Municipal bonds; a statement of the principles of law and custom governing the issue of American municipal bonds

Front matter

AT

LOS ANGELES

LIBRARY

Contents

I — The Problem Stated

The municipal bond; creature of law; general principles must be studied; the municipality existed before the nation; municipal needs create municipal debt; necessity for borrowing money; annual taxation inadequate; procedure of bond issue outlined; tax ordinance; budget; bond ordinance.

II — The Municipal Bond

Chapter I THE PROBLEM STATED

Origin of municipal bond. — The municipal bond is a creature of law. There is no other security which to the same extent as the municipal bond owes its incidents to law and not only to law but to statutory law. The origin of a municipal bond is a statute, or more than one statute. Its terms, its effect, its means of payment, are all statutory. There is no other written instrument, except the promissory note and the last will and testament, which depends so much for its vitality upon statute law.

While statutes governing the issue of bonds differ greatly among themselves, there is, and always must be, a certain similarity and agreement in principles, because such statutes aim to produce substantially the same result. General principles can be deduced from a study of statutes and decisions of the courts, construing fiscal legislation.

To form any right judgment on a municipal bond, a knowledge or at least an understanciing of principles is necessary. Unless we clearly understand what a municipal corporation is, what its financial powers are, how it raises its money, and how it pays its debts, we can have no intelligent appreciation of the circumstances which make its bonds worth much or little.

Early importance of municipality. — With the political history, even with the history of the growth and development of municipalities, we are not particularly concerned. Our interest is with the present and immediate future. We may, however, note in passing that the city (the municipality) is older than the state or the nation. The glory that was Greece and the grandeur that was Rome, was the glory of

Athens and the grandeur of the Eternal City, not of welldefined nations with clearly limited frontiers. Paris was a great lady before modern or even medieval France arose to do her homage. London lay before the spires of Westminster before the Welsh marches or the Scottish border knew the King's peace. New York, Boston and Philadelphia were relatively metropolitan before thirteen sovereign and independent commonwealths gathered to form the United States.

As man emerged from the savage state, his relative weakness and lack of natural offensive members developed the need of mutual aid and protection. Groups of families formed villages in the remote past as today. The close association of human beings with fixed habitations and common necessities developed needs which could and can be met only by co-operation. A large and dense collection of human beings occupying a limited area have needs peculiar to themselves, which create the necessity for municipal or local government and regulation, and thus in its turn the necessity for corporate organization.

What those needs are we know in a general way, but we must give them passing consideration. How those needs are met it will be our secondary purpose to ascertain. The result of such needs expressed in terms of today is municipal debt. The evidences of such debt are the subject of our inquiry.

Origin of bond issue. — A bond issue has its origin in the necessity for borrowing money. When a municipal corporation decides to undertake a public improvement such as the construction of a water supply system, it borrows the money to pay the cost. It borrows because the cost is usually too great to be raised in one year from current taxes.

Suppose that a small city raises by tax each year five hundred thousand dollars to pay its expenses. Its tax rate may be two dollars and fifty cents for each hundred, or twenty-five dollars for each thousand dollars of taxable property. The assessed valuation .of taxable property in such a city, having the assumed tax rate and budget, is twenty million dollars. If it becomes necessary or desirable to expend two hundred and fifty thousand dollars on its water supply system, the effect on the tax rate of raising all the money in one year would be to increase it to three dollars and seventy-five cents a hundred or thirty-seven dollars a thousand. This exceeds the rate of tax which can be endured by property assessed at

THE PROBLEM STATED 3

Its full cash value. Hence the money for the water supply system must be borrowed and repaid in installments.

As evidence of the borrowing, the city authorizes its proper officers to execute and deliver promises to repay the borrowed money at a definite time. Such instruments are called bonds and are negotiable instruments, on which interest is payable at an agreed rate per annum.

It not infrequently happens that the necessity for a bond issue arises from pressure exerted by local banks. The annual municipal revenues may have fallen short and the deficiency of taxes may have forced the municipality to borrow to meet Its running expenses. Obligations Issued in anticipation of current revenues ought not to be funded and may not be. In States having proper fiscal statutes. But appropriations may have been made for capital expenditures, and local banks may have loaned the city money for a short period until taxes are collected, or bonds can be Issued.

