Today's post is long, but, we think, worth the investment of your time.
Bankruptcy is the way to get rid of debt. Plaintiffs who have sued the debtor but who have not reduced the lawsuit to a judgment are unsecured creditors. Unsecured creditors for the most part, go to the end of the payment queue, and that usually means then get squat.
In In re Stockton, No. 14-17269 (Dec. 10, 2018), a three-judge panel of the U.S. Court of Appeals for the Ninth Circuit addressed whether it makes a difference that the plaintiff is a property owner, and the lawsuit that has not been reduced to judgment is an inverse condemnation claim for a taking: can a city's Chapter 9 bankruptcy reorganization plan shed the obligation to pay just compensation, or is an inverse condemnation claim protected by the Takings Clause from impairment?
Over a strong ("adamant") dissent, the panel held that yes, the City of Stockton can do just that.
How the city ended up in bankruptcy -- at that time the largest city to go that ignominious route -- is a long story. The panel opinion sets out what you need to know. A real municipal horror story. So, too, is the story of how Michael Cobb ended up getting the shaft.
The short version is that Cobb's father owned property, and back in more sunny days (1998, to be precise) the city condemned a portion of that property by a road by California's version of quick-take (Not true title-transferring quick take, but rather immediate pre-judgment possession only. But that matters not for our purposes.) Stockton made a deposit of $90k, got possession, built its road. After his father died, Michael Cobb inherited the property and subbed in as the defendant in the still-not-quite-resolved condemnation action. He withdrew the $90k deposit, thus waiving under California law all defenses except greater compensation. As the panel majority noted, "[h]e did not assert a counterclaim for greater compensation in the condemnation proceeding." Slip op. at 9.
Apparently, Mr. Cobb had a change of heart, because "[s]even year later, [he] attempted to return" the deposit amount to the city, which declined to accept the money, telling him that his decision to withdraw was final. Cobb put the money into an interest-bearing account.
Here's where it gets sticky. The city never closed out its condemnation case, and the California trial court dismissed the action for lack of prosecution (California law requires that a case be tried within five years of commencement). Cobb then brought his own inverse condemnation suit in a California court, alleging that the city's failure to prosecute the eminent domain action left unresolved the final amount of compensation and damages, which means there had been a taking without compensation. After all, Stockton had its road.
The trial court sustained the city's demurrer (motion to dismiss to you non-Californians), concluding Cobb has missed the statute of limitations. Cobb's inverse claim accrued when the city occupied the land, and that had happened more than five years prior. But the California Court of Appeal reversed, "finding that his claim was timely because it 'did not accrue until the City's occupation of the property became wrongful, which did not occur until the eminent domain proceeding was dismissed.'" Slip op. at 10. As the Ninth Circuit panel majority noted, "[t]he merits of his inverse condemnation claim remain unadjudicated and unproven." Slip op. at 10. An unliquidated and unsecured money damage claim.
The city then petitioned for Chapter 9 bankruptcy. With an unliquidated claim, Cobb went to the end of the queue. But he didn't go quietly. He filed a claim for $4.2 million, which included his claim for compensation and damages for the taking, interest, attorneys fees and costs, and taxes. The city's reorganization plan put Cobb's claim in Class 12, end of the queue.
On February 11, 2014, Cobb filed an objection to confirmation of the plan, alleging that his “claims in inverse condemnation are protected by the Fifth and Fourteenth Amendments to the United States Constitution and cannot be impaired by the Plan.” He did not contest the listing of his claim as unsecured.
Slip op. at 11.
The U.S. Bankruptcy Court overruled Cobb's objection to confirmation of the plan, concluding "[t]he bankruptcy clause does not permit the adjustment of a debt for greater compensation," and even if "the debt were reduced to judgment, it would be a general unsecured debt at the moment the judgment was issued." Slip op. at 11. The parties agreed that the Ninth Circuit, not the U.S. District Court, should hear the appeal. While the appeal was pending, the city's bankruptcy plan became effective.
To the Ninth Circuit majority, that last bit was fatal. Two judges concluded that the appeal became equitably moot because the plan was not stayed:
Cobb sought no stay whatsoever. He did not seek a stay in the bankruptcy court. He did not seek a stay in the district court. He did not seek a stay in our Court. While he was appealing the rejection of his plan objections, he took no action to stay the plan’s implementation, although confirmation proceedings< were ongoing. He did nothing.
