Kentucky Employees Retirement System et al. vs. Seven County Services, Inc.

Filing 30

MEMORANDUM OPINION AND ORDER by Judge David J. Hale on 3/31/2016 - Appellant KERS's motion to certify a question to the Kentucky Supreme Court 25 is DENIED. The bankruptcy court's conclusion that the Kentucky Employee Retirement System&# 039;s non-hazardous plan is a "multi-employer plan" is REVERSED as clear error. Instead, the record shall reflect that the plan is actually a "multiple-employer plan." In all other respects, the bankruptcy court's decision is AFFIRMED. The cross-appeal of Seven Counties is DENIED as moot and DISMISSED. cc: Counsel, Clerk of Court, United States Bankruptcy Court for the Western District of Kentucky(DAK)

UNITED STATES DISTRICT COURT
WESTERN DISTRICT OF KENTUCKY
LOUISVILLE DIVISION
KENTUCKY EMPLOYEES RETIREMENT
SYSTEM and the BOARD OF TRUSTEES
OF KENTUCKY RETIREMENT SYSTEMS,

Appellants/Cross-Appellees,

v.

Civil Action No. 3:15-cv-25-DJH

SEVEN COUNTIES SERVICES, INC.,

Appellee/Cross-Appellant.
* * * * *

MEMORANDUM OPINION AND ORDER
Kentucky’s largest public pension fund appeals a ruling of the United States Bankruptcy
Court for the Western District of Kentucky, which permits a community mental health provider
to withdraw from participation in the pension. For decades, Seven Counties Services, Inc., a
private behavioral health services provider, paid into Kentucky Employees Retirement System, a
public pension system. Starting in 2013, the burden became too great—Seven Counties could
not afford to pay both its Kentucky Employee Retirement System contributions and continue to
provide its services. So it filed for Chapter 11 bankruptcy relief. Its goal was to leave KERS;
KERS tried to bar Seven Counties’ exit. The bankruptcy court decided that Seven Counties
qualified for Chapter 11 relief, that its relationship with KERS was based on contract, and that it
could reject that contract with KERS. KERS has appealed the decision. KERS also proposes
that this Court certify a question to Kentucky’s highest court. Meanwhile, Seven Counties has
filed what it calls a “protective cross-appeal” to suggest alternative reasons to uphold the
decision below if the Court decides the bankruptcy court was wrong to find that the parties’
relationship was contractual. After careful consideration, the Court concludes that a certification
to the Kentucky Supreme Court is unnecessary. As well, the Court will deny KERS’s appeal and

1

uphold the bankruptcy court’s decision with one correction to the bankruptcy court’s factual
conclusions.
I.

FACTUAL BACKGROUND

There is only one significant objection1 to the bankruptcy court’s factual findings. The
Court will correct that factual error, but it will otherwise rely on the factual findings of the court
below. The following is a recitation of only those facts needed to understand the Court’s
decision. For a more detailed account, see the bankruptcy court’s thorough and well-drafted fact
section.
A. The Transition to Private Providers of Behavioral Health Services
Historically, the states treated the mentally ill.

(Stayed Litigation Docket No. 6-1,

PageID # 114)2 Often, that meant that the states institutionalized their wards. This approach
changed when President Kennedy signed the Community Mental Health Act in 1963. (Id.) The
CMHA gave federal funds to help create community-based mental health centers, now called
“CMHCs.” Since then, the states have taken a less direct role in treating mental and behavioral
health issues, and fewer people with these ailments have been institutionalized.
After the CMHA became law, Kentucky began planning how to coordinate “public and
private efforts” to provide mental health services. (Id., PageID # 120 (citing Ky. Exec. OR. 64207 (Mar. 17, 1964)))

It had a plan by 1966, when twenty non-profit corporations were

organized “to provide community mental health services in Kentucky.” (Id.) To become a
1

The parties agree that the bankruptcy court was wrong to call the retirement system at issue a
“multi-employer plan.” (See Docket No. 19, PageID # 2967) Instead, it is a “multiple-employer
plan.” (Id.) The distinction has to do with whether the plan is maintained pursuant to one or
more collective bargaining agreements. See generally 29 U.S.C. § 1002(37)(A)(ii). It does not
appear, however, that the distinction matters for the purposes of this Opinion.
2
This litigation involves three cases. Two of them have been consolidated to form this case.
The other, 3:15-cv-75-DJH, is currently stayed. The Stayed Litigation’s documents will be cited
to as “S.L.D.N. _____.”
2

CMHC in the state, an entity first had to be a non-profit incorporated under Chapter 273 of the
Kentucky Revised Statutes and receive designation from the Kentucky Cabinet for Health and
Family Services (the “Cabinet”). (Id.) One of the first CMHCs to incorporate was Kentucky
Region Eight Mental Health-Mental Retardation Board, Inc. (“Region Eight”). (Id., PageID #
120-21) Region Eight, later renamed “River Region,” served the same counties—Jefferson and
six surrounding counties—that Seven Counties now serves. (Id.) Today, only fourteen CMHCs
operate in Kentucky, with each serving a specific geographic area of Kentucky. (Id.) Each one
is a non-profit that is exempt from local, state, and federal income taxes. (Id.)
Remember, these newly created CMHCs took over services that had previously been
provided by the state. (Id.) Indeed, many people who went to work for the CMHCs had been
employed by Kentucky state government, and they had earned credit towards their retirements
through KERS. (Id.) As the state shifted services from public to private behavioral health
services providers, many state employees made the necessary move to private employment with
the CMHCs. (Id.) But this created a dilemma: The workers were reluctant to lose the benefits of
state employment, including their pensions. (Id.) And so, Governor Edward T. Breathitt signed
Executive Order 66-378 in June 1966. (S.L.D.N. 6-1, PageID # 122) The order rolled all
CMHC employees—not just those who had previously worked for state government—into the
Kentucky Retirement System (the “System”).
Not all of the CMHCs wanted to participate in the System. (Id.) Three of them created
tax-sheltered annuity retirement programs instead. (Id.) KERS sued those three CMHCs in
Franklin Circuit Court to force their participation in the System, and the Franklin Circuit Court
ruled for KERS. (Id). But in 1974 when the case reached the Kentucky Court of Appeals (then
Kentucky’s highest court), see Ky. Region Eight v. Commonwealth, 507 S.W.2d 489 (Ky. Ct.

3

1974), that court reversed the Franklin Circuit Court decision, deciding that the CMHCs did not
have to participate in the system. (S.L.D.N. 6-1, PageID # 122) The Kentucky Court of
Appeals’ decision held that the CMHCs were not state agencies, their employees were not state
workers, and the receipt of state grants or funds does not transform a private entity into a state
agency. Ky. Region Eight, 507 S.W.2d at 490-91.
B. The Rise of Seven Counties
By 1978, River Region was struggling financially. (S.L.D.N. 6-1, PageID # 123) It tried
to be adjudicated bankrupt. (Id.) The Cabinet’s predecessor inserted itself into the bankruptcy
proceedings as an interested party, asking the bankruptcy court not to adjudicate River Region
bankrupt because, if River Region were bankrupt, its services would stop. (Id.) The state agreed
to pay River Region’s operating costs until August 1978, when the newly-formed Seven
Counties could step in. (Id.)
Some River Region employees challenged the entity’s right to be declared bankrupt.
(Id.) They argued that River Region was an alter ego and surrogate of the Commonwealth. (Id.,
PageID # 124) But that argument failed. (Id.) In January 1980, the bankruptcy court ruled that
“River Region was not a state agency or instrumentality.” (Id. (citing Greenberg v. River Region
Mental Health-Mental Retardation Board, Inc. (In re River Region Mental Health-Mental
Retardation Board, Inc.), slip op. at *4, Case No. 78-00193-L (Bankr. W.D. Ky. Jan. 8, 1980))
The bankruptcy court’s decision was based on several conclusions: first, that Kentucky did not
control River Region’s affairs; next, that any money River Region got from the state was for
“contracted-for-services”; and last, that River Region’s public function alone did not make it a
state actor. (Id.) On appeal, this Court affirmed the Greenberg decision. (Id. (citing Greenberg
v. River Region Mental Health-Mental Retardation Board, Inc. (In re River Region Mental

4

Health-Mental Retardation Board, Inc.), Case No. 80-0089-L(B) (W.D. Ky. Sept. 11, 1980)
(Ballantine, J.))) Then in a per curiam opinion, the Sixth Circuit Court of Appeals affirmed
Judge Ballantine’s conclusion that River Region was not a state agency or instrumentality. See
Halikas v. River Region Mental Health-Mental Retardation Board, Inc, Case No. 80-5433 (6th
Cir. Oct. 22, 1981).
Meanwhile, in June 1978, the Cabinet’s predecessor decided to make Seven Counties the
successor to River Region. (Id., PageID # 126) The three entities—River Region, Seven
Counties, and the Cabinet’s predecessor—worked together closely during River Region’s
bankruptcy to keep mental health services available in the region. (Id.) Seven Counties took
over in August 1978. (Id., PageID # 127) By 1982, River Region had ceased to exist as a
corporate entity. (Id., PageID # 126)
Today, Seven Counties provides behavioral health services to some 33,000 people in
Jefferson and the six surrounding counties. (Id., PageID # 114) It is a non-profit entity with “no
shareholders or members.” (Id.) All of its profits go to its maintenance. (Id.) If it were ever to
be dissolved, its governing documents stipulate that any remaining assets are to be distributed to
charitable organizations. (Id.)
A board of directors runs Seven Counties.

