R. Kane Burnette and Alan K. Zeigler, Bradley
It doesn’t matter which of Alabama’s 67 counties you live in – there’s a county board of education in your county, and that board has a fleet of the familiar school-bus yellow school buses transporting students to and from school and school activities. Moreover, there are almost 70 city boards of education in Alabama, and many of those boards have bus fleets, too.
As a general rule, a school bus has a reasonable useful life of about 10 years. It’s not unusual to see older buses on the roads, though. It’s often easy to identify the age of a school bus without looking at the odometer: on each side of each bus, there will be an acquisition number in bold black numbers. A bus marked “2015 – 17” is the 17th bus acquired by that particular school system in the fiscal year that ended September 30, 2015.
Just the Facts
It was recently reported that public school buses in Alabama cover more than 350,000 miles each day. That’s more than 7,600 buses running more than 10,000 routes twice a day to see that Alabama’s public school children are at school when it starts and back home at the end of the day.
The average school bus, equipped to meet all state and federal safety mandates, costs approximately $83,260. Jerry Lassiter, with the State Department of Education, reports that approximately 355,000 students ride a school bus twice a day during the school term.
For the fiscal year 2020, the state of Alabama allocated $47,083,530 to the various county and city boards of education in the state as “fleet renewal funds.”
Who Pays for the Bus?
The answer to that question is short: either the local board of education buys the buses in its fleet, or it leases them. None are paid for directly by the state.
The legislative intent behind Alabama’s “fleet renewal program” is to provide, on an annual basis, a cash allocation per bus (the amount is set by the Legislature as part of the Education Budget) so that, in theory, the allocation would pay for a bus over its expected 10-year useful life. Theories are nice, but they do not always work out in real life – with less money in the Education Trust Fund than desirable, each board’s annual allocation for fleet renewal falls a bit short of completely funding one year’s cost of owning the bus. This difference must be made up by the local board out of local revenues, mainly the receipts of sales taxes and/or ad valorem taxes.
May a Local Board Finance a Bus? And How Does that Happen?
Alabama law authorizes local boards of education to issue warrants (similar in many respects to bonds or notes but, for reasons that might well be left to another discussion, called warrants because – and this is the very best reason – that is the form of indebtedness that the Alabama Code prescribes that boards issue when it’s time to borrow money) to fund capital school improvements and equipment, such as school buses. Warrants may be secured by a pledge of the local board’s share of one or more ad valorem taxes and/or other revenues such as receipts from sales taxes.
Here’s the catch: the Alabama Code specifically provides that boards of education may NOT pledge the “fleet renewal funds” it receives from the State as security for loans incurred to buy buses. That may seem counter-intuitive, but it is the law. Boards may USE “fleet renewal funds” to retire such debt, but they may NOT pledge those funds as security. Whenever you lend money to a board, for any lawful purpose, you are advised to be sure the loan terms are clearly set out in a board-issued warrant that includes a pledge of whatever tax or taxes the board is offering as security for payment of the principal and interest.
Many community banks view loans as asset-based financing, backstopped by identifiable real or personal property. It may make more sense to view loans to boards of education (and other governmental entities) as secured by cash flow, by a pledge of tax revenues. Make certain that the revenue stream is adequate to cover the annual debt service payment, and confirm that the pledged revenue stream will be in place for the duration of the debt. In other words, if the security is a sales tax, be sure that the city or county that levies the tax and pays the proceeds over to the board agrees and represents to your bank that it will continue to levy and collect and pay over the sales tax for the duration of the debt.
Most ad valorem taxes levied for public school purposes in Alabama have been voted for a specific duration. It’s incumbent on you to make sure the tax or taxes being pledged for your benefit are authorized to be levied for the duration of the loan.
Once you’ve gotten the security issue out of the way, remember that the Alabama Code provides that the issuance of the warrant must be approved by the State Superintendent of Education. Without that approval, the warrant is likely void and unenforceable, and no one wants that result. Some bankers take for granted that loans to Boards of Education and other governmental entities are tax-exempt – that is, the interest income is exempt from federal and Alabama income taxation. However, you can be sure that’s the case only if certain prerequisites are met:
the warrant has been issued in accordance with Alabama law,
the State Superintendent of Education has approved, in writing, the issuance of the warrant,
the board of education has represented that the warrant proceeds will be spent in accordance with the arbitrage regulations of the U. S. Treasury Department and that the board will comply with various post-issuance requirements, and
the board has filed the IRS form 8038-G with the appropriate Internal Revenue Service center.
All of a sudden, this might have gotten unduly complicated. You might decide to turn to your in-house counsel or to bond counsel for assistance. One thing is for certain: your Bank’s standard promissory note form might not meet your needs. If your Bank, as the registered holder of the warrant, is ever audited as to the deductibility of the interest income, you may well want to have in your loan file what is usually referred to as an opinion of Bond Counsel. That opinion, plainly speaking, would be rendered by a lawyer or a firm of lawyers and would address the due and valid issuance of the warrant and the status of the interest income thereon being exempt from federal and Alabama income tax.
What about Just Leasing the Bus and Not Worrying about All of This?
Bus manufacturers/vendors and some large banks may offer so-called “easy terms” on equipment leasing or installment sale contracts. The chief financial officer of each local board of education in Alabama is known as the chief school financial officer (“CSFO”). Most CSFOs have extensive accounting backgrounds and, when faced with a potential lease, will probably ask: what’s the APR (annual percentage rate) or, in plainer terms, what will this cost us annually?
We’ll pause here for a word or two about equipment leases, which are sometimes presented as a solution to a referendum requirement that Alabama governmental entities do not face. Along these lines, in many states, capital borrowing by governmental entities must be approved by referendum. In those states, capital leases are sometimes popular because the entity merely leases, rather than purchases, the capital equipment, meaning that no referendum is required. Alabama is not one of those states – it does not have a referendum requirement for capital borrowing. Thus, in Alabama, it makes no legal difference whether the bus is purchased or leased, so long as the board of education has made the best financial deal.
Nevertheless, capital leases or installment sale programs may be a satisfactory alternative to the issuance of warrants and outright purchases. Under these programs, a board of education may, pursuant to Alabama’s governmental leasing law, offer a “general obligation” pledge, rather than selecting a particular tax (or several taxes) to pledge, an alternative that may be desirable for a Board with property taxes that are soon-to-expire or with revenue sources that have coverage concerns. Capital leases are considered “loans” under the tax-exempt bond portions of the Internal Revenue Code, so a bank is still well-advised to pay attention to the four prerequisites noted above in order to be certain they have properly booked a tax-exempt obligation.
R. Kane Burnette and Alan K. Zeigler practice in the public finance area in the Birmingham office of Bradley Arant Boult Cummings LLP. Kane can be reached at 205.521.8755, firstname.lastname@example.org, and Alan at 205.521.8257, email@example.com. Burnette is a graduate of The University of Alabama Law School and Zeigler is a graduate of the Vanderbilt University Law School.