Merit Decision: The Relationship Between Charter Schools and Their Operators. Hope Academy Broadway Campus v. White Hat Mgt., L.L.C.

On September 15, 205, the Supreme Court of Ohio handed down a merit decision in Hope Academy Broadway Campus v. White Hat Mgt., L.L.C., 2015-Ohio-3716. In a very fractured opinion authored by Justice Lanzinger, the court held that White Hat (the collective name for the companies that operated and managed the charter schools that brought this suit) gets to keep the personal property titled in its name, purchased with public dollars, and used in the daily operations of the schools unless the schools pay for it, but when the operator of a charter school uses public dollars to buy property for use in the schools it runs, a fiduciary relationship arises. Chief Justice O’Connor and Judge John Wise of the Fifth District Court of Appeals, who sat on this case for the recusing Justice O’Donnell, concurred in the syllabus and judgment only. Justices Kennedy and French concurred in judgment in part, dissented in part, and concurred in paragraph one of the syllabus. Justice O’Neill concurred in the syllabus but dissented from the opinion and judgment. Justice Pfeifer dissented, period. The case was argued September 23, 2014.

Case Background

The plaintiffs in this case are the governing boards of ten charter schools (“the Schools”). Charter schools (by statute, the correct name is community schools, but the blog will use their more familiar name) which are public schools by definition, but exempt from many of the requirements of traditional public schools, are governed by a board, and operate pursuant to a Community School Agreement between the schools and a sponsor approved by the Ohio Superintendent of Public Education. Charter schools are allowed to contract with private educational management organizations to administer the schools’ daily functions. The defendants in the case are private, for-profit companies that operated and managed the Schools (collectively, “White Hat”).

Each of the ten plaintiff Schools entered into substantially identical management agreements (also referred to as the contracts) with one of the management companies owned by White Hat. Each contract required White Hat to handle day-to-day operations within each school, including the purchasing of furniture, computers, books, and all other equipment. White Hat was to purchase personal property on behalf of the School, and unless a particular funding source (which is never defined) required the property to be titled in the name of the school, all property was titled in White Hat’s name. White Hat was paid a “Continuing Fee” based upon the number of students in each school, plus reimbursements for state and federal grants. Part of this continuing fee was used to buy the personal property at issue in the case. These contracts also expressly provided that White Hat would operate as an independent contractor, and not as an agent or a fiduciary.

After the original contracts expired, the parties entered into a series of stand-still management agreements which allowed them to continue as if the contracts were still in effect.

The Schools performed very poorly under White Hat’s management, with some of the schools shut down and some just a step away from that. This poor performance caused the Schools to raise a number of issues, including how White Hat spent the money it received to run the Schools. When White Hat refused to provide meaningful information about its use of public funds, the Schools filed suit in May of 2010, seeking declaratory and injunctive relief, an accounting, and damages for breach of contract and breach of fiduciary duty.  Among other things, and relevant here, the Schools contended that they were entitled to all property purchased by White Hat with public funds, without having to pay White Hat for that property.

Procedural Posture

The trial court found that the Schools were entitled only to the personal property titled in their names under the management agreements, but that White Hat owned the rest, which the Schools would have to buy back from White Hat if they wanted that property. The trial court also found that no formal general fiduciary relationship was created by the management agreements. The Tenth District Court of Appeals affirmed, in an opinion written by Judge Susan Brown and joined by Judges Gary Tyack and Retired Judge John McCormac, sitting by special assignment. The appeals court found the contracts unambiguously gave White Hat the right to make the schools pay to buy back any personal property it had bought with the continuing fee, and there was no fiduciary duty created by the agreements.

Read the oral argument preview of this case here and an analysis of the argument here.

What the Supreme Court of Ohio was asked to decide

  1. Were the buy-back provisions in these contracts enforceable against the schools, meaning if the schools wanted that personal property would they have to pay White Hat for it?
  2. Is there a fiduciary relationship between a management company and the charter school that it operates?

Short Answers

Yes, to both questions.

Case Syllabus

The analysis of this particular case is probably best understood with the syllabus first, to understand the position of the justices, so here it is.

  1. An entity that manages the daily operations of a community school pursuant to contract with the school’s governing authority is an operator within the meaning of R.C. 3314.02(A)(8)(a).
  2. A management company that undertakes the daily operation of a community school has a fiduciary relationship with the community school that it operates.
  3. The fiduciary relationship between an operator and its community school is implicated when the company uses public funds to purchase personal property for use in the school that it operates.

