By CHRISTIE MARTIN and LEN WEISER-VARON

The IRS on April 11, 2018 released Revenue Procedure 2018-26 (Rev. Proc. 2018-26), which expands remedial action options in connection with certain post-issuance leases to private parties of facilities financed with tax-exempt bonds. Whereas previously the bond issue(s) that financed the leased facility would have to be redeemed or defeased to preserve the tax-exemption of the applicable bonds, the new remedial action permits the bonds to remain outstanding if the present value of the lease payments is applied to other bondable expenses. The new Revenue Procedure also introduces remedial action for certain types of tax credit bonds and direct pay bonds that did not previously have access to remedial action options.

The Internal Revenue Code provides for the issuance of tax exempt bonds under Section 103 (“tax-exempt bonds”), qualified bonds with refundable tax credits payable to issuers under Section 6431 (“direct pay bonds”) and qualified bonds providing tax credits to holders (“tax credit bonds”). Each of these types of bonds has eligibility requirements including the prescribed uses of the proceeds. For example, in the case of tax-exempt bonds issued for the benefit of government entities or 501(c)(3) non-profit borrowers, there are strict limits on private use of bond-financed facilities that are inconsistent with the sale or lease of such facilities to a private party. When proceeds are not used for qualified uses, or cease to be so used, the bonds lose their tax advantage unless an allowable remedial action is taken to cure the nonqualified use. Existing regulations provide for certain remedial actions for tax-exempt bonds and tax credit bonds issued as qualified zone academy bonds.

Rev. Proc. 2018-26 expands the existing remedial action options for tax-exempt bonds to allow an alternative use of “disposition proceeds” to cure nonqualified use resulting from eligible leases (defined below) of financed property. Prior to the new Revenue Procedure, the only remedial action available in the case of such leases was a redemption or defeasance of bonds, often requiring the redemption or defeasance of the entire bond issue that financed the leased facility. Building on the existing alternative use of disposition proceeds remedial action for exclusively cash sales of tax-exempt financed facilities, the new Revenue Procedure treats an “eligible lease” as a disposition made exclusively for cash, and deems the “disposition proceeds” to be an amount equal to the present value of all of the lease payments required to be made under the eligible lease. Instead of redeeming or defeasing the applicable bond issue, tax-exemption of the applicable bonds can be preserved by expending these deemed disposition proceeds on other bondable expenses, provided the issuer expects such expenditure to occur within two years of the date of the lease. This eligible lease remedial action is expected to be helpful to governmental issuers that wish to convert bond-financed public facilities into public-private partnerships using long-term lease arrangements, as well as others who no longer need bond-financed facilities for their original purpose and want the flexibility to lease rather than sell those facilities without retiring the associated tax-exempt debt.

A lease is an “eligible lease” if (a) the consideration for the lease is exclusively cash lease payments (regardless of when paid) that are not themselves financed with tax-advantaged bond proceeds, and (b) the term of the lease (i) is at least equal to the lesser of 20 years or 75% of the weighted average reasonable expected economic life of the leased property, or (ii) runs through the earlier of (x) the end of the reasonably expected economic life of the leased property at bond issuance or (y) the latest maturity date of the bonds.

In contrast to a sale that produces actual disposition proceeds that can be expended during the two-year period, the present value amount required to be expended during the two-year period in the context of a long-term lease is likely to exceed the lease payments actually realized by the issuer or borrower during such two-year period. However, such “out-of-pocket” expenditures may be expenditures that the issuer or borrower already was planning to finance from available cash during such period, and even if that is not the case, expending that amount from sources other than tax-exempt bonds will often be less costly than refinancing on a taxable basis part or all of the tax-exempt bond issue that financed the leased facility. Accordingly, the alternative expenditure option may substantially reduce the costs associated with disposing of a no longer needed facility financed with tax-exempt bonds in situations where a lease is preferable to a sale.

