Ruling May Jeopardize O.C. Recovery Efforts

A critical part of Orange County’s bankruptcy recovery could unravel because a judge ruled unconstitutional Tuesday a statute almost identical to the special-purpose law that helped the county emerge from its fiscal crisis.

Citing a 116-year-old section of the California Constitution, the Los Angeles judge ruled that the transfer of $50 million in transportation money to prop up the teetering Los Angeles County health-care system was unlawful.

Orange County obtained comparable legislation to achieve the diversion of $570 million from the same pool of transportation funds to be able to pay for $880 million in borrowings the county needed to emerge from bankruptcy last summer.

Richard I. Fine, the Century City lawyer who brought the action on behalf of a former Los Angeles County transportation official, said he may file a similar case challenging the shifting of funds by Orange County.

“The constitutional issues look identical,” said Fine, adding that he is currently studying the Orange County bankruptcy bailout legislation.

But Bruce Bennett, the county’s bankruptcy lawyer, said Tuesday evening that the Los Angeles case may have absolutely no bearing on Orange County.

“I would emphasize that this is what one court has said about one situation in one particular set of circumstances,” Bennett said.

Bennett said that before the Orange County statute is set aside, someone would have “to convince not only a Superior Court [judge in Orange County] but a higher court that there is a constitutional defect, under a different set of facts, and none of that has occurred.”

Citing attorney-client privilege, Bennett said he could not comment on whether other lawyers had raised the specter that special legislation to assist the county’s bankruptcy recovery might be unconstitutional when the bankruptcy recovery laws were sought last year.

But, Bennett added, “clearly we would not have built our recovery plan on statutes we thought were unconstitutional.”

The county paid $9 million to MBIA Insurance Corp. to ensure that the entire $880 million of Orange County recovery debt, issued in the form of certificates of participation, would be paid off.

The insurance guarantees that the debt will be repaid as each installment comes due, in the event Orange County is unable to pay.

After a preliminary review of that insurance policy Tuesday evening, Bennett said, “we are not aware of any exclusion under the applicable insurance policy” that would prevent the insurance from being used to repay the notes in the event of an adverse legal finding.

The ruling by Los Angeles Superior Court Judge Richard C. Hubbell provoked a number of anxious telephone calls among the small universe of county officials, lawyers and financial advisors who lived through the largest municipal bankruptcy ever.

“I could hear the screaming through my window here in San Diego,” said Patrick C. Shea, a lawyer who represented a committee of cities, schools and other government agencies that shared in the $1.64-billion loss to the county-run investment pool that triggered the bankruptcy.

“This is really a big-issue problem, and that is whether these transfers of funds have a legal foundation for them,” Shea added.

Christopher Varelas, a vice president with Salomon Bros., the county’s financial advisor, and the chief architect of the financial portion of the bankruptcy recovery plan, said that he needed “to see the ruling and the details of the Los Angeles situation” before he could comment.

“But right now,” Varelas continued, “I see no need for concern, given that the situations are different and that there have been no legal challenges to the diversion” of funds from the Orange County Transportation Authority.

The legal underpinning for the judge’s ruling is a reform put into the California Constitution in 1878. It was written into the law after a series of financial calamities throughout California caused municipalities to go broke after they had benefited from special legislation allowing them to issue bonds.

“The bubble burst in the 1870s as California followed the rest of the nation into a severe financial depression,” the California Supreme Court wrote in a 1970 decision. “Banks collapsed, the securities markets declined, municipalities defaulted on their bonds, businesses closed and trade stagnated.”

The court went on to note: “Popular dissatisfaction had begun to focus on the special legislation authorizing local indebtedness, since it was felt that this gave undue influence to narrow interest groups seeking public financing of projects from which they would reap disproportionate benefits.”

The Constitution was amended to say that “a local or special statute is invalid in any case if a general statute can be made applicable.”

Attorney Fine argued in the Los Angeles case that the diversion of $50 million in so-called Bradley-Burns sales tax revenue from the Los Angeles Metropolitan Transportation Authority to the County of Los Angeles was thus invalid, because the Los Angeles bailout legislation could have been written in such a way “that it provided assistance to all counties.”

“Since the .25% Bradley-Burns sale and use tax affects all California counties, the same result would have occurred if a general statute was used,” he said.

In Orange County’s case, the special legislation enabled the county to divert $38 million a year in Bradley-Burns funds for 15 years. The Orange County Transportation Authority had been receiving those funds and was using them to help operate the county bus system.

Companion laws also authorized the diversion of $12 million a year for 20 years from county programs for flood control, redevelopment and harbors, beaches and parks.

The proposed diversions touched off furious behind-the-scenes debates, as well as public outrage, over the prospect of vastly diminished county bus service and reduced budgets for flood control and recreation.

Bennett said that lawyers at the New York firm of Wilkie, Farr & Gallagher, hired by the county, substantially wrote the bill that the county’s legislative delegation pushed through the Assembly and Senate in the closing hours of the 1995 session.

Leslie Mazza, who billed the county at $400 an hour, would not comment Tuesday on the matter, nor provide telephone numbers for her colleagues, Peter Kenny and Dale Collinson, who, she said, “drafted the legislation.”

Fine said he would be surprised if Orange County’s lawyers had not reviewed the legal history of special legislation before advocating and eventually obtaining the bankruptcy recovery statutes.

Even in a cursory review of California case law, Fine said, “you would have found the cases” where courts have consistently considered special legislation to be unconstitutional.

County officials Tuesday said it would take them days to determine what effect a similar challenge might have in Orange County.

Stan Oftelie, chief executive of the Orange County Transportation Authority, said his office was attempting to review the judge’s ruling.

“We are going to sort and sift through what this decision means,” Oftelie said.

He added that the Orange County arrangement is different from Los Angeles County’s because Orange County and OCTA actually exchanged tax revenue, while in Los Angeles County the MTA simply made a gift of its funds to the health-care agency.

And Gary Burton, Orange County’s chief financial officer, said that while both counties lobbied for the special 1995 legislation, “there are some clear differences. Theirs was a gift. . . . Ours was a revenue diversion.

“At this point, I don’t see it having a major impact on us. We are not the ones involved in the litigation.”

Bennett said there are significant differences in the actual legislation benefiting Los Angeles and Orange County.

“The two statutes are different in lots of ways,” Bennett said. “In Orange County’s, there are explicit findings about the statewide interest in successfully resolving the Orange County crisis, as it was affecting the ability of other entities to issue debt and the price it would be issued at.”

Bennett said the county would “closely observe” the Los Angeles case and seek to “participate” in any appeal of that case.

Los Angeles County officials expressed confidence that they can get the ruling overturned on appeal, but Board of Supervisors Chairman Zev Yaroslavsky warned Tuesday: “If it is not, it will wreak havoc.”

“We think we have good grounds for appeal,” added Gerald F. Crump, the chief assistant county counsel for Los Angeles.

Crump said Los Angeles County contends that special legislation can be created for a county if there is “a rational basis” for applying it to only one governmental entity.

In any event, Bennett said there was no way to know whether a lawsuit in Orange County would force the county to redo its bankruptcy plan.

“There are far too many permutations or possible outcomes that would have to be considered,” he said. “I regard that contingency as pretty far away at this point in time.”

But, he added, “it certainly wouldn’t help matters for the revenue reallocations to be terminated.”

Also contributing to this report was staff writer Shelby Grad.