You Say Potato, Court Says Solvent: Idaho Bankruptcy Court Dismisses Municipality’s Chapter 9 Case for Lack of Evidence of Insolvency.

Contributed by Marvin Mills
Within three months after a federal court entered a $4,000,000 judgment against Boise County for violating the Fair Housing Act, the purportedly cash-strapped municipality filed for bankruptcy protection under chapter 9 of the Bankruptcy Code.  Alamar Ranch, the prevailing plaintiffs in the action, objected to Boise County’s petition, contending that the county did not meet the requirements of section 109 of the Bankruptcy Code and, therefore, did not file its petition in good faith.  Section 109 establishes who may be a debtor and requires, among other things, that a municipality be insolvent when it files its petition.  On September 8, 2011, the United States Bankruptcy Court for the District of Idaho dismissed Boise County’s chapter 9 bankruptcy case because the county failed to carry its burden of proving that it was insolvent.  Faithful Bankruptcy Blog readers will note the contrast between the insolvency rulings in In re Boise County and City of Vallejo.
In its motion to dismiss Boise County’s chapter 9 case, Alamar Ranch challenged the county’s asserted insolvency on the basis that the county had been paying, and would be able to pay, its debts (including the multi-million dollar judgment) as they came due.  Alamar Ranch relied upon the municipality’s own schedules — which showed assets of approximately $27.8 million and liabilities of approximately $7.4 million — to demonstrate that, on the petition date, Boise County had surplus funds that rendered it ineligible under section 109.
Boise County (which does not include within its limits the City of Boise) countered that it was insolvent on the date of its petition because the county could not, for a variety of reasons, pay all its debts as they became due.  Boise County asserted that appropriations by the county are allocated in a “fund” system, and the county only could pay the Alamar Ranch judgment from a certain general fund.  Boise County likened its situation to that of the City of Vallejo and explained that the use of its other funds was limited to certain specific purposes, which did not include payment of the judgment.  The county also claimed that it could not raise sufficient money to pay the judgment by levying a property tax increase or issuing warrants.  The county further stated that a bond issuance was not a viable option because the county had “‘nothing to bond’” and that it could not incur long-term debt without a public election, which the county believed would be unsuccessful.  Boise County also added to its list of possible setbacks certain contingent medical expense liabilities that the county estimated in the amount of $550,000, as well as potential reductions in contributions from the state of Idaho and the federal government (which together fund two-thirds of the county’s budget).
The United States Bankruptcy Court for the District of Idaho evaluated the record and concluded that Boise County failed to establish that it was insolvent under section 109(c)(3).  To qualify as insolvent, a municipality must establish under section 101(32)(C)(i),(ii) of the Bankruptcy Code that it is “generally not paying its debts as they become due” or is “unable to pay its debts as they become due.”  As the court explained, the first test considers current, general nonpayment, whereas the second test involves future inability to pay.  The court determined that Boise County was paying all its debts as they came due, with the exception of the contingent medical liabilities.  The court ruled, however, that the failure to pay a relatively small category of claims — where funds were available to pay such claims — did not satisfy the level of general nonpayment that section 101(32)(C)(i) requires.  The court also observed that the evidence in the record as to the amount of such medical liabilities was equivocal, and the record contained no evidence as to when such liabilities were due. Consequently, the court concluded that Boise County failed the first test of insolvency.
The court determined that Boise County also failed the second test of insolvency because the county would be able to pay its expenses, including the judgment for Alamar Ranch, going forward.  To satisfy section 101(32)(c)(ii), Boise County had to prove its inability to pay its future debts as of the petition date.  The court rejected Boise County’s argument that Idaho state laws restricted the use of certain funds, based upon the court’s interpretation of such laws.  The court further determined that Boise County could transfer the surplus money available in certain of the county’s unrestricted funds to fund any indebtedness the county incurred through the issuance of warrants to pay the Alamar Ranch judgment.  In its cash flow analysis, the court determined that the funds immediately available in the county’s various trust accounts, along with the surplus money from certain funds, were sufficient to satisfy the county’s projected liabilities for 2012 (including the Alamar Ranch judgment).
The Boise County ruling hinged, in part, on the court’s conclusion that certain of the county funds were unrestricted based upon the court’s analysis of state law.  By comparison, in City of Vallejo, the Bankruptcy Appellate Panel of the Ninth Circuit ruled that the bankruptcy court did not abuse its discretion by basing its insolvency finding on testimony that certain of the city’s funds were restricted, despite claims by the labor unions that such testimony was inadmissible legal opinion.  According to the 9th Cir. B.A.P., the testimony was helpful because, without it, the city would have been required to submit evidence as to why each of its funds was restricted, and the bankruptcy court would have needed to rule on whether each fund was restricted.  The B.A.P. stated that the testimony was the most concise means for the city to prove that its funds were restricted.
Notably, on September 20, 2011, Boise County filed a motion, pursuant to Bankruptcy Rules 9023 and 7052, seeking (i) a new judgment or an amendment of the court’s judgment and (ii) additional findings of fact and conclusions of law, based upon the county’s adopted 2012 budget.  As of today, the court has not ruled on that motion.
The Boise County ruling likely will lead potential chapter 9 debtors to pay close attention to the evidence and arguments required to establish their insolvency.  In light of the recent insolvency conflicts in both Boise County and City of Vallejo, it remains to be seen whether a similar insolvency battle also looms in the already contentious chapter 9 case of Pennsylvania’s state capital.  In fact, just days after the city filed its petition, the Commonwealth of Pennsylvania filed an objection to the city’s eligibility as a chapter 9 debtor, arguing that a state law enacted earlier this year prohibits Harrisburg from filing a petition for bankruptcy protection under chapter 9.