McCroskey v. Gustafson

638 P.2d 51, 1981 Colo. LEXIS 827

• Court: Supreme Court of Colorado
• Decided: December 7, 1981
• Docket: No. 80SC109
• Status: Published

Opinions

ROVIRA, Justice.

Petitioners are citizens and taxpayers of the City and County of Denver (City). They challenge the ruling of the court of appeals which held that they lacked standing to bring an action on behalf of the City. McCroskey v. Gustafson, Colo.App., 611 P.2d 984 (1980). We granted certiorari in order to consider the ruling of the court of appeals. We affirm.

Carl Gustafson and his employer, Quinn & Co., Inc. (respondents), were bond consultants for the City and advised the City on a number of bond issues from 1971 through 1974. In late 1975 Gustafson recognized that a favorable bond market might provide a method for the City to refund a prior bond issue and make a substantial profit. He wrote a letter to the mayor of Denver suggesting that the City could make an arbitrage profit of between $2,500,000 and $3,750,000 by way of this transaction. In the letter he indicated that Quinn & Co. would be acting as an underwriter and would assume all opportunity for profit and all risk of loss as an underwriter. In the letter and in a formal contract that was subsequently signed by the City, it was expressly stated that respondents would not be consultants, fiduciaries, or agents of the City for this transaction and intended to make a profit on the sale of federal securities to the City.

Gustafson’s plan involved the City’s issuance of low interest tax-exempt bonds which would be purchased by Quinn & Co. The City would then use the proceeds to purchase federal securities from Quinn & Co. which would yield a higher rate of interest than the tax-exempt bonds and thus provide the City with a profit. However, the Internal Revenue Service, recognizing the possibility of abuse inherent in this type of transaction, set limits on the amount of profit which a city could realize through this type of refunding. If the City exceeded the maximum profit, the tax-exempt status of its municipal bonds would be forfeited.¹

In order to comply with these profit limitations, respondents sold the City federal securities at a price which was above par value. Thus, the City realized the maximum allowable profit of $1,800,000 without jeopardizing the tax-exempt status of its bonds while respondents made $2,700,000 on the sale of the federal securities to the City.

In their complaint the petitioners claim that: Gustafson was in a confidential relationship with the City; respondents were unjustly enriched because they breached their duty to disclose the amount of profit they expected to realize through the transaction; and there was an alternative means of accomplishing the bond financing which would have resulted in a payment of approximately $2,700,000 to the federal government. They further claim that Gus-tafson, as a member of the state legislature, violated his fiduciary duty to the people of the State of Colorado and the citizens of Denver by using the power and influence of his public office for private gain. By way of relief, they ask that punitive damages and attorneys’ fees be assessed against respondents and that judgment be entered in favor of the City for $2,700,000. The City was named as a defendant, but no claim for relief was made against the City.

Prior to bringing this action, the petitioners made demand upon the City to sue respondents for the recovery of the profit. The City refused to bring the action, so the petitioners filed suit individually and on behalf of the taxpayers and citizens of the City.

The trial court granted respondents’ Motion for Summary Judgment and entered a Judgment of Dismissal in favor of the respondents and the City.

The court, after examining the pleadings, depositions, answers to interrogatories, and affidavits on file, found that respondents were acting as principals and not in a fiduciary capacity for the City; that it was readily ascertainable from the documents that respondents would make $2,700,000 profit over and above the amount that the City would receive; that under the Internal Revenue Code provisions the transaction was legal; and that the City could not receive any additional profit without jeopardizing the tax-exempt status of its securities.

The court, assuming arguendo that the petitioners had standing to bring the action, ruled that the City received all that it was entitled to receive and that Gustafson’s position in the state legislature created no fiduciary relationship with the City and was immaterial to his dealings with the City.

Petitioners appealed the judgment of dismissal. The court of appeals affirmed on the ground that the petitioners lacked standing to bring the action on behalf of the City and thus did not reach the substantive issues of the case. McCroskey v. Gus-tafson, supra.

This case presents the following question: When do citizen-taxpayers have standing to bring an action on behalf of a municipality?

The court of appeals set forth a two-part test to determine whether a taxpayer had standing to sue on behalf of a municipality. It held that it was the taxpayer’s burden to allege sufficient facts to show that he has met the following requirements:

“(1) That the municipality itself has the right and power to bring the action.... Also, ... he must allege that he has made a demand upon the municipality, which demand the municipality has refused.... and,

“(2) That the taxpayer is bringing the action in a case in which the municipal corporation has the discretion to bring the action but has refused to do so because of fraud, collusion, bad faith, or ultra vires acts by the corporation, ... or in which the municipality has a specifically enjoined, non-discretionary duty to bring the action but has failed to do so.”

