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Web address: http://www.law.com/ny
VOLUME 228—NO. 98
THURSDAY, DECEMBER 11, 2002
Liberty Bonds
A Low-Cost Commercial and Retail Boost
S
oon after the twin towers fell,
New York City and state made
plans to revitalize and redevelop Lower Manhattan. A key to
this redevelopment is a new form of
low-interest rate financing provided
by Liberty Bonds.
Proceeds of Liberty Bonds may be
used for the acquisition, construction,
reconstruction and renovation of nonresidential real property for commercial
or retail purposes (including fixed tenant improvements associated with
either), or public utility property, located in the Liberty Zone and for certain
projects located outside the Liberty
Zone but within the city.
The Liberty Zone, that area below
the jagged line formed by Canal Street,
East Broadway and Grand Street, is the
focus of various federal tax benefits
enacted in the Job Creation Act and
Worker Assistance Act of 2002. Shortterm tax incentives provided by the
act, codified in Section 1400L of the
Internal Revenue Code of 1986, as
amended and targeted to redeveloping
the Liberty Zone, include targeted
employee tax credits, additional depreciation deductions, increased expensing
of business property, an extended
replacement period for involuntarily
Valerie Pearsall Roberts is a partner at
Jones, Day, Reavis & Pogue. James H.
McCormick, an associate at the firm,
assisted in the preparation of this article.
FINANCING
VALERIE PEARSALL
ROBERTS
converted Liberty Zone property,
five-year depreciation of qualified
Liberty Zone leasehold improvement
property and the issuance of tax exempt
bonds to finance the construction and
rehabilitation of commercial, retail
and public utility nonresidential real
property and residential rental property
located in the Liberty Zone.
How the Bonds Work
Liberty Bonds are tax-exempt debt
obligations to be issued in an aggregate
principal amount not to exceed $8
billion by the New York Liberty
Development Corporation (LDC) on
behalf of the state, or the New York City
Industrial Development Agency (NYC-
IDA) on behalf of the city (together, the
issuers) before Jan. 1, 2005, and sold to
the general public (bondholders).
Proceeds of Liberty Bonds will be
loaned to qualified borrowers to finance
commercial and retail Liberty Zone
Projects. A limited amount of Liberty
Bonds may be issued for specified NonZone Projects. Each issue of Liberty
Bonds will be secured by pledged project
revenues, generally without recourse to
the borrower, issuer, city or state.
The credit worthiness and interest
rate on an issue of Liberty Bonds will
depend on the project’s credit worthiness, credit enhancement on the bonds
provided by municipal bond insurance,
other credit support or a guarantor,
the financing structure, and market conditions generally. Liberty Bonds are a
unique means of providing tax-exempt
financing not previously available for
commercial and retail projects.
Interest savings due to Liberty Bond
financing can be substantial because
interest on such bonds is exempt from
federal, state and local income taxes,
and is not an item of tax preference
subject to the alternative minimum tax.
Those tax savings are generally passed
through to the borrower.
Major differences between commercial
loans obtained from banks or insurance
companies (conventional financing) and
Liberty Bond financing include the
interest rate on, and source of, the funds
loaned (in conventional financing, funds
NEW YORK LAW JOURNAL
are provided by commercial lenders
charging commercial (taxable) interest
rates versus governmental issuers lending
amounts borrowed from bondholders at
low interest rates due to the triple tax
exempt status of such interest); the
limitations imposed on the borrower
and on the project (by conventional
financing lenders versus by the federal
government through restrictions on the
use of Liberty Bond proceeds contained
in Sections 103, 141-150 and 1400L of
the code, as well as restrictions imposed
by the issuers).
In addition, commercial financing
is often a two-step process consisting
of construction period financing by
one lender followed by “permanent”
financing by a second Lender (often
containing a balloon payment which
must be refinanced at market interest
rates by another lender). In contrast,
Liberty Bonds can be used for both construction and permanent financing, or
simply permanent financing, so long as
the Liberty Bonds are issued before their
sunset date of Jan. 1, 2005. In contrast
to conventional financing, the structure
of tax exempt debt is extremely flexible.
