One Peachtree Pointe
1545 Peachtree Street, N.E.
Suite 700
Atlanta, GA 30309-2401
(404) 885-1500
Fax (404) 892-7056
http://www.seyfarth.com/
404.888.1883 direct
404.892.7056 fax
danmcrae@mindspring.com
dmcrae@seyfarth.com
“EVERYTHING YOU NEED TO KNOW ABOUT
BONDS”
Use this Legal Product,
Industrial Development Revenue Bonds,
To Finance New or Expanded Facilities
At the Lowest Possible Interest Rate
July 1, 2003
Daniel M. McRae
Partner
Seyfarth Shaw
7th Floor
1545 Peachtree St. NE
Atlanta, GA 30309
404.888.1883
fax 404.892.7056
danmcrae@mindspring.com
dmcrae@seyfarth.com
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EVERYTHING YOU NEED TO KNOW
ABOUT BONDS
By
Daniel M. McRae
Introduction
Despite the title, this paper does not relate everything that would need to be known, in
every context, concerning bonds. Rather, the purpose of this paper is to provide an overview of
how one type of tax-advantaged financing, industrial development revenue bonds, can be used to
finance different types of projects on a cost-effective basis.
Industrial development revenue bonds (“IDBs”) are a means by which companies can
finance capital projects, including land, buildings, and equipment and certain transaction costs.
In Georgia, this type of financing is often the key to other incentives, such as property tax
abatement. With tax-exempt IDBs, the financing is cheaper for the company that is the actual
borrower, because the lender does not pay normal federal or state income tax on the interest it
receives. IDBs are sometimes also referred to as industrial revenue bonds (“IRBs”).
All IDBs are issued by some unit of state or local government (the “Issuer”).
In Georgia, IDBs are usually issued by local development authorities and sometimes are
issued by other state and local authorities. The bond proceeds are passed on to the company
through a financing lease, an installment sale agreement or loan agreement and the payments by
the company thereunder match the debt service on the IDBs.
In Georgia, a financing lease is often used in order to obtain an exemption from local
property tax by having the authority be the “owner” and lessor on the project during the term the
lease. Such an abatement actually requires more in the way of an underlying structure, but
except in certain rare cases, the use of IDBs is a prerequisite. With a financing lease, upon
retirement of the bonds and the expiration of the lease, the company will acquire title to the
project by purchasing the project for a nominal consideration under a purchase option contained
in the lease.
Under each of the foregoing structures, the company will be the ultimate owner of the
project and, while the bonds are outstanding, will be treated as the owner of the project for
federal tax purposes, and for accounting purposes. Hence, the company will be entitled to claim
depreciation on the project and will be entitled to deduct interest on the bonds as a business
interest expense. The Company would not be entitled to deduct rent if the financing lease
structure is used. In the case of federally tax-exempt IDBs for airports, docks, wharves and mass
commuting facilities, the company will be a true lessee and will not be the tax-owner of the
financed facilities and may not claim depreciation thereon, but may claim a deduction for rent.
The company will generally be the only obligor on the financing, except to the extent that
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credit support is provided by a stockholder guaranty or letter of credit. The Issuer acts merely as
a conduit. Except in extremely rare instances, the Issuer and the related local or state
government have absolutely no obligation for the repayment of the IDBs other than from funds
received from the company.
Generally, an Issuer will permit its IDBs to be sold only in a private placement to a bank,
insurance company or other financial institution., unless the IDBs are either rated by a national
rating agency or secured by a letter of credit. Privately placed IDBs are frequently sold to a bank
that has a preexisting banking relationship with the company. If the bonds are to be sold to a
single purchaser, such as a bank, in a private placement, the issue often consists of a single bond,
which may be issued as a draw-down obligation.
Reasons for Using IDBs.
