Court Finds Plan Does Not Violate Requirement that Municipal Indebtedness be Approved by a Two-Thirds Vote of the Electorate

A lease-back financing plan the City of San Diego adopted to fund public infrastructure improvements does not violate state and local requirements that municipal indebtedness exceeding annual income and revenue be approved by a two-thirds vote of the electorate, the Fourth District Court of Appeal affirmed in a recently published decision. In San Diegans for Open Government v. City of San Diego, the court affirmed that the California constitutional debt limitation is inapplicable to such a financing plan because the Public Facilities Financing Authority of the City of San Diego, a joint powers authority, is a separate public entity from the City.

In 1991, the City and its Redevelopment Agency formed the Financing Authority pursuant to the Joint Exercise of Powers Act. As of Feb. 1, 2012, the Redevelopment Agency was dissolved. The City, as the successor agency to the Redevelopment Agency, assumed the Redevelopment Agency’s assets, rights and obligations. In 2013, the City and its Housing Authority reconstituted the Financing Authority for the purpose of financing certain public capital improvements.

In February 2014, the City Council adopted an ordinance that authorized the Financing Authority to issue lease revenue bonds to finance various public capital improvements to be funded with the bond proceeds. The financing plan was based on a lease-back arrangement whereby the City leases properties it owns to the Financing Authority and the Financing Authority leases the properties back to the City for lease payments in an amount equal to the debt service on the bonds.

California Constitution article XVI, section 18 (the “debt limit”) prohibits cities, (including charter cities), counties and school districts from entering into an indebtedness or a liability that in any year exceeds the income and revenue provided for such year unless the local agency first obtains a two-thirds voter approval of the obligations. In a 1998 decision in Rider v. City of San Diego, the California Supreme Court previously held that a long-term lease obligation entered into by the City and a joint power authority, of which the City was a member, was a contingent obligation and was not considered an “indebtedness or liability” under the debt limit. This was because the joint powers authority that issued the bonds was a separate legal entity from the City and, by law, the joint powers authority’s debts were not the City’s debt.

In this case, the SDOG brought a reverse validation action challenging the City’s lease-back financing plan, alleging that the Rider case is factually distinguishable, the financing plan “is an artifice designed to circumvent” the debt limit, the Financing Authority is not legally autonomous but is a “subordinate agency” of the City, and, thus, its debt is actually a debt of the City and subject to a two-thirds vote of the electorate. The appellate court rejected these contentions. It observed that the facts distinguishable to Rider were immaterial and Rider made clear that, for purposes of the debt limitation provisions, when a financing authority created to issue bonds has a genuine separate existence from the City it does not matter whether or not the City essentially controls the financing authority. It concluded that California law does not restrict the authority of the Housing Authority or the City as the successor agency to the Redevelopment Agency to participate in the Financing Authority.