Amicus Curiae Brief — Chemical Bank v. Public Utility District No. 1

MAR 1 1985 No. 84-1258

IN THE

Supreme Court of the United States

OCTOBER TERM, 1984

CHEMICAL BANK AND

WASHINGTON PUBLIC POWER SUPPLY SYSTEM,

7 Petitioners,

PUBLIC UTILITY DISTRICT No. 1 OF BENTON

COUNTY, WASHINGTON, et al.,

Respondents.

On Petition for Writ of Certiorari to the

Supreme Court of the State of Washington

MOTION FOR LEAVE TO FILE

BRIEF AMICUS CURIAE

AND

BRIEF FOR THE

PUBLIC SECURITIES ASSOCIATION

AS AMICUS CURIAE

IN SUPPORT OF THE PETITION

R. THOMAS STANTON

SQUIRE, SANDERS & DEMPSEY

520 Madison Avenue

ROBERT A. PORTNOY

General Counsel New York, New York 10022

NEAL H. ATTERMAN (212) 715-4990

Deputy General Counsel GLENN M. YouNG *

PUBLIC SECURITIES E. THOMAS MORONEY, JR.

ASSOCIATION SQUIRE, SANDERS & DEMPSEY

One World Trade Center 1201 Pennsylvania Avenue, N.W.

New York. New York 10048 Washington, D.C. 20004

(212) 466-1900 (202) 626-6600

Of Counsel * Counsei of Record

February 28, 1985

SN EIST GI I I ES I NI OS I I

WILSON - EPES PRINTING Co.. INC. - 789-0096 - WASHINGTON. D.C. 20001

Ye

IN THE

Supreme Court of the United States

OCTOBER TERM, 1984

No. 84-1258

CHEMICAL BANK AND

WASHINGTON PUBLIC POWER SUPPLY SYSTEM,

Petitioners,

Vv.

PUBLIC UTILITY DISTRICT No. 1 OF BENTON

COUNTY, WASHINGTON, et al.,

Respondents.

On Petition for Writ of Certiorari to the

Supreme Court of the State of Washington

MOTION FOR LEAVE TO FILE

BRIEF AMICUS CURIAE

The Public Securities Association (PSA) hereby re-

spectfully moves, pursuant to Rules 36.1 and 42 of the

Rules of this Court, for leave to file the attached brief

amicus curiae in support of the petition for a writ of

certiorari. The consent of petitioners, Chemical Bank

and Washington Public Power Supply System, has been

obtained. Consent of each respondent has not been

granted. A request for consent was made to the first

named respondent, Public Utility District No. 1 of Ben-

ton County, Washington, and many of the other Wash-

ington Public Utility Districts. That request was refused.

Th. decision of the Supreme Court of the State of

Washington raises serious constitutional questions under

the fifth and fourteenth amendments and article 1, sec-

tion 10 of the United States Constitution. If allowed to

stand, the decision may have serious impact upon the abi!-

ity of state and local governments to finance their capital

projects through public debt offerings.

PSA, as the representative of broker-dealers and banks

that underwrite over 90 percent of municipal bond is-

sues, has a substantial and continuing interest in the out-

come of this litigation as more fully explained in the

attached brief. PSA is requesting the opportunity to

make its views known to the Court and to underscore

and supplement the argument presented by the Petition-

ers.

Accordingly, PSA hereby requests that the Court grant

this Motion for Leave to File Brief Amicus Curiae and

accept the attached brief as part of the record in this case

Respectfully submitted,

GLENN M. YOUNG

Counsel of Record

SQUIRE, SANDERS & DE“ PSEY

1201 Pennsylvania Avenue, N.W.

Washington, D.C. 20004

(202) 626-6600

February 28, 1985

TABLE OF CONTENTS

Page

ee OF RN Gy ye 8 yo rrr ii

INTEREST OF AMICUS CURIAE .............................. 1

STATEMENT OF THE CASE ........0 1

The Municipal Bond Marketplace... 1

i a _ccaswnanataanmsacansntcaciesas 4

SUMMARY OF ARGUMENT ......... 8

Po CLES bt. rr 5-00 SS RRO ge ee eS 9

I. The Participants Have Unconstitutionally Taken

The Bondholders’ Property _............ 9

A. The Participants’ Inducement and Subse-

quent Destruction of the Bondholders’ In-

vestment is an Unconstitutional Taking of

RET en Senne Soa 9

B. The Participants’ Retention of the Principal

Amount is an Unconstitutional Taking of

REE I rN Ce 12

II. The Washington Supreme Court’s Decision Un-

constitutionally Impairs The Obligation Of Con-

RIMES Ue i a Ro eae Ae ee 16

ii

TABLE OF AUTHORITIES

Cases Page

Appleby v. City of New York, 271 U.S. 364 (1926) .. 16

Carondelet Canal Co. v. Louisiana, 233 U.S. 362

ITITI ishiselaciastsadieaianesccinakesbeasintnitebibigsandsasbeniceddancaataaahiuds 18

Chemical Bank v. Washington Public Power Sup-

ply System, 102 Wash.2d 874, 691 ‘P.2d 524

(1984) (Chemical Bank II) .............................---- passim

Chemical Bank v. Washington Public Power Sup-

ply System, 99 Wash.2d 722, 666 P.2d 329 (1983)

nn NN celine 4

Columbia R. Co. v. South Carolina, 261 U.S. 236

6 SE RRR Pm ntie ee a err iG reo RER 18

Cross Lake Club v. Louisiana, 224 U.S. 632 (1912).. 18

Faitoute iron & Steel Co. v. City of Asbury Park,

Se te SII sigins se nicessphehnanincicnendaninnehennsien 17

Gelpcke v. City of Dubuque, 68 U.S. (1 Wall.)

