Request By:
Mr. James R. Ramsey
Director
Division of Investment and
Debt Management
Office for Policy and Management
Finance and Administration Cabinet
Frankfort, Kentucky 40601
Opinion
Opinion By: Steven L. Beshear, Attorney General; By: Charles W. Runyan, Assistant Deputy Attorney General
You request the opinion of this office concerning revenue bonds issued and to be issued by the State Property and Buildings Commission, relating to capital construction projects for state agencies.
The law firm of Rogers and Wells of New York is currently serving as bond counsel for project 31, embracing certain mental health projects which includes the financing of mental health facilities at Outwood and Eastern State Hospital. The law firm raises the question as to whether or not a debt service reserve account and a capitalized interest account, as financing costs of marketing a bond issue, are "a cost of issuance" , under pertinent statutes?
This is a pertinent and important question, when considering (this will be taken up in some detail hereinafter) that the legislative approval of such capital construction projects is expressed in terms of line item appropriations in the biennial budget, but which budgetary items cover only the original principal debt, i.e., the costs of construction.
Your position, and the practice of the commission in the past has been the same, is that the construction cost is one thing, and the financing cost is another and additional cost. In that connection, you related this background:
"The State Property and Buildings Commission, upon request from a state agency, issues revenue bonds to finance General Assembly approved capital construction projects for that agency. The revenue bond form of finance historically utilized within the Commonwealth is based upon the theory that the State Property and Buildings Commission lease the capital construction project to the agency in question. The agency's lease payment is utilized by the State Property and Buildings Commission to make debt service payments on the bonds issued to finance the capital construction project. The source of funds for the agency's lease payment is General Assembly appropriated debt service. The appropriation of debt service is for the two year budget cycle and must be reappropriated each biennium until the bonds are retired.
"The revenue bond issued by the State Property and Buildings Commission does not have the same 'security' to the bondholder as would exist for a general obligation bond issue. The reason for this is that the retirement of the outstanding bonds is dependent upon a biennial appropriation of debt service by the General Assembly.
"To enhance the security and hence marketability of the revenue bonds sold by the State Property and Buildings Commission, the Commission normally borrows an additional amount of bonds in an amount to fully fund a debt service reserve account and a capitalized interest account. Financial advisors employed by the Commission and Moody's Investor's Service have both advised the Commission that this practice does indeed enhance the security of the bond issue, thus improving the marketability of the bonds and thereby lowering the Commission's borrowing costs.
"As an aside, one must look at the recent Pike County Building Commission bond issue where the fiscal court of Pike County failed to renew with the Pike County Building Commission its lease for a project. The debt service reserve account was used to make bond payments due and hence avoid a default on the bond issue. Thus, the debt service account proved to be a critical component of the financing. "
The legislative approval of such capital construction projects came in under legislation enacted in 1979 (Ex. Sess.) Ch. 4, i.e., KRS 45.750 to 45.800. In 1980 (Ch. 96), KRS 56.870 to 56.874, dealing generally with legislative approval of state fiscal obligations, were enactedr. We shall revert to this later in the opinion.
Prior to the advent of the above legislation involving legislative approval of capital construction projects and revenue bond issues, the legislature was not required to formally approve such construction and bonds. The key funding statute for public projects was KRS 58.050, which reads:
"All money received from the bonds shall be applied solely for the acquisition, construction, maintenance or improvement of the public project, and the necessary expense of preparing, printing and selling said bonds, or to advance the payment of the interest on the bonds during the first three (3) years following the date of the bonds, or to provide an initial debt service reserve; and the proceeds of such bonds may be supplemented by contributions from the issuing governmental agency or from any other source toward the cost of construction of the project or toward the creation of a debt service reserve for the protection and benefit of the bondholders, or for any other purpose related to the financing of the acquisition and construction of such public project; and it may be further provided that any contribution made for the purpose of assisting in the initial establishment of a debt service reserve for the benefit and protection of the bondholders may be returned or reimbursed to the contributor thereof whenever other equivalent funds have been provided from the revenues of said project or from any other source toward the establishment of such debt service reserve."
