Request By:
Mr. Spencer E. Harper, Jr.
Harper, Ferguson & Davis
Attorneys at Law
310 West Liberty Street
Louisville, Kentucky 40202
Opinion
Opinion By: Robert F. Stephens, Attorney General; By: Charles W. Runyan, Assistant Deputy Attorney General
You request our opinion as to the constitutionality of the provisions of KRS 103.251, authorizing the securing of industrial building revenue bonds by a foreclosable mortgage lien on the industrial project building financed by such bonds.
THE ISSUE
Specifically, the question is whether KRS 103.251, providing that a foreclosable mortgage deed of trust may be placed on the industrial building project to secure the payment of the industrial building revenue bonds, is constitutional, when applied to such a bond issue, in terms of §§ 157 and 158 of the Kentucky Constitution?
CITY OF FLATWOODS INDUSTRIAL BUILDING REVENUE BONDS.
The City of Flatwoods, Kentucky, has authorized the issuance of $850,000 principal amount of its Industrial Building Revenue Bonds in order to fund the construction of a facility for the treatment or care of the aged or infirm, which literally meets one of the definitions of a permissible "industrial building" , as described in KRS 103.200. Under the statutory plan of KRS 103.200, et seq., the City of Flatwoods, with the proceeds of the Industrial Revenue Bonds, will acquire machinery and equipment and a site and erect the project building, all to be leased to a private Kentucky corporation. The lease agreement provides for the payment of rentals over a specified contract period sufficient to pay off the bonds with interest, etc. See
Faulconer v. City of Danville, Ky., 232 S.W.2d 80 (1950). The city will sell the project to lessee under its option to purchase, where the bonds and interest have been paid, etc.
BONDS SECURED BY MORTGAGE ON THE PROJECT BUILDING.
The bonds are issued and secured by the "indenture and Mortgage Deed of Trust" (executed by city to trustee, etc.), pursuant to which (1) the rents derived by the city from the leasing of the project are pledged to the trustee as security for payment of the bonds and interest and (2) the property constituting the project is subjected to a foreclosable first mortgage lien under the Indenture of Trust. However, the lease expressly declares that no city assets, funds, moneys shall ever be obligated to the payment of principal of or interest on the bonds. In the event of foreclosure of the mortgage lien, no deficiency judgment against the city shall be permitted.
Standard provisions are included in the financing documents to the effect that the bonds are payable solely and only from the rents and revenues generated by the project and from funds received upon the foreclosure of the first mortgage lien at the decretal sale thereof, in the event such procedures are carried out. The form of bond provides specifically such terms and cautions the bondholders that, notwithstanding the fact that a foreclosable mortgage lien is granted, as specifically authorized by KRS 103.251, no deficiency judgment may ever be taken against the City of Flatwoods.
KRS 103.250 provides that a statutory mortgage lien shall exist upon the industrial building so acquired in favor of the holders of the bonds and coupons. The industrial building remains subject to the statutory mortgage lien until full payment of the bonds and interest. The statutory lien covers also any machinery and equipment described in the lease instrument. Subsection (2) of KRS 103.250 provides for a court appointed receiver to administer the industrial building in case of default on the payment of the bonds or interest. The receiver may charge and collect rents, to be applied to the bond issue purposes.
THE MORTGAGE STATUTE
KRS 103.251 provides in part that, notwithstanding the statutory lien of KRS 103.250, the bond documents may provide that the issuer of the bonds execute a mortgage deed of trust in favor of the trustee on the project, providing that in the event of default by the issuer in payment of the bonds or interest or in other deed of trust covenants, the trustee, for the bondholders, may institute and carry through foreclosure proceedings in which the property secured by the indenture may be sold, the proceeds of sale to be applied to payment of the bonds and interest and costs of proceedings.
The issuer has an option to rely either upon the statutory lien of KRS 103.250 or the mortgage deed of trust as provided in KRS 103.251. Here the City of Flatwoods opted for KRS 103.251.
CONVENTIONAL ASPECTS OF THE BOND ISSUE.
The revenue bonds are payable solely from the revenue derived from the building. Further, the bond documents expressly declare that such bonds shall not constitute an indebtedness of the city within the meaning of the constitution. There is no financial obligation, concerning the payment of such bonds, of the city as relates to the city treasury, the depository of city governmental revenues and taxes. The security and source of payment are the rents. All of these provisions have been held to not involve or constitute a financial obligation of the city in terms of §§ 157 and 158 of the
Kentucky Constitution. Faulconer v. City of Danville, 313 Ky. 468, 232 S.W.2d 80 (1950). While the city has an obligation of good faith to the bondholders under the bond documents, that is not equivalent to the financial obligation of the city or city indebtedness under §§ 157 and 158,
Constitution. White v. City of Hickman, Ky., 415 S.W.2d 379 (1967) 381.
