By Megan Hafner
Does your city need to renovate city hall or buy a new firetruck? Are you wondering where the city will come up with the money for these important expenditures?
It’s not always easy because by law, cities can’t just go to the bank and take out a loan. Instead, cities must find specific authority in state law to borrow money or carry debt. Authority for a specific situation involves consideration of detailed and interrelated state laws (and of the city charter for charter cities). However, a discussion of some broad categories of authority in state law may give you an idea of some of the possibilities.
Bonds are the most common way for cities to raise capital, or “borrow” money. A bond (or an “obligation”) is a promise to pay a stated amount of money, including principal and interest, at a fixed future date, made for the purpose of incurring debt.
In essence, a city gets money now in exchange for a promise to pay the money back over a certain number of years. Chapter 475 in Minnesota law governs the issuance of bonds. Bonds typically have a term of 10 to 30 years, although in some situations a city can issue a short-term bond (maturing in no more than three years).
Cities mainly issue two types of bonds: general obligation (GO) bonds and revenue bonds. GO bonds are obligations for which a city pledges the full faith and credit of the city to their payment. This means the city will use its taxing authority to pay them back. Some GO bonds are subject to voter approval, but there are several exceptions to that requirement.
Revenue bonds require a city to pay principal and interest from a specific revenue source, such as charges for water. Most revenue bonds do not require voter approval.
Federal laws govern requirements for cities issuing bonds, as well as the tax-exempt status of the bonds. Attorneys who specialize in bond law help ensure that most bonds issued by cities (municipal bonds) are tax-exempt, making them attractive to people or entities who invest in bonds.
Certificates of indebtedness
State law authorizes cities to issue debt in the form of certificates of indebtedness or capital notes for specific types of purchases or spending. For example, Minnesota Statutes, section 412.301 authorizes cities to finance the purchase of certain capital equipment (e.g., firetrucks and ambulances) by issuing certificates or notes.
The certificates or notes must be paid within 10 years, and cities must levy taxes to pay the principal and interest on the notes. When the purchase is for a large dollar amount, it is subject to a reverse referendum (where residents can petition for a special election on the purchase).
Other examples include Minnesota Statutes, section 475.754, which authorizes cities to issue certificates of indebtedness to cover expenses related to a natural disaster or other public emergency. Cities can manage short-term cash flow problems by issuing certificates under Minnesota Statutes, section 412.261 in anticipation of tax revenues, and under Minnesota Statutes, section 475.755 when it turns out that that the property tax levy the city certified will not cover city costs.
Minnesota Statutes, section 465.71 authorizes cities to lease property with an option to purchase under a lease-purchase agreement. In this situation, the title to the property is retained by the seller or vendor (or assigned to a third party such as a bank) as security for the purchase price.
No election is required for a lease-purchase agreement. However, the city must have the right to terminate the lease-purchase agreement at the end of any fiscal year during its term without a penalty provision so great that it makes termination a practical impossibility.
Conditional sales contract or contract for deed
Minnesota Statutes, section 412.221 grants cities authority to purchase personal property, like trucks or equipment, through a conditional sales contract. It also allows cities to purchase real property (buildings or land) through a contract for deed.
The contract must have a term of no more than five years, and the seller is limited to recovering the property if the city fails to pay all or part of the contract price. These contracts are also subject to a reverse referendum when the dollar amount is high.
Municipal borrowing is complicated and involves consideration of numerous state and federal laws. While for some basic situations, you’ll only need to consult with the city attorney, more complex situations—such as issuing bonds or certificates of indebtedness—will require involvement of bond counsel and financial advisors.
Megan Hafner is a research attorney with the League of Minnesota Cities. Contact: email@example.com or (651) 281-1226.
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