The statute (KRS 58.050) in effect provides that the bond proceeds shall be applied solely for construction costs, for expenses in printing and selling the bonds, and for payment of interest on the bonds during the first three years, or to provide an initial debt service reserve. The proceeds of the bonds may be supplemented by contributions from the issuing governmental agency, or from any other source, toward construction costs or creation of a debt service reserve.
Thus the practice has been that the bond proceeds are used to pay off the construction costs; and an additional amount of such bonds is issued to fund the financing costs (payment of principal and interest) under a debt service reserve account and capitalized interest account. The State Property and Buildings Commission leases the capital construction project to the agency in question; and the agency's lease payment is used by the commission to make debt service payments on the bonds. The source of funds for the agency's lease payment is the General Assembly's appropriated debt service. KRS 56.450(4) envisions the legislature's providing the affected agency with appropriations adequate to fund a debt service, except that constitutionally the legislature is not legally bound to make appropriations to continue the payment of the "rentals" beyond each biennium. Preston v. Clements, 313 Ky. 479, 232 S.W.2d 85 (1950) 90. Of course, that reasoning was necessary to enable the court to hold that revenue bonds do not constitute an indebtedness of the state within any constitutional provision or inhibition.
KRS 45.750 to 45.800 merely formalized the biennial budgeting of agency funds sufficient for debt service payments. However, those statutes only embrace the legislature's inclusion in the biennial budget of a line item account involving total estimated capital construction costs of the project, nothing else. Financing costs are not treated in that legislation.
KRS 56.870 was first enacted in 1980 (Ch. 96, § 1). It read:
"(1) Notwithstanding any statutory provisions to the contrary, prior to the issuance and sale of any definitive bonds or temporary bonds, or the securing of any interim financing through bond anticipation notes, loan agreements or by any other means, each agency, authority, board, corporation, cabinet, commission, or any other agency or instrumentality of the Commonwealth shall first obtain approval of any such financing from the general assembly, sitting in regular or special session. Such approval shall be evidenced by the adoption by the general assembly of a specific act or the adoption by the general assembly of the biennial budget report and the biennial appropriation act which shall specify the purposes for such financing.
"(2) The biennial appropriation act and budget report shall also establish a ceiling for revenue bonds which require a general fund appropriation to retire.
"(3) The provisions of subsection (1) of this section shall not be applicable to the financing of any project in any case where the project for which financing is proposed is certified by the governor, as hereinafter provided, to be of such type as to independently produce revenues sufficient to fully meet debt service on such financing so that no appropriation of state general funds will be required. Such certification shall be made in writing by the secretary of finance to the statutory head of the issuing agency or authority with a copy to the governor and the legislative research commission."
Thus a capital construction project to be funded with revenue bonds must first get the approval of the General Assembly in session. Such approval is evidenced by the adoption of a specific act or the inclusion in the executive budget and biennial appropriation act of a line item covering the construction costs of the project and stating that the funding of the construction costs is from revenue bonds to be issued. See, for example, Part V (Capital Construction Fund), H.B. 295, Chapter 398 of 1982 Acts, State Appropriations Act, pages 1326 and 1337 (DHR), Bureau for Health Services.
Your letter contains these remarks about KRS 56.870:
"KRS 56.870 requires the General Assembly to authorize projects to be funded by debt. Therefore, as a practical matter, when the Office for Policy and Management and the Governor submit the Executive Budget to the General Assembly, the capital construction component of the budget contains a request for the authorization of an amount equal to the construction costs of the project. At the same time, the agency in question requests the authorization of an amount equal to the debt service payments on the bond issue. The bond issue size will be greater than the authorized construction costs of the project since included in the bond issue are the borrowing for the debt service reserve account, the capitalized interest account, and other fees necessary as party of the marketing of the bond issue. The Commission has, as a matter of policy, in corporated these issuance costs in the bond issue (over and above the amount required to satisfy the construction costs of the project) based upon the Commission's interpretation of KRS 56.872 which allows for the Commission to do so as long as these costs of issuance do not exceed the estimated cost of the authorized bond project by more than twenty-five percent (25%)." (Emphasis added).
