When is it Debt?

1. When is it Debt? NCGFOA 2011 Annual Summer Conference July 18, 2011

2. When is it Debt? - A Panel Discussion • Panelists • Tim Romocki, Debt Management Director, NC Department of State Treasurer • Mary Nash Rusher, Hunton and Williams LLP • Steve Cordell, McGuireWoods LLP

3. Questions to ask about all Long Term Contracts • Is it Debt? • Does it require LGC Approval? • Who decides?

4. Debt: Legal Definition • What is “debt”? • Webster’s Dictionary: Debt is “something owed” • 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 • N.C. Constitution: • Article 5 Finance, Section 4 Limitations upon the increase of local government debt • (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.” • Under the Constitution, “Debt” secured by a unit’s faith and credit (i.e. pledge of taxing power) requires a vote of the people • 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)

5. Generally Accepted Accounting Principles • Debt – “obligations to be paid in the future” • Long term Liabilities • Notes payable • Installment Purchases • Obligations under long-term capital lease • Bonds payable (e.g. General Obligation, Special Obligation and Revenue Bonds) • Bond Anticipation Notes • Pension and OPEB obligations • Accrued vacation time • Accrued landfill closure and post closure care costs

6. Is LGC Approval Required • Extends for 5 or more years from the date of the contract (including renewal period) • Obligates the unit to pay sums of money to another, without regard to whether the payee is a party to the contract • Obligates the unit over the full term of the contract to pay a principal amount of at least $500,000 or a sum equal to .01% of the assessed value of property subject to taxation in the unit AND • 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. N.C. General Statutes require LGC Approval for a wide variety of contracts and obligations • In general, incurrence of liabilities involving capitalassetfinancing require LGC approval • Traditional Debt (G.O. Bonds, Revenue Bonds, Special Obligation Bonds, 160A-20) • 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:

7. Legal Foundations • Local Governments must have statutory authority to incur debt and enter long-term contract, and must follow statutory procedures strictly • General Statutes • Chapter 159 • Article 4 – General Obligation Bonds • Article 5 – Revenue Bonds • Article 8 – Financing Contracts, Incurrence of Indebtedness and similar type of financing arrangements • Chapter 159I – Special Obligation Bonds • Chapter 159G – Clean Water Revolving Loans • Chapter 160A – 20 – Financing contracts with security interests • Chapter 160A-274 - Sale, lease, exchange & joint use of govt. property • Chapter 115C-528 – Lease purchase contracts by local boards of education • Chapter 157 – Article 1 – Housing Authority Bonds • Chapter 159C – Industrial Facilities and Pollution Control Financing Authorities

8. Is it Debt? Does it need LGC Approval? • When considering a proposed contractual obligation or arrangement, the unit must consider a number of questions: • Is it authorized by North Carolina statute? • Does it require LGC approval? • How will it impact the unit’s balance sheet? • Will it be a taxable or tax-exempt obligation? • These issues arise often in context of leases, public-private partnerships, and economic development projects

9. 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: • Transfer of title to the asset at end of lease • Lease terms include “bargain” purchase option • Lease term is more than 75% of the asset’s economic life • 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 but a “debt” for tax purposes (and therefore eligible to tax-exempt financing) • Test for capital vs. operating lease treatment different under GAAP and Internal Revenue Code

10. Is it Debt? Does it need LGC Approval? • Example 1 – Office Building lease • City seeks to encourage development in specific section of downtown • City agrees to lease an office building from private developer group • To secure financing, developer must have long-term master lease with City • City intends to sublease space which will provide source of payment for master lease • Developer will manage the building • Lease term is 20 years • City will not own building at end of lease, nor does lease contain a bargain purchase option • Present value of lease payments at City’s borrowing rate approximately equals fair market value of building

11. Is it Debt? Does it need LGC Approval? • Example 2 – Development Agreement #1 • Developer purchases City’s outdated convention center • Developer plans to convert convention center site to mixed-use development – retail/entertainment/restaurant/office • 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 • Reimbursements to be made over 3 years provided developer reaches project milestones • City expects significant increase in valuation of tax base in the development area which will offset the required reimbursements • If development is sold within 7 years of project initiation, City is entitled to receive partial reimbursements for payments made

12. Is it Debt? Does it need LGC Approval? • Example 3 – Interlocal Agreement • City A enters into an interlocal agreement to acquire Town B’s water and sewer system assets valued at over $10 million • Town B is not provided a security interest in its assets to be acquired by City A • City A will assume Town B’s outstanding revolving loans with the State that financed system improvements. $4.5 million is outstanding • City A will also make annual payments over eight years totaling $500,000 at a 0% interest rate

13. Is it Debt? Does it need LGC Approval? • Example 4 – Development Agreement #2 • Water and Sewer Authority and Developer enter into an agreement for the construction of water and sewer infrastructure • 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 • The developer also agrees to increase the size of the mains to allow service to adjacent future developments • In return for upsizing the mains, the Authority agrees to reimburse the developer for the extra costs • Reimbursements will be from future capacity fees to be paid by future developers over the next 20 years

14. Questions? Contact Information: Tim Romocki, 919-807-2360, tim.romocki@nctreasurer.com Mary Nash Rusher, 919-899-3066, mnrusher@hunton.com Steve Cordell, 704-343-2136, scordell@mcguirewoods.com