Hazel Hawkins Appeal

Case 3:24-cv-02266-JD Document 8 Filed 07/17/24 Page 1 of 67
3:24-cv-02266-JD
UNITED STATES DISTRICT COURT

FOR THE NORTHERN DISTRICT OF CALIFORNIA
SAN FRANCISCO
In re:
On Appeal from
San Benito Health Care District dba the United States Bankruptcy Court
Hazel Hawkins Memorial Hospital, for the Northern District of California
Debtor.
Bankruptcy Court Case No.:
San Benito Health Care District dba 23-50544 SLJ
Hazel Hawkins Memorial Hospital, Chapter 9
Appellant,
Judge: Hon. James Donato
v. Courtroom: 11
California Nurses Association & Location: 450 Golden Gate Avenue
National Union of Healthcare Workers, San Francisco, CA 94102
Appellees.
APPELLANT’S OPENING BRIEF
MICHAEL A. SWEET (SBN 184345)

msweet@foxrothschild.com
JACK PRAETZELLIS (SBN 267765)
jpraetzellis@foxrothschild.com
NICHOLAS A. KOFFROTH (SBN 287854)
nkoffroth@foxrothschild.com
FOX ROTHSCHILD LLP
345 California Street, Suite 2200
San Francisco, California 94104
Telephone: (415) 364-5540
Facsimile: (415) 391-4436
Counsel for Appellant, the San Benito

Health Care District dba Hazel Hawkins
Memorial Hospital
160689364.1
CORPORATE DISCLOSURE STATEMENT
Pursuant to Rule 8012 of the Federal Rules of Bankruptcy Procedure,
Appellant, San Benito Health Care District dba Hazel Hawkins Memorial Hospital,
hereby discloses that it is a California health care district organized and operated,
pursuant to §§ 32000 et seq. of the California Health and Safety Code, and that it
has no parent corporation and has no shareholders. Therefore, no entity owns or
controls ten percent or more of its shares.
160689364.1
TABLE OF CONTENTS
Introduction ................................................................................................................1
Jurisdictional Statement .............................................................................................4
Issues on Appeal.........................................................................................................5
Statement of Facts and Procedural History................................................................7
A. The Parties .............................................................................................7
B. The District Is the Sole Comprehensive Health System in the

County and Has Struggled with Chronic Financial Challenges............8
C. A Late-2022 Fiscal Emergency Renders the District With Too

Little Cash on Hand to Justify a Bankruptcy Filing............................10
D. The Short-Term Cash Management Initiatives Had Downsides—

the District Advanced Cash Receipts from Future Periods and Did
Not Pay Certain Significant Obligations. ............................................12
E. The Development of the District’s Cash Flow Projections and

Pendency Plan. ....................................................................................14
F. The District’s Financial State and Outlook on the Petition Date. .......16
G. The Eligibility Order ...........................................................................18
Summary of Argument .............................................................................................19
Argument..................................................................................................................23
A. The Bankruptcy Court Erred as a Matter of Law in Excluding the

District’s Largest Due and Unpaid Petition Date Obligation—the
Annual Pension Funding Obligation—from Both Insolvency
Analyses. .............................................................................................23
1. California’s Vested Rights Doctrine Recognizes a

Constitutional Right to Annual Pension Funding That
Renders the Pension “Actuarially Sound.” ...............................24
2. California Recognizes a Separate Constitutional Fiduciary

Duty to Appropriately Fund a Pension. ....................................29
ii
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3. The Eligibility Order, Which Addresses Whether the

Entirety of an Unfunded Actuarially Accrued Liability Is
Due, Misstates the Relevance of Actuarial Determinations. ....31
B. Current Insolvency under § 101(32)(C)(i). .........................................36
1. The District Did Not Waive Its Right to Argue That It Was
Currently Insolvent. ..................................................................36
2. The Omission of the Annual Pension Funding Obligation

from the Totality of the Circumstances Test Is Not Harmless
Error Where the Debt Is Material. ............................................38
C. Prospective Insolvency under § 101(32)(C)(ii). .................................41
1. The Bankruptcy Court’s Reliance on Accrual-Based

Historical Financial Data to Contradict Cash Projections Is
Inconsistent with the Legal Standard for Insolvency under §
101(32)(C)(ii) and the Applicable Burden of Proof. ................41
2. The Bankruptcy Court Narrowly Limited Its Analysis to the

District’s Financial Projections and Misconstrued the
District’s Expert Evidence. .......................................................48
D. The Bankruptcy Court’s Misplaced Reliance on CNA’s Expert

Witness and Erroneous Admission of Testimony as Expert
Testimony. ...........................................................................................52
1. The Expert’s Conclusion That Accrual Based Reporting “Is

More Reliable” Than Cash Forecasting Contradicts the
Legal Standard Applicable to Chapter 9 Insolvency.................52
2. The CNA Expert Ignored Available Evidence of the

District’s Bank Account Balances, in Favor of Accrual
Based Monthly GAAP Reporting, to Sew Doubt About the
District’s Cash Projections. .......................................................54
Conclusion ...............................................................................................................55
iii
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TABLE OF AUTHORITIES
Page(s)
Cases
Alameda Cty. Deputy Sheriff’s Ass’n v. Alameda Cty. Emps.’ Ret.

Ass’n, 9 Cal. 5th 1032, 1076 (Cal. 2020) .....................................................24, 25
Barnhill v. Johnson,
503 U.S. 393 (1992) .............................................................................................. 6
Bd. of Admin. v. Wilson,

52 Cal. App. 4th 1109 (Cal. Ct. App. 1997) .................................................27, 28
In re Brace,
979 F.3d 1228 (9th Cir. 2020) .............................................................................. 6
Brandt v. Bd. of Ret.,

136 Cal. App. 4th 140 (Cal. Ct. App. 2006) ....................................................... 31
Cal Fire Local 2881 v. Cal. Pub. Emps.’ Ret. Sys.,

6 Cal. 5th 965, 977 (2019) .................................................................................. 24
Carman v. Alvord,
31 Cal. 3d 318 (1982) ......................................................................................... 32
In re City of Bridgeport,
129 B.R. 332 (Bankr. D. Conn. 1991) ............................................................4, 41
In re City of Chester,
649 B.R. 633 (Bankr. E.D. Pa. 2023) .....................................................34, 35, 40
In re City of Detroit, Mich.,

504 B.R. 191 (Bankr. E.D. Mich. 2013) ......................................................passim
In re City of Stockton, Cal.,

475 B.R. 720 (Bankr. E.D. Cal. 2012) ................................................................ 41

493 B.R. 772 (Bankr. E.D. Cal. 2013) .........................................................passim

526 B.R. 35 (Bankr. E.D. Cal. 2015) .................................................................. 25
iv
160689364.1
In re City of Vallejo,
408 B.R. 280 (B.A.P. 9th Cir. 2009) ..............................................................4, 42
Cty. of Orange v. Ass’n of Orange Cty. Deputy Sheriffs,

192 Cal. App. 4th 21 (Cal. Ct. App. 2011) ......................................................... 32
U.S. Bank N.A. ex rel. CWCapital Asset Mgmt. LLC v. Vill. at

Lakeridge, LLC,
138 S. Ct. 960 (2018) ............................................................................................ 7
Fed. Trade Comm’n v. Qualcomm Inc.,

969 F.3d 974 (9th Cir. 2020) ............................................................................ 5, 6
Focus Media, Inc. v. Nat’l Broad. Co. (In re Focus Media),

378 F.3d 916 (9th Cir. 2004) .............................................................................. 39
In re Hamilton Creek Metro. Dist.,

143 F.3d 1381 (10th Cir. 1998) .................................................................... 23, 28
Highland Capital Mgmt., L.P. v. Schneider,

379 F. Supp. 2d 461 (S.D.N.Y. 2005) ................................................................ 54
Imperial Cty. Sheriff’s Ass’n v. Cty. of Imperial,

87 Cal. App. 5th 898 (Cal. Ct. App. 2023) ...................................................33, 34
In re Kaypro,
218 F.3d 1070 (9th Cir. 2000) ............................................................................ 42
Kumho Tire Co. v. Carmichael,

526 U.S. 137 (1999) .............................................................................................. 7
Kummetz v. Tech Mold, Inc.,

152 F.3d 1153 (9th Cir. 1998) .............................................................................. 6
LinkCo., Inc. v. Fujitsu Ltd.,

No. 00-7242, 2002 WL 1585551 (S.D.N.Y. July 16, 2002) .............................. 55
Lopez v. Catalina Channel Express, Inc.,

974 F.3d 1030 (9th Cir. 2020) .............................................................................. 7
In re Marciano,
446 B.R. 407 (Bankr. C.D. Cal. 2010), aff’d, 459 B.R. 27 (B.A.P.
9th Cir. 2011) ...................................................................................................... 39
v
160689364.1
Marin Ass’n of Pub. Emps. v. Marin Cty. Emps. Ret. Ass’n,

2 Cal. App. 5th 674 (Cal. Ct. App. 2016) ........................................................... 25
Mid-Del Therapeutic Ctr., Inc. v. C.I.R.,

30 Fed. Appx. 889 (10th Cir. 2002) (unpublished) ............................................ 46
Mijares v. Orange Cty. Emps. Ret. Sys.,

32 Cal. App. 5th 316 (Cal. Ct. App. 2019) ...................................................32, 33
Miller v. California,
18 Cal. 3d 808 (1977) ......................................................................................... 25
Munro v. Univ. of S. California,

2022 WL 16955481 (C.D. Cal. Nov. 1, 2022) ................................................... 52
In re Novatel Wireless Sec. Litig.,

846 F.Supp.2d 1104 (S.D. Cal. 2012)................................................................. 52
O’Neal v. Stanislaus Cty. Emps.’ Ret. Ass’n,

8 Cal. App. 5th 1184, 1208 (Cal. Ct. App. 2017) ............................................... 29
Olin Corp. v. Lamorak Ins. Co.,

2018 WL 1901634 (S.D.N.Y. Apr. 17, 2018) .................................................... 52
Owens v. Kaiser Found. Health Plan, Inc.,

244 F.3d 708 (9th Cir. 2001) ................................................................................ 6
Ralston Dev. Corp. v. U.S.,

937 F.2d 510 (10th Cir. 1991) ............................................................................ 46
In re Sierra Steel, Inc.,

96 B.R. 275 (B.A.P. 9th Cir. 1989) .................................................................... 42
Suzy’s Zoo v. Comm’r,

273 F.3d 875 (9th Cir. 2001) ................................................................................ 7
United States Gypsum Co. v. Lafarge North America, Inc.,

670 F.Supp.2d 737 (N.D. Ill. 2009) .................................................................... 52
United States v. Jose,

131 F.3d 1325 (9th Cir. 1997) .............................................................................. 6
vi
160689364.1
United States v. Olano,

507 U.S. 725 (1993) ............................................................................................ 37
United States v. Suddarth,

795 Fed. Appx. 337 (6th Cir. 2019).................................................................... 46
Valdes v. Cory,
139 Cal. App. 3d 773 (Cal. Ct. App. 1983) ............................................26, 27, 28
In re Villages at Castle Rock Metro. Dist. No. 4,

145 B.R. 76 (Bankr. D. Colo. 1990) .............................................................42, 53
White v. Ford Motor Co.,