Rev. Proc. 2018-26 also provides for curing a nonqualified use of direct pay bond proceeds by simply reducing the amount of the refundable tax credit to eliminate the amount allocable to the nonqualified bonds. This is a common sense and simple way to remediate nonqualified use of otherwise taxable bonds. To effect this remedial action, the issuer must exclude the portion of the interest allocable to the nonqualified bonds that accrues on or after the date of the nonqualified use on the first Form 8038-CP filed after the nonqualified use occurs.

Finally, Rev. Proc. 2018-26 extends the availability of certain existing remedial actions to direct pay bonds and tax credit bonds. In addition to the reduction in subsidy available to direct pay bonds as described in the previous paragraph, an issuer may cure a nonqualified use by redeeming or defeasing nonqualified bonds or applying disposition proceeds to an alternative qualified use.

Rev. Proc. 2018-26 applies to a nonqualified use that occurs on or after April 11, 2018 and may be applied to a nonqualified use that occurs prior to April 11, 2018.

 

 

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Last week, President Trump unveiled his proposal to fix our nation’s aging infrastructure. While the proposal lauded $1.5 trillion in new spending, it only included $200 billion in federal funding. To bridge this sizable gap, the plan largely relies on public private partnerships (often referred to as P3s) that can use tax-exempt bond financing. In evaluating bankruptcy and default risk with P3s and similar quasi-governmental entities it is important to understand whether such entities are eligible debtors under the Bankruptcy Code, and, if so, whether they are Chapter 11 or Chapter 9 eligible.

P3s often involve the issuance of bonds by quasi-governmental hybrids, including so-called “63-20 corporations” (named after an IRS Revenue Ruling) that meet IRS criteria for the issuance of bonds by a non-profit corporation “on behalf of” a state or municipality. Such hybrids are used because they have a sufficient nexus to a state or municipal government to satisfy federal tax criteria for the issuance of tax-exempt municipal debt, while being sufficiently distinct from the state or municipal government to escape otherwise applicable state law restrictions on the incurrence of debt. Given such hybrid nature, questions can arise about whether the issuing entity is eligible for Chapter 9 of the Bankruptcy Code (in those states that have authorized filings under that Chapter) or Chapter 11 of the Bankruptcy Code. That distinction is significant.

Not only are the rules in Chapter 9 and Chapter 11 different (particularly as they relate to bond debt), but there are more eligibility restrictions in Chapter 9 than in Chapter 11. Chief among these is the requirement of specific state authorization for Chapter 9 eligibility. Where such authorization currently does not exist, bondholders can be lulled into a false sense of security thinking their issuer cannot file bankruptcy under Chapter 9, only to find out that the issuer is Chapter 11 eligible.

The issue of Chapter 11 eligibility of a quasi-governmental entity was recently discussed by the United States Bankruptcy Court for the Northern District of Illinois in In re Lombard Public Facilities Corporation, 2017 Bankr. LEXIS 4323 (Bankr. N.D. Ill. Dec. 18, 2017). The legal analysis provided in that decision, in which the court ultimately held that the debtor was eligible under Chapter 11, may prove significant for future P3 bankruptcies.

First a brief review of some of the relevant statutory architecture in the Bankruptcy Code is in order. Entities meeting the Bankruptcy Code’s definition of a “governmental unit” are ineligible to be debtors under Chapter 11 (or Chapter 7). This is because the Chapter 11 eligibility requirements set forth in Section 109(d) of the Bankruptcy Code limit the types of entities that may be Chapter 11 debtors. One such entity that may be a Chapter 11 debtor is “a person that may be a debtor under Chapter 7” of the Bankruptcy Code. The definition of “person” (set forth in Section 101(41) of the Bankruptcy Code) expressly excludes a “governmental unit” from its definition. “Governmental unit” is defined by Section 101(27) of the Bankruptcy Code as follows:

“The term “governmental unit” means United States; State; Commonwealth; District; Territory; municipality; foreign state; department, agency or instrumentality of the United States (but not a United States trustee while serving as a trustee in a case under this title), a State, a Commonwealth, a District, a Territory, a municipality, or a foreign state; or other foreign or domestic government.” (emphasis added)

Entities meeting the above definition of a “governmental unit” are ineligible to be debtors under Chapter 7 or Chapter 11. Unless such entities are “municipalities” (as defined in Section 101(40)), and the other requirements of Chapter 9 are met (including state authorization of Chapter 9), they will be ineligible for Chapter 9 relief as well, and thus ineligible for bankruptcy under any chapter.

