Court Finds Nonprofit Still Owes Money to Kentucky Retirement System

A nonprofit was allowed to file for bankruptcy and exit the Kentucky Retirement System, but a federal court has ruled it still owed contributions while bankruptcy proceedings were ongoing.

The 6th U.S. Circuit Court of Appeals has decided that Seven Counties Services Inc., a nonprofit provider of mental health services, should have maintained its statutory obligation to contribute to the Kentucky Employees Retirement System (KERS) during the pendency of its bankruptcy proceedings.

In 2014, the U.S. Bankruptcy Court for the Western District of Kentucky ruled that Seven Counties Services, which serves Louisville, Kentucky, was permitted to leave KRS due to rising pension costs, which the court deemed as an unsustainable financial burden for Seven Counties. The bankruptcy court ruled Seven Countries is considered a private, nonprofit corporation rather than a government entity, and is therefore not required to stay with KRS.

The bankruptcy court and a district court both held that Seven Counties is eligible to file under Chapter 11, that the relationship between Seven Counties and KERS is based on an executory contract and that Seven Counties is not required to make post-petition contributions. The appellate court affirmed the conclusion that Seven Counties is a non-governmental unit, eligible to file. However, lacking guidance from the Kentucky state courts, it asked the Kentucky Supreme Court to certify whether the relationship between the nonprofit and the state retirement plan was contractual or statutory.

The Kentucky Supreme Court held that Seven Counties’ participation in and contributions to KERS are based on a statutory obligation and that Seven Counties payments to KERS qualified as “statutorily mandated assessments” under Kentucky law.

Now before the appellate court after that assessment, the 6th Circuit concluded that Seven Counties was required to fulfill that statutory obligation. It reversed the bankruptcy court’s contrary conclusion and remanded the case for further proceedings.

When Seven Counties filed its bankruptcy petition in April 2013, the KERS employer contribution rate was 24% of each employee’s “creditable compensation.” The contribution rate increased to 27% on July 1, 2013, and rose again to 39% beginning July 1, 2014.

At the 24% employer contribution rate, Seven Counties said it could “perform its charitable mission or pay system contributions that [would] force it to terminate operations,” but it could not “do both,” according to the court opinion. During the pendency of the bankruptcy—April 6, 2013, to February 6, 2015—Seven Counties did not submit monthly reports of employee “creditable compensation” or withhold and pay employee and employer contributions to KERS that would have been due had such monthly reports been filed. Based on Seven Counties’ annual payroll and the applicable employer contribution rates, KERS claims that Seven Counties was statutorily obligated to pay it $30,323,775.31 during that period.

The appellate court considered the nonprofit’s obligation under U.S. Code Title 28 Section 959(b). That section says, “a trustee, receiver or manager appointed in any cause pending in any court of the United States, including a debtor in possession, shall manage and operate the property in his possession as such trustee, receiver or manager according to the requirements of the valid laws of the state in which such property is situated, in the same manner that the owner or possessor thereof would be bound to do if in possession thereof.”

Seven Counties first argued that Section 959(b) does not apply to the statutory framework governing its relationship with KERS because the section “has not been extended beyond” the realm of laws enforcing a state’s police power to protect the health and safety of its citizens. The appellate court noted that KERS cited no cases in which Section 959(b) has been invoked to require payments into a pension system, but, the court said, “the lack of such enforcement cases is likely because it is recognized that companies may discharge pension obligations in Chapter 11 reorganization proceedings.”

KERS argued that the section’s plain language does not allow a debtor to selectively choose which valid state laws to follow. The appellate court found that KERS’s argument that Section 959(b)’s text applies more broadly than solely to health and safety laws has some support in cases from other circuits.

The 6th Circuit said, “Applying Section 959(b)’s plain language (and considering its application by other circuits), we must conclude that Seven Counties was required to manage its property according to the valid state laws and make contributions during the pendency of the bankruptcy proceeding.    

The court noted, however, that without Seven Counties’ reports regarding “creditable compensation” for the relevant period, it cannot determine whether KERS’s calculation of what it is owed is correct. “We leave it to the bankruptcy court to determine the amount that Seven Counties should be ordered to pay after Seven Counties provides monthly employer reports to KERS for April 6, 2013, to February 5, 2015,” the opinion states.

The court also suggested that an informal resolution may be appropriate. It said if Seven Counties’ statement that it could either perform its charitable mission or make contributions to KERS, but it could not do both is still true, “Kentucky has an interest in avoiding a result that leaves approximately 33,000 Kentucky citizens without safety-net mental health services.”