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In re City of Stockton

United States Court of Appeals, Ninth Circuit

December 10, 2018

In re City of Stockton, California, Debtor,
City of Stockton, Debtor-Appellee. Michael A. Cobb, Objector-Appellant,

          Argued and Submitted November 14, 2016

          Resubmitted December 10, 2018 San Francisco, California

          Appeal from the United States Bankruptcy Court for the Eastern District of California Christopher M. Klein, Chief Bankruptcy Judge, Presiding D.C. No. 12-32118

          Bradford J. Dozier (argued), Atherton & Dozier, Stockton, California, for Objector-Appellant.

          Robert Loeb (argued), Orrick Herrington & Sutcliffe LLP, Washington, D.C.; Christopher J. Cariello, Orrick Herrington & Sutcliffe LLP, New York, New York; Lesley M. Durmann, Patrick B. Bocash, and Marc A. Levinson, Orrick Herrington & Sutcliffe LLP, Sacramento, California; for Debtor-Appellee.

          Before: Sidney R. Thomas, Chief Judge, and Ronald M. Gould and Michelle T. Friedland, Circuit Judges. [*]



         The panel dismissed as equitably moot an appeal from the bankruptcy court's order denying an objection to confirmation of the Chapter 9 plan of adjustment of the City of Stockton.

         The objector had filed an inverse condemnation claim against the City in state court. The plan classified the claim as a general unsecured claim.

         Agreeing with the Sixth Circuit, the panel dismissed the appeal as equitably moot because the objector did not seek a stay of confirmation; the plan had been substantially consummated; the relief of undoing plan confirmation would bear unduly on innocent third parties; and the bankruptcy court could not fashion relief without undoing the confirmed plan.

         The panel also affirmed the bankruptcy court's conclusion that the objector's claim-that the Takings Clause exempted his unsecured claim from reorganization-failed on the merits. The panel concluded that the objector's purported property interest was, in reality, a claim for monetary relief.

         Dissenting, Judge Friedland wrote that the objector sought only to have his claim for just compensation under the Takings Clause excepted from discharge, and a claim that falls outside of bankruptcy cannot be subject to the bankruptcy doctrine of equitable mootness. On the merits, Judge Friedland wrote that because the objector maintained a constitutional claim for just compensation, and because that claim should have been excepted from discharge, the state-court inverse condemnation action should have been allowed to proceed.



         Michael Cobb appeals the bankruptcy court's order denying his objection to confirmation of a Chapter 9. However, he did not seek a stay of confirmation at any stage; the plan has been substantially consummated; the relief of undoing plan confirmation would bear unduly on innocent third parties; and the bankruptcy court could not fashion relief without undoing the confirmed plan. Therefore, we dismiss his appeal as equitably moot. His claims also fail on the merits.



         When it filed its Chapter 9 petition, Stockton became the largest city in history to seek municipal bankruptcy protection. The recession had reduced property values by half, and 22% of Stockton's residents were unemployed. Franklin High Yield Tax-Free Income Fund v. City of Stockton (In re City of Stockton), 542 B.R. 261, 265 (B.A.P. 9th Cir. 2015). The City was unable to pay bondholders, it had over-committed to public pensions, and its accounting system was in disarray. Id. Budget cuts left police able to respond only to emergency calls. Id. at 266, 274. Stockton ranked 10th in the nation in its violent crime rate, with homicides at an all-time record. In re City of Stockton, 493 B.R. 772, 780 (Bankr. E.D. Cal. 2013). In a cost-cutting initiative commenced in 2008, the City workforce decreased by 25%. Id. The police force was reduced by 20%; the fire department's workforce by 30%; and the public works employee workforce by 38%. Id.

         Despite these cost-cutting measures, the City projected a general fund deficit of almost $9 million as of June 2012 and a deficit of $20 to $30 million in the next fiscal year. Id.; Franklin, 542 B.R. at 266. The City Council authorized diversion of money from earmarked funds and intentionally defaulted on payments for over $2 million of bonds. In re City of Stockton, 493 B.R. at 781, 789. It also authorized a neutral evaluation process under California Government Code § 53760, a prerequisite to a Chapter 9 bankruptcy filing. Franklin, 542 B.R. at 266.