Background

The debtor, the Lombard Public Facilities Corporation (the “Debtor”), was created to operate a convention center, hotel and restaurants (the “Project”) pursuant to a 2003 ordinance adopted by the Village of Lombard (the “Village”). Specifically, the ordinance approved the formation of “a not-for-profit corporation to assist in the financing and construction of a convention hall and hotel facility.” The ordinance further stated that the proposed Project was in the public interest of the citizens of the Village and that its creation was a proper public purpose. Following the ordinance, the Debtor filed its articles of incorporation with the Illinois Secretary of State as a not-for-profit corporation.

The state statute authorizing the Village to create the Debtor provides that a public facility corporation such as the Debtor is to be a “business agent of the municipality” and that such entity shall assist the municipality it serves in its essential governmental purposes. The statute further provides that control is to be maintained by appointing, removing and replacing board directors of the public facility corporation and by having title transferred to the municipality upon retirement of any bonds or other issued debt instruments.

The Village reportedly needed to incorporate the Debtor because the Village was not authorized to borrow the money needed to complete the Project. Accordingly, revenue bonds were issued in 2005 and 2006 that were payable solely from and secured by revenues generated by the Debtor and the assets of the Project. As is common in such financings, the bond documents expressly provide that the obligations were non-recourse to the Village – i.e. the Village itself was not liable on the bonds.

Shortly after the Debtor was formed, it applied to the Illinois Department of Revenue for an exemption from the Illinois Retailers’ Occupation Tax Act. In its application, the Debtor argued that its otherwise taxable purchases of goods should be tax-exempt because it was an “agent or instrumentality” of the Village and that the purchases were by a “governmental body.” Ultimately, both the tax court and an appellate court denied the Debtor’s request.

The Debtor filed for bankruptcy under Chapter 11 on July 28, 2017. Approximately one week after the filing, one of the bondholders filed a motion to dismiss the Debtor’s case, arguing that the Debtor was not an eligible Chapter 11 debtor because it was a “governmental unit.” The bondholder’s arguments were supported by the United States Trustee and the former asset manager of the hotel (collectively, the “Movants”). The motion was opposed by the Debtor, as well as ACA Financial Guaranty Corporation, the bond insurer for certain of the issued bonds, and certain other bondholders.

The Question Before the Court

The issue before the Bankruptcy Court was straight-forward: was the Debtor an instrumentality of the Village within the Bankruptcy Code’s definition of “governmental unit”? If “yes,” then the Debtor could not be a debtor under Chapter 11 and the case would be dismissed; if “no,” then the Debtor’s case could proceed. Notably, another consequence of being a “governmental unit” would be that the Debtor would have no access to relief under the Bankruptcy Code under any chapter since Chapter 9s are not currently authorized in Illinois.

The Position of the Parties – the Applicability of the Monorail Case

Before turning to the Bankruptcy Court’s decision, some discussion of In re Las Vegas Monorail Co., 429 B.R. 770 (Bankr. D. Nev. 2010) (the “Monorail Case”), is warranted. While the Bankruptcy Court’s decision made only a brief reference to the Monorail Case, the applicability of the Monorail Case was heavily debated by the parties in their briefs.

The Debtor: The Debtor argued that the Monorail Case was the “most influential and comprehensive modern case interpreting the term ‘instrumentality’ in the context of Chapter 11 eligibility.” In the Monorail Case, the Bankruptcy Court for the District of Nevada undertook a detailed historical analysis of the Bankruptcy Code (in particular Chapter 9) and applicable caselaw and used that analysis to formulate a three-part test for determining whether a debtor is an instrumentality: (i) whether the debtor has the typical characteristics of a municipality, specifically the power of eminent domain, the taxing power or sovereign immunity; (ii) whether the debtor has a public purpose, and if so, whether the parent entity (e.g., the Village) controls the debtor, in particular on a day-to-day basis; and (iii) the manner in which the debtor is described or classified under state or other applicable law. This proves to be a relatively restrictive test (which is why the Debtor supported it) as the first and second factors in particular would generally only be applicable to entities providing core governmental functions. The Debtor argued that each of these three factors weighed against a finding that the Debtor was an instrumentality of the Village; therefore, it was eligible for Chapter 11.