Slip op. at 14. Read pages 11-18 for the majority's application of the other three factors which federal courts employ to determine equitable mootness. Short version:
The reorganization train has left the station. Cobb did not pursue any bankruptcy stay remedies, much less pursue them with the requisite diligence. The plan has long been substantially consummated. He offers too little, too late. None of the factors that we consider in deciding whether to apply the doctrine of equitable mootness favor Cobb. Thus, his appeal must be dismissed.
Slip op. at 18.
But read on, takings junkies. because starting on page 18 is where the majority opinion gets interesting. because Cobb argued that the Takings Clause exempted his unsecured claim from the city's reorganization plan. Slip op. at 19 ("Distilled to its essence, Cobb’s argument on appeal is that he has a property interest that cannot be adjusted in bankruptcy.").
Not so, held the majority. His was merely an unsecured money claim. Nor was it a property claim: he had "relinquished his property interest in the land more than 15 years before bankruptcy was filed." Slip op. at 19. He had never objected to the city's claim that the deposit was the amount of compensation finally owing. He withdrew the deposit, meaning he waived all claims (except greater compensation), an argument the panel majority noted he never made in the condemnation case ("He did not assert a counterclaim for greater compensation in the condemnation proceeding.").
Thus, the bankruptcy court properly concluded that once Cobb withdrew the tendered compensation, he waived by operation of law all claims and defenses in his favor as to the property, except for a claim for greater compensation, which is an unsecured monetary debt claim.
Slip op. at 20.
Say what? Under California law, a property owner doesn't need to make a "counterclaim" in order to preserve his right to claim more than the deposit amount. She merely needs to assert the defense of just comp in her answer. Was the majority merely being loose with terminology, and correctly noting that Cobb's Answer didn't seek just compensation? Or did the majority just get it wrong, and buy the notion that Cobb's failure to assert a Counterclaim was somehow fatal to his argument for more than the deposit?
Next, the majority concluded that "Cobb independently relinquished any interest he had by allowing the city to construct the road and open the road to public use." Slip op. at 20. "Under California law," the majority held, "if a property owner allows the government to complete the taking of the property for public use, he is 'denied the right to enjoin the agency.'" Id. Sorry, we're confused on that one. How does a condemnee enjoin a taking that is in progress? Does the owner really "allow" the government to "complete the taking?"
Thus, the majority concluded,
when the bankruptcy was filed, Cobb did not possess a right to the property protected by the Fifth Amendment. It had been extinguished. What remained was bare legal title—without any other property rights and subject to defeasance by the prior litigation—and an unsecured statutory monetary claim for greater compensation.Cobb’s theory seems to be that an unliquidated, statutory claim for greater compensation cannot be adjusted in bankruptcy. But it is purely a monetary claim. As the bankruptcy court pointed out, if the inverse condemnation claim had been reduced to a judgment, it would be subject to adjustment in bankruptcy; therefore, it is not logical to say that an unliquidated claim for greater compensation cannot be adjusted in bankruptcy.
Slip op. at 21.
The majority rejected Cobb's argument that there's something different about just compensation. That the constitutions require the payment of just compensation (and in the case of California, damages as well) is irrelevant. Id. ("Nor does the character of any claim asserting an unconstitutional taking make it immune from evaluation on the merits in bankruptcy."). Besides, the majority concluded, "'just compensation' under the Takings Clause is not equivalent to 'full compensation.'" Slip op. at 23.
One judge (Judge Friedland) dissented. (An "Obama judge" in the current verboten parlance, if that sort of thing matters to you.) We suggest you read her entire dissent, staring on page 26. Her major point is that Cobb was arguing that his constitutional claim for compensation cannot be subject to bankruptcy, which means that it cannot be subject to the "judge-made bankruptcy doctrine of equitable mootness." The majority seemed to think that the remedy Cobb sought was to unwind Stockton's bankruptcy plan, when instead, his only desire was to be exempt from the plan. Id. at 27 ("I am unaware of any case in which we have applied an equitable mootness analysis to an individual's claim that an asset should have been excepted from discharge and excluded from bankruptcy proceedings altogether."). Let me pursue my compensation claim outside the bankruptcy plan was the relief Cobb sought.
Nor was Judge Friedland convinced by the majority's argument that Cobb had waived all of his property rights:
as a matter of constitutional first principles, I believe municipalities are obligated to provide just compensation for any taking of private property, regardless of the bankruptcy laws. And regarding Cobb’s claim in particular, I believe that Cobb has preserved a constitutional claim for just compensation, and that his claim thus should have been excepted from discharge.
