Opinion ID: 2543124
Heading Depth: 1
Heading Rank: 3

Heading: Impairment of Contract under the Contract Clause

Text: ś 14 This matter is here on appeal from summary judgment, which is properly granted if there are no material issues of fact and the moving party is entitled to judgment as a matter of law. An appellate court reviews a grant of summary judgment de novo. Wash. Fed. of State Employees v. State, 127 Wash.2d 544, 551, 901 P.2d 1028 (1995). ś 15 A party challenging a statute's constitutionality bears the heavy burden of establishing its unconstitutionality. Larson v. Seattle Popular Monorail Auth., 156 Wash.2d 752, 757, 131 P.3d 892 (2006) (citing Amalgamated Transit Union Local 587 v. State, 142 Wash.2d 183, 205, 11 P.3d 762, 27 P.3d 608 (2000); Hemphill v. Tax Comm'n, 65 Wash.2d 889, 891, 400 P.2d 297 (1965)). This standard is met if argument and research show that there is no reasonable doubt that the statute violates the constitution. Larson, 156 Wash.2d at 757, 131 P.3d 892 (citing Amalgamated Transit, 142 Wash.2d at 205, 11 P.3d 762). ś 16 The intervenors contend that the trial court erred in concluding on summary judgment that the initiative unconstitutionally impairs the contract between the bondholders and Sound Transit in violation of article I, section 23 of the Washington Constitution. The Washington Constitution, article I, section 23 mandates that No . . . law impairing the obligations of contracts shall ever be passed. [5] It is fundamental that this prohibition against impairing contracts reaches any form of legislative action, including direct action by the people through the initiative process. Ruano v. Spellman, 81 Wash.2d 820, 825, 505 P.2d 447 (1973). ś 17 The prohibition against any impairment of contracts is `not an absolute one and is not to be read with literal exactness.' Tyrpak v. Daniels, 124 Wash.2d 146, 151, 874 P.2d 1374 (1994) (quoting Home Bldg. & Loan Ass'n v. Blaisdell, 290 U.S. 398, 428, 54 S.Ct. 231, 78 L.Ed. 413 (1934)). But when a state interferes with its own contracts, those impairments `face more stringent examination under the Contract Clause than would laws regulating contractual relationships between private parties'. Tyrpak, 124 Wash.2d at 151-52, 874 P.2d 1374 (quoting Allied Structural Steel Co. v. Spannaus, 438 U.S. 234, 244 n. 15, 98 S.Ct. 2716, 57 L.Ed.2d 727 (1978)); Caritas Servs., Inc. v. Dep't of Social & Health Servs., 123 Wash.2d 391, 402-03, 869 P.2d 28 (1994). Sound Transit is a municipal corporation and, therefore, its contracts qualify as public contracts. Tyrpak, 124 Wash.2d at 152, 874 P.2d 1374. ś 18 This court uses a three-part test to determine if there has been an impairment of a public contract: (1) does a contractual relationship exist, (2) does the legislation substantially impair the contractual relationship, and (3) if there is substantial impairment, is it reasonable and necessary to serve a legitimate public purpose. Tyrpak, 124 Wash.2d at 152, 874 P.2d 1374; Caritas Servs., 123 Wash.2d at 403, 869 P.2d 28; Carlstrom v. State, 103 Wash.2d 391, 694 P.2d 1 (1985). However, even minimal impairment of contractual expectations in public contracts violates the contract clause where there is no real exercise of police power to justify the impairment. Tyrpak, 124 Wash.2d at 156, 874 P.2d 1374. ś 19 [T]o exempt a contract from constitutional protection demands significant justification. Id. States and other government entities have rarely been able to justify impairing contractual obligations entered into in financial markets, such as the public bond market. See, e.g., Caritas Servs., 123 Wash.2d at 405, 869 P.2d 28 (in almost every case, the United States Supreme Court has held a governmental unit to its contractual obligations when it enters into financial or other markets). As the Supreme Court noted in United States Trust Company of New York v. New Jersey, 431 U.S. 1, 27, 97 S.Ct. 1505, 52 L.Ed.2d 92 (1977), the only time in this century the alteration of a municipal bond contract has been sustained was in 1942 when a bankrupt local government was placed in receivership by a state agency and a plan was approved that was adopted with the purpose and effect of protecting creditors (citing Faitoute Iron & Steel Co. v. City of Asbury Park, 316 U.S. 502, 62 S.Ct. 1129, 86 L.Ed. 1629 (1942)). ś 20 Turning to the first prong of the Tyrpak test, it is well-settled that municipal bonds are contractual obligations protected by the contract clause. Tyrpak, 124 Wash.2d 146, 874 P.2d 1374 (the outstanding bonds of the Port of Vancouver, a municipal corporation, constitute a contract between the port and the bondholders, protected by the contract clause); Metro. Seattle v. O'Brien, 86 Wash.2d 339, 544 P.2d 729 (1976) (bonds issued by Metro, a