Federally Tax-Exempt IDBs. In the case of projects that qualify for tax-exempt IDB
financing (as described below), the principal reason for using federally tax-exempt IDBs is to
finance the project at the lower interest cost that can be obtained as a result of the exclusion from
gross income of the interest received on tax-exempt IDBs. For example, a lender (i.e., bond
investor) in the 39 percent tax bracket, who would be willing to lend funds to a particular
borrower at 10 percent on a conventional basis, would achieve the same after-tax yield on a taxexempt IDB paying interest at 6.1 percent (the net of 10 percent interest income taxed at a 39
percent tax rate). This is an oversimplified example, but nevertheless demonstrates the basic
attraction of tax-exempt IDB financing. Even lower effective interest rates, in the range of 3.5 to
5.5 percent, can be achieved by the use of tax-exempt IDBs that are secured by a bank letter of
credit and issued as variable rate demand bonds. Such bonds, even though they are long-term
obligations, bear interest at short term rates that are periodically reset to the prevailing market
rate for short term obligations. Such bonds are generally sold through an underwriter or
placement agent to tax-exempt money market funds. Tax-exempt IDBs are exempt from the
registration requirements of the federal securities laws.
Federally Taxable IDBs. Even if a project does not qualify for federally tax-exempt
financing, there are reasons why a company might wish to finance the project with federally
taxable IDBs.
In Georgia, one reason for using federally taxable IDBs is to achieve such incentives as
property tax abatement for the project. A sale-lease back structure must be used under which the
Issuer finances and owns the project, and leases it to the company and grants a purchase option
to the company.
This type of financing can be used in conjunction with other financings. For example,
the company might obtain financing for a national or international expansion program, and use
the proceeds of a borrowing from its lead lender to purchase taxable IDBs, the proceeds of which
are used to finance a project for the company or a subsidiary of the company.
A second reason for using taxable IDBs is to access a different source of funding. For
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example, taxable IDBs, which are secured by a bank letter of credit and issued in the form of
variable rate demand bonds, are typically sold through an underwriter or placement agent to
taxable money market funds. The financing costs associated with such variable rate demand
bonds are considerably lower than the costs of conventional financing (generally less than the
prime rate). Unless taxable IDBs are registered with the S.E.C. (the cost of which is prohibitive),
they must be either privately placed or supported by a bank letter of credit.
Georgia Income Tax Exemption. The interest on Georgia IDBs is exempt from Georgia
income tax, whether or not the interest thereon is federally tax-exempt. Thus, if the bonds are
sold to purchasers in Georgia, that tax savings may have a small favorable effect on the interest
rate on the IDBs. These “taxable” IDBs are used in transactions designed to provide property tax
abatement for the company.
Types of Federally Tax-Exempt IDBs
Because the proceeds of IDBs are used for the benefit of a private company and are
repaid from funds provided by the company under the lease, installment sale agreement or loan
agreement, IDBs are classified as “private activity bonds” under the Internal Revenue Code.
Under the Code, only certain types of private activity bonds bear interest that is excludible from
gross income for federal income tax purposes, including the following:
“Exempt Small Issue” Bonds. Exempt small issue IDBs are the most common type of
tax-exempt IDBs. The facilities financed must be primarily for manufacturing purposes
(except that they also may be, but rarely are, used for certain first-time farm projects).
For these IDBs to be tax-exempt, either (i) the amount of the bonds (and certain prior
issues of bonds) must be $1 million or less or (ii) the total amount of the bonds, certain
prior issues and certain capital expenditures within the local jurisdiction must be less than
$10 million. There is a $40 million nationwide wide cap that is applicable to each
company and certain “related persons.”
There are a number of other requirements that must also be complied with, including
obtaining an allocation of the state bond “cap.” This is an IRS requirement administered
in Georgia through the Georgia Department of Community Affairs (“DCA”). If these
limitations and requirements are not complied with in any way, the interest on IDBs will
not be federally tax-exempt.
Exempt Facilities Bonds. Bonds for certain specific types of projects may also qualify
for tax-exempt financing. These projects include airports, docks and wharfs, mass transit
facilities, solid waste facilities, water/sewer projects, certain housing projects and certain
electric generating facilities. The $10 million and $40 million limits that apply to
“exempt small issue” IDBs are not applicable to “exempt facility” IDBs. Issues of such
bonds often exceed $100 million. An allocation from DCA is required, except in the case
of qualified veterans’ mortgage bonds, bonds for airports, docks and wharves, and bonds
for governmentally owned high-speed intercity rail facilities. In the case of nongovernmentally owned high-speed intercity rail facilities a volume allocation is needed
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for only 25% of the bond issue.