Key Precedent

Chapter 3314 (establishes community schools and sets forth entire statutory framework for their operation)

R.C. 117.01(C) (“public money” means “any money received, collected by, or due a public official under color of office, as well as any money collected by any individual on behalf of a public office or as a purported representative or agent of the public office.”)

Cordray v. Internatl. Preparatory School, 2010-Ohio-6136. (An officer, employee, or duly authorized representative or agent of a community school (in this case its treasurer) is a public official and may be held strictly liable to the state for the loss of public funds.)

Foster Wheeler Enviresponse, Inc., v. Franklin Cty. Convention Facilities Auth., 78 Ohio St.3d 353 (1997) (A contract ‘does not become ambiguous by reason of the fact that that in its operation it will work a hardship upon one of the parties thereto.’)

Cincinnati City School Dist. Bd. of Edn. v. Conners, 2012-Ohio-2447 (Contracts that bring about results that the law seeks to prevent are unenforceable as being against public policy.)

State ex rel. Ohio Congress of Parents & Teachers v. State Bd. of Edn, 2006-Ohio-5512 (Upholds the constitutionality of the community school legislation; declares that community schools are public schools.)

In re Termination of Emp. of Pratt, 40 Ohio St.2d 107 (1974) (“A fiduciary relationship exists when special confidence and trust is reposed in the integrity and fidelity of another and there is a resulting position of superiority or influence, acquired by virtue of this special trust.”)

Renaissance Academy for Math & Science of Missouri, Inc. v. Imagine Schools, Inc. W.D.MO 2014 WL 7267033 (Missouri, 2014) (A fiduciary relationship between the charter school’s board and operator exists because the board placed its trust and confidence in its operator to create a successful learning environment and to manage the school’s operations. In short, the operator took over the de facto persona of the school’s governing authority.)

Yovich v. Cuyahoga Falls City School Dist. 10th Dist. No. 91-AP-1325 (June 23, 1992)(Once public funds are paid to a private entity, they lose their public character.)

Merit Decision

How Charter Schools are Set Up and Managed

I am not going to repeat Justice Lanzinger’s background material on how charter schools are set up, organized, and run—you can read that yourselves in ¶¶ 13-21 of the opinion. There she discusses the differences among sponsors, governing authorities, and operators. Relevant here is the operator part—the governing authority of a charter school can hire an operator to manage the day-to-day operations of the school. The Schools in this case hired White Hat for this purpose, so White Hat is an operator. Justice Lanzinger had this to say about such operators:

“Yet it remains a fact that operators, unlike sponsors and governing authorities, remain largely unregulated… there are currently no specific requirements for the content of the contracts between the governing authority and an operator. While fees to sponsors are capped, R.C. 3314.03(C), there is no ceiling on the amount of funding that can be passed on to private operators such as White Hat. Indeed, the schools in this case transferred to White Hat nearly all of the taxpayer dollars they otherwise would have retained for the education of students.”

Position of the Parties

The Schools

The schools argue that White Hat improperly titled in its own name the personal property it bought with public dollars for use in schools. When buying such property with public funds, the private operator (White Hat) is acting as a purchasing agent, and the property must be titled in the name of the schools. A private entity that performs the governmental function of operating a charter school has a fiduciary relationship with that school. White Hat should be accountable for the public funds it received because these funds remain public even after they are transferred to White Hat.

White Hat

The legislature already provides for accountability by requiring operators to submit detailed financial accounts, which are subject to audit. Funds do not retain their public character after they are received by the party being paid. The enabling legislation in this area contemplates that the parties will negotiate their obligations in an enforceable contract, which is what the parties did here. These contracts are fully enforceable as written. Among other things, the contracts state that the operator is an independent contractor, not an agent or fiduciary.

Resolution of the Two Issues

The Personal Property

The issue here is who owns the personal property after the contracts have ended. According to the contracts, White Hat buys the personal property for the schools. The source of funds for those purchases is the continuing fee, which are public funds. When the contract is over, the schools can buy the personal property back from White Hat, unless a particular funding source, such as a particular grant, required property to be titled in the school’s name.

