Bankruptcy Lawsuit Sent to State Court

The judge who presided over the massive Orange County bankruptcy case ruled Wednesday that his court was not the place to decide a lawsuit challenging the constitutionality of special-purpose legislation that helped lift the county out of the bankruptcy.

U.S. Bankruptcy Judge John E. Ryan agreed with attorneys for a government watchdog group who argued that since the entire matter involves California constitutional issues, it should be heard by a state court judge.

“These issues are primarily state issues,” Ryan said, adding that the Orange County Superior Court judge who hears the case could refer bankruptcy issues to his court, as state judges have from time to time.

It was the first court hearing in the case brought by the Committees of Correspondence in December, just weeks after a Los Angeles Superior Court judge declared unconstitutional a nearly identical special-purpose statute used to divert $50 million in transportation funds to Los Angeles County’s financially ailing health care system. That ruling is now on appeal.

The legislation benefiting Los Angeles County was passed at the same time as statutes enabling Orange County to dedicate $570 million in transportation tax revenue as a revenue stream to pay off part of $880 million in borrowings used last June to allow the county to emerge from bankruptcy.

Although the case was originally filed in Orange County Superior Court, attorneys for the county immediately filed a motion to move the lawsuit to Bankruptcy Court, which they claimed had “post-confirmation” jurisdiction over certain legal matters even though the bankruptcy is technically over.

In urging the Bankruptcy Court judge to retain jurisdiction, Bruce Bennett, the county’s bankruptcy lawyer, argued that the county’s ability to perform certain financial functions “may not be completely paralyzed, but certainly are circumscribed” as long as a constitutional challenge to the bailout legislation is pending.

But Richard I. Fine, the Century City lawyer who filed the case on behalf of Steve White, an Anaheim activist who heads the steering committee of the Committees of Correspondence, argued that existing federal bankruptcy statutes and case law mandated that the case be returned to state court.

After the hearing, Fine said that “this matter should never have been removed to Bankruptcy Court,” a tactic he criticized as “stalling” by the county.

If the watchdog group prevails in its lawsuit, it could unravel the county’s bankruptcy recovery plan and force the county to make the sort of deep spending cuts that the recovery plan forestalled, primarily through borrowing.

Although the $880 million in bonded indebtedness is fully insured, meaning that insurance money would become available if the transportation and other funds dried up, county lawyers and advisors have repeatedly said that relying on insurance funds was a remote possibility.

The Orange County bailout was made possible by the passage of several special-purpose laws that allowed the county to divert not only taxes that were previously dedicated to transportation, but also money for harbors, beaches and parks, as well as redevelopment funds.

Before the county could sell $880 million in bonds, it had to identify sources of revenue to guarantee repayment. The largest source was $38 million a year for 15 years in Bradley-Burns funds, which the Orange County Transportation Authority had used to help operate the bus system.

During the hearing, Fine argued that the matter could end up once again in Bankruptcy Court if a state court rules that the bailout legislation was unconstitutional, and a new financial plan must be written.

“But that would be after the declaration of the unconstitutionality of the legislation,” Fine argued. “This court need not be involved in the determination of those constitutional issues.”

After the hearing, Bennett said: “We will be defending this in state court and it will take a little longer, but I don’t expect the result will be any different. We will prevail.”