LOS ANGELES — About $1.5 billion in California redevelopment agency bond proceeds are in limbo, according to data compiled by a local official, as the state government challenges whether the agencies had any right to issue them.

Locals are fighting the state government over bonds issued in the period after Gov. Jerry Brown announced his proposal to eliminate redevelopment but before lawmakers passed the legislation to do so.

As officials from the state's Department of Finance met with successor agencies to the former RDAs in the final months of 2012, word spread that state officials were saying that the proceeds from bonds issued between January 2011 and June 28, 2011 could not be spent.

Since then, the DOP has apparently softened its stance. So far it's not helping Brad Raulston, executive director in the city manager's office for National City, a working-class city of 58,000 in southern San Diego County.

Raulston's agency issued $40 million of bonds for various projects during the time frame being called into question.

That includes $15 million in bond proceeds needed to move forward on a $76 million affordable housing project being developed by Related Cos.

De La Rosa & Co. was lead underwriter on National City's offering with Stone & Youngberg as co-manager on the bonds that sold in March 2011.

To make a point about the importance of the DOF clarifying its position on bonds issued during that time frame, Raulston compiled information in a spreadsheet showing that at least 50 agencies issued $1.5 billion in bonds during that time period.

Information provided to The Bond Buyer by Interactive Data in January 2012 estimated that 397 of former redevelopment agencies had a total of $19.8 billion in outstanding tax allocation bonds.

According to Department of Finance spokesman H.D. Palmer, the successor agencies can spend the bond proceeds if they are being used on a project deemed to be an "enforceable obligation."

In that context, an enforceable obligation refers to a project in which an agreement was signed between the RDA and a developer. The agreement had to have been signed before June 28, 2011, when the California Legislature approved the bill dissolving the agencies.

If the projects connected to the 2011 bond proceeds are not approved by the DOF, the successor agencies will be forced to defease the bonds or repurchase the bonds on the open market, Palmer said.

Officials refer to them as the "stranded bond proceeds."

Raulston said he has the necessary contract for the affordable housing project, but DOF still didn't approve it as an enforceable obligation.

State officials have only approved $2.8 million in expenditures of the $15 million issued for the affordable housing project. National City issued a large amount of bonds, but only had a small amount of agreements in place, according to DOF officials.

Palmer said the department is blocking expenditures of some bond proceeds because many entities just went out and sold lots of bonds regardless of whether they had projects in the works.

"Many of these cities — knowing very well that the governor planned to dissolve the RDAs — decided to subvert the law," Palmer said. "I'm surprised so many issued bonds given the uncertainty."

State officials characterized consultants' advice to move forward on bond sales given the uncertainty to be a "dereliction of duties" on their part.

"There is a very distinct difference between selling bonds for enforceable obligations and selling bonds to try to beat a deadline when the rules of the road are about to change," Palmer said.

Lewis Feldman, chairman of the Los Angeles office of the Goodwin Procter law firm, said the bonds issued in 2011 that were covered by bond counsel opinions are either enforceable by their terms or not.

"If not, the bond counsel is going to be liable for that opinion, because the bonds had to be viable at that time to give that opinion," Feldman said.

None of his clients were advised to issue bonds in 2011.

"We would always speak to the Department of Finance," Feldman said. "All my guys said you can't issue debt on that basis; you have to find alternative ways to do it."

Since the governor proposed dissolution of the agencies in his January 2011 budget, it was obvious that was the way things were going, Palmer said. That was not so obvious to others in the state.

"At the time many 2011 bonds were issued, there was no RDA dissolution legislation before the Legislature," said Bill Ihrke, partner with Costa Mesa, Calif.-based law firm Rutan & Tucker. "The state can't retroactively impair lawfully issued bonds."

Ihrke pointed out that the measure introduced by the governor in January 2011 to dissolve redevelopment agencies was defeated in both the Senate and the Assembly in March. Legislation eliminating RDAs, and a companion bill allowing the agencies to pay the state to remain in existence, was introduced and passed in the final moments of budget discussions on June 28, 2011.

Redevelopment agencies across the state joined in a lawsuit challenging the legislation. The state RDAs were frozen in suspended animation for the final six months of 2011 while they waited to hear what the court would decide.

It took most people by surprise, Ihrke said, when the California Supreme Court killed redevelopment completely by affirming legislation eliminating the redevelopment agencies, but negating the measure allowing them to pay money to the state to stay in business.

Not allowing the successor agencies to use the proceeds for those bonds as intended violates the covenants, according to Irhke. Attempting to pay them back early could also result in violations of bond covenants.

"You can't defease them until they are callable," said Michael Busch, president of Urban Futures, National City's financial advisor. "If they sit there idle for several years, the IRS will have concerns about the tax issues."

The bonds would either have to sit in escrow with the trustees until they reach the 10-year call date or a secondary market buyback of the bonds would have to occur. In the secondary market, the city would likely have to pay a premium to investors to encourage them to sell the bonds back to the issuer, Raulston said.

"By denying the use of the tax-exempt bond proceeds DOF is creating tax problems for bondholders that will certainly trigger litigation," Raulston wrote in a letter to Steve Szalay, a department official. "Since defeasing the bonds can't occur for 10 years, banking the proceeds for that time will create a colossal negative arbitrage cost to taxpayers."

Raulston estimates that it will cost National City $16 million in negative arbitrage if the bonds have to sit in escrow for 10 years.

He said the city wasn't rushing to market in 2011 in an attempt to leverage the RDA. The projects that would be funded by the bonds are part of the city's five-year plan.

In addition to Related's 201-unit affordable housing project, National City also had several road improvement projects planned, including bike paths and traffic calming on one street and a major streetscaping project on another street currently undergoing infrastructure improvements.

The streetscaping project on 8th Street was to come immediately after sewer and other repairs were completed. They are almost done, but without state approval on expenditure of the bond proceeds, the city might have to just conclude those repairs without completing the streetscaping, Raulston said.

"We can't leave the street all torn up indefinitely," he said.

The city's largest project is the affordable housing that would be constructed by Related.

Like most affordable housing projects, it involves several sources of funding to enable the developer to make the project pencil out while offering below-market housing prices.

"It is affordable housing," Bill Witte, president of Related California. "It requires a certain amount of financing assistance. The majority of it was going to come from the bond proceeds."

Related Cos. was hoping to start construction in early 2014 depending on it qualifying for tax credits. But it can't get the tax credits unless it can use the bond proceeds.

In the meantime, it could lose $8.6 million in State Proposition 1C grants, which come from state general obligation bonds, and $2 million in grants from the federal Environmental Protection Agency it qualified for as a brownfield site while it tries to convince the state that the project meets its post-redevelopment agency era requirements, he said.

"From a legal point of view can the state go back retroactively once the bonds have been sold and effectively claim those proceeds?" Witte asked. "I don't know how that works, particularly when the proceeds have been directed toward a specific use as opposed to just stockpiling bonds. We have a disposition and development agreement with the city."

Related was selected following a request for proposal process in 2008, according to Rick Westburg, Related's project manager. The disposition and development agreement, or DDA, was signed before the June 2011 deadline, he said. "It is an enforceable obligation," he said. "Bond issuance was always part of the negotiations. It just happened that we did it in 2011 as we were finishing up the DDA."

The project, Witte said, will deliver everything redevelopment was supposed to provide to blighted areas: affordable housing reclaiming a brownfield site and a transit-oriented development project.

"These issues are not about the future of redevelopment — that has already been decided," Witte said. "These issues are about projects that have legally binding contracts."

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