Sk as 18

Gerzof v. Sweeney, 22 NY2d 297, 239 N.E.2d 521

I hn a a 15

Gillespie v. Yell County, 124 F.2d 632 (8th Cir.,

PTR Eee Sean ade eee Er SOE EN oP RP 14

Hughes v. Washington, 389 U.S. 290 (1967) ....... 11, 15, 16

Kaiser Aetna v. United States, 444 U.S. 164

a Ra eid amiennbinslaiios 9,10

Logan County National Bank v. Townsend, 139

I a 14

Louisiana R. & Nav. Co. v. Behrman, 235 U.S. 164

| Rete a aes We On Reker OSES Rit ROO 18

Louisiana Vv. Wood, 102 U.S. 294 (1880) ......0000.. 14

Mariniello v. Shell Oil Company, 511 F.2d 8538

I cs eausisidlianiics 18

Marsh v. Fulton County, 77 U.S. (10 Wall.) 676

5 RRC as SRO GSP Nee tacest a aN ON oA 14

Murray Vv. Charleston, 96 U.S. 482 (1878).............. 15, 16

Noel v. Cole, 98 Wash.2d 375, 655 P.2d 245 (1982) .. 13

Parkersburg v. Brown, 106 U.S. 487 (1883) ....... 14

Penn Central Transportation Co. v. New York City,

— foe 22 2 ERR PS reveenee 9

iii

TABLE OF AUTHORITIES—Continued

Page

Ruckelshaus v. Monsanto Co., 52 U.S.L.W. 4886,

em § Fes | ee ee ee 9,12

Terre Haute & I.R. Co. v. Indiana, 194 U.S. 579

a an 18

Tidal Oil Co. v. Flanagan, 263 U.S. 444 (1924) ....... 17,18

United States v. General Motors Corp., 323 U.S.

RE 5 MUTED <esisisstscinsispnasietbinsneidaadscceisaineantbthliiamiailanedaneiid 12

United States Trust Co. v. New Jersey, 481 U.S.

5 CRED Sauecsbaeadaeiddaeheabssabasodsaddsiidlabataaiiodal ete 12, 16, 17, 18

Webb’s Fabulous Pharmacies, Inc. v. Beckwith, 449

8 i FR ee eT LETT s 9, 15, 16

Statutes

Wash. Rev. Code § 35.23.440 (44) (1983) _..0..000... 5

Wash. Rev. Code § 35.24.290(3) (1983) 0000. 5

Wash. Rev. Code § 35.27.370(4) (1983)... 5

Wash. Rev. Code § 35A.80.010 (1983) ....0.0 5

Wash. Rev. Code § 35.92.050 (1983) —...0..22o. 6

Wash. Rev. Code ch. 43.52 (1983) -....00000... ee. 5

Wash. Rev. Code § 43.52.410 (1983) _........... unechanetes 5, 19

Wash. Rev. Code § 45.52.910 (1983) _..000.oe co. 5

Wash. Rev. Code § 54.16.040 (1983) 000. 5

1988 Wash. Laws, ch. 308 § 1....................................... 19

Other Authorities

Text Books

Fairman, HISTORY OF THE SUPREME COURT OF THE

UNITED STATES, Vol. IV (1971) .........................-- 3

McQuillin, MUNICIPAL CORPORATIONS, Vol. 10

BS gS a eee revere nnerrcten 13

Palmer, LAW OF RESTITUTION, VOL. 2 § 12.18

ER ERS EC, AINSI a OE Sete Se eae Oe UTE ER 15

Public Securities Association, FUNDAMENTALS OF

MUNICIPAL BONDS (1981) ................20..020...22eeeeeee 2,3

Law Reviews

Comment, Chemical Bank v. WPPSS: A Case of

Judicial Meltdown, 5 J. Energy L. & Pol’y 273

PRINEIT cdisdssesatgacsiicudcncntdatiesbsniaere: aceasta Ap amet mee ne 5, 6

iv

TABLE OF AUTHORITIES—Continued

Comment, Chemical Bank v. Washington Pudlic

Power Supply System: An Aberration in Wash-

inyton’s Application of the Ultra Vires Doctrine,

5 U. Puget Sound L. Rev. 59 (1984) ............0........

Epstein, Toward A Revitalization of the Contract

Clause, 51 U. Chi. L. Rev. 703 (1984) _..............

Note, Chemical Bank v. Washington Public Power

Supply System: The Questionable Use of the

Ultra Vires Doctrine to Invalidate Governmental

Take-or-Pay Obligations, 69 Cornell L. Rev. 1094

SETI: wichsininanigescunabaniiunsissagniltiinincdipiasnetinaasamelaiaanicnmestndiie

Note, The Constitutionality of the New York Mu-

nicipal Wage Freeze and Debt Moratorium:

Resurrection of the Contract Clause, 125 U. Pa.

es. BP EMI vinsainctscitinadialiieanialabtalebahaalbcioicads

Note, A Cry For Reform in Construing Washing-

ton Municipal Corporation Statutes, 59 Wash.

Bik A Te IID Scensavccsnuthibinactiaesmnineiniaanadiaaeds

Note, A Process Oriented Approach to the Contract

Clause, 89 Yale L.J. 1623 (1980) ...... halal Lela

Sunstein, Naked Preferences And The Ceonstitu-

tion, 84 Colum. L. Rev. 1689 (1984) 000000...

Witten & Hecht, Whoops, There Goes Washington:

Is California Next?, 15 Pac. L.J. 955 (1984) .......

Newspapers and Magazines

After Default the Questions of Blame and Duty

Linger, Washington Post, December 5, 1984.......

All WPPSS Bonds Seen in Jeopardy Without BPA

Aid, The Bond Buyer, September 12, 1983 .........

Analysts Assess WPPSS Fallout, Engineering

News-Record, August 4, 1983 200.000... cccccccceeeeeeee

Bani: Makes Move to Force Record Bond Default,

Washington Post, July 23, 1983 0000...

A Belt and Suspenders, Forbes, December 5, 1983..

Financial Fallout From Washington State’s Bond

Biast, Christian Science Monitor, June 20, 1983..

Localities Urged to Borrow More for Infrastruc-

ture, The Bond Buyer, April 18, 1984 _...0....

Page

17

v

TABLE OF AUTHORITIES—Continued

Up From Whoops, Wall Street Journal, August 13,

I Sethe teschcanieieeti atin elegant ni oasctitataatbides

Washington Financial Reports, April 2, 1984 _.......

Whoops A $2 Billion Blunder: Fallout From a Rec-

ord Default Spreads From Washington State to

Wall Street, Time, August 8, 1983 ......................

Trade Authorities

Board of Governors of the Federal Reserve Sys-

tem, Flow of Funds Accounts, Assets and Lia-

bilities Outstanding, First Quarter 1984, No. Z.1

op SEE ESE re ee

Board of Governors of the Federal Reserve Sys-

tem, Flow of Funds Accounts, Third Quarter

1984, No. Z.1 (November 1984) ............0000000 oe...

