CONSTITUTIONAL DEBT LIMITATION ON MUNICIPALITIES IN MISSOURI

by Terry M. Jarrett and Lowell Pearson

Synopsis: The Missouri Constitution limits the amount of debt that a municipality may incur. Given the modern economy, a municipality may be faced with a myriad of multi-year financial transactions, triggering the constitutional debt limit provision. This article traces the history of the debt limit provision, discusses how Missouri courts have addressed this issue, and provides practice pointers for practitioners.

I. Introduction

Municipalities are public entities run by elected officials accountable to the voters and taxpayers. These elected officials must be aware that the Missouri Constitution prohibits them from binding future leaders with debt. Given the modern economy, a municipality is faced with a myriad of multi-year transactions, whether they be copy machine leases, loan agreements, or other long term financial arrangements. Any multi-year transaction requiring the expenditure of funds over a period of years could face rigorous scrutiny by taxpayers and others. The good news is that Missouri courts have set out a road map for municipalities that, if followed, will assure compliance with the constitutional debt-limitation provision.

The majority of states have constitutional, statutory, or charter limitations on borrowing by municipalities. Missouri, with its constitutional debt-limitation provision, is in that majority. These debt-limitation provisions require municipal authorities to observe certain guidelines in incurring debt. When pursuing economically advantageous opportunities, elected officials must be careful to observe these guidelines lest their actions be declared unconstitutional or otherwise unlawful.

The purpose of this article is to address the debt limitation provision¹ contained in Missouri's Constitution, as well as relevant case law interpreting that provision. By understanding the guidelines to incurring debt under the constitutional limitation, city officials can take advantage of economic opportunities without fear of running afoul of the constitutional provision.

II. Background

A leading authority on municipal corporations, Eugene McQuillin's The Law of Municipal Corporations Third Edition, sets out the policies underlying debt limitations of municipalities. "Debt-limitation provisions are designed to promote the common good and welfare."² The purpose of debt limitation is to "serve as a limit to taxation and as a protection to taxpayers; to maintain municipal solvency, both governmental and proprietary; and to keep municipal residents from abusing their credit, and to protect them from oppressive taxation."³ Furthermore, debt-limitation provisions not only prevent a current legislature from binding a future legislature but also prevent legislators from sticking tomorrow's taxpayers with today's bills.⁴

There are three types of debt limit provisions: (1) constitutional provisions; (2) statutory provisions; and (3) charter provisions.⁵ These debt limit provisions limit the debt in one of three ways: (1) by "forbidding indebtedness in excess of a certain percent of the value or assessed value of the taxable property in the [municipality]"; (2) by "limiting indebtedness in any one year to the income and revenue provided for [that] year"; and (3) by a combination of the two.⁶

Missouri has a constitutional provision that limits indebtedness in any one year to the income and revenue provided for that year plus any unencumbered balances from previous years.⁷ Municipalities have become quite creative in structuring transactions to meet the debt-limitation provisions when obtaining financing for needed municipal projects. This creativity increasingly causes taxpayers and others to challenge the financing plans as violative of the constitutional debt-limitation provision. So far, Missouri courts have upheld many challenged financial plans as constitutional.

The constitutional limitation on indebtedness of local governments in Missouri originated in the constitution of 1875.⁸ The need for such a constitutional limitation putting local governments on a cash basis arose because many local governments were in poor financial condition from lax administration by local officials, bad investments in railroads, and the depression of 1873.⁹ During this period of Missouri history, the people lacked confidence in both state and local governments. As a result, the constitution of 1875 restricted the power of state and local governments in a variety of ways, including placing spending limitations on both the legislature and local governments.¹⁰ The spending limitation on local governments was retained in art. VI, § 26(a) of the constitution of 1945.

III. Article VI, Section 26(A)

An examination of the constitutional debt limitation of municipalities in Missouri begins with the constitutional provision itself, art. VI, § 26(a). It states in full:

No county, city, incorporated town or village, school district or other political corporation or subdivision of the state shall become indebted in an amount exceeding in any year the income and revenue provided for such year plus any unencumbered balances from previous years, except as otherwise provided in this constitution.