Slip op. at 29-30 (footnote omitted).
Congress' power to adopt bankruptcy laws is subject to the rights guaranteed by the Bill of Rights, which as we know includes the Fifth Amendment's Just Compensation Clause. That was confirmed as far back as 1935 by the Supreme Court in Louisville Joint Stock Land Bank v. Radford, 295 U.S. 555 (1935) ("[t]he bankruptcy power, like other great substantive powers of Congress, is subject to the Fifth Amendment.").
Moreover, Judge Friedland concluded that Cobb "took all the steps necessary to preserve his constitutional claim for just compensation." Slip op.at 34. The condemnation itself triggered Cobb's right to just comp, and he "retained this right by filing an inverse condemnation action and pursuing it in accordance with the appropriate state procedures." Id. at 35.
The majority instead holds that Cobb has forfeited all property rights in the condemned parcel under California law, and that his pending claim is “simply” a statutory claim for monetary damages. But the statutory character of Cobb’s claim does not diminish its constitutionally protected status—indeed, a constitutional claim for just compensation is a statutory claim for monetary damages under California law.
Slip op. at 35-36.
Withdrawing the deposit was not a waiver of his claim for more compensation (indeed, the quick take procedure would be unconstitutional if it somehow extinguished a claim for more compensation). And, the availability of an inverse condemnation action is what saves it, in cases like these where there's an affirmative exercise of the condemnation power, an actual physical taking of the property, and then an abandonment of the affirmative condemnation. As Judge Friedland writes, "[a]n inverse condemnation action became available to Cobb when the City failed to prosecute its eminent domain action to final judgment and thus did not complete the condemnation procedures required under California law to compensate Cobb an to secure title for the City." Slip op. at 37 (footnote omitted).
But what about the majority's conclusion that Cobb's unliquidated claim for compensation is merely a statutory monetary claim? Judge Friedland responded that no, even though California's inverse condemnation process is a creature of statute, the Fifth Amendment requires compensation, and thus, "[t]akings claims arising in California do not somehow lose their constitutional status merely because California's procedures for seeking just compensation were codified by statute rather than solely through caselaw." Slip op. at 40. "And," she added," actions for just compensation could be characterized as claims for money; that is the nature of the claim."
Because Cobb was asserting a constitutional claim for just compensation and not a mere monetary claim, his claim should not have been subject to the bankruptcy process at all:
And try as the majority might to reframe a claim for “greater compensation” as some monetary claim unrelated to the property owner’s constitutional right to just compensation for taken property, the California Supreme Court has equated a claim for greater compensation following a quick take procedure with the constitutional right to just compensation. See Mt. San Jacinto Cmty. Coll. Dist., 151 P.3d at 1175 (rejecting a party’s argument that California’s quick-take procedures deprive property owners of their constitutional right to just compensation on the ground that “section 1255.260 does not require waiving a claim for greater compensation with withdrawal of the deposit”). Under California law, a claim for “greater compensation” comprises Cobb’s ability “to litigate the issue of adequate compensation,” Clayton, 78 Cal. Rptr. at 753, that is, the “amount of ‘just compensation’ to which [he] [i]s entitled,” Contra Costa Water Dist. v. Vaquero Farms, Inc., 68 Cal. Rptr. 2d 272, 274–75 (Ct. App. 1997) (rejecting the argument that a condemnee waived the ability to argue that just compensation had not yet been paid by withdrawing the probable just compensation deposit under section 1255.260). The amount of just compensation is precisely the matter at issue in Cobb’s inverse condemnation action.
Slip op. at 41.
And Cobb "allowing" the city to build the road wasn't a waiver of all his property rights, merely his right to stop the city from building the road. That was not the full extent of his property rights, which included, of course, the right to the full and perfect equivalent for his property. In other words, just compensation.
Judge Friedland wrapped it up by "respectfully but adamantly" dissenting. Which tells us that this one might not be over just yet. Stay tuned.
Barista's note: at the recent eminent domain conference in Scottsdale, a colleague noted one of our favorites, Clubber Lang's response in one of the Rocky movies. We think it applicable here.
Extra credit. Here's the oral argument video:
In re City of Stockton, No. 14-17269 (9th Cir. Dec. 10, 2018)
