NATIONAL ASSOCIATION OF BOND LAWYERS
Voice from the Past
Chapter 2
Industrial Development Bonds started out in Mississippi as
general obligation bonds voted by the people at elections and
subject to statutory or constitutional debt limits. They were by
no means the first bonds to be issued for the benefit of private
corporations; indeed, the railroad bonds of the second half of
the 19th century were issued for that purpose. Abuses of the
power to issue such bonds were responsible for the existence of
most State debt limits and election requirements as well as the
prohibitions against the loan of the credit of a State or
political subdivision. The same reaction inspired the Michigan
Constitutional prohibition against bonds for works of "internal
improvement" -- a provision that can shock a young bond lawyer
trying to work on a water revenue bond issue in that
State.
However, things were different in the depression in the deep
South, where young people could find no way to make a living on
the farms or in rural towns and villages. Even after World War
II many of these municipalities were dying because their young
adults were going to the cities for whatever work could be found.
Few factories were locating anywhere. And the produce of the
farms often lacked a market because no processor was nearby. It
appeared that the problem should be addressed by the citizens
using the borrowing power of a town to help some entrepreneur
build a factory that would use local employees to make products
of local farms. At first the Mississippi Supreme Court turned
down bonds voted for such a purpose as a loan of credit, but then
upheld an issue in which the factory would remain the property of
the municipality whether or not the tenant-operator stayed in
business and paid the rent. This led Charles and Trauernicht
(who approved most Mississippi municipal bonds then) to take the
position that bonds for such purpose could not be secured by a
mortgage.
I started working on such bonds issued by political
subdivisions in Louisiana, where Chapman and Cutler approved most
issues in the 1950's. One issue was for a dairy operation that
bought milk from local farmers; another plant was to be built to
make things out of bagasse. On asking what bagasse was, I was
told that it is the residue left over from harvesting and
squeezing the juice out of sugar cane. Both were small issues in
a day when a $100,000 issue was considered a large one. They
were voted at elections and sold at advertised public sales. No
one worried about any requirement for registering them with the
Securities and Exchange Commission because the bonds were secured
by and sold on the credit of the taxing power of the issuer.
They were also sold to local investors, mostly banks, I suspect.
The Internal Revenue Service showed no curiosity about such
bonds. I don't know what happened to the projects later, I hope
they prospered. At least I have not heard of any default.
I recall a deal (perhaps for a shoe factory) that did not
get done because, after the bonds had been voted and sold, the
mayor refused to sign them. He had looked at the company's most
recent balance sheet and found it unsatisfactory: the company was
losing money and almost bankrupt; the mayor was not going to
subject his town to this sort of burden. The dealer asked if
there was any way to force the mayor to sign the bonds and
deliver them in accordance with the town's contract. I recalled
that when test litigation is to be brought, the form of the
lawsuit may be a writ of mandamus to compel a mayor to sign bonds
that he conveniently refuses to sign, but did not recommend the
practice in this case. As I had been hired by the issuer, I
could not participate in any suit against it, but suggested to
the dealer that he make a list of his expenses in the deal and
send it to the mayor with a request for reimbursement. I don't
recall getting paid either, though I may have sent a bill for the
usual $25 for issues that didn't go through.
The practice of issuing general obligation industrial
development bonds moved north like the spring, but slower. In
time my partners were working on them in Arkansas, Tennessee and
Kentucky. All were small. Then a funny thing happened. Someone
realized that if a company had good enough credit to sell bonds
on its own, the bonds could be revenue bonds, payable solely from
the rentals of the industrial facility, and the issuer's credit
need not be involved. Industrial development bonds had to be
first approved in a test case by each State Supreme Court, so it
was not difficult to include in such litigation the question of
whether the company could buy the project, after the revenue
bonds issued for its construction were paid, for nominal
consideration. The large issues that existed mainly for the
purpose of obtaining tax-exempt interest rates attracted
attention from the Internal Revenue Service and then the Congress
after several years during which the IDB business bloomed and
boomed.
I recall my big lesson in the difference between the
Louisiana Civil Code and the common law at that time. When it
was suggested that such revenue bonds be issued in Louisiana
pursuant to newly enacted legislation, a local lawyer, on reading
the proposed documents, ascertained that the company would get
the plant after the revenue bonds were paid for only $1,000.
"But that's lesion beyond moiety!" he exclaimed. I gulped and
asked, "What's that?" Lesion beyond moiety turned out to be a
Civil Code doctrine to the effect that if a piece of immovable
property is sold for less that one-half its value, a court can
set the transfer aside. This question, with whatever else we
thought should be decided by the State Supreme Court, was
included in the test litigation. The Court came to a sensible
decision: that the transaction was in fact a long term sale
agreement (a characterization supported by the Civil Code) and
that the price the company would pay was well in excess of half
the value, and besides, the lesion-beyond-moiety doctrine was
intended to protect widows and orphans, not cities and parishes.