Federal tax law, and North Carolina state law, allow tax-exempt bonds to be issued to benefit privately owned, for-profit housing developments. The very popular 4% low-income housing tax credit program in fact requires that bonds be issued to finance housing construction or rehabilitation costs. Developers like using tax-exempt bonds since they carry lower interest rates than comparable commercial financing.
For bonds to be tax-exempt, they have to be issued by a governmental entity – a city, county or local housing authority. That means the developer can’t issue the bonds itself. So developers ask these entities to issue bonds to help finance the developers’ private projects.
Although the local government issues the bonds, the local government has no financial liability for the bonds. The agreements among the county, the bondholders and the developers state explicitly that the local government’s only responsibility is to relay to the bondholders any funds the developer pays to the government – and in fact the documents say the developer is supposed to bypass the locality in making bond payments. It is this “pass-along” feature that results in these transactions being referred to as “conduit” bond issues – the local government is only a conduit between the developer and the bondholders.
Everyone involved in a transaction like this – developers, bondholders, rating agencies, bankers, the LGC – understands fully that the local government has no financial obligation. Developers also routinely agree to cover your legal fees and any other costs. Further, the bonds also have no effect on the locality’s bond ratings or its calculated debt limits or ratios.
On the other hand – if something goes wrong, you have what we call “newspaper risk” – people will want to know more about what your involvement was, and how you could have prevented a bad outcome (spoiler: you probably couldn’t have).
So if you get this request to issue bonds, should you do it?
We don’t think you should be afraid of this process, or worried that it’s some “too good to be true” scam. But the developer is asking you a favor, and you don’t have to do it. Ask yourself these questions:
Do you like the proposed project?
- It may be affordable housing, but you still have every right to apply your regular land use policies, including requirements for infrastructure improvements, streets and sidewalks, recreation set-asides and the like. Get all the information you want about the developer’s plans.
Do you trust the proposed developer?
- “Trusting” a developer is different from “liking” a developer. You certainly want the developer to demonstrate the financial resources and technical experience to bring a project to completion. You can provide in your documents that if the individuals who approach you don’t stay involved in the project, all bets are off.
What am I getting out of this?
- The answer: a new or renovated affordable housing development, and a new or renewed guarantee of long-term affordability (along with the developer’s paying all your costs). Most localities decide that’s a lot of benefit, but every circumstance is unique.
What are you going to have to do?
Preliminary resolution. Early in the process, the developer will ask your governing board to adopt a resolution stating a preliminary, general intent to cooperate with the developer in the bond issuance process. This is sometimes called an “inducement” resolution. The developer needs this as part of its funding application for the tax credit process and for other reasons related to the tax-exempt bond rules. Passing this resolution doesn’t bind you to go through with the transaction, but it does indicate that you’re willing to proceed based on what you know so far. When you’re ready to consider this resolution, you might want to have a developer’s representative present to give a brief presentation on their plans.
Final resolution when ready for a bond issue. Later in the process, the governing board will have to adopt another resolution giving final approval to the issuance of the bonds, including approval of the final form bond documents and financing details.
There can be a long gap in time between the developer’s request for the two actions, perhaps as much as a year. The developer will be working to complete its financing package, including the financing documentation, and the preparation for its construction-related activities. You can be as in the loop for, or as distant from this process as you care to be. We think it’s a good practice to have an agreement for the developer to provide a formal, in-person update on the process at least quarterly. You can also set an expiration date on your inducement resolution.
Suggested – Have a public hearing. You can often get through this process without a local public hearing. But we think public hearings are cheap insurance, and so we suggest you consider holding a local public hearing either in connection with the inducement resolution or shortly thereafter – it doesn’t seem fair to have it at the end of the process when the developer will have so many additional sunk costs.
What else should we do?
Make sure your developer is on the hook for your costs. You want an agreement from the developer to pay your costs and expenses from the time you start to talk about this. Sometimes the offer for expenses from the developer will say something like, “the developer will pay your expenses from the bond proceeds.” They aren’t trying to get away with something there (in my experience), but you want something that obligates the developer from Day One, even if bonds never get issued.
Make sure someone on your side of the table is on top of the documents and the process. That can be your regular attorney, a bond or housing attorney you bring in on your side, or anyone else – but have someone specifically responsible. Don’t rely on someone from the developer’s packaged team to look out for your community’s interests. You need to know what’s going on throughout the process, and what you’re getting yourself into when you sign those final bond documents.
Let us know if we can help you through a conduit bond process, and click here for our disclaimer.