With relatively little fanfare last year, shortly before he was given an early retirement by the voters, Governor Tom Corbett of Pennsylvania signed into law Act 199, which amends the Commonwealth’s program for distress municipalities known as Act 47.

Act 199 makes numerous changes to municipal recovery in Pennsylvania.  While most of the attention has focused on the law’s beefed up enforcement provisions through greater use of receivership, hard deadlines on a municipality’s stay in the program, and the specter of “disincorporation” by the state, of equal import are the law’s provisions which grant recovering municipalities greater flexibility in imposing taxes.

Read more about the law’s tax changes here.

From the Patriot News, comes a story that Mayor Eric Papenfuse will be introducing a new 10-year tax abatement program for new residential and commercial construction throughout the City:

Under the proposal, owners of existing residential properties would not pay additional property taxes on any improvements for 10 years, no strings attached. …

The proposal also provides incentives for new construction, but those property owners must jump through three hoops to get a tax break. They must hire 15 percent local workers, prove they have 15-percent minority participation and pay prevailing wage for construction management and service contracts.

Even then, commercial developers will only be guaranteed a 50-percent abatement for 10 years for new construction and improvements. To earn a bigger tax break, they must create permanent jobs, according to a graded scale that provides a 70-percent abatement for the creation of at least 10 jobs.

To achieve a 100-percent abatement, a commercial developer would need to create 80 or more permanent jobs that are new to Harrisburg, under Papenfuse’s proposal.

We’ve written about the state’s LERTA program before. The most interesting aspect of Papenfuse’s proposal consists of the various “strings” that would be attached to the tax abatement for commercial development.  Under the LERTA statute, this is permissible- as local municipalities are afforded great flexibility in crafting the requirements for obtaining the abatement.

Papenfuse’s proposal is expected to be formally introduced to City Council this evening.  Of course, getting the City on board is only the first step – under LERTA, each taxing authority must separately approve the proposal.  Papenfuse must therefore get the blessing of both Dauphin County and the Harrisburg City School District to achieve maximum benefit for the proposal.

In particular, the support of the School District will be necessary, as school taxes generally make up the largest portion of the taxes to be abated in any LERTA program.  It remains to be seen whether the School District, which has also dealt with financial distress in the last few years and continues to operate under a recovery officer, will support the plan.

The Patriot News is reporting that the City will be holding a meeting tonight to discuss a possible new LERTA tax-abatement program in the City.  LERTA (short for “Local Economic Revitalization Tax Assistance Act”) is a state law that permits local jurisdictions (counties, municipalities and school districts) to offer real estate tax incentives to spur development and redevelopment in the local jurisdiction.

LERTA only exempts from taxation the value of the new construction; the owner continues to pay all existing real estate taxes. No other taxes (federal, state or local) are affected by the program.

While LERTA tax abatements remain controversial in some circles, they are an effective tool for municipalities to fight blight and spur economic development (when used correctly).

Interested to learn more about LERTA?  Check out my summary of the program here.

The MSRB recently published a revised version of proposed Rule G-42, concerning the duties owed by municipal advisors to their public entity clients. The MSRB’s changes to the Rule incorporate many of the comments previously received from the public, the effect of which would be to substantially relax the duties owed by municipal advisors to their municipal entity clients.  The MSRB expects that the changes to the Rule will reduce the compliance burden for those firms required to register as municipal advisors.  Municipal entities, however, will generally have to take affirmative steps to obtain certain information from their advisors, which previously would have been automatically provided to them under the Rule as originally proposed.

For a complete analysis of the changes, check out my write-up here.

It’s no secret that the City of Scanton is facing tough times. Operating under an Act 47 designation of distressed status since 1992, the City faces enormous financial pressures – most notably with respect to its pension obligations.  According to the most recent report prepared by the Pennsylvania Public Employee Retirement Commission (based on 2013 actuarial reports), the City reported total pension assets of $43,762,008, but a liability of $194,041,288 – for a funding ratio of just 23%.  Not suprisingly, the City’s pension fund has been operating under a determination of “severely distressed” for some time.

