Agencies’ Right to Sell Bonds Without Voter OK Upheld

The state Supreme Court on Thursday upheld a technique widely used by local governments to avoid submitting bond proposals to the ballot, ruling that independent joint-government agencies can issue bonds for building projects without voter approval.

The unanimous decision was a victory for 113 cities, including Los Angeles, which asked the court for freedom to continue to issue such bonds to pay for public construction.

The court acted in a lawsuit filed by three Libertarian Party activists who opposed the sale of bonds to finance a $205-million expansion of the San Diego Convention Center.

Richard Rider and the two other plaintiffs charged that the San Diego Financing Authority, formed by the city and the San Diego port district, was a shell entity created to avoid a requirement in the California Constitution that cities win a two-thirds vote of the public before engaging in such financing.

But the court ruled that cities can create separate authorities to evade the requirement. Scores of cities have created such agencies to sell bonds for public works.

Justice Ming W. Chin, who wrote the ruling, said the court had agreed to review the case because “any doubt about the validity of these financing plans” would make the bonds less attractive to buyers.

The lawyer who brought the case to the court criticized the ruling, saying that it would allow cities to put taxpayers at risk for projects they may or may not want.

“Taxpayers now are officially out of the loop when it comes to incurring debt,” said Carl Fabian. “The Supreme Court said cities are free to incur all the debt they want to incur as long as they do it through a paper or shell entity.”

But Charles A. Bird, who represented San Diego and the financing authority in the case, argued that the court’s ruling will save taxpayers money. “By eliminating a potential element of legal risk to this kind of bond, it will save the taxpayers of California millions of dollars a year in interest rates,” he said.

The bonds at issue are called lease revenue bonds. They are sold by joint powers authorities, which are created by contracts signed by two or more governmental agencies.

The San Diego case illustrates the legal sleight of hand involved with such bonds. Rather than have the city of San Diego issue the bonds and pay the interest itself, which would have required voter approval, the city and the port district created the financing authority and agreed to lease the convention center to it for $2. At the same time, the city agreed to sublease the center back from the authority. While the authority paid off the bonds, the city paid rent to the authority equal to the debt service. The city’s mayor and city manager make up half of the authority’s governing board.

The city takes money out of the general fund and “calls it rent payments, but what it is is debt servicing on the bonds,” plaintiffs’ attorney Fabian said.

He said that when he went to City Hall to investigate the financing authority, it had no office, no employees, no equipment. Like other such authorities, it exists on paper only to avoid the vote requirement, he said.

Chin stressed that the court was “not naive” about such transactions.

“Here, the city and the port district have created a financing mechanism that matches as closely as possible . . . a city-financed project, but avoids the two-thirds vote requirement,” Chin wrote.

“Nevertheless, the law permits what the city and the port district have done,” he added. “Plaintiffs are correct that this conclusion allows local governments to burden taxpayers with potentially high costs that voters have not approved, but local governments impose similar burdens on taxpayers every time they enter into long-term leases involving property of substantial value.”

Chin noted that the state Constitution does not include joint powers agencies in a list of governmental bodies that are prohibited from incurring debt without voter approval. San Diego’s City Charter also does not restrict such agencies, he said.

“Because the financing authority has a genuine separate existence from the city, it does not matter whether or not the city ‘essentially controls’ the financing agency,” he wrote.

Such financing agreements also insulate cities from prohibited indebtedness because the obligation to pay rent ends if the building is destroyed or the city cannot use it, he said.

But default on such bonds is rare, said San Diego’s Bird. He said the clarity of the court’s ruling will put investors at ease and improve the price of the bonds.

“It is really a wonderful decision for public financing in California,” he said.