1.2.4.5 Contingent Obligation Exception

1.2.4.5 Contingent Obligation Exception

PREMISE – An obligation such as a service contract or debt related financial product may be eligible for the exception if the public agency’s obligation to make payments from the income and revenue of a future fiscal year is contingent upon the public agency’s benefitting from the service or product during that fiscal year.

LEGAL REQUIREMENTS – The public agency must have no payment obligation in any fiscal year unless in that fiscal year the other party is providing benefits (e.g., services, use of property) or is at least able to perform required services or make required payments. For example, one leading case found that a multiyear sewage disposal service contract with a private company fell within the exception because the obligation to make payments in future years did not arise until the service was provided to the city in those future years.47 The payment obligation in any fiscal year may exceed the amount of the actual benefit received in that year.

CAVEAT AND QUALIFICATIONS – Because the case law is not well developed, Contingent Obligation Exception structures generally require a validation proceeding if the financing requires an unqualified opinion to proceed. 

COMMON APPLICATIONS IN THE PUBLIC FINANCE CONTEXT – The Contingent Obligation Exception is commonly applied to service contracts, interest rate swaps (See Section 2.3.3, Interest Rate Swaps and Synthetic Structures) and financial products.