(See id., PageID # 128)

The Board’s

membership “is self-perpetuating, and the membership . . . is determined by a majority vote of
the Seven Counties Board of Directors.”

(Id.)

When there is a vacancy, a “nominating

committee,” which is made up of the Board’s secretary and five other Board members the
secretary appoints, presents possible new members to the Board. (Id.) No representative of
Kentucky state government has ever had “the power to select members of the [B]oard.” (Id.,
PageID # 129) Likewise, the Board can, by majority vote, remove any member with or without

5

cause, but no one outside the Board may remove a director. (Id.) A representative of the
Cabinet’s Department for Behavioral Health, Development and Intellectual Disabilities3 attends
the Board’s meetings. The Department’s representative is not, however, a Board member, nor
does he have a vote. (Id., PageID # 129-30) Indeed, the Department’s recent representative, Lou
Kurtz, acknowledged during the proceedings below “that when the Board goes into executive
session, he leaves the meeting.” (Id., PageID # 130) The Board hires Seven Counties’ chief
executive officer, and the CEO is responsible for hiring other officers and employees. (Id.,
PageID # 130-31) Kentucky state government plays no role in the hiring of Seven Counties’
staff.

(Id., PageID # 131)

These facts all demonstrate that though the Kentucky state

government depends upon Seven Counties’ operations, Seven Counties has a recognized and
legal independence from the state.
C. The State’s Involvement with the CMHCs
The Cabinet is the primary source of funds for all CMHCs. (Id., PageID # 132) The
funds come either from Medicaid or “through general fund dollars sent to” the Department for
Behavioral Health. (Id.) The Cabinet has oversight over the CMHCs’ “annual plans and
budgets.” (Id.) CMHCs must provide the Cabinet with “accountable outcome data” about the
services they provide. (Id.)
The Cabinet must also “designate” the CMHCs. (Id.) This means that the Cabinet
reviews the CMHC’s bylaws, board composition, and operations to determine whether they meet
3

For clarity’s sake, it is helpful to reiterate the chain of command here. At the head of
Kentucky’s executive branch is its governor. The rest of the executive branch is made up of
“cabinets”—administrative bureaucracies similar to the federal system’s “departments” (like the
Department of Labor, Treasury, and so on). Kentucky’s cabinets have within their purview even
smaller administrative bureaucracies called “departments.” This Opinion is concerned only with
Kentucky’s Cabinet for Health and Family Services, which oversees the Department for
Behavioral Health, Development and Intellectual Disabilities, which in turn regulates CMHCs,
including Seven Counties.
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minimum standards.

(Id.)

CMHCs must also comply with certain statutes.

(Id.)

Once

designated, CMHCs are eligible to receive significant contracts from the Cabinet. (Id., PageID #
133) The Cabinet pays the CMHCs only through contracts; the CMHCs receive no direct
appropriations from the state legislature. (Id.)
Seven Counties’ relationship with the state—like the relationships between all the
CMHCs and the state—is voluntary. (Id.) Each year, Seven Counties must ask the Cabinet for
authorization to continue serving as the CMHC for its region. (Id.) The recognition qualifies
Seven Counties to bid for state contracts for which it would not otherwise be eligible; in
exchange, Seven Counties submits itself to “extensive regulatory oversight.” (Id.) So Seven
Counties and the other CMHCs could still exist without the Cabinet’s designation, “but would
operate on a much smaller scale.” (Id., PageID # 134) Among other requirements, CMHCs
must set term limits on directors, “comply with the Civil Rights Act of 1964,” hold at least
twelve board meetings each year, and maintain certain standing committees. (Id., PageID # 135)
Of course, the Cabinet’s most significant leverage over a CMHC is its ability to “dedesignate” its recognition of a CMHC. (Id.) In severe cases, emergency provisions allow the
Cabinet “to take control of a CMHC much as the Cabinet undertook with River Region on a
temporary basis to ensure patient care during the transition [from River Region to Seven
Counties].” (Id. (citing KY. REV. STAT. § 210.440) These emergency powers are narrow: The
Cabinet must give notice of its intent and the CMHC may request a hearing. (Id.) Yet despite
the Cabinet’s authority to de-designate, there is “no provision in the statutes or regulations . . .
for the Cabinet to dissolve or terminate the corporations serving as CMHCs or to take title of a
CMHC’s assets in the event of de-designation.” (Id.)

7

The bankruptcy court analyzed in detail how the Commonwealth treats Seven Counties.
(See id., PageID # 136-39) It found that Kentucky treats Seven Counties primarily like a private
entity, even though it is treated as a “public agency” for some limited purposes, such as the
obligations imposed by the Kentucky Open Records Act. (Id., PageID # 136-37) For one, Seven
Counties must apply and pay for “permits and licenses from the state to operate its business.”
(Id., PageID # 136) As well, the Kentucky General Assembly does not appropriate any money to
Seven Counties; the only money Seven Counties receives from the state comes from contracts
for services. (Id.) Historically, Kentucky and its agencies have acknowledged that the CMHCs
are private entities. (Id., PageID # 139) In 1981, the general manager of Kentucky Retirement
Systems (“KRS”) responded to a CMHC letter of inquiry and stated that the CMHCs had always
been private. (Id.) Though Seven Counties, like all CMHCs, is subject to regulatory oversight,
neither Kentucky nor any of its agencies has day-to-day control over Seven Counties. (Id.,
PageID # 155) And Kentucky’s secretary of state has twice revoked CMHC corporate charters
for failure to make required annual reports. (Id., PageID # 139) The bankruptcy court also
rejected the theory that Seven Counties is a “special purpose government entity” under Ky. Rev.
Stat. § 65A.010(8)(d). (Id., PageID # 138)
D. Seven Counties, the Kentucky Employee Retirement System, and Funding Woes
The General Assembly created KERS in 1956. (Id., PageID # 139) “Its purpose is to
provide a secure means of retirement savings for state government employees.” (Id.) The
General Assembly created KRS in the same year. (Id.) KRS is an “agency” of Kentucky’s
executive branch that administers three of Kentucky’s retirement systems, including KERS. (Id.,
PageID # 139-42) KERS has a hazardous and non-hazardous “plan.” (Id., PageID # 140)

8

Though they are called “plans,” they are actually “tiers within a single defined benefit plan.”
(Id.) Seven Counties participates in the non-hazardous tier. (Id.)
Each of the three KRS-administered systems is a trust funds held and applied solely for
the benefit of the members. (Id.) As of June 2013, a total of 127,576 members participated in
KERS. (Id.) Some private employers contribute to KERS, but employers that “are integral parts
of state government” have their contributions paid by appropriations from the General Assembly.
(Id., PageID # 141-42) Seven Counties has never enjoyed this status; KERS does not claim, and,
indeed, nothing in the record suggests that Seven Counties’ contributions to KERS have ever
been funded by general appropriations from the General Assembly. Employer contributions
comprise “normal costs,” which are the costs of funding the benefits earned each year, and the
“amount needed to fund the actuarially accrued liability amortized over a fixed period of thirty
years” starting in June 2013. (Id., PageID # 143) KRS adopts an employer contribution rate
“that represents the actuarially required contribution rate (the ‘ARC’).” (Id.) But it is really the
General Assembly that sets the rate in the budget.

(Id.) When Seven Counties filed for

bankruptcy protection, the KERS employer contribution rate was 23.61% of each employee’s
creditable compensation.

(Id.)