Public Securities Association, Municipal Securities

EE eee RN

Public Securities Association, 1984 Statistical

Yearbook of Municipal Finance (forthcoming) ..

Page

BRIEF OF THE PUBLIC SECURITIES ASSOCIATION

AS AMICUS CURIAE

IN SUPPORT OF THE PETITION

INTEREST OF AMICUS CURIAE

The Public Securities Association (PSA) is a national

trade organization of approximately 300 members, pre-

dominantly broker-dealers and banks. PSA’s members

underwrite in excess of 90% of the bonds and other obli-

gations of state and local governments publicly sold in the

United States. These obligations are commonly referred

to as “municipal bonds.” PSA members have underwrit-

ten municipal bonds in all 50 states and the District of

Columbia. Among the purposes of PSA is the mainte-

nance of a stable, efficient, and orderly municipal bond

market. The principles at stake in this case are extremely

important to these PSA purposes, and to public confi-

dence in the municipal bond market. Accordingly, PSA

and its members are vitally interested in this Court

granting review.

STATEMENT OF THE CASE

The Municipal Bond Marketplace. Over 6,000 new is-

sues of municipal bonds are marketed or placed each year

in the United States. Public Securities Association, Sta-

tistical Yearbook of Municipal Finance, The New Issue

Market in 1983 (1984). In 1984, the dollar amount of

newly issued municipal bonds was more than $100 bil-

lion. Public Securities Association, Statistics Available

in its Municipal Securities Computer Database (to be

published in 1984 Statistical Yearbook of Municipal Fi-

nance). The principal amount of municipal bonds out-

standing in the United States is approximately $500 bil-

lion. Board of Governors of the Federal Reserve System,

Flow of Funds Accounts, Assets and Liabilities Outstand-

ing, First Quarter 1984, No. Z.1 (March 1984). Individ-

ual investors, either directly or through unit-investment

trusts and open-end bond funds, are an increasingly im-

2

portant segment of this market. For example, such indi-

vidual investors purchased about 70% of the new issues

of municipal bonds during the third quarter of 1984.

Board of Governors of the Federal Reserve System, Flow

of Funds Accounts, Third Quarter 1984, No. Z.1 (Novem-

ber 1984).

Municipal bonds are issued by state and local govern-

ments for a wide range of public purposes. Proceeds

from such bonds are used to construct and maintain such

public projects as rvads, water and sewer lines, and

schools. Such financing is critical now and access by is-

suers to the municipal capital markets will only become

more so as issuers attempt to meet their infrastructure

and other financing needs during the balance of this

century. It is estimated that 80% of the capital needs of

state and local government during the rest of this decade

will be raised through municipal bond issues. 42 Wash-

ington Financial Reports, April 2, 1984 at 550; see also

Localities Urged to Borrow More for Infrastructure, The

Bond Buyer, April 18, 1984 at 1.

Municipal bonds are largely held by individual inves-

tors who primarily are seeking safe, reliable investments

providing a specified yield and, at maturity, a return of

their investment. As stated in the Petition, the Washing-

ton Public Power Supply System (WPPSS) bonds are

widely held by individuals. Chemical Bank and Washing-

ton Public Power Supply System, Petition for Certiorari,

at 8-9 (February 4, 1985) [hereinafter cited as Petition].

This reliance upon the safety of municipal bonds as in-

vestments has not been without foundation. Since the

depression of the 1930’s, there have been relatively few

defaults on the tens of thousands of issues of municipal

bonds in which the American public has invested. Public

Securities Association, FUNDAMENTALS OF MUNICIPAL

BonpDs, 1-3, 118 (1981). As a result of their historical

stability, municipal bonds have been highly regarded as

reliable investments giving issuers ready access to the

capital markets. This investment reliability is based, in

important part, upon the settled nature of municipal fi-

nance law in all jurisdictions and the willingness of is-

suers of such obligations to abide by their contracts.

The municipal bond market has not, however, always

enjoyed a reputation for stability and reliability. After

the Civil War, state and local debt was issued to finance

the building of railroads. The late nineteenth century

brought the onset of depression and widespread disil-

lusionment with unfulfilled promises by railroad develop-

ers. As a result, many defaults ensued and some issuers

resorted to bond contract repudiation in an attempt to

avoid payment. These repudiations were widely and

fiercely challenged in the state courts and over two hun-

dred of these challenges reached this Court. This Court

almost invariably upheld the validity of the bonds and

ordered municipal payment. In the end, the practice

developed of obtaining independent legal opinions attest-

ing to the legality of such municipal debt obligations.

This development restored the market’s reliability and

efficiency.1 See VI C. Fairman, HISTORY OF THE SUPREME

COURT OF THE UNITED STATES, 918-1101 (1971); Public

Securities Association, FUNDAMENTALS OF MUNICIPAL

BONDS, 32-35, 47-48 (1981).

The practice of relying upon bond counsel opinions,

and the market acceptance of those opinions, not only al-

layed concerns borne of the post-Civil War experience

but also avoided the need to seek prior judicial approval

of all potential questions concerning bond issuance. Nec-

essarily, such opinions are based upon the application of

judicial precedent and relevant legal principles. With

great frequency it is necessary for counsel to apply estab-

lished legal principles to a particular point of interpreta-

tion that has not been expressly determined by the courts.

It is of no small importance that counsel be able to rely

1 Fairman writes of the period: “Eventually this wasteful experi-

ence ran its course. The regularity and confidence essential to sound

municipal borrowing was attained by such developments as the rise

of bond counsel... .” Jd. at 1101.

4

upon the reasonable and natural application of such legal

principles. It would be impossible to maintain the effi-

ciency of the current municipal bond market if prior

judicial determination was necessary in all, or even most,

instances. Only a small number of new issues are pres-

ently examined by the courts prior to issuance. If the

thousands of issues newly marketed each year required

prior judicial decision, the courts would have time for

little else and the market would be stultified.

The Decision Belew. In this case, thousands of inves-

tors from across the nation have relied upon opinions of

counsel proffered by the respondents as participants in

the projects. Those counsel opined that the participants

had the legal authority to enter into the contracts that

very explicitly bound them to make certain payments

whether or not the projects were completed, thus assuring

the purchasers of the bonds that they would be repaid

even if the projects failed. The participants also ex-

pressly represented that those obligations were duly au-

thorized and validly given. Those opinions, and the par-

ticipants’ representations, were based upon existing statu-

tory authority and prior judicial decisions. And as the

Washington Supreme Court noted: “all parties assumed

that statutory authority existed.” Chemical Bank v.

