CHICAGO – The Minnesota Supreme Court has cleared the path for the state’s use of an appropriation pledge to refund $757 million of tobacco securitization bonds, by finding that the proposed bonds can’t be labeled a “public debt” subject to limits on how proceeds are used.
The state’s high court issued its opinion Wednesday in a complaint filed by Minnesota Management and Budget Commissioner James D. Schowalter in April asking the court, in effect, to validate the use of an appropriation pledge for a tobacco refunding. Minnesota Attorney General Lori Swanson argued against the deal’s legality.
The court in its majority opinion sided with MMB.
“We conclude that the proposed tobacco appropriation bonds do not constitute public debt for which the state’s full faith, credit, and taxing powers have been pledged under the plain language of Article XI, Section 4 of the Minnesota Constitution; therefore, the restrictions imposed” by statute “do not apply to the bonds,” the opinion read.
The state was pushed to undertake the legal process by Swanson, who pressed to include it in tobacco bond legislation approved and signed by Gov. Mark Dayton last year as part of a fiscal 2012-13 budget deal that helped end a 20-day partial government shutdown.
The legislation allowed for the use of either a tobacco securitization or an appropriation pledge, but only if the Minnesota Supreme Court validated the appropriation. While the use of an appropriation pledge would result in lower interest rates and savings of at least $65 million, the state needed funds from the tobacco issue quickly to balance the budget.
It moved forward with a transaction last November backed by annual payments it receives from its settlement reached with major tobacco companies. The issue included an extraordinary optional redemption feature that allows the state to redeem the bonds in the event it sells appropriation-backed refunding bonds by a deadline of Dec. 1, 2012.
Swanson’s office contested the legality of the deal, arguing before the state’s high court that the bonds constitute a public debt and represented an attempt by the state to bypass rules that don’t permit the use of public debt to balance the budget.
MMB lawyers countered that the proposed bonds were not subject to state constitutional rules on how proceeds of public debt are used because the legislation and bond documents clearly spell out that the state’s full faith and credit and taxing powers are not pledged. The Legislature retains the ability not to appropriate debt service.
“In light of the decision, the state anticipates that it will proceed with a refunding of the tobacco revenue bonds, which will save Minnesota taxpayers tens of millions of dollars. The final savings amount will be determined by market considerations when the bonds are sold,” Schowalter said in a statement Wednesday.
Swanson’s office responded to the decision noting that the office was following the directive of the Legislature which included the need for a court ruling in the tobacco legislation because it had sufficient doubt. “That was the process set up by the Legislature,” said Swanson spokesman Ben Wogsland. “The court has rendered its final decision.”
Although the court pointed out that its decision is limited to its review of the tobacco deal, the ruling potentially clears the way for the state’s planned use of an appropriation pledge to back nearly $500 million of bonds for a new $975 million stadium for the National Football League’s Minnesota Vikings.
The stadium package signed by Dayton last year calls for an appropriation backing for bonds that would cover the public’s share of the stadium’s costs being born by the state and city of Minneapolis.
Nationally, lawyers and analysts have been watching to see how the Minnesota high court would interpret its “public debt” statutes as market participants debate and assess the safety and security of an “appropriation” pledge.
Such a pledge often carries just a slight credit rating penalty of one level below a general obligation pledge.
“Every state has different constitutional provisions on debt but for ones similar to Minnesota this opinion could be helpful in providing guidance,” said one Minnesota-based lawyer following the case.
In rendering its decision, the court quoted state constitutional language that defines public debt as including “any obligation payable directly in whole or in part from a tax of state wide application on any class of property, income, transaction or privilege, but does not include any obligation which is payable from revenues other than taxes.”
Such debt issuance is limited to purposes for acquiring and bettering public land and buildings and other public improvements of a capital nature; refunding outstanding bonds; establishing and maintaining highways; promoting forestation; constructing, improving, and operating airports; and developing the State’s agricultural resources.
The opinion noted that the bond documents “make clear that the annual appropriation is subject to repeal, reduction, or unallotment, and that the bondholders have no remedy for the State’s failure to make principal or interest payments.”
If the Legislature fails to appropriate debt service the bonds are cancelled.
“There is no basis upon which we could reasonably conclude that the bonds involve a pledge of the state’s full faith, credit, and taxing powers” and so don’t qualify as a public debt, the opinion reads.
During oral arguments over the summer, lawyers from Kutak Rock LLP who represented MMB zeroed in the lack of a full faith and credit pledge behind the tobacco refunding bonds. MMB lawyers stressed that the bonds would be payable solely from a standing appropriation of amounts appropriated annually from general fund revenues.
“This is a slippery slope if this court validates these bonds,” Swanson’s solicitor general Alan Gilbert told justices in arguments, potentially opening new avenues to balance the budget and deficit spending.
Swanson’s office attempted to persuade the court that the legislature, though not technically bound to honor repayment, would in effect be required to or risk losing an investment-grade rating and market access.
In its majority opinion, the court said of the attorney general’s concern that validating the bonds would open the gates to future deficit financing: “Although this concern is not unfounded, our role here is limited to interpreting the language of the constitution… the wisdom of issuing appropriation refunding bonds is a public policy matter for the other branches of state government.”
The driving factor behind the state’s refunding plans is a reduction in interest costs with net present-value savings estimated at a minimum of 3%. The tobacco securities carry a true interest cost of 4.79% and carried credit ratings in the high triple-B and single-A category. While the final rate on the refunding bonds with the sturdier appropriation pledge is subject to market conditions, the state projected its true interest cost at about 3.27% in court filings.
Justice Alan Page issued a dissenting opinion stating that the court does not provide advisory opinions and because the bonds have not been issued any decision is advisory. He also believes the bonds constitute a public debt. Justice Paul Anderson also agreed with Page that the bonds constitute a public debt but he believes the court had jurisdiction to decide the case without the bonds being issued.