Employees also contribute five percent of their creditable

compensation to KERS. (Id., PageID # 142) Employees who started after September 1, 2008,
though, make an additional one percent health insurance contribution. (Id.) The employee
contributions are “picked up” by employers—that is, they are withheld before tax. (Id.)
KERS is a defined benefit plan. (Id., PageID # 143) This means that each retiree’s
annual benefits are determined by multiplying final compensation, the “benefit factor,” and the
retiree’s years of service. (Id., PageID # 143-44) Defined benefit plans—as opposed to defined
contribution plans—are “at risk for underfunding” because they are limited to the return on

9

investments from employer and employee contributions, but the benefits paid to pensioners are
not so limited. (Id., PageID # 144) This is why the ARC is so important: “The solvency of the
fund to meet future retirement obligations is dependent upon consistent payment of the ARC.”
(Id.) When contributions are less than the ARC, it almost guarantees that the fund will be unable
to fully pay future retiree benefits. (Id.)
It does not take an expert to conclude that KERS’s non-hazardous plan is in poor shape.
(See id.) As recently as the year 2000, the non-hazardous plan was 100% funded. (Id.) Since
then, though, there has been a decline in funding for three reasons. (Id.) First, market losses in
2000-2001 and 2008-2009 diminished the fund’s asset values by 17%. (Id.) Second, the General
Assembly approved increased retirement benefits to keep up with inflation without providing
additional appropriations to fund the increase. (Id.) Last, and most important, the General
Assembly has consistently failed to require contribution rates commensurate with the ARC. (Id.)
Indeed, when the bankruptcy court issued its order in 2014, the General Assembly had failed to
set an employer contribution rate meeting the ARC in fifteen of the previous twenty-two years.
(Id., PageID # 143) Despite this dubious track record, the General Assembly did make recent
changes to Ky. Rev. Stat. § 61.565(3)(c) and (5) to require funding the full ARC rate going
forward. (Id.) That change took effect with the beginning of Kentucky’s 2015 fiscal year, July
2014. (Id.) Of course, these changes had other consequences—like the insolvency of Seven
Counties—that led to this case.
Defined benefit plans are, by their nature, vulnerable to legislative underfunding. The
Commonwealth’s decision to open KERS to private employers put the system at even greater
risk. (Id.) As mentioned above, Kentucky extended KERS’s coverage to private entities in the
1960s to help transition from public to private mental health service providers. But the 1966

10

expansion also covered employees who did not transition from public employment. (Id.) That
is, Kentucky took on the risk of paying “for future retiree benefits to employees who never
worked for the state.” (Id., PageID # 145) Actions have consequences: opening the system to
private employers only increased the risk of nonpayment, which, in turn, increased the risk that
the system would be underfunded. (Id., PageID # 144) And private employers—unlike the
Commonwealth of Kentucky—can fail and cease to exist; KRS cannot “force a private entity to
pay employer contributions if it cannot afford to stay in business.” (Id., PageID # 145)
That is the predicament Seven Counties and KRS now face. When the General Assembly
passed Senate Bill 2—the amendment to Kentucky’s statutes that now requires the General
Assembly to demand private employers in KERS meet the ARC—the contribution rates for
CMHCs were raised to, but capped at, 24%. (Id., PageID # 143) The 24% cap was a special
carve-out for CMHCs; other employers had their rates go up to almost 27% beginning July 2013.
(Id., PageID # 143-46) Historically, before the rate was raised to 24% for CMHCs, Seven
Counties was able to pay its employer contributions “because the rate had been manageable.”
(Id., PageID # 146) Indeed, if the 1966 KERS expansion had been limited to employees
transitioning from state government, Seven Counties would still be able to afford its
contributions. (Id.) Instead, when Senate Bill 2 was enacted in 2013, “Seven Counties was
rendered insolvent.” (Id.) Even capped at the 24% carve-out for CMHCs, Seven Counties
cannot afford to both pay its contributions and render its services. (Id.) The bankruptcy court
crunched the numbers: At 24% cap, Seven Counties’ employer contributions would sap more
than two-thirds of Seven Counties’ gross revenues, leaving it with insufficient funds to provide
its services. (See id.) After Senate Bill 2, Seven Counties can either pay its contributions or live
up to its mission. “It cannot do both.” (Id.) Even if the Court were to decide that the applicable

11

law required Seven Counties to continue its participation in KERS—which would shutter Seven
Counties—the practical result would be the same: whether it leaves the system or remains, Seven
Counties will not be able to pay its required contributions. (See id., PageID # 154)
The Court recognizes that the plan’s health will suffer from the loss of Seven Counties.
At the start of these proceedings, Seven Counties accounted for 2.53% of the total membership
in the KERS non-hazardous tier, and 3.32% of all employer contributions. (Id., PageID # 150)
E. The Looming Crisis
Thomas Cavanaugh is KERS’s outside actuary. (Id., PageID # 151) His job is to
calculate KERS’s future liability and the actuarial value of KERS’s assets, “which allows him to
calculate a contribution rate” that transcends market fluctuations. (Id.) The difference between
those two values is KERS’s unfunded liability. (Id., PageID # 151-52) The size of the unfunded
liability “has exploded.” (Id., PageID # 152) There are several reasons for the “explosion.” The
most obvious cause is the General Assembly’s serial underfunding. (Id.) Additionally, the value
of the assets dropped in 2000-2001 and 2008-2009 because of unstable markets. (See id.) And
changing demographics have also played a role. (Id.) The result is that the system “does not
have nearly enough money to meet its needs to pay expected benefits.” (Id.) In June 2013, the
KERS non-hazardous plan had racked up total liabilities of about $2.5 billion; of the total
liabilities, about $1.6 billion was unfunded, even after accounting for prospective employer and
employee contributions. (Id.) In sum, only 23.4% of the non-hazardous plan is actually funded.
(Id.) This means that, as of 2013, the state pension system had less than a quarter of the funding
necessary to meet its future obligations.
The unfunded liability is especially worrisome because, in 1972, the General Assembly
changed the law to make KRS an “inviolable contract.” (Id., PageID # 161 (citing KY. REV.

12

STAT. § 61.692))

That is, the laws governing Kentucky’s pension system recognize an

agreement between the members of KERS and the state. That agreement prevents the General
Assembly from reducing or impairing “by altercation, amendment, or appeal,” the benefits the
pensioners earn over their terms of employment. (Id. (citing KY. REV. STAT. § 61.692; Jones v.
Bd. of Trs. Of Ky Ret. Sys., 910 S.W.2d 710, 711 (Ky. 1996)))

Perhaps recognizing the

magnitude of the impending shortfall, however, the General Assembly in Senate Bill 2 changed
the laws again to allow the legislators to “amend, suspend, or reduce” the retirement benefits of
any state workers who began participating after January 2014 if “the welfare of the
Commonwealth so demands.” (Id., n.12)
Because the KERS non-hazardous plan is a defined benefit plan, “there is no accounting
for the contributions by the employer.” (Id., PageID # 152) All employer contributions are
commingled. (Id.) Still, Seven Counties presents unique actuarial considerations. Its employees
tend to be younger on average and tend to have less service time on average than the typical
member of the KERS non-hazardous plan, which means Seven Counties has a “lower accrued
liability” compared to other employers in the system. (Id.) Seven Counties’ employees earn
more money than the average plan participant, but they also end up with lower retirement
benefits on average. (Id., PageID # 153) Cavanaugh says this paradox is due to a higher
turnover rate in the medical field. (Id.) These factors together mean that “the cost structure or
the demographic profile” of Seven Counties’ employees is lower than average for the nonhazardous plans. (Id.) But because all employers pay the same rate, Seven Counties must “pay
more proportionally” than those with higher cost structures. (Id.) If Seven Counties had its own
plan, its contribution rates—as well as its employees’ rates—would be lower than in KERS.
(Id.)

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Another effect of the cost-sharing nature of the defined benefits plan is that, when a
contributing employer leaves the plan, the burden falls on the remaining members to fill the void.
(Id.) Cavanaugh calculated that if Seven Counties stopped participating in fiscal year 2015, the
employer contribution rate would need to rise from 38.77% to 39.56% to meet the ARC. (Id.) In
fiscal year 2033, the contribution rate with Seven Counties would be 33.49%, but without Seven
Counties, the rate would climb to 36.24%. (Id.) Clearly, the departure of private-employer
participants such as Seven Counties will add to the burden on the system.
F. Procedural History
Seven Counties filed for Chapter 11 bankruptcy protection in April 2013. (D.N. 15,
PageID # 2091) The primary purpose of the bankruptcy petition was to seek relief from its
KERS obligations. (Id.) Seven Counties sought an order from the bankruptcy court rejecting its
“executory contract, if any exists, between [Seven Counties] and KERS.”

(Id. (citations

omitted)) KERS objected to that motion. (Id.)
Seven Counties then filed an adversary proceeding.4 (Id.) It asked the bankruptcy court
to declare either that (1) it was ineligible to participate in KERS, or (2) that KERS was not a
governmental plan, which would permit Seven Counties to withdraw under the Employee
Retirement Income Security Act.

(Id., PageID # 2092)

KERS said the action should be

dismissed because of sovereign immunity, but the bankruptcy court disagreed. (Id.) KERS
appealed. That action (case number 3:14-cv-00189-JHM) is in abeyance pending resolution of
the issues currently before the Court. (Id.)

4

In bankruptcy court, an adversary proceeding is a “lawsuit that is brought within a bankruptcy
proceeding, governed by special procedural rules, and based on conflicting claims usually
between the debtor (or the trustee) and a creditor or another interested party.” BLACK’S LAW
DICTIONARY 64 (10th ed. 2014). A party in interest, including a creditor, “may raise and may
appear and be heard on any issue in a case under” Chapter 11. 11 U.S.C. § 1109.
14

In June 2013, KERS also filed an adversary proceeding. (Id.) Its action focused on two
First, KERS argued that Seven Counties was a “governmental unit” under the

issues.