The Movants: The Movants argued that the Monorail Case was of “limited utility” and distinguishable on its facts. In particular, the Movants noted that the Monorail Case centered on the definition of “municipality” in Section 101(40), and not the definition of “governmental unit” in Section 101(27). While both definitions include the word “instrumentality,” the Movants argued that the word has different meanings in the two definitions, and cited to cases that supported their position. Moreover, the Movants highlighted that while the Monorail Case provided a thorough review of legislative history, it was the legislative history of Chapter 9, and not that of the definition of “governmental unit.” Legislative history relating to the latter, the Movants argued, showed Congressional intent to “defin[e] ‘governmental unit’ in the broadest sense” and that the term “governmental unit” was meant to encompass entities that (i) have an “active” relationship with a federal, territorial, state or municipal government, and (ii) “carry out some governmental function” (emphasis added). In contrast to the test set forth in the Monorail Case, applicability of a broad test would cause more entities to fall within the definition of “governmental units” and therefore be ineligible for Chapter 11.

The Bankruptcy Court Decision

The Bankruptcy Court sided with the Debtor, finding that the Debtor was not an instrumentality of the Village, therefore not a “governmental unit,” and thus eligible to be a Debtor under Chapter 11.

The Bankruptcy Court was dismissive of the various arguments that state statutes and formation ordinances supported a close relationship between the Debtor and the Village as well as the Movants’ argument that the Debtor should be bound by its argument before the tax court that it was an instrumentality of the Village. As to the applicable legal framework, the Bankruptcy Court appeared to agree with the Movants that the Court should look to the legislative history relating to the definition of “governmental unit” (i.e., supporting a broad test) to determine whether the Debtor was an instrumentality of the Village. But the Court parted ways with the Movants on application of that test, swiftly concluding that the Debtor’s commercial activities in the hotel and convention business, which were in direct competition with similar entities, did not equate to “carrying out some governmental function.”

The Bankruptcy Court neither ignored, nor adopted, the Monorail Case, yet was clearly influenced by it. As the Bankruptcy Court neared its conclusion in the case, it stated that the Debtor appropriately “noted” the analysis of the Monorail Case and then applied the three Monorail Case factors, in each instance agreeing with the Debtor that they supported the conclusion that the Debtor was not an instrumentality of the Village and therefore not a governmental unit.

Conclusion

Know thy borrower is an important rule for any lender. Knowing whether your borrower is eligible for relief under the federal Bankruptcy Code and if so under what chapter is an important part of that analysis. While often the distinction among governmental units that are not eligible for bankruptcy, municipalities that may be eligible for Chapter 9 bankruptcy, and other entities which may be eligible under other Chapters of the Bankruptcy Code including Chapter 11 is clear, sometimes it is not (as the Lombard and Monorail cases show us). As more hybrid entities come into the marketplace, understanding these distinctions will only become more important.

By CHUCK SAMUELS, MEGHAN BURKE, LEN WEISER-VARON and JOHN REGIER

Mintz Levin’s Chuck Samuels, Meghan Burke, Len Weiser-Varon, and John Regier discussed the new tax reform bill in a webinar entitled “Tax Reform: The Threat of Annihilation of Tax Exempt Financing.”  The panel, uniquely qualified governmental, bond, and legislative counsel, offered insight on proposed tax changes, the prospects for enactment of the legislation, and how participants in tax-exempt financings can respond to this development.

You can listen to the complete webinar here.

In order to understand the context in which the current tax reform bill, H.R. 1, is being considered, it is important to know the meaning of two bits of Washington jargon: “budget reconciliation” and the “Byrd rule.”  Though somewhat arcane, these terms have a substantial impact both on the likelihood of enactment of tax reform legislation and on the contents of, and revisions to, such legislation.