         Unlike other voluntary bankruptcy petitioners, a Chapter 9 debtor must prove that it is eligible for bankruptcy relief. 11 U.S.C. §§ 109(c), 921(c). One of the statutory requirements is that the debtor must prove that it is insolvent. 11 U.S.C. § 109(c)(3). Here, the City filed a petition for an Order for Relief alleging that it was eligible for bankruptcy and, in fact, was insolvent. After a three-day bench trial, the bankruptcy court issued an extensive order making factual findings and determining that the City was eligible for Chapter 9 relief. As to insolvency, the court examined the City's ability to: (1) pay its debts as they matured (commonly referred to as "cash insolvency"); (2) pay for the costs of providing services required for the health, safety, and welfare of the community (commonly called "service delivery insolvency"); and (3) create a balanced budget (termed "budget insolvency"). After considering the evidence, the court found that:

The sum of the evidence establishes that the City was insolvent by all available measures when it filed its chapter 9 case. It was cash insolvent, unable to pay its debts as they came due as required by § 101(32)(C) and § 109(c)(3). That it was service delivery insolvent confirms that the cash insolvency was not a mere technical insolvency. That it was budget insolvent for the long term confirms that the insolvency would persist without realignment of revenues and expenses. Hence, the City satisfied the insolvency requirement of § 109(c)(3).

In re City of Stockton, 493 B.R. at 790-91.

         The ensuing Chapter 9 proceedings were complex, costly, and contentious. Franklin, 542 B.R. at 266. Pre-petition settlements were reached with a number of creditors, and collective bargaining agreements were renegotiated. Id. Under the guidance of a court-appointed mediator, post-petition settlements were reached with the California Public Employees' Retirement System; the Stockton Police Officers' Association; the Official Committee of Retirees; Assured Guaranty Corporation (which insured the City's pension bonds); the National Public Finance Guarantee Corporation (an insurer of almost $100 million in city bonds); Ambac Assurance Corporation (an insurer of $13.3 million in City certificates of participation); and Wells Fargo Bank (indenture trustee for a number of the City's bond issues). Id. at 266-67. Eventually, over the objections of some creditors, including Cobb, Stockton's plan of reorganization was confirmed. Id. at 268.

         The plan was funded by "a sales tax increase in the greatest amount and for the longest period permitted by California law." Id. at 271 (citation omitted). Under the plan, City employees and retirees "shared the pain" with the capital market and bond creditors, losing the pension and lifetime health benefits around which they had planned their futures. Id. (citation omitted). The plan provided for payment of $1.5 billion in claims distributed among 20 classes of creditors.

         The plan became effective in February 2015. Id. at 276. Pursuant to the plan, the City made wire transfers totaling $13.1 million, including a settlement of heath care benefits to retirees and payments to institutional creditors. The City implemented the provisions of the plan, restructuring its obligations to two other major institutional creditors by conveying title to 17 parking lots and garages, assigning leasehold interests, and assigning an option for the purchase of a city office building. The City has continued to make its payments pursuant to the plan, with secured creditors receiving lower payments on the secured debt and unsecured creditors receiving lesser amounts.


         So, what was Objector-Appellant Michael Cobb's part in all of this? The background is somewhat procedurally complex. Cobb's father, Andrew Cobb, owned a parcel of land in Stockton. In 1998, the Stockton City Council resolved that the public necessity required the condemnation of a strip of land across the parcel for the purpose of building a road.

         In California, the power of eminent domain can be exercised through traditional condemnation proceedings, where possession is taken at the time of judgment, or through "quick-take" condemnation where a locality can take possession upon depositing a probable compensation amount determined by a qualified expert appraiser. Cal. Const. art. I, § 19; Cal. Civ. Proc. Code § 1255.010; see also Mt. San Jacinto Cmty. Coll. Dist. v. Superior Court of Riverside Cty., 151 P.3d 1166, 1168 (Cal. 2007). Following the deposit of funds under the "quick-take" procedure, the government may move the court for an immediate possession order. Cal. Civ. Proc. Code § 1255.410. If the defendant elects to withdraw the proposed compensation amount, he waives all claims and defenses to the condemnation, except a claim for greater compensation. Cal. Civ. Proc. Code § 1255.260.

