[1994/oagheade.htm]

OAG 94-1

January 7, 1994

State Senator Susan Johns

Chair, Program Review & Investigations Subcommittee

Legislative Research Commission

Frankfort, Kentucky 40601

Dear Senator Johns:

You have requested our assistance with some questions raised by your committee's study of the Kentucky Association of Counties (KACo) and its self-insurance programs. The facts relevant to your questions are these:

Pendleton and Marshall Counties executed an interlocal cooperation agreement in which they created a trust called Kentucky Association of Counties Reinsurance Trust. At about the same time, a private corporation, KRT Insurance Company, Inc., was incorporated. The trust issued tax-exempt bonds in the amount of $50 million and used the proceeds to acquire all the stock of the corporation, make a loan to the corporation, and establish a reserve fund. The corporation then sought to be licensed as an insurance company so that it could provide reinsurance to various KACo self-insured groups.

You ask the following questions regarding the trust:

a. Does the creation of a corporation by KRT violate section 179 of the Kentucky Constitution which prohibits the General Assembly from authorizing any county to be a stockholder in any company, association or corporation or to obtain or appropriate any money for or to loan its credit to any corporation, association or individual.

We believe that your question inadvertently uses the phrase "creation of a corporation by KRT" rather than "ownership of KRT by the trust." As we understand your question, you are asking whether section 179 of the state constitution, which prohibits counties from owning stock in a corporation, also prohibits counties from forming a trust that owns stock in a corporation.

Our understanding of the trust arrangement indicates that the trust functions as a conduit through which government bonds have been used to acquire all the stock in a corporation. Obviously, the two counties involved have, by creating the trust, attempted to do via the interlocal cooperation act that which they could not have done independently. The interlocal cooperation act, however, does not give governmental units any greater authority than they possess separately. We said in OAG 78-364 that "only those powers which can be exercised individually can be exercised collectively." Therefore the trust's authority is no greater than that of either county, and since the counties cannot own stock in a corporation, neither can the trust.

Your next question is:

b. Is it constitutional for counties to join together and form a trust under the interlocal cooperation act and then the trust forms a corporation that issues revenue bonds?

Again, we believe that your question does not correctly state the situation. The bonds were not issued by the corporation, as your question states; the bonds were issued by the trust, which used the proceeds from the sale of the bonds to buy all the stock in the corporation. There is no constitutional provision prohibiting the sale of bonds by such a trust; however, the issuance of any such bonds must comply with the specific statutory authorization for the bond issue. OAG 87-20.

In 1988 the legislature enacted KRS 65.150(4), which provides:

An association of governmental units formed for the purpose of providing insurance to the participating members may act on behalf of and with the approval of the participating governmental units to borrow money and issue revenue bonds to fund the costs of providing the insurance. Revenue bonds issued pursuant to the authority granted in this subsection shall be issued in accordance with KRS 65.270.

Under this statute, an association of governmental units can issue revenue bonds to provide "insurance to the participating members." We know of no reason why this statute would be unconstitutional; therefore, if the trust had issued revenue bonds to provide insurance to the participating members, its actions would be legal under this statute. The statute does not authorize the actions taken by the trust, however, for two reasons. First, in our view the statute plainly contemplates the purchase of insurance, not the purchase of an insurance company. The common and ordinary understanding of the phrase "providing insurance" relates to the procurement of insurance coverage; it does not signify the purchase of stock in an insurance company. Second, the statute states that the insurance obtained by revenue bonds must be for the "participating members." Page 3 of the trust's bond issue statement provides that KRT Insurance Company, Inc., "will offer reinsurance, stop-loss insurance and excess-loss insurance to three self-insurance funds operated by the Kentucky Association of Coun-ties. . . . The Company may also provide such insurance and reinsurance to other self-insurance funds operated by the Kentucky Association of Counties." Because the bonds in question were sold for the purpose of providing insurance to entities other than the two "participating members" (Pendleton and Marshall Counties), the bond issue is not authorized by KRS 65.150(4).

c. Has this arrangement created any joint and several liability which would be constitutionally unacceptable?

This question was answered in OAG 93-54, a copy of which is enclosed. In that opinion we said that a debt is not unconstitutional simply because it creates a joint and several liability. In addition we should point out that the bond issue statement says, "The Commonwealth of Kentucky, any county, any municipality or any political subdivision will not be liable thereon." While we can neither confirm nor deny the accuracy of that statement, if it is correct then the bond issue imposes no liability at all on the counties.

You have also asked the following question regarding the fact that KACo self-insured groups contract with a third party to administer the insurance programs:

Is any statute violated when these self insurance and loan groups contract with a third party administrator without any type of open bid process?

The answer to this question depends on whether the services provided by the third party administrators should be deemed professional services. Under KRS 424.260, local governmental units do not have to employ a bid process for the procurement of professional services. While we cannot definitively answer this question without a firm understanding of exactly what these third party administrators do, we expect that they provide services involving the use of training, discretion, and judgment in the field of insurance, and therefore the administrators probably provide professional services that need not be bid.

Your final question involves the fact that at least one program administrator is the chairman of a related trust fund. You ask:

Is there any conflict of interest if the Chairman of the Board of Directors [of the trust] is also the executive director of the private corporation servicing as the third party administrator, which supplies services to the fund?

This is an exceedingly difficult question, and we cannot answer it with the same degree of certitude expressed elsewhere in this opinion. We encounter two problems in attempting a legal analysis of this question. The first is that the trust created pursuant to interlocal agreement comprises an entity that is to say the least novel to the law, and is perhaps unprecedented. The trust blends elements of a public and a private entity. The trust itself is without doubt a governmental body of some sort, but the status of the trustees-parties you have called directors-is open to question. They are not necessarily public officials before they become trustees, and it is not clear whether they become public officials when they assume the position of trustee. We simply do not know how a court would analyze the trustees' potential conflicts of interest. The most we can say is that if the trustees are public officials, then a potential incompatibility of offices would be analyzed under the standard set forth in Polley v. Fortenberry, 268 Ky. 369, 105 S.W.2d 143 (1937), which states that offices are incompatible if one is subordinate to the other, or the performance of one interferes with the other, or the functions are inherently inconsistent, or the occupancy of both offices is detrimental to the public interest. If this is the applicable standard, then we believe it is likely that an incompatibility would arise.

A second problem involves the fact that conflicts of interest by trustees are generally viewed in terms of the potential for self-dealing as a violation of a trustee's fiduciary obligation to the trust beneficiary. In the situation that you are investigating, the trustee's employment as third party administrator was disclosed from the beginning, and we are told that the situation was even incorporated into the founding documents. Therefore, a court might be reluctant to find that a trustee is in violation of his fiduciary obligation to the beneficiary when the beneficiary has specifically acknowledged that the alleged conflict should be incorporated into the documents creating the trust. That is to say, a court has the power to remove a trustee who is not acting in the beneficiary's best interest (76 AmJur2d, Trusts �257), but we speculate that a court might not be inclined to protect a beneficiary who does not want to be protected.

In any case, our responses to your previous questions might render this last question moot.

We appreciate the assistance of the Legislative Research Commission in furnishing us with written materials that provide the factual background for this opinion. Because the KRT bond issue was a complex undertaking, we have no way of ascertaining whether there are additional documents or facts that could affect the conclusions we have reached. Our opinion is, of course, based on the situation as it has been presented to us; a definitive answer to the questions can be provided only through court action.

We trust that this information will prove helpful to you.

Sincerely,

Chris Gorman

Attorney General

Ross T. Carter

Assistant Attorney General