Early cases interpreted art. VI, § 26(a) inconsistently. In Grand River Township v. Cooke Sales and Servs., Inc., the Supreme Court of Missouri interpreted art. VI, § 26(a) to prohibit a local government from entering into contracts that obligate it to make payments beyond one calendar year.¹¹ This restrictive interpretation precluded a local government from entering into any multi-year lease or financing arrangement, no matter how economically desirable or advantageous. Just months later, the Supreme Court in State ex rel. Strong v. Cribb revisited the issue and rejected the inflexibility of Grand River Township by holding that a three-year lease for road machinery did not violate the Missouri Constitution.¹² This inconsistency¹³ remained for 28 years until 1992, when the Supreme Court of Missouri made its definitive interpretation of art. VI, § 26(a).

The Supreme Court's unanimous opinion in Mercantile Bank of Illinois v. School Dist. of Osceola¹⁴ is now recognized as the leading authority on art. VI, § 26(a). There, the Supreme Court interpreted art. VI, § 26(a) to "mean that a [local government] can enter [into] a contract requiring payments over more than one year provided the payments due in any one year of the contract do not exceed the [local government's] revenue, income and unencumbered balances in that [fiscal] year."¹⁵ In mathematical terms, the Mercantile Bank formula is:

Unencumbered Balances Total Income and Total Expenditures

From Previous Years + Revenue Provided ³ For the Year

For the Year

If the left side of the equation is greater than or equal to the right side, no violation of art. VI, § 26(a) occurs. Each of these three elements in the equation is discussed below.

1. Unencumbered Balances From Previous Years

The unencumbered balances from previous years is the total balance that "you have left over from previous years that is not already encumbered."¹⁶ In other words, unencumbered balances are asset account balances that are available for the municipality's use. Examples of unrestricted asset accounts include cash and cash equivalent and investment accounts.

2. Total Income And Revenue Provided For The Year

The total income and revenue provided for the year is "a total of what your taxes will bring in for that year, [and] whatever other income you may have for that year."¹⁷ Under art. VI, § 26(a), a municipality may "anticipate the revenue collected, and to be collected, for any given year."¹⁸ Consequently, the income and revenue element can be derived from a municipality's projected budget for the year.

3. Total Expenditures For The Year

The total expenditures for the year is "what you have to spend in any year."¹⁹ The Supreme Court further explained:

Article VI, section 26(a), does not require the political subdivision, here the School District, to measure the entire lease obligation as a current expenditure. This is the import of the "in any year" and "for such year" language of section 26(a). Instead, rent payments are an expenditure for current expenses of the School District in the year-tight compartments in which those payments are due. Thus, only those payments due in a particular fiscal year are considered expenditures for determining whether the School District exceeded the expenditure limitation imposed by article VI, section 26(a).²⁰ (emphasis added)

Accordingly, the total amount of a long-term debt is not counted as indebtedness in one year. Only the payment that is due in that year is counted as an expenditure.²¹

The Mercantile Bank formula applies to all types of multi-year leases, contracts, and financing arrangements that a municipality may encounter. In the Mercantile Bank case, the school district entered into a 60-month lease for two copy machines and agreed to pay $300 monthly. The lease contained an acceleration clause on default. The school district defaulted, and the lessor accelerated the payments and sued for the amount of $8,569.20. The school district defended by alleging that under art. VI, § 26(a) it had no authority to enter into a multi-year lease and that any contract in violation of this constitutional provision was void. The circuit court sustained the school district's motion for summary judgment. The lessor appealed.

The Supreme Court reversed and remanded, holding that all agreements by political subdivisions to make payments in subsequent years are not void, but voidable if the agreement violates the formula.²²

Other types of financing arrangements have also been challenged. In St. Charles City-County Library Dist. v. St. Charles Library, Bldg. Corp.²³ the Eastern District of the Missouri Court of Appeals upheld the validity of "lease-purchase contracts."

In the St. Charles City-County Library Dist. case, the library district wanted to build a new library building. It owned a tract of land. The district conveyed the land to the non-profit "St. Charles Library Building Corporation," created to aid the district in building the library. The corporation secured a loan with the land as collateral. The corporation then leased the property back to the district. The rent payments paid by the district to the corporation were assigned to the banks to repay the corporation's loan.