         Stockton elected to use the "quick-take" process. Thus, pursuant to California Civil Procedure Code § 1255.010, the City had an expert appraise the parcel to determine the amount of just compensation owed to Andrew Cobb. The appraiser valued the parcel at $90, 200.00. As required by the "quick-take" provisions, the City deposited that sum with the California State Treasurer Condemnation Deposits Fund. That same day, the City initiated eminent domain proceedings in the Superior Court of California, County of San Joaquin, to acquire a permanent easement over the parcel (the "eminent domain action").

         Later that year, the Superior Court determined the City had met the requirements of § 1255.010, concluded it had met the requirements of probable compensation, and issued an Order for Prejudgment Possession in favor of the City. A road was then built on the parcel, and the Stockton City Council passed a resolution in 2000 accepting the improvements.

         In the meantime, Andrew Cobb passed away and his son, Michael Cobb, inherited the parcel. After Andrew Cobb's death, Cobb was substituted in the condemnation action. He entered into a stipulation with the City allowing him to withdraw the deposited amount and, in 2000, he withdrew the entire amount of the deposit. At that point, by operation of law, he waived all of his defenses and claims to the property, except a claim for greater compensation. Cal. Civ. Proc. Code § 1255.260. In other words, Cobb gave up all rights to the property. He did not assert a counterclaim for greater compensation in the condemnation proceeding.

         Seven years later, Cobb attempted to return the $90, 200.00 to the City-apparently in an attempt to revoke his earlier waiver-but the City would not accept the funds, explaining that the withdrawal of probable compensation was final under California law. Cobb deposited the funds into an interest-bearing trust account.

         In 2007, the Superior Court dismissed the City's eminent domain action because it had not been brought to trial within five years of its commencement, as is required by California Civil Procedure Code § 583.310. A year later, Cobb filed a complaint in San Joaquin County Superior Court, seeking relief for inverse condemnation (the "inverse condemnation action"). The complaint alleged that because the City failed to prosecute the eminent domain action, the true market value of the parcel remained undetermined and thus Cobb had not received the just compensation due him under the California Constitution. Over the next several months, Cobb amended his complaint three times, adding claims for quiet title, ejectment, trespass, and declaratory relief. The City demurred to all the amended complaints. The Superior Court sustained the City's demurrer as to the inverse condemnation claim on the grounds that it was barred by the statute of limitations because the taking occurred more than five years before the complaint was filed, and it sustained the City's demurrer as to the other claims on the grounds that they were barred by the doctrine of intervening public use.

         Cobb appealed the Superior Court's dismissal of his inverse condemnation claim solely on statute of limitations grounds. He did not appeal the dismissal of the quiet title, ejectment, trespass, or declaratory relief claims. In 2011, the Court of Appeals reversed the dismissal of Cobb's inverse condemnation claim, finding that his claim was timely because it "did not accrue until the City's occupation of the property became wrongful, which did not occur until the eminent domain proceeding was dismissed." Thus, what remained of his state court action was simply an unliquidated and unsecured monetary damage claim. The merits of his inverse condemnation claim remain unadjudicated and unproven. As the bankruptcy court pointed out, given the various defenses available to the City, "Mr. Cobb has a very steep hill to climb in his action for greater compensation in the California courts."

         Thereafter, in 2012, the City petitioned for bankruptcy protection under Chapter 9. In a Chapter 9 bankruptcy, the debtor is not required to file schedules and a statement of financial affairs. Rather, the debtor is required to file a list of creditors. 11 U.S.C. § 924. Any claim on the debtor's list is deemed filed as a proof of claim pursuant to 11 U.S.C. § 501, unless the debt is listed as contingent, disputed or unliquidated. 11 U.S.C. § 925.

         When it filed its list of creditors in this case, the City identified Cobb's claim as an unsecured, disputed liability claim of an unknown amount. Subsequently, Cobb filed a proof of claim for $4, 200, 997.26. Cobb's claim consisted of a principal of $1, 540, 000.00 for the parcel, $2, 282, 997.26 in interest on the principal, $350, 000.00 in attorney's fees and expenses, $13, 000.00 in costs of suit, and $15, 000.00 in real estate taxes and maintenance and insurance costs. Cobb did not assert on his proof of claim that his claim was secured.

