Obligations of South Carolina Municipalities: A Brief Overview

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1 Obligations of South Carolina Municipalities: A Brief Overview By Margaret Christian Pope, Esquire B. Eric Shytle, Esquire Haynesworth Sinkler Boyd, PA 1201 Main Street, Suite 2200 Columbia, SC Published December 2003

2 Obligations of South Carolina Municipalities: A Brief Overview Municipalities, unlike ordinary business enterprises, must observe significant restrictions on their ability to borrow money. Perhaps most importantly, only certain types of borrowings are authorized by the South Carolina Constitution. The two basic categories of borrowings available to a municipality are general obligation debt and revenue debt. Municipalities may also borrow money pursuant to more narrowly specialized authorizations, including lease-purchase transactions, special source financing, and tax increment financing. General Obligation Debt General obligation debt is defined by the South Carolina Constitution to mean any indebtedness" of the debtor that is secured in whole or in part by a pledge of its full faith and credit. Therefore, general obligation bonds must be secured by ad valorem property taxes and are generally paid from such taxes. General obligation debt may be incurred only for a purpose that is a public purpose and a corporate purpose of the issuing municipality. The relevant statutory reference for municipal general obligation debt is the Municipal Bond Act, Section et seq., Code of Laws of South Carolina, 1976, as amended. Further restricting the ability of municipalities to issue general obligation debt is the debt limit, which provides that a municipality may not issue general obligation debt in an aggregate principal amount that exceeds eight percent of the assessed value of taxable property in such municipality. A municipality should confer with the auditor of the county in which it is located prior to issuing debt to ensure that its borrowing is within the eight-percent limitation. The calculations required to determine the applicable assessed value are technical and complex, and the most prudent course is to consult with bond counsel in making such calculations. The debt limit does not apply, however, to debt of political subdivisions issued prior to November 30, 1977; debt approved prior to issuance in a referendum; tax anticipation notes; or authorized lease-purchase transactions. For practical purposes the most important exclusion here is that general obligation debt approved in a referendum will not be charged against the eight-percent limit. The municipality should carefully follow the required procedures in issuing general obligation debt. The governing body of the municipality must adopt an ordinance approving the issuance of the debt. The ordinance must be given two readings, but no public hearing is required. Unless a notice as prescribed by Section (8), Code of Laws of South Carolina, 1976, as amended, is published, the ordinance is subject to repeal by citizen initiative for sixty days following adoption. Publication of the notice reduces the sixty-day period to twenty days following publication. Moreover, unless the debt to be incurred does not exceed $1,500,000 and is repayable over ten years or less, the debt must be sold at public competitive sale. See Section (4), Code of Laws of South Carolina, 1976, as amended. Notice of such sale must be published in a newspaper of general circulation in South Carolina (e.g., The State) or in New York City (e.g., The Bond Buyer). Depending on the type of issue, notice must be published at least seven days prior to the sale date. In the case of a private sale, the municipality must publish a notice of sale at least seven days prior to the closing date. Revenue Debt Revenue debt, unlike general obligation debt, is secured by a limited pledge of and lien upon a designated stream of revenues. Perhaps the most common form of revenue debt for South Carolina 2

3 municipalities is debt secured by the revenues of a utility system, generally issued pursuant to the Revenue Bond Act for Utilities, codified as Chapter 21 of Title 6 of the Code of Laws of South Carolina, 1976, or the Revenue Bond Refinancing Act, codified as Chapter 17 of Title 6 of the Code of Laws of South Carolina, The relevant system, under Chapter 21, may be one of a laundry list of utilities including waterworks, sewer, garbage and trash disposal, solid waste transfer, natural gas, ice plants, power plants, hospitals, piers, docks, terminals, airports, toll bridges, ferries, drainage, city halls, courthouses, armories, fire stations, auditoriums, hotels, gymnasiums, cemeteries, curb markets, etc. South Carolina case law has more particularly defined whether or not certain systems on this list constitute a public purpose. Significantly, the South Carolina Constitution requires that a referendum be held prior to a municipality acquiring by initial construction or purchase and operating gas, water, sewer, electric, transportation or other public utility systems. The issuance of revenue debt will generally result in the imposition of certain restrictions on the operation and maintenance of the system generating the pledged revenues. Among other things, the issuing municipality will be required to maintain rates adequate to sustain the system and support the debt, to deposit certain revenues of the system with a custodian bank, and to segregate all revenues into several designated funds. In addition, when a municipality initially issues revenue bonds, the bond ordinance will provide the circumstances under which additional bonds with equivalent lien priority may be delivered. The most important condition is the provision that includes the earnings test, which generally requires net revenues equal to a specified percentage (usually 120% or 125%) of aggregate debt service on bonds secured by such revenues. In addition to the Revenue Bond Act for Utilities and the Revenue Bond Refinancing Act, Section 14 of Article X of the South Carolina Constitution authorizes the issuance of indebtedness payable solely from a revenue producing project or from a special source, upon the conditions prescribed by the General Assembly. Among the types of common special source debt other than utility revenue debt are tax-increment financings (authorized by Section 14(10) of Article X of the South Carolina Constitution and Chapter 6, Title 31 of the S.C. Code) and fee-in-lieu-of-tax special source revenue bonds (authorized by Sections and of the S.C. Code). All revenue debt must be issued pursuant to the provisions of an ordinance that must be given not less than two readings with six days between the two readings. Revenue bonds may be publicly or privately sold. In a negotiated sale, the underwriter is compensated by the payment of a commission, which generally comes from bond proceeds. This commission is referred to as underwriter s discount and is expressed as a dollar amount per $1,000 of principal issued. Many revenue bonds today are sold to the State of South Carolina through one of two programs. First, the Safe Drinking Water State Revolving Loan Fund Program is designed to assist public water utilities in financing the costs of infrastructure needed to achieve or maintain compliance with the federal Safe Drinking Water Act. Loans are made on a priority basis pursuant to a priority list developed by the South Carolina Department of Health and Environmental Control. Interest rates are usually quite competitive, and the loans will mature over a 20- to 30-year period. Applications are generally taken from October 1 through June 30 of each year. Second, the Water Pollution Control State Revolving Loan Fund Program is designed to assist public sewer utilities in financing the costs of wastewater related infrastructure, including in some cases storm water projects. Again, interest rates are quite competitive, and the loans will mature over a period not exceeding 20 years. Applications are generally taken from October 1 through June 30 of each year. 3