In an effort to shore up its pension fund, the City earlier this year passed a controversial commuter tax plan, pursuant to which every nonresident working in the City would pay an earned income tax of 0.75%.  City residents were not affected by the tax.  Not surprisingly, a group of commuters quickly sued, and among other things argued that the plan was invalid under state law because it singled out the nonresidents.

On Tuesday, the Lackawanna County Court of Common Pleas – senior Judge Braxton, of Philadelphia, presiding – agreed, and threw out the City’s new commuter tax – the day before it was to go into effect.  A copy of the Judge’s decision can be found here. An appeal seems likely.

Assuming the decision stands, where does the City of Scranton go from here?  Perhaps it will go back to the drawing board to come up with a new earned income tax plan that affects both City residents and nonresidents equally.  Perhaps it will look to the example of its neighbor Allentown, which recently completed a long-term lease of its water and sewer system, in an effort to shore up its finances, and consider such a disposition of assets.  With the news that long-awaited reforms to Act 47 might finally happen, it might also look to rely on the added tax flexibility in those reforms to address the problem.

Whatever it does, time may be running out for the Electric City to address the problem on its own.

Reprinted with permission from the September 24, 2013 issue of The Legal Intelligencer. 
© 2013 ALM Media Properties, LLC. 
Further duplication without permission is prohibited. All rights reserved.

If you are a municipality in Pennsylvania, you do not have an easy life.  In many ways, you operate like a small business: you have revenues, expenses, assets, liabilities and cash flow.  But you also operate under a set of rules pursuant to state statutes.  These rules are made by your “creator” – the Commonwealth of Pennsylvania.  Your creator operates in a political environment in which many of the entities with whom you deal have more influence with the creator than you do.  The rules under which you operate are often slanted against you.

When it comes to revenues, you rely primarily on real estate taxes and earned income taxes.  In more mature communities, like cities and boroughs, the ability to raise taxes is limited.  Combined with significant poverty populations and declining industry, these mature communities can experience revenue shortfalls even in flush years.  Raising taxes may not always solve the problem; at some point, tax increases will result in lower collections.  Many smaller cities or boroughs are also county seats, with significant portions of the land owned by governmental entities or nonprofit corporations, such as hospitals and colleges, which are generally exempt from taxation under state law.

On the expense side, typically 70% of your budget is earmarked to pay for labor costs in the form of salaries, benefits, pensions and post-employment heath care.  Under state law, you are often forced into an arbitration process with uniformed employees in which your ability to pay the award is not taken into account by the arbitrators.

The recipe of a limited revenue stream and uncontrollable expenses results in a “structural deficit” – on an ongoing basis, the municipality’s revenues consistently are less than its expenses.  If you talk to municipal managers these days in Pennsylvania, you will find that they all feel the pressures of limited revenues and uncontrollable expenses.  Even some fairly wealthy municipalities that do not (yet) have structural deficits have begun to experience the problem.

If you have a material structural deficit, the usual reaction is to cut expenses, raise taxes and increase efficiency.  At some point, however, the cuts become so deep, and taxes so high, that you compromise your ability to operate and provide needed services.  You then turn to the only other option available: exploit assets and liabilities to generate current cash flow.

Municipal assets may be exploited in many ways to convert them into current cash.  You might  sell an asset, such as a public works building, to a municipal authority in exchange for cash up front, and then lease the building back for continued use with regular rental payments.  You might enter into a public-private partnership, or P3, and lease public facilities, such as parking garages, to a private entity who will pay you a combination of upfront cash and recurring lease payments.  You might also take money which is intended for specific purposes, such as sewer rental receipts intended to improve the sewer system, and apply it towards the deficit.

You can also incur new liabilities to generate current cashflow.  In Harrisburg, for example, this was done by the city charging “guaranty fees” whenever it guaranteed a bond issue of one of its authorities, or by accepting an upfront payment whenever it entered into an interest rate swap transaction.  These cash payments were used to plug the city’s structural deficit in specific years.

