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November 7, 2012

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Temple Of Justice Update: How Can Local Governments Structure Debt?

by WSBA

Washington’s Constitution prevents local governments from taking on certain levels of debt without a popular vote. In a case with the unwieldy caption In re Bond Issuance of Greater Wenatchee Regional Events Center Public Facilities District, No. 86552-3 , the Washington Supreme Court decided whether that constitutional provision is implicated when a city promises to pay the debt for a separate entity in the event the entity cannot service the debt.

Case Facts and the Debt Provision

In 2006 several local governments, including the city of Wenatchee, created a municipal corporation to build and run an events center. The corporation issued debt. In 2011, it sought to use that ability to issue long-term bonds. The corporation wanted low interest on the bonds. So, it persuaded Wenatchee to promise that if the corporation couldn’t make payments, Wenatchee would make them. Wenatchee agreed to do so, but first filed a lawsuit asking whether the Constitution authorized such an arrangement.

By a 5-4 vote, the Washington Supreme Court answered “No.”

Article VIII, § 6 of Washington’s Constitution forbids local governments from incurring debt greater than 1.5 percent of the taxable property in their purview; the cap can be raised to 5 percent, but only if voters agree.

The debt cap found its genesis in the late 19th century. Local governments at the time often issued debt to finance railroads, which then went bust, leaving local taxpayers with the bill. While the principal behind the cap is straightforward, the application is anything but.

Risk of Loss Rule

Justice Wiggins, writing for the Court, traced a long line of cases interpreting the debt provision. Over the years, Washington courts have created various tests to decide whether particular agreements constitute the debt to be prevented by Article VII, § 6. Justice Wiggins surveyed the decisions and noted the key issue is “who bears the risk of loss in the underlying obligation.” Under such a test, an agreement is debt if taxpayers — rather than creditors or bondholders — will be on the hook if the project fails.

Two strands of cases, however, complicate the simplicity of that test. Under one strand, contingent obligations — such as a promise to pay for a sewer on the condition that the sewer is actually built — is not “debt.” In those situations, taxpayers only pay if they receive what they promised to pay for. Under another strand, if one promises debt in the event another defaults on it, the promise constitutes debt. As time progressed and cases accumulated, the two strands expanded to the point where they conflicted.

Justice Wiggins resolved the conflict by returning to the first principal: if taxpayers will ultimately be on the hook, the promise is debt and hence is subject to the limits in Washington’s Constitution. As for Wenatchee’s promise, which absolutely committed Wenatchee to pay if the corporation defaulted and contained no limit on Wenatchee’s liability, the majority decided that it was indeed debt. Referring to its duty to enforce the Constitution, the majority explained it would not “sit idly by while municipalities creatively attempt to exceed their proper debt limits[.]”

Dissenting Opinion

Four justices dissented. Justice Fairhurst wrote for them. She began by suggesting that debt contemplated by Article VIII, § 6 has several characteristics: it must be borrowed money, it must not be paid with current-year taxes, and the revenue to pay it must not come from a specially dedicated source. Applying those rules, the dissenters concluded that Wenatchee’s promise was not a debt. Wenatchee did not borrow any money to make the promise. The agreement also prevented the corporation’s creditors from reaching Wenatchee in the event of default. Quite simply, the dissent argued,

[u]nless and until the City borrows money and pledges its full faith and credit toward repayment, the City is not incurring debt within its constitutional meaning.

The dissent further urged Wenatchee’s promise was nothing but a contingent obligation. Finally, the dissent rejected the risk-of-loss rule the majority announced, arguing that it was little more than a judicial second-guess of a legislature’s decision.

Read the parties’ briefs and multiple amici briefs.

Young Lawyers Committee — The Voice of New/Young Lawyers

The Washington Young Lawyers Committee (WYLC) is the vehicle for new attorneys and law students to get involved with the Washington State Bar Association.

Read more from the YLC.  Learn more about the YLC.

1 Comment Post a comment
  1. Bethany
    Nov 10 2012

    Sweet article! I found the simple and concise breakdown of the decision to be valuable.

    Reply

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