312 F.3d 998 (9th Cir. 2002) ................................................................................ 7
Statutes
11 U.S.C. § 101(32)(C) .....................................................................................passim
11 U.S.C. § 101(32)(C)(i) .................................................................................passim
11 U.S.C. § 101(32)(C)(ii) ................................................................................passim
11 U.S.C. § 109(c)(3) .........................................................................................18, 19
11 U.S.C. § 921(c) ................................................................................................... 19
28 U.S.C. § 157(a) and (b) ......................................................................................... 5
28 U.S.C. § 158(a) ..................................................................................................... 5
28 U.S.C. §§ 1334(a) ................................................................................................. 5
CAL. HEALTH & SAF. CODE §§ 32000 et seq.......................................................... 7, 8
Other Authorities
U.S. CONST. ..................................................................................................25, 26, 28
CAL. CONST. ...........................................................................................25, 26, 28, 29
CAL. CONST., Art. XVI, § 17..............................................................................29, 30
FED. R. BANKR. P. 8002(a)(1) .................................................................................... 5
vii
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FED. R. BANKR. P. 8003(a)(4) .................................................................................... 5
FED. R. BANKR. P. 8014(a) ......................................................................................... 1
viii
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Appellant, the San Benito Health Care District dba Hazel Hawkins Memorial
Hospital (the “District” or the “Debtor”), the debtor in the above-referenced
bankruptcy case (the “Bankruptcy Case”) filed under chapter 9 of title 11 of the
United States Code (the “Bankruptcy Code”)1 before the United States Bankruptcy
Court for the Northern District of California (the “Bankruptcy Court”), hereby
submits this Appellant’s Opening Brief (the “Brief”), pursuant to Rule 8014(a) of the
Federal Rules of Bankruptcy Procedure (the “Bankruptcy Rules”).
INTRODUCTION
The central issue in this appeal is the extent to which the Bankruptcy Code
requires a distressed municipal debtor to be out of cash on, or soon after, the Petition
Date. The Bankruptcy Court dismissed the District’s Bankruptcy Case based on an
unduly narrow view of the chapter 9 insolvency tests while excluding the District’s
pension obligations from the analysis.
The issue is of critical importance to the District and other municipal health
care providers that must balance the desire to remain open with the obligation to
ensure any winddown is initiated with sufficient funds to protect patient care. The
District operates a 25-bed, critical access, acute-care hospital—the only hospital in
1
Unless otherwise defined herein, all references to “Section” and “§” refer to a
section of the Bankruptcy Code.
160689364.1
the county and the only provider of crucial services such as emergency and labor
and delivery. The District also operates two skilled nursing facilities licensed for 119
beds that serve long-term, low income, and difficult to transfer patients. It is also
offers primary and specialty care services at eight clinics throughout the county.
Transitioning patients and preserving medical records in the event of a closure is
both costly ($5 million) and time consuming (six months). If the Bankruptcy Code
requires the District to be out of cash before filing its bankruptcy petition, eligible
municipal healthcare providers would have to put public health and safety at risk
before taking advantage of the protections of the Bankruptcy Code.
The Bankruptcy Court held that the District did not satisfy the insolvency
standard, in part, by ignoring the annual pension contribution, between $3 million
and $4.05 million, that the District had not funded as of the Petition Date. The
Bankruptcy Court found that “the District has no legal obligation to pay the
actuarially determined contributions [to its pension plan], which are neither
presently, unconditionally owing, nor presently enforceable.” This holding is at odds
with California’s well-established vested rights doctrine and fiduciary obligations
that require annual funding of pensions to satisfy the pensions long-term, unfunded
actuarially accrued liabilities. Indeed, the Bankruptcy Court’s ruling departs from
other chapter 9 eligibility holdings that specifically find these obligations “due and
owing” for purposes of the insolvency analysis. To hold otherwise would require that
2
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a pension be brought to failure—and retirees begin missing benefits payments—
before the obligation is considered a “debt.” It finds no support in case law and
constitutes legal error. The omission of this significant debt from the Bankruptcy
Court’s insolvency analyses requires, at minimum, remand for further findings
concerning the impact of the debt on the District’s insolvency.
With respect to the two alternative insolvency definitions applicable to
municipalities—current insolvency on the petition date or prospective insolvency—
the Bankruptcy Court adopted exacting standards that exceed the applicable standard
of proof and case law. The Bankruptcy Court erroneously held that the District
waived any argument it was currently insolvent by admitting it could pay some
vendors even though it did so by not satisfying other obligations. The Bankruptcy
Court also effectively required that the District’s cash forecasts, which were utilized
to project the date the District would run out of cash, should match with the District’s
accrual-based, historical financial reporting despite the two accounting
methodologies speaking “different languages.” The Bankruptcy Court eschewed
reference to evidence that was not in the form of a financial statement, and never
squared the acknowledged fact that the District was down to just 1.5 days of cash on
hand six months before the bankruptcy filing. While pinpoint accuracy and certainty
of historical financial reporting is always preferable, it is not realistic or required by
the applicable legal standards that “implicates the notions of time and projections
3
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about the future.” In re City of Stockton, Cal., 493 B.R. 772, 788 (Bankr. E.D. Cal.
2013).
A municipality need not (and should not) bring itself to the brink of financial
calamity before being eligible for bankruptcy relief. It is not required to take
“actions [that] defied fiscal prudence” to stave-off insolvency where “raiding funds
for short-term needs would simply cripple [the municipality] more.” In re City of
Vallejo, 408 B.R. 280, 293 (B.A.P. 9th Cir. 2009). Indeed, municipalities “cannot go
out of business. Chapter 9 is intended to enable a financially distressed
[municipality] to ‘continue to provide its residents with essential services.’” In re
City of Bridgeport, 129 B.R. 332, 336-337 (Bankr. D. Conn. 1991) (quoting
H.R.Rep. No. 1011, 100th Cong., 2d Sess. 2 (1988), U.S.Code Cong. & Admin.
News 1988, pp. 4115, 4116).
For the reasons set forth more fully herein, the District submits that the
Eligibility Order must be reversed and the matter remanded either for further
proceedings or for factual findings consistent with the appropriate legal standards
applicable to insolvent municipal debtors.
JURISDICTIONAL STATEMENT
This is an appeal from the Bankruptcy Court’s final order (the “Eligibility
Order”) finding that the District was not eligible to be a debtor, under §§ 109(c) and
4
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921(c) and dismissing the Bankruptcy Case. A00746.2 The Bankruptcy Court’s order
overruling the District’s objection to CNA’s expert testimony (the “Hurley Order”)
merged with the final Eligibility Order. See FED. R. BANKR. P. 8003(a)(4); A00708.
This appeal is timely because the notice of appeal was filed on April 4, 2024, which
is fourteen days after the Bankruptcy Court entered the Eligibility Order on March
21, 2024. Compare id. with A00760; see also FED. R. BANKR. P. 8002(a)(1).
The Bankruptcy Court has subject-matter jurisdiction concerning the
District’s eligibility to be a debtor, pursuant to 28 U.S.C. §§ 1334(a), by reference
from this Court, under 28 U.S.C. § 157(a) and (b) and this Court’s General Order
No. 24.
This Court has jurisdiction to hear appeals from final orders of the Bankruptcy
Court, pursuant to 28 U.S.C. § 158(a).
ISSUES ON APPEAL
1. Whether the Bankruptcy Court erred in holding that “the District has
no legal obligation to pay the actuarially determined contributions [to its pension
plan], which are neither presently, unconditionally owing, nor presently enforceable”
under California law for purposes of assessing insolvency under § 101(32)(C).
A00783. Conclusions of law are reviewed de novo. See, e.g., Fed. Trade Comm’n v.
2
All references to “A” followed by a number refer to a page, or pages, of the
Appendix in Support of Appellant’s Opening Brief filed concurrently herewith.
5
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Qualcomm Inc., 969 F.3d 974, 993 (9th Cir. 2020); In re Brace, 979 F.3d 1228, 1232
(9th Cir. 2020).
2. Whether the District waived its right to argue that it was insolvent,
under § 101(32)(C)(i), when it held sufficient cash to maintain operations by not
paying other obligations that were due and owing. Waiver of a legal argument is a
question of law reviewed de novo. See, e.g., Owens v. Kaiser Found. Health Plan,
Inc., 244 F.3d 708, 713 (9th Cir. 2001); Kummetz v. Tech Mold, Inc., 152 F.3d 1153,
1154 (9th Cir. 1998).
3. Whether the Bankruptcy Court erred in holding that the totality of the
circumstances did not establish that the District was insolvent, under
§ 101(32)(C)(i), when it omitted the District’s pension funding liability from the
analysis. Conclusions of law are reviewed de novo. See, e.g., Fed. Trade Comm’n v.
Qualcomm Inc., 969 F.3d 974, 993 (9th Cir. 2020); In re Brace, 979 F.3d 1228, 1232
(9th Cir. 2020).
4. Whether the Bankruptcy Court correctly construed the scope of the
prospective insolvency definition, under § 101(32)(C)(ii). Questions of statutory
interpretation are reviewed de novo. United States v. Jose, 131 F.3d 1325, 1327 (9th
Cir. 1997) (en banc); Barnhill v. Johnson, 503 U.S. 393, 397 (1992) (whether facts
satisfy the statutory definition of a transfer, under § 101, is a question of law).
6
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5. Whether the Bankruptcy Court erred in its application of historical facts
to the prospective insolvency definition, under § 101(32)(C)(ii). Mixed questions of
law and fact involving undisputed primary facts and disputed inferences and legal
consequences are reviewed de novo. See Suzy’s Zoo v. Comm’r, 273 F.3d 875, 878
(9th Cir. 2001); U.S. Bank N.A. ex rel. CWCapital Asset Mgmt. LLC v. Vill. at
Lakeridge, LLC, 138 S. Ct. 960, 967 (2018).
6. Whether the Bankruptcy Court correctly applied the preponderance of
evidence standard applicable to insolvency determinations under § 101(32)(C).
Improper allocation of the burden of proof is reviewed de novo. See Lopez v.
Catalina Channel Express, Inc., 974 F.3d 1030, 1033 (9th Cir. 2020).
7. Whether the Bankruptcy Court abused its discretion in admitting the
testimony of the California Nurses Association’s (“CNA”) expert witness.
Evidentiary rulings on the admission of expert testimony are reviewed for abuse of
discretion. See White v. Ford Motor Co., 312 F.3d 998, 1006 (9th Cir. 2002); Kumho
Tire Co. v. Carmichael, 526 U.S. 137, 152 (1999).
STATEMENT OF FACTS AND PROCEDURAL HISTORY
A. The Parties
The Appellant, the District, is a California health care district organized and
operated, pursuant to §§ 32000 et seq. of the California Health and Safety Code.
A00819 (Tr., at 21:13-15); see also A00019.
7
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The Appellees, CNA and the National Union of Healthcare Workers
(“NUHW”), are California labor unions that represent certain employees of the
District under memoranda of understanding with the District. A00895-896.
B. The District Is the Sole Comprehensive Health System in the County and
Has Struggled with Chronic Financial Challenges.
The District is the only health care service provider of its magnitude and one
of the largest employers in San Benito County, California (the “County”). A00819-
20, A00823. The District operates a 25-bed, critical access, acute-care hospital that
provides emergency, intensive care, medical-surgery, mother-baby, radiology and
laboratory services. A00820. The District operates two skilled nursing facilities
licensed for 119 beds that serve a majority long-term, Medi-Cal residents. Id.,
A00823. The District also operates eight clinics—six are rural health clinics—that
receive approximately 55,000 patient appointments per year. A00820. The District’s
hospital is the only facility in the County to provide emergency, intensive or surgical
care and the only facility at which mothers can deliver a baby in the County. A00821.
The District’s skilled nursing facilities provide the only long-term nursing care in
the County. Id. The next nearest hospital is 30 minutes to an hour away and long-
term nursing care alternatives are scant. A00824.
The District has long struggled to maintain its financial footing. The District
became a critical access hospital in March 2020 in an effort to access increased
8
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Medicare reimbursement rates of up to 99% of the cost of care. A01218-19. The
designation required the District to reduce its bed-count to 25—lower than its then-
recent average census—just as COVID-19 surged its daily patient census up to 44.
A01218, A01220. The COVID surge resulted in increased government funding for
the District, but the District was required to repay some of these funding sources.
A01219. The surge in patient population required the District to turn to registry
staffing options that came with a premium of three to four times the regular cost of
an employee. A01220. On balance, the District’s costs to respond to COVID—labor,
PPE, ventilators, and other equipment—plus the loss of elective procedure revenue
resulted in a net cash flow losses. A01220-21. Moreover, as a smaller health system,
the District lacked the economies of scale to negotiate competitive reimbursement
rates with commercial payors and has no ability to negotiate with government payors
like Medicare and Medi-Cal. A01222.
In early 2022, the District solicited a report from an outside consultant—
ADAMS—to address strategic planning approaches. A00834. The ADAMS report
concluded that the District needed to expand service offerings to remain competitive;
the District was losing market share to larger systems outside of the County. A00837.
ADAMS presented three alternative scenarios to exit critical access designation,
increase patient volumes and services, and expand the District’s facilities—each of
which would cost hundreds of millions in capital expenses. A00839-40.
9
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Additionally, the District is burdened with employee benefit obligations that are
more expensive than comparable systems, including a defined benefit pension and a
self-insured health plan that costs the District $15 million per year. A00838-39. The
District adopted building a new hospital as part of its strategic plan at a meeting in
October 2022. A00848.
C. A Late-2022 Fiscal Emergency Renders the District With Too Little Cash
on Hand to Justify a Bankruptcy Filing.
A series of compounding financial crises had placed enormous strain on the
District’s cash flow beginning mid-2022. In June 2022, Medicare gave the District
notice of a recoupment liability of $5.2 million to be repaid within 12 months and a
concurrent reduction going forward of about $5.2 million in reimbursements.
A01201, A01205. The District had a $1.1 million payment of the employer portion
of payroll taxes—deferred under the CARES Act—that became due in December
2022. A01201-02. Additionally, the District experienced lower patient volumes for
five months after going out-of-network with its largest commercial payor due to
stalled contract negotiations in July 2022. A01207. The District was also grappling
with high inflation and the continued fallout from COVID-19 expenses. A01201-02.
Similarly, the District was unable to keep-up with two liabilities related to its defined
benefit plan: (i) the District had not been satisfying its contractual obligation to fund
the pension benefit annually (in an amount ranging between $3 million and $4.05
10
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million) under its collective bargaining agreements; and (ii) the District had no
ability to fund the actuarially-determined, long-term funding shortfall under the plan
estimated to be approximately $14.7 million driven (in part) by past annual
underfunding. A01209, A01216-17, A01223.
By late October 2022, the District projected that by mid-December 2022, it
would hold just 1.4 days of cash on hand—determined by dividing the then-current
daily operating expense of the District by its cash on hand. A00853-54, A00856. The
projections further reflected that the District would be unable to fund the last payroll
in December 2022. Id.
On November 4, 2022, the District declared a fiscal emergency that would
have permitted an immediate bankruptcy filing but then determined that bankruptcy
was infeasible for two reasons. A00767, A00854, A00859. First, the District
concluded it could not propose a feasible plan given insufficient cash on hand at the
time. A00859-60, A01056-57. Second, the District considered the catastrophic
impact a rapid closure of services would have on the community and patients,
particularly the District’s long-term care patients. A01075-76. The District’s closure
analysis concluded that a responsible closure and transfer of care (and patient
records) would take at least six months and cost approximately $5 million. A01073-
75. The District was forced to develop an alternative strategy to stabilize operations
11
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after concluding that its limited cash could not be used to fund a bankruptcy case
without jeopardizing patient care.
D. The Short-Term Cash Management Initiatives Had Downsides—the
District Advanced Cash Receipts from Future Periods and Did Not Pay
Certain Significant Obligations.
The District turned its attention to short-term stabilization initiatives to
preserve cash. These stabilization initiatives included stringent cash management
protocols where the District slow-paid vendors in breach of contract terms, did not
pay the $1.1 million IRS tax obligation due in December 2022, and did not make the
actuarially-determined, annual funding obligations to its defined benefit plan.
A01202, A01210. The District advanced revenue from future periods, including
taking advances on property tax revenue, and obtaining additional short-term
secured financing from a state program. A00860-64, A01063. To free-up cash, the
District also sold real estate it owed, froze hiring, and closed its home health service
line. Id. The short-term stabilization efforts slowly pushed the projected date the
District would run out of cash from December 2022, to February 2023, and then to
April 2023. A01052, A01055, A01076. Despite the temporary success of the short-
term initiatives, the District concluded that the cash flow benefits were not a
sustainable long-term solution because they relied on nonpayment of obligations and
12
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payment advances that necessarily resulted in a concomitant decrease in future
projected revenue.
The District had to either increase revenue or decrease expenses to achieve
long-term stability—objectives the District could not achieve with its chronic
challenges. A01079-80. First, the District concluded it could not increase revenue
because, as a 25-bed critical access hospital, the District did not generate sufficient
patient volume. A01080. ADAMS, the previously-mentioned third-party consultant
concluded that the District would need to shed the critical access hospital designation
(and related 25-bed limitation), expand the District’s facilities and services, and
increase patient volumes to remain competitive. A00837, A00839-43. However, the
capital expenses associated with these proposals presented by the consultant—each
in the hundreds of millions of dollars—far exceeded the District’s financial ability.
Id. Second, the District concluded that it could not materially decrease long-term
expense obligations. The District performed a study that concluded its employee