Apparently, you feel that the language of KRS 56.872(2) covers the matter of a debt service reserve and capitalized interest, and other costs of marketing a bond issue, as "issuance costs" per that statute. The phrase, "costs of issuance of bonds," is not defined by these statutes or any other Kentucky statutes. Thus we must examine closely the practice of the Commission in terms of KRS 58.050 and 56.872(2) for direction. The latter reads:
"(2) In the event the cost of an authorized bond project exceeds its estimated cost, as approved by the General Assembly, the financing of such project may be authorized upon approval by the secretary of the finance and administration cabinet, so long as such cost does not exceed the estimated cost by more than twenty-five percent (25%). In the case of financing of any bond project approved by the general assembly, the costs of issuance of bonds or notes shall be added to project costs in determining the principal amount of authorized financing of any such project." (Emphasis added).
It cannot be forgotten that revenue bonds do not constitute an indebtedness of the Commonwealth. See §§ 49, 50, and 171, Kentucky Constitution; and Turnpike Authority of Kentucky v. Wall, Ky., 336 S.W.2d 551 (1960). However, in terms of the state's future issues of governmental obligation and revenue bonds, the state must perpetually think of its good faith to bondholders. A multiplicity of loan defaults in a financial crisis would bring on the question of the state's ability to live up to its good faith to the bondholders.
CONCLUSION
We must first keep in mind that KRS 58.050 mentions debt service reserve and interest costs as part of the costs of a bond issue, which may be supplemented "from any other source" (which could include additional bonds). Since the practice of the Commission and the Department of Finance's interpretation followed that concept precisely in the past, the courts would undoubtedly uphold the interpretation and practice under the rule of contemporaneous construction. O'Connell v. Duff, 276 Ky. 782, 125 S.W.2d 718 (1939). Further, KRS 58.050 is not an isolated fragment of law. It is to be considered, under the doctrine of pari materia, together with KRS 56.872(2) as a whole or as a part of a system, since no different purpose is indicated. Dieruf v. Louisville & Jefferson County Bd. of Health, 304 Ky. 207, 200 S.W.2d 300 (1947).
KRS 56.872(2) clearly suggests that the debt service reserve and capitalized interest costs are "costs of the bond issue" , which costs may be added to the construction costs, provided the bond financing costs do not exceed twenty-five percent (25%) of what amounts to the construction costs. As Justice Palmore, for the Court, wrote in Barrett v. Stephany, Ky., 510 S.W.2d 524 (1974), the court has a duty to construe the statutes literally if it is reasonably possible to do so. Here there is no difficulty in construing, as a matter of reason, the literal wording of this statute.
KRS 45.750, et seq., involve only construction costs, not bond financing costs.
The projects in question are not subject to the "debt ceiling" concept expressed in KRS 56.871. See OAG 81-242, relating to the Kentucky Housing Authority.
It is our opinion that under KRS 58.050 and 56.872(2) the costs of issuing bonds, inclusive of bond discount, capitalized interest, and a debt service reserve, are in fact and as a matter of law proper "costs of issuance" of such bonds, to be added to the authorized level of a revenue bond financed project (which construction project costs are delineated in capital construction sections of the biennial appropriations and budget report) in arriving at the authorized financing of such project.
Such "financing costs" are vital and inevitable if Kentucky is to continue issuing revenue bonds with the requisite safeguards against default. The power to include such financing costs in the total bond package is also an implied power of the State Property and Buildings Commission in issuing revenue bonds under KRS 56.450(4). This implied power is clearly and inevitably necessary in order that the Commission may carry out its express power of issuing revenue bonds. As the court said in Folks v. Barren County, 313 Ky. 515, 232 S.W.2d 1010 (1950), "It is a rule not less of reason than of law that where the end is expressly given, the means necessary to the effectuation of that end are given by implication."
The implied power is here sufficient. However, the conclusions as to KRS 58.050 and 56.872(2), above resolve any doubt in this matter and are indeed dispositive of the question.
Within the total context of the express and implied Kentucky statutory authority of the Commission as relates to financing costs of bond issues, we are reminded of Justice Holmes' writing that "The life of the law has not been logic: it has been experience."