Under the Congressional Budget Act of 1974, budget reconciliation is a two-step process. Under the first step, reconciliation instructions are included in the annual budget resolution. The federal fiscal year runs from October 1 through September 30. Congress passes a budget resolution specifying spending and revenue levels for that year, and, in the case of tax revenues, containing instructions to the two tax-writing committees, the House Ways and Means Committee and the Senate Finance Committee, as to the changes in law that they are to propose in order to achieve the specified tax revenue levels. Continue Reading The Budget Reconciliation Process and the “Byrd Rule”: Implications for the Ongoing Tax Reform Effort

By CHRISTIE MARTIN and MIKE SOLET

On September 28, 2017, the Internal Revenue Service (IRS) withdrew previous proposed regulations and released new proposed regulations (the “Proposed Regulations”) relating to public approval requirements for tax exempt private activity bonds.  The Proposed Regulations (found at https://www.federalregister.gov/documents/2017/09/28/2017-20661/public-approval-of-tax-exempt-private-activity-bonds) are intended to update and streamline implementation of the public approval requirement for tax exempt private activity bonds provided in section 147(f) of the Internal Revenue Code, including scope, information content, methods and timing for the public approval process.   They generally do not change the requirements for issuer approval and host approval set forth in the current temporary regulations originally promulgated in 1983.

Continue Reading IRS Releases New Public Approval Proposed Regulations

On September 13, 2017, the Municipal Securities Rulemaking Board (the “MSRB”) published a market advisory on selective disclosure (the “Notice”). The stated purpose of the Notice is to “increase awareness” of selective disclosure as a “market fairness” concern.  Although the Notice acknowledges that selective disclosure by issuers of, or conduit obligors on, municipal securities is not prohibited or “inherently problematic”, the Notice cautions issuers and obligors in the municipal market not to selectively disclose material nonpublic information.

The Notice’s bottom line is to urge that issuers of and obligors on municipal securities voluntarily disclose to the broader marketplace information that is potentially material and is being disclosed or has been disclosed to a subset of actual or potential bondholders “by a method or combination of methods that is reasonably designed to effect broad, non-exclusionary distribution of the information to the public”, including, for example, by posting the relevant information on the MSRB’s EMMA website.

The Notice addresses the practice of certain municipal securities issuers and obligors of making selective disclosure, which occurs when certain classes of investors (the Notice singles out investment bankers, investment advisers and institutional investors as “typical” recipients) are given access to information but other investors are not. Selective disclosure may occur when the issuer presents information relating to an issue to current or prospective investors, for example, during road shows, investor conferences and one-on-one investor calls or meetings. The Notice states that “these events are not inherently problematic, but they can become so when the information conveyed is nonpublic and material”.

The Notice addresses selective disclosure in both the primary and secondary markets. As an example, the MSRB notes that investor conferences and investor calls often include question-and-answer sessions, which may place the issuer at risk of discussing nonpublic material information, such as information that is not included in the preliminary official statement. As to secondary market selective disclosure, the MSRB uses the example of when an issuer might provide new nonpublic material information, which is not required to be disclosed pursuant to Rule 15c2-12 under the Securities Exchange Act of 1934 (“Exchange Act”) or any other rule, to select investors or analysts.

As an example from other markets, the Notice outlines some of the requirements of the Securities and Exchange Commission’s (SEC) Regulation Fair Disclosure, more commonly known as Regulation FD, adopted in 2000 to address, in part, selective disclosure by public companies. The regulation provides that, when an issuer discloses material nonpublic information to certain persons (e.g., brokers, dealers, investment advisers and investment companies), it must publicly disclose that information. If the selective disclosure was intentional, the issuer must make the public disclosure simultaneously; if it was unintentional, the issuer must make the public disclosure promptly.

The Notice acknowledges that Regulation FD does not apply to municipal issuers (or to obligors on municipal securities that are not public issuers of non-municipal securities), as municipal issuers are exempt from regulation by the SEC (other than antifraud provisions). Similarly, while the Exchange Act provides the MSRB with broad authority to write rules governing the activities of brokers, dealers, municipal securities dealers and municipal advisors, it does not provide the MSRB with authority to write rules governing the activities of issuers.