The lease was for one year, with 24 successive options to renew for one year under the same conditions. If the district exercised all the options, it then had the option of buying the property for $100.

The district filed a declaratory judgment action with the circuit court to determine whether the lease-purchase agreement violated art. VI, § 26(a). The circuit court held that there was no violation. The Court of Appeals affirmed.²⁴

The court began by noting that "[l]ease-purchase contracts entered into by municipal corporations have engaged the attention of courts throughout this country for many years. Subdivisions of state governments have frequently used lease-purchase contracts in an attempt to evade constitutional debt restrictions similar to those imposed in Missouri under Article VI, Section 26."²⁵

Relying on prior authority, the Court of Appeals detailed the requirements for a valid lease-purchase agreement. First, the lease-purchase agreement must not "[create] a present indebtedness [that] obligates the City to impose taxes in succeeding years to satisfy this indebtedness."²⁶ This requirement is met if the lease is no longer than one year. 27

Second, the lease-purchase agreement must not create the annual need for taxation to retire the liability.²⁸ A lease satisfies this requirement if it contains yearly options to renew.²⁹

Third, the lease-purchase agreement must be terminable at the city's option.³⁰ This requirement is met if the city holds the option to renew.³¹

A lease-purchase agreement for a one-year term and containing annual options to renew, held only by the municipal corporation, meets all three requirements. Such an agreement does not violate art. VI, § 26(a). As the St. Charles City-County Library Dist. court concluded:

Because of its options, the lease here in question does not create "long-term repayment obligations" on the part of the District, nor is there an obligatory annual need for taxation to retire the liability.³²

As long as a lease-purchase agreement is terminable at the municipal corporation's option, the lease is constitutional.³³

In addition to the court in St. Charles City-County Library Dist., other Missouri courts have upheld the validity and constitutionality of similar lease/option agreements that meet the St. Charles City-County Library Dist. requirements.³⁴

In the most recent case to consider the issue, the Missouri Court of Appeals for the Southern District upheld the validity of a financing arrangement to purchase land and certain improvement projects. In Burks v. City of Licking,³⁵ the state selected Licking for the site of a state prison. Licking then purchased a parcel of land and deeded it to the state for the prison site. To finance the land purchase and certain improvements, the city utilized a financing arrangement similar to the one used in St. Charles City-County Library District. First, the city entered into a base facility lease agreement with a bank. The city leased to the bank certain city-owned property (not related to the land for the prison). In return, the bank agreed to pay rent to the city. Simultaneously with the base lease agreement, the city entered into a one-year facility lease agreement with 14 options to renew held by the city. Under this agreement, the bank leased the property back to the city.

Pursuant to the agreements, the bank also issued $595,000 worth of "Certificates of Participation" to fund the acquisition and improvement costs. This constituted the rent the bank paid to the city under the base lease agreement. The city pays annual rent under the facility lease agreement according to a schedule that is part of the agreement. These rental payments obligate the city to pay off the $595,000 Certificates over a 15-year period. The Certificates mature at different times. However, payments are due only once a year on each December 1, beginning in 1998 and ending in 2012. A taxpayer sued, challenging the financing arrangement as unconstitutional.³⁶

The court declined to address whether the financing arrangements between the city and the bank were improper because the issue was not stated in the points relied on, and thus not preserved for review.³⁷ However, the court did address the taxpayer's argument that art. VI, § 26(a) required the city to show the entire $595,000 debt as an expenditure in one fiscal year. If true, the city would have been in violation of art. VI, § 26(a), according to the court.³⁸ However, if the city is only required to show the annual debt payment due in the corresponding fiscal year, then the city would not be in violation of the constitutional provision.³⁹

Applying the Mercantile Bank formula, the court held as follows:

Thus, Mercantile Bank teaches that Licking is not required to measure the entire $595,000 debt as a current expenditure. Only the $55,130.83 payment is an expenditure for the City's 1998 fiscal year in determining whether the City exceeded the expenditure limitation under Article VI, Section 26(a). Therefore, by only considering the first year's payment as an expenditure, it is clear that Licking did not exceed the expenditure limitation.⁴⁰

Thus, the Burks court upheld the validity of a multi-year financing arrangement under the Mercantile Bank framework.