McCroskey v. Gustafson, Colo.App., 611 P.2d at 987 (citations omitted).

The petitioners challenge the court of appeals’ departure from the standing test established by this court in Wimberly v. Ettenberg, 194 Colo. 163, 570 P.2d 535 (1977), and reaffirmed in Dodge v. Department of Social Services, 198 Colo. 379, 600 P.2d 70 (1979). They further argue, in the alternative, that the new test established by the court of appeals is erroneous because it focuses upon the reasons for the municipality’s refusal to sue rather than upon the existence of fraud, collusion, bad faith or ultra vires in the challenged act itself. They claim that if the new test is adopted by this court it should be modified to reflect this distinction and to make it consistent with the test in other jurisdictions.²

We begin our analysis by reviewing several prior standing cases. Wimberly v. Et-tenberg, supra, involved an action brought by bail bondsmen against a county judge challenging a pretrial release program that allowed a criminal defendant to deposit 10% of the total amount of his bail as a condition of pretrial release. The standing inquiry established in Wimberly consisted of the following questions: (1) whether the plaintiff was injured in fact, and (2) whether the injury was to a legally protected right as contemplated by statutory or constitutional provisions. 194 Colo, at 168, 570 P.2d at 539. This test was applied in Dodge v. Department of Social Services, supra. Dodge was an action brought by citizens and taxpayers against the State of Colorado, seeking to enjoin the expenditure of public funds for nontherapeutie abortions.

The test approved in these two cases is grounded in a recognition of limitations on the power vested in the judiciary by the Colorado Constitution³ and in considerations of judicial self-restraint and economy. The rationale underlying these standing requirements applies equally to all litigants. These factors are based upon constitutional as well as jurisprudential considerations.

In the case now before us, the court of appeals announced a separate test to be applied in suits in which citizen-taxpayers sought to bring a representative action on behalf of, and not against, a municipality. It recognized that the same constitutional and policy considerations controlled but held that the “Wimberly-Dodge test would unduly restrict taxpayer standing in this context,” McCroskey v. Gustafson, 611 P.2d at 987, because of the difficulty in establishing injury in fact to the taxpayer and the “paucity of circumstances in which the taxpayer could point to a specific statutory or constitutional provision protecting a legal interest of the taxpayer that the municipality’s refusal to sue has injured.” Id. ■

Because the court of appeals recognized a difference between citizen-taxpayer suits against a municipality and citizen-taxpayer suits brought on behalf of a municipality, it tailored the standing inquiry to fit the latter circumstance while still adhering to the policy dictates embodied in Wimberly and Dodge.

The first part of the court of appeals’ standing test is the “functional equivalent of requiring the taxpayer to allege an injury in fact to himself.” Id. However, rather than examining the interest of the particular citizen-taxpayer who is before the court, this test focuses upon the municipality’s right and power to bring suit and its refusal to do so upon the taxpayer’s demand.

The second part of the court of appeals’ standing test addresses the policies of judicial restraint and constitutional limitations on the exercise of judicial power. Here, rather than inquiring whether the injury was to a legally protected right as contemplated by statutory or constitutional provisions, the court of appeals framed the inquiry from the perspective of the power vested in the municipality in the particular case. Thus, it held that a taxpayer could bring the action when the municipality had discretion to bring the act but refused to do so because of fraud, collusion, bad faith, or ultra vires acts by the municipality.

Petitioners argue that by adopting this test the court of appeals is narrowing the class of plaintiffs who would be granted standing to litigate a claim on behalf of a municipality. They first contend that under the Wimberly-Dodge test they would be granted standing to bring this action. They assume that they could establish injury in fact and then argue that this injury was to a legal interest which is protected by statutory or constitutional provisions.

This argument is based upon petitioners’ reading of Colo.Const. art. X, sec. 13. This provision provides:

“Making profit on public money — felony. The making of profit, directly or indirectly, out of state, county, city, town or school district money, or using the same for any purpose not authorized by law, by any public officer, shall be deemed a felony, and shall be punished as provided by law.”

They argue that Gustafson, as a member of the state legislature, is a public officer and that this transaction with the municipality violates the public policy embodied in this provision. We disagree. Gustafson’s position in the legislature is immaterial to his business dealings with the City, which are totally unrelated to his position as a member of the General Assembly. Furthermore, the constitutional provision cannot “properly ... be understood as granting persons in the plaintiff’s position a right to judicial relief.” Warth v. Seldin, 422 U.S. 490, 500, 95 S.Ct. 2197, 2206, 45 L.Ed.2d 343, 355-56 (1975).