The impulse to issue bonds may come when a bank examiner calls the attention of the bank to the fact that It holds too much city paper — an amount beyond the limit which It Is legally authorized to lend or an amount too great In relation to Its assets.

Preliminary steps. — The necessity having arisen and the initiative having been taken by the executive, the financial officer or officers consult the law-making body, such as the city council In second class cities in New York State. Ordinarily the city council has a committee on finance, the members of which have had little or no experience with, or understanding of, financial problems. Nevertheless, the finance committee meets and confers with the financial officials and It is agreed that bonds must be Issued. In short, the finance committee agrees to recommend the passage of appropriate local legislation, that Is, the ordinance or resolution author- ^ Izing the bonds.

Then the delegated officials confer with the corporation counsel and the latter consults with counsel who makes a specialty of municipal business. At this conference the facts are laid before counsel. The interest rate which the proposed bonds are to bear Is frequently determined after consultation with the representatives of the better class of Investment banking houses, the term or length of time the bonds are to run is computed, and other details are arranged.

Ordinance authorizing bond issue. — An ordinance authorizing the bonds is next prepared and a draft submitted to the local authorities for consideration. If satisfactory in form, it is introduced in the local legislative body. If the majority of the council be of the same political faith as the officials in charge of the matter, the ordinance is made an administration measure and all the members of the council of that particular political party retire around a corner and "caucus." The minority members retire around another corner and likewise "caucus." Then it shortly appears in the newspapers that the majority party, being possessed of all the wisdom, all the intelligence and all the administrative ability of the nation, as locally represented, is about to introduce an ordinance for the issue of bonds.

We will assume that the ordinance is introduced, properly approved in caucus and adopted by the necessary vote. A two-thirds or larger vote is frequently required. Counsel then prepares the necessary resolution prescribing the form and contents of the bond and setting forth the notice of sale which must be published.

Printing. — If the market is fairly stable and the interest rate can be regarded as settled, it is usually advisable at this point actually to prepare — that is, engrave or print — the bonds themselves. The practice of engraving municipal bonds has practically disappeared. They are printed on tinted sheets with steel-engraved borders and the perfection of printing is such that, everything considered, a type-printed bond makes a better looking instrument. Regarding coupons, experience shows that they should be reproduced by photolithography to obtain the best results.

Publication of notice. — Public sale of the bonds is usually »required. This rheans that a notice must be published describing the proposed Issue by its amount, interest rate, maturity, and the like, and stating that the bonds of the issue will be offered for sale at a specified time and place. During periods of daylight-saving time it has been found helpful to specify which variety of time is meant. The notice of sale contains all the provisions which an intending bidder needs to know and usually calls for sealed offers or proposals for the purchase of the bonds which must be accompanied by a certified good-faith check for a stated percentage, usually two per cent of the amount of the issue. The notice should be,

THE PROBLEM STATED 5

and is sometimes required to be, published in a metropolitan financial paper.

Sale. — The zero hour having arrived, representatives of interested bond houses meet the municipal officials in charge of the matter at the place of sale. After the bids have been received and opened for consideration, a list is prepared and the highest bidder determined. A resolution awarding the bonds to the successful bidder is then adopted.

When the bonds are prepared and ready for delivery, the purchasing bond house is notified. Counsel is requested to say whether or not the bonds can be taken up. When all is ready, a representative of the purchaser meets with the financial officer in charge of the delivery and brings with him a certified check to pay for the bonds — the amount of which check has previously been determined — and the bonds are counted, examined as to signatures, delivered, and paid for.

With the merchandising of the bonds — the sale by the dealer to the ultimate holder or investor — this book has no concern. The various kinds of municipal bonds which find a place in the market and the numerous elements which determine the price at which such bonds can be sold under ordinary conditions are, however, discussed.