These strategies may mask the problem for a time.  But, eventually the problems catch up to you: the additional debt you create results in new debt service on top of the old, and ultimately larger deficits.  Meanwhile, your sewer system and other assets, which you have not maintained, start crumbling.

Things become dire when cash flow problems develop.  You literally do not have enough cash on hand to make payroll, pay debt service on bonds, and pay vendors enough to keep them at bay.  You probably also have long ago run through whatever rainy day fund you may have had.  You then need a loan to keep going.  If you are lucky, you find a local bank that will make the loan, or you may have to deal with a hedge fund and get a really expensive loan.  But eventually, when your luck runs out, you cannot get a loan from anyone, and you’re faced with a series of tough decisions: pay your employees or risk danger to your citizens, pay your bondholders or risk being locked out of the debt market, pay your vendors or have no gasoline, tires, insurance, paper, pencils, computers, etc.

For municipalities in Pennsylvania faced with this set of dire choices, the only feasible option available is to seek relief under Act 47, the Municipal Financial Recoveries Act.  Since the enactment of Act 47 in 1987, at least twenty-seven municipalities have sought relief under Act 47.  And, Act 47 has worked well in some respects – it has kept distressed municipalities from completely melting down.  But while Act 47 has succeeded in preventing complete financial meltdown, it has largely failed when it comes to the more important goal: getting municipalities back on solid financial footing and out of distress.  To date, only six municipalities have successfully exited the Act 47 Program, with some preferring to remain under the program’s oversight to better manage their finances.

Why has Act 47 failed in this regard?  The simple reason is that municipalities who can get out of Act 47 would return to the same set of unworkable “regular” laws governing municipalities that put them into Act 47 in the first place.  Thus, for some municipalities looking to bring their revenues and expenses in line on the way to financial recovery, Act 47 perversely has become the goal, rather than the vehicle to accomplish the goal.

Changes in state law are needed in order to give municipalities the tools they need to not only survive, but to thrive.  A fundamental change would be to “right size” the delivery of certain services that would be delivered better on a regional or county basis.  Except for Illinois, our state has the largest number of local governments in the nation.  Certain services, such as police, fire, water and sewer, could be delivered on a regional basis with taxes or charges imposed and collected on a regional basis.  All of the municipalities could continue to maintain local roads and deliver other services that make sense at the local level.

Changes are also needed to balance the interests of municipalities and public employees.  In arbitration proceedings with police and fire unions, the ability of the municipality to pay should be an important factor taken into account in making an award.  Laws mandating defined benefit plans need to be reviewed and changed to bring them in line with the realities of today’s economy.  Public employees should have the same type of defined contribution plans as are common in the private sector.  Municipalities simply cannot afford defined benefit plans in the long run.

The General Assembly has held hearings to examine the operation of Act 47, and has considered several bills that would change the process by which municipalities borrow money.  A more comprehensive approach is needed, however.  The fate of our municipalities is one of the great public policy issues facing the Commonwealth of Pennsylvania.  Nothing affects our daily lives more than the delivery of basic municipal services in our communities.  The proper functioning of our local governments also has a tremendous effect on the ability of our state to develop and attract successful businesses, and ultimately on our ability to compete in the global marketplace.

For too long, municipalities have been an afterthought under state law. Their interests need to be given more consideration when balancing all of the interests at play in our Commonwealth.

Yeah, I know, crazy right? Here is the story. Apparently the Union did not think so. When the American Federation of State, County and Municipal Employees (“Union”) and the City of Philadelphia (“City”) could not reach terms on a new collective bargaining agreement, they submitted the dispute to binding interest arbitration.

The Union was seeking, among other things, 8 percent annual wage increases! The City countered that it simply did not have the money to fund the Union’s demands. The Union argued that the City’s financial health was irrelevant. Huh? How can you pay for something if you don’t have any money?

The Union’s argument was essentially – cut programs, raise taxes, lay off other workers we don’t care; how you pay for our 8 percent annual pay increases is your problem not ours! Insane, right?

