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New Jersey Passes Referendum to Limit State Borrowing

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Corporate & Finance Alert

November 18, 2008

On November 4, 2008, voters of the State of New Jersey (the “State”) passed a referendum to limit certain types of State borrowing, which referendum was passed by 57% of the State electorate. Specifically, the voters approved an amendment to the State Constitution which requires voter approval of any new legislation that authorizes the State to borrow money by issuing bonds through any State agency or independent State Authority secured by a pledge of “annual appropriations” to pay the principal of and interest on such bonds, unless such debt is paid from an independent non-State government source of revenue paid by a third party or from a source of State revenue dedicated by the New Jersey Constitution (the “Referendum”).

Prior to the passage of the Referendum, the New Jersey Constitution, Article VIII, Section 2, paragraph 3, limited the State Legislature from creating any debt greater than one percent of the annual budget without approval of the voters (the “Debt Limitation Clause”). The Supreme Court of New Jersey had ruled in Lonegan v. State, 174 N.J. 435 (2002 and Lonegan v. State, 176 N.J. 2 (2003) that the Debt Limitation Clause applied only to debt obligations of the State which contained a binding, non-repealable full faith and credit pledge to pay off the debt directly with State taxes. The Supreme Court of New Jersey held that the Debt Limitation Clause did not apply to debt secured by “annual appropriations”, which is a promise of the State Legislature that it will enact future budget appropriations to pay the principal and interest on such debt, because such debt did not constitute a full faith and credit pledge of the State. Consequently, the State Legislature had been permitted to finance projects with this financing structure without the need for voter approval.

This “annual appropriation” debt financing structure became the primary method that various State agencies utilized to finance numerous capital projects. For example, this financing structure was utilized numerous times by the New Jersey Economic Development Authority to finance the school construction program to provide new facilities for public schools. Over nine billion of debt has been issued just for this purpose using this financing structure. The “annual appropriations” financing structure gained widespread acceptance in the credit markets. Even though this financing structure, which is essentially a promise to pay from future budget appropriations by the State Legislature, does not carry the full faith and credit of the State as do general obligations bonds approved by the voters, the credit marketplace considered this financing structure similar to State general obligation debt because it was unlikely the State would default on these State appropriation bonds because of the impact such default would have on its future ability to borrow. The rating agencies assigned ratings on these financings that were just slightly lower than a State general obligation debt financing. According to the New Jersey Treasury Department, out of the $32 billion debt the State and its agencies have outstanding, only $2.8 billion of debt was approved by the voters.

The Referendum contains two exceptions to the voter approval requirement. The first is State debt to be repaid from an independent non-State government source of revenue paid by third persons. Examples include debt issued by the New Jersey Turnpike Authority and repaid by tolls collected, debt issued by the New Jersey Educational Facilities Authority and repaid by a university or college, and debt issued by the New Jersey Health Care Facilities Financing Authority and repaid by hospitals. The second exception is debt to be repaid from a State revenue source that is constitutionally dedicated for specific uses which only the voters can establish. Examples include debt issued by the Transportation Trust Fund Authority and repaid from the constitutionally dedicated gasoline tax and debt issued by the Garden State Preservation Trust and repaid from the constitutionally dedicated portion of the sales tax.

Besides the two exceptions set forth in the Referendum, “annual appropriation” debt financings are also permitted in two additional instances since the Referendum only applies to transactions authorized pursuant to State legislation enacted subsequent to the date of the Referendum. First, transactions financed under current legislation for new construction projects are permitted to be secured by annual appropriations from the State. Examples include the continued financing of the school construction program by the New Jersey Economic Development Authority until the debt limitation in the applicable authorizing statute is reached. Second, transactions financed under current legislation include refinancing of existing annual appropriation transactions.

The Referendum will restrict future State debt financings unless voter approval is obtained, however, voter approval will not be required if the transaction comes within one of the two exceptions noted in the Referendum or the transaction is authorized under current legislation. These carve outs are significant and will enable the State to undertake various projects and incur a significant amount of debt (including debt secured by annual appropriations) without needing to obtain voter approval. So while the net effect of the Referendum on State debt issuance will be to restrict many new transactions, a significant amount of transactions will still be able to financed without the need to go to the voters.