Trustee and Bondholder Rights and Remedies
By James Spiotto
A. In understanding the rights and remedies of bondholders and trustee, it is important to understand the critical differences between revenue bonds and general obligation bonds, lease appropriation bonds and conduit financings and their respective source of payment:
- Revenue bonds are generally only payable from the pledged revenue, specific tax source or revenue related to the municipal enterprise financed and no other recourse to the issuing municipality.
- General obligation bonds are backed by the full faith and credit of the municipality and may also have a contractual or statutory pledge of revenue.
- Upon default bondholder may institute lawsuits requesting the debt be immediately paid or certain actions be taken by the municipality or be required to specifically perform under the documents.
- Municipal lease or appropriation backed bonds (non-recourse to municipality’s full faith and credit but recourse to annual appropriation or leased property. Note: cannot legally bind successor legislature to appropriate funds).
- Conduit financing (non-recourse to municipality, must be for a general public purpose and the credit support is the non-profit or corporate entity benefited).
- Upon default on lease appropriation bonds the remedies are limited to those set forth in the documents and applicable law and generally limited to the municipality’s loss of use of the leased facility and ability to relet the facility. In conduit financing the remedies are generally limited to the not-for-profit or corporate entity benefitted without recourse to the municipality.
B. Upon default (breach of covenant or failure to make payment of principal or interest), bondholder may institute a lawsuit for a money judgment, mandamus, specific performance, or equitable relief such as for injunction or an accounting or for foreclosure on collateral (if permitted) or other relief.
- Mandamus – All states would permit a bondholder upon default to petition for mandamus that in essence requires a municipal official to levy taxes to pay an obligation. The problem is constitutional and statutory debt limits and time, cost and delay.
- Receiver – 46 states and Puerto Rico permit bondholders to petition a court to appoint a receiver upon default especially in the case of a default on the revenue bond for financing of a municipal enterprise.
- Accounting – At least 22 States and the District of Columbia and Puerto Rico allow for bondholders or representative to bring an action for an accounting to require the local government to account for how bond funds have been spent.
- Foreclosure – At least 28 states permit some form of foreclosure on mortgaged or secured real property upon default on a financing of that facility or structure generally related to conduit financing.
- Injunction – At least 15 states permit bondholder to obtain some form of injunctive relief upon default to protect and preserve their rights and remedies.
- There is other relief available, such as suits for specific performance of covenants like a rate covenant, security fraud for material misrepresentations in offering material related to the sale and purchase of the bonds and notes, equitable remedies for wrongfully transferred or distribution of funds.
For more detailed 50 state analysis and discussion, see Spiotto, J., A. Acker and L. Appleby, Municipalities in Distress? How States and Investors Deal with Local Government Financial Emergencies. Chapman and Cutler LLP, 2012.
James E. Spiotto, Co-Publisher © James E. Spiotto. All rights reserved (2015).