1.2.4.2 Annual Appropriation Exception
PREMISE – The premise of the Annual Appropriation Exception is similar to the Current Fiscal Year Exception (See Section 1.2.4.1 above). A debt obligation qualifies for this exception if the source of repayment is an annual appropriation made by the public agency.
LEGAL REQUIREMENTS – The public agency’s payment obligation in each fiscal year must be limited to income or revenues that the public agency elects in that fiscal year to appropriate for that purpose, or the public agency must have the ability, in each fiscal year, to terminate the agreement without further payment.
CAVEATS AND QUALIFICATIONS – If there is no legal consequence to the public agency of a failure to appropriate, lenders or debt holders must rely on a public agency’s “moral obligation” (expressed or implied) to appropriate or on the public agency having a strong desire to preserve its reputation in the public capital markets by making its payments. As a result, annual appropriate financings are generally structured as leases with the public agency losing possession of the facility if it fails to appropriate. Investors generally require the leased asset be an “essential facility” that the public agency (the lessee) would find difficult to replace if possession were given up and for which the lessee would therefore be inclined to appropriate rental payments. If, however, the consequences are so severe that the public agency is essentially compelled to appropriate (e.g., loss of the use of property, or other rights worth far more than the amount owed, or some other “forfeiture”), the arguments justifying the use of this debt limit exception may not hold.44
COMMON APPLICATION IN THE PUBLIC FINANCE CONTEXT – Although used frequently outside of California, credit issues and the availability of the Contingent Obligation Exception and the “Offner Dean” Lease Exception described below make reliance on the Annual Appropriation Exception in California infrequent.