Articles

COUNTY COMMISSIONERS ASSOCIATION OF PENNSYLVANIA

COUNTY SOLICITORS SEMINAR
JUNE 25, 2004
George M. Aman III

Traps Under State Law for Unwary Solicitor in a County Financing

1. Power to Borrow. Increasingly local governments, and probably counties too, are asked to borrow money for various new types of projects of the county or to assist worthy organizations. In these situations, the solicitor should remember to check the existence of substantive power in the county to borrow.
   

   • The Local Government Unit Debt Act does not provide substantive power for borrowing, but only the limits and the procedure. It does provide, however, that debt may be incurred for any project which the local government unit is authorized to own, operate or subsidize. 53 Pa. C.S. § 6005(c). The concept that the power to borrow may be implied from the power to construct a project reflects prior case law. See Garr, et al. v. Fuls, et al., 286 Pa. 137, 133 A. 150 (1926). Thus, the task is to find a county power to construct or subsidize the object at hand.

   • As an example, recently a county successfully used the broad power to acquire property as a basis for a commercial development project. Hedman v. County of Warren, 2004 WL 503371 (Pa. Commwlth.2004).
2. Limited Power to Borrow for Operating Expenses. New borrowing requests may also test the distinction between what is a "capital" item and what is operating expense. Except in extreme situations, a local government may only borrow long-term to finance the "cost of a project" as defined in the Debt Act. 53 Pa. C.S. § 8007. This term includes, of course, the preliminary and "soft" costs. An item which is not financed as part of a larger project must have a useful life of at least five years. It also includes capitalized money to finance operating expenses, but only those which are related to a capital project being financed and then only to a date one year following completion of the project.
   
   • Borrowing for regular operating expenses is only authorized to cover cash flow deficiencies in anticipation of tax receipts for the current year. 16 P.S. § 1771; 53 Pa. C.S. §8121.
   • While tax anticipation borrowing is widely used, it has been abused in various ways. One abuse has been to borrow solely to obtain investment income. This tactic probably has no valid basis as a matter of substantive power, as well as violating the Federal tax regulations, which were discussed by the preceding speaker.
   • Another questionable practice is to use the proceeds of tax anticipation borrowing as a financing source for capital projects. Tax anticipation borrowing under the Debt Act is intended to provide operating funds to cover cash flow deficits in the government unit's budget. It must be repaid within the same year it was borrowed. 53 Pa. C.S. §8123. It cannot be repaid from long term borrowing or tax anticipation borrowing of the next year.
   • Permanent financing should be used to pay the cost of capital projects. The Debt Act does provide a procedure for issuing bond anticipation notes, which, for market reasons, is seldom used. 53 Pa. C.S. §8108.
3. Power to Guarantee. A county may be asked to guarantee the debt of a corporation; presumably a nonprofit corporation serving a public purpose. Guaranty agreements create what is called "lease rental debt" under the Debt Act. 53 Pa. C.S. § 8002(a). Lease rental debt can only be created for debt of an "authority." The term "authority" itself is defined to include a nonprofit corporation. However, to be eligible for a guarantee, a nonprofit corporation must be "organized by a local government unit", or possibly one which is under the control of the local government guaranteeing its debt (See 53 Pa. C.S. §8002(c)). Many existing nonprofit corporations will not be able to meet this requirement. However, a recent case does recognize, in a dictum, the power of a local government to create and use a nonprofit corporation for certain activities. Greater Fourth Street Associates v.Smithfield Township, 816 A2d. 388 (Pa. Commwlth. 2003).
4. Power to Lend. Rather than guaranteeing a debt, a county may be asked to borrow money in order to lend money to a private corporation engaged in activities with a public purpose.
   
   • Here again, the issue is whether the County Code or other statute authorizes the transaction. The authority can sometimes be found in the powers given to counties under the Code to engage in specific activities.
   • Loans to other municipalities or to an authority create much less problem, but the existence of power still should be investigated. Frequently it can be found under the Intergovernmental Cooperation Act. 53 Pa. C.S. §2302 to 2315.
   • Federal tax regulations impose important restrictions on the use of borrowed funds for this type of activity.
5. Proper Preparation for Borrowing.
   
