Opinion ID: 2369443
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Heading Rank: 1

Heading: Validity of the Statutory Preferences and Priorities

Text: Whether the provisions of R.I. Gen. Laws § 19-15-7 and 42-116-7(b) through (e) as enacted on February 8, 1991 constitute a valid exercise by the legislature of the `police powers' of the State of Rhode Island or whether such provisions constitute (i) a law impairing the obligation of contracts in violation of Article I, Section 10 of the Constitution of the United States or Article I, Section 12 of the Constitution of Rhode Island, (ii) a taking of private property for a public use without just compensation in violation of Amendment V of the Constitution of the United States or Article I, Section 16 of the constitution of Rhode Island or (iii) a denial to any person of equal protection of the laws under Amendment XIV, Section 1 of the Constitution of the United States or Article I, Section 2 of the Constitution of Rhode Island? Sections 19-15-7 and 42-116-7 of the DEPCO act set forth the priority of claims and the order of distribution as follows: (1) reasonable administrative expenses, (2) unsecured claims for wages, (3) unsecured claims of depositors up to an amount insurable under the Federal Deposit Insurance Act, 12 U.S.C. §§ 1811-1832 (1988), (4) unsecured claims of depositors that exceed the amounts recoverable under the Federal Deposit Insurance Act, (5) unsecured claims of any local, state, or federal taxing agency entitled to priority under law, and (6) unsecured claims of all general creditors and depositors to the extent not accorded priority above. We note at the outset that the state has broad police powers to pass legislation promoting the health, welfare, and safety of the people. (Opinion to the Governor), 24 R.I. 603, 605, 54 A. 602, 603 (1902). As stated above, the broadest scope of that power in furtherance of a public purpose is in the area of economic welfare. Advisory Opinion to the Governor, 113 R.I. at 595, 324 A.2d at 646-47. The first constitutional challenge under this question is whether the preferences and priorities set forth in the DEPCO act constitute a law impairing the obligation of contracts in violation of the State and the Federal Constitutions. U.S. Const. Art. I, sec. 10; R.I. Const. art. 1, sec. 12. In Energy Reserves Group, Inc. v. Kansas Power & Light Co., 459 U.S. 400, 103 S.Ct. 697, 74 L.Ed.2d 569 (1983), the Supreme Court announced the following three-part test to determine whether legislation unconstitutionally impairs the obligation of contracts. First, has the state law in fact substantially impaired a contractual relationship? Id. at 411, 103 S.Ct. at 704, 74 L.Ed.2d at 580. Second, if the law constitutes a substantial impairment, can the state show a legitimate public purpose behind the regulation, such as the remedying of a broad and general social or economic problem? Id. at 411-12, 103 S.Ct. at 704-05, 74 L.Ed.2d at 581. Third, is the legitimate public purpose sufficient to justify the impairment of the contractual rights? Id. at 412, 103 S.Ct. at 705, 74 L.Ed.2d at 581. Under traditional receivership law, depositors and general creditors would share in any available assets on a pro rata basis. Under the DEPCO act depositors are paid in full before general creditors receive anything. Thus the general creditors' actual recovery may be substantially affected if the available assets are inadequate. We find, however, that this new priority does not impair the contractual relationship but affects only the timing of payment. See In re Inland Dredging Corp., 61 F.2d 765, 766 (2d Cir.1932) (impairment clause allows changes in remedy but not in right), cert. denied, 288 U.S. 611, 53 S.Ct. 403, 77 L.Ed. 985 (1933). Furthermore, even if we were to find an impairment of the contractual relationship, that impairment would be sufficiently justified by the legitimate public purpose of returning funds to deposit creditors and eventually to the Rhode Island economy. The second constitutional challenge is whether the statutory preferences and priorities constitute a taking of private property for public use without just compensation in violation of the State and the Federal Constitutions. U.S. Const. Amend. V; R.I. Const. art. 1, sec. 16. It is well settled that interests in specific property created by mortgages, security interests, or liens may not be taken without just compensation. United States v. Security Industrial Bank, 459 U.S. 70, 75, 103 S.Ct. 407, 410-11, 74 L.Ed.2d 235, 240-41 (1982). Contract rights that do not create interests in specific property, however, remain subject to alteration by paramount federal or state powers exercised for public purposes. Peick v. Pension Benefit Guaranty Corp., 724 F.2d 1247, 1275-76 (7th Cir.1983), cert. denied, 467 U.S. 1259, 104 S.Ct. 3554, 82 L.Ed.2d 855 (1984). The private property at issue here is the pool of assets belonging to the failed financial institutions in receivership. Neither the depositors nor the general creditors have interests in any specific property of the institution; only their claims based on contractual or tort liability are affected. The Supreme Court has identified three factors that determine whether there has been an unconstitutional taking: (1) the character of the governmental action, (2) the economic impact of the regulation on the claimant, and (3) the extent to which the regulation has interfered with distinct investment-backed expectations. Connolly v. Pension Benefit Guaranty Corp., 475 U.S. 211, 224-25, 106 S.Ct. 1018, 1026, 89 L.Ed.2d 166, 178-79 (1986). Applying these factors to the DEPCO act, we find as follows. First, no property has been physically invaded or appropriated for the government. The Supreme Court has stated that an unconstitutional taking may be found more readily when the property is physically invaded than when interference arises from some public program adjusting the benefits and burdens of economic life to promote the common good. Penn Central Transportation Co. v. New York City, 438 U.S. 104, 124, 98 S.Ct. 2646, 2659, 57 L.Ed.2d 631, 648 (1978). Second, the economic impact on creditors amounts to a mere adjustment of the timing of distribution with respect to the available assets. Third, general unsecured creditors by definition have no investment-backed expectations. Their interests are subject to such variables as changes in the law of receivership and insolvency of the institution. Accordingly we conclude that the statutory priorities do not amount to an unconstitutional taking of private property. The third constitutional challenge is whether the statutory preferences and priorities constitute a denial to any person of the equal protection of the laws. U.S. Const. Amend. XIV, sec. 1; R.I. Const. art. 1, sec. 2. Although the state has wide discretion in enacting legislation, it must show that the legislation is rationally related to a legitimate state interest in order to overcome an equal-protection challenge. City of New Orleans v. Dukes, 427 U.S. 297, 303, 96 S.Ct. 2513, 2516-17, 49 L.Ed.2d 511, 516-17 (1976). The mere fact that the legislation could have been drawn more precisely will not invalidate the statute. Lindsley v. Natural Carbonic Gas Co., 220 U.S. 61, 78, 31 S.Ct. 337, 340, 55 L.Ed. 369, 377 (1911). The constitutional safeguard is offended only if the classification rests on grounds wholly irrelevant to the achievement of the State's objective. McGowan v. Maryland, 366 U.S. 420, 425, 81 S.Ct. 1101, 1105, 6 L.Ed.2d 393, 399 (1961). As we have discussed above, the DEPCO act serves a legitimate state purpose: it alleviates the widespread economic hardship caused by the current banking emergency. Furthermore, the statutory priorities are rationally related to this purpose by providing an orderly mechanism for restoring funds to the state's wounded economy. The provisions allowing for the payment in full of smaller claims before larger ones are neither arbitrary nor capricious but serve to further the legitimate state interest. See United Wire, Metal and Machine Health and Welfare Fund v. State Deposit Insurance Fund Corp., 307 Md. 148, 159-60, 512 A.2d 1047, 1053 (1986) (discussing rational relationship between reduction in number of accounts and reduction in costs of receivership).