Municipal ordinances and budgets. — Reference has been made to the budget and to the bond ordinance or resolution. A preliminary reading of a municipal tax ordinance, budget, and bond ordinance, and consideration of the form of each, will be helpful to an understanding of the discussions of principles. The tax ordinance is the written legislative act of the local board or body having the power to levy taxes, which provides for the levying of a tax for municipal purposes and specifies in general terms the objects for which the tax is levied. The budget specifies in detail how the amount of tax is to be expended. The bond ordinance is the legislative act of the municipality, authorizing the Issue of bonds. Forms of each of these documents follow this chapter.

Tax Ordinance of the City of Clifton, New Jersey, for the

Year 1922

AN ORDINANCE RELATING TO TAXES FOR THE YEAR NINETEEN HUNDRED AND TWENTY-TWO

BE IT ORDAINED, by the City Council of the City of Clifton that there shall be assessed, raised by taxation and collected for the fiscal year 1922 the sum of Six Hundred Twenty-Six Thousand, Four Hundred Twenty-Three Dollars and Ninety Cents ($626,423.90), for the purpose of meeting the appropriations set forth in the following statement of resources and appropriations for the fiscal year 1922.

RESOURCES

Surplus Revenue Appropriated None

Miscellaneous Revenues .$ 76,900.00

School Monies from State, School Balances, etc 102,000.00

Revenue from other sources than Taxes $178,900.00

APPROPRIATIONS

Appropriations in City Budget $397,702.76

Appropriations for School Purposes 387,150.00

Overexpenditure of Appropriations, 1921 18,053.65

Deficit Surplus Revenue, 1921 ; 2,417,49

$805,323.90 Revenue from other sources than Taxes 178,900.00

Net amount to be raised by Taxation $626,423.90

Budget of the City of Clifton, N. J.

For the Fiscal Year Beginning January i, 1922, and Ending December 31, 1922

ANTICIPATIONS

Surplus Revenue None

Surplus Revenue Appropriated None

MISCELLANEOUS ANTICIPATED:

Fees and Permits $ 4,000.00

Fines and Penalties 4,000.00

Health Permits 3,000.00

Franchise Tax 40,000.00

Gross Receipts Tax 6,500.00

Interests and Costs 7,100.00

Licenses 4,300.00

Auto Bus Receipts 6,000.00

$ 76,900.00 Amount to be raised by Taxation 320,802.76

$397,702.76

THE PROBLEM STATED 7

APPROPRIATIONS

1922 GENERAL GOVERNMENT:

Administrative and Executive $ 16,000.00

Assessment and Collection of Taxes 9,200.00

Department of Finance 1,200 00

Interest on Current Loans 7,000.00

Grounds and Buildings 4,500.00

Advertising, Printing and Office Supplies 5,500.00

PRESERVATION OF LIFE AND PROPERTY:

Police Pension Fund 2,600.00

Rental of Hydrants 5,000.00

HEALTH AND CHARITIES:

Ctiarities 500.00

STREETS, HIGHWAYS AND SEWERS:

Cleaning and Maintenance of Streets 20,000.00

Street Improvement Liabilities 1921, 1920, 1919 25,302.80

Garbage and Aslies 12,500.00

Lighting of Streets 17,500.00

Engineering Department 14,000.00

EDUCATION:

DEBT SERVICE:

Payment of Bonds 30,000.00

Payment of Sinking Fund 13,936.26

Interest on Bonds 59,700.00

School Construction in excess of bond issue 465.55

CONTINGENCIES 10,000.00

$397,702.76

School Bond Ordinance for the City of Camden, N. J.

AN ORDINANCE AUTHORIZING THE ISSUE OF $1,000,000 SCHOOL

BONDS OF THE CITY OF CAMDEN AND PROVIDING

FOR THEIR PAYMENT

RECITALS:

Pursuant to due action by the Board of Education and the Board of School Estimate an appropriation has been requested for certain school purposes as follows:

Purpose Cost

Building and furnishing two new fireproof school houses. .. .$ 385,000 Building and furnishing additions to three non-fireproof

school houses 425,000

Building fireproof administration building and stockroom... 50,000

Purpose Cost

Furnishing machine shop in new high school 65,000

Constructing cement sidewalks and fences for all schools 75,000

$1,000,000

It is advisable to issue bonds to provide funds for said purposes in pursuance of an Act of the Legislature of the State of New Jersey entitled: "An Act to establish a thorough and efficient system of free public schools, and to provide for the maintenance, support and management thereof," approved October 19, 1903, as amended.