Thankfully, the arbitration panel rejected the Union’s argument and determined that it was appropriate to consider the City’s ability to pay. However, the Union was undeterred. The Union petitioned the court to vacate the arbitration decision, arguing that the panel should not have considered the financial health of the City when rejecting their hefty wage increases. Thankfully, the court disagreed.

The court concluded that the Union’s arguments lacked merit, and that it was appropriate for the arbitration panel to consider ability to pay when making decisions regarding wages and other compensation related items.

Thankfully, the arbitration panel and the court brought some sanity to what seemed like an insane dispute. Ability to pay is obviously highly relevant to consideration of pay and benefit demands. Public employers are facing increasing budget constraints these days and are often on the brink of distressed status. When evaluating union demands, public employers must consider their ability to pay and when appropriate explain to the union early and often that the budget simply cannot tolerate increased expenses. Where appropriate, lay the foundation for demonstrating the financial inability to meet the union’s demands.

The Securities and Exchange Commission (“SEC”) recently announced that it has charged the City of Harrisburg with violations of various anti-fraud provisions of federal securities laws in connection with the resource recovery facility and other outstanding municipal bonds issued or guaranteed by the City.  The City has accepted a settlement of the charges in which it agreed to correct the issues prospectively without payment of any monetary penalties.  Other municipalities and their elected officials should take notice of the grounds for the SEC’s charges: the City’s failure to meet its post-issuance continuing disclosure responsibilities and the misleading public statements made by the City’s elected officials.  In light of these events, municipalities should revisit their continuing disclosure compliance plans and ensure that their elected officials are aware of their responsibilities under federal securities laws.

Post-issuance compliance has been the subject of heightened SEC scrutiny over the last few years.  The SEC’s interest in compliance with continuing disclosure obligations specifically stems from its duty to ensure that secondary-market investors (i.e., investors purchasing municipal bonds from other investors following the initial sale of the bonds) have the necessary information to evaluate a prospective investment.  For secondary-market investors, perhaps the easiest way to evaluate an investment is to have access to current financial statements, which serve to evidence the financial health of the municipality that issued or guaranteed the bonds.  The City of Harrisburg’s problems with the SEC can be traced to the City’s failure to timely and accurately prepare such financial statements in compliance with its continuing disclosure obligations.

In its announcement, the SEC noted that, until recently, the most current publicly available financial report provided by the City was from 2008, and that this report omitted or misstated material information about the City’s financial condition.  The SEC also noted that the City failed to file annual financial reports from January 2009 through March 2011, and therefore, updated City financial information was not available to secondary-market investors.

With minimal public information about the City’s finances available, the SEC determined that secondary-market investors would have to identify other sources of information concerning the City, including public statements made by City officials.  Under these circumstances, the City had an obligation to ensure that such information did not contain false or misleading statements about the City’s finances.  The SEC noted several instances in which such public statements made by the City contained false or misleading statements.  Among the information noted by the SEC was a 2009 “State of the City” address made by former Mayor Stephen Reed, as well as budget documents and mid-year fiscal reports.

The evaluation by the SEC of elected officials’ public statements and other publicly available information, under the circumstances described in its announcement, should demonstrate to municipalities, particularly those facing fiscal challenges, the importance of complying with continuing disclosure obligations, as failure to do so may invite SEC scrutiny of other publicly available information which may not have been prepared by competent professionals.  SEC review of public speeches by elected officials, such as a “State of the City” address, is especially troubling, as such speeches are inherently political in nature and often are not intended to communicate financial information in a fashion to be relied upon by secondary-market investors.  Municipalities should therefore take care to adopt a robust continuing disclosure compliance plan, designate responsible municipal officers or employees to carry out the plan, provide necessary training to those officers and employees, and engage professionals to assist as necessary.

