Bankruptcy Court Declines to Force Municipality into Mediation of Dispute Unrelated to Chapter 9

Contributed by Marvin Mills
Readers may recall that, according to at least one bankruptcy court, chapter 9 debtors are not required to obtain bankruptcy court approval of compromises and settlements. Because section 904 of the Bankruptcy Code expressly limits the ability of bankruptcy courts to interfere with the political and governmental functions of a chapter 9 debtor, municipalities have substantially more autonomy during a bankruptcy case than chapter 11 debtors. Recently, the United States Bankruptcy Court for the Northern District of California provided another example of municipal autonomy when it ruled that it could not appoint a mediator over a chapter 9 debtor’s objection.
In In re Palm Drive Health Care District, a hospital district, which had filed for bankruptcy relief under chapter 9, elected to close a Sonoma County hospital as part of a realignment of the district’s healthcare services. A nonprofit foundation, which had formed to provide charitable contributions to the hospital, submitted a proposal to the debtor suggesting a means for reopening the hospital. The debtor rejected the proposal. In response, the foundation filed a motion pursuant to section 105 of the Bankruptcy Code for appointment of a mediator to resolve the “impasse in discussions” regarding the rejected proposal. In its motion, the foundation asserted, among other things, that the debtor had not engaged in good faith negotiations because the debtor had dismissed the proposal without subjecting it to an independent and unbiased review.
The debtor challenged the motion on multiple grounds, including the court’s lack of jurisdiction. Relying on section 904, the debtor asserted that the court could not grant the relief requested because the subject matter of the dispute was beyond the constitutional limits of the court’s power.
The court began its analysis by acknowledging that section 105 provides “broad equitable powers that would certainly include appointment of a mediator.” (Section 105 is applicable in chapter 9 pursuant to section 103(f).) The court found, however, that such power is restricted by section 904, which prohibits courts from interfering with any of the political or governmental powers of a chapter 9 debtor without its consent. In light of this limitation, the court concluded that it did not “have jurisdiction to interfere with the political and policy choices a health care district makes in running its affairs.”
Notwithstanding the limitation imposed by section 904, the court stated that it could appoint a mediator over a chapter 9 debtor’s objection under certain circumstances. Specifically, where the contested matter arises under chapter 9 — such as an entity’s eligibility to be a debtor pursuant to section 109(c), or the confirmation of a municipality’s proposed plan of adjustment — the court stated that it had “wide latitude” in choosing the manner of adjudicating the dispute, including appointing a mediator. The dispute at issue, however, was not based on an asserted right that required the court’s adjudication. Because the foundation was not a creditor and had no standing to enforce any rights against the debtor, the court concluded that it would be improper to interfere with the debtor’s governmental powers by forcing it into mediation.
Although the Palm Drive Health Care District ruling is noteworthy, its impact likely will be limited to enabling chapter 9 debtors to avoid mediation of disputes that plainly relate to the exercise of their political and governmental powers. In complex chapter 9 cases, however, the most contentious battles have been fought over eligibility and confirmation issues, which are fair game for court-ordered mediation. Given the critical role of mediators in various chapter 9 cases currently pending in the United States, we can expect mediation to remain a preferred tool for bankruptcy courts seeking to resolve the major disputes that arise in other large municipal bankruptcy cases.