Multi-modal structures and embedded
derivatives are common features.
Limitations
The major limitations imposed by the
act are that only $8 billion of Liberty
Bonds, in the aggregate, may be issued.
Of that $8 billion, no more than $2
billion may be issued for Non-Zone
Projects, and no more than $800 million may be issued for retail property
(defined as property used for retail sales
of tangible property and functionally
related and subordinate property); 95
percent of the net proceeds of each
issue of Liberty Bonds must be spent on
eligible costs; each project and each
issue of Liberty Bonds must be approved
by one of the issuers each issue of Liberty Bonds must be designated as such by
either the governor or mayor; and all
such Liberty Bonds must be issued
before Jan. 1, 2005.
Although amortization on each issue
of Liberty Bonds must begin no later
than 10 years after the bonds issue, principal amortization before that time is
not required. The maximum term of
Liberty Bonds is not specifically limited
by the act, but the weighted average
maturity of tax exempt bonds cannot
exceed 120 percent of the remaining
weighted average useful life of the bondfinanced property.
Eligible Costs
As noted above, 95 percent or more of
the net proceeds of each issue of Liberty
Bonds must be spent on eligible costs.
For Liberty Zone Projects, eligible
------------------------------------------------
There are limitations
on costs which can be
financed with proceeds of
Liberty Bonds. The most
important is that only
5 percent of the net proceeds
can be spent on non-eligible
costs.
------------------------------------------------
costs means capitalizable costs of
acquisition, construction, reconstruction and renovation of nonresidential
real property (other than moveable
property) including commercial property, retail property and fixed tenant
improvements associated with either
type of property, as well as public utility
property (such as gas, water, electric and
telecommunication lines).
For Non-Zone Projects, similar costs
(other than costs for public utility
property) constitute eligible costs, but
only if such property is part of a project
consisting of at least 100,000 square feet
of contiguous usable office or other
commercial space located in a single
building or multiple adjacent buildings.
The act provides a $2 billion cap on
Liberty Bonds issued for Non-Zone
Projects but provides no requirement
that Non-Zone Bonds be issued nor any
“set-aside” for Non-Zone Projects.
Open Questions
Among the questions yet unanswered
are the limits of what constitutes “commercial” property for purposes of Liberty
Bond financing. For example, do hotels,
recreational facilities or movie studios
constitute “commercial” property for
purposes of the act?
Another open question involves the
financing of “fixed tenant improvements.” It is unclear whether the cost of
fixed tenant improvements paid by the
tenant can be financed with Liberty
Bonds, whether the tenant, itself, can be
a direct borrower of Liberty Bond proceeds, or whether the owner can or must
finance the fixed tenant improvements
and recover the financed costs as “additional rent” under the lease.
Eligible cost status is unclear for many
other expenditures, such as certain carrying costs, developers’ fees paid to the
developer or related parties, and costs
for other items not described in the act
or its legislative history. Clarification of
such issues is necessary.
There are limitations on costs which
can be financed with proceeds of Liberty Bonds. The most important limit is
that only 5 percent of the net proceeds
can be spent on non-eligible costs.
This 5 percent, frequently referred
to in tax-exempt financing as the “5
percent bad money” portion, can be
used to pay costs of issuance for the
bonds (limited to 2 percent of the bond
proceeds) or other non-eligible costs
such as working capital, or moveable
fixtures or equipment.
Non-eligible costs in excess of the
5 percent bad money limit and costs
of issuance in excess of the 2 percent
limit must be paid from another source
of funds. In addition no more than
25 percent of the proceeds of an issue
of Liberty Bonds may be used to
acquire land.
THURSDAY, DECEMBER 11, 2002
Joint Requirements
The issuers jointly implemented
the New York Liberty Bond Program,
sharing benefits and responsibilities to
provide a user-friendly process for
potential borrowers.
In August 2002, the issuers published
Legal and Administrative Requirements
(Form Legal 08/02) (available from
either issuer) detailing program requirements including the following
Threshold Eligibility Requirements.
