Part VII of James Spiotto’s Series on Fiscal Distress Myths & Realities:
Do the State Statutes and Case Law Provide Effective Remedies?
Myth: There are no Effective Remedies for State and Local Government Bond Defaults
Reality: There are Effective Statutory Remedies for State and Local Government Bond Defaults (Mandamus, Receiver, Suit to Recover Judgment, Accounting, Foreclosure, Injunction, Suit for Instruction by Bond Trustee or for Approval of Settlement, etc.)
The critical differences between revenue bonds and general obligation bonds, lease and appropriation bonds and conduit financings:
- Revenue Bonds – Revenue bonds are generally only payable from the pledged revenue, specific tax source or revenue related to the municipal enterprise financed and no other recourse to the issuing municipality.
- General Obligation Bonds – General obligation bonds are backed by the full faith and credit of the municipality and may also have a contractual or statutory pledge of revenue.
- Basic Right to Payment for Revenue and General Obligation Bonds – Upon default, bondholder may institute lawsuits requesting the debt be immediately paid or certain actions be taken by the municipality or be required to specifically perform under the documents.
- Lease and Appropriation Bonds – Municipal lease or appropriation backed bonds (non-recourse to municipality’s full faith and credit but recourse to annual appropriation or leased property. Note: cannot legally bind successor legislature to appropriate funds).
- Conduit Financing – Conduit financing (non-recourse to municipality, must be for a general public purpose and the credit support is the non-profit or corporate entity benefited).
- Basic Right to Payment for Lease, Appropriation and Conduit Financing – Upon default on lease and appropriation bonds, the remedies are limited to those set forth in the documents and applicable law and generally limited to the municipality’s loss of use of the leased facility and ability to relet the facility. In conduit financing the remedies are generally limited to the not-for-profit or corporate entity benefitted without recourse to the municipality.
Upon default (breach of covenant or failure to make payment of principal or interest), bondholder may institute a lawsuit for a money judgment, mandamus, specific performance, or equitable relief such as for injunction or an accounting or for foreclosure on collateral (if permitted) or other relief:
- Mandamus – All states would permit a bondholder upon default to petition for mandamus that in essence requires a municipal official to levy taxes to pay an obligation. The problem is constitutional and statutory debt limits and time, cost and delay. (See Appendix for breakdown)
- Receiver – 46 states and Puerto Rico permit bondholders to petition a court to appoint a receiver upon default especially in the case of a default on the revenue bond for financing of a municipal enterprise. (See Appendix for breakdown).
- Accounting – At least 22 states and the District of Columbia and Puerto Rico allow for bondholders or representative to bring an action for an accounting to require the local government to account for how bond funds have been spent. (See Appendix for further breakdown).
- Foreclosure – At least 28 states permit some form of foreclosure on mortgaged or secured real property upon default on a financing of that facility or structure generally related to conduit financing. (See Appendix for further breakdown).
- Injunction – At least 15 states permit bondholders to obtain some form of injunctive relief upon default to protect and preserve their rights and remedies. (See Appendix for further breakdown).
- Other relief.
- (For more detail see Appendix from Municipalities in Distress? 50 State Survey in forth- coming 2nd Edition)
Have State Courts Enforced or are Required to Enforce Bondholders Rights and Remedies?
- To the degree state courts have chosen not to enforce certain traditional rights or remedies, this is important information for investors especially during times of financial distress. Likewise, favorable rights and remedies allowed by the state courts are important to know and may help enhance the issuer’s credibility in the market.
Earlier articles in this series:
Fiscal Distress Myths and Realities Part I: Default Rate
Fiscal Distress Myths and Realities Part II: Use of Chapter 9
Fiscal Distress Myths and Realities Part III: Consequences of Default
Fiscal Distress Myths and Realities Part IV: Can a Municipality File Chapter 9?
Fiscal Distress Myths and Realities Part V: Factors that Help Prevent Municipal Default
Fiscal Distress Myths and Realities Part VI: Types of Public Debt Honored in Full in Chapter 9
Look out for more parts of James Spiotto’s Fiscal Distress Myths & Realities coming soon.
James E. Spiotto, Co-Publisher © James E. Spiotto. All rights reserved