benefits—including its defined benefit plan and self-insured health plan that cost
$15 million per year—were materially more expensive than comparable systems.
A00838-39. Salaries, wages, and benefits represented approximately 70% of the
District’s annual expenses. A01080. But, the District was prohibited from modifying
these expenses under collective bargaining agreements. Id. The District had
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stretched the short-term initiatives as far as possible and required a long-term
approach to stabilize operations before running out of cash once again.
E. The Development of the District’s Cash Flow Projections and Pendency
Plan.
As it struggled to stay afloat through its fiscal crisis, the District utilized two
teams of financial professionals, each for separate purposes. First, the District
employed its regular finance department, headed by the District’s chief financial
officer, for the District’s ordinary course financial reporting, compliance, and
operations. A01201. Second, in November 2022, the District engaged an outside
financial consultant to provide restructuring financial advisory services, including
cash flow forecasting. A01055. As a result of their different purposes, the work
product of these teams did not “speak the same language.” A01054-55. The District’s
finance department focused on backward-looking historical reporting under
Generally Accepted Accounting Principles (“GAAP”), whereas the financial advisor
focused on developing forward-looking projections based on cash accounting. Id.
The District’s financial advisor was tasked with cash management efforts
including implementing cash management controls and developing a cash forecast
to tightly monitor cash availability. The financial advisor prepared weekly updated
cash flow projections that represented a “rolling work product”—the projections
were “started in November of 2022 and then updated weekly throughout the
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pendency of the case.” A01131. The original projections were premised on the
District’s actual performance from August 2022 through October 2022. A01141. The
historical performance data was comprised of the District’s bank data, which was
imported to a financial model and adjusted for the District’s projected schedule and
estimates for supplemental revenue receipts. A01053-54. The cash flow projections
also excluded expenses associated with cash management initiatives, including the
IRS debt and annual pension funding obligation. A01100-01.
By the end of April 2023, the financial model “had the benefit of actual cash
performance from August 2022 through April 2023,” the deep involvement of the
District’s financial advisor in weekly cash management efforts, and, “at a
minimum,” incorporated into the underlying model the District’s financial
performance from “December 2022 to April 2023.” A01141-42. At that time, the
projections reflected that the District would become critically low on cash by
January 2024 and subsequently run out of cash by November 2024 despite the short-
term initiatives. A01636-37.
On May 22, 2023, the District’s board adopted a pendency plan (the
“Pendency Plan”) and the supporting financial projections prepared by the District’s
financial advisor. A01618, A01622. The Pendency Plan presents two alternative
long-term restructuring strategies in bankruptcy: (i) pursue a transaction with a
larger health care system that can achieve sufficient economies of scale and preserve
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current health care services for the County; or (ii) implement a responsible, phased
service reduction absent a transaction. A01631-35. Both alternatives required the
District to address the significant benefits expenses it had been unable to alter outside
of bankruptcy. Id.
On May 22, 2023, the District’s board authorized the District to file a
bankruptcy case to achieve the restructuring objectives laid out in the Pendency Plan.
A01618. On May 23, 2023, the District filed its bankruptcy petition. A00001.
F. The District’s Financial State and Outlook on the Petition Date.
The District’s financial state was grim on the Petition Date. As of the Petition
Date, the District held $9.5 million in its bank accounts, according to the District’s
bank account records. A01638 (Tab “Activity,” Column P, Row 10072).3 At the time,
the District’s operating expenses were $422,000 per day, leaving the District in
violation of its bond covenants, with approximately 22.51 days of cash on hand on
the Petition Date. A00729.
Significant debts remained unpaid as of the Petition Date ranging between
$4.14 million and $5.2 million. First, the District is obligated under its agreements
with CNA, NUHW, and other unions to fund a benefit equal to 1.3% of each
employees’ annual compensation to the defined benefit plan each calendar year.
3
All references to the Excel file at A01638 assumes the corrections are made to the
formula in Column P of the Activity Tab set forth on the record. See A01124-27.
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A01215-16. The annual funding amount is actuarially determined and includes the
annual funding requirement and an amount necessary to satisfy the plan’s unfunded
actuarially accrued liability over time. A01210. The District presented a range of
annual pension funding contribution calculations known or knowable as of the
Petition Date: (i) the $3 million expense the District estimated when calculating its
fiscal year end June 30, 2023 budget, based on estimated “hours [employees] worked
that year,” A1209; (ii) the most recent actuarily determined obligation as of the
Petition Date, in the amount of $3.7 million, A01059; and (iii) the $4.05 million
actuarily determined amount the District’s actuaries calculated postpetition to
determine the contribution based on facts as of the Petition Date, A00721. The
District had not paid the budgeted pension funding obligation for calendar year 2022
as of the Petition Date. A1210. Second, the District had not paid $1.14 million in the
employer portion of payroll taxes deferred under the CARES Act due by December
31, 2022. A1202. Third, the District’s short-term cash management initiatives also
relied heavily on the “slow payment” of trade vendors. A00862-63.
The District had no structured plan or ability to repay these debts. In each
case, the District’s chief financial officer confirmed that funding the pension and IRS
obligations were “something we do when there is cash available” without regard to
the maturity of the obligation. A01209.
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Moreover, the cash on hand did not include any reserves for approximately
$6.5 million of known contingencies required to responsibly maintain patient care
and going concern operations. It remained the case that the District was required to
consider the estimated $5 million it would take to responsibly transition patient care
upon a closure. A01073-75. Additionally, the District was aware that a piece of
equipment required to keep the hospital operating, with an approximate $1.5 million
replacement cost, was already beyond end-of-life. A00828.
The District’s net cash flow calculations demonstrated significant risk the
District would deplete all cash on hand. As of the Petition Date, the District projected
that its net cash flow for June 2023 through December 2023 would be negative $2.6
million. A01636. Projected net cash flow for calendar year 2024 was projected at
negative $6.1 million. A01637. The District’s financial expert at trial testified that
simply paying the outstanding IRS and pension payments, alone, would result in a
negative cash balance of $3.1 million in January 2024. A01311-12.
G. The Eligibility Order
CNA and NUHW filed objections to the District’s eligibility to be a debtor
under §§ 109(c) and 921(c). A00177, A00292. CNA argued that the District was not
eligible because it was not insolvent, as that term is defined in § 101(32)(C), as
required by § 109(c)(3). A00177. NUHW also alleged that the Debtor was not
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insolvent and further argued that the Debtor did not file the Bankruptcy Case in good
faith, under § 921(c). A00292.
On March 21, 2024, following a four-day bench trial in December 2023, the
Bankruptcy Court entered the Eligibility Order. In the Eligibility Order, the
Bankruptcy Court found that the Debtor was not insolvent, as that term is defined in
§ 101(32)(C). A00785, A00797. The Bankruptcy Court dismissed the Bankruptcy
Case on those grounds, under § 921(c), and did not reach whether the Bankruptcy
Case was filed in good faith.
SUMMARY OF ARGUMENT
The Bankruptcy Court erred in its construction of the two statutory insolvency
tests applicable to chapter 9 eligibility. Section 921(c) provides that a bankruptcy
court may dismiss a chapter 9 bankruptcy case “if the petition does not meet the
requirements of this title.” 11 U.S.C. § 921(c). Section 109(c) sets forth the
requirements for an entity to be eligible to be a debtor under chapter 9 of the
Bankruptcy Code, including, among other things, that the entity is “insolvent.” 11
U.S.C. § 109(c)(3). The Bankruptcy Code sets forth two alternative insolvency
definitions applicable to municipalities in § 101(C)(32). As set forth more fully
below, the District respectfully submits that the Bankruptcy Court committed
reversible error when it found that the District did not establish by a preponderance
of the evidence that it was insolvent under either of the two definitions.
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As an initial matter, the Bankruptcy Court excluded from its analysis of both
insolvency tests the District’s outstanding and unpaid annual pension funding
obligation based on a misapplication of applicable California law. The Bankruptcy
Court held that nonpayment of the annual pension funding obligations is immaterial
because “the District has no legal obligation to pay the actuarially determined
contributions” to its pension. This legal holding—an issue raised by the Court and
not the parties—contradicts California state law rendering immediately enforceable
the annual funding requirements to satisfy present contractual funding obligations
and an annual amount to satisfy the unfunded actuarially accrued liability of the
plan. As such, the Bankruptcy Court committed legal error when it excluded the
annual pension funding obligation from the insolvency analysis. Moreover, the
Bankruptcy Court never concluded that its insolvency analysis would be unchanged
had it considered the pension obligation. Accordingly, the legal error requires, at
minimum, remand for further findings on the impact of the pension obligation to the
Bankruptcy Court’s analysis.
Under the first test, referred to as “current insolvency,” a debtor is insolvent
for purposes of chapter 9 eligibility if it is “generally not paying its debts as they
become due.” 11 U.S.C. § 101(32)(C)(i). First, the Bankruptcy Court incorrectly
found that the District waived current insolvency. The District stated it could pay
going forward obligations on the Petition Date, but its ability to do so was contingent
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on nonpayment of other debts like the IRS and pension. Indeed, when asked by the
Bankruptcy Court at trial, the District’s counsel expressly stated the District was not
waiving the current insolvency argument. Second, had the Bankruptcy Court
correctly recognized annual pension funding obligations as debts that are due and
owing for purposes of the insolvency analysis, the undisputed amounts of the IRS
and pension payment defaults alone require a finding of the District’s insolvency
under the applicable totality of the circumstances.
Under the second, so-called “prospective insolvency” test, a debtor is
“insolvent” for purposes of chapter 9 eligibility if it is “unable to pay its debts as
they become due.” 11 U.S.C. § 101(32)(C)(ii). First, the Bankruptcy Court adopted
a more stringent standard for prospective insolvency by eschewing the
“preponderance of the evidence” standard in favor of requiring that the District prove
“that the numbers and projections in the forecast presents an accurate and reliable
portrayal of its finances.” As a practical matter, the Bankruptcy Court sought
reconciliation of the District’s forward-looking cash projections with the District’s
historical accrual-based financial reporting under GAAP despite evidence that the
two accounting methodologies speak “different languages.” The Bankruptcy Court’s
imposition of a standard that requires forward-looking projections to be as accurate
as historical reporting (which can be verified with the benefit of hindsight) is a far
more stringent standard than adopted by case law. Second, the Bankruptcy Court
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focused solely on financial reporting and ignored case law requiring that the
prospective insolvency analysis ultimately determine whether the “municipality [is]
in bona fide financial distress that is not likely to be resolved without use of the
federal exclusive bankruptcy power to impair contracts.” The narrow construction
of the analysis and evidence deemed relevant erroneously constrained the legal
inquiry applicable to prospective insolvency.
Additionally, the Bankruptcy Court abused its discretion in admitting expert
testimony, over the District’s objection, where the expert admittedly did not purport
to be an expert in the cash insolvency standard set forth in the Bankruptcy Code.
Despite this, the Bankruptcy Court admitted testimony—and ultimately adopted the
expert’s conclusion—that accrual-based accounting is a more accurate financial
metric to determine insolvency under the applicable chapter 9 standard. Moreover,
the Bankruptcy Court adopted the expert’s conclusions about the reliability of the
District’s cash projections despite the expert’s admission that he never reviewed the
bank data underlying the projections.
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ARGUMENT
A. The Bankruptcy Court Erred as a Matter of Law in Excluding the
District’s Largest Due and Unpaid Petition Date Obligation—the Annual
Pension Funding Obligation—from Both Insolvency Analyses.
The two alternative definitions for municipal insolvency are satisfied if the
District was either “generally not paying its debts as they become due” or “unable
to pay its debts as they become due.” 11 U.S.C. § 101(32)(C) (emphasis added). “As
‘due’ is unqualified in § 101(32)(C), combining these definitions yields: presently,
unconditionally owing and presently enforceable.” In re Hamilton Creek Metro.
Dist., 143 F.3d 1381, 1385 (10th Cir. 1998)). The Bankruptcy Court analyzed
California cases holding that the entire unfunded actuarially accrued liability
(“UAAL”) of a pension system—in this case $14.7 million—is not “presently,
unconditionally owing, nor presently enforceable.” A00779-83. The Court then
made an analytical jump that any portion of the District’s annual contributions to
the pension attributable to the UAAL is likewise unenforceable. Id. Conflating the
total UAAL with the District’s annual contributions is legal error because
California’s “vested rights doctrine” grants public plan participants have a
constitutionally enforceable, implied contract right to an “actuarially sound
retirement system.” As discussed more fully below, those cases require a public
entity to make contributions representing the public employer’s “ongoing share of
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the actuarial equivalent of amounts necessary to fund current and future benefits due
covered employees.” Moreover, a party challenging an employer’s failure to fund
annual, actuarially determined contributions may bring their claims immediately,
rather than waiting for the pension to ultimately fail. Accordingly, the holding that
“the District has no legal obligation to pay the actuarially determined contributions,”
and the Court’s omission of the District’s multi-million-dollar annual pension
contributions from both insolvency analyses, constitute reversible legal error.
1. California’s Vested Rights Doctrine Recognizes a Constitutional
Right to Annual Pension Funding That Renders the Pension
“Actuarially Sound.”
“Both the United States and California Constitutions contain provisions that
prohibit the enactment of laws effecting a ‘substantial impairment’ of contracts,
including contracts of employment.” Cal Fire Local 2881 v. Cal. Pub. Emps.’ Ret.
Sys., 6 Cal. 5th 965, 977 (2019). This prohibition extends to substantial impairments
of a public employee’s implied contractual rights to a pension, which vest upon
employment. See Alameda Cty. Deputy Sheriff’s Ass’n v. Alameda Cty. Emps.’ Ret.
Ass’n, 9 Cal. 5th 1032, 1076 (Cal. 2020) (citing Cal Fire Local 2881, 6 Cal. 5th at
984-985; Kern v. City of Long Beach, 29 Cal. 2d 848 (1947)). “[T]he mere fact that
performance is in whole or in part dependent upon certain contingencies does not
prevent a contract from arising, and the employing governmental body may not deny
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or impair the contingent liability any more than it can refuse to make the salary
payments which are immediately due.” Miller v. California, 18 Cal. 3d 808, 815
(1977) (in bank) (quoting Kern, 29 Cal. 2d at 855).
The vested rights doctrine addresses the extent to which modifications to a
pension plan impair the ultimate contingent liability to the employee-participant.
“Under the ‘California Rule,’ as it has come to be known the contract clause of the
state Constitution requires any modification of public employee pension plans to
satisfy a standard established in a long line of California Supreme Court decisions.”
Alameda Cty. Deputy Sheriff’s Ass’n v. Alameda Cty. Emps.’ Ret. Ass’n, 9 Cal. 5th
1032, 1053 (Cal. 2020) (citing Cal Fire Local 2881, 6 Cal. 5th at 971; Allen v. City
of Long Beach 45 Cal. 2d 128 (1955)); In re City of Stockton, Cal., 526 B.R. 35, 55-
56 (Bankr. E.D. Cal. 2015) (recognizing “vested rights” doctrines under California
Constitution and United States Constitution). Although, pension rights may be
modified prior to retirement under those narrow standards, the California “Supreme
Court has repeatedly stated that [] pension rights may not be ‘destroyed.’” Marin
Ass’n of Pub. Emps. v. Marin Cty. Emps. Ret. Ass’n, 2 Cal. App. 5th 674, 696 (Cal.
Ct. App. 2016) (collecting cases). “When the Supreme Court says that vested
pension rights may not be ‘destroyed,’ it [prohibits] . . . effectively abolishing a
pension plan [a] legislative authority refuses to fund.” Id. at 701-702 (citing Bellus
v. City of Eureka, 69 Cal. 2d 336, 352 (1968); Valdes v. Cory, 139 Cal. App. 3d 773,
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787 (Cal. Ct. App. 1983); Klench v. Bd. of Pension Fd. Commrs., 79 Cal. App. 171,
182 (Cal. Ct. App. 1926)).
The constitutional prohibition against “destroying” pension rights includes the
temporary suspension of annual contributions to address fiscal crises. In Valdes v.
Cory, retirees challenged California’s enactment of “urgency legislation designed to
balance the fiscal year 1981–1982 budget and to avoid a year-end deficit.” 139 Cal.
App. 3d at 777. The statute “prohibit[ed] the payment of state-employer
contributions from the state general fund to the Public Employees’ Retirement Fund
for the months of April, May, and June 1982[, which] were previously appropriated
for PERS funding in the 1981–1982 budget.” Id. at 778. Other provisions similarly
modified budgeted school-employer contributions to PERS for the same months and
effectuated a “reversion” of those funds to the surplus of the state general fund. See
id. The modifications would provide significant savings to the state, but “[t]here
would be a corresponding diminution in the PERS reserve against deficiencies
account[, and n]o provision [was] made for future replacement of this amount in the
reserve account.” Id.
The California Court of Appeal held that the suspension of contributions to
the state pension—even if temporary—violated the contracts clauses of both the
California Constitution and the United States Constitution. The legislation impaired
vested rights of retirees because it required PERS to use funds held in a “reserve
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against deficiencies” “to satisfy the state’s contractual obligations to make monthly
contributions to the retirement fund so that monies regularly appropriated for that
purpose can irretrievably be redirected to balance the state budget.” Id. at 788-789.
Importantly, the Court of Appeal found specifically problematic that the legislation
effected “a reduction without regard to actuarial consequences in funds previously
allocated by legislative appropriation for special purposes.” Id. at 790. The Court of
Appeal made no distinction between contributions required for current benefits or
UAAL when it held that:
the Legislature’s rescission of existing appropriations for