Washington Public Power Supply System, 102 Wash. 2d

874, 899, 691 P.2d 524, 5388 (1984) [hereinafter cited as

Chemical Bank II).*

Yet, in spite of that unanimous assumption, which was

confirmed by legal opinions and formal governmental ac-

tion, the Washington Supreme Court overruled the trial

court determination of contract validity and held that

many of the participants were without authority to enter

into the financing commitments. It did so in a decision

noteworthy, to put it mildly, for its breach of the rule

of stare decisis. The majority opinion conveys the im-

2 Chemical Bank Vv. Washington Public Power Supply System, 99

Wash. 2d 722, 666 P.2d 329 (1983) will hereinafter be cited as

Chemical Bank I.

5

pression of a single-minded effort to achieve a result

that fully discharges the participants from all their

obligations and deprives bond investors of their rea-

sonable expectations. That opinion arbitrarily, cate-

gorically, and perfunctorily dismissed every conceiva-

ble ground that might support repayment of the bondhold-

ers. The majority dismissed claims of statutory authority

under Washington statutes that (1) grant authority to

purchase electricity [RCW 54.16.040; RCW 35.23.440

(44); RCW 35.24.290(3); RCW 35.27.370(4); RCW

35A.80.010; RCW 43.52.410], (2) give broad authority

to WPPSS as a joint operating agency [RCW ch. 43.52],

including a provision that such chapter be construed lib-

erally [RCW 45.52.910], and (3) allow many of the par-

ticipants to construct energy facilities [RCW 35.92.050].

After concluding that the participants had no authority

to enter into the financing agreements that contained

so-called “dry hole’ obligations, the majority dismissed,

with equal quickness and lack of substantive support, the

equitable claims of estoppel and restitution. This denial

of all remedy has been uniformly criticized by legal com-

mentary as being an unsupportable and unpredictable

result under pre-existing Washington law.*

The surprising and arbitrary nature of the majority

opinion is most apparent from the strong dissent of three

of the nine Justices of the Washington Supreme Court.

In their dissent, those Justices make it clear that, in their

view, the majority adopted special rules of statutory in-

terpretation and imposed new requirements for statutory

3 See Witten & Hecht, Whoops, There Goes Washington: Is Cali-

fornia Next?, 15 Pac. L.J. 955 (1984); Note, Chemical Bank v.

Washington Public Power Supply System: The Questionable Use

of the Ultra Vires Doctrine to Invalidate Governmental Take-

or-Pay Obligations, 69 Cornell L. Rev. 1094 (1984); Comment,

Chemical Bank v. WPPSS: A Case of Judicial Meltdown, 5 J.

Energy L. & Pol’y 273 (1984) ; Comment, Chemical Bank v. Wash-

ington Public Power Supply System: An Aberration in Washing-

ton’s Application of the Ultra Vires Doctrine, 5 U. Puget Sound L.

Rev. 59 (1984); Note, A Cry for Reform in Construing Washington

Municipal Corporation Statutes, 59 Wash. L. Rev. 653 (1984).

6

application; applying both retroactively to deprive the

investors of their contract and property rights in order to

avoid the imposition of increased utility charges on those

who are voters in the State of Washington.* The unfortu-

nate implication is that an elected state court, in grap-

pling with an unpopular case, may have permitted politi-

cal considerations to tip the scales of justice.

As a result, legal commentators, the investment commu-

nity, and the public at large are understandably skeptical

of the Washington Court’s decision. The decision has

been referred to as “strange” and “corrupting,” ° “dis-

honest” and protectionist,’ and a politically popular de-

cision’ rendered by an “elected tribunal.” * The Chris-

tian Science Monitor stated the premise bluntly: “Many

investors regard the decision as political rather than

legal. They believe the courts were searching for a way

to bail out the utilities.” °

This skepticism not only taints the credibility of the

judiciary and undercuts our shared notions of political

fairness but also impairs confidence in the municipal

finance market to the detriment of all state and local gov-

ernments. The dissent expresses understandable concern

about the probable effects of the majority’s decision upon

the ability of Washington municipalities to finance their

capital projects. Chemical Bank IJ, 102 Wash. 2d at 917,

691 P.2d at 548 (Utter, J., dissenting). And, public re-

action to the WPPSS default suggests that the Washing-

4 Chemical Bank II, 102 Wash. 2d 874, 918, 691 P.2d 524, 546

(1984) (Utter, J., dissenting).

5 Up From Whoops, Wall Street Journal, August 13, 1984, at 15.

® Comment, Chemical Bank v. WPPSS: A Case of Judicial Melt-

down, 5 J. Energy L. and Pol’y 278, 298 (1984).

7 Note, A Cry For Reform In Construing Washington Municipal

Corporation Statutes, 59 Wash. L. Rev. 653, 660 (1984).

8 After Default the Questions of Blame and Duty Linger, Wash-

intgon Post, December 5, 1984 at 1, 16, col. 1.

® Financial Fallout from Washington State’s Bond Blast, Chris-

tian Science Monitor, June 20, 1983 at 10, 11, col. 1.

7

ton decision has had a costly effect upon the bond market

and bond prices.’® True, such an effect may be amelio-

rated over time, as the market assesses whether Chemical

Bank II can safely be characterized as an aberration.

Still, so long as the decision below stands, the impression

will nevertheless remain that at least one state court, in

a case involving the largest default in municipal bond

history, felt constrained to permit local financial exigen-

cies to affect its application of legal precedent.

For these reasons, this Court should review the decision

of the Supreme Court of Washington. Without such

review, the underlying principles upon which municipal

bond financing currently operates efficiently may be

eroded, just as it was in the late nineteenth century.