Bankruptcy Code, which would make it ineligible for Chapter 11 relief. (Id. (citing 11 U.S.C. §
101(27))) Finally, KERS wanted to force Seven Counties to perform its statutory obligations to
KERS during the bankruptcy proceedings. (Id.) KERS requested a preliminary injunction; the
bankruptcy court conducted an evidentiary hearing on the requested injunction but ultimately
denied the motion and ordered that the evidence from the hearing be put into the trial record.
(Id.) The case was tried in March 2014. (Id., PageID # 2093) Bankruptcy Judge Joan Lloyd
issued an opinion in May 2014 concluding that Seven Counties’ participation in KERS was
based on an unwritten executory contract; that Seven Counties did not need to comply with its
obligations to KERS after petitioning for bankruptcy; and that Seven Counties is not a
“governmental unit” under the Bankruptcy Code and thus can file for Chapter 11 relief and reject
its contract with KERS. (Id.) KERS appealed. The appeal is the basis of this Memorandum
Opinion.
II.

STANDARD

Review of Bankruptcy Court’s Decision on Appeal
On appeal, this Court will review the bankruptcy court’s conclusions of law de novo. In
re Isaacman, 26 F.3d 629, 631 (6th Cir. 1996). That is, the Court will consider questions of law
as though it were the original trial court. Razavi v. Comm’r of Internal Revenue, 74 F.3d 125,
127 (6th Cir. 1996). The Court will reverse findings of fact, however, only if they are clearly
erroneous. Fed. R. Civ. P. 52(a)(6). When there are mixed questions of fact and law, the Court
will review them de novo. Williams v. Mehra, 186 F.3d 685, 689 (6th Cir. 1999).

15

Certification of Question to State Court
When presented with questions of Kentucky state law that may decide a case, and when it
appears that there is no binding precedent from the Kentucky Supreme Court or Court of
Appeals, then this Court may certify those questions of Kentucky law to the Kentucky courts.
Ky. R. Civ. P. 76.37. The decision to certify is, however, up to this Court’s discretion. Transam.
Ins. Co v. Duro Bag Mfg. Co., 50 F.3d 370, 372 (6th Cir. 1995).

Certification is “most

appropriate when the question is new and state law is unsettled.” Ky. Press Ass’n, Inc. v.
Kentucky, 355 F. Supp. 2d 853, 863 (E.D. Ky. 2005) (quoting Transam. Ins., 50 F.3d at 372)).
III.

DISCUSSION

The Court turns first to KERS’s request to certify a question to the Kentucky Supreme
Court. For the reasons that follow, the Court will decline to certify the proposed question.
Instead, the Court will address the issues the parties raised on appeal and explain its decision to
affirm the bankruptcy court’s ruling.
A. Certification to Kentucky Courts
The question KERS seeks to certify is direct: is Seven Counties’ participation “as a
department in” KERS based on contract or statutes? (D.N. 25, PageID # 3893) KERS gives
several arguments as to why certification is needed. (Id., PageID # 3902-21) Yet its position
depends most on its view that this is an open question of Kentucky state law whose answer is
important to Kentucky. (Id.)
There is no need to certify a question to the Kentucky Supreme Court. Certification is a
tool meant to give this Court “guidance from a court to which [it is] bound to defer on issues of
state law.” Rutherford v. Columbia Gas, 575 F.3d 616, 623 (6th Cir. 2009). In some situations,
certification can save the Court “time, energy, and resources and help build a cooperative judicial

16

federalism.”

Arizonans for Official English v. Arizona, 520 U.S. 43, 77 (1997) (citations

omitted; internal quotations omitted). Other courts have certified questions when, for example,
the case presents issues of particular importance to the state. In re Beverly Hills Fire Litig., 583
F. Supp. 1163, 1165 (E.D. Ky. 1984) (certifying a question “of utmost concern to Kentucky and
its courts”). Certification is not obligatory, even if there is doubt regarding a state law. Gascho
v. Global Fitness Holdings, LLC, 918 F. Supp. 2d 708, 713 (S.D. Ohio, 2013) (citing Lehman
Bros. v. Schein, 416 U.S. 386, 391 (1974)). Whether to certify a question to the Kentucky
Supreme Court is within this Court’s discretion. Lehman Bros., 416 U.S. at 391. In this case,
certification to the state court is neither needed nor likely to be of much help.
KERS’s main argument for certification is the importance of these issues to Kentucky.
The Court fully recognizes that this case’s resolution will be important to Kentucky—regardless
of the outcome. Nevertheless, the time, energy, and resources of the federal courts have already
been spent on this case; thus, the efficiency concerns described in Arizonans for Official English
carry little sway. KERS argues that “[t]here does not appear to be any caselaw from the
Supreme Court of Kentucky or Kentucky Court of Appeals that addresses the fundamental
question of Kentucky law raised by the [bankruptcy court opinion]: whether Seven Counties’
participation is based on statutory authorization and executive order, or by an implied contract.”
(D.N. 25, PageID # 3902)
But the Court agrees with Seven Counties’ position that KERS has presented the issue as
a false dichotomy. (See D.N. 26, PageID # 3936) In briefing, KERS consistently framed this
issue as an “either-or” proposition. (See, e.g., D.N. 25, PageID # 3902) That is, KERS has
presented the issue as either (1) Seven Counties took part because of statutes, or (2) it took part
because of a contract. But as this Court has already indicated, “[t]he bankruptcy court did not

17

find that KERS and Seven Counties had a contract outside of the statutory framework; rather, it
concluded that they had formed a contract that was governed by those statutes.” Ky. Emps. Ret.
Sys. v. Seven Counties Servs., Inc., Civil Action No. 3:15-cv-75-DJH, 2015 W.L. 474311, at *3
(W.D. Ky. Feb. 4, 2015). KERS admits that statutes can create contractual obligations. (D.N.
27, PageID # 3959-60)

KERS would of course acknowledge that Kentucky courts have

addressed issues of contract interpretation and enforcement. See, e.g., Hazard Coal Corp. v.
Knight, 325 S.W.3d 290, 298 (Ky. 2010) (“[T]he construction and interpretation of a contract . . .
are questions of law to be decided by the court.” (citations omitted)). The Court is able to
consider the issues of this case and decide whether or not the statutes that govern these
transactions were effectively the terms of an implied contract without need of certifying a case to
Kentucky courts. The motion to certify a question to the Kentucky Supreme Court will therefore
be denied.
B. The Appeals from the Bankruptcy Court’s Decision
After trial, the bankruptcy court ruled in favor of Seven Counties. (S.L.D.N. 6-1) The
bankruptcy court made three main conclusions. First, Seven Counties is not a “governmental
unit,” but is a “person” under the Bankruptcy Code, so it may seek Chapter 11 bankruptcy relief.
Next, Seven Counties was not obligated to keep contributing to KERS after it began its
bankruptcy proceedings. Last, Judge Lloyd concluded that there was an executory contract
between Seven Counties and KERS that Seven Counties could reject under Chapter 11.
KERS appealed the decision in briefing that was, at times, needlessly pointed.5 (See D.N.
15, PageID # 2093) First, KERS argued that there was no evidence of a contract between it and

5

In briefing, counsel for KERS made disrespectful comments about the bankruptcy court.
Among other remarks, counsel said that the bankruptcy court was “[g]rasping for any straw,” and
18

Seven Counties. (D.N. 15, PageID # 2093) Even if there was a contract, KERS argued the
contract was not executory—that is, Seven Counties could not reject it in Chapter 11 bankruptcy.
(Id.) Next, KERS argued that the bankruptcy court erred when it decided that Seven Counties
was not a “governmental unit.” (Id., PageID # 2094) It contends that the bankruptcy court’s
error included two flawed interpretations of Kentucky law. (Id.) Finally, KERS takes issue with
the bankruptcy court’s statement that the system is a “multi-employer cost-sharing defined
benefit state plan.” (Id. (citing, e.g., S.L.D.N. 6-1, PageID # 143)) KERS argues that the
classification of the KERS non-hazardous plan was not properly before the bankruptcy court;
moreover, KERS claims that the bankruptcy court’s conclusion as to the type of plan was
“plainly wrong.” (Id.)
For its part, Seven Counties supports the bankruptcy court’s finding. (D.N. 19) It does
make at least one concession, though: Seven Counties agrees that the bankruptcy court was
wrong when it labelled the system a “multi-employer plan”; it is actually a “multiple-employer
plan.” (D.N. 19, PageID # 2967) Seven Counties doubts that this distinction will matter for
purposes of this appeal, but KERS suggests that an erroneous classification of the type of system
at issue could negatively affect future aspects of the litigation. (Id.; D.N. 23, PageID # 3790)
Seven Counties also filed a “protective cross-appeal” that gives alternative reasons to
uphold the bankruptcy court’s decision. (D.N. 17) KERS retorts that it is improper for the Court
to consider the cross-appeal. (See D.N. 20) Yet Seven Counties maintains that the Court may
consider those arguments if it finds that the bankruptcy court’s ultimate conclusion was correct
but its reasoning was flawed. (See D.N. 22)

“obtusely” reaching conclusions. (See, e.g., D.N. 15, PageID # 2118, 2120) This approach was
unnecessary and unwarranted.
19

The Court will uphold the bankruptcy court’s decision. The Court finds that Seven
Counties qualifies for Chapter 11 relief, that Seven Counties was not required to continue paying
its obligations during these proceedings, that there was an executory contract between KERS and
Seven Counties, and that Seven Counties may reject that contract. The Court will, however,
correct the bankruptcy court’s flawed description of the plan as “multi-employer.”
1. Seven Counties Qualifies for Chapter 11 Bankruptcy Relief
The Court first considers whether Seven Counties may seek Chapter 11 relief. The
bankruptcy court thought so. (See, e.g., S.L.D.N. 6-1, PageID # 115-16) Chapter 11 states that
“only a person” may qualify as a debtor under its provisions.