employer contributions, theoretically representing the
“employer’s ongoing share of the actuarial equivalent of
amounts necessary to fund current and future benefits
due covered employees,” substantially impairs public
employees’ assurance that they will ultimately receive the
retirement benefits to which they become entitled. The
loss of a $187 million appropriation to the retirement fund,
together with the potential longterm investment yield
therefrom is not inconsequential.
Id. at 789-790 (quoting Carman v. Alvord, 31 Cal. 3d 318, 325 (1982) (in bank))
(emphasis added). Accordingly, the Court of Appeal found the temporary failure to
fund actuarially determined pension contributions was unconstitutional and invalid.
See id. at 792-793.
Subsequent California decisions confirm that the vested rights doctrine
includes a specific right to an “actuarially sound retirement system” that provides
for annual contributions to fund current benefits and underfunding liabilities. Bd. of
Admin. v. Wilson, 52 Cal. App. 4th 1109, 1131 (Cal. Ct. App. 1997). In Wilson, the
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California Court of Appeal found unconstitutional statutes that authorized the state
to fund pensions in arrears. See id. at 1118-1119, 1135. In construing Valdes, the
Court of Appeal held that “[a]ctuarial soundness of the system is necessarily implied
in the total contractual commitment, because a contrary conclusion would lead to
express impairment of employees’ pension rights.” Id. at 1133. The Court of Appeal
specifically reiterated its observation in Valdes that “[a]uthority is not lacking . . .
for the proposition that employee pension beneficiaries have a vested interest in the
integrity and security of the source of funding for the payment of benefits.” Id. at
1134. In reviewing the evidence, the Court of Appeal found that the delay in arrears
payments would render the pension actuarially unsound and, thus, found that the
statutes in issue were unconstitutional.
The vested rights doctrine precludes the District from simply turning a blind
eye to the effect of current pension contributions (or the lack thereof) to the long-
term actuarial soundness of its pension. In Hamilton Creek Metropolitan District,
the Tenth Circuit held that installment payments on bond obligations were not “due”
because payment was only required in the underlying agreement “to the extent
District funds were available.” 143 F.3d at 1384-1385. As such, the “interest
payments are neither presently, unconditionally owing, nor presently enforceable
because they are indefinitely contingent on the availability of certain Plan-defined
funds.” Id. at 1385. By contrast, the California Constitution and United States
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Constitution imply a contract obligation between the District and its employees that
mandate annual pension contributions that maintain an actuarially sound pension,
even though the ultimate payment to employee-retirees is contingent. As evidenced
in the line of vested rights cases, these annual funding obligations are presently
enforceable legal obligations that can be adjudicated prior to retirement and before
any UAAL threatens imminent pension failure. The Court acknowledged the
uncontested evidence that the District was not funding its defined benefit plan as of
the Petition Date. A00782; see also A01210. Unlike Hamilton Creek Metropolitan
District, deferral of the contributions did not arise from the nature of the underlying
legal obligation, but, instead, the District’s cash management decision to defer
pension contributions notwithstanding the legal obligation. Accordingly, the
District’s annual, actuarially determined pension funding obligations (inclusive of
amortized UAAL amounts) are “due” under the vested rights doctrine.
2. California Recognizes a Separate Constitutional Fiduciary Duty to
Appropriately Fund a Pension.
In addition to the vested rights doctrine, the California Constitution imposes
fiduciary obligations to public pensions. See O’Neal v. Stanislaus Cty. Emps.’ Ret.
Ass’n, 8 Cal. App. 5th 1184, 1208 (Cal. Ct. App. 2017) (“[I]t is clear from the text
of California Constitution, article XVI, section 17 that, at a minimum, we must
review the duties of trust fiduciaries to act for the benefit of and hold trust funds for
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their beneficiaries”). In O’Neal, the Court of Appeal considered whether employees
could state a claim for breach of constitutional fiduciary duty where a retirement
board made two modifications intended to help “participating employers manage a
[fiscal] crisis in the short term” by taking actions to reduce annual contributions for
unfunded liabilities in the wake of the Great Recession. 8 Cal. App. 5th at 1192,
1217. First, the Court of Appeal considered the way the board modified its funding
of unfunded liabilities and found that the facts “could support an inference that [the
board] took steps to reduce employer contributions owed under its actuarial
calculations based on the financial interests of the employers.” Id. at 1218. Second,
the Court of Appeal found a basis for a potential breach where amortization
modifications for unfunded liabilities “could be viewed as ensuring at the time that
the unfunded liabilities of the fund would increase each of those years and,
potentially, in perpetuity.” Id. at 1221. “With respect to both theories, evidence
showing the resulting increase in unfunded liabilities and subsequent decrease in
actuarial funding percentages could demonstrate potential damages accrued due to
these changes.” Id. This was the case even where the plan had no present “fiduciary
obligation to pay nonvested benefits.” Id. at 1220. As such, California’s
constitutional fiduciary obligations recognize a present obligation to make annual,
actuarially determined contributions to a pension necessary to fund future benefits
regardless of whether the benefits are presently due. Accordingly, the California
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constitutional fiduciary duties establish a separate legal basis under which annual
contributions are “due.”
3. The Eligibility Order, Which Addresses Whether the Entirety of an
Unfunded Actuarially Accrued Liability Is Due, Misstates the
Relevance of Actuarial Determinations.
The Eligibility Order omits consideration of the District’s annual pension
funding obligations from both insolvency analyses, under § 101(32)(C), based on
the erroneous conclusion that the District had “no legal obligation to pay the
actuarially determined contributions.” A00727. The Eligibility Order does not
include an analysis of the California’s vested rights doctrine or constitutional
fiduciary duties. Instead, the Court relied upon cases holding that the total UAAL is
“not considered current financial obligations.” A00779. The Court’s primary error
was failing to distinguish between the total, contingent UAAL of a pension plan and
the constitutionally imposed, annual contribution obligation to maintain the actuarial
soundness of the pension.
The Eligibility Order principally cites to cases holding that the aggregate
UAAL of a pension is not presently due and owing and either do not address annual
pension contributions or acknowledge that they are analytically distinct liabilities.
These cases stand for the uncontroversial proposition that a “[UAAL] does not
represent a debt that is payable today.” Brandt v. Bd. of Ret., 136 Cal. App. 4th 140,
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157 (Cal. Ct. App. 2006);4 see also Cty. of Orange v. Ass’n of Orange Cty. Deputy
Sheriffs, 192 Cal. App. 4th 21, 37 (Cal. Ct. App. 2011) (“An unfunded liability such
as a UAAL is not created at the time of the award of enhanced benefits, but occurs
over years.”); Mijares v. Orange Cty. Emps. Ret. Sys., 32 Cal. App. 5th 316, 325
(Cal. Ct. App. 2019) (accord). In County of Orange, the Court of Appeal specifically
observed that “our case does not involve an annual payment to OCERS” when
distinguishing the annual pension contribution analysis in Carman, supra. Cty. of
Orange, 192 Cal. App. 4th at 37 (emphasis added). Indeed, highlighting the
distinction between these two components of pension liabilities, the County of
Orange held that the treatment of UAAL as indebtedness bears no similarity to that
of pension contribution obligations. Compare id. (holding a UAAL “actuarial
projection is not indebtedness as traditionally understood”) with Carman, 31 Cal. 3d
at 326 (“We hold that indebtedness as traditionally understood covers obligations
arising under City’s pension.”).
In Mijares, the Court of Appeal rejected an employer’s argument that the
entire UAAL that arose following the retirement of all employes was immediately
due and owing but affirmed the trial court’s ruling that the retirement system had
4
Brant is also cited for the notion that “[t]he existence of [UAAL] is not in itself
bad, any more than a mortgage on a house is bad.” See A00779 (quoting Brandt, 136
Cal. App. 4th at 157). While this may be the case, the issue here is different: whether
the District is required to make the mortgage payment.
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authority to require payment of the UAAL through annual contributions. See
Mijares, 32 Cal. App. 5th at 325, 330, 332-333 (observing that “there is a continuing
obligation to assess the assets and liabilities needed for the retired employees’
prospective benefits”). The Court of Appeal held that the applicable statutory
authority “contain[ed] no express limitations on the County Retirement System’s
authority to seek payment of Unfunded Liability” and that, “[o]nce a retirement
board sets contribution rates based upon the recommendation of its actuary, those
rates are binding.” Id. at 324, 329 (internal citations omitted). Accordingly, the cases
cited by the Court stand for the proposition that the UAAL of a pension plan is not
due and owing and do not address whether the annual contribution obligations that
include an amortized amount necessary to fund a long-term UAAL are “due.”
Indeed, the citation to Imperial County Sheriff’s Association in the Eligibility
Order confirms the obligation to fund annual contributions, inclusive of amounts
necessary to satisfy the UAAL. The Court cited Imperial County Sheriff’s
Association for the distinction the Court of Appeal drew between normal cost and
UAAL. See A00722 (quoting Imperial Cty. Sheriff’s Ass’n v. Cty. of Imperial, 87
Cal. App. 5th 898, 903-904 (Cal. Ct. App. 2023)). However, the Court of Appeal in
that case clarified that “[t]wo types of costs must be paid each year to fund the
system retirement benefits of County employees: normal cost and the amortized
payment of the unfunded actuarial accrued liability (UAAL).” Imperial Cty. Sheriff’s
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Ass’n, 87 Cal. App. 5th at 903-904 (emphasis added); see also id. at 904 (“Once the
normal cost and UAAL contribution rates are determined and communicated to the
County, the County Board is then statutorily obligated to implement the contribution
rates recommended by the ICERS Board.”). These cases either do not support, or
contradict, the Court’s ultimate legal conclusion that the District had “no legal
obligation to pay the actuarially determined contributions.”
Importantly, the Bankruptcy Court’s ruling runs contrary to other chapter 9
eligibility rulings that considered annual pension contributions in the context of an
insolvency analysis—none of which have attempted to parse the UAAL as the
Bankruptcy Court did here. In the City of Chester’s bankruptcy case, the court found
that the city “did not make its full annual legally required pension payments,
otherwise known as minimum municipal obligation” and found that
it is clear that the City is insolvent because it is currently

