Traditionally, municipalities and school districts (hereinafter “local governments”) issue bonds or notes to fund capital projects and equipment purchases, including improvements to roads, buildings, water and sewer systems and parks and other recreational facilities owned by the local government. The interest paid by a local government to the holders of its bonds or notes is exempt from taxation, provided that the local government has complied with certain statutory and regulatory requirements at the time of issuance and continues to comply with such provisions until such indebtedness is retired.
An important policy consideration that underlies the constitutional and statutory framework for the issuance of debt in New York State is the premise that present generations should not be permitted to unduly burden future generations with debt. Another policy consideration is that there ought to be a link between the benefit derived from the item financed with bonds or notes and the term over which such indebtedness is amortized. The New York State Legislature has determined that it is not prudent to have indebtedness outstanding long after the useful life of the asset. These policy considerations and others are often at the forefront in the minds of our elected officials. As such, many local governments resist issuing debt altogether. However, in some circumstances the “pay as you go” strategy gives way to the issuance of debt to fund a project. For example, the local government may no longer be able to effectively function and serve its constituents without expanding certain facilities. Another common example is where a local school district cannot meet State mandates or accommodate enrollment increases without facility upgrades or expansion. In these situations, where substantial capital projects must be undertaken at a cost of several million or tens of millions of dollars, the “pay as you go” strategy may not be feasible; and the governing body may determine that the long term benefit of the facility improvements to current and future constituents, when weighed against the debt service costs, is sufficient to justify the issuance of bonds or notes to fund its project. In many cases, the local government will determine that the benefit of a capital improvement will extend over a period of many years and that there is a certain fairness in spreading the cost over a longer period, rather than burdening current taxpayers with the entire cost.
In some instances, local governments may be confronted with a situation where they need to issue bonds or notes to fund items that are not capital in nature, such as judgments, various claims, awards or determinations. These types of financings are generally referred to as “working capital financings.” One common example of a working capital financing is the issuance of bonds or notes to fund real property tax challenge liabilities of a local government. The aim of working capital financings is to remove a liability from the balance sheets of a local government. Since working capital financings do not result in the construction of a tangible or “benefit producing” facility for the local government, elected officials and local government administrators tend to avoid them whenever possible. In some instances (e.g. the existence of a single large dollar judgment or several judgments that aggregate to a large dollar amount) there are benefits to spreading the costs of the judgment over several years as well, much like the benefits derived from financing the costs associated with the construction of a new town hall or new school building over several years. In fact, by not having to pay the judgment in one year, the local government will avoid a significant tax rate spike or other associated fiscal stress. Although it is now well-settled law that a local government can issue bonds to finance judgments, settled claims, awards or determinations, this was not always the case. This article will discuss the constitutional and statutory authority that permits local governments to issue debt for the purposes of funding judgments, settled claims, awards or determinations. It will also look at the controlling case in this area and its holding. Last, certain Federal Tax law matters relating to working capital financings will also be explored.
New York State Constitution – Article VIII, Section 2 of the New York State Constitution states that “[n]o indebtedness shall be contracted for longer than the period of probable usefulness of the object or purpose for which such indebtedness is to be contracted … to be determined by the governing body of the county, city, town, village or school district contracting such indebtedness pursuant to general or special laws of the State Legislature, which determination shall be conclusive ….” N.Y.S. Constitution, Article VIII, Section 2. By enacting these provisions, the New York State Legislature and the people of this State acknowledge that not all items should be financed with the issuance of indebtedness and that only those objects or purposes identified or selected by the State Legislature and assigned a useful life in the Local Finance Law can be financed.
The power to issue debt to fund judgments was first implicated in Cherey v. the City of Long Beach, a case in which a taxpayer questioned the power of the City of Long Beach to issue bonds to fund certain unpaid judgments against the City. 282 N.Y. 382 (1940). The Plaintiff taxpayer argued that Article VIII, Section 2 prohibited the City of Long Beach from issuing bonds to fund the judgments because such judgments had no period of probable usefulness and therefore Article VIII, Section 2 prohibited the City from contracting “indebtedness for longer than the probable usefulness of the object or purpose for which such indebtedness is to be contracted …” 1 Id. at 385.