While noting the apparent absurdity of transferring public funds to White Hat to buy property for itself, and then requiring schools to buy it back with more public funds, Justice Lanzinger’s opinion found that was what the parties contractually agreed to. So, any property that had to be titled in the name of the schools belongs to the schools; the rest had to be bought back from White Hat.

White Hat as Fiduciary

The contracts state that the parties acknowledge that their relationship is that of independent contractor. Justice Lanzinger’s opinion holds that the parties’ characterization of their relationship is not controlling. The contracts obligated White Hat to make these purchases on behalf of the schools, and generally to advance the interests of the schools. Thus, the court notes, the schools placed trust and confidence in White Hat, giving it broad discretion to act on their behalf, and placed White Hat in a position of superiority and influence—all hallmarks of a fiduciary relationship. So, the court concludes that a fiduciary relationship was created by the conduct of the parties, but based on the record in the case, the court cannot tell if it was breached, and doesn’t say that has to be determined on remand.

Observations About the Analysis of this Opinion

I knew this one was going to be a bear. It has been pending for almost a year. And it was clear from the oral argument that it wasn’t clear exactly what the case was about—certainly more than just buying some used furniture and equipment.

I get many calls about who to vote for justice of the Supreme Court of Ohio. This decision gives the clearest window into a true difference in judicial philosophy among the justices than any I have studied in some time.

Justice Lanzinger’s Lead Opinion

Justice Lanzinger clearly believes the schools were flimflammed in these contracts, but were represented by lawyers when the contracts were negotiated, and can’t be heard to complain now just because they made a bad deal. Her opinion is a model of careful analysis and legislative deference, but at the same time telegraphing disapproval of the way charter school operators have been allowed to operate.

“The contracts contemplate that funds designated by the Ohio Department of Education for the education of public school students will be used for the benefit of public schools, and not their private operators…The notion that the schools would knowingly transfer their funds to White Hat for White Hat to purchase the property for itself (and then later require the schools to buy the property back with additional public funds) does not seem supportable but was an agreed-upon term…The wisdom of the buy-back term can be questioned….The schools were represented by their own legal counsel, and they agreed to the provisions in the contracts. They may not rewrite terms simply because they now seem unfair.”

Justice Lanzinger also notes, clearly in response to Justice O’Neill’s position in dissent, that the schools never argued the contracts were unconscionable, so she does not address that issue. Counsel for the schools also acknowledged that point in oral argument. But Lanzinger also states later in the opinion that although it was not raised, she believed that the issue of unconsionability “invites further exploration in this case,” commenting that “the legislature has enacted statutes that take a laissez-faire attitude toward operators of community schools. We leave it to the General Assembly to determine whether public policy requires stiffening of the regulatory scheme governing these matters.”

Justice Kennedy’s Position

Justice Kennedy, joined by Justice French, clearly thinks White Hat is being unfairly criticized here, and is fully entitled to the contract provisions that were negotiated by the parties. Note these comments from her opinion:

“The majority suggests nefariousness when it asserts that the schools ‘transferred to White Hat nearly all of the taxpayer dollars they otherwise would have retained for the education of students’….The governing board transferred to White Hat not only money but also responsibilities, expenses, and risk. ”

Later, she wrote, “contrary to the innuendo of the majority, the parties’ agreement did not diminish the amount of funds dedicated to “the education of students” because Hope Academy did not retain any responsibility for educating students.”

To Kennedy, the contracts are simply enforceable as written, and under their terms, which the parties completely agreed to, White Hat owns the property that was purchased with the continuing fee. So, she (and Justice French) can agree with the first paragraph of the syllabus, which simply re-states the law that an entity that manages the daily operations of a community school pursuant to contract with the school’s governing authority is an operator within the meaning of R.C. 3314.02(A)(8)(a). But she strongly disagrees that there is any kind of fiduciary relationship or agency relationship created here. She relies on the fact that the parties agreed in their contracts that White Hat was an independent contractor, and on Ohio law holding that there can be no fiduciary relationship between an independent contractor and an employer unless both parties understand the relationship to be one of special trust and confidence, of which there was no evidence here. Plus the contract expressly states otherwise. As to agency, other than when it used grant money to buy property that had to be titled in the Schools’ name, What Hat never acted as an agent for the Schools. The Schools wanted no responsibility for or control over implementing their educational models, and no control over management. They left that totally to White Hat, which functioned as an independent contractor in operating the Schools.