Fortunately, review was then granted and the founda-

tions of public finance—the obligation of contract and

legal predictability—-were preserved. To allow the Wash-

ington Supreme Court decision to go unreviewed may

prompt other state and local governments to resort to, or

at least attempt to obtain, state court protection as an

alternative to honoring the obligations of financial con-

tracts that in hindsight prove to have been made for un-

successful projects. Such a development could well under-

mine what is currently an efficient, effective, and very

10 See A Belt and Suspenders, Forbes, December 5, 1983, at 250,

250-251 (WPPSS “has done for bond sales what Baldwin-United

has done for annuities.”); Whoops A $2 Billion Blunder; Fallout

From a Record Default Spreads From Washington State to Wall

Street, Time, August 8, 1983, at 50 (investor confidence shaken) ;

All WPPSS Bonds Seen in Jeopardy Without BPA Aid, The Bond

Buyer, September 12, 1983, at 1 (WPPSS uncertainties have led

to an interest rate increase of about 150 basis points for municipal

bonds.); Analysts Assess WPPSS Fallout, Engineering News-

Record, August 4, 1983, at 10 (WPPSS default “threw the whole

system into question—the value of a legal opinion, the value of a

rating. Utilities will . . . have to pay higher yields.” quoting G.

Friedlander, vice president at Smith Barney, Harris Upham &

Co.) ; Bank Makes Move To Force Record Bond Default, Washing-

ton Post, July 23, 1983, at 1 (default could “cost municipalities

hundreds of millions of extra dollars in financing charges’’).

8

desirable public finance marketplace to the detriment of

not only all participants in that market but also the

nation as a whole.

SUMMARY OF ARGUMENT

As demonstrated by the Petition, the Washington

Supreme Court decision raises substantial federal ques-

tions under the Taking, Contract, and Due Process Clauses

of the United States Constitution. We wish to emphasize

the interests of bondholders and the unfortunate effect of

that decision on the municipal bond market and to urge,

from that perspective, that issues arising under both the

Taking Clause and the Contract Clause require review by

this Court. Specifically, the governmental inducement of

the bondholders’ investment and the subsequent denial of

all remedies—including even simple restitution—are, from

a municipal bond market perspective, the most pernicious

aspects of the Washington Court’s decisicn when reviewed

under the Taking Clause. Similarly, from that perspec-

tive, a review of the Washington Court’s decision under

the Contract Clause is fully warranted under the partic-

ular circumstances here presented.

More generally, this case uniquely calls for the appli-

cation of the constitutional principles underlying both the

Taking Clause and the Contract Clause to eliminate the

fundamental evil against which those clauses stand—the

imposition of arbitrary or political actions or decisions

that would reallocate wealth solely on the basis of re-

gional or political favoritism."’ Indeed, those principles

must be applied in this case where state agency repudia-

tion of contractual obligations is upheld by a state court

decision, uniformly criticized for its protectionist focus

and cavalier denial of remedial relief, that results in bil-

11 See Sunstein, Naked Preferences And The Constitution, 84

Colum. L. Rev. 1689 (1984). Many of the clauses of the Constitu-

tion focus on a single underlying evil: “the distribution of re-

sources or opportunities to one group rather than another solely on

the ground that those favored have exercised the raw political

power to obtain what they want.” Jd. at 1689.

9

lions of dollars being transferred from the pockets of

bondholders comprised primarily of out-of-state residents

to the pockets of Washington state residents.

ARGUMENT

I. The Participants Have Unconstitutionally Taken The

Bondholders’ Property.

The cancellation of the participants’ agreements, and

the resultant transfer of billions of dollars from the bond-

holders to the participants and their ratepayers, amounts

to a taking of private property in violation of the fifth

amendment of the Constitution. The Washington Court in

countenancing such contract repudiation not only upheld

such action—but also eliminated all remedial relief—even

the minimally compensatory right of restitution.

Petitioners have argued, and we agree, that the partic-

ipants’ abrogation of their contracts and retention of over

two billion dollars in principal amount constitutes an

unconstitutional taking under the decisions of this Court

in Penn Central Transportation Co. v. New York City,

438 U.S. 104 (1978) and Webb’s Fabulous Pharmacies,

Inc. Vv. Beckwith, 449 U.S. 155 (1980). Two particularly

outrageous aspects of the participants’ actions draw

special attention.

A. The Participants’ Inducement and Subsequent De-

struction of the Bondholders’ Investment is an Un-

constitutional Taking of Property.

This Court has held that government may not induce

an investment, thereby creating a legitimate investment-

backed expectation of private property, and then destroy

that expectation by taking the property without just com-

pensation. Ruckelshaus v. Monsanto Co., 52 U.S.L.W.

4886, 4892, 81 L.Ed 2d 815, 838 (1984) (“explicit gov-

ernmental guarantee formed the basis of a reasonable

investment-backed expectation’) ; Kaiser Aetna v. United

States, 444 U.S. 164 (1979).

There could be no clearer example than this case

of intentional, governmenta! inducement leading to the

10

creation of an investment-backed expectation, followed by

its destruction by the government. The participants con-

tracted with and directed WPPSS; the participants hired

counsel to give opinions; the participants entered into

the bond financing transaction with clear awareness of

the “dry hole” provision and its market significance; the

participants allowed and authorized that transaction to

go to the public bond market with the representation that

the “dry hole” provision secured repayment of the bonds;

indeed, the participants authorized WPPSS to go to that

same public market fourteen times with that same repre-

sentation. Thus participants intentionally and knowingly

induced a $2.25 billion transfer of principal from private

bondholders. After such transfer, and when their projects

failed, the participants willfully destroyed the security for

the bonds thereby eliminating all source of repayment.

The proposition that government may not encourage the

private sector to incur investment costs and then proceed

to take the completed investment without compensation is

at least as applicable here as in Kaiser. Indeed, the gov-

ernmental activity in Kaiser was mild compared to the

participants’ actions. The Army Corps of Engineers in

Kaiser merely consented to the dredging of a pond and

construction of a channel—activity that ultimately created

a navigable body of water that the government claimed

thereby became subject to public use. Yet, the Court in

requiring compensation noted the government’s induce-

ment: “While the consent of individual officers cannot

‘estop’ the United States, it can lead to the fruition of a

number of expectancies embodied in the concept of ‘prop-

erty’—expectancies that, if sufficiently important, the

Government must condemn and pay for before it takes

over the management of the landowner’s property.”

Kaiser, 444 U.S. at 179 (citations omitted). It does not

require intense analysis to view Kaiser as teaching that,

while the unauthorized actions of individual officials may

not contractually bind the municipality, they can lead to

the fruition of expectations that at least must be paid for

if taken. Certainly, the participants actively induced the

11

investment. It would be as if the Army Corps of Engi-

neers in Kaiser had sought out the developer and given

him a written guarantee that the completed marina would

be his, instead of merely allowing the investment to be

made.

