Third Court of Appeals Provides Clarity in Chapter 1205 Bonds Validation Lawsuits

By José de la Fuente

An unusual and sometimes mysterious creature of Texas law – Chapter 1205 of the Texas Government Code, which allows for expedited declaratory judgment actions to validate public bonds – has recently become less mysterious, after the Texas Third Court of Appeals issued its recent opinion in Cities of Conroe, Magnolia, and Splendora v. Paxton, 03-16-00785-CV, 2018 WL 4190803 (Tex.App.—Austin Aug. 31, 2018, no pet. h.). The bond validation process of Chapter 1205 has been utilized with some regularity in cases involving contracts, including cases in which other public entities are on the other side, raising questions as to the nature of disputes that could be considered in a Chapter 1205 case and the implication of the governmental immunity of public entity parties that may oppose the relief requested.

In this case, the San Jacinto River Authority (“SJRA”) filed a Chapter 1205 suit in Travis County, a permissible venue under the statute, seeking to resolve numerous issues related to its issuance of bonds, including ongoing contractual disputes that it had with certain cities regarding its wholesale water rate. Several opposing parties, including several cities that were contract customers of SJRA, appeared and asserted pleas to the jurisdiction generally claiming that 1) SJRA’s requested relief went beyond the permissible bounds of 1205, and 2) the cities were immune to such a suit. The trial court judge denied their pleas, and the Third Court considered the parties’ arguments on an interlocutory appeal of that denial.

Justice Pemberton’s opinion is long and detailed, and contains some very helpful analysis on multiple points of Chapter 1205 law; but in summary, the Court held that:

Breach-of-contract claims do not belong: SJRA’s attempt to obtain a Chapter 1205 adjudication that the City of Conroe had breached its contract with SJRA was beyond the scope of matters that can be adjudicated under Chapter 1205, and thus that claim was non-jurisdictional (that is, the question of whether Conroe breached its contract does not belong in a Chapter 1205 suit, and must be litigated by another mechanism, such as an ordinary breach-of-contract suit). Thus, the Court of Appeals reversed the denial of the plea to the jurisdiction in that respect;

Claims to validate a contractual “rate” are permissible: SJRA’s remaining requested relief, including “that the SJRA issued its fiscal year 2017 Rate Order, including the setting of its fiscal year 2017 rate, in accordance with the procedures set forth in the GRP Contracts,” and “that the SJRA’s fiscal year 2017 rate, Rate Order, and the GRP Contracts, including the Contract with Conroe, are legal and valid,” is within the scope of Chapter 1205, and thus the denial of the plea to the jurisdiction on that basis was proper. Importantly, a declaration as to the legality and validity of a contract – even one for which there is a dispute about whether the issuer properly followed it – is within the scope of Chapter 1205, and is proper subject-matter for a Chapter 1205 case. The Court even went on to say that “to the extent the Cities are maintaining that adjudication affecting personal or particularized rights rather than public rights is inherently incompatible with an in rem action, they are similarly mistaken”; and

Chapter 1205 claims are an exception to governmental immunity: The cities’ claim that governmental immunity rendered them immune from such adjudication was rejected. The court specifically held that (particularly in light of its striking of the claim for breach of contract, discussed above) cities are not immune from being parties to and being bound by a Chapter 1205 suit, observing that the claims are

within a recognized ‘exception’ holding that immunity is not implicated by claims that would enforce an underlying statutory or constitutional requirement “that government contracts be made or performed in a certain way, leaving no room for discretion.” Such requirements or duties in this case would be formed by SJRA’s enabling statute and the statutes deeming “incontestable” the GRP bonds (including bond covenants) and the GRP Contracts. his text is indented.

The Court went on to hold that if a party “asserts that the GRP Contracts are statutorily beyond legal challenge,” the claim also would not implicate governmental immunity.

The opinion also made findings on numerous smaller issues that, while less controversial, were not entirely settled before this case: e.g., a Chapter 1205 suit can be brought both before and well after the securities are issued, and the defined term “public security authorizations” in the statute includes contracts like SJRA’s.

The opinion also suggests that, if a party to a contract believes that Chapter 1205 does not provide the requisite due-process protections (because of its broad and general notice provisions), the proper mechanism is a constitutional challenge to the statute’s enforcement. However, as the constitutionality of Chapter 1205 has been the subject of appellate opinions in the past, this path does not seem to be a particularly viable one.

While the SJRA case is now on remand to the trial court, it is likely to return to the Third Court of Appeals once final judgment is issued, and we may receive even more guidance as to the interpretation of Chapter 1205 at that time. In any case, we now know that public entities with governmental immunity may nonetheless be parties to and may be bound by a Chapter 1205 suit filed by a third party, and in such cases, the legality and validity both of their contracts and the issuer’s performance thereunder with respect to setting rates can be decided. Governmental entities, and any entity that is a party to a contract with a government entity that may issue bonds, should be cognizant of this better-defined playing field, and realize that whether they would like to be or not, they are players in the game when a Chapter 1205 suit is filed.