The average of the different periods assigned by said statute for the maturity of bonds issued for said purposes, taking into consideration the amount of bonds to be issued as herein provided for said several purposes, is thirtythree (33) years.

BE IT ORDAINED BY THE CITY COUNCIL OF THE CITY OF CAMDEN:

Section I. School bonds of the City shall be issued in the aggregate principal amount of $1,000,000, shall be dated May 1, 1922, and $30,000 thereof shall mature on May 1 in each of the years 1923 to 1945 inclusive and $31,000 thereof shall mature on May 1 in each of the years 1946 to 1955 inclusive. Said bonds shall bear interest at the rate of five per centum (5%) per annum, payable semi-annually on May 1 and November 1 in each year, shall be of the denomination of $1,000 each, and shall be in such form as may be provided by resolution.

Section 2. Said bonds shall be sold at public sale as provided by law, or if no bids are received at public sale, then at private sale.

Section 3. In each year after the issuance of said bonds, the City shall in its annual tax levy raise money sufficient to pay the interest and principal of such bonds as may mature during such year.

Section 4. This Council does hereby concur in and consent to the appropriation referred to in the preambles hereof, and to the issuance of the bonds herein authorized.

Section 5. All ordinances and parts of ordinances in conflict herewith are hereby repealed. This ordinance shall take effect immediately.

Chapter II THE MUNICIPAL BOND

Conditions of negotiability. — Generally speaking, bonds are not negotiable instruments. This is probably true without qualification as to the bonds of individuals, and the exception is in the case of bonds issued by various bodies corporate and politic. The development of modern business has made it necessary that these obligations should be easily and readily transferable, and that purchasers should take them free of all latent equities.

The municipal coupon bond payable to bearer or order is a negotiable instrument, having all the attributes of negotiable paper under the law merchant and the uniform negotiable instruments laws of the various States. The United States Supreme Court has said: "Obligations of municipalities in the form of these in suit here are placed, by numerous decisions of this Court, on the footing of negotiable paper. They are transferable by delivery and, when issued by competent authority, pass into the hands of a bona fide purchaser for value before maturity, freed from any infirmity in their origin";^ and whenever the question has arisen, it has been so decided where the bond has been properly drawn.

The conditions of negotiability, so far as applicable to municipal bonds, are :

A. The instrument must be in writing and signed by the maker or

drawer,

B. It must contain an unconditional promise or order to pay a cer-

tain sum of money,

C. On demand, or at a fixed or determinable future time,

D. To order or bearer.

Brief consideration will show that a municipal bond, payable to bearer or order, has all the elements of negotiable paper. It remains a "negotiable instrument" if registered,^

but if properly registered, Its negotiable character may be said temporarily to be suspended.^

Bona fide purchaser has good title. — The Incidents and consequences of such negotiability need not be fully considered here, and belong indeed to the study of negotiable Instruments, as such. For our particular purposes, it is important only to note that there is no defense to a suit for payment of a negotiable Instrument (valid In its Inception) in the hands of one who has acquired It before maturity, for value and without notice of any defenses. The settled rule of commercial law is that one is a bona fide purchaser of negotiable paper (such as Is a properly drawn and issued municipal bond) who takes It before maturity and without notice of equities, and such purchaser Is said to obtain a perfect title. One who purchases from a bona fide holder gets as good a. title as the seller had.

Instrument void in inception never valid. — It must be kept in mind, however, that the protection afforded a bona fide holder of a negotiable municipal bond does not validate an instrument which Is void in its Inception; that is, a bond which the municipality has no power to issue. The analogy between such a bond and the promissory note of a lunatic is perfect. A lunatic after "office found," that is, after a sheriff's jury has declared the individual to be "non compos mentis," has no power whatsoever to make a contract. Hence a lunatic (after "office found") cannot make a valid promissory note. Whatever the instrument is, it is not a negotiable instrument with the attributes of negotiability.