   • A most recent example of need for preparation is illustrated by the case involving the requirement for preliminary estimates of costs. County of Northampton v. Department of Community and Economic Development, 825 A.2d 1245 (Pa. 2003). The Debt Act requires that before issuing bonds the issuer must record that it has obtained realistic cost estimates from professional engineers or other persons qualified to give such estimates. 53 Pa. C.S. § 8006. In the Northampton case, the Supreme Court upheld the power of the Department to hold a hearing to determine whether a county had obtained such estimates. Bond ordinances usually contain a recital that the issuer has obtained such estimates, but in view of the case just cited, it would be well to make certain that the file contains a memorandum concerning the estimated cost of each item financed, and also who provided the estimate.
   • Estimate of Useful Life. The estimate of useful life of a financed facility determines the maximum length of financing which may be undertaken for it. 53 Pa. C.S. § 8142(a). The Act requires that the ordinance contain a statement listing the estimated useful life of the project, or projects, being financed. 53 Pa. C.S. § 8103(a)(1). This also could be a trap for the unwary solicitor if it cannot be proved that any real determination of the useful life was ever made.
6. Preliminary Resolution. Sometimes in the rush of preparing for a financing, especially a refunding, no formal action is taken before the meeting at which the bonds are sold. If some of the members of the governing body have not been informed about the details of the financing, they may withhold their approval at the last minute. Unless such a resolution has been adopted, objections may be made even after the bonds are issued, by those who say they didn't know the details and were "pressured" to vote for the bond ordinance. This is embarrassing though of little legal effect. To deal with this possibility, the Debt Act authorizes, but does not require, the adoption of a preliminary resolution about the intention to issue bonds. 53 Pa. C.S. § 8102. This power can be used by having a preliminary resolution adopted, setting forth the amount of the bond issue, the general purpose, and the method by which the bonds will be sold.
7. Reimbursement Resolution. Admittedly this is not a matter of state law, but one of the traps I have seen most frequently is when a municipality starts constructing a capital improvement, paying the costs from its accumulated surplus, and then it decides to have a bond issue. However, unless some exceptions apply, tax exempt bonds may not be issued to reimburse the municipality for its own funds spent previously for a project, unless it has recorded before the construction begins, its intention to use its own funds temporarily, with reimbursement promptly from bond issue proceeds. This must take the form of a "reimbursement resolution" complying with the IRS regulations. §1.150-2(d).
8. Preliminary Review of Outstanding Debt. Before starting a financing it is important to look at the financial records and determine the nature and amount of a municipality's outstanding debt. This is important even if the outstanding debt is well below the limit, because the municipality must include in its filing with the Department of Community and Economic Development an accurate Debt Statement. 53 Pa. C.S. §8110. This does not speak as of the date after the bond issue. Underwriters and investors like to know how much the municipality can borrow in its next bond issue, and so the Official Statement will state the status of the debt after the issue. The Debt Act, however, requires stating the debt outstanding as of a date before the proposed issue, but not too much earlier. It must speak as of a date less than 60 days before the issue.
9. Common Errors in Calculating Outstanding Debt. These include the following: 
   • Omitting a small or ancient bank loan;
   • Listing an issue even though it was refunded;
   • Omitting an item which technically is "debt" but was not treated that way by the municipality. This includes debt created by a lease obligation for equipment, unless the lease contains a realistic nonappropriation clause.
   • Listing only the proceeds actually drawn down under a loan agreement. Debt may be technically "outstanding" even though the full amount has not been drawn.
   • Tax anticipation borrowing is not "debt" under the Debt Act, and so should not be included.

Preparation of the debt statements should be coordinated by the financial advisor or underwriter, with the issuer's finance director. Often, though, it is not checked carefully enough and the filing is "bounced" by the Department.

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