11 U.S.C. § 109(a).

The

definitions section dictates that “‘person’ includes individual, partnership, and corporation,” but
it specifically says that “governmental unit(s)” are not included, with a few exceptions. 11
U.S.C. § 101(41). Seven Counties is a “person,” because it is a non-profit corporation under
Kentucky law.

So it should qualify for Chapter 11 relief unless it is excludable as a

“governmental unit.” Under the bankruptcy code, a “governmental unit” is:
[The] United States; State; Commonwealth; District; Territory; municipality;
foreign state; department, agency, or instrumentality of the United States (but not
a United States trustee while serving as a trustee in a case under this title), a State,
a Commonwealth, a District, a Territory, a municipality, or a foreign state; or
other foreign or domestic government.
11 U.S.C. § 101(27).
To begin, Seven Counties could be considered a governmental unit only if it qualifies as a
“department, agency, or instrumentality” of the federal government, Kentucky, or a municipality.
After much discussion, Judge Lloyd ruled out each of those possibilities and concluded that
Seven Counties was not a governmental unit. (See D.N. 6-1, PageID # 164-77) On appeal,
KERS remained silent on whether Seven Counties is a department or an agency, so the Court

20

will treat its silence as a concession that neither label applies here. Instead, KERS argues that
Seven Counties is an instrumentality of Kentucky. (D.N. 15, PageID # 2125-2133) The Court
disagrees.
Congress did intend for “governmental unit” to be defined broadly. (See S.L.D.N. 6-1,
PageID # 164 (citing S. Rep. No. 95-989, at 24 (1979))) And “instrumentality” is not defined in
the code, which leaves its meaning open to interpretation. When construing a term in a statute,
the Court first looks to the word’s plain meaning. See United States v. Clarke, 445 U.S. 253, 254
(1980). Black’s Law Dictionary carries two definitions of “instrumentality”: (1) “A thing used to
achieve an end or purpose”; and (2) “A means or agency through which a function of another
entity is accomplished, such as a branch of a governing body.” BLACK’S LAW DICTIONARY 919
(10th ed. 2014). As Judge Lloyd stated, these definitions could plausibly be read to include
Seven Counties. (S.L.D.N. 6-1, PageID # 170) However, as she also noted, the other courts that
have addressed cases similar to this one have held that the word’s plain meaning is unhelpful for
determining what qualifies as an “instrumentality of the state” under the Bankruptcy Code. (Id.
(see also, In re Hosp. Auth. of Charlton Co., No. 12-50305, 2012 WL 2905796, at *5 (Bankr.
S.D. Ga. July 3, 2012)))6 In this regard, the legislative history does provide some guidance:
“Department, agency, or instrumentality” does not include an entity that owes its
existence to state action, such as the granting of a charter or a license but that has
no other connection with a state or local government or the federal government.
The relationship must be an active one in which the department, agency, or
instrumentality is actually carrying out some governmental function.
6

Ironically enough, KERS uses In re Hospital Authority to imply that the plain meaning of
“instrumentality” should carry the day. (See D.N. 15, PageID # 2125 (where KERS cites In re
Hospital Authority for the proposition that courts first consider the plain meaning, then declares
that “[u]nder a plain meaning analysis, Seven Counties is an instrumentality of the
Commonwealth.”)) The problem with that implication, of course, is that the very case upon
which KERS relies plainly states that “dictionary definitions of ‘instrumentality’ are too general
to be instructive,” and that even after consulting the legislative history, the “definition of
‘instrumentality’ remains vague.” In re Hosp. Auth., 2012 WL 2905796, at *5.
21

S. Rep. No. 95-989, at 24 (1979). That paragraph provides much fodder for discussion.
No reasonable person would disagree that Seven Counties “owes its existence to state
action,” at least in part. Again, it took an act of Congress, and steps taken by Kentucky’s
executive branch, to transition mental and behavioral health in Kentucky from state control to
private providers. And there is certainly an ongoing relationship between Seven Counties and
the state—Seven Counties is regulated by the state, and much of Seven Counties’ revenue is
derived from contracts with the state. Yet the question remains whether the relationship between
the two is “active” and whether Seven Counties is “carrying out some governmental function.”
To answer these questions, Judge Lloyd looked to Las Vegas Monorail, 429 B.R. 770
(Bankr. D. Nev. 2010). In that case, Nevada’s bankruptcy court found that the non-profit
corporation running Las Vegas’ monorail system was neither an “instrumentality of the state”
nor a “municipality,” which, for purposes of the Bankruptcy Code, meant that the non-profit
qualified for relief under Chapter 11 but not Chapter 9 (the chapter that provides relief for
municipalities). The Nevada court examined other areas of the Bankruptcy Code to help give
meaning to the use of “instrumentality” in § 101(4). See id. at 788. After comparing the listed
components of “instrumentality” in the Bankruptcy Code with the Code’s use of “municipality,”
the Nevada court saw that “three distinct threads” emerged. Id. First, does the entity in question
have powers “typically associated with sovereignty”? Those powers include “eminent domain,
the taxing power [and] sovereign immunity.” Id. Next, if the entity does not have the powers of
the state or only weak versions of them, does the entity have a public purpose? Id. If so, the
more control the state has over the entity’s “day-to-day activities, the more likely the entity is an
instrumentality.” Id. Last, how does the state designate and treat the entity? Id. Judge Lloyd

22

adopted these criteria when she weighed whether Seven Counties was a governmental unit.
After detailed analysis, she concluded it was not. (S.L.D.N. 6-1, PageID # 170-77)
Before looking to Judge Lloyd’s analysis, the Court first turns to KERS’s objection to
Judge Lloyd’s use of the old River Region cases7 and Las Vegas Monorail. (See D.N. 15,
PageID # 2127-28) KERS posits that when Judge Lloyd considered those cases, she improperly
conflated the terms “municipality” and “governmental unit.” The River Region cases, KERS
notes, were tried before the Bankruptcy Code even contained the term “governmental unit,” so
those decisions turned on whether the CMHCs were municipalities. (Id., PageID # 2127) And
the factors Las Vegas Monorail used to decide whether an entity was a governmental unit were
originally meant to decide whether something was a municipality. (Id. at 2128)
To make its point, KERS turns again to In re Hospital Authority. (Id.) But this reliance
is misplaced.

The In re Hospital Authority court did caution that “[t]he definition of

‘governmental unit’ is broader than the definition of ‘municipality.’” 2012 WL 2905796 at *6.
However, that court also reached this conclusion: “Nonetheless, I find that the factors identified
by the Las Vegas Monorail court are relevant in determining whether an entity is a governmental
unit.” Id. Then the court examined the entity in question through the lens of the three Las Vegas
Monorail factors. Id., at *6-*9. KERS tries to play this off by saying that the In re Hospital
Authority court applied the factors “in some sense,” (D.N. 15, PageID # 2128), but that
suggestion is disingenuous—the court fully considered and applied the Los Vegas Monorail
factors.