Different forms of bonds. — The form of a municipal coupon bond, registerable at the option of the holder as to principal only or as to both principal and Interest, with its coupons, conversion certificate and registration gridiron, follows this chapter. Such bond is payable to bearer and hence is transferable by delivery. If the owner so desires, it may be registered as to principal in his name, after which registration it is payable only to the person in whose name it Is registered, until such registration Is changed. The owner may also cause It to be fully registered, that Is, as to interest as well as to principal. If this is to be done, the coupons are detached and cancelled and the fact noted on the conversion certificate.

'Switzerland v. R. R. (N. Y., 1912), 152 App. Div. at 75.

THE MUNICIPAL BOND 11

Forms of coupon and registered bonds used in New York follow the New Jersey form first referred to. The peculiarity of a New York coupon bond is that while it may be fully registered — that is, as to both principal and interest — it may not be registered as to principal only. A bond in the form first given may be registered as to principal only and the coupons may continue to pass by delivery as they are not affected by such registration.

The narrative of a bond. — The narrative of a bond begins with the name oi the promising corporation which should always be its correct legal corporate title. A mere misnomer does not In most, if not all, jurisdictions affect the validity of the instrument but it is apt to make the draftsman feel foolish. Some cities have curious names. Trenton, New Jersey, for instance, is "The Inhabitants of the City of Trenton." Hoboken, no longer having a council, and whose mayor Is only such for ceremonial purposes, is legally known as "The Mayor and Council of the City of Hoboken." New York City was until recently "The Mayor, Aldermen and Commonalty of the City of New York." Apparently everybody but the mayor and aldermen constituted the common herd.

The present tendency is toward short names, and many municipalities, particularly in New Jersey, have taken advantage of the permission contained In general statutes to shorten their long and unwieldy titles.

The clause "for value received" deserves consideration. No contract Is valid without a consideration — something paid or done to Induce the promise to be made. If the maker of the promise — that is, the bond — says It has "received value," it will not be heard to deny the truth of the statement.

Next comes the promise to pay to the bearer of the bond a designated sum of money, usually one thousand dollars, on a definite date and to pay interest at a specified rate per cent at certain times. The medium of payment, that is whether gold coin, lawful money, or whether payable in New York exchange, Is stated, as is also the place of payment.

Parenthetically we may note that the bond differs from most other bonds In that It does not begin with "Know all men by these presents." This expression went out of fashion some years ago, and now obtains only in localities where legal verbiage is more Important than legal effect.

Registered versus coupon bonds. — The covenant as to registration follows. Until recently (although of late years the individual investor has acquired prominence as a purchaser of municipals) savings banks, insurance companies and trustees were the purchasers of most municipals, and preferred to have their bonds registered, thus making it unnecessary for their officers and agents to cut coupons and acquire the coupon thumb. The real purpose was to suspend negotiability, in order to protect their securities from theft. The individual investor wants coupon bonds, which are transferable by delivery, and the ownership of which is not evidenced by registration.

The description of the issue ordinarily sets out its principal amount and maturities. This is followed by a reference to the statute which authorizes the issue of the bond and ordinarily a reference to local legislation.

Dillon's estoppel clause. — The value of such a clause is great, for it means that all acts and things necessary to be done have been done in a legal manner. An estoppel is not, however, complete protection, for the officer signing the bond must have authority to make it and no recital can make up for an entire lack of authority. This should always be kept in mind by the prospective bond purchaser.

"If a municipal corporation, having general authority to issue bonds for specified purposes, puts forth a negotiable municipal bond issued for a lawful purpose, and therein recites, through its duly authorized officials, whose province and duty it is to ascertain and peculiarly to know the facts, compliance with the specific provisions of the law essential to the issuance of the bond, the municipality is, as against a bona fide holder of the bond, purchasing for value, and on faith of the recitals, estopped to deny the truthfulness of the recitals." ^

"Nothing is better settled than this rule — that the purchaser of bonds, such as these, is held to know the constitutional provisions and the statutory restrictions bearing on the question of the authority to issue them; also the recitals of the bonds he buys; while, on the other hand, if he act in good faith and pay value, he is entitled to the protection of such recitals of facts as the bonds may contain." ^

The face of the bond ends with the testimonium, or name

*To'wn of Climax v. Burnside (Ga. 1920), ISO Ga. 556; 104 S. E. 435. 'Lake Co. v. Graham (1888), 130 U. S. 674 at 680.