The Notice also acknowledges that selective disclosure, even of material nonpublic information, does not in and of itself constitute inside information for purposes of “insider trading” prohibitions, as such prohibitions generally have been construed as applicable only where the disclosure is made in breach of a duty to the issuer. However, the Notice appears to promote reducing selective disclosure by highlighting the risk that selective disclosure of nonpublic and material information might be indicative of material omissions or misstatements in offering documents or result in transactions that might be considered insider trading.

The Notice suggests that issuers and conduit obligors may wish to develop and follow guidelines for disclosure in a manner that disseminates all potentially material nonpublic information to all market participants. This is not unlike the push a few years ago by the Internal Revenue Service for issuers to establish post-issuance compliance guidelines.  The Notice further suggests that issuers consider adopting, on a voluntary basis, the dissemination principles set forth in Regulation FD.

The MSRB claims that the purpose of the Notice “is not to discourage direct communications between issuers and investors and/or analysts, as road shows, investor conferences and other similar communications are legitimate market practices that are not inherently problematic.” Although the Notice is measured in tone and does not communicate any new legal requirements, it may prompt some issuers to decide that it is overly burdensome to sort through what good faith nonpublic communications might be deemed “unfair” selective disclosure, and to determine that their most efficient options are to err on the side of not entertaining calls or meetings involving individual analysts or investor groups or to post all nonpublic communications (presumably including transcripts of oral discussions) on EMMA.  Although some issuers have adopted model standards to address these concerns; for some issuers, especially smaller issuers that are not in the market regularly, a policy of publicly posting everything that is said may well have a chilling effect on routine conversations between issuer representatives and investors.  There also may be routine and follow-up conversations between issuer representatives and investor representatives that focus on details and monitoring of generally known items that an issuer may reasonably deem not to be material, and there is no reason to discourage such interactions.

It is to be hoped that the municipal market will continue to operate in a manner that acknowledges investor protection and market integrity and that continues to disclose material information to all without an overreaction that shuts down individualized discussions.

By LEN WEISER-VARON

The U.S. Supreme Court’s June 26 opinion in Trinity Lutheran Church of Columbia, Inc. v. Comer, precluding states from discriminating against churches in at least some state financing programs, raises anew the question of whether states may, or are required to, provide tax-exempt conduit bond financing to churches and other sectarian institutions.  The Supreme Court’s decision further complicates an already complicated analysis of that question by bond counsel,  and in some instances may tip bond counsel’s answer in favor of green-lighting tax-exempt financing of some capital projects of sectarian institutions.

The First Amendment to the U.S. Constitution precludes Congress and, via the Fourteenth Amendment, states from legislating the establishment of religion (the “Establishment Clause”), or prohibiting the free exercise thereof (the “Free Exercise Clause”).  Under a line of Supreme Court cases that has been cast into doubt but never expressly repudiated by a majority of the U.S. Supreme Court, the Establishment Clause has been held to prohibit state financing of “pervasively sectarian” institutions, i.e. institutions that “are so ‘pervasively sectarian’ that secular activities cannot be separated from sectarian ones.” Roemer v. Board of Publ. Works of Maryland (1976).   Continue Reading Tax-Exempt Financing of Churches, Parochial Schools and Other Sectarian Institutions After Trinity Lutheran Church: Permitted? Required? Let us Pray for Answers

By MEGHAN BURKE and POONAM PATIDAR

Public financing, including tax-exempt bond financing, of facilities used by professional sport teams has long been a controversial topic, with advocates and opponents disagreeing over whether the public benefits sufficiently to justify public subsidies.  Since 2000, over $3.2 billion of tax exempt bonds have been issued to finance the construction and renovation of 36 sports stadiums.

A bill has been introduced that would eliminate the availability of federally tax-exempt bonds for stadium financings.  Under existing tax law, use of a stadium by the applicable professional sports team constitutes “private use,” but taxable “private activity bond” status, which is triggered by “private use” of the financed facility combined with the presence of “private security or payment” for the applicable bonds, can be avoided by structuring the bonds to be payable from tax or other revenues unrelated to the financed stadium.

