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Why public authority debt isn’t covered by the state constitution, as explained by the NY Court of Appeals

October 27, 2011

Public authorities were invented to get around the debt restrictions in the state constitution, such as the provision requiring voter approval of state debt and the restriction against grants and loans to private corporations. Without public authorities, these limitations would make it a lot more difficult to finance infrastructure projects and many public works. There’s a fine line between circumventing the constitution and violating it, however, especially when you’re dealing with fiscal measures that could have extensive impacts on the state’s budget. In New York though, the courts have come down firmly on the side of public authorities, as illustrated in the Court of Appeals’ decision in Schulz v. State, 84 N.Y.2d 231 (1994).

The case involved a transportation financing act that was approved by the Legislature in 1993. The act authorized the Thruway Authority and the MTA to issue 30 year bonds for various infrastructure projects, with the debt service to be paid from dedicated funds annually appropriated by the Legislature. The transportation act, however, expressly stated that the bonds wouldn’t create any legal or moral obligation on the state’s part to guarantee them.

The plaintiffs, who were all citizen taxpayers, claimed that the Act was both fiscally imprudent and that it violated the debt restrictions in the state constitution:

Plaintiffs contend first that debt contracted by the public authorities is indistinguishable from debt contracted by the State and thus within the referendum requirement [of the state constitution]. … They urge moreover, that as a practical matter the Legislature always will appropriate money for the Funds rather than risk damaging the State’s credit rating. The effect of long-term appropriation-risk bonds, they say, is to “contract debt” within the meaning of article VII, § 11 [of the state constitution], and the failure to submit the proposed law to a public referendum renders the enactment unconstitutional.

The court wasn’t completely unsympathetic to these claims, and it acknowledged that “when the main purpose of a statute is to effect ‘indirectly that which cannot be done directly, the act is to that extent void, because it violates the spirit of the fundamental law.'” But the court was also reluctant to issue an activist ruling and interfere with the public authority financing model used in the transportation act, which was, after all, an “enactment of the Legislature—a coequal branch of government.” The court also emphasized that it would give “deference to public funding programs essential to addressing the problems of modern life.”

In its analysis of the plaintiffs’ first claim—that public authority debt is also state debt, and must be submitted to the voters by referendum under the constitution—the court provided some history:

The precursor to the referendum requirement… was adopted under the Constitution of 1846 as part of a sweeping reform of public borrowing practices, in an effort to protect the State from the uncertain and possibly disastrous consequences of incurring future liabilities—”liabilities easy for a current generation to project but a burden on future generations.” Known as “the people’s resolution,” the amendment reserved to voters the power to determine, by referendum, whether a proposed law creating debt would take effect. …

Getting the people to approve state borrowing isn’t easy though, and it wasn’t long before the Legislature developed revenue certificates and public authorities to get around the constitutional debt restriction. “Shortly after the turn of the century,” the court noted,

the Legislature devised a new vehicle for funding public works projects that appeared to insulate the State from the burden of long-term debt: legislative creation of legally separate public benefit corporations, known as public authorities, to discharge particular functions. … Such public benefit corporations would separate their administrative and fiscal functions from those of the State, to “‘protect the State from liability and enable public projects to be carried on free from restrictions otherwise applicable.'”

In a 1926 case, Williamsburgh Savings Bank v. State, 243 N.Y. 231, the Court of Appeals held the state responsible for bonds issued by an authority-like commission, explaining that the state had  authorized the commission to issue the bonds and so had a “moral obligation” to guarantee them. However, a constitutional amendment was passed in 1938 to overrule this decision and prevent the state from assuming public authorities’ debts. This provision is contained in art. X, section 5 of the constitution, which states that:

Neither the state nor any political subdivision thereof shall at any time be liable for the payment of any obligations issued by such a public corporation…, nor may the legislature accept, authorize acceptance of or impose such liability upon the state or any political subdivision thereof….

As the court explained, moreover, “debate at the Constitutional Convention included discussion of whether the State would be liable in the event an authority were unable to meet its obligations, and the language of the amendment was tailored to make clear that it would not.”

Based on this history and other provisions in the 1938 amendments, the court concluded that public authorities are “expressly empowered… to contract debt independently of the State.” In other words, public authority debt isn’t “state debt,” as the plaintiffs had argued, and so public authorities don’t have to comply with the debt restrictions in the state constitution.

Even if state debt and authority debt are classified as separate things, the plaintiffs also argued “that the Act contracts debt of the State by imposing a moral obligation on the Legislature to continue appropriating revenue to the special Funds.” As the court explained:

plaintiffs characterize the Act as creating “moral obligation” debt—a term apparently coined in the 1960’s to describe appropriation-risk bonds that could not legally bind the Legislature beyond a session but would create a “moral obligation” to appropriate money should a public authority be unable to redeem its bonds. The existence of such a moral obligation would provide some assurance (though not an enforceable legal obligation) to bondholders that the bonds would retain their value.

The court rejected this argument. The transportation act required all of the bonds to contain a statement saying that they weren’t state obligations, and it also disavowed the existence of any moral obligation. The court also emphasized that “article X, §5 was adopted after Williamsburgh precisely to overrule constitutionally the possibility of the State assuming a moral obligation as to debt of a public authority.” This constitutional restriction against assuming authority debt, coupled with the disclaimers in act, was in the court’s opinion “sufficient to remove any reasonable expectation on the part of bondholders that the State will guarantee return in the event of default on the part of the Authority or that the bonds place them in privity with the State.”

Altering their moral obligation argument somewhat, the plaintiffs next claimed that “in reality, the bonds are backed by the State’s full faith and credit because the consequences of default would be ruinous, assuring that [annual] appropriations will be made.” As a result, the plaintiffs said, “the Act obligates the State to continue appropriations for the life of the bonds—some 30 years—creating long-term State ‘debt.'”

The court, however, had “previously held that a proposal to fund in a subsequent year, subject to legislative appropriation and explicit disclaimer, does not create legally binding debt.” As the court explained:

In People ex rel. Hopkins v Board of Supervisors, we observed that while the Legislature might endeavor to incur future liabilities, to be appropriated on a year-to-year basis without submitting the spending plan to the people, “[n]o harm or loss has or can come from this practice.” Such spending plans are effectual only to the extent subsequent Legislatures indeed do “give effect to them by providing the means and directing their payment, but the discretion and responsibility is with them as if no former appropriations had been made. No duty or obligation is devolved upon them by the acts of their predecessors. … Laws making annual appropriations from a special fund do not and cannot create debts within the meaning of the referendum requirement.

In a final note, the court seemed to acknowledge the dubious basis for defining public authority debt as something entirely separate from state debt—especially where authorities like the MTA and the Thruway are involved, which are for all intents and purposes “too big to fail.” As the court noted, “if as plaintiffs urge modern ingenuity, even gimmickry, have in fact stretched the words of the Constitution beyond the point of prudence, that plea for reform in State borrowing practices and policy is appropriately directed to the public arena.”

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3 Comments leave one →
  1. Peter Galie permalink
    October 28, 2011 7:25 am

    Patty, Amy and Scott,

    Just wanted to express my appreciation for this blog and your efforts generally to bring transparency and clarity to the status and functions of public authorities. Long over due.

    Let’s hope it makes a difference

    Peter Galie

  2. Bill Licata permalink
    October 28, 2011 8:45 am

    Amy,

    Is it the modern ingenuity or even gimmickry of financial instruments created by the financial sector which has stretched the words of the Constitution or is it the interpretive powers of the Court which is changing what appears to be the plain language of the Constitutional provisions?

    Sincerely,
    Bill Licata

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