4 Leasing and Other Alternatives Until 1996, both real property improvements and equipment could be financed through leasepurchase transactions that were subject to non-appropriation and were therefore not considered debt within the meaning of the Constitution. The exclusion of such transactions from constitutional debt restrictions was approved by the Supreme Court of South Carolina in the case of Caddell v. Lexington County School District No. 1, 296 S.C. 397, 373 S.E.2d 598 (1988). As of January 1, 1996, however, most lease-purchases of land, buildings, and fixtures must be treated as debt for 8% debt limitation purposes, unless approved by referendum. See Section , Code of Laws of South Carolina, 1976, as amended. Accordingly, political subdivisions have since that date generally ceased entering into lease-purchase transactions for land, buildings, and fixtures. Even after 1996, however, certain lease-purchase agreements do not count against the debt limit. These include agreements that finance assets for a system that is expected to generate sufficient revenues to pay amounts due under the financing agreement; agreements that finance equipment and rolling stock; agreements that finance the refunding of lease-purchase transactions entered into prior to January 1, 1996, provided that there is a savings achieved by the refunding; agreements that are secured solely by accommodation and hospitality fees in accordance with (A)(4), Code of Laws of South Carolina, 1976, as amended; and agreements that finance energy efficiency projects or guaranteed energy savings contracts. Regardless of applicable statutory law, each lease-purchase agreement should include a nonappropriation clause. The non-appropriation clause gives the municipality the right to terminate the agreement at the close of each fiscal year. The courts have reasoned that as long as the obligation is terminable on an annual basis, it may be treated as a current expense rather than long term debt. In addition, no lease-purchase agreement should contain a non-substitution clause. Such a clause is a covenant by the municipality that, in the event it exercises its right to non-appropriate, it will not in the subsequent year expend funds for equipment similar to that leased under the non-appropriation agreement. Courts in several other states have found that non-substitution clauses obviate the ability of the municipality to choose to non-appropriate. Without a meaningful non-appropriation clause, the leasepurchase agreement might be treated as general obligation debt. Finally, a municipality entering into a lease-purchase transaction should be aware of certain other provisions that may curb or eliminate the right to non-appropriate. For example, some non-appropriation clauses contain a covenant that the municipality will do everything in its power to have funds appropriated. These covenants are not appropriate for fiscally autonomous bodies, and should be deleted. Likewise, some leasing companies provide for acceleration of all scheduled payments in the event of default. These provisions should be limited to recovery of sums appropriated in the then-current fiscal year. Another alternative to traditional forms of debt is debt secured by accommodations and/or hospitality fees. As noted above, lease-purchase agreements secured solely by accommodation and hospitality fees are not treated as debt for purposes of the 8% debt limit. Local governments in South Carolina began several years ago to impose a charge on hotel accommodations and restaurants. The South Carolina Supreme Court upheld the constitutionality of these types of charges in Hospitality Assoc. of South Carolina v. County of Charleston, 320 S.C. 219, 464 S.E.2d 113 (1995). In 1997, as a reaction to the decision in Hospitality Assoc., the General Assembly undertook to limit the imposition of alternative revenue charges and otherwise impose limits on the growth of taxes and fees imposed by local governments. See et seq., et seq., Code of Laws of South Carolina, 1976, as amended. In any event, local governments have since the Hospitality Assoc. decision reviewed the possibility of leveraging alternative revenue sources by securing bonds or other obligations with such 4

5 sources. Such obligations would not require the imposition of additional ad valorem property taxes or an increase in utility system rates. A related possibility for securing a municipal debt instrument is the capital projects sales tax. Particularly in counties with a sufficient sales tax base, it is likely to be a popular alternative to property tax levies in connection with the construction of needed public facilities. Such obligations do, however, raise certain constitutional questions, including whether the capital projects sales tax qualifies as something other than a tax or license and thus a legal source of security for revenue bonds. For that reason, debt secured by the proceeds of a capital project sales tax may be charged against the issuing municipality s debt limit. A final possibility is tax increment financing. This type of debt is incurred for the purpose of redevelopment in areas that are or threaten to become blighted. The municipality issuing such debt may pay debt service from the additional (or incremental) tax revenues that result from the redevelopment. Property taxes collected within a redevelopment project area in excess of the amount of taxes attributable to the total initial equalized assessed value of all taxable real property in the redevelopment project area are paid to the municipality. These taxes are deposited into a special tax allocation fund to pay redevelopment project costs and to discharge any obligations issued to pay such costs. This type of debt is not chargeable against the debt limit of the municipality, but is subject to significant conditions in the authorizing legislation. 5