Qualified 50l(c)(3) Bonds. These bonds are issued for the benefit of
501(c)(3)[charitable] organizations, and are often used to finance hospitals and college
facilities. The $10 million and $40 million limits on small issue IDBs are not applicable
to 501(c)(3) bonds. No volume cap allocation is required.
Enterprise Zone Bonds and Empowerment Zone Facility Bonds. “Enterprise zone
facility bonds” are bonds, at least 95% of the proceeds of which are used to provide an
“enterprise zone facility” (land, buildings, and equipment) to be used in a federally designated
enterprise zone or empowerment community for use by an “enterprise zone business.” The
financed property must add value to the capital base of the zone, either as newly constructed
property, purchased property that will have its first “in-zone” use pursuant to the financing or
property in the zone that is substantially renovated. The bonds may be issued to finance retail,
service and other commercial projects, as well as manufacturing projects. “Enterprise zone
facility bonds” have been permitted since 1993. However, less than ten (and perhaps as few as
five) issues were closed prior to the enactment of the Taxpayer Relief Act of 1997. This track
record is the result of the “per user” limitations on issue size ($3 million per zone/$20 million
nationally; see below) and the need for continuous compliance with certain operating
requirements. The 1997 Act provides for the issuance of “empowerment zone facility bonds” for
projects in 20 new empowerment zones. These zones are comprised of 15 in urban areas
designated by the Secretary of HUD, and 5 in rural areas designated by the Secretary of
Agriculture. “Empowerment zone facility bonds” are similar to “enterprise zone facility bonds”.
However, the $3 million “per user” limit on the amount of “enterprise zone facility bonds” that
can be issued for a company and related persons for facilities located in a single zone, and the
$20 million “per user” limit on the amount of “enterprise zone facility bonds” that can be issued
nationwide for a company and related persons, do not apply to “empowerment zone facility zone
bonds”. Also, “empowerment zone facility bonds” will not be counted for purposes of the $3
million and $20 million cap on “enterprise zone facility bonds”. In addition, “empowerment
zone facility zone bonds” are subject to a volume cap based on the population of the zone, rather
than the state’s private activity cap (which is applicable to “enterprise zone facility bonds”). For
both types of bonds, the 1997 Act provides for a startup period during which compliance with
certain operating requirements are waived, and provides that, after the expiration of a three-year
“test period” that commences at the end of the startup period, the operating requirements are
waived, except for the requirement that 35% of the employees at the project must be residents of
the zone. The 1997 Act will have limited positive effect on the issuance of “enterprise zone
facility bonds” in the existing enterprise zones and empowerment communities. Its true
significance may lie in a substantial volume of “empowerment zone facility zone bonds” being
issued in the 20 new empowerment zones. This result might occur because the inapplicability of
such bonds of the $3 million and $20 million issue size limits will permit the tax-exempt
financing of large projects, including large retail projects and shopping malls.
Timing
An issue of variable rate tax-exempt IDBs, secured by a letter of credit, takes about 60 to
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90 days to close from the date of finalization of the letter of credit commitment from the bank.
Fixed rate tax-exempt IDBs secured by a letter of credit can be issued in about 60 days from the
date of receipt of the bank’s letter of credit commitment. Fixed rate tax-exempt IDBs, credit
enhanced in other ways, take about 90 days to close from the date that the other credit
enhancement is committed. Privately placed tax-exempt or taxable IDBs can be closed in about
60 days. The periods indicated above are subject to being accelerated or extended depending on
such factors as coordinating of public meeting and notice requirements, etc. The steps that apply
are discussed in more detail below.
How the Process Works
The typical steps in IDB financings are described below. If the issue involves taxable
IDBs, a number of steps (marked with an “*”) are omitted, and step 2 (marked “**”) may be, but
is generally not, omitted.
1.
File an Application for Financing. Most Issuers require the company to file with
it an application or request for financing which describes the company, the nature and estimated
cost of the project and the number of jobs the project will create. Often financial information
relating to the company must accompany the application.
2.
