WASHINGTON — The groundbreaking nature of direct-pay Build America Bonds has led the National Association of Bond Lawyers to issue new guidance recommending bond counsel give opinions to issuers that the bonds qualify as BABs rather than give tax opinions to investors.
“The novel structure of direct-payment BABs requires issuers, purchasers, or underwriters and bond counsel to rethink how and if tax opinions for direct payments BABs will be of interest only to the issuer, not investors and underwriters,” NABL wrote in a 14-page report that was prepared by an ad hoc committee and dated June 30 but not released until yesterday.
“We thought it would be a good service to our members to do a report like this just to highlight the things that bond lawyers ought to think about,” said J. Foster Clark, a partner at Balch & Bingham LLP in Birmingham. “When giving the tax opinions related to BABs, because of the novel structure of [them], that tax opinion sort of gets turned around.” The former NABL president led the committee that drafted the report.
With traditional tax-exempt bonds, investors typically require an unqualified tax opinion from bond counsel that the bonds are tax-exempt and compliant with the relevant tax laws and rules. If the Internal Revenue Service determines the bonds are taxable because of tax law violations, the investor, who generally accepts lower interest rates in exchange for the tax exemption, may have to pay tax on the interest earned from the bonds.
However, direct-pay BABs are already taxable, and issuers, rather than bondholders, are at risk since the payments they receive from the federal government could be terminated if the bonds are found to be unqualified or noncompliant with tax requirements. Even though they are taxable, BABs are still subject to some of the same tax requirements as tax-exempt bonds
As a result, “in most instances the tax opinion for direct-payment BABs will be of interest only to the issuer,” the bond lawyers wrote in the report. “Neither investors nor underwriters should generally require an opinion as to the qualification of the bonds.”
It may even be appropriate for bond counsel to decline to participate in a direct-pay BAB transaction if the issuer is unwilling to seek written tax advice and the bond counsel determines that a failure to provide written tax advice would run counter to its professional obligations, the report stated.
But the group identified two instances when investors and underwriters may want to seek an opinion on the BABs’ qualifications. The first is if the bonds are exempt from state and local taxes. Some states exempt from their taxes bonds that are federally tax-exempt. The stimulus law authorizing BABs contains a provision stating that the bonds should be exempt from state taxes, if they would have been had they been federally tax-exempt.
Investors also may require an opinion if the direct payments received by the issuer for BABs comprise “a significant portion” of the funds available to pay debt service — in other words if the issuer would not be able to continue to make debt service payments if the subsidy payments are interrupted or terminated.
Some BAB issuers may be willing to accept a qualified opinion, which are standard in the taxable market, the report stated. That is in contrast to the tax-exempt bond market where investors expect unqualified opinions.
The report includes some samples of legal language that could be used in opinions to issuers, underwriters, or investors.