Southern Inyo Healthcare District v. Optum Bank, Inc. (In re Southern Inyo Healthcare District), 2020 WL 634295, Adv. No. 17-01077-A (Bankr. E.D. Cal. Feb. 10, 2020)
A debtor healthcare district objected to a proof of claim filed by a bank and sought a declaratory judgment that the bank’s security interests were invalid because the loan violated state law. The bankruptcy court denied the healthcare district’s motion for summary judgment and granted in part and denied in part the bank’s motion for summary judgment. The bankruptcy court held that there was a genuine issue of material fact as to whether the loan had been properly authorized and whether it complied with the debt restriction limits of the California Health & Safety Code. The bankruptcy court also refused to grant the bank’s summary judgment motion as to its claim for restitution, holding that, if the loan was an ultra vires act for the healthcare district, restitution was most likely unavailable.
Southern Inyo Healthcare District (“Southern Inyo”) is a rural healthcare district founded under the California Local Health Care District Law. Section 32130.2 of the California Health & Safety Code (the “Health Code”) permits hospital districts to issue promissory notes for “equipment or items which have a useful life equal to, or longer than, the terms of the note, as determined by the board of directors.”
In 2011, Southern Inyo’s board of directors (the “Board”) approved entry into a $1.7 million loan with UHC of California (the “UHC Loan”) to purchase information technology and electronic health records equipment and software (the “Equipment”) for use in its facilities. The Board’s resolution approving entry into the UHC Loan contained no findings as to the useful life of the Equipment and did not reflect that the Board had considered the useful life of the Equipment vis-à-vis the UHC Loan.
In October 2014, facing financial difficulties, the Board approved entry into an approximately $1,500,000 ten-year mortgage loan with Optum Bank (“Optum”) to be secured by a first deed of trust against Southern Inyo’s real property. The proposed Optum loan required monthly interest payments between January and June of each year, but no interest payments between July and December. The interest rate on the proposed loan for the first five years of repayment was 5.25%, and for the second five years the Federal Home Loan Bank of Seattle’s five-year loan rate plus 3.59%. The minutes of the October 2014 meeting do not reflect any discussion of the useful life of the Equipment. The actual loan Optum Bank made to Southern Inyo in February 2015 was a ten-year promissory note for $1.676 million (the “Optum Loan”), with a monthly year-round payment schedule, and was secured by both a deed of trust against Southern Inyo’s main office building and security interests in substantially all of its personal property. Moreover, the interest rate on the second five years of the loan was higher than the interest rate approved in October 2014. The proceeds of the Optum Loan were used to refinance the approximately $1.4 million balance of the UHC Loan and another smaller line of credit.
In 2016, Southern Inyo filed for chapter 9 protection in the United States Bankruptcy Court for the Eastern District of California (the “Bankruptcy Court”). Optum filed a secured proof of claim for $1.17 million. Southern Inyo commenced an adversary proceeding against Optum seeking disallowance of Optum’s proof of claim and a declaratory judgment that Optum’s security interests were invalid because the loan was made in violation of Section 32130.2. The parties filed cross-motions for summary judgment, with Southern Inyo contending that (1) it was mistaken to authorize a loan that was unenforceable under Health Code section 32130.2 and (2) applicable law precludes a public entity from encumbering public assets in favor of a private lender. Optum argued that, even if the loan violated Health Code section 32130.2, Optum was entitled to restitution.
Section 32130.2 of the Health Code contains the following relevant restrictions on California hospital borrowing: first, the borrowing must be through an issue of negotiable promissory note approved by resolution of a majority of the board of directors; second, the maturity date for promissory notes cannot ever exceed ten years (and, in the case of promissory notes issued to purchase equipment, the maturity date may not exceed the useful life of the equipment); third, the total aggregate amount of notes outstanding at any one time must not exceed 85% of all estimated revenues income and revenues for the fiscal year; fourth, the maximum annual interest rate may not exceed 12 percent. Actions that are wholly beyond the powers of a governmental entity are ultra vires and void.
The Bankruptcy Court denied Southern Inyo’s summary judgment motion and granted Optum’s summary judgment motion in part.
I. Optimum Entitled to Summary Judgment
The Bankruptcy Court held that Optimum was entitled to summary judgment on the following issues:
- Promissory Note: The Optum Loan was a negotiable promissory note as required by the Health Code.
- Ten-Year Maturity Date: The Optum Loan matured on the tenth anniversary of its execution.
- Debt-to-Income Ratio: Southern Inyo’s debt-to-income ratio was 27 percent four months after the Optum Loan was issued, leaving no genuine dispute of material fact that the Optum Loan did not cause Southern Inyo’s debt-to-income ratio to exceed 85 percent of its estimated revenue for the fiscal year.
- Interest Rate: Optum at all pertinent times charged an interest rate of less than 12 percent per annum.
- Security Interest: Under the Health Code, if Southern Inyo was authorized to enter into the Optum Loan, it was entitled to encumber its assets to secure that loan.
II. Optum Not Entitled to Summary Judgment
Optum was not entitled to summary judgment on its restitution claim. As a general rule, because ultra vires acts by a public entity are void, parties that enter into the ultra vires contract with a public entity are without remedy. They cannot sue a public entity in quasi-contract because restitution considerations are outweighed by the need to protect and limit a public entity’s contractual obligations. While limited exceptions to this rule exist, such as where a contract was within the scope of a public agency’s authority, but was rendered invalid due to a blunder in execution, Optum had not carried its burden of proof as to its entitlement to an equitable remedy. Additional facts were required to determine if any of the exceptions applied.
III. Genuine Issue of Triable Fact
The Bankruptcy Court held that neither party had sustained its burden on the following issues, which presented genuine issues of triable fact:
- Authorization: The Bankruptcy Court held that a genuine issue of material fact existed as to whether the Board had authorized the Optum Loan because there were material differences between the loan proposal approved by the Board in October 2014 and the actual loan executed by Southern Inyo in February 2015.
- Useful Life: Optum Bank had produced no written evidence (whether in the form of resolutions or minutes) that the Board had made “useful life” of the Equipment findings either when entering into the UHC Loan or when refinancing the UHC Loan with the Optum Loan. Moreover, because the UHC Loan was subject to the useful life limitation, the refinancing through the Optum Loan was also subject to those more restrictive limits, not the ten-year limit. Southern Inyo had not, however, demonstrated the absence of admissible parol evidence from which a “useful life” finding might be made, thus failing to discharge its burden of proof.
Article courtesy of David P. Simonds (Hogan Lovells US LLP) and Edward McNeilly (Hogan Lovells US LLP).
Link to the full decision: In re Southern Inyo Healthcare District