7

Greenberg v. River Region Mental Health-Mental Retardation Bd., Inc. (In re River Region
Mental Health-Mental Retardation Bd., Inc.), Case No. 78-00193-L (Bankr. W.D. Ky. Jan. 8,
1980), aff’d, Case No. C-80-0089-L(b) (W.D. Ky. Sept. 11, 1990), aff’d sub nom. Halikas v.
River Region Mental Health-Mental Retardation Bd., Inc., 667 F.2d 1026 (6th Cir. 1981), cert
denied, 457 U.S. 1106 (1982).
23

The Las Vegas Monorail approach is instructive. After applying the Las Vegas Monorail
approach to the facts of this case, the Court concludes that Seven Counties is not a governmental
unit.
a. Traditional Government Attributes
Seven Counties does not have traditional governmental attributes such as eminent
domain, sovereign immunity, and taxing powers. 429 B.R. at 788. KERS does not claim that
Seven Counties has eminent domain powers. (S.L.D.N. 6-1, PageID # 171) As for sovereign
immunity, Judge Lloyd deftly compared Seven Counties to a Kentucky Supreme Court case,
Comair, Inc. v. Lexington-Fayette Urban Cty. Airport Corp., 295 S.W. 3d 91, 99 (Ky. 2009), that
addressed whether sovereign immunity extended to Lexington, Kentucky’s airport. (S.L.D.N. 61, PageID # 172) From this analysis, she ultimately concluded that Seven Counties did not
qualify for sovereign immunity. (Id.) KERS does not challenge her conclusion. That leaves
taxing powers as the lone governmental attribute that could apply to Seven Counties.
KERS argues that Seven Counties has the ability to tax. (D.N. 15, PageID # 2129) It
relies on Ky. Rev. Stat. § 210.460(1). That statute provides that when a CMHC board believes
that the CMHC has not been appropriated enough funds for its needs, the CMHC may seek a
special ad valorem tax. In order for it to get that tax, though, the Cabinet must approve of the tax
and the CMHC must request a fiscal court to assess it. Of course, there is a difference between
requesting a tax and assessing a tax. Seven Counties must rely on both the Cabinet’s approval
and the fiscal courts in the counties it serves to assess and collect any tax dollars. These
significant limitations undercut the argument that Seven Counties has traditional government
powers. KERS also notes that Seven Counties “is 95% funded with government dollars, which
come from tax revenues.” (D.N. 15, PageID # 2130) Yet this argument also falls short. Many

24

private entities—for example, medical practices whose patients are mostly insured by Medicaid
or construction companies that specialize in building and maintaining public highways—depend
largely on government dollars. That alone does not make them governmental entities. Without
the ability to tax, Seven Counties is left without indicia of traditional governmental attributes.
This Las Vegas Monorail factor weakens the claim that Seven Counties is a governmental entity.
b. Level of State Control
The second Las Vegas Monorail factor becomes relevant if Seven Counties reflects a
public purpose. That is, does Seven Counties “reflect goals and activities which augment the
State’s provision of some public function”? Las Vegas Monorail, 429 B.R. at 789. Seven
Counties does have a public purpose: to provide behavioral and mental health services for the
people who live in its service area. With that in mind, the inquiry now becomes how much
control Kentucky exercises over Seven Counties. This analysis is important because there are
many entities that have public purposes—like “the Red Cross and other charities”—that could
not fairly be considered instrumentalities of government because the entities’ functions are not
controlled by government. Id. So the extent of government control matters.
The type of governmental control also matters. If the government’s control is meant to
protect the government’s finances or the public fisc, then the entity is an instrumentality of the
government. Id. On the other hand, if the government’s control “is more akin to oversight or
regulation, then the entity is not an instrumentality.” Id. (citations omitted).
KERS argues that Kentucky exercises substantial control over Seven Counties. (D.N. 15,
PageID # 2130-31) It lists as reasons the Cabinet’s ability to impact Seven Counties’ “structure,
funding, budget and operations,” and Seven Counties’ reliance on state money. (Id.) It also
points to the power of the Cabinet secretary to name a caretaker for CMHCs or even revoke

25

recognition of the CMHCs. (Id. at 2131) Still, consideration of these eventualities results in the
conclusion that Kentucky’s power over Seven Counties is limited to largely typical oversight and
regulation.
As Judge Lloyd surmised, “[t]he great weight of evidence” shows Kentucky does not
exercise the extent and type of control needed to make Seven Counties a governmental unit.
(S.L.D.N. 6-1, PageID # 173) Seven Counties is a private, non-profit corporation. (Id.) No
“agent or representative” of the state appoints Seven Counties’ board of directors, or any of
Seven Counties’ officers, executives, or employees. (Id.) Moreover, Kentucky does not vet or
approve Seven Counties’ choices for its board of directors, its officers and executives, or its
employees. (Id.) Seven Counties’ employees do not work for the state and are not perceived as
public employees. (Id., PageID # 173-74) The Cabinet’s liaison to Seven Counties admitted at
trial that he observes and reports on Seven Counties meetings, yet he has no control over them.
(Id.) Indeed, he is often barred from Seven Counties’ executive sessions. (Id.) The Cabinet has
the authority to “de-designate” a CMHC, but de-designation would simply prevent Seven
Counties from bidding on state contracts; de-designation would not in and of itself shutter Seven
Counties. (Id., PageID #175) That is, the Cabinet cannot shut down Seven Counties or take
away its corporate status. Besides, it appears that the power to de-designate is limited, and rarely
used. (Id., PageID # 135) It is limited because, for example, the Cabinet must provide thirty
days’ notice and the target CMHC may request a hearing. (Id.) It is rare because, from the
record, it appears that only two CMHCs—Seven Counties and Kentucky River Community Care,
Inc.—became designated entities after some other entity lost its designation. (Id.) And nothing
in the record suggests that the Cabinet or any other representative of Kentucky can “seize or
exercise dominion” over Seven Counties’ property. (Id., PageID # 175)

26

What about Seven Counties’ finances? KERS points out that 95% of Seven Counties’
funding comes from the state.

(D.N. 115, PageID # 2090) That is true, but only in the sense

that Seven Counties contracts with the state to provide services.8 (S.L.D.N. 6-1, PageID # 175)
That money does not come from direct appropriation of funds, the way that the General
Assembly could directly appropriate funds to a state agency. If Seven Counties received grant
money from the state, it would have to submit a budget to the Cabinet showing how it spends the
grant money. (See id. at 174) But even this would be more like oversight than anything else—
Kentucky gives Seven Counties grant money for a specific purpose; its review of Seven
Counties’ budget is simply to ensure that the grant’s purpose is adhered to. (See id. (citations
omitted)) And of course, there are other non-profits in Kentucky that receive grant money
without damage to their corporate status.
Viewing these facts, Judge Lloyd found that Kentucky exercises even less control over
Seven Counties’ operations than did Nevada over the monorail corporation in Las Vegas
Monorail. (Id., at PageID # 173) She was right. Kentucky has but a “limited measure of public
control, regulation, or oversight” over Seven Counties. See Las Vegas Monorail, 429 B.R. at
786. Because it lacks traditional government attributes and because Kentucky exercises only
trivial control over it, Seven Counties is not a “governmental unit” under the Bankruptcy Code.
And so, it thus far appears that Seven Counties qualifies for Chapter 11 relief.
c. How Kentucky Designates Seven Counties
The final Las Vegas Monorail factor is an analysis of “the effect of the State’s own
designation and treatment of the entity.” 429 B.R. at 788. For this inquiry, “some deference” is
given to Kentucky’s “categorization of the entity.” Id. at 789. This deference is not dispositive,
8

And it is not as though Seven Counties is required to provide 95% of its services to the state. It
could, in theory, provide behavioral health services to others.
27

but it reflects the desire of Congress to give the states greater leeway. See id. This factor is not
concerned with the label the state uses; rather, the analysis focuses on what the “label carries
with it.” Id.
The evidence presented at trial indicates that Kentucky treats Seven Counties as a private
entity. Like in Las Vegas Monorail, Seven Counties must “obtain licenses and franchises just as
if it were a purely private entity.” (S.L.D.N. 6-1, PageID # 136 (quoting 429 B.R. at 798)) Like
other corporations, if Seven Counties does not update its annual reports with Kentucky’s
Secretary of State, its corporate status may be dissolved. (Id., (citing KY. REV. STAT. §§
273.3671, 14A.6-010)) Again, it contracts with the state to provide services for a fee. (Id.
(citing 200 K.A.R. 5:309(1)(11) (2013))) And though Seven Counties must comply with the
Kentucky Open Records Act because the Commonwealth provides Seven Counties with at least
25% of its funds, Seven Counties is not subject to the Kentucky Open Meetings Act. (Id., at
PageID # 137 (citing Ky. O.A.G. 02-ORD-222; Ky. O.A.G. 96-OMD-180 at *2)) These facts
suggest that Kentucky treats Seven Counties as a private entity and not a governmental unit.
One possible hurdle remains. KERS claims that Seven Counties counts as a “special
purpose governmental entity” under Kentucky law. (See D.N. 15, PageID # 2131-33; see also
D.N. 23, PageID # 3789) A special purpose governmental entity “exist[s] to serve a public
purpose and must be subject to standards of accountability so that the public, other local
governmental entities, and state government can be apprised of the their status and activities.”
(D.N. 15, PageID # 2131 (quoting 2013 Ky. Acts ch. 40, sec. 1(8)(a)-(c)))
Judge Lloyd determined that Seven Counties is not a special purpose governmental
entity. She cited several reasons, (S.L.D.N., PageID # 137-38), but the Court will recite only a
few. First, she noted that Seven Counties fails one requirement because it is not an “agency,