Furthermore, like the developer in Kaiser, the bond-

holders did not accept the risk of confiscation of this gov-

ernmentally induced investment. The bondholders took

the risks normally assumed in the municipal bond market,

namely that the value of their bonds might decrease

and/or that the participants might default by reason of

an inability to pay. Under no circumstance did the bond-

holders willingly take the risk that the participants might

simply decide not to pay or more incredibly, that any

decision to back out would be countenanced by the Wash-

ington Supreme Court in a decision that appears to create

law solely to produce a preordained result. To assert

that the bondholders took the risk of calculated breach of

contract undercuts the very concept of contract, particu-

larly in the municipal bond market. Fortunately, the

Washington Court may not constitutionally use its ex

post facto realignment of bondholder/participant risks to

vindicate the participants’ taking of the bondholders’ in-

vestment. Cf. Hughes v. Washington, 389 U.S. 290, 296-

97 (1967) (Stewart, J., concurring) (“a sudden change

in state law, unpredictable in terms of relevant prece-

dents . . . cannot be permitted to defeat” the Taking

Clause). The fact is the bondholders made a loan to the

participants—not a gift—and the “dry hole” provision

not only induced the marketing of the bonds, but also

determined precisely the allocation of risk. In sum, the

bondholders held indebtedness, not equity, and assumed

the market and default risks inherent in any municipal

bond transaction. The participants obtained the benefit

of the financing in support of their projects and assumed

the risk that such projects might not be as successful as

predicted or would even fail totally.

12

B. The Participants’ Retention of the Principal Amount

is an Unconstitutional Taking of Property.

The Washington Court, by denying any restitutionary

remedy, has sanctioned the participants’ unconstitutional

taking of the bondholders’ funds. To justify this result,

the Washington Supreme Court concluded that the pro-

ceeds received from the sale of the bonds only benefited

WPPSS as the joint operating agency and that, therefore,

no restitution was due from the participants. Chemical

Bank IT, 102 Wash. 2d at 911, 691 P.2d at 545. This con-

clusion, however, ignores the fundamental facts. The par-

ticipants caused WPPSS to act as their agent. Independ-

ent of the participants, WPPSS had no intention, no need,

indeed no ability, to build the projects for which the bonds

were issued. WPPSS was conceived, designed, and em-

ployed as nothing more than a conduit on behalf of, and

for the convenience of, the participants. Thus, under any

possible, fair analysis the benefit of the bond proceeds was

intended for and ran to the participants. It was precisely

to obtain such benefit, by assuring bond marketability,

that the participants offered the “dry hole” inducements.

See United States Trust Co. v. New Jersey, 431 U.S. 1,

18 (1977) (Bond marketability is a recognizable benefit. ).

WPPSS by itself could not, nor did it desire to, market a

single bond for the projects without the involvement of, or

except for the benefit of, the participants.

More to the point, is the question of by whom was the

property destroyed. See Ruckelshaus v. Monsanto Co.,

52 U.S.L.W. 4886, 4891, 81 L.Ed 2d 815, 833-34, (1984) ;

United States v. General Motors Corp., 323 U.S. 373, 378

(1945) (“deprivation of the former owner rather than

accretion of a right or interest to the sovereign consti-

tutes the taking”). And, as to that determinative ques-

tion there is no dispute but that the participants are

solely responsible for the destruction of the bonds’ value.

It was the abrogation by the participants of their commit-

ment to provide security for the bonds, and not failure of

the projects, that destroyed the bonds’ value. It is, ulti-

mately, irrelevant whether WPPSS or the participants

13

received the benefit of the bonds. What is dispositive and

beyond argument is the act of destruction and the actors

involved: the participants’ repudiation of contract and

retention of principal as sanctioned by the Washington

Supreme Court.

The Washington Court’s decision also foreclosed any

restitutionary remedy whatsoever on the basis of its con-

clusion that participants’ assumption of “dry hole” obli-

gations was substantially ultra vires. Chemical Bank II,

102 Wash. 2d at 910-911, 691 P.2d at 544-45. Even if

one could accept the Washington Court’s questionable

interpretation of municipal authority, it cannot be plau-

sibly asserted that such “authority ... [was] so com-

pletely lacking it seems fair to presume bad faith on the

part of the private party [bondholders].” Noel v. Cole,

98 Wash. 2d 375, 381 n.3, 655 P.2d 245, 250 n.3 (1982).

Yet that bad faith presumption is necessary for a finding

of substantive ultra vires and a denial of restitution under

Washington law.’* It is fundamentally indefensible for

12 The Noel court held that the lack of authority there alleged did

not render the contract substantively ultra vires and hence restitu-

tion was awarded. The Court used a two part ultra vires test: (1)

“the agency must have had the power it sought to exercise but

merely have exercised it in an irregular manner or by unauthorized

procedural means,” and (2) “the action must not be malum in se,

malum prohibitum, or manifestly against public policy.” The Court

held that the state “had the general authority to sell the timber

rights” and the action was not so against public policy as to pre-

sume bad faith. Noel, 98 Wash. 2d at 381-82, 655 P.2d at 249-50.

Substantive ultra vires may defeat the demand for payment

where no reasonable person could have thought the act authorized

or if there is an express prohibition of the power purportedly

exercised. See 10 E. McQuillin, MUNICIPAL CORPORATIONS, § 29.131

(8rd ed. 1981). It cannot be said either that there was a clear

lack of authority to enter into the Participant Agreements or that

the bondholders acted in bad faith. The Washington Court ac-

knowledged that authority to enter into the “dry hole” obligations

existed, if either control or ownership had been maintained by the

participants. Moreover, it is beyond dispute that all concerned

parties believed in good faith that the “dry hole” obligations were

valid.

4‘

14

the Washington Court to have held that the participants’

failure to exercise sufficient contro! over the projects—a

requirement nowhere set forth in any relevant statute or

imposed by prior judicial decision—amounts to substan-

tively ultra vires activity. Indeed, it is disingenuous for

the Washington Court to assert that there was a complete

lack of authority for the participants’ contracts when,

prior to the decision in Chemical Bank I, the Washington

legislature itself deemed it necessary to enact express re-

strictions on the authority of public bodies to conclude the

“dry hole” contracts. See infra note 16. Moreover, both

the trial court and three members of the Washington

Court itself did not find the lack of authority in this

instance to be clear. In that light, it is difficult to assert,

much less conclude, that the bondholders either acted in

bad faith or in disregard of the participants’ complete

“lack of authority.” The Washington Court’s finding of

substantive ultra vires, however, rests entirely upon that

flawed premise.