municipal corporation, constitute a contract between Metro and the bondholders, protected by the contract clause); Ruano, 81 Wash.2d 820, 505 P.2d 447 (bonds issued by King County, a municipal corporation, constitute a contract between King County and the bondholders, protected by the contract clause). [6] Here, the Sound Transit Bonds constitute a contract between Sound Transit and the bondholders protected by the contract clause of the Washington Constitution. ś 21 Additionally, the contractual obligations in municipal bonds protected by the constitution include the terms in the municipal bonds, the Official Statement, the authorizing resolutions, and the statutory provisions governing the applicable municipal corporation in existence when the bonds were issued and sold. See, e.g., Tyrpak, 124 Wash.2d at 152, 874 P.2d 1374 (the contracts formed between the Port of Vancouver and its bondholders are made up of the terms of the bonds, their authorizing resolutions, and the statutes governing port districts and bond issues); O'Brien, 86 Wash.2d at 350, 544 P.2d 729 (discussing contractual obligations contained in the Official Statement and underlying statutory provisions applicable to the municipal corporation); Ruano, 81 Wash.2d at 825-27, 505 P.2d 447 (discussing authorizing resolutions and statutory provisions). See also Cont'l Ill. Nat'l Bank & Trust Co. of Chi. v. State, 696 F.2d 692, 695-96 (9th Cir.1983) (agreement entered into by the Washington Public Power Supply System with bondholders included promises to bond purchasers made in the form of bond resolutions and the state statutes giving them effect). Thus, the contract protected by the constitution includes the terms of the bonds, their authorizing resolutions (No. R98-47, No. R98-48, and No. R99-4), the Official Statement, and chapters 81.112 and 81.104 RCW governing Sound Transit. ś 22 Turning to the second prong of the test, a contract is impaired by legislation which alters its terms, imposes new conditions, or lessens its value. Retired Pub. Employees Council of Wash. v. Charles, 148 Wash.2d 602, 625, 62 P.3d 470 (2003). When assessing the impairment of a municipal bond contract, the contract is substantially impaired when the legislation detrimentally affects the financial framework which induced the bondholders to originally purchase the bonds, without providing alternative or additional security. Tyrpak, 124 Wash.2d at 153-54, 874 P.2d 1374. In accordance with United States Trust Co. and other relevant federal court decisions, this court has repeatedly held that the financial framework of a bond contract is detrimentally affected and bond obligations are impaired when a law put into effect after bonds were issued diminishes a tax source (i.e., repeals a tax or reduces the tax base) that was pledged to support repayment of the bonds. Tyrpak, 124 Wash.2d at 155, 874 P.2d 1374; O'Brien, 86 Wash.2d at 351-52, 544 P.2d 729; Ruano, 81 Wash.2d at 826-27, 505 P.2d 447. [7] ś 23 In Tyrpak, 124 Wash.2d at 148-50, 874 P.2d 1374, this court struck down a law that would have permitted the Port of Camus-Washougal to annex areas of the neighboring Port of Vancouver, allowing the Port of Camas-Washougal rather than the Port of Vancouver to collect property taxes from the newly annexed lands. Six years prior to the legislation, the Port of Vancouver had issued and sold bonds to the public that were secured in part by those property taxes. This court held that the Port of Vancouver's bond contract with its bondholders was substantially impaired. Id. at 155, 874 P.2d 1374. The court explained that [t]he bondholders bought the bonds with the presumption that the Port of Vancouver would continue to exist in the form that was described at the time of the bonds issue and if a change were made, their security would be protected. Id. Thus, as there was no compensation for the lost security, the reduction of the pledged property constituted an unconstitutional impairment of the contract. Id. at 156-57, 874 P.2d 1374. ś 24 Similarly, this court found an unconstitutional impairment in O'Brien. In O'Brien, the Municipality of Metro Seattle (Metro) issued and sold bonds to the public that were secured by two taxes, an MVET and sales tax. The bonds were issued to begin a capital acquisition and improvement program for a transit system. The court explained that: Metro's bonds were sold on the basis of representations contained in an Official Statement offering the bonds. The bondholders relied on that Official Statement in negotiations leading to the sale of the bonds. In the Official Statement, Metro pledged that it would levy the 1 percent motor vehicle excise tax and the 0.3 percent retail sales tax as authorized by the legislature. O'Brien, 86 Wash.2d at 350, 544 