Municipal financings are often perceived as a very complex, and even overwhelming, undertaking. The various rules and regulations which govern the process oftentimes seem complicated and difficult to understand. Keep in mind that no matter how difficult or cumbersome the process may seem, the issuance of bonds or notes by a municipality is simply the mechanism through which it borrows money. The following five points outline some of the basics that all municipal officials should know when considering the issuance of bonds or notes.

DEFINE THE PURPOSE OF THE BORROWING
A municipality issues bonds or notes to borrow money. And, unlike most borrowers in the private sector, it may borrow money on a tax-exempt basis. That is, if properly structured, municipal bonds or notes carry a federal income tax-exemption on the interest earned on the bonds or notes; and therefore, investors will buy tax-exempt municipal bonds or notes at a lower interest rate than taxable bonds. As a result, the municipal issuer will pay a lower interest rate on the money it borrows.

As implied by the above, issuing bonds or notes on a tax-exempt basis requires any such borrowing to be in compliance with the Internal Revenue Code of 1986 (the “Code”) and the various regulations promulgated thereunder. Compliance with the Code and its regulations drives much of what is undertaken when issuing bonds or notes, including the nature of the projects which may be financed with tax-exempt bond or note proceeds.

Generally speaking, a municipality may issue debt to (i) finance capital projects, such as the construction of governmental offices, the renovation of road systems, or the purchase of fire trucks, and (ii) to refinance existing debt. A municipality refinances debt for the same reason that one would refinance a mortgage – to take advantage of lower interest rates in order to achieve savings over the length of the borrowing. Under certain circumstances, a municipality may also undertake short-term borrowings in anticipation of tax and other revenues (known as tax and revenue anticipation notes or bonds), to ensure the consistent operation of the municipality in those instances when tax and other revenue streams may vary month-to-month.

CONSIDER TIMING AND STRUCTURE
When undertaking a tax-exempt financing, a municipality must consider (i) when it will require the bond or note proceeds to undertake its desired project, (ii) the timing of the financing, that is, how long it will take to complete the borrowing to access the funds; (iii) the interest rate environment at the time of the borrowing, or market conditions, and (iv) the public support for the project being financed. In short, the municipality must “time” the financing as best it can to access the lowest interest rates at the time the money is needed to undertake the project, taking into consideration the public support for the project.

Critical to the timing consideration is the determination of the approach the municipality desires to undertake in financing the project. Generally speaking, a municipality may undertake the financing by issuing bonds or notes through the capital markets, often referred to as a public offering. Or, the municipality may issue a bond or note for purchase by a bank or other lending institution. Either approach includes within it other structural considerations or options, all of which should be determined in conjunction with the decision to borrow money, and certain of those determinations may impact the timing of the borrowing.

RETAIN THE APPROPRIATE PROFESSIONALS
To that end, and having determined to undertake a borrowing through the issuance of municipal bonds or notes, it’s important to retain the appropriate professionals early in the finance process to assist the municipality as it navigates through the financing. Below is a list of professionals often retained in a municipal financing, and the roles each may play:

Financial Advisor – Although not required, a municipality may choose to retain a financial advisor to assist it in undertaking the decision to borrow money and the timing of such decision, to determine the finance structure, to identify appropriate professionals, and to “quarterback” the finance process. The Financial Advisor can work with the municipality to develop a preferred “repayment schedule” for the money to be borrowed, taking into consideration the budgeting needs of the municipality and the municipality’s tax and revenue stream. Additionally, the Financial Advisor can assist the municipality in developing “requests for proposals” for the selection of a bank, should the municipality determine to privately place its bond or note, and for the selection of other professionals to the financing.

Underwriter – An Underwriter is only required should the municipality choose to access the capital markets to borrow money, that is, to undertake a public sale of its bonds or notes.