THE MUNICIPAL BOND 13

of the promissor, and statement of the official character of the officers signing the instrument, the date of the instrument, the signatures of the officers and the corporate seal.

The coupons attached call for the payment of a definite sum, usually a half year's interest, on a definite date and they are separate and independent promises to pay and In themselves constitute negotiable instruments.

On the back of the bond, ordinarily called the panels, the conversion certificate usually appears, and the registration gridiron, the purposes of which are obvious.

Municipal bond rarely secured by lien on specific property.— In conclusion, it should be noted that the municipal bond is rarely secured by a lien on specific property. A lien in the strict legal sense is the right of a creditor to sell property belonging to the debtor to satisfy the debt. Many bonds of private corporations are liens on real estate but a municipal bond, payable as we shall see from moneys raised by taxation, is a lien upon nothing, not even on the general revenues of the municipality issuing it. The means of obtaining funds to pay the bond and the remedy of the bondholder in case of default are discussed in subsequent chapters.

Form of New Jersey Coupon Bond, Registerable as to Principal Only or as to Both Principal and Interest

STATE OF NEW JERSEY, THE CITY OF CAMDEN

SCHOOL BOND

The City of Camden, a municipal corporation of the State of New Jersey, for value received, promises to pay to the bearer of this bond, or if it be registered, to the registered holder on the first day of May, 19 , the sum of one thousand dollars ($1,000.) and to pay interest thereon at the rate of four and one-half per centum (4j/2%) per annum, semi-annually on the first days of May and November in each year from the date of this bond until it matures, upon presentation and surrender as they severally mature of the coupons therefor annexed hereto, or if this bond be registered as to both principal and interest, then to the registered holder. Both principal and interest of this bond will be paid in lawful money of the United States of America, at the ofBce of the City Treasurer of said City.

This bond may be registered as to principal by the holder in his name on the books of the City, kept in the office of the City Treasurer, and such registration shall be noted on the back of this bond, after which no valid transfer of this bond shall be made except on said books until after registered transfer to bearer. Such registration shall not affect the negotiability of the coupons which shall continue to pass by delivery. At the request of the holder, thi3 bond will be converted into a bond registered as to both principal and interest and the coupons annexed hereto detached and cancelled and thereafter both principal and interest shall be payable only to the registered holder.

This bond is one of an issue, the authorized principal amount of which is $1,000,000, the bonds of which are of like tenor, except as to maturity, and is issued pursuant to an Act of the Legislature of the State of New Jersey, entitled: "An Act to establish a thorough and efficient system of free public schools and to provide for the maintenance, support and management thereof," approved October 19, 1903, and the acts amendatory thereof and supplemental thereto, and an ordinance of said City entitled: "An Ordinance authorizing the issue of $1,000,000 School Bonds of the City of Camden and providing for their payment" duly adopted April 13, 1922, and published as required by law.

It is hereby certified and recited that all conditions, acts and things required by the Constitution and Statutes of the State of New Jersey to exist, to have happened and to have been performed, precedent to and in the issuance of this bond exist, have happened, and have been performed, and that the issue of bonds of which this is one, together with all other indebtedness of said City, is within every debt and other limit prescribed by the Constitution and Statutes of said State.

IN WITNESS WHEREOF, the City of Camden has caused this bond to be signed by its Mayor and City Comptroller under the seal of the City and attested by the City Clerk and the coupons hereto annexed to be authenticated by the facsimile signature of the City Treasurer and this bond to be dated the first day of May, 1922.

Mayor City Comptroller

Attest:

City Clerk

Form of Coupon No. $22.50

The City of Camden, a municipal corporation of the State of New Jersey,

will pay to the bearer on the 1st day of , 19. . . .,

the sum of Twenty-two and 50/100 Dollars ($22.50) in lawful money of the United States of America, at the office of the City Treasurer of said City, being six months interest then due on its School Bond dated May 1, 1922, and bearing No