28

authority, or entity created or authorized by statute.” (Id., at PageID # 137 (quoting Ky. Rev.
Stat. § 65A.10(9)(a))) She also decided that Seven Counties was a private entity under the
statute, such that it could not be a governmental entity. (Id., at PageID # 138 (citing KY. REV.
STAT. § 65A.010(9)(d))) The relevant portion of the statute defines “private entity” as “any
entity whose sole source of public funds is from payments pursuant to a contract with a city,
county, or special purpose governmental entity, including funds received as a grant or as a result
of a competitively bid procurement process.” KY. REV. STAT. § 65A.010(6)(a). Judge Lloyd
reasoned that, though a technical reading might hold that Seven Counties is not a private entity
because it receives public funding from the state and federal governments (and not just cities,
counties, or special purpose governmental entities), such a reading would be “absurd.”
(S.L.D.N. 6-1, PageID # 138)
KERS tried to parry these conclusions and prove that Seven Counties is a special purpose
governmental entity. Even if it is right, though, the Court doubts it would make much difference.
Again, the label itself is not what matters—what matters is what comes with the labels. Las
Vegas Monorail, 429 B.R. at 789. As Seven Counties noted, the statute only obliges special
purpose governmental entities to submit reports to state government. (D.N. 19, PageID # 2982
(citing KY. REV. STAT. § 65A.020)) To the Court, this relatively minor requirement cannot be
applied to overcome the other, more significant attributes which collectively and
overwhelmingly suggest that Kentucky recognizes and treats Seven Counties as a private entity.
For this reason, as well as the reasons discussed above, the Court must conclude that Seven
Counties is eligible for Chapter 11 relief.

29

2. An Executory Contract Exists Between Seven Counties and KERS
Seven Counties argued to the bankruptcy court that an executory contract exists between
it and KERS, and that 11 U.S.C. § 365 allows the contract to be rejected. (S.L.D.N. 6-1, PageID
# 185) To determine whether this is correct, the Court must follow a two-step inquiry: (1) is
there a contract between KERS and Seven Counties; and (2) is that contract “executory”? The
bankruptcy court answered yes to both those questions. (See id., PageID # 186-94) The Court
agrees with both conclusions.
a. The Relationship Between Seven Counties and KERS Is Contractual
“Whether or not a contract exists between [Seven Counties] and KERS is a matter of
state law.” (Id., PageID # 186 (citing Butner v. United States, 440 U.S. 48, 54 (1979)) Under
Kentucky law, contracts must have “offer and acceptance, full and complete terms, and
consideration.” Collins v. Ky. Lottery Corp., 399 S.W.3d 449, 455 (Ky. Ct. App. 2012) (citation
omitted). Here, each requirement is met.
An offer requires “the manifestation of willingness to enter into a bargain, so made as to
justify another person in understanding that his assent to that bargain is invited and will conclude
it.” RESTATEMENT (SECOND)

OF

CONTRACTS § 24 (1981). In 1979, Seven Counties made a

written offer to join KERS—to pay employee “pick ups” if KERS would let Seven Counties’
employees be in the pension system. (S.L.D.N. 6-1, PageID # 186; see also D.N. 19, PageID #
2988) Kentucky’s attorney general considered the offer and advised Kentucky’s governor to
accept it.

(S.L.D.N. 6-1, PageID # 187 (citing Ky. O.A.G. 78-685)))

Acceptance is a

“manifestation of assent to the terms thereof made by the offeree in a manner invited or required
by the offer.” RESTATEMENT § 50. KERS assented to the proposal when Kentucky Governor
Julian Carroll issued Executive Order 79-78, which allowed Seven Counties to participate in

30

KERS, on January 24, 1979. (See S.L.D.N. 6-1, PageID # 187) The terms of the contract are
detailed extensively in the statutes and regulations governing KERS. And both sides received
consideration for entering into the contract. Kentucky courts have defined consideration as
A benefit conferred to a promisor or a detriment incurred by a promisee. A
benefit occurs when the promisor, in exchange for a promise, obtains a legal right
to which he was not otherwise entitled. A detriment occurs when the promisee, in
exchange for the promise, waives a right to which he was otherwise entitled to
exercise.
Martin v. Pack’s Inc., 358 S.W.3d 481, 484 (Ky. Ct. App. 2011) (citations omitted). Moreover,
“[t]he performance or return promise may be given to the promisor or to some other person.”
RESTATEMENT § 71(4). In this case, each side gained benefit in exchange for detriment. Seven
Counties took on a detriment because it agreed to pay into KERS, something it was previously
not required to do. In exchange, it benefitted because its employees were then covered under
Kentucky’s pension system. KERS took on a detriment because, once Seven Counties entered
the system, it became liable for paying the benefits of Seven Counties retirees.

Wider

participation also benefitted KERS. With all this in mind, the Court concludes that a contract
exists between these two entities.
KERS challenges this conclusion on multiple grounds. The Court will address the
arguments in turn.
First, KERS protests that there was no written or oral contract between it and Seven
Counties. (D.N. 15, PageID # 2097-01) Its argument is really that the relationship is governed
by statute, not contract, as evidenced by the inability of Seven Counties to produce a written
document styled as a contract. This view misses the point. The holding below, and of this
Court, is that the statutes governing the relationship between the two comprise the terms of the
contract. After all,

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the incorporation of applicable existing law into a contract does not require a
deliberate expression by the parties. . . . [T]he parties to a contract—including the
government, in a contract between the government and a private party—are
presumed or deemed to have contracted with reference to existing principles of
law.
Under this presumption of incorporation, valid applicable laws existing at the time
of the making of a contract enter into and form a part of the contract as fully as if
expressly incorporated in the contract.
11 Williston on Contracts § 30:19 (4th ed. 2015). At the time of offer and acceptance,
the statutes governing KERS existed. Thus, those statutes were incorporated into the
agreement between KERS and Seven Counties. See id. And so, the terms of the contract
are in writing—they existed in Kentucky’s statutes before Seven Counties even began
participating in the system.

With the terms secure, all that was needed for Seven

Counties to contract with KERS was an offer to participate in the program and an
acceptance of that offer.
Regardless, KERS’s argument that Ky. Rev. Stat. § 45A.245(1) requires contracts
with the Commonwealth to be in writing is unavailing.

As Judge Lloyd correctly

surmised, that statute is meant to prevent an inadvertent waiver of Kentucky’s sovereign
immunity from breach of contract damages. (S.L.D.N. 6-1, PageID # 190-91) As this is
not a case for breach of contract damages, the statute is inapplicable. Moreover, the
Kentucky Court of Appeals has found that parties had contracts with the Commonwealth
and could pursue certain forms of relief even without a written contract. See, e.g.,
Newton v. Univ. of Louisville, 2009-CA-002197-MR, 2010 WL 4366360, at *4 (Ky. Ct.
App. Nov. 5, 2010) (finding contract with state based on an employment handbook).9

9

While the Court recognizes that unpublished decisions of the Kentucky Court of Appeals are
not binding, it finds the court’s conclusion in Newton illustrative.
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Second, KERS says that there was no statutory authority for Seven Counties to contract
with KERS. (Id., PageID # 2101-05) Frankly, this argument seems to contradict itself. KERS
admits that the “General Assembly delegated [the authority to permit employers to participate in
KERS] to the Governor to be exercised by the executive order process.” (Id., PageID # 2102)
Despite this admission, KERS then says that the non-delegation doctrine—the concept that the
powers of administrative agencies are “limited to those conferred expressly by statute or exist by
necessary and fair implication”10—prohibits an entity like Seven Counties from reaching an
agreement to participate in KERS. (Id.) These two positions are incompatible. If the General
Assembly ceded to the executive branch the authority to offer new employers entry into the
system, why would the non-delegation doctrine bar Seven Counties from accepting the offer?
Third, KERS argues that Governor Carroll could not enter into a contract on behalf of
KERS.

(Id., PageID #2105-07)

Instead, Governor Carroll was only authorized to issue

executive orders allowing employers to participate. (Id., PageID # 2106) The problem with
KERS’s position is that it implies Governor Carroll either assented to a contract or issued an
executive order, but not both. Judge Lloyd’s opinion, however, rests on the implicit assumption
that Governor Carroll assented to the offer by issuing the executive order. As stated above, the
General Assembly gave Governor Carroll the authority to extend participation in the system to
non-profits. The Court sees no reason—in law or common sense—to say that his issuance of an
executive order allowing Seven Counties to participate in the system was not the functional
equivalent of assenting to a contractual arrangement.
KERS’s fourth contention is that KERS received no consideration. (Id., PageID # 210708) For the reasons discussed above, this too is inaccurate. KERS received benefits—it received
10

Baker v. Commonwealth of Ky., No. 2005-CA-001588-MR, 2007 WL 3037718, at *34 (Ky.
Ct. App. Oct. 19, 2007) (internal citations omitted).
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employer pick-ups from Seven Counties, and the addition of a new employer spread risk within
the system. This satisfies the consideration requirement.
Finally, KERS argues that a contract between Seven Counties and KERS “violates Ky.
Rev. Stat. §§ 61.510(3) and 61.520(1) and is therefore void.” (Id., PageID# 2108) KERS makes
no attempt to prove that the contract between Seven Counties and KERS violates those statutes,
however.