P.2d 729 (footnote omitted). Two years after the bonds were issued and sold, the legislature failed to remit MVET to Metro, reducing the bondholders' security. ś 25 In O'Brien, the State conceded that the constitution would not permit it to withdraw Metro's taxing authority to levy and collect the MVET or to divert the proceeds from the tax to some other purpose. Id. at 351, 544 P.2d 729. Instead, the State argued that its actions in failing to remit the tax proceeds to Metro did not prevent the taxes from continuing to serve as security for the bondholders because the State would remain indebted to Metro for the amounts collected for Metro and Metro continued to have an account receivable subject to future legislative appropriation. This court disagreed: The answer . . . is simple. This is not what was promised to the bondholders. Id. Accordingly, this court found that the reduction in bondholders' security impermissibly impaired the contract. In short, respondent asks the bondholders to accept an account receivable and an assumption that the state will appropriate funds to cover debt service in lieu of a financially sound operating transit system with the ability to complete its comprehensive plan. Id. ś 26 Again, in Ruano, this court found that a proposed initiative altering the security pledged for repayment of bonds violated the contract clause. In that case, King County issued and sold bonds in the public bond market to build the Kingdome. King County pledged the proceeds of a hotel/motel tax as security for the bonds, in addition to other security. Ruano, 81 Wash.2d at 825, 505 P.2d 447. King County was authorized to levy and collect the hotel/motel tax but could use the proceeds of the tax only for paying all or any part of the cost of acquisition, construction, or operating of stadium facilities or to pay or secure the payment of all or a portion of general obligation bonds issued for such purpose. Id. at 826, 505 P.2d 447. An initiative was proposed after the bonds were sold, proposing to take away King County's authorization to build the Kingdome. The appellant in that case argued that the bond contract was not impaired because King County could continue to collect the pledged tax. This court disagreed: Appellant contends, without citing to authority, that the decision to terminate the stadium would in no way affect the levy of the special excise tax. Yet substantial doubt is obviously created as to the continued collection of a tax which can be levied for a single purpose when that purpose cannot be realized. The situation is analogous to an effort by the legislation to repeal the authority to levy this tax. That such an effort would be futile and in violation of the constitution is the holding of Von Hoffman v. Quincy, 71 U.S. (4 Wall.) 535, 554, 18 L.Ed. 403 (1866), wherein the United States Supreme Court said: It is equally clear that where a State has authorized a municipal corporation to contract and to exercise the power of local taxation to the extent necessary to meet its engagements, the power thus given cannot be withdrawn until the contract is satisfied. Ruano, 81 Wash.2d at 826-27, 505 P.2d 447. Accordingly, the court in Ruano found that repeal of the hotel/motel tax pledged as security to the bondholders, as proposed by the initiative, would constitute an impermissible impairment of the bond contract in violation of the constitution. ś 27 Applying the second prong of the Tyrpak test, we conclude that section 6 of the initiative impaired Sound Transit's contract with its bondholders. Under the terms of the bonds, Sound Transit pledged the MVET and covenanted to collect the MVET while the bonds were outstanding. Section 6 of the initiative expressly withdrew Sound Transit's ability to levy and collect the MVET, reducing the bondholder's security. Moreover, section 6 of the initiative alters the terms of the bonds because Sound Transit will be unable to fulfill its covenant to collect and levy the MVET while the Sound Transit Bonds are outstanding. ś 28 This impairment is substantial because it detrimentally affects the financial framework which induced the bondholders to purchase the bonds, without providing alternative or additional security. [8] As in Tyrpak, O'Brien, and Ruano, the bondholders were induced to purchase the bonds based on the promise that Sound Transit would continue to levy and collect the MVET, among other taxes. Importantly, the initiative offers no alternative or additional security to the bondholders; it simply withdraws Sound Transit's authorization to levy and collect the MVET. At the time the bonds were issued and sold, Sound Transit had an unconditional grant of power to levy and collect the MVET, subject to limitations on amount and receipt of voter-approval, which