In Cherey, the Court underscores several of the policy considerations mentioned above, namely that “current expenses should ordinarily be paid from current income and that when indebtedness is contracted to meet extraordinary expenditures or expenditures not expected to recur, the indebtedness should be paid within the period in which the benefit expected to result from such expenditures is enjoyed.” Id. at 386. In addition, the Court highlights the danger of “postponing the payment of current expenses and placing upon later generations the burden of paying for benefits long after the benefits have ceased. Id. In deciding this case in favor of the City of Long Beach, the Court held that the unambiguous language of Article VIII, Section 2 does not limit the issuance of indebtedness to the construction or acquisition of a physical structure; and the Court acknowledged that “not every object or purpose for which debt is contracted does have such a period of extended usefulness.” Id. at 388-389. However, the Court did note that there must be a reasonable basis for the determination that the object or purpose for which the indebtedness is contracted will probably be useful in the future as well as the immediate present. It is conceivable that one such determination by elected officials and local government administrators could be that the fiscal stress on the current and future generations created by paying a judgment in one year is best avoided by issuing indebtedness to fund the judgment. Id. at 389-90.
In its decision, the Court states that it does not assume the role of creating additional safeguards to prevent local governments from manipulating or abusing the grant of authority to incur indebtedness for judgments, settled claims, awards and determinations. Id. at 390. The concern that Plaintiff Cherey highlights is the local government’s potential manipulation that would result in the issuance of bonds or notes to fund a purpose that could not otherwise be funded under the New York State Constitution or the Local Finance Law. Specifically, Plaintiff Cherey argues that “the constitution prohibits a municipal corporation from contracting indebtedness … for objects or purposes of purely transient usefulness and … that an indebtedness contracted to pay a judgment is in effect an indebtedness contracted to pay the obligation which underlies the judgment and may not be made payable at a date when the original obligation is of no continuing use.” Id. Again, the Court does not accept the argument made by Mr. Cherey and states that the Court cannot insert itself to provide additional safeguards not contemplated by the Constitution. Id. According to the Court, such a safeguard, against this type of manipulation, “often lies in the ballot.” Id.
The central holding of this case can be found in language of the last several paragraphs of the decision. Therein the Court declares that the “determination of the period of probable usefulness of the objects or purposes for which indebtedness is incurred is not left to the local subdivisions.” Id. at 390. In all circumstances, as required by Article VIII, Section 2 of the Constitution, the determination of the period of probable usefulness must be made by the State Legislature in the form of a general or special law. Id. More importantly, once the State Legislature has made such a determination, it is presumed to be valid and conclusive. Id. at 390-391.
According to the Court, the enactment of Section 11.00 of the Local Finance Law follows the mandates prescribed by Article VIII, Section 2 of the Constitution and therefore must be valid. The Court concludes it decision by holding that “the constitution does not prohibit the issuance of bonds or notes to accomplish a public purpose where the bonds are payable within the period, as determined by the State Legislature.” Id. at 391. The Legislature has, in reaching its determination, weighed the benefits of providing for a period of probable usefulness against the harm to the public interest. Id. Since the Legislature has determined to assign a period of probable usefulness, such determination cannot be overturned by a court. Id. at 392.
Local Finance Law – As set forth in Cherey, “the enactment of Section 11.00 of the Local Finance Law ‘constitutes a legislative construction that the provision of Article VIII, Section 2 permit’ local governments to contract indebtedness for the purpose of funding judgments.” Id. at 390. Section 11.00 of the Local Finance Law assigns a period of probable usefulness to many objects or purposes. A period of probable usefulness is the maximum period during which obligations for a particular purpose may be amortized. The Local Finance Law at subdivision 33 of Section 11.00 prescribes a period of probable usefulness for obligations issued to finance the settlement of judgments, claims, awards and determinations against a municipality, school district or district corporation. In addition, subdivision 33-a of the Local Finance Law provides a period of probable usefulness for tax certiorari judgments, compromised claims or settled claims resulting from court orders on proceedings brought pursuant to article seven of the real property tax law (the “RPTL”).
Often court ordered or approved settlements of judicial proceedings have frequently been financed by local governments in New York State. In many instances, parties to a legal proceeding will evidence their settlement of a controversy by submitting a settlement agreement or stipulation of settlement to the court in which the proceeding is pending. A judge’s order approving such stipulation would serve as sufficient authority for payments to be made as required under the terms of the settlement agreement and for obligations to be issued to finance such payments.