And the Court sees no reason why those provisions—one saying that CMHCs

admitted to participate will count as “departments” and the other that the governor has authority
to admit employers to the system—would void any agreement between the two entities.
b. The Contract Between the Two Is Executory
With a contract in hand, the inquiry becomes whether that contract is executory. But just
as the Bankruptcy Code avoids defining “governmental unit,” it likewise does not define
“executory contract.” (S.L.D.N. 6-1, PageID # 191 (citing Chattanooga Mem’l Park v. Still (In
re Jolly), 574 F.2d 349 (6th Cir. 1978))) Perhaps the omission is intentional. In Chattanooga
Memorial Park, the Sixth Circuit opened its discussion with the observation that “the phrase
[“executory contract”] is meaningless.” 574 F.2d at 350. It then cited the oft-used definition that
an executory contract is one where “the obligations of both the bankrupt and the other party to
the contract are so far unperformed that the failure of either to complete performance would
constitute a material breach excusing the performance of the other.” Id. at 351 (quoting Vern
Countryman, Executory Contracts in Bankruptcy: Part I, 57 Minn. L. Rev. 439, 460 (1973)).
The Sixth Circuit concluded that the definition was helpful but not conclusive. Id.
Instead, the Sixth Circuit determined that the “key . . . is to work backward, proceeding
from an examination of the purposes rejection is expected to accomplish.”

Id.

If those

objectives cannot be accomplished with rejection or if they are already accomplished, “then the

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contract is not executory within the meaning of the Bankruptcy Act.” Id. This reflects the
reality that “executory contracts involve obligations which continue into the future.”

Id.

(citation omitted). That is, “[g]enerally they are agreements which include an obligation for the
debtor to do something in the future.” Id.
Under either the Countryman approach or the more functional analyis that the Sixth
Circuit applied in In re Jolly and the bankruptcy court used below, the contract between Seven
Counties and KERS is executory. The contract is executory under the In re Jolly approach
because Seven Counties “has the continuing future obligation” to contribute to KERS. (S.L.D.N.
6-1, PageID # 193) But if it is forced to pay those obligations, Seven Counties will cease
operations. The purpose of rejection, then, is to relieve Seven Counties of onerous contractual
obligations that will drive it out of business. Seven Counties could achieve that purpose by
rejecting this contract, which means the contract is executory. (Id.)
The Countryman approach is also satisfied. Each side to this contract still has continuing
obligations. Seven Counties must keep making contributions. KERS must keep managing the
pension portfolio for Seven Counties employees and paying benefits once the employees retire.
KERS takes issue with this, saying that these are obligations owed to employees and not
employers like Seven Counties. (D.N. 15, PageID # 2120) But it is well established that
consideration for a contract can require that “[t]he performance or return promise may be given
to the promisor or to some other person.” Restatement § 71(4) (emphasis added). If obligations
owed to some third party can count for consideration, there is no reason why unperformed
obligations to third parties would somehow preclude finding an executory contract. The Court
concludes that this is an executory contract that Seven Counties may reject under 11 U.S.C. §
365.

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3. Seven Counties Is Not Required to Continue Post-Petition Obligations
The last issue to address here is one the bankruptcy court addressed early in its opinion:
whether 28 U.S.C. § 959(b)—which essentially says that trusts, receivers, or managers in
bankruptcy must continue to comply with state laws in their use of the bankrupt entity’s assets—
supersedes Seven Counties’ ability to reject its executory contract with KERS. (See S.L.D.N. 61, PageID # 177-85) This issue springs from KERS’s complaint, where it asked for a permanent
injunction to force Seven Counties to comply with its “Statutory Obligations” under Kentucky
law. (Id., PageID # 177) That is, KERS wanted Seven Counties to keep withholding its
employee “pick up” deductions and to pay all scheduled contributions. (Id.) At the same time,
of course, Seven Counties sought to reject its executory contract with KERS. Though the two
issues were legally distinct, the bankruptcy court logically decided to deal with them together.
(Id.) The Court agrees. Seven Counties is not required to make any post-petition contributions.
The Court notes that the bankruptcy court also addressed the question of whether 11
U.S.C. § 363(d)(1)—which allows a trustee to sell or lease a bankrupt entity’s property so long
as the transactions comply with laws outside the Bankruptcy Code—could require Seven
Counties to keep participating in the system. (Id., PageID # 178) KERS argued that it did. (Id.)
Judge Lloyd carefully detailed why that portion of the Bankruptcy Code did not apply to or
affect this case. (Id.) As neither side challenges that decision, and because the Court concludes
Judge Lloyd’s analysis was correct, the Court will not scrutinize the conclusion further.
Turning now to 28 U.S.C. § 959(b), this portion of the Bankruptcy Code requires that a
debtor “manage and operate property post-petition per valid state laws where the property is
located.” (Id., PageID # 179 (where the bankruptcy court offers a plain language interpretation
of the relevant Bankruptcy Code language)) The point here is that Congress did not intend for

36

the Bankruptcy Code to preempt all state laws and wanted to keep trustees from “insulating
themselves by using the federal courts to circumvent compliance with state laws.” Robert C.
Furr, Trustee’s Obligation to Comply with State Law, AM. BANKR. INST. J. 30, 42 (2011).
KERS contends that state laws that give structure to the arrangement between KERS and
Seven Counties are the types of state laws requiring compliance from bankruptcy debtors. (Id.,
PageID # 2122-24) And it points to a case, City of West Jordan v. Utah State Retirement Board,
767 P.2d 530, 534 (Utah 1988), for the proposition that a state has a legitimate interest in
determining a minimum amount of retirement benefits that must be provided to “public
employees by its political subdivisions.” (Id., PageID # 2123) Last, KERS pleads for the Court
to reverse the bankruptcy court’s decision in order to protect the general welfare of the retirees
who rely on state pensions. (Id., PageID # 2124)
The courts that have addressed these issues have decided that the types of state laws
debtors must continue to comply with are those relating to health, safety, and welfare. For
example, courts have forced debtors to continue complying with laws protecting the environment
from toxic pollution, to continue complying with local zoning requirements, and to adhere to
liquor licensing rules.

(S.L.D.N 6-1, PageID # 179 (citations omitted))

As Judge Lloyd

concluded, the cases relate to areas where the state has broad police power to protect the health
and well-being of its citizens. (Id.) Significantly, no court has ever ruled that laws relating to
retirement benefit plans are included. (Id.) The case that KERS points to, City of West Jordan,
is readily distinguishable. West Jordan dealt with a city trying to withdraw from a state pension
system. Of course, Kentucky does have a legitimate interest in setting and providing retirement
benefits for its public employees, and it does have a legitimate interest in ensuring its political
subdivisions contribute their fair share to those systems. But this case does not relate to public

37

employees. And, despite what label Kentucky gives it, Seven Counties does not count as a
political subdivision under the Bankruptcy Code. The Court does not equate the situation
presented here with the other cases where courts have found that § 959(b) required a debtor to
continue state obligations.

To the extent, though, that there might be an overlap where

Kentucky’s law somehow conflicts, “state law must yield.” (Id., PageID # 180 (citing Saravia v.
1736 18th Street N.W., L.P., 844 F.2d 823, 826 (D.C. Cir. 1988)))
The laws governing Kentucky’s retirement system are not the types of health, safety, and
welfare laws courts have previously required debtors to comply with under § 959(b). The Court
recognizes, however, that the distant final resolution of this case may one day contribute to
further difficulties for KERS, and perhaps its participants. Yet this concern cannot alter the
conclusion that Seven Counties’ obligations to KERS were effectively severed when it sought
bankruptcy protection. The Bankruptcy Code does not require Seven Counties to fulfill any
post-petition obligations to KERS.
IV.

CONCLUSION

After de novo review, the Court concludes that the bankruptcy court reached the correct
legal conclusions. Accordingly, and the Court being otherwise sufficiently advised, it is hereby
ORDERED as follows:
1. Appellant KERS’s motion to certify a question to the Kentucky Supreme Court (D.N.
25) is DENIED.
2. The bankruptcy court’s conclusion that the Kentucky Employee Retirement System’s
non-hazardous plan is a “multi-employer plan” is REVERSED as clear error.
Instead, the record shall reflect that the plan is actually a “multiple-employer plan.”
3. In all other respects, the bankruptcy court’s decision is AFFIRMED.

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4.

The cross-appeal of Seven Counties is DENIED as moot and DISMISSED.

March 31, 2016

David J. Hale, Judge
United States District Court

cc:

Clerk of Court, United States Bankruptcy Court for the Western District of Kentucky

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