Last month, the Governor signed legislation into law affecting the ways in which cities and towns may use premiums and accrued interest received upon the sale of bonds and notes.  The changes are helpful to municipalities and are the result of years of advocacy by municipal associations and many of us who work to help our municipal clients through the process of issuing bonds and notes.

When cities and towns sell bonds and notes, the purchasers of those bonds and notes will often pay the city or town a premium over and above the principal amount of the bonds and notes.  They pay this premium in return for the city or town paying higher interest rates on the bonds or notes than prevailing market conditions would require.  Accrued interest is only paid to a city or town if the date of the bonds or notes (i.e., the date interest typically starts to accrue) is before the date the city or town delivers the bonds or notes to the purchaser and receives the borrowed funds.  In each case, the premium and accrued interest paid to a city or town upon the issuance of bonds or notes effectively offsets additional interest expense the city or town will need to pay to the owners of the bonds or notes.

Massachusetts General Laws Chapter 44, Section 20 governs the permissible use of premium and accrued interest by cities and towns.  Due to a change in that law in 2016, municipalities were no longer able to apply premium and accrued interest received upon the sale of bonds and notes to offset the increased interest expense they had to pay on the bonds and notes.  Instead, municipalities were permitted to apply premium to pay costs of issuing the bonds and notes, and the remaining premium, together with any accrued interest, could only (i) be used to pay costs of the related project and reduce the amount of the borrowing (and only if authorized to do so by the town meeting or city or town council) or (ii) be appropriated by the town meeting or city or town council to pay for another capital project for which the city or town had authorized or could authorize a borrowing for an equal or longer period of time under state law.  For any bonds or notes the debt service on which was excluded from the limits of Proposition 2 ½, cities and towns were expected to apply any net premium and accrued interest to pay project costs and reduce the amount of the borrowing, as taxes in excess of the levy limit (a) could not exceed the true interest cost of the borrowing for the approved, debt-excluded project or (b) be used to support the financing of a project that had not been so approved.

In addition to creating procedural barriers to the expenditure of premium and accrued interest by requiring approval by the local legislative body, the 2016 law unnecessarily caused significant budget challenges for many cities and towns.  This was especially so with respect to premium received upon the issuance of short-term notes.  Accrued interest has generally not been a problem as most cities and towns have avoided receiving it by dating their bonds and notes the same date that they issue the bonds and notes and receive the borrowed funds.  With respect to premium for short-term notes, all of the unbudgeted and unexpected higher interest cost is payable in the same or the next fiscal year (in contrast to bonds, where the higher interest cost is spread over the multi-year life of the bond issue).  Consequently, the higher interest cost on notes has often been difficult for cities and towns to absorb without being able to use the premium to cover it.

The recent amendment to M.G.L. Chapter 44, Section 20 enacted in Section 20 of Chapter 102 of the Acts of 2021 addressed some of the key procedural and budgetary challenges with the law governing the use of premiums and accrued interest.  Specifically, the amended law provides for the following:

• Costs of Issuance: Premium may still be applied to pay the costs of issuing bonds or notes.
• Payment of Interest on Notes: Net premium (i.e., the premium remaining after paying costs of issuance) and accrued interest received from the sale of notes must be applied to the first payment of interest on the notes.
• Bonds that ARE Debt-Excluded: Net premium and accrued interest received from the sale of bonds the debt service on which is excluded from the limits of Proposition 2 ½  must be applied by the city or town treasurer to pay project costs and reduce the size of the borrowing.  Local legislative authorization to do so is no longer required.
• Bonds that are NOT Debt-Excluded: Net premium and accrued interest received from the sale of bonds the debt service on which is not excluded from the limits of Proposition 2 ½ may be applied by the city or town treasurer to pay project costs and reduce the size of the borrowing.  Local legislative authorization is no longer required to do so.  If the treasurer does not apply any net premium and accrued interest in such manner, then the town meeting or city or town council may appropriate the net premium and accrued interest to pay costs of another capital project for which the city or town has authorized a borrowing or may authorize a borrowing under state law.  The new project no longer needs to be a project for which the city or town could have borrowed for an equal or longer period of time as the term of the bonds and any notes issued in anticipation thereof.  (If, however, the new project has a shorter useful life than the project financed with the bonds, the city or town should consult with us to confirm there will not be any issues with doing so under federal tax law.)
• Exception for De Minimis Bond Premium: If the net premium and accrued interest received from the sale of bonds is not more than $50,000, the city or town, with the approval of its mayor, city or town manager or select board (as applicable), may apply such amount to the payment of indebtedness.  (If the bonds are tax-exempt bonds, any such amount generally should be applied to pay debt service on that particular bond issue under federal tax law.)

We look forward to working with our clients to address any questions about the new law and to help ensure compliance with its requirements for the use of premiums and accrued interest.