Subdivision 33 of Section 11.00 of the Local Finance Law provides the period of probable usefulness for judgments, various claims, awards or determinations. The New York State Legislature has assigned several “periods of probable usefulness” when it drafted this subdivision. The following is a summary of such provisions:
A judgment or a compromised or settled claim against a local government, or an award or sum payable by a local government pursuant to a determination by a court, or an officer, body or agency acting in an administrative or quasi-judicial capacity. PPU: 5 years
Where a single judgment, claim, award or sum or any combination thereof in a single fiscal year, amounts to more than 1% of the average assessed valuation of the local government. PPU: 10 years
Where a single judgment, claim, award or sum or any combination thereof in a single fiscal year, amounts to more than 2% of the average assessed valuation of the local government. PPU: 15 years
Similarly, subdivision 33-a of Section 11.00 of the Local Finance Law provides the period of probably usefulness for tax certiorari judgments, compromised claims or settled claims against a local government resulting from court orders on proceedings brought pursuant to Article 7 of the RPTL. The following is a summary of the periods of probable usefulness affecting the financing of such tax certiorari judgments:
Notwithstanding the provisions of subdivision 33, the payment in a single fiscal year of judgments, compromised claims or settled claims against a local government resulting from court orders on proceedings brought pursuant to Article 7 of the RPTL. PPU: 5 years
Where the accumulated tax refunds to be paid are more than 1% but less than 3% of that portion of the real property tax levy of such local government for the year in which payment is to be made. PPU: 10 years
Where the accumulated tax refunds to be paid are more than 3% but less than 5% of that portion of the real property tax levy of such local government for the year in which payment is to be made. PPU: 15 years
Where the accumulated tax refunds to be paid are more than 5% of that portion of the real property tax levy of such local government for the year in which payment is to be made. PPU: 20 years
In some instances, local governments have sought and received permission from the New York State Legislature, in the form of a special statute, the authority to issue bonds or note for a period of longer that what is permitted by subdivisions 33 and 33-a. For example, legislation enacted on behalf of the Haverstraw-Stony Point Central School District, Rockland County, permitted bonds to be issued for a term of not to exceed 30 years if the accumulated tax refunds of that District exceeded 10% of the District’s tax levy in the year in which the payments were to be made. See Chapter 733 of the Laws of 2005 of the State of New York.
As a general rule, legal costs incurred by the local government in connection with a judgment, claim, award or determination may not be financed with bonds or notes. However, if such costs, including court costs, are included in the judgment, claim, award or determination, the local government may finance such costs. See 1952 Op. St. Compt. # 5792 (unreported).
It is important to note that the adoption of a bond resolution by the governing body of a local government authorizing the issuance of bonds or notes to pay a judgment is not subject to referendum and, thus, considerably reduces the amount of time that is needed to authorize indebtedness. In fact, a local government can begin to incur indebtedness for the purpose of paying a judgment, claim, award or determination almost immediately following the adoption of the authorizing bond resolution. However, in practice, no indebtedness is generally incurred for at least three to five weeks from the date of board action authorizing such indebtedness. This slight delay is due to the fact that it is generally recommended that the local government publish a legal notice in its local newspaper, commencing a 20-day estoppel period2 before borrowing.
Federal Tax Law Matters – Local governments issue tax-exempt bonds to finance costs of capital projects and certain non-capital items, and the issuer wants the interest on such bonds or notes to remain exempt from federal, state and New York City income tax. If the interest on any obligations of a municipal or school district is to be exempt from federal income taxation, the municipality or school district must certify that it will use the proceeds from the sale of such obligations to pay a bona fide claim. Pursuant to applicable federal tax regulation, the claim must be one that is recognized by a court, the payment of such bona fide claim should not be subject to challenge following the issuance of the bonds, and the amount of the claim must be ascertainable and definite. Today, there exists no doubt that local governments have the authority under Article VIII, Section 2 and the Local Finance Law to issue bonds or notes to finance judgments, settled claims, awards and determinations. However, when a local government is faced with a situation where it must contemplate the issuance of bonds or notes for this purpose, it should always consider some of the policy considerations discussed in this article and other factors which could not be discussed (e.g. impact of issuing bonds or notes for this purpose upon the local government’s credit rating). It is only after careful consideration of all of the benefits and risks that the local government can determine whether to proceed or not to proceed.
William J. Jackson is an attorney at Hawkins Delafield & Wood LLP in the firm’s New York local government and school district finance practice group. Since joining the firm, Mr. Jackson has been involved with various property tax-supported and revenue bond and note issues involving local governments, school districts and public authorities. Prior to attending law school, Mr. Jackson was an assistant vice president at a large national financial advisory firm, which served local governments and school districts.
1. It is important to note that shortly after the Constitutional Convention, the New York Legislature enacted legislation that assigned a period of probable usefulness to the financing of judgments by local governments. Cherey v. the City of Long Beach, 282 N.Y. 382, 387 (1940).
2. Title 6 of the Local Finance Law provides a method to limit the period for taxpayer challenge from 4 months (the amount of time generally granted for an Article 78 challenge) to 20 days. This mechanism is only available where the resolution authorizing the issuance of bonds or notes (or a summary thereof) is published together with a statutory notice. The estoppel procedure does not bar challenges made on constitutional grounds.
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