If transaction participants and the IRS refuse to go after bond counsel for bad opinions, they get a “free ride,” said Mark Scott.

WASHINGTON – Spurred by an Internal Revenue Service ruling that its bonds are taxable, the Baker Correctional Development Corp. in Florida plans to try to obtain a waiver from having to call the bonds as well as a federal loan to refund the bonds from tax-exempt to taxable.

This is the latest information from interviews with the parties involved, a material event notice BCDC filed with the Municipal Securities Rulemaking Board last week and a conference call the Baker County Sheriff's Office held with bondholders on Feb. 15.

At issue are $45 million of first mortgage revenue bonds that BCDC issued in 2008 to finance the acquisition of land for, and construction of, the Baker County Detention Facility in MacClenny, Fla.

The detention center, which opened in 2009, is owned by BDCD, a nonprofit formed in 2006 to acquire and construct one or more jails in Baker County. It is operated by the Baker County Sheriff's Office and currently holds roughly 500 inmates, about 400 of which are federal.

The IRS began auditing the bonds and last September sent BCDC a Notice of Proposed Issue suggesting the bonds were taxable.

Under the federal tax law, bonds become private activity bonds if more than 10% of the proceeds are for private use and more than 10% of the debt service payments are from, or secured by, private payments. PABs are taxable unless they fall within one of several "qualified" categories, none of which contain jails.

The IRS considers federal prisoners to be private persons. Most of the Baker County Detention Center's inmates are from U.S. Immigration and Customs Enforcement, the U. S. Marshals Service, and the U.S. Bureau of Prisons, Jeffrey Cox, the finance director for the Baker County Sheriff's Office told bondholders on the conference call. Cox also said the jail's daily inmate population was up to roughly 500 and that its finances were in good shape.

Peter Dame, an attorney with the Ackerman law firm in Jacksonville who is representing BCDC in the IRS dispute, told bondholders that BCDC was trying to refinance the bonds and get them off the market as tax-exempt. This was something the IRS wants, he said.

It was clear from the discussion that BCDC does not have the money to refund the bonds. Dame said the issuer was "exploring a federal government program that may be available to provide essentially a refinancing" and had "retained investment bankers to assist them with that." He told bondholders he thought the IRS would give BCDC some time to pursue the option.

But soon afterward, the IRS sent BCDC a proposed adverse determination that its bonds were taxable.

The official statement for the bonds contains a special mandatory redemption provision under which the bonds must be redeemed in whole at 105% if there is a "Determination of Taxability" on the bonds. The redemption must occur "on the earliest practicable dated selected by the trustee, and in no event later than 90 days following the occurrence of a Determination of Taxability."

The March 8 event notice filed on EMMA said "Unless the issuer is successful in refinancing the bonds, the issuer will not have sufficient monies to redeem the bonds upon a mandatory redemption resulting from the occurrence of a Determination of Taxability."

"The issuer will contact the bond trustee with the intent of obtaining the approval for a restructuring of the bonds that would result in the reissuance of the bonds as taxable bonds and waiver of the mandatory redemption," the notice said, adding, "The issuer anticipates that the bond trustee will seek the advice and direction from the holders of the bonds. The timing and terms of such restructuring are yet to be determined."

Mark Scott, former director of the IRS' tax-exempt bond office who now has a practice representing whistleblowers and said he has some involvement in this case, said the transaction participants or the IRS should go after the bond counsel, Sell & Melton in Macon, Ga., who gave the wrong opinion that the bonds were tax-exempt. "Otherwise it's a free pass for bad bond counsel," Scott said. R. "Chix" Miller at Sell & Melton could not be reached for comment.

BCDC has hired Raymond James to help it obtain a loan from the Department of Agriculture's Community Facilities Direct Loan & Grant Program, according to sources. The program provides low interest loans and grants to help finance the development of essential community facilities in rural areas. These facilities must "provide … an essential service to the local community for the orderly development of the community in a primarily rural area, and … not include private, commercial or business undertakings."

The 2008 bonds were underwritten by Bergen Capital in New Jersey. Underwriter's counsel was Hill Wallack in Princeton, N.J. Counsel to the county was Brown & Broling in Florida.

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