• Liberty Zone new construction:
Each project for new commercial construction located within the Liberty
Zone must create at least 20,000 square
feet of contiguous commercial space.
• Liberty Zone renovation: Each
renovation project within the Liberty
Zone must contain at least 50,000
square feet of contiguous commercial
space, and must involve expenditures
for “base building improvements” of at
least $50 per square foot.
If the project involves the acquisition
of an existing facility, the renovation
expenditures must equal or exceed 50
percent of the portion of the facility cost
financed by Liberty Bond proceeds.
For this purpose “base building
improvements” are generally valueadding capital improvements for an
existing building, increasing the area or
volume of the building or constituting a
replacement, or substantial upgrade of,
core facilities and systems, and having a
life in excess of three years.
• Non-Zone New Construction: Each
non-zone project for new commercial
construction must create at least
100,000 square feet of contiguous
commercial space.
• Non-zone renovation: Each
non-zone renovation project must
contain at least 100,000 square feet of
contiguous commercial space, and must
involve expenditures for “base building
improvements” of at least $100 per
square foot.
If the project involves the acquisition
of an existing facility, the renovation
expenditures must equal or exceed 50
percent of the portion of the facility cost
financed by Liberty Bond proceeds.
• Prohibited person proscription:
Financing is denied when an applicant,
owner, principal, affiliate or obligor
is in default or breach of its written
obligations to the issuer, city, state or
certain related entities or has been
convicted of a felony or crime involving
moral turpitude.
• Prohibited users: The federal
government and its instrumentalities,
and perhaps by the city and state, are
exempt from the program.
project. Such resolution does not ensure
issuance of the bonds, but is a necessary
first step.
When the issuer is satisfied that the
project terms are substantially final,
the state and city will request the
governor or the mayor, at his discretion,
to “designate” the bonds, a legal
requirement of the act.
Thereafter, the issuer will adopt a
Liberty Bond resolution authorizing the
terms of the bonds (including the
maximum principal amount and the
bond structure ), and make an environmental impact finding, if necessary.
Joint Principals
Conclusion
Jointly announcing the Liberty Bond
Program, Governor George E. Pataki
and Mayor Michael R. Bloomberg stated
as its major principles to repair and
replace damaged or destroyed commercial space and to improve lower quality
commercial space; to create additional
multifamily residential rental housing
and complementary retail development
in the zone; to provide modern office
space for displaced and decentralizing
businesses in central business districts
throughout the city; to attract new
residents and employers to the city; and
to encourage environmentally responsible design and construction.
The Program Principles and Threshold Eligibility Requirements, together
with additional information regarding
the Liberty Bond financing process can
be found in the Issuers’ Project Application, New York Liberty Bond Program,
Commercial Facilities (Form APPL
08/02), available from either issuer.
In general, an applicant must complete and sign the application request
and, together with an application fee of
$25,000 (payable 50 percent to each
issuer) submit it to either issuer for
review by the state and city, for consistency with the Program Principles and
the Legal and Program Requirements.
If the project is accepted, the issuer
will adopt a resolution “inducing” the
Although the benefits can be
substantial, Liberty Bond financing is
highly complex.
An act as commonplace as signing a
lease with an anchor tenant prior to
obtaining an inducement resolution
from an issuer could preclude the use of
Liberty Bond financing.
Borrowers should keep the Web sites
handy, contact the issuers, and hire
competent counsel with a combination
of real estate and bond counsel
experience, as early in the projectplanning process as possible.
The issuers are making the program
user-friendly and are committed to the
issuance of Liberty Bonds and the
rebuilding of the Liberty Zone.
Applications and additional information may be obtained from the LDC
at www.nylovesbiz.com or by calling
212-803-3766; or the NYC-IDA at
www.newyorkbiz.com/libertybonds,
212-312-3600, or [email protected].
This article is reprinted with permission from the
December 11, 2002 edition of the NEW YORK LAW
JOURNAL. © 2002 NLP IP Company. All rights
reserved. Further duplication without permission is
prohibited. For information contact, American
Lawyer Media, Reprint Department at 800-888-8300
x6111. #070-12-02-0020
www.jonesday.com