The Underwriter may be selected through a competitive sale or negotiated process. In a competitive sale process, a variety of underwriters submit bids to the municipality and the bonds are awarded to the Underwriter that offers to pay the municipality the lowest interest cost. Or, the Underwriter may be selected in a negotiated transaction, where the municipality hires the Underwriter at the beginning of the finance process, and the Underwriter helps find investors for the bonds or notes. If the municipality chooses an Underwriter through a negotiated process, the Underwriter may undertake many of the duties undertaken by a Financial Advisor: it will assist in the development of the plan of finance, assist in the development of the structure, and assist in determining the timing of the sell of the bonds or notes based on market conditions, among other things. It should be noted, however, that while an Underwriter has a duty to deal fairly with the municipality, it does not have a fiduciary duty to act in the best interests of the municipality, such as a Financial Advisor. The Underwriter’s primary role in the transaction remains purchasing the municipality’s securities with an aim toward distribution, and therefore its interests may at times conflict with the municipality.

Bond Counsel – Bond Counsel should be retained very early in the finance process. Bond Counsel, like the municipality’s solicitor, represents the municipality as the issuer of the bonds or notes. Bond Counsel provides guidance in structuring issues related to tax law; reviews applicable law to confirm the municipality’s authority to issue the bonds or notes and its conformity with legal requirements, including the Local Government Unit Debt Act; drafts the applicable ordinance and other finance documents; and renders its legal opinion regarding the tax-exempt status of the bonds or notes.

Of course, and in addition to the professionals unique to the municipal finance process, the municipality’s solicitor works closely with the municipality and with bond counsel to ensure that all of the municipality’s legal requirements are met.

REMEMBER THE LOCAL GOVERNMENT UNIT DEBT
In structuring a bond or note financing, the municipality’s professionals must not only consider tax law and securities law requirements (as applicable in the context of a public offering), they must also consider all state law requirements. In Pennsylvania, a municipality may not incur debt without being in compliance with the Local Government Unit Debt Act (or LGUDA). That is, a municipality may not “transfer” the bond or note to a purchaser without demonstrating, among other things, that the anticipated borrowing, together with any other outstanding debt of the municipality, will not cause the municipality to exceed its statutorily prescribed debt limits, as determined by LGUDA.

While most municipalities recognize the debt limitations as set forth in LGUDA, many overlook that LGUDA also sets forth requirements which directly affect the structure of a municipality’s financing, the length of any borrowing, the repayment schedule, and the purposes for which a municipality may finance or refinance any project. All of these factors are considered in the LGUDA approval process.

The LGUDA approval process is a complex and critical component when considering the timing of any financing. The approval process may become more complex this year if recent proposed amendments to LGUDA are enacted. On February 1, Senator Mike Folmer (R-Lebanon) introduced a series of bills to reform perceived shortcomings in LGUDA as it currently exists. Of interest to municipalities are proposed changes to the LGUDAapproval process, which, if enacted, would require all municipalities to obtain preliminary approval for a debt issuance before commencing a financing. The preliminary approval requirement would be in addition to the existing LGUDA approval requirements.

THE WORK ISN’T FINISHED AFTER THE BONDS OR NOTES ARE ISSUED
The Internal Revenue Service (“IRS”) now strongly recommends that any issuer of tax-exempt debt, including a municipality, have in place certain “post issuance compliance policies,” designed to ensure that the municipality maintains the tax-exempt status of the bonds or notes issued through the maturity date (or earlier prepayment) of such bonds or notes. In fact, the Form 8038G, completed by Bond Counsel at the time of a tax-exempt financing, and executed by the municipality at the closing for such bonds or notes, specifically inquires as to whether the municipality has such post issuance compliance policies in place. Bond Counsel, and the municipality’s solicitor, can assist a municipality in the drafting of a post issuance compliance policy that (i) complies with the recent guidance suggested by the IRS, and (ii) works well with the municipality’s existing practices and procedures.

Should the municipality determine to issue its bonds or notes through a public financing, the municipality will need to take certain steps to keep their investors informed, at the time of issuance and afterward. The municipality will be required to provide on an annual basis its audited financial statements and such other finance documents as determined at the time of the financing. In addition, the municipality will have the obligation to discuss certain events, as listed in a continuing disclosure certificate or agreement the municipality will execute at the time of the closing for the bonds or notes.