Except in the most extreme circumstances, municipal

corporations have not been permitted to cite lack of

authority to contract or incur indebtedness as a basis to

enrich themselves by excusing their obligations to repay

funds advanced. Many years ago, this Court held that:

“While . . . the bonds cannot be enforced, because defec-

tively executed, the money paid for them may be recovered

back. ... ‘[T]he obligation to do justice rests upon all

persons, natural or artificial, and if a county obtains

the money or property without authority, the law, inde-

pendent of any statute, will compel restitution or compen-

sation.’” Louisiana v. Wood, 102 U.S. 294, 299 (1880)

(quoting Marsh v. Fulton County, 77 U.S. (10 Wall.)

676, 684 (1871)); see also Logan County National Bank

v. Townsend, 139 U.S. 67 (1891) ; Parkersburg v. Brown,

106 U.S. 487 (1883); Gillespie v. Yell County, 124 F.2d

632, 637 (8th Cir., 1942) (“Persons who have innocently

paid their money for [invalid] bonds are universally held

to be entitled to recover ....”). Professor Palmer has

similarly considered and ad‘ressed this issue. “It would

15

be a manifest injustice to permit a municipality to borrow

money pursuant to an invalid promise to repay it, retain

the money, or use it for a proper municipal purpose, and

yet not be accountable for the enrichment.” II G. Palmer,

LAW OF RESTITUTION, § 12.18, at 670 n.11 (1978).

The underlying purpose and effect of these decisions is

in accord with the Taking Clause. Just as a state may

not arbitrarily redefine property rights, similarly it may

not arbitrarily redefine, by “ipse dixit,” contract rights or

equitable remedies that amount to property interests.

Cf. Webb’s Fabulous Pharmacies, Inc. v. Beckwith, 449

U.S. 155 (1980); Hughes v. Washington, 389 U.S. 290,

296-97 (1967) (Stewart, J., concurring). Absent bad

faith on the part of the lender, a municipality may not

borrow money, albeit without authority to do so, and then

refuse to repay the loan."* The Taking Clause prohibits

such confiscation unless: (1) municipal authority is so

completely lacking as to negate any inference of govern-

mental action and to suggest bad faith on the part of the

lender, or (2) the award of restitution would substan-

tially undercut an express, legitimate state interest." To

read the Taking Clause in a more restrictive manner

would gut it of any meaning in the municipal finance con-

text. A municipality could always manage to borrow

funds “illegally” and thereby avoid repayment pursuant

to its contract, as well as the requirement of just compen-

18 Cf. Murray V. Charleston, 96 U.S. 482, 445 (1878) (a sovereign

right to withhold or aiter the terms of payment cannot be read into

state contracts). Murray also must be read as disallowing a claim

that special and obscure rules govern municipal authority to borrow

and hence the obligation to repay. Murray minimally requires a re-

strictive ultra vires doctrine—only the most egregious (and there-

fore notorious) lack of authority, leading to the presumption of bad

faith, can relieve the municipal obligation to return monies or bene-

fits received in consideration for an invalid contract.

‘4 Compare contracts made in direct violation of public bidding

statutes. The award of quasi-contractual relief in such an instance

would completely undermine the statute by allcving the municipal-

ity to reap the services and the contractor to be paid fair value.

See e.g., Gerzof V. Sweeney, 22 NY2d 297, 239 N.E.2d 521 (1968).

16

sation. This would elevate municipalities to a level of

sovereignty this Court found unacceptable a century ago.

See e.g., Murray v. Charleston, 96 U.S. 432 (1878). And,

if supported by decisions like Chemical Bank II, it would

weaken to the detriment of all municipalities the relia-

bility of contractual obligations on which the municipal

bond market has rested since this Court’s early repudia-

tior of such conduct.

Il. The Washington Supreme Court’s Decision Unconstitu-

tionally Impairs The Obligation Of Contract.

An apparent hurdle to an assessment of the Contract

Clause issue present in this case is the Washington Court’s

conclusion that no authorized contract ever existed. How-

ever, a state court’s interpretation as to the existence of a

contract is necessarily reviewable as a question of federal

constitutional law when the Contraci Clause is implicated.

Appleby v. City of New York, 271 U.S. 364 (1926) ; ef.

Webb’s Fabulous Pharmacies, Inc. v. Beckwith, 449 U.S.

155 (1980); Hughes v. Washington, 389 U.S. 290, 296-

97 (1967) (Stewart, J., concurring). Thus, the Wash-

ington Supreme Court’s attempt to deny the existence of

the eontract by “ipse dixit” or arbitrary change of state

law, begins rather than precludes a “Contract Clause”

inquiry.

The Washington Supreme Court’s retroactive denial of

municipal authority and release of the participants from

their “dry hole” obligations is an unconstitutional impair-

ment of the bondholders’ contracts. The Contract Clause

prevents the abrogation by a state of its own indebtedness.

United States Trust Co. v. New Jersey, 431 U.S. 1, 17

(1977). Indeed, a state’s abrogation of its own obliga-

tions is the most worrisome of contract impairments.

State self-interest can, in such an instance, overwhelm

traditional checks upon state action. This is especially

true in the municipal bond context where the state has

only a purely financial interest at stake. Indeed, only

once in this century has alteration of a municipal bond

contract been sustained by this Court and that was a case

17

where a bankrupt municipality was placed in receiver-

ship. United States Trust, 481 U.S. at 27 (citing Faitoute

Iron & Steel Co. v. City of Asbury Park, 316 U.S. 502

(1942)). In this case, the participants, the bondholders,

the trial court, the dissent in Chemical Bank II, legal

commentary on that decision and, perhaps, even the Wash-

ington legislature all found, at one time or another, au-

thority for the contracts under the applicable Washing-

ton statutes and prior Washington decisions governing

statutory interpretation. The surprising opinion of the

Washington Supreme Court, however, released the munic-

ipalities from their contractual obligation to provide

the bond payments. Unless this Court grants certiorari

and reverses the decision below, the municipal partic-

ipants, having signed a contract pledging payment and

having received its benefits for five years, will have suc-

cessfully repudiated their contractual obligations when it

appeared that they would become unexpectedly burden-

some.