Adoption of Inducement Resolution.** Next, an Inducement Resolution is
adopted at a duly called meeting of the Issuer, “inducing” the company to proceed with the
project and providing that bond proceeds may be used to reimburse the company for certain
project costs that it may wish to pay with its own funds prior to the issuance of the bonds. If the
bonds are to be tax-exempt IDBs, this Inducement Resolution should be adopted before the
company makes major expenditures for project costs, because (under the federal tax regulations)
proceeds of tax-exempt IDBs can only be used to pay project costs after the bonds are issued and
to reimburse (i) project costs paid by the company not earlier than 60 days prior to the adoption
of the Inducement Resolution (or some other “declaration of intent” on the part of the issuer to
issue the bonds), (ii) certain preliminary expenditures and (iii) other capital expenditures in an
aggregate amount not to exceed the lesser of $100,000 or 5 percent of the proceeds of the IDBs.
3.
Preliminary Negotiation. If it has not already done so, the company then
commences preliminary negotiations with prospective bond purchasers (such as banks) or with
placement agents, or underwriters for the sale of the bonds.
4.
Obtain Bond Sale Commitment. Detailed financing terms will, as a result of the
preliminary negotiations, be agreed upon, and a bond purchase commitment letter will then be
issued and accepted by the company. Having a detailed commitment letter generally saves time
(and other aggravations) in the document drafting process referred to in step 7, below.
5.
TEFRA Hearing.* In the case of federally tax-exempt IDBs, TEFRA hearing and
approval proceedings are conducted. This step requires that a public hearing be held on at least
14 days notice published in the local newspaper. Following the TEFRA Hearing, the bond issue
is approved by the elected officials of the local general purpose government (i.e., the county or
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the city, as the case may be). This step is sometimes combined with step 2, relating to the
Inducement Resolution, where the amount of the financing is not likely to be changed.
6.
Application for an Allocation of the State Bond Cap.* In the case of federally taxexempt bonds, other than qualified 501(c)(3) bonds, certain “exempt facilities bonds” (referred to
above) and current refunding bonds, the Issuer next applies for an allocation (in an amount equal
to the proposed bond amount) of a portion of the state’s bond cap necessary for the bonds.
7.
Basic Bond Documents. Upon finalization of the terms of the financing
commitment, bond counsel drafts the basic financing documents for review by the parties to the
transaction.
8.
Adoption of Bond Resolution. Upon agreement of the parties as to the terms and
provisions of the bonds and the basic financing documents, the Issuer will, at a meeting duly
held, adopt a Bond Resolution authorizing the bonds and approving the financing documents.
9.
Validation Proceeding. Following the adoption of the Bond Resolution, a bond
validation proceeding is commenced in the Superior Court of the county in which the Issuer is
located. Validation is a routine judicial proceeding, but the entire process takes about 30 days.
During that period, various closing documents are prepared by bond counsel.
10.
Closing. The transaction may be closed on the first mutually agreed-upon date
after obtaining a favorable validation judgment from the Superior Court (forever confirming the
validity of the bonds), and after obtaining an allocation of the state bond cap (if such allocation is
required).
Conclusion
IDBs are a financing alternative that should be considered by any company proposing to
finance a project. IDBs are a unique form of financing, requiring counsel having experience in a
number of areas, including state bond law, federal and state tax law, and federal and state
securities laws, experience in the structuring of such transactions; and experience in identifying
potential purchasers for such bonds. In Georgia, particularly if property tax abatement or other
incentives are part of the transaction, counsel should have experience in these fields, and with
Georgia’s communities, as well. Lawyers in the CORE Group in Georgia have served as bond
counsel on Georgia, Florida and Alabama IDB issues and as underwriter’s counsel on issues of
IDBs in those states and in Mississippi. We represent authorities throughout the State of Georgia
that issue bonds. We also serve as counsel to companies that are involved in IDB financings.
Our firm is listed among nationally recognized bond counsel in the Bond Buyer’s Municipal
Marketplace (the “Red Book”). Several of the lawyers in the CORE Group are members of the
National Association of Bond Lawyers.
More Information
This paper is a quick-reference guide for company executives and managers, and
economic developers. The information in this paper is general in nature. Various points which
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could be important in a particular case have been condensed or omitted in the interest of
readability. Specific professional advice should be obtained before this information is applied to
any particular case.
If you have any questions or comments, we would be pleased to provide more
information. Please contact:
Daniel M. McRae, Partner
Seyfarth Shaw
1545 Peachtree Street, N.E., 7th Floor
Atlanta, Georgia 30309
Telephone: 404/888-1883
Facsimile: 404/892-7056
danmcrae@mindspring.com
dmcrae@seyfarth.com
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