Lease Agreements and Bond Fund Issues

Posted by on Apr 5, 2006 in Information | 0 comments

Many of the questions we have received in the last few years have related to equipment lease agreements and conduit financing through the use of a public trust issuing revenue bonds. Rosenstein, Fist & Ringold, Inc. have addressed the important legal issues related to these two areas of concern in their recent issue of Chalkboard. We appreciate the assistance of the firm for allowing us to reproduce this article for our clients:

Rosenstein, Fist & Ringold has previously advised our clients that we are now supplementing the legal representation which we offer our school districts by providing legal representation service, counsel and guidance in the area of tax exempt bond financing. In the course of our representation of clients, it has come to our attention that certain bond financing techniques being considered or used throughout the sate could be violative of Oklahoma law. This alert sets forth a financing technique which we believe has been used in Oklahoma and which arguably does not comply with Oklahoma law. This technique, referred to as “conduit financing” involves the use of a public trust and the issuance of revenue bonds to make improvements to school district property. The clearest way to present this extremely complex structure is to use an example.

Example

Set forth below, for illustrative purposes, is an example of the financing transaction which gives us concern.

1. School District desires to build a gymnasium for $2,000.000.

2. The School districts building fund is insufficient and its bonding capacity in the current year and over the next several years is only $400,000 per year due to the valuation of the property within its geographic boundaries and the outstanding indebtedness of the School District. Thus, even if the School District issued general obligation bonds to the maximum extent allowed by law, the money generated by the sale of its bonds will be far less than the amount needed to construct its gymnasium.

3. A public trust (either an existing trust or one created for the purpose) agrees to assist the school district by entering into a ground lease covering the construction site; building the gymnasium and subleasing the improved property back to the school district.

4. The public trust finances the construction cost by issuing revenue bonds. The issuance by the public trust of revenue bonds does not require a vote of the people and is not subject to Constitutional debt limits.

5. The School District, recognizing the value of the commitment by the public trust, leases its ground to the public trust so that the public trust now has a tract of land upon which it can construct the gymnasium.

6. The public trust subleases the ground back to the School District, along with the gymnasium on that ground, which the public trust has caused to be built. The cost of the project has been paid from the loan proceeds which the public trust received in connection with its sale of its revenue bonds.

7. The school district will be required to pay sufficient rent to the public trust to repay the principal and interest due under the trust’s revenue bonds.

8. As a result, the School District proposes a general obligation bond issue whereby it will issue general obligation bonds in the amount of $400,000 per year serially to “construct, acquire and equip a gymnasium.”

9. The School District’s general obligation bond referendum passes. The money received by the School District as a result of the School District’s bond issue is being used to pay rent to the public trust under the School District’s sublease with the public trust.

The Problem

We have been advised that some school districts are considering or have already entered into conduit financings where the installments of rent are paid through the issuance of the school district’s general obligations bonds approved by the voters, to be issued annually as bonding capacity permits for the purpose of “constructing, acquiring and equipping a gymnasium.”

The fundamental problem with this structure is that the proceeds which the School District received from the issuance of its general obligation bonds may not be used to make payments under its sublease pursuant to which it subleases the gymnasium from the public trust. The conduit financial of the public trust is not the problem.

Article X, Section 26(a), of the Oklahoma Constitution allows school districts to issue bonds, subject to financial limitations and voter approval, for the purpose of acquiring or improving school sites, constructing, repairing, remodeling or equipping buildings, or acquiring school furniture, fixtures or equipment. The Oklahoma Constitution does not allow school districts to issue bonded indebtedness for the purpose of paying lease payments. The Oklahoma School Code authorizes school districts to rent property or lease-purchase property provided that the lease payments must be made out of appropriations for the applicable, current fiscal year. The rule is clear: if lease payments are made by a school district, they must be made from annual appropriations and the obligation to make payments may not extend beyond the current fiscal year. Bond proceeds may not be used to make lease payments.

Additionally, with one exception that is noted below, general obligation bond proceeds may not be used to acquire title to building, fixtures of equipment that is financed by the school district through a “lease-purchase” agreement. A lease-purchase agreement is an agreement pursuant to which (a) the school district is obligated to pay annual lease installments consisting of principal and interest, (b) the school district may terminate the lease if the necessary funds are not appropriated for a fiscal year, and (c) the school district attains title and receives a bill of sale to he assets after it has made all lease payments. The critical aspect of a lease-purchase agreement is that the school district has the right to terminate the lease-purchase agreement at the end of any fiscal year and “walk away from the deal” by returning the property that it was leasing, and without any further liability to the lessor. The only time that the proceeds of general obligation bonds of a school district can be used to acquire property being financed through a lease-purchase agreement is when the bond proceeds pay the full principal amount owed under the lease-purchase agreement resulting in a transfer of title to the property to the school district. In this manner, the school district has acquired property; not merely paid an installment payment.

On November 13, 2002, the Attorney General issued Opinion No. 2002-43 concerning the use of general obligation bonds to make annual installment payments under a lease-purchase agreement for the purpose of acquiring buildings or equipment. Summarily, the Attorney General concluded that:

The bonds, if issued, must be used to “acquire” school building sites, fixtures or equipment or other facilities.

The term “acquire” means obtaining full legal title, possession or control. It specifically does not include a fractional or divided interest in a building or facility. No statute exists which allows a school district to make lease-purchase installments from bond proceeds if the leased property remains in the lessor and the school district does not acquire it.

Whether proceeds of a general obligation bond are used to “acquire” title in real or personal property depends on the facts and circumstances of each case.

It is possible to use bond proceeds to accelerate the acquisition of property. However, the property must consist of personal property or equipment which can be severed from the real estate without damage to the property itself or to the building. You may not simply allocate a portion of the purchase price or construction cost to components separate and apart from the building itself.

While not addressed in Attorney General Opinion No. 2002-43, we have an additional concern with respect to the structure specified in the example and its possible violation of the Oklahoma Bond Issue Proceeds Act (Act”). The purpose of the Act is to assure the citizens of Oklahoma that the proceeds of the bond issues which they have approved will be expended form the purposes of projects approved by them. Even in its most favorable light, it is at lease questionable as to whether a general obligation bond proposal in which the electorate is requested to approve the issuance by the School District of its general obligation bonds to construct and acquire a gymnasium and its equipment” provides sufficient notice to the electorate that the proceeds will be used to pay rent or acquisition payments under an annually terminable sublease agreement with a public trust. Any member of the board of education, who knowingly violates the provisions of the Act, shall forfeit his office.

The primary concern of Rosenstein, Fist & Ringold is, and always has been, that of sound legal advice to the boards of education which we represent. We urge all school district administrators and board members to exercise caution with respect to this financing technique. We remain available to assist school districts in developing legal general obligations bond issues, and we are also available to evaluate the legal risk attributable to overly aggressive or overly creative bond issues.

Copyright 2006 Rosenstein, Fist & Ringold

Eric P. Nelson and Jerry Zimmerman are both members of the National Association of Bond Lawyers, and may be reached at ericn@rfrlaw.com and jerryz@rfrlaw.com.

Comments are closed.