This Court’s decision in Tidal Oil Co. v. Flanagan, 263

U.S. 444 (1924), does not preclude the Washington

Court’s decision from being subject to constitutional re-

view under the Contract Clause. The policies behind

Tidal Oil would not be disserved by reviewing the decision

below under the Contract Clause. Tidal Oil was designed

to avoid common law distortion by preventing every state

court decision from becoming of constitutional dimen-

sion. Additionally, the exclusion of judicial decisions

rested upon the belief that it is legislative misbehavior

with which the Contract Clause was primarily concerned.

See Epstein, Toward A Revitalization of the Contract

Clause, 51 U. Chi. L. Rev. 708, 747-48 (1984). Tidal Oil,

however, need not be read as precluding a review of state

judicial abrogation of municipal financial obligations when

it is apparent that such judicial action is merely serving

as a substitute for, or an extension of, state legislative

action.

Rather, in such situations state judicial review of con-

tract authority, like state legislative impairment of such

18

contracts, should be subjected to more exacting review.

See United States Trust, 431 U.S. at 26; see also Note,

A Process Oriented Approach to the Contract Clause, 89

Yale L. J. 1623, 1627 (1980) ; Note, The Constitutionality

of the New York Municipal Wage Freeze and Debt Mora-

torium: Resurrection of the Contract Clause, 125 U. Pa.

L. Rev. 167, 187-90 (1976). The deference normally given

to state court determinations cannot be justified when

the impression is uniformly created among impartial ob-

servors that political considerations or regional prefer-

ence may have influenced the reasoning proffered in sup-

port of those determinations.”

Moreover, this Court has undertaken review of state

judicial decisions under the impairment clause when those

decisions give effect to or enforce legislative action. Tidal

Oil, 263 U.S. at 453 (citing with approval Louisiana R.

& Nav. Co. v. Behrman, 235 U.S. 164, 170-71, (1914) and

Carondelet Canal Co. v. Louisiana, 233 U.S. 362, 376

(1914)); see also Columbia R. Co. v. South Carolina, 261

U.S. 236, 245 (1923) (“[A]lthough the state court may

have construed the contract and placed its decision dis-

tinctly upon its own construction, if it appears, upon

examination, that in real substance and effect, force has

been given to the statute complained of our jurisdiction

attaches.” ) ; Cross Lake Club v. Louisiana, 224 U.S. 632,

638-39 (1912) (“[W]hen the state court, either expressly

or by necessary implication, gives effect to a subsequent

law of the state whereby the obligation of the contract is

alleged to be impaired a federal question is presented.’’) ;

Terre Haute & I.R. Co. v. Indiana, 194 U.S. 579 (1904).

This result is supported by the legitimate concern that

state self-interest in such circumstances has permeated

the state judiciary. See Mariniello v. Shell Oil Company,

511 F.2d 853, 859 (8rd Cir., 1975: (in both Columbia

Railway and Terre Haute this Court was confronted with

15 This Court’s admonition in Gelpcke v. City of Dubuque, 68

U.S. (1 Wall.) 175, 206-07 (1864) is worth recalling: ‘We shall

never immolate truth, justice, and the law, because a State tribunal

hee erected the altar and decreed the sacrifice.”

19

state court decisions that “worked a substantial forfeiture

of land or money in favor of the state government.” ).

In this case, the inference that the Washington Supreme

Court, by its forced approach to statutory interpretation,

may have been extending legislative action is clearly

present and urges review by this Court. In this respect it

should be noted that the Washington legislature banned

unlimited “dry hole” commitments after the WPPSS

default but before the decision in Chemical Bank I.

While the Washington Supreme Court did not expressly

rely on the statutory amendment, it did acknowledge the

enactment in a different context. More importantly, the

result of its strained statutory interpretation was to give

retroactive effect to the amendment as a practical matter.

If, as unfortunately seems apparent, the Washington

Court has chosen to join the fray by rendering a decision

that seems little more than a practical replacement for

legislative action, then by that choice it has made its deci-

sion subject to review as constituting an unlawful impair-

ment of contract.

CONCLUSION

By its decision in Chemical Bank II, the Washington

Supreme Court would push concepts of municipal finance

back to the late nineteenth century, to the immediate

relief of the participants but the continuing distress of the

municipal bond marketplace. Fortunately, in that earlier

era, this Court refused to permit municipal governments

to repudiate their obligations just because the projects for

16 RCW 43.52.410 amended in 1983 to add the proviso: “[N]o

city or district may enter into a contract or compact with an

operating agency to purchase electric energy, or to purchase or

participate in a portion of an electrical generating project, that

commits the city or district to pay an amount in excess of an ex-

press dollar amount or in excess of an express rate per unit of

electrical energy received.” 1983 Wash. Laws, ch. 308 §1. This

amendment passed the Washington Legislature April 22, 1983 and

was approved by the Governor of Washington on May 17, 1983.

Chemical Bank I was decided June 15, 1983.

20

which those obligations were assumed turned out to be

unsuccessful or unpopular. Although the constitutional

landscape has changed significantly in the past 100 years,

the fundamental concepts protecting the property rights

of citizens from abrogation by state and local government

have not been abandoned. The application of those con-

cepts to this case produce the conclusion that the Wash-

ington Court’s reconstruction of state law constituted an

impairment of the bondholders’ contracts and that the

participants’ retention of the bondholders’ funds consti-

tuted an uncompensated taking of private property. A

review of this case by this Court is fully warranted, inter

alia, to assure the application of those fundamental con-

stitutional concepts for the protection of, and the mainte-

nance of continued confidence in, the municipal bond

market.

Amicus, therefore, respectfully suggests that the peti-

tion for a writ of certiorari to the Supreme Court of

Washington should be granted.

Respectfully submitted,

R. THOMAS STANTON

SQUIRE, SANDERS & DEMPSEY

ROBERT A. PORTNOY

General Counsel

NEAL H. ATTERMAN

Deputy General Counsel

PUBLIC SECURITIES

ASSOCIATION

One World Trade Center

New York, New York 10048

(212) 466-1900

Of Counsel

February 28, 1985

520 Madison Avenue

New York, New York 10022

(212) 715-4990

GLENN M. YOUNG *

E. THOMAS MORONEY, JR.

SQUIRE, SANDERS & DEMPSEY

1201 Pennsylvania Avenue, N.W.

Washington, D.C. 20004

(202) 626-6600

* Counsel of Record