unable to fund, and historically has failed to fund, its
substantial obligations under the Pension Plans, which are
unconditionally owed and presently enforceable.
In re City of Chester, 649 B.R. 633, 655 (Bankr. E.D. Pa. 2023) (emphasis added).
Moreover, the court actually considered the $100 million UAAL and the city’s
“consistently underfunded pension obligations” in its current insolvency analysis as
further indicia of insolvency. Id.
Likewise, in the City of Detroit’s bankruptcy case, the bankruptcy court found
that the city was “generally not paying its debts as they came due,” under
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§ 101(32)(C)(i), in part because it “deferred payment” on its “pension
contributions.” In re City of Detroit, Mich., 504 B.R. 191, 262 (Bankr. E.D. Mich.
2013). The pension contributions at issue were necessary analyzed “[u]sing current
actuarial assumptions” that were projected to grow depending on changes in the
underlying actuarial assumptions. Id. at 208-209. The City of Detroit court undertook
no effort to parse the actuarially determined contributions associated with
underfunding liabilities despite acknowledging that the city had substantial UAAL.
Id. at 208; see also City of Chester, 649 B.R. at 656 (finding city prospectively
insolvent where “it is apparent that further budget cuts alone will not make a dent in
the substantial outstanding and ongoing pension obligations and retiree healthcare
costs”). The Eligibility Order does not distinguish City of Chester or City of Detroit
or offer other rationale for departing from the underlying presumption that annual
pension funding obligations must be considered for purposes of insolvency,
regardless the components of the actuarially determined annual funding obligation.
The Bankruptcy Court committed legal error when it extrapolated, from cases
addressing unfunded actuarially accrued liabilities, that “the District has no legal
obligation to pay the actuarially determined contributions” to its pension without
regard to California’s vested rights doctrine or constitutional fiduciary duties. The
Court’s insolvency rulings in the Eligibility Order must be reversed because this
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misstatement of law resulted in the omission of one of the District’s principal, unpaid
debts on the Petition Date, the pension, from either insolvency analysis.
B. Current Insolvency under § 101(32)(C)(i).
1. The District Did Not Waive Its Right to Argue That It Was
Currently Insolvent.
The Bankruptcy Court erroneously held that the District waived the argument
that it was insolvent under § 101(32)(C)(i). A00721. The Bankruptcy Court
acknowledged that the District explicitly asserted at trial, and in posttrial briefing,
that it was insolvent under § 101(32)(C)(i) and that it was not waiving the argument.
See A00803 (“THE COURT: . . . I do have a question before we begin, which is,
I’m wondering if the debtor is actually contesting 101(32)(C)(i) . . . . MR. SWEET:
That’s right, Your Honor. We’re not waiving that issue.”); see also A00697-700.
Nevertheless, the Bankruptcy Court cites to two statements that it holds as
amounting to a waiver of the right to argue current insolvency under § 101(32)(C)(i):
 A Petition Date declaration by the District’s CEO stating, “[a]s of the date
of this Declaration, the District is projected to hold sufficient cash on hand
to continue operations without a reduction in services through December
2023, assuming the District makes no further changes to its operations.”
A00721.
 A prepetition staff report to the District’s Board that states, “[t]he current
cash flow forecast indicates that, while it was cash flow insolvent in
November 2022, the short-term stabilization efforts have removed it from
qualifying as cash-flow insolvent.” A00721.
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Importantly, however, the Court does not reconcile these statements with the
legal standard for current insolvency or the operative facts underlying the cited
statements. A municipality is insolvent, under § 101(32)(C)(i), if it is “generally not
paying its debts as they become due.” 11 U.S.C. § 101(32)(C)(i). The District’s
Petition Date operations, and the cash flow forecast referenced in the staff report,
both contemplate nonpayment of the $1.1 million debt to the IRS and nonpayment
of annual pension funding obligations. See, e.g., A01210 (“Q. So although the
pension was included as an expense in the budget, was that contribution made as
budgeted? A. It was not. . . . We did not pay the IRS.”); A1055-56 (identifying
significant assumptions in the District’s cash projections, including nonpayment of
annual pension contributions and IRS debt). Accordingly, the District’s statements
that it could continue operations was explicitly premised on nonpayment of other
debts.
“[W]aiver is the intentional relinquishment or abandonment of a known
right.” United States v. Olano, 507 U.S. 725, 733 (1993). The Bankruptcy Court does
not square the two statements by the District cited in the Court’s waiver analysis
with the underlying legal standard for insolvency, under § 101(32)(C)(i). As the
District argued, nonpayment of a few significant obligations, such as the annual
pension funding and IRS obligation, are material considerations under the Ninth
Circuit’s totality of the circumstances test for current insolvency, discussed below.
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The payment of trade liabilities to continue operations as of the Petition Date does
not waive the District’s insolvency argument where the District only funded ongoing
operations through intentional nonpayment of other debts (i.e., the IRS and pension)
owing as of the Petition Date. See Detroit, 504 B.R. at 263 (finding current
insolvency where “the City stopped paying its trade creditors to avoid running out
of cash. But for these and other deferments, the City would have completely run out
of cash by the end of 2013.”). The District’s ability to continue funding operations
on the Petition Date did not serve to waive its right to argue that nonpayment of other
debts still rendered it insolvent. Accordingly, the Bankruptcy Court’s waiver holding
must be reversed because it resulted from the misapplication of historical facts to the
applicable legal standards governing waiver and insolvency under § 101(32)(C)(i).
2. The Omission of the Annual Pension Funding Obligation from the
Totality of the Circumstances Test Is Not Harmless Error Where
the Debt Is Material.
Courts in the Ninth Circuit analyze the totality of the circumstances to
determine whether nonpayment of certain debts rises to the level of “general
nonpayment” contemplated by the statute. See Eligibility Order at 21 (citing In re
Vortex Fishing Sys., Inc., 277 F.3d 1057, 1072 (9th Cir. 2002)). “[T]here is
‘substantial authority for the proposition that even though an alleged debtor may owe
only one debt, or very few debts, an order for relief may be granted where such debt
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or debts are sufficiently substantial to establish the generality of the alleged debtor’s
default.’” In re Marciano, 446 B.R. 407, 421 (Bankr. C.D. Cal. 2010) (quotation
omitted), aff’d, 459 B.R. 27 (B.A.P. 9th Cir. 2011), aff’d 708 F.3d 1123 (9th Cir.
2013). This is particularly the case where the debtor has “substantial amounts of
unpaid bills and no plans or ability to pay them.” Focus Media, Inc. v. Nat’l Broad.
Co. (In re Focus Media), 378 F.3d 916, 929 (9th Cir. 2004) (superseded by statute
on other grounds).
The District presented undisputed evidence that the IRS debt and annual
pension obligation were unpaid as of the Petition Date and that the District had no
ability or plan to repay the debts. As set forth above, the parties did not contest that
the IRS obligation, in the amount of $1.14 million, and the annual pension funding
obligation, in an actuarially determined amount ranging from $3 million to $4.05
million depending on the date of calculation, were unpaid on the Petition Date.
A00721. The amounts of the obligations are undisputed—the only dispute is whether
the pension obligation was “due and owing” for purposes of the insolvency analysis.
The District also presented uncontested evidence that the District’s funding plans for
both obligations were non-existent: the District would fund either as cash
materialized to do so. A01100, A1209-10. However, the cash never materialized and
were intentionally omitted from cash forecasting as a cash management strategy.
A1209-10. The only evidence submitted concerning the effect of paying these debts
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as of the Petition Date came from the District’s financial advisor and expert, who
both concluded that payment would “quite substantially” advance the projected run
out of cash date for the District and cause an immediate cash crisis. A01101. In the
City of Chester, the court found current insolvency under nearly identical grounds,
holding that:
Because the City has not been paying its debt obligations
as they become due and its revenues are insufficient to pay
off its [minimum annual pension funding] obligations and
tax obligations, inter alia, the City is insolvent pursuant to
the first prong under § 101(32)(C)(i).
City of Chester, 649 B.R. at 655. Based on the preponderance of the evidence—
indeed the uncontested evidence—the Bankruptcy Court erred in holding that the
District was not currently insolvent given the significance of the debts.
At minimum, the Bankruptcy Court’s legal conclusion that the annual pension
funding obligation was not “due and owing” requires remand for further findings.
The Bankruptcy Court never concluded that its analysis of the totality of the
circumstances test would remain unchanged if the annual pension funding obligation
were considered in addition to the IRS obligation. Instead, the Bankruptcy Court
focused solely on the IRS obligation and concluded that it, alone, “does not rise to
the level of general nonpayment contemplated by § 101(32)(C)(i).” A00729. As
such, remand for further findings is necessary to the extent this Court finds the
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annual pension funding obligation a debt for purposes of the current insolvency
analysis.
C. Prospective Insolvency under § 101(32)(C)(ii).
1. The Bankruptcy Court’s Reliance on Accrual-Based Historical
Financial Data to Contradict Cash Projections Is Inconsistent with
the Legal Standard for Insolvency under § 101(32)(C)(ii) and the
Applicable Burden of Proof.
Section 101(32)(C)(ii) provides that a municipality is insolvent if it is “unable
to pay its debts as they become due.” 11 U.S.C. § 101(32)(C)(ii). The
§ 101(32)(C)(ii) “language ‘unable to pay as they become due’ in the municipal
insolvency definition implicates the notions of time and projections about the
future.” City of Stockton, Cal., 493 B.R. at 788. “[A] municipality need not be
actually out of cash before it is cash insolvent.” Id. The analysis requires “a
projection of the availability of expected cash to meet expected expense” to
determine the “actual point of running out of cash.” Id.; see also City of Bridgeport,
129 B.R. at 337-338. The District has the burden to establish insolvency under “the
familiar preponderance-of-evidence standard of basic civil litigation.” In re City of
Stockton, Cal., 475 B.R. 720, 726 (Bankr. E.D. Cal. 2012).
In the Eligibility Order, the Bankruptcy Court adopted a more stringent
standard for prospective insolvency. The Bankruptcy Court held that the District
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“has the burden of proving that the numbers and projections in the forecast presents
an accurate and reliable portrayal of its finances.” A00731. The statement of law
crafted by the Bankruptcy Court appears to derive from its interpretation of
Generally Accepted Accounting Principles (“GAAP”), which the Bankruptcy Court
explains “are designed to create financial reports that are accurate and reliable.”
A00733. Yet, courts typically reject the use of GAAP as a legal standard for balance
sheet insolvency determinations. See In re Kaypro, 218 F.3d 1070, 1076 (9th Cir.
2000) (evaluating balance sheet insolvency and holding that “[t]here is no generally
accepted accounting principle for analyzing the insolvency of a company”); In re
Sierra Steel, Inc., 96 B.R. 275, 278 (B.A.P. 9th Cir. 1989) (evaluating balance sheet
insolvency and holding that “[r]equiring application of GAAP would make
accountants and the board which promulgate GAAP the arbiters of insolvency
questions. Clearly the Code provides that judges should make such decisions.”). This
is particularly the case in chapter 9, where the insolvency definition requires a
projected cash flow analysis and precludes consideration of “balance sheet”
insolvency. See, e.g., In re Villages at Castle Rock Metro. Dist. No. 4, 145 B.R. 76,
84 (Bankr. D. Colo. 1990); In re City of Vallejo, 408 B.R. 280, 289 (B.A.P. 9th Cir.
2009). Moreover, the strict GAAP standard conflicts with the broad construction of
“§ 109(c)’s eligibility requirements to provide access to relief in furtherance of the
Code’s underlying policies.” Vallejo, 408 B.R. at 289 (quoting In re Valley Health
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Sys., 383 B.R. 156, 161 (Bankr. C.D. Cal. 2008)) (internal quotations omitted).
Accordingly, the Bankruptcy Court erred in adopting an incorrect legal standard for
prospective insolvency.
Assuming, arguendo, the Bankruptcy Court’s construction of the prospective
insolvency test is correct, the Bankruptcy Court erred in is application of the burden
of proof to the test. Courts analyzing insolvency commonly find that the
preponderance of the evidence standard is satisfied through testimony of witnesses
familiar with a municipality’s finances, even in the absence of expert testimony. See,
e.g., Detroit, 504 B.R. at 264 (finding insolvency based on lay testimony of financial
advisors with “extensive personal knowledge of the City’s affairs” and “reject[ing]
[] argument that expert testimony is essential”); Stockton, 493 B.R. at 790 (relying
on testimony concerning availability of local tax measures as a viable funding
source). The District provided detailed testimony that its cash flow projections were
the result of a “rolling work product”—weekly cash flow projections—“that [its
financial advisor] started in November of 2022 and then updated weekly throughout
the pendency of the case.” A01131. The original projections were premised on the
District’s actual performance from August 2022 through October 2022. A01141. The
historical performance data was comprised of the District’s bank data, which was
imported to a financial model and adjusted for the District’s projected schedule and
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estimates for supplemental revenue receipts.5 A01054. The cash flow projections
also excluded expenses associated with cash management initiatives, including the
IRS debt and annual pension funding obligation. A01100-01. By the time of the
bankruptcy filing, the financial model “had the benefit of actual cash performance
from August 2022 through April 2023,” the deep involvement of the District’s
financial advisor in weekly cash management efforts, and, “at a minimum,”
incorporated into the underlying model the District’s financial performance from
“December 2022 to April 2023.” A01141-42. The cash flow projections used with
the bankruptcy filing were prepared shortly after the last full week of April 2023 and
reflected that the District would run out of cash in November 2024. A01131-32,
A01636. The District’s financial expert added in the IRS and pension payment
obligations and concluded that these adjustments, alone, would result in a negative
cash balance of $3.1 million in January 2024. A01312. The testimony provided
thorough explanations of the basis of the projections from persons with first-hand
5
The Eligibility Order asserts that “[w]ithout any breakdown of revenues and
expenses, the court cannot evaluate B. Riley’s figures vis-a-vis the District’s own
historical numbers and the context of how B. Riley estimated the various figures.”
A00735. However, the District’s financial advisor gave detailed testimony
concerning the source of revenues and expenses that were unchallenged. A01099-
105. The notion that the District did not meet its burden because its projections did
not offer the same line-items as the District GAAP based historical financial
reporting further suggests application of a more stringent and legally inaccurate
standard.
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knowledge of the District’s finances and, thus, satisfied the District’s burden even
under the Bankruptcy Court’s restrictive, GAAP-based legal standard.
The Bankruptcy Court erred by requiring the District to produce projections
that matched actual historical results. The Court found that the District’s projections