The bill would amend the Internal Revenue Code to treat bonds used to finance a “professional sports stadium” as automatically meeting the “private security or payment” test,  thus rendering any such bonds taxable irrespective of the source of payment.

This bill is identical to a version introduced in the House of Representatives in February and a slight departure from prior versions in the House that extended the exclusion from tax-exempt financing to a broader category of “entertainment” facilities.

What’s new this time? There are versions of legislation intended to terminate tax-exempt financing of professional sports stadiums in both the House and Senate, arguably evidencing an increased likelihood of advancement.

By CHARLES E. CAREY

On March 15, 2017, the Securities and Exchange Commission (“Commission” or “SEC”) published in the Federal Register for comment proposed amendments to Rule 15c2-12 (the “Rule”) under the Securities Exchange Act of 1934 (“Exchange Act”) that would amend the list of event notices required under the Rule in a manner that, if such amendments are finalized in their proposed form, would likely require issuers of, or “obligated persons” on, publicly offered municipal bonds to provide detailed ongoing disclosure of any new debt, derivatives and other “financial obligations.”

The Rule requires that a broker, dealer, or municipal securities dealer (collectively, “dealers”) acting as an underwriter in a primary offering of municipal securities reasonably determine that an issuer or an obligated person has undertaken, in a written agreement or contract for the benefit of holders of the municipal securities, to provide to the Municipal Securities Rulemaking Board (“MSRB”) through the MSRB’s Electronic Municipal Market Access (“EMMA”) system, prompt notice of specified events. The proposed amendments would amend the list of such event notices to include;

  • (i) incurrence of a financial obligation of the obligated person, if material, or agreement [by the obligated person] to covenants, events of default, remedies, priority rights, or other similar terms of a financial obligation of the obligated person, any of which affect security holders, if material; and
  • (ii) default, event of acceleration, termination event, modification of terms, or other similar events under the terms of a financial obligation of the obligated person, any of which reflect financial difficulties.

The proposed amendment provides a broad definition of “financial obligation” which includes: a (i) debt obligation, (ii) lease, (iii) guarantee, (iv) derivative instrument, or (v) monetary obligation resulting from a judicial, administrative, or arbitration proceeding. The “financial obligation” definition excludes traditional municipal bonds which are already covered by the Rule.

In the release accompanying the proposed amendments, the SEC noted that if new financial obligations or new material covenants, events of default or remedies impacted an issuer’s or obligated person’s liquidity and creditworthiness, the credit quality of the issuer’s or obligated person’s outstanding debt could be adversely affected which could impact an investor’s investment decision or other market participant’s credit analysis. Such changes to credit quality could also affect the price of the issuer’s or obligated person’s existing bonds.  Items the SEC referenced as potentially material include debt service coverage ratios, rate covenants, additional bond tests, contingent liabilities, events of default, remedies and priority payment provisions (including structural priority such as balloon payments, for example).

The Commission’s accompanying release stated that the event notice of incurrence of a material financial obligation generally should include a description of the material terms of the financial obligation. According to the release, examples of such material terms include the date of incurrence, principal amount, maturity and amortization, and interest rate, if fixed, or method of computation, if variable (and any default rates); the release states that disclosure of other terms may be appropriate as well, depending on the circumstances.

Unless the proposed amendments are pared back following the comment period, they are likely to result in the required disclosure by issuers or obligated persons of municipal bonds subject to the Rule of virtually all new loan agreements with banks or other private lenders, privately placed municipal bond indentures or loan agreements, swap agreements, real estate leases, and material judgments or arbitration rulings, as issuers and obligated persons are unlikely to shoulder the administrative burden and legal risk associated with determinations of which obligations, and which terms of such obligations, are “material” and which are, and will remain in hindsight, clearly immaterial.  Similarly, for expense and risk reasons, it is more likely that full legal documents will be disclosed versus substantially redacted or summarized versions.