Petitioners next challenge the standing rule on the grounds that it is more restrictive than the rule enunciated in the treatise authored by McQuillin and employed in other jurisdictions. We disagree.

The test put forth by McQuillin states that a taxpayer’s right to bring an action on behalf of a municipality is subject to the following conditions:

“(1) The municipality itself must have a clear right and power to sue; (2) a taxpayer cannot sue third persons in behalf of the municipality unless the bringing of such action is a duty devolving upon the municipal authorities, as to which they have no discretion and which they have refused to perform; (3) either a demand must have been made that suit be brought by the public officers of the municipality, or it must be alleged and shown that such demand would be unavailing; and (4) the action does not lie where it would be grossly inequitable to enforce the claim, nor where the basis thereof is a claim of the taxpayer’s rather than that of the municipality.”

18 E. McQuillin, The Law of Municipal Corporations § 52.17 (3d ed. 1977) (footnotes omitted).

These conditions are similar to those formulated by the court of appeals. However, this test requires that the municipality have an affirmative duty to bring the action. It does not contemplate a taxpayer’s action on behalf of the City when the City has no duty to bring the action and the bringing of the action is within the discretion of the municipality.

The test established by the court of appeals, on the other hand, does allow a taxpayer to bring suit on behalf of a municipality if the municipality has the “discretion to bring the action but has refused to do so because of fraud, collusion, bad faith, or ultra vires acts by the corporation.” McCroskey v. Gustafson, 611 P.2d at 987. Thus, this test is not narrower than the one established in McQuiilin and in fact encompasses a wider range of circumstances than the McQuiilin test.

Petitioners next claim that the test in other jurisdictions focuses upon fraud, collusion, bad faith, or ultra vires acts in the underlying transaction rather than on the municipality’s refusal to exercise its discretion to bring suit because of these factors. The rule in California is that a taxpayer may bring an action on behalf of a municipality in cases involving fraud, collusion, ultra vires, or failure of the municipality to perform an affirmative duty to bring suit. Harman v. City and County of San Francisco, 7 Cal.3d 150, 496 P.2d 1248, 101 Cal.Rptr. 880 (1972); Silver v. City of Los Angeles, 57 Cal.2d 39, 366 P.2d 651, 17 Cal.Rptr. 379 (1961).

However, the rule established by the court of appeals in this case provides a better standing inquiry because it focuses directly upon the municipality’s exercise of its discretion or refusal to perform a duty to bring suit. The existence of fraud, collusion, bad faith, or ultra vires acts in the underlying transaction is not a helpful criterion for the court to employ in deciding whether it should grant taxpayer standing. Rather, the court should consider why the municipality refuses to exercise its discretion under these circumstances. Undoubtedly, there will be cases in which municipal officials will be involved in fraud, collusion, bad faith, and ultra vires acts; and this will carry over into their decision on whether or not to bring suit against themselves. However, it will not always be the same officials deciding whether to bring an action; thus, the court should focus on the reason for the municipality’s failure to exercise its discretion to bring suit.

The test established by the court of appeals provides a sound basis to decide the standing question in a suit brought by a citizen-taxpayer on behalf of a municipality. We adopt that test here.

We agree that these petitioners lack standing to bring this action. There was no injury to the City nor was there any allegation of fraud, collusion, bad faith, or ultra vires acts which affected the City’s decision not to bring suit.

We affirm.

ERICKSON and QUINN, JJ., dissent. DUBOFSKY, J., does not participate.

1 . See section 103(c) of the Internal Revenue Code of 1954 for the provision which controlled this transaction.

2 . The petitioners cite Harman v. City and County of San Francisco, 7 Cal.3d 150, 496 P.2d 1248, 101 Cal.Rptr. 880 (1972); Silver v. City of Los Angeles, 57 Cal.2d 39, 366 P.2d 651, 17 Cal.Rptr. 379 (1961); and 18 E. McQuiliin, The Law of Municipal Corporations § 52.07 (3d ed. 1977) in support of this contention.

3 . “In Colorado, Article III of the Colorado Constitution prohibits any branch of government from assuming the powers of another branch. Courts cannot, under the pretense of an actual case, assume powers vested in either the executive or the legislative branches of government.” Wimberly v. Ettenberg, 194 Colo, at 167, 570 P.2d at 538.