did not “present an accurate and reliable portrayal of its finances” because they did
not square with the District’s historical financial records reported under GAAP.
A00731-34. The Bankruptcy Court compared the projected ending cash balance for
December 2022 and April 2023 with the District actual cash on hand at the end of
each period. A00732. The Bankruptcy Court observed that actual cash on hand at
the end of each period was greater than projected—ranging from $614,253 greater
to $6.2 million greater than projected—while the District was incurring $422,000 in
daily operating expenses.6 Id. The District gave five7 specific examples why the
projected cash would be less than what was ultimately on hand at the end of a given
period—the difference between revenue and expense realization in accrual versus
cash accounting, the different reporting dates, the District’s efforts to advance actual
cash receipts before projected periods, the omission of restricted and petty cash, and
6
The Bankruptcy Court also erroneously aggregated the differences between each
measurement date to conclude a $15 million difference in projected cash over actual
cash. A00735. This is not supported by the evidence—a difference of that magnitude
would be reflected in a difference between reported and actual cash of $15 million
during a particular measurement date. The record contains no such $15 million
difference between actual and projected cash on any given date.
7
The Eligibility Order cites to only two. A00732.
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unbudgeted revenue. A001054-55, A01115-17, A01129; see also A01638 (Tab
“Activity,” Rows 10347 & 10701).
By contrast, the Bankruptcy Court’s analysis centers on efforts to reconcile
the District’s accrual-based historical financial records with cash-based projections
that do not “speak the same language” and “aren’t comparable” for direct
reconciliation purposes. A01054-55, A01162-63. The difference between accrual
accounting and cash accounting can lead to a “substantial difference in results”
because the methods can result in alternative “date[s] when [the entity] records the
revenue it earns.” See, e.g., Ralston Dev. Corp. v. U.S., 937 F.2d 510, 514-515 (10th
Cir. 1991); United States v. Suddarth, 795 Fed. Appx. 337, 385 (6th Cir. 2019) (Clay,
J. dissenting). Accrual accounting is antithetical to the ultimate legal issue—whether
and when the District will run out of cash—because its focus on in “when did the
transaction occur and recording that transaction in the proper period” rather than
identifying “what is my prospective cash balance look like?” A01054-55; see also
Mid-Del Therapeutic Ctr., Inc. v. C.I.R., 30 Fed. Appx. 889, 891 n.1 (10th Cir. 2002)
(unpublished) (explaining that the cash method of accounting includes income and
expenses in the year “in which they are actually received or made” whereas the
accrual method does so when “all of the events have occurred that fix the right to
receive income or pay liability”).
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By way of example, the District’s own bank records reflect approximately
$9.5 million of cash on hand on the Petition Date. A01638 (Tab “Activity,” Column
P, Row 10072). Yet, just eight days later, on May 31, 2023, the cash balance in the
District’s accounts grew to $13.7 million. A01123. The District’s GAAP-based
financial statements—which only recorded cash on hand at month-end—reflected
$14.9 million on hand as of May 31, 2023. A01128-29. The multi-million-dollar
difference in eight days of operations is simple and confirmable after reviewing the
District’s bank records: the natural variability in the District’s realization of
supplemental revenue from its payors and an earlier-than-projected closing of the
sale of District real estate.8 The smaller difference between the cash and GAAP
month-end accounting is also easily explained: cash accounting only included
accounts that could be easily liquidated (a $400,000 difference), the recordation of
income when deposited under cash accounting versus when income is received but
not yet deposited in accrual accounting, and voided checks. A01129. The testimony
8
At trial, the District showed the difference totaled approximately $4.5 million. On
May 24, 2024, the District received a $1.1 million Distinct Part Unit supplemental
payment and approximately $300,000 of additional Rate Range reimbursement that
were unexpected payments and unbudgeted in the Pendency Plan. A01115, A01638
(Tab “Activity,” Rows 10189 & 10166). The District also realized the $1.5 million
revenue from sale of real estate on May 26, 2023 and $1.2 million of Quality
Incentive Pool payments that were both budgeted for later in June 2023. See id.; see
also A01638 (Tab “Activity,” Rows 10347 & 10701).
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at trial clearly explains the variances—the Bankruptcy Court’s effort to engage in a
month-to-month direct reconciliation was flawed.
The Bankruptcy Court erred when it required the District to demonstrate that
its projections satisfied the same level of accuracy as historical financial reporting
without respect to testimony and required reconciliation with an accrual-based
financial report inconsistent with the ultimate legal inquiry under § 101(32)(C)(ii).
2. The Bankruptcy Court Narrowly Limited Its Analysis to the
District’s Financial Projections and Misconstrued the District’s
Expert Evidence.
“The theme underlying the two alternative definitions of municipal insolvency
in § 101(32)(C) is that a municipality must be in bona fide financial distress that is
not likely to be resolved without use of the federal exclusive bankruptcy power to
impair contracts. The insolvency must be real and not transitory.” Stockton, 493 B.R.
at 788. As such, under § 101(32)(C)(ii), “longer-term budget imbalances (budget
insolvency) and the degree of inability to fund essential government services
(service delivery insolvency) also inform the trier of fact’s assessment of the relative
degree and likely duration of cash insolvency.” Id. at 789; see also Detroit, 504 B.R.
at 263. The court in Stockton analyzed budget and service delivery insolvency to
determine whether the insolvency was “persistent” and “not a mere technical
insolvency.” Stockton, 493 B.R. at 791. Contrary to the Bankruptcy Court’s holding,
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the Stockton court also concluded that these considerations are independent bases to
find insolvency. Compare id. at 789 (“even if the projections . . . did not suffice to
support a conclusion of cash insolvency per § 101(32)(C), the inability to formulate
a balanced budget . . . without impairing contractual obligations independently
supports the finding of insolvency) with A00736 (“the Stockton decision . . . only
considered other categories to ascertain whether . . . the city was manufacturing
insolvency”). Similarly, the analysis of prospective insolvency in City of Detroit
places significant emphasis on service delivery insolvency. See Detroit, 504 B.R. at
263-264 (while financial insolvency metrics “might more neatly establish the City’s
‘insolvency’ under 11 U.S.C. § 101(32)(C), it is the City’s service delivery
insolvency that the Court finds most strikingly disturbing in this case”).
The Bankruptcy Court committed two reversible errors in its prospective
insolvency analysis. First, the Bankruptcy Court erred by mischaracterizing the cash
flow test performed by the District’s expert. The principal cash flow test performed
by the District’s expert involved adding to its financial projections the repayment of
the District’s debt to the IRS and pension obligations without any other modification.
A01309-10. These two changes resulted in a negative cash on hand balance of $3.1
million in January 2024. A01311-12. The Eligibility Order does not address this
independent test performed by the District’s expert—other than by making the
legally incorrect determination that annual pension funding is not a debt and
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recasting doubt on the underlying projections. A00736. Moreover, even accepting
the Bankruptcy Court’s criticism of the underlying projections, the Bankruptcy
Court never addressed the fact that these modifications rendered the District cash
flow negative below even the largest variance between actual and projected cash by
August 2024. Compare A01669 (projecting negative $6.5 million cash on hand in
August 2024) with A00732 (asserting $6.2 million variance between projected and
actual cash on hand in February 2023). The Bankruptcy Court erred when it did not
address that the District was projected to be out of cash by August 2024 under the
strictest standards.
Second, the Bankruptcy Court unduly limited its analysis of the District’s
prospective insolvency by focusing on whether “two sources” of financial data—the
District’s cash flow projections and expert report and testimony—satisfied the
District’s burden. A00730. The Bankruptcy Court faults the District’s expert for
considering other “subcategories” of financial metrics utilized by the District’s
expert to perform a “confirmatory” solvency analysis that admittedly considered
cash needs beyond the standard chapter 9 insolvency test. A00736, A01314.
However, the Court acknowledges as “undisputed” that the District was “in a dire
financial situation at the end of 2022,” when it was down to just 1.5 days’ cash on
hand and was on the verge of missing payroll. A00711, A00853-54. In the course of
preserving operating cash, the District closed a service line, obtained loans and
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advances on future payments, froze hiring, delayed vendor payments, and sold
property, among other things. A00861-64. The District’s cash on hand improved as
a result, but it was “operating on a ‘razor’s edge’ for several months prior” to the
Petition Date. See Detroit, 504 B.R. at 263. And it remained the case that the District
was required to consider the estimated $5 million it would take to responsibly
transition patient care upon a closure or the $1.5 million it would cost to replace a
necessary piece of equipment already beyond end-of-life. A00828, A01074.
Moreover, although the Bankruptcy Court adopted the CNA expert’s much lower
cash on hand requirement, the Bankruptcy Court never squared this testimony with
the fact that the District still held far less cash on hand than that standard on the
Petition Date. Compare A00797 (union expert supported 59.8 day’s cash on hand as
sufficient) with A00785 (identifying range of 28.7 and 35.4 days of cash on hand).
The Bankruptcy Court’s analysis omits all of these factors that bear directly on
whether the District really did (or could) rebound from its admittedly undisputed
insolvency in December 2022.
Accordingly, the Bankruptcy Court’s reliance on limited evidence and its
narrow construction of the breadth and ultimate aim of the prospective insolvency
analysis constitute reversible error.
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D. The Bankruptcy Court’s Misplaced Reliance on CNA’s Expert Witness
and Erroneous Admission of Testimony as Expert Testimony.
1. The Expert’s Conclusion That Accrual Based Reporting “Is More
Reliable” Than Cash Forecasting Contradicts the Legal Standard
Applicable to Chapter 9 Insolvency.
The Bankruptcy Court erred in overruling the District’s motion in limine to
exclude CNA’s expert testimony. Courts must exclude expert testimony that applies
the incorrect legal standard. See Olin Corp. v. Lamorak Ins. Co., 2018 WL 1901634,
at *21 (S.D.N.Y. Apr. 17, 2018) (“Expert testimony [ ] should be excluded when it
applies the wrong legal standard.”) (citing cases); In re Novatel Wireless Sec. Litig.,
846 F.Supp.2d 1104, 1108 (S.D. Cal. 2012) (excluding expert testimony for applying
wrong legal standard); United States Gypsum Co. v. Lafarge North America, Inc.,
670 F.Supp.2d 737, 745 (N.D. Ill. 2009) (excluding expert witness from testifying
where expert “applied the incorrect legal standard in formulating damages”); Munro
v. Univ. of S. California, 2022 WL 16955481, at *4 (C.D. Cal. Nov. 1, 2022) (finding
expert’s conclusions neither reliable nor relevant because it is “premised on an
incorrect legal standard”).
The insolvency definition applicable to municipalities in chapter 9 is unique
from other insolvency definitions in the Bankruptcy Code. “The language ‘unable to
pay as they become due’ in the municipal insolvency definition implicates the
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notions of time and projections about the future.” City of Stockton, Cal., 493 B.R. at
788. By contrast, “[t]he primary use of ‘insolvent’ in other chapters of the
Bankruptcy Code refers to what is commonly described as ‘balance-sheet
insolvency,’ which is a financial condition such that liabilities exceed assets.” City
of Stockton, Cal., 493 B.R. at 788 (emphasis added); see also Villages at Castle Rock
Metro. Dist. No. 4, 145 B.R. at 84 (“For most bankruptcy purposes, insolvency is a
balance sheet test.”). “However, for Chapter 9 purposes insolvency is not a balance
sheet test, but instead is a question of whether the debtor is unable to pay its debts
as they come due.” Villages at Castle Rock Metro. Dist. No. 4, 145 B.R. at 84.
It is undisputed—and acknowledged by the Bankruptcy Court—that CNA’s
expert was not presented as an expert in chapter 9 insolvency. A00754. Nevertheless,
the Bankruptcy Court permitted the expert to testify as to whether financial
documents based on accrual-based or cash-based accounting are more reliable in the
context of a chapter 9 insolvency analysis. A00735, A00753. Indeed, the Bankruptcy
Court ultimately adopted the expert’s conclusion that “GAAP-based statements are
designed to create financial reports that are accurate and reliable.” A00733.
However, the expert’s unfamiliarity with—and failure to utilize—the chapter 9
insolvency standards that explicitly require focus on projections that the
municipality will run out of cash render the expert’s conclusion untethered from a
legal standard. Accordingly, the Bankruptcy Court abused its discretion when it
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overruled the District’s objection to the expert’s testimony and subsequently adopted
the expert’s position with respect to the most reliable accounting methodology for
purposes of assessing chapter 9 insolvency.
2. The CNA Expert Ignored Available Evidence of the District’s Bank
Account Balances, in Favor of Accrual Based Monthly GAAP
Reporting, to Sew Doubt About the District’s Cash Projections.
CNA admits that its expert concluded the District’s cash projections were
inaccurate while never actually considering the underlying financial data supporting
the projections. The Bankruptcy Court found “well-reasoned and credible” the
expert’s conclusion that the District’s cash forecasts were unreliable. A00735.
However, the expert admittedly did not consider or reconcile the projections (and
the District’s explanations for variances) with the District’s bank records. A00752,
A01464. Moreover, the expert never formed an opinion concerning the reason for
the allegedly inaccurate projections. A01380-81 (“I don’t know why, because I
didn’t have access to the same kind of information that they had access to but it
would seem to me that there is something that’s missing from their numbers”)
(emphasis added). Without considering the underlying data supporting the
projections, the expert’s ultimate conclusion that the projections are “speculative”
is, itself, mere speculation without a foundation in the data that actually served to
create the projections. See, e.g., Highland Capital Mgmt., L.P. v. Schneider, 379 F.
54
160689364.1
Supp. 2d 461, 469 (S.D.N.Y. 2005); LinkCo., Inc. v. Fujitsu Ltd., No. 00-7242, 2002
WL 1585551, at *2 (S.D.N.Y. July 16, 2002) (rejecting expert report that “‘does no
more than counsel . . . will do in argument, i.e., propound a particular interpretation
of [defendant]’s conduct’”). Accordingly, the Bankruptcy Court abused its discretion
in accepting the conclusion of CNA’s expert concerning the reliability of cash
projections where the expert admittedly did not base the opinion on available
confirmatory data.
CONCLUSION
For the foregoing reasons, the District respectfully requests that this Court:
(i) reverse the Bankruptcy Court’s ruling in its Eligibility Order that the District did
not establish that it was insolvent under a preponderance of the evidence, find that
the District is eligible to be a debtor under §§ 109(c) and 921(c) and not subject to
dismissal, and remand for further proceedings; or (ii) in the alternative, reverse the
Bankruptcy Court’s ruling on the legal tests for insolvency under § 109(c) and
remand for further findings consistent with the appropriate test for insolvency.
[The remainder of this page is intentionally blank.]
55
160689364.1
Respectfully submitted,
FOX ROTHSCHILD LLP
Dated: July 17, 2024 By: /s/ Nicholas A. Koffroth

