511 B.R. 431
Bankr. W.D. Ky.2014Background
- Seven Counties Services, Inc. (Seven Counties) is a Kentucky nonprofit community mental health center (CMHC) that provides behavioral-health services across seven counties and relies heavily on state contracts and Medicaid revenue.
- In 1979 Seven Counties was brought into the Kentucky Employees Retirement System (KERS) by executive order; since then it has collected employee "pick-up" contributions and paid employer contributions to KERS.
- KERS sued after Seven Counties filed Chapter 11 (April 4, 2013), seeking (inter alia) declarations that Seven Counties is a "governmental unit" ineligible for Chapter 11, injunctive relief compelling continued post‑petition contributions, and to prevent rejection of the parties’ relationship; Seven Counties moved to reject the potentially executory contract with KERS under 11 U.S.C. § 365.
- The bankruptcy court held extensive evidentiary hearings and found Seven Counties is a private nonprofit (not a governmental unit), eligible to be a Chapter 11 debtor, and that the relationship with KERS is contractual and executory.
- The court rejected KERS’s arguments that federal statutes (28 U.S.C. § 959(b), § 363(d)(1)) or state law prevent rejection; it held federal bankruptcy law governs and permitted Seven Counties to reject the executory contract as an exercise of its sound business judgment.
- Judgment: KERS’s complaint dismissed with prejudice; the debtor’s Amended Motion to Reject was granted and Seven Counties may reject its contract with KERS.
Issues
| Issue | Plaintiff's Argument (KERS) | Defendant's Argument (Seven Counties) | Held |
|---|---|---|---|
| Whether Seven Counties is a "governmental unit" and therefore ineligible for Chapter 11 | Seven Counties was designated by executive order to participate in KERS and thus is a governmental "department/agency/instrumentality" excluded from Chapter 11 | Seven Counties is a private nonprofit formed under K.R.S. ch. 273, not created or controlled as an arm of the state; federal law controls Bankruptcy Code terms | Held: Not a governmental unit; Seven Counties is a "person" eligible for Chapter 11 (Counts I–II denied for KERS) |
| Whether the court must compel Seven Counties to continue post‑petition employer/employee contributions under 28 U.S.C. § 959(b) or § 363(d)(1) | § 959(b) and § 363(d)(1) require debtor-in-possession to manage property in compliance with state law and thus bar rejection or termination of participation in KERS | § 959(b) addresses operation/health/safety regulation of property and does not override § 365; § 363(d)(1) does not mandate continued participation; state law cannot supplant federal bankruptcy powers | Held: § 959(b) and § 363(d)(1) do not compel continued participation; KERS’s requested injunction denied (Count III) |
| Nature of employer obligation to KERS: tax/fee/assessment or contract | KERS characterizes contributions as statutory obligations enforceable post‑petition (regulatory fee/assessment) | Contributions are contractual obligations between employer and KERS; treating them as taxes or regulatory police‑power obligations would raise constitutional and statutory problems under Kentucky law | Held: Employer contributions are contractual in nature for purposes of this dispute; statutory/regulatory characterization insufficient to prevent rejection |
| Whether the Seven Counties–KERS relationship is an executory contract that debtor may reject under § 365 | KERS argued the contract is not executory (no continuing KERS obligations) and that rejection would impair statutory scheme and other employers | Seven Counties argued the arrangement satisfies contract elements under Kentucky law and is executory under the Sixth Circuit’s functional approach (Jolly): ongoing debtor obligations and rejection would benefit the estate | Held: The relationship is a contract under Kentucky law and is executory; Seven Counties may reject it under § 365 in its sound business judgment |
Key Cases Cited
- Unsecured Creditor’s Comm. of DeLorean Motor Co. v. DeLorean, 755 F.2d 1223 (6th Cir. 1985) (preliminary injunction factors cited)
- Kentucky Region Eight Mental Health–Mental Retardation Bd., Inc. v. Commonwealth, 507 S.W.2d 489 (Ky. 1974) (CMHCs not integral parts of state government)
- Halikas v. River Region Mental Health–Mental Retardation Bd., Inc., 667 F.2d 1026 (6th Cir. 1981) (affirming bankruptcy court that River Region was not a state agency)
- Las Vegas Monorail Co. v. Boyd (In re Las Vegas Monorail Co.), 429 B.R. 770 (Bankr. D. Nev. 2010) (instrumentality analysis: sovereign powers, public purpose/control, and state designation)
- Chattanooga Memorial Park v. Still (In re Jolly), 574 F.2d 349 (6th Cir. 1978) (functional approach to executory-contract analysis)
- Kentucky River Cmty. Care, Inc. v. N.L.R.B., 193 F.3d 444 (6th Cir. 1999) (CMHC not political subdivision or part of state government)
- Comair, Inc. v. Lexington–Fayette Urban County Airport Corp., 295 S.W.3d 91 (Ky. 2009) (sovereign‑immunity analysis; integral‑part test)