         In 2013, the City filed its first amended plan for adjustment of its debts (the "plan"), which listed 19 classes of claims. The plan included Cobb's claim in Class 12 as a general unsecured claim. On February 11, 2014, Cobb filed an objection to confirmation of the plan, alleging that his "claims in inverse condemnation are protected by the Fifth and Fourteenth Amendments to the United States Constitution and cannot be impaired by the Plan." He did not contest the listing of his claim as unsecured.

         In 2014, the bankruptcy judge overruled Cobb's objection to confirmation of the pending plan of adjustment. The bankruptcy judge explained that Cobb is left with only a claim for more money because the road had long since been built on the parcel and because by withdrawing the probable just compensation, Cobb had waived by operation of law all claims except a claim for greater compensation. In an oral ruling, the bankruptcy judge concluded that "[t]he bankruptcy clause does permit the adjustment of a debt for greater compensation," and "if [the debt] were reduced to judgment, it would be a general unsecured debt at the moment the judgment was issued."

         Cobb did not seek a stay of plan confirmation from the bankruptcy court. Cobb timely appealed the bankruptcy court's order overruling his objection to the plan to the district court for the Eastern District of California. He did not seek a stay of plan confirmation before the district court.

         Cobb and the City both stipulated, pursuant to 28 U.S.C. § 158(d)(2)(A), that the appeal warranted proceeding directly to the Court of Appeals for the Ninth Circuit. On August 7, 2014, the district court certified this appeal to this Court, pursuant to 28 U.S.C. § 158(d)(2)(B)(ii). A motions panel of our Court granted Cobb's motion to appeal directly to this Court. Cobb did not seek a stay of plan confirmation. The bankruptcy court confirmed the City's plan of adjustment and issued a final judgment. Cobb did not seek a stay following plan confirmation, and the plan became effective on February 25, 2015.



         Finality is essential to the success of bankruptcy reorganization plans. A reorganization plan almost always involves tradeoffs, debt adjustment, partial asset liquidation, and the infusion of new revenue sources. Both creditors and the debtor require certainty so that the debtor can return to economic health, and the creditors can maximize their recovery within the debtor's ability to pay. In the case of a municipal reorganization, the public has an enormous stake in the outcome so that critical government programs, such as law enforcement, fire protection, and public works, can be restored. Thus, if a creditor wishes to challenge a reorganization plan on appeal, we require the creditor to seek a stay of proceedings before the bankruptcy court. When a stay is requested, all affected parties are on notice that the plan may be subject to appellate review and have an opportunity to present evidence before the bankruptcy court of the consequences of a stay. "A confirmed reorganization plan operates as a final judgment with res judicata effect." Unsecured Creditors Comm. v. Southmark Corp. (In re Robert L. Helms Constr. & Dev. Co.), 139 F.3d 702, 704 (9th Cir. 1998) (en banc).

         If the creditor does not seek a stay, then the creditor risks dismissal of the appeal on the grounds of equitable mootness. "An appeal is equitably moot if the case presents transactions that are so complex or difficult to unwind that debtors, creditors, and third parties are entitled to rely on the final bankruptcy court order." JPMCC 2007-C1 Grasslawn Lodging, LLC v. Transwest Resort Props., Inc. (In re Transwest Resort Props., Inc.), 801 F.3d 1161, 1167 (9th Cir. 2015) (quoting Rev Op Grp. v. ML Manager LLC (In re Mortgs. Ltd.), 771 F.3d 1211, 1215 (9th Cir. 2014)). If there is a confirmed bankruptcy plan that deserves finality-for employees, retirees, creditors, taxpayers, and for the future of the City-it is Stockton's.


         We have identified four factors to determine whether an appeal is equitably moot, namely: (1) whether a stay was sought; (2) whether the plan has been substantially consummated; (3) the effect of the remedy on third parties not before the court; and (4) "whether the bankruptcy court can fashion effective and equitable relief without completely knocking the props out from under the plan and thereby creating an uncontrollable situation for the bankruptcy court." In re Transwest Resort Props., Inc., 801 F.3d at ...

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