The Ninth Circuit handed down an opinion last week that could be misread to mean that public employees’ indemnification rights survive confirmation of a city’s chapter 9 municipal debt adjustment plan. In reality, the opinion on Sept. 8 by Circuit Judge Kim McLane Wardlaw only stands for the unremarkable proposition that the city voluntarily rekindled its indemnification obligations after confirmation.

The case arose from the chapter 9 filing in 2008 by the city of Vallejo, Calif. Before bankruptcy, a man sued the city and police officers for using excessive force in an arrest. Also before bankruptcy, the plaintiff stipulated to dismissing the suit against the city with prejudice. On agreement of the parties, the suit was stayed during Vallejo’s bankruptcy.

After Vallejo confirmed its chapter 9 plan, the plaintiff revved up the lawsuit in district court against the police officers. Before trial, the city agreed to provide the officers with defense and pay any judgments against them. Ultimately, the plaintiff won a judgment against one of the officers for $50,000 plus about $350,000 in legal fees.

The officer, represented by the city attorney, filed a motion in district court for relief from the judgment under Rule 60(b), contending that the judgment should be deemed a litigation claim that would be paid 20 or 30 cents on the dollar under Vallejo’s plan. Although the judgment was not against the city, Vallejo was trying to pay off its recently assumed indemnification obligation at a fraction of face value.

The city’s theory was based on a California statute that broadly requires municipalities to indemnify their workers. In this instance, the officer did not file a claim in the city’s bankruptcy, although the officer assuredly knew his employer was in bankruptcy.

The district court denied the Rule 60(b) motion, and the Ninth Circuit affirmed.

The principal basis for the decision is non-controversial. The appeals court held that the statutory indemnification obligation did not transmute the judgment into a claim dealt with by the plan, because the judgment was against the officer in his individual capacity.

The police officer argued that failing to transform third parties’ claims against individuals into claims against bankrupt municipalities would demoralize law enforcement personnel by leaving them to fear they could be personally responsible for judgments if a city’s plan does not pay the claims in full. Judge Wardlaw’s answer might be misunderstood in a manner that would cause mischief in corporate reorganizations.

Although the meaning of the opinion is not entirely clear, Judge Wardlaw appeared to imply correctly that the city’s indemnification obligation would have been discharged had the city not agreed after confirmation to pay defense costs and cover any judgments. However, she did say, without citing authority, that the officers were not required to file claims to preserve their indemnification rights because the city never listed them as potential creditors. That statement appears to be inconsistent with Section 944(c)(2).

Because the agreement to indemnify occurred after discharge, Judge Wardlaw said that the city’s “indemnification obligation is a post-petition debt that is not subject to discharge.”

She also appeared to interpret the plan to mean that the city assumed its statutory indemnification obligations, which might otherwise have gone by the boards. In that respect, the opinion is a generous reading of the plan, which only said that the city would operate after bankruptcy in conformance with state law.

Consequently, the opinion should not be read to mean that statutory indemnification obligations survive bankruptcy automatically.

On cursory reading, however, the opinion might be interpreted incorrectly to mean that statutory indemnification survives bankruptcy. Needless to say, that interpretation would upset traditional notions of corporate reorganization given state laws that require companies to indemnify their officers and directors.

Cutting off indemnification claims by discharge, or paying them cents on the dollar as unsecured claims, is not typically a problem in the corporate sphere because companies typically carry directors and officers’ liability insurance. The survival or reinstatement of indemnification obligations is more significant in chapter 9 cases because municipalities may be self-insured or have inadequate coverage.

The opinion would have been better without the statement that the officer was not required to file a claim because he was not listed as a creditor. Section 944(c)(2) provides that claims are excepted from discharge only as to creditors that “had neither notice nor actual knowledge of the case.” It would have been preferable, if it were the case, to say that the police officer’s union had an understanding that the plan would not impair indemnification obligations.