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When is it Debt?When is it Debt?
NCGFOA 2011 Annual Summer ConferenceNCGFOA 2011 Annual Summer Conference
July 18, 2011 July 18, 2011
When is it Debt? - A Panel Discussion
• Panelists
o Tim Romocki, Debt Management Director, NC Department of State Treasurer
o Mary Nash Rusher, Hunton and Williams LLP
o Steve Cordell, McGuireWoods LLP
Questions to ask about all Long Term Contracts
• Is it Debt?
• Does it require LGC Approval?
• Who decides?
Debt: Legal Definition
• What is “debt”?o Webster’s Dictionary: Debt is “something owed”o Black’s Law Dictionary: Debt: a sum of money due by certain and express
agreement; a specified sum of money owing from one person to another o N.C. Constitution:
o Article 5 Finance, Section 4 Limitations upon the increase of local government debt
o (5) ” Definitions. A debt is incurred within the meaning of this Section when a county, city or town, special district, or other unit, authority, or agency of local government borrows money.”
o Under the Constitution, “Debt” secured by a unit’s faith and credit (i.e. pledge of taxing power) requires a vote of the people
o Also cannot give or lend its credit in aid of any person, association, or corporation without a vote of the people. A loan of credit occurs when a unit exchanges its obligations with or in any way guarantees the debts of an individual, association, or private corporation. (Article 5, Section 4, subsections (3) and (5)
Generally Accepted Accounting Principles
• Debt – “obligations to be paid in the future”o Long term Liabilitieso Notes payableo Installment Purchaseso Obligations under long-term capital leaseo Bonds payable (e.g. General Obligation, Special Obligation
and Revenue Bonds)o Bond Anticipation Noteso Pension and OPEB obligationso Accrued vacation timeo Accrued landfill closure and post closure care costs
Is LGC Approval Required
N.C. General Statutes require LGC Approval for a wide variety of contracts and obligationso In general, incurrence of liabilities involving capital asset financing require LGC
approvalo Traditional Debt (G.O. Bonds, Revenue Bonds, Special Obligation Bonds, 160A-20)o Under 159-148, any contract, agreement, memorandum of understanding, and any
other transaction having the force and effect of a contract ...made or entered into by a unit of local government, relating to the lease, acquisition, or construction of capital assets. Four criteria generally:
(1) Extends for 5 or more years from the date of the contract (includingrenewal period)
(2) Obligates the unit to pay sums of money to another, without regard to
whether the payee is a party to the contract(3) Obligates the unit over the full term of the contract to pay a
principalamount of at least $500,000 or a sum equal to .01% of the
assessed value of property subject to taxation in the unit AND
(4) Obligates the unit, expressly or by implication, to exercise its power to levy taxes either to make payments falling due under the contract or to pay any judgment entered against the unit as a result of the unit's breach of the contract.
Legal Foundations
• Local Governments must have statutory authority to incur debt and enter long-term contract, and must follow statutory procedures strictly
• General Statuteso Chapter 159
o Article 4 – General Obligation Bondso Article 5 – Revenue Bondso Article 8 – Financing Contracts, Incurrence of Indebtedness and similar type
of financing arrangementso Chapter 159I – Special Obligation Bondso Chapter 159G – Clean Water Revolving Loanso Chapter 160A – 20 – Financing contracts with security interestso Chapter 160A-274 - Sale, lease, exchange & joint use of govt. propertyo Chapter 115C-528 – Lease purchase contracts by local boards of educationo Chapter 157 – Article 1 – Housing Authority Bondso Chapter 159C – Industrial Facilities and Pollution Control Financing Authorities
Is it Debt? Does it need LGC Approval?
• When considering a proposed contractual obligation or arrangement, the unit must consider a number of questions:
o Is it authorized by North Carolina statute?o Does it require LGC approval?o How will it impact the unit’s balance sheet?o Will it be a taxable or tax-exempt obligation?
• These issues arise often in context of leases, public-private partnerships, and economic development projects
When is a Lease “Debt”?
• Under GAAP, a lease is a capital lease (treated as debt) or an operating lease (an operating expense and not debt). The four tests in FAS 13:
o Transfer of title to the asset at end of leaseo Lease terms include “bargain” purchase optiono Lease term is more than 75% of the asset’s economic lifeo Present value of lease payments is more than 90% of fair
value of the asset
Note: A lease can be an operating lease for GAAP purposes buta “debt” for tax purposes (and therefore eligible totax-exempt financing)
o Test for capital vs. operating lease treatment different under GAAP and Internal Revenue Code
Is it Debt? Does it need LGC Approval?
• Example 1 – Office Building leaseo City seeks to encourage development in specific section of
downtowno City agrees to lease an office building from private developer
groupo To secure financing, developer must have long-term master lease
with City o City intends to sublease space which will provide source of
payment for master leaseo Developer will manage the buildingo Lease term is 20 yearso City will not own building at end of lease, nor does lease contain a
bargain purchase optiono Present value of lease payments at City’s borrowing rate
approximately equals fair market value of building
Is it Debt? Does it need LGC Approval?
• Example 2 – Development Agreement #1o Developer purchases City’s outdated convention centero Developer plans to convert convention center site to mixed-use
development – retail/entertainment/restaurant/officeo To induce the developer to acquire and develop the property,
City agrees to reimburse the developer for construction of public infrastructure improvements required by the developer
o Reimbursements to be made over 3 years provided developer reaches project milestones
o City expects significant increase in valuation of tax base in the development area which will offset the required reimbursements
o If development is sold within 7 years of project initiation, City is entitled to receive partial reimbursements for payments made
Is it Debt? Does it need LGC Approval?
• Example 3 – Interlocal Agreemento City A enters into an interlocal agreement to acquire Town B’s
water and sewer system assets valued at over $10 milliono Town B is not provided a security interest in its assets to be
acquired by City Ao City A will assume Town B’s outstanding revolving loans with the
State that financed system improvements. $4.5 million is outstanding
o City A will also make annual payments over eight years totaling $500,000 at a 0% interest rate
Is it Debt? Does it need LGC Approval?
• Example 4 – Development Agreement #2o Water and Sewer Authority and Developer enter into an
agreement for the construction of water and sewer infrastructureo To induce the Authority to provide an allocation of sewer
capacity for its development, the agreement requires the developer to install the sewer mains servicing the development
o The developer also agrees to increase the size of the mains to allow service to adjacent future developments
o In return for upsizing the mains, the Authority agrees to reimburse the developer for the extra costs
o Reimbursements will be from future capacity fees to be paid by future developers over the next 20 years
Questions?
Contact Information:
Tim Romocki, 919-807-2360, [email protected]
Mary Nash Rusher, 919-899-3066, [email protected]
Steve Cordell, 704-343-2136, [email protected]