Michael A. Sweet
Jack Praetzellis
Nicholas A. Koffroth
Counsel for the San Benito Health Care
District dba Hazel Hawkins Memorial
Hospital
56
160689364.1
CERTIFICATE OF COMPLIANCE WITH TYPE-VOLUME LIMIT
I hereby certify that the foregoing document complies with the type-volume
limit of FED. R. BANKR. P. 8015(a)(7)(B) (allowing 13,000 words) because,
excluding the parts of the document exempted by FED. R. BANKR. P. 8015(g), this
document contains 12,730 words. This document complies with the typeface
requirements of FED. R. BANKR. P. 8015(a)(5) and the type-style requirements of
FED. R. BANKR. P. 8015(a)(6) because this document has been prepared in a
proportionally spaced typeface using Microsoft Word in 14-point Times New
Roman.
Dated: July 17, 2024 /s/ Nicholas A. Koffroth

160689364.1
CERTIFICATE OF SERVICE
I hereby certify that on July 17, 2024, I electronically filed the foregoing
document with the Clerk of the Court for the United States District Court for the
Northern District of California by using the CM/ECF system.
I further certify that parties of record to this appeal who either are registered
CM/ECF users, or who have registered for electronic notice, or who have consented
in writing to electronic service, will be served through the CM/ECF system.
I further certify that I have also served the foregoing document by the means
set forth below on the following parties:
Courtesy Copies via Personal Delivery
Chambers of the Honorable James Donato

