The National Association of Bond Lawyers released a paper Tuesday to educate bond lawyers and other market participants about general obligation bonds in the wake of the Detroit and Jefferson County, Ala. bankruptcy filings.
The big takeaway from the paper is that "not all general obligation debt is the same," said Dee Wisor, an attorney at Butler Snow LLP in Denver who was chair of the NABL committee that prepared the report.
He added that market participants can't just make assumptions based on the bond's name. "You have to dig deeper to understand more about the credit," Wisor said.
The paper was something that NABL President Allen Robertson mentioned as a priority when he started his term last September. It is designed to educate NABL members and assist market participants in evaluating GO credits, Wisor said.
Historically, market participants have viewed GO bonds, which have very low default rates, as very safe investments. Investors and others have generally assumed that all GO bonds are backed by pledges of the issuer's full faith and credit and taxing power, and that the pledges mean that the bonds will be treated as secured claims if the issuer entered Chapter 9 bankruptcy, according to the report.
However, recent events such as the bankruptcy filings of Detroit and Jefferson County have called these assumptions into question and raised questions about GO bonds' security. "It has become apparent that all general obligations bonds do not enjoy the same security or the same remedies for enforcement of the promise to pay under state or local law," NABL said. "Further, the treatment of general obligation bonds in a Chapter 9 bankruptcy case is uncertain and will depend on the security provided by applicable state law."
NABL said that GO bonds' characteristics are determined by state and local law, and the source and security for debt service payments on the bonds varies from issuer to issuer. Contrary to popular belief, some GO bonds are only supported by either a pledge or the issuer's full faith and credit or a pledge of the issuer's taxing power, rather than by both pledges. Also, the characteristics of issuers' full faith and credit obligations vary from state to state, and it may be hard for issuers to explain the attributes of its full faith and credit pledges.
There are three general types of GOs: unlimited tax, limited tax and bonds payable from the issuer's general fund. Still, there are variations across state and local governments on exactly what these terms mean. GOs may also be secured by another source of revenues, such as those from utilities, NABL said.
The paper also discusses what remedies bondholders have, in the event of debt service nonpayment on GOs, under state law prior to a municipal bankruptcy filing. The remedies depend on state constitutions and laws as well as the steps an issuer promised to take to ensure payment, whether certain funds or specific taxes are pledged as security for the bonds and whether the pledged funds are subject to a lien, NABL said.
The main remedy available to GO bondholders is to have a court issue a writ of mandamus that compels a public official to pay the debt service. However, judges generally can only issue these types of writs if the duty to pay the debt service is mandatory and imposed by state law, which in some circumstances may not be the case. Also, government officials can try to frustrate enforcement of the writ, and courts may be unwilling to issue writs when there is a need for governments to prioritize providing services to their citizens, NABL said.
A key issue relating to issuers who can file for municipal bankruptcy is whether their GO bonds are secured claims or unsecured claims that can be repaid at a potentially steep discount. GO bonds can be treated as secured claims if they are secured by a lien that is statutory or on "special revenues," NABL said.
Many issues about the treatment of GO bonds in Chapter 9 bankruptcy cases are unresolved, NABL said, because municipal bankruptcy cases are rare, and settlements can prevent issues relating to GO's from being decided in a final judicial resolution. The unresolved issues include whether different types of GOs are treated differently and, if they are, what the basis for the different treatment is.
Disclosures in bond documents for GOs need to be tailored to each bond issue because of differences in state and local laws, NABL said. The group lists several items that those involved in preparing official statements for GO issues may want to consider disclosing. These include if there is a full faith and credit pledge and how that pledge is defined, is the obligation to fund debt service for unlimited and limited tax senior to paying regular operating expenses and if the issuer can file for bankruptcy under state law.