it obtained. The pledge of the two major taxes, the sales tax and MVET, was a critical part of the financial framework inducing the bondholders to invest in the bonds. Investors purchasing the Sound Transit Bonds were told that they could rely on two major revenue streams, which are quite different in character, to secure the bonds. The sales tax depends on the amount of taxable sales that occur within Sound Transit's taxing district each month. Such monthly sales vary based on the strength/weakness and performance of the local economy and are therefore somewhat volatile. By contrast, the MVET revenue depends on the value of all currently owned vehicles. MVET revenues provide a stable revenue stream because vehicle owners pay the tax regardless of their current rate of spending on new purchases. Significantly, while Sound Transit reserved the right to reduce the sales tax pledged and covenanted to bondholders, the Sound Transit bonds did not reserve the right to reduce the MVET pledged to bondholders in any amount. ś 29 The intervenors contend that I-776 did not impermissibly impair the contract because the market for the bonds remained strong following the law's enactment. In agreement, the dissent asserts that a reduction in the bond's current market value is the ultimate evidence a bond contract obligation has been impaired, given the rationality and efficiency of the marketplace. Dissent at 1023, 1027. ś 30 The United States Supreme Court rejected this reasoning nearly 30 years ago in United States Trust Co., 431 U.S. at 18-19, 97 S.Ct. 1505. There, the parties presented credible but conflicting evidence on whether the repeal of a bond contract's security provision negatively impacted the current market price of the affected bonds. As here, supporters of the repeal presented evidence showing that the bonds retained a favorable credit rating and market price. The Court regarded the focus on current market value as inappropriate, stating, Factors unrelated to repeal may have influenced price. In addition, the market may not have reacted fully, even as yet, to the covenant's repeal, because of the pending litigation and the possibility that the repeal would be nullified by the courts. United States Trust Co., 431 U.S. at 18, 97 S.Ct. 1505. In the Court's view, irrespective of the bonds' current market value, substantial impairment of the bond contract occurred when the legislature repealed an important security provision upon which the bondholders relied in purchasing the bonds without replacing it with a comparable security provision or offering just compensation. United States Trust Co., 431 U.S. at 19, 97 S.Ct. 1505. ś 31 The record here illustrates the wisdom of United States Trust Co.'s rejection of the current market value standard proposed by the intervenors. In an attempt to disprove that repeal of the MVET prejudiced bondholders, intervenors presented evidence that Sound Transit's bond credit rating remained steady in the wake of I-776. Ironically, however, the credit rating was based, in part, on the credit evaluator's prediction that this court would affirm[] the bond contract in adherence to well-established case law and hold that Sound Transit could continue to collect the MVET. RP at 4142. Thus, the stability of Sound Transit's credit rating reflects the market's assumption that this court will nullify I-776 to the extent it prevents Sound Transit from fulfilling its contractual obligations. While the intervenors and the dissent would have us depend on the rationality of the marketplace to decide whether a law reduces the value of a contract, the market apparently has placed its faith in this court to act rationally by protecting the value of the contract in adherence to well-established case law governing contract clause claims. ś 32 The intervenors further assert that the bond contract was not impermissibly impaired because Sound Transit has other revenue to pay the principal and interest on the Sound Transit bonds. The intervenors point out that tax revenue from the sales tax, which accounts for approximately 79 percent of Sound Transit's tax revenue, could be used to pay the bondholders. Tax revenue from the MVET accounts for approximately 21 percent of Sound Transit's tax revenue. Moreover, the intervenors claim that prior tax revenue collected was more than sufficient to pay off the bonds thus fully securing the bonds, even though Sound Transit used such revenue to build and operate the transit system as authorized by statute and by the bond contract. Thus, the intervenors claim there is no impairment due to prior and future revenue. ś 33 This argument has no merit and has been soundly rejected by this court. In O'Brien, for example, the court acknowledged that the revenues from