introduction to tax-exempt 501(c)(3) bonds william p. scott, esq. nixon peabody llp

Introduction to Tax-Exempt 501(c)(3) Bonds

William P. Scott, Esq.

Nixon Peabody LLP


• Legal Basis

– State Law authorizing issuance

• State Tax Exemption – Kentucky v. Davis case

– Section 145 of Internal Revenue Code

• 95% Test (no activities producing UBIT)


• Bond Financing Documents– Trust Indenture

• Form of Bond– Redemption Provisions

• Grant of Security• Trustee-held Funds

– Purposes: e.g. construction, debt service and reserves– Investment of Funds

• Defaults and Remedies• Defeasance (i.e. refunding)


• Bond Interest Rates– Fixed Rate– Variable Rate Demand Bonds

• Weekly or Daily rate changes

• Optional Tender by Bondholders

– Commercial Paper (or Flexible) Rates• Interest pricing on each individual bond

– Multi-Annual or Term Rate– Mandatory Tenders of Bonds (when they occur)

– Role of Remarketing Agent or Auction Agent


• Bond Interest Rates (cont’d)– Auction Rate (more to come in panel discussion)

• Auction Process

• Credit Enhancement– Letter of Credit

• Confirming letter of credit

– Bond Insurance• Rating downgrades

• Liquidity Facility– Standby Bond Purchase Agreement– Used when Credit Enhancer doesn’t cover tendered bonds – Relationship between Credit and Liquidity Providers


• Interest Rate Swaps– Purpose– Documentation– Termination Payments

• Mark-to-market effect on financial statements

– Effect on financial covenants• Entering into swap

• Financial ratio covenants

– Insurance of Swap


• Financing Agreement with Borrower– May be loan, lease or sale agreement

– In Mass., is combined with Trust Indenture• and called a Loan and Trust Agreement

– Borrower agrees to pay debt service on Bonds


• Master Trust Indenture– Purposes:

• Repeat borrowings with parity security• Pooling credit strength of Obligated Group

– Joint and several liability

– The Obligated Group uses the Master Indenture to issue Notes and Guaranties

– In a bond financing, the Note (or Guaranty) goes to the Bond Trustee under the Bond Indenture.


• Timing of a Bond Transaction– Selection of Financing Team

• Underwriter• Financial Advisor?• Borrower Counsel• Bond Counsel• Selection of Issuer?• Credit Enhancement?• Trustee


• Timing of a Bond Transaction (cont’d)

– Determination of Financing Structure• Security and covenants

– Due Diligence– TEFRA Approval (Public Hearing, Elected Official signs)– Borrower’s board approval– Preliminary Official Statement (POS)

• Inclusion of financial statements, agreed-upon procedures ltr.


• Timing of a Bond Transaction (cont’d)

– Marketing of Bonds– Bond Purchase Agreement (Issuer Approval)– Final Official Statement– Closing– Post-closing

• Reporting required under financing documents

• Continuing Disclosure – SEC Rule 15c2-12

• Arbitrage Rebate (unless exempt)