigation was not to obtain property of (or from) the City, nor exercise control over the City’s property. The court referenced the resident’s promise not to attempt to obtain a monetary award, and commented, “If that assurance turns out to be inadequate, this court has tools at hand to deal with a transgression.” With respect to section 362(a)(4), the court did not find a significant risk that the litigation would result in an act to create, perfect, or enforce any lien against property of the City. In fact, the court observed that it was unclear that a judicial lien against the City’s property was even available. Accordingly, the court concluded that the automatic stay under section 362(a) did not bar commencement of the litigation challenging the tax measure language.
The court then addressed section 922(a) of the Bankruptcy Code, which further stays (among other things) the commencement or continuation of an action against an officer or inhabitant of the debtor municipality to the extent such action “seeks to enforce a claim” against such municipality. Focusing again on whether the resident was seeking to enforce a claim against the City, the court explained that the subject matter of the litigation would not involve a right to payment. The court acknowledged that the litigation could result in fees or other costs, but again noted that the resident had promised to not seek any monetary award and had waived any right to recover attorney’s fees. The court reiterated that it had “corrective tools at hand” if the resident’s assurance proved to be inadequate. On these bases, the court concluded that section 922(a) did not stay the tax measure litigation.
Finally, the court considered the application of the stays under section 362(a) and 922(a) in light of sections 903, 904, and 943(b) of the Bankruptcy Code. The court stated that section 903 “reserves state power to control municipalities by legislation or otherwise in the exercise of political or governmental powers of the chapter 9 municipal debtor.” Providing for and regulating elections, explained the court, is an exercise of governmental powers of a municipality that falls within the meaning of section 903. The court further observed that, pursuant to section 904, the court was barred “from interfering with any of the political or governmental powers of the City.” According to the court, the City’s submission of the 3/4-cent tax measure for voter approval fell within the scope of section 904. The court went on to note that the plan confirmation requirements in section 943(b) expressly contemplate that electoral or regulatory approval of a chapter 9 plan of adjustment may be required. Based on its analysis of sections 903, 904, and 943(b), the court concluded that “it would be strange if the automatic stay of [section] 362(a) or the additional automatic stay of [section] 922(a) were to be construed in a manner that would thwart the ordinary course of state electoral process.”
Judge Klein’s decision provides a new perspective on the scope and application of the automatic stays in chapter 9 cases. Given the limited number of decisions in complex chapter 9 cases such as Stockton, the court’s ruling provides additional guidance for practitioners in assessing the contours of the automatic stays under sections 362(a) and 922(a). On the other hand, the decision provides scant support for creditors seeking stay relief to obtain property of a debtor-municipality, as the court expressly conditioned its ruling on the movant’s promise to not seek any monetary award against the municipality.
Notably, the Stockton resident did proceed with the state court litigation challenging the impartiality of the tax measure language. On August 30, 2013, however, the Superior Court of California, County of San Joaquin denied the resident’s petition as untimely. Consequently, the ballot language remains unchanged, and on November 5, 2013, Stockton residents will decide the fate of the 3/4-cent tax and, perhaps, the course of the City’s chapter 9 case.
Disclosure: Weil represents a party in the Stockton bankruptcy case, although Weil was not involved in the dispute addressed in Judge Klein’s opinion.