IV. Conclusion

"As Thomas Jefferson once stated '…public debt (is) the greatest of dangers to be feared.'"⁴¹ The purpose of debt-limitation provisions is to protect taxpayers from oppressive taxation and to prevent current elected officials from binding future elected officials. Any multi-year transaction or arrangement requiring the expenditure of funds over a period of years could face rigorous scrutiny by taxpayers and others. The good news for elected officials is that Mercantile Bank and Burks give municipalities a clear road map that, if followed, will assure that such transactions or arrangements will withstand scrutiny. Thus, if transactions are properly structured municipalities can pursue economically advantageous opportunities without fear of violating the constitution.

Endnotes

This article addresses only Article VI, Section 26(a), which limits "indebtedness of local governments without a popular vote." Sections 26(b) and 26(c), address limitation of indebtedness authorized by popular vote. Though Sections 26(b) and (c) are beyond the scope of this article, practitioners should review these sections.

2 15 McQuillin Mun Corp § 41.01 (3rd Ed. 1995).

3 Id.

4 Id.

5 15 McQuillin Mun Corp § 41.03 (3rd Ed. 1995).

6 Id.

7 Mo. Const. art. VI, § 26(a).

8 Mo. Const. art. X, § 12 (1875).

9 Ronald M. Belt, Constitutional Limitations on Indebtedness of Local Governments in Missouri, 1957 Wash. U. L.Q. 59, 59-60 (1957).

10 Isador Loeb, Conventions and Constitutional Conventions In Missouri, 1 Journal Missouri Constitutional Convention of 1875 at 25-42 (1920).

11 Grand River Township v. Cooke Sales and Servs., Inc., 267 S.W.2d 322, 325 (Mo. 1954).

12 State ex rel. Strong v. Cribb, 273 S.W.2d 246, 250 (Mo. banc 1954).

13 In Mercantile Bank of Illinois v. School Dist. of Osceola, 834 S.W.2d 737 (Mo. banc 1992), the court discussed the Grand River Township and State ex rel. Strong cases, noted the inconsistency, and concluded: "In the face of this uncertainty in the precedent, we believe that a fresh consideration of the demands of article VI, section 26(a), is warranted."

14 Mercantile Bank of Illinois v. School Dist. of Osceola, 834 S.W.2d 737 (Mo. banc 1992).

15 Mercantile Bank, 834 S.W.2d at 741.

16 Id.

17 Id.

18 Id. (emphasis added)

19 Id.

20 Id.

21 Id.

22 Id. (emphasis added)

23 St. Charles City-County Library Dist. v. St. Charles Library Bldg. Corp., 627 S.W.2d 64 (Mo. App. E.D. 1981). Although this case was decided before Mercantile Bank, its holding is consistent with the Mercantile Bank holding.

24 Id.

25 Id.

26 Id.

27 Id. at 67 n.1.

28 Id. at 68.

29 Id.

30 Id. at 67-68.

31 Id. At 68.

32 Id.

33 Id.

34 See Jennings v. City of Kansas City, 812 S.W.2d 724 (Mo. App. W. D. 1991); Hellman v. St. Louis County, 302 S.W.2d 911 (Mo. 1957).

35 Burks v. City of Licking, 980 S.W.2d 109 (Mo. App. S.D. 1998). Harvey M. Tettlebaum of Husch & Eppenberger, LLC and the authors of this article represented the City of Licking and its mayor in this case.

36 Id. at 110.

37 Id. at 115.

38 Id.

39 Id.

40 Id. at 116.

41 15 McQuillin Mun Corp § 41.01 (3rd Ed. 1995).

Lowell Pearson is a member in the Jefferson City office of Husch & Eppenberger, LLC. He received his J.D., 1984, from Stanford University. He is a member of The Missouri Bar and Cole County Bar Association. Mr. Pearson is the administrative law editor for The Missouri Bar's Courts and CLE Bulletin.

Terry Jarrett is an associate in the Jefferson City office of Husch & Eppenberger, LLC. He received his J.D., 1996, from the University of Missouri-Columbia School of Law. Mr. Jarrett is a member of the American Bar Association, The Missouri Bar and the Cole County Bar Association.