MARTINEZ, CALIF. -- The California Superior Court of Contra Costa County Friday struck a blow to the state and the Richmond Unified School District by ruling that the district's defaulted certificates of participation are constitutional.
In a terse and forceful bench ruling that is expected to be appealed, Judge John F. Van de Poel swept aside the state and school district's arguments that the $9.8 million lease issue violated the state constitution's prohibition against long-term debt not approved by voters, because it was used largely to finance operating deficits rather than capital projects.
"The use to which the proceeds of the site lease was made is irrelevant to the issue of the constitutional debt limit," the judge said, in a line of reasoning that bond attorneys said closely follows a 50-year court tradition in California upholding the validity of lease securities, known as the Offner-Dean rule.
The lease underlying the 10-year Richmond certificates, issued in 1988, does not constitute long-term debt because the "payments are due only in the year when the site was used, and the payments could not be accelerated," Van de Poel said. In addition, "payments due in any one year clearly do not exceed the district's income and revenue provided for that year," and "the lease payments are due only if the site is usable," he said.
The judge's broad ruling not only upheld the constitutionality of the Richmond lease contract, but also stated that the district had ample authority under the education code and other statutes to negotiate the lease. And it said the district could not avoid liability for its breach of contract when it defaulted in August 1991 by blaming the state, its bond counsel, for underwriters for its actions.
Given the sweeping scope of the ruling, D. Ronald Ryland of Sheppard, Mullin, Richter & Hampton, the attorney for the issue's trustee, U.S. Trust Co. of New York, said his next move in the case will be to ask the judge to order the district to make its past due lease payments, which total over $2 million.
But state and school district attorneys said they will appeal the ruling, possibly right away. "We need a better reading" of the constitution, even if it means "prolonging the uncertainty in the bond market," said Michael E. Hersher, deputy general counsel of the state education department.
The state and the school district at a hearing here Friday attempted strenuously to convince the judge to change his mind, warning that the ruling could encourage other financially pressed school districts and municipalities in the state to issue lease securities simply to stave off insolvency, as Richmond did.
The decision represents a "significant expansion of the exception" to the constitutional debt limit carved out by the Offner-Dean rule, and "is going to have statewide consequences," said Floyd D. Shimomura, assistant state attorney general.
He urged the judge to be "careful" about turning the Offner-Dean rule into a loophole to be used by hard-pressed governments for deficit financing.
"The impulse to use an expanded Offner-Dean exception may be difficult to resist if the economy stays the way it is," he said.
Hersher agreed. "We're concerned about the future. The fiscal situation is only getting worse, not better" for governments in the state, he said, and the "unwise" use of lease securities invited by the ruling could become an overwhelming temptation for some.
Hersher asked the judge to refine or clarify the scope of his ruling, but Van de Poel brusquely declined. "I will not elucidate any more than I have done. You're not going to get any more from me," he said.
The judge also rebuffed attempts by the school district's attorney, Martha Buell Scott of Breon, O'Donnell, Miller, Brown & Dannis, to change or soften the ruling. She argued that the Offner-Dean exception to the debt limit should not be seen as allowing "an agency with a 100 million budget to go out and borrow up to 100 million a year."
Scott pleaded with the judge to "pierce the form and look at the substance" of the Richmond lease. "This is precisely the evil that the constitution meant to forestall," she said.
The Richmond scheme, which in essence "mortgaged" the schools' administration building and other assets to get operating cash, was "clearly debt and nothing else," she said.
The judge also gave short shrift to Scott's argument that the school district relied to its detriment on representations made by the issue's underwriter, Rauscher, Pierce Refsnes of San Francisco, that it was obligated to make lease payments only if it had sufficient funds to do so. The risk that the district would stop making payments because of insufficient funds was stated in the issue's offering documents, she pointed out.
But the judge ruled that "the risk to investors of nonpayment by the district is distinct from the district's obligation to pay the lease payments." He told Scott that her arguments only make "sense" if used in an attempt to share the blame for any damages resulting from the default.
Defense attorneys after the hearing said they were "surprised" at how quickly and easily the judge dispensed with their arguments. Besides appealing the ruling, Hersher said the state may also seek legislation outright prohibiting any further use of certificates for deficit financing.
"We may have to drop the other shoe," he said.
The ruling may also force Gov. Pete Wilson to rethink his opposition to a bill he vetoed this summer that was designed to help the district negotiate its way out of its financial problems and start repaying the certificates. Hersher said.
"The governor was saying we should pursue aggressively the constitutional question and see if we can get out of" any obligation to rescue the district, he said. But now he may need to "go back" to the legislation, he added.