She and Justice French join in the judgment only to the extent it affirms the court of appeals’ ruling on the enforceability of the buy-back provisions, but not on the fiduciary relationship part.

Justice O’Neill’s Position

Justice O’Neill agrees with all three paragraphs of the syllabus, but dissents from the opinion and judgment. He would find the contract unenforceable on public policy grounds, writing that the buy-back provision was “illegal and unenforceable ab initio, and it is this court’s constitutional obligation to put an end to this tragic legal fiction,” adding that “refusal to uphold the buy-back provision of this contract is neither judicial activism nor rewriting the parties’ contract in order to provide a more equitable result. Rather, it is the application of existing statutes and Supreme Court of Ohio case law to prevent theft of public property.”

His further observations about this contract:

“By contract, White Hat promised to safeguard and effectively utilize $90 million of public funds that were specifically set aside to educate the children of Ohio. And by contract, White Hat promised the children of Hope Academy that it, White Hat, would fulfill its fiduciary duty by providing a quality education for the sum of $90 million. The only part of that contract that was fulfilled was that White Hat thoroughly and efficiently received the $90 million. There has been no quality education, there has been no safeguarding of public funds, and there most certainly has been no benefit to the children…This is not an enforceable contract. It is a fraudulent conversion of public funds into personal profit. That is not the relationship that was bargained for, and it is not one that this court can magically create to protect the profits of White Hat.”

No one joined Justice O’Neill in his position, but his agreeing to all three syllabus paragraphs is what provided the majority for the syllabus of the case.

Justice Pfeifer’s Position

Justice Pfeifer dissented, period, joining in no part of the opinion. He agrees with Justice O’Neill that these contracts are unenforceable, and does not think the contract language is as clear as the majority finds it to be. He had this to say:

“In effect, the contracts call for the public to give money to a company to buy materials for the company to use on the public’s behalf to operate a public school. The contracts require that after the public pays to buy those materials for a public use, the public must then pay the companies if it wants to retain ownership of the materials. This contract term is not merely unwise as the as the opinion would have us believe; it is extremely unfair, so unfair, in fact, as to be unconscionable…The contract term is so one-sided that we should refuse to enforce it.”

Now What?

The case got sent back to the trial court “for an inventory of the property and its disposition according to the contract terms.” But as Justice Pfeifer notes, most of the stuff—furniture, old computers and instructional material, is probably obsolete or relatively worthless. And Justice Kennedy noted there is no need to do an inventory because all the property was titled when bought.

And as for the more critical finding about the existence of a fiduciary relationship here, set forth in paragraphs two and three of the syllabus, while important and significant, seems to have no application to the holding here.  Justice Kennedy takes the position in her partial dissent that those two paragraphs “are especially confusing because they are wholly dicta, with no identified relevance to this case and therefore with uncertain application in the future.” I agree that they don’t seem to be actually applied in this case, but I think they could be quite significant in the future.

Concluding Observations

As I said earlier in this post, this is a very revealing decision on judicial philosophy. I noted after argument that the problem could just be in the statutory scheme which set up these charter schools. It is truly outrageous, in my view. And charter schools  get public dollars first, with no need to rely on tax levies!

Following oral argument I noted that the Schools clearly were totally outsmarted in the negotiation of the management contracts, but gave credit to arguing counsel for the schools that she didn’t use that as an excuse.  Still, I noted that although this crowd is not one to legislate from the bench, or add terms to contracts, there was clearly a sense of moral outrage in the air. I also noted that although the contract states that White Hat is an independent contractor, just saying so doesn’t automatically make it so—the position adopted by Justice Lanzinger, but noted that Justice French seemed most inclined to buy that argument, which she did.  I predicted that the court might well impose a fiduciary duty in this context, which it did.  The remand instruction does not include consideration of any breach of fiduciary duty, although  the case was remanded for “further proceedings.” The Schools did allege breach of fiduciary duty in their complaint and now have something to stand on.

Honestly, I’m with Justices O’Neill and Pfeifer on this one.  I think what White Hat has gotten away with is unconscionable—and I mean in educational results, as much as the amount of money these folks have received.

So, you may ask, at the end of the day, who won this case?  Well of course White Hat won the point of requiring the schools to buy back the personal property titled in its name.  But I think the finding of a fiduciary relationship here between the parties is far more significant, and likely to bring about some interesting results on remand, which I doubt will go smoothly.

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