two tax sources substantially exceeded the requirements for debt service on the bonds. However, the court observed that this excess coverage was an important reason for a favorable rating received from municipal bond rating services. O'Brien, 86 Wash.2d at 350, 544 P.2d 729. The excess coverage was also an important factor in the decision of the bondholders to purchase the bonds. Id. Thus, the court reasoned, The bonds could not have been sold at the same price and interest rate if the coverage had been significantly less than represented. Id. See also Ruano, 81 Wash.2d at 827, 505 P.2d 447 (rejecting appellants argument that bonds were not impaired because the entire tax base of King County secures the general obligation bonds because it is not the contract entered into with the bond buyers). [9] ś 34 The third prong of the test is whether the challenged legislation is `nevertheless justified as a reasonable and necessary exercise of the State's sovereign power.' Tyrpak, 124 Wash.2d at 156, 874 P.2d 1374 (quoting Cont'l Ill., 696 F.2d at 697). This third prong of the impairment test strikes a balance between the inherent police power of the state and the legitimate expectations of those who enter into contracts. Tyrpak, 124 Wash.2d at 156, 874 P.2d 1374 (citing U.S. Trust Co. v. New Jersey, 431 U.S. 1, 23-24, 97 S.Ct. 1505, 52 L.Ed.2d 92 (1977)). As this court explained, `a revenue bond might be secured by the State's promise to continue operating the facility in question; yet such a promise surely could not validly be construed to bind the State never to close the facility for health or safety reasons.' Tyrpak, 124 Wash.2d at 156, 874 P.2d 1374 (quoting U.S. Trust, 431 U.S. at 25, 97 S.Ct. 1505.) Nevertheless, to exempt a contract from constitutional protection demands significant justification. Tyrpak, 124 Wash.2d at 156, 874 P.2d 1374. Hence, `even minimal impairment of contractual expectations violates the contract clause where there is no real exercise of police power to justify the impairment.' Id. (quoting Birkenwald Distrib. Co. v. Heublein, Inc., 55 Wash.App. 1, 9, 776 P.2d 721 (1989)). ś 35 In this case, the intervenors claim that a change in tax policy justifies reducing the bondholders' security. However, this justification has been soundly rejected for over a century. See, e.g., Tyrpak, 124 Wash.2d 146, 874 P.2d 1374 (no justification for impairment when purpose of law is to reduce taxing power of one entity to benefit another); O'Brien, 86 Wash.2d at 350-52, 544 P.2d 729 (constitution prevents legislature from withdrawing taxing power or divert the proceeds to some other use when tax pledged to bonds); Ruano, 81 Wash.2d at 826-27, 505 P.2d 447 (futile and in violation of the constitution to repeal authority of municipality to levy tax when action reduced bondholders' security, citing Von Hoffman v. Quincy, 71 U.S. (4 Wall.) 535, 554-55, 18 L.Ed. 403 (1866)). ś 36 Next, the intervenors contend that the initiative did not impair the Sound Transit bonds because the power . . . to change tax policy far outweighs any impairment of the bond contract created by the initiative and the Washington Constitution, article VII, section 1 prohibits surrendering or contracting away the power to tax, which the intervenors content Sound Transit did. The intervenors point to no authority for this contention. Indeed, long-standing authority is to the contrary. For example, in Continental Illinois, 696 F.2d at 699-700, the court rejected a similar argument made by defendants that a Washington municipal corporation remains subject to state regulation and cannot be allowed to contract itself out from state control. As the court explained, the argument misperceives the nature of the restriction on state action imposed by the contract clause. As a creature of the state, a municipal corporation derives its power from the legislature. Once having granted certain powers to a municipal corporation, which in turn enters into binding contracts with third parties who have relied on the existence of those powers, the legislature (or here, the electorate) is not free to alter the corporation's ability to perform. Id. (citing Louisiana ex rel. Hubert v. New Orleans, 215 U.S. 170, 175-78, 30 S.Ct. 40, 54 L.Ed. 144 (1909); Wolff v. New Orleans, 103 U.S. 358, 365-68, 26 L.Ed. 395 (1880)). See also O'Brien, 86 Wash.2d at 350, 544 P.2d 729 (State bound not to withdraw taxing authority under the constitution). [10] We find no merit in the justifications offered by the intervenors for the impairment of Sound Transit bonds. ś 37 Consistent with long-standing law, we hold that section 6 of the initiative impairs Sound Transit's contractual obligations with its bondholders in violation of the contract clause. WASH. CONST. art. I, § 23.