Such bond issues have been held to not violate § 179, Kentucky Constitution, such that the city does not lend its credit.
Norvell v. City of Danville, Ky., 355 S.W.2d 689 (1962).
CONSTITUTION, §§ 157 and 158
Section 157 provides that no city shall become indebted in any manner or for any purpose to an amount exceeding, in any year, the income and revenue provided for such year, without the assent of two-thirds of the voters thereof, voting at an election to be held for that purpose. Section 158 of the constitution establishes a maximum indebtedness for cities of the third class, based upon a certain percentage of the value of the taxable property therein. But the cases cited above hold that no such "indebtedness" is involved in the issuance of such bonds in connection with the conventional aspects thereof.
THE NATURE OF THE MORTGAGE ON PROJECT PROPERTY.
Now as to the new element this bond issue presents, i.e., the mortgage on the project property under KRS 103.251.
First, the city is not acquiring a building for city governmental purposes. The acquisition of the project property is a proprietary action permitted by the statutes.
Falconer v. City of Danville, supra.
While the courts have upheld such bond issues as a valid public purpose, the project property is really designed to be acquired for private use.
Gregory v. City of Lewisport, Ky., 369 S.W.2d 133 (1963).
We think the proprietary aspect and the private use of the project property are crucial in determining this issue.
The "private use" aspect is laid out in bas-relief by the court in holding that the competitive bidding has no application to the acquisition of the project property.
Massey v. City of Franklin, Ky., 384 S.W.2d 505 (1964) 507. Further, the city has no authority to condemn the site for the project building, since the constitutional sections relating to condemnation relate only to the acquisition of property for "public use", regardless of whether the "public purpose" provisions of the constitution are satisfied, or not.
City of Ownersboro v. McCormick, Ky., 581 S.W.2d 3 (1979) 7.
The court, in
Norvell v. City of Danville, Ky., 355 S.W.2d 689 (1962) 691, 692, emphasized that a city, under the industrial revenue bond legislation, acts in a proprietary capacity and stands on the same footing as a private corporation exercising such powers as are lawfully permissible.
The central factual element here is simply that the proprietary project is acquired from proceeds of the bond issue, and not from the general fund or tax revenues of the city. Thus the project property can only represent, in this total context, the money from whence the project property came. Any other perception is unrealistic.
The mortgage statute, KRS 103.251, enacted in 1976, contemplates only the acquisition of project property with the bond proceeds. The court, in
City of Bowling Green v. Kirby, 220 Ky. 839, 295 S.W. 1004 (1927), by way of dictum, pointed out that where a mortgage could foreclose its mortgage on the project property (city revenue bonds to enlarge city waterworks), and where the project property is acquired with city revenues or taxes, the foreclosure and sale of the property would constitute the payment of the "debt" by the municipality, within the meaning of §§ 157 and 158, Constitution.
Judge Cullen, in Skidmore v. City of Elizabethtown, Ky., 291 S.W.2d 3 (1956) 5, emphasized the centrality of tax revenues in the context of § 157 of the Constitution:
"We think Section 157 of the Constitution is concerned only with the protection of such future revenues as can be expected in the form of taxes."
CONCLUSION
Under the foregoing analysis and authorities, it is our opinion that the mortgage provisions applied in the City of Flatwoods bond issue is constitutional in terms of the indebtedness restrictions of §§ 157 and 158 or the Kentucky Constitution. In this situation no general fund revenues or tax revenues of the city will ever be involved, even should the mortgage ever be foreclosed and the property sold. No deficiency judgment can be obtained against the city. Clearly the bond transaction does not fall within the above rule given in City of Bowling Green v. Kirby. As you so aptly put it, KRS 103.251 is merely a logical remedial refinement of the industrial revenue bond law, which is calculated to give the bondholders additional security, and thus promotes a lower rate of interest as to the bonds, but which in no way violates the constitution. The critical point here is simply that the mortgage provision in no way converts the situation into an indebtedness of the city within the meaning of §§ 157 and 158, Constitution.
Finally, "The courts, in deference to legislative bodies, which must be presumed to have acted within the scope of their powers, will not strike down a statute unless its violation of the constitution is clear, complete and unequivocal. The statute whenever possible should be construed to be constitutional."