The proposed amendments do not appear to require disclosure of the termination or satisfaction of financial obligations previously disclosed on EMMA as material events; accordingly they may result in the accumulation over time on EMMA of a variety of lengthy loan agreements, indentures, swap agreements and the like with no clear way for bondholders or brokers accessing EMMA to determine whether the relevant obligations and the related agreements continue in effect. Such overdisclosure may limit the pool of investors with respect to the obligations of the issuer or obligated person, in that brokers responsible under MSRB Rule G-47 for conveying to customers all material information about the security accessible on EMMA may opt not to do so for securities with EMMA postings that include unwieldy amounts of raw legal documents.

Issuers and obligated persons may also deem the requirement to publicly disclose otherwise private transactions adverse to their business interests. Currently, for example, an issuer or obligated person may negotiate different covenants and different covenant levels with different private lenders, without each lender necessarily having access to the covenants of the other lenders.  If the amendments require the issuer or obligated person to disclose on EMMA the coverage, days cash on hand, interest rates and other material terms of its private loan arrangements, the result over time may be for each new lender to require, in effect, most favored nation status with covenants and other terms at least as tough as the toughest terms previously agreed to by the applicable issuer or obligated group.  Reasonable minds may disagree on whether that should “come with the territory” when an issuer chooses to access the public municipal market, but to date such public disclosure of the details of private transactions has not been required.

The second new event notice, for the occurrence of a default, event of acceleration, termination event, modification of terms, or other similar events under the terms of a financial obligation of the issuer or obligated person, presents a different judgment call for issuers and obligated persons, as such disclosure is only required if the event “reflects financial difficulties.” Some of the examples cited in the release for subsequent events include monetary or covenant defaults that might result in acceleration of the debt, swap events, such as rating downgrades, which might require the posting of collateral or the payment of a termination payment and changes to the contract rights of the counterparties to financial obligations. Again, it is unlikely that entities subject to such requirements would expend much legal capital on parsing through whether a swap termination event, or even an amendment of loan documents, “reflects financial difficulties”, and the tendency is likely to be towards overdisclosure.

There are additional ambiguities in the proposed amendments. According to the accompanying release, the amendments will only be applicable to continuing disclosure agreements executed after the amendments are finalized, but it is unclear, for example, whether an issuer or obligated person that executes a continuing disclosure agreement governed by the amended Rule will be required to disclose all previously incurred material “financial obligations”, or whether only “financial obligations” incurred following the execution of such an agreement will be subject to such disclosure.  The accompanying release does indicate that the required notice of default, event of acceleration, termination event, modification of terms, or other similar events under the terms of a financial obligation which reflect financial difficulties would apply with respect to financial obligations previously incurred.

Unlike many of the existing events for which event notices are currently required under the Rule, which occur rarely, incurrence of financial obligations occurs regularly for many issuers and obligated persons. Accordingly, these amendments arguably would constitute the broadest expansion to date of the Rule’s continuing disclosure requirements. They are sure to generate many comments from affected parties before they are finalized.

By MAXWELL D. SOLET and CHRISTIE MARTIN

As the Trump administration attempts to substantially reduce the amount of federal regulations, both the Deputy Tax Legislative Counsel of the Treasury Department and an Associate Chief Counsel at the Internal Revenue Service indicated this week that we are likely to see a virtual halt to formal tax law “guidance” for the foreseeable future.  Such guidance includes regulations, revenue rulings, and revenue procedures, the principal means by which Treasury and IRS provide interpretations of tax statutes.  However, both officials stated that the IRS will continue to provide taxpayer-specific private letter rulings (PLRs).  In addition to more PLRs being requested to resolve ambiguities in connection with particular transactions, the freezing of the formal guidance process could result in PLRs being given more weight than ever in the analysis of other transactions.  Not only will bond attorneys have more incentive to read and rely upon the only available tea leaves as to the IRS’s position, but IRS attorneys may write more substantive letter rulings with the expectation that they will guide practice beyond the particular transactions being ruled upon.  While officially non-precedential, PLRs have long been of particular importance in the tax-exempt bond practice, where formal guidance is slow and case law is almost nonexistent.