United States District Court
Office of the Clerk
450 Golden Gate Ave, 16th Floor
San Francisco, CA 94102
Dated: July 17, 2024 /s/ Nicholas A. Koffroth

160689364.1

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Case 3:24-cv-02266-JD Document 8 Filed 07/17/24 Page 1 of 67

UNITED STATES DISTRICT COURT

APPELLANT’S OPENING BRIEF

MICHAEL A. SWEET (SBN 184345)

Counsel for Appellant, the San Benito

CORPORATE DISCLOSURE STATEMENT

Pursuant to Rule 8012 of the Federal Rules of Bankruptcy Procedure,

has no parent corporation and has no shareholders. Therefore, no entity owns or

controls ten percent or more of its shares.

Jurisdictional Statement .............................................................................................4

Statement of Facts and Procedural History................................................................7

A. The Parties .............................................................................................7

B. The District Is the Sole Comprehensive Health System in the

C. A Late-2022 Fiscal Emergency Renders the District With Too

D. The Short-Term Cash Management Initiatives Had Downsides—

E. The Development of the District’s Cash Flow Projections and

G. The Eligibility Order ...........................................................................18

Summary of Argument .............................................................................................19

A. The Bankruptcy Court Erred as a Matter of Law in Excluding the

1. California’s Vested Rights Doctrine Recognizes a

2. California Recognizes a Separate Constitutional Fiduciary

3. The Eligibility Order, Which Addresses Whether the

B. Current Insolvency under § 101(32)(C)(i). .........................................36

2. The Omission of the Annual Pension Funding Obligation

C. Prospective Insolvency under § 101(32)(C)(ii). .................................41

1. The Bankruptcy Court’s Reliance on Accrual-Based

2. The Bankruptcy Court Narrowly Limited Its Analysis to the

D. The Bankruptcy Court’s Misplaced Reliance on CNA’s Expert

1. The Expert’s Conclusion That Accrual Based Reporting “Is

2. The CNA Expert Ignored Available Evidence of the

Alameda Cty. Deputy Sheriff’s Ass’n v. Alameda Cty. Emps.’ Ret.

Bd. of Admin. v. Wilson,

Brandt v. Bd. of Ret.,

Cal Fire Local 2881 v. Cal. Pub. Emps.’ Ret. Sys.,

In re City of Detroit, Mich.,

In re City of Stockton, Cal.,

In re City of Stockton, Cal.,

In re City of Stockton, Cal.,

Cty. of Orange v. Ass’n of Orange Cty. Deputy Sheriffs,

U.S. Bank N.A. ex rel. CWCapital Asset Mgmt. LLC v. Vill. at

Fed. Trade Comm’n v. Qualcomm Inc.,

Focus Media, Inc. v. Nat’l Broad. Co. (In re Focus Media),

In re Hamilton Creek Metro. Dist.,

Highland Capital Mgmt., L.P. v. Schneider,

Imperial Cty. Sheriff’s Ass’n v. Cty. of Imperial,

Kumho Tire Co. v. Carmichael,

Kummetz v. Tech Mold, Inc.,

LinkCo., Inc. v. Fujitsu Ltd.,

Lopez v. Catalina Channel Express, Inc.,

Marin Ass’n of Pub. Emps. v. Marin Cty. Emps. Ret. Ass’n,

Mid-Del Therapeutic Ctr., Inc. v. C.I.R.,

Mijares v. Orange Cty. Emps. Ret. Sys.,

Munro v. Univ. of S. California,

In re Novatel Wireless Sec. Litig.,

O’Neal v. Stanislaus Cty. Emps.’ Ret. Ass’n,

Olin Corp. v. Lamorak Ins. Co.,

Owens v. Kaiser Found. Health Plan, Inc.,

Ralston Dev. Corp. v. U.S.,

In re Sierra Steel, Inc.,

Suzy’s Zoo v. Comm’r,