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When a water utility seeks to increase supply to address a growing population in the community which it serves, most states have very clear laws that would allow such a utility to issue revenue bonds to fund a “utility project.” Such projects include infrastructure as it has always been understood – a reservoir, a desalination plant, new pipes, new water treatment facilities, or the like. Using bonds allows a utility to make a large one time expenditure and spread the cost of the investment over time and among both current and future rate payers. Alternatively, when a water utility seeks to address growth by decreasing demand through a distributed infrastructure project, such as funding irrigation controllers or gray water systems on a large scale, most states do not have clear legal authority that would allow a water utility to fund the projects using revenue bonds or other types of traditional debt-financing. Without the ability to use debt to spread the costs over time, many utilities are limited in how much they can invest in distributed measures at any one time.

The option for water utilities to fund more large scale distributed infrastructure projects is becoming more appealing as utilities seek to reduce demand, delay the need for major supply infrastructure projects, and conserve resources. However, whether utilities can fund such projects using debt financing raises numerous legal questions. Thus, water utilities should investigate several key areas in their state’s laws, as they evaluate what options they have for funding distributed infrastructure projects.

Constitutional “Gift Clauses”

Most states have clauses in their constitutions that prohibit or limit government entities or agencies from granting, donating, or subsidizing individuals, associations, or corporations. Some of these “gift clauses” are extremely broad and have been interpreted by the courts as absolute prohibitions. Other state gift clauses have been interpreted to include exceptions for the government providing funds to private entities if such provision serves a public purpose. Assuming that a state’s gift clause provides the public purpose exceptions, then the issue becomes whether the funding of distributed infrastructure serves a public purpose. State case law may be instructive in situations where courts have addressed and defined public purpose. But additionally, some state legislatures have attempted to ward off legal challenges by including statutory language to clarify that when a utility spends funds for a certain type of project, it is deemed to serve a public purpose. Clearing the constitutional hurdle is a huge step in determining whether bond funding of distributed infrastructure may be possible for a water utility.

Enabling Statutes and Bonding Authority

There may be several statutes that come into play depending on what type of local government entity seeks to fund a distributed infrastructure project. First, there are local government laws addressing bonding authority for counties or municipalities, specifically related to their ability to operate water or wastewater systems. Additionally, depending on the state, there may be special districts, regional authorities, or other types of umbrella entities that embody more than one local government, all of which may have power to operate water utilities. Such entities have their own bonding authority, likely found in whatever enabling legislation was put in place to allow for their creation. Furthermore, some states provide for the creation of a separate legal entity to engage in bonding on behalf of a water or wastewater utility. Such legal entities would generally have uniquely defined bonding authority, as well. With respect to the types of projects for which the utility can use its bonding authority, the statutes may include a very specific list, such as property, rights, and easements to be used for the construction or acquisition of waterworks systems, or may include general terms such as “capital projects” or “utility projects,” that may be defined to include a broader list. Additionally, some statutes may require that the project to be funded be controlled or owned by a public entity. Unfortunately, in many states, the statutory definitions would not appear to allow for a utility to use bonds to fund a water efficient washing machine in someone’s private residence.

Most likely, a utility provider will face conflicting provisions and statutory definitions at play. For example, perhaps the utility provider is a community development district. In the enabling statutes, the community development district is granted bonding power arising under a much older statute, which governs bonding authority for local governments. The community development district statute provides that such entities may issue revenue bonds to fund “projects” and includes a relatively broad definition, under which, arguably, distributed infrastructure could be included. However, the older bonding statute provides that entities may issue revenue bonds only to fund “utility projects” defined so narrowly, that it could not include anything other than traditional water infrastructure. For the forward thinking water utility, interested in broadening the definition of what types of projects can be financed with bonds, such conflicting statutes can be frustrating and seem to impede an entity’s willingness to move forward and attempt to finance such a novel form of infrastructure.

Additionally, other problems may arise in the bonding statutes, particularly related to how the bond funds can be repaid. Continuing on with the aforementioned example, perhaps the community development district determines that based on principles of statutory interpretation, the enabling legislation with the broader definition of utility projects governs, and distributed infrastructure can fall under such a definition. There may be a separate provision in the underlying bonding act that states that the bonds may only be repaid with proceeds received from the sale of water. Such a provision can place a significant limitation on what cost recovery mechanisms the community development district can use, which may discourage their attempts to implement distributed infrastructure projects, in an effort to keep rates from going up.

What a Utility Can Do Today

Because making statutory changes takes time, and because making constitutional changes is a very difficult process in most states, a utility may opt to attempt to find a solution that works within the state’s present laws. Perhaps, until the law can catch up with the technology, there are other options for funding that a utility could use, such as grant funds designed for conservation projects. It is encouraging to know that some utilities around the country, such as the Southern Nevada Water Authority, have interpreted the laws of the State in their favor, and have had programs in place for extended periods of time without legal challenges.

Additionally, there are other issues not discussed in this blog that utilities need to consider when evaluating whether to fund these types of projects with bonds. For example, utilities need to ensure that they maintain federal tax exemptions, and comply with Generally Accepted Accounting Principles. The Environmental Finance Center and other entities across the country, such as Ceres and WaterNow Alliance, are working on further investigating these issues. For more information, go to our website at http://www.efc.sog.unc.edu.

What creative distributed infrastructure projects are being implemented by your local water utility?

Erin Riggs is a legal advisor to the EFC. She is a graduate of the University of Florida’s Levin College of Law where she pursued a law degree with a specialization in Environmental and Land Use issues.

One Response to “A Double Standard? Debt Financing of Distributed Infrastructure Projects: A Legal Perspective”

  1. Andrew R

    Like this analysis. I think it should be a priority of legislators and environmental lobbyists to consider the opportunities to fund creative utility projects, as Erin has described, in order to address demand while preserving resources.

    Reply

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