When does a Tennessee city or county 'lend its credit' to a private party in a way that triggers the constitutional requirement of a 3/4 voter approval?

Subject

Opinion No. 15-42, Lending of Credit by Municipality, April 27, 2015

Plain-English summary

Tennessee's constitution (Article II, § 29) blocks counties and cities from "lending their credit" to private people or companies unless three-fourths of voters approve. Senator Gardenhire asked the AG whether three common transactions trigger that clause: paying a vendor in advance for goods, selling municipal goods or services on a deferred-payment basis, and selling real property to a developer in exchange for a promissory note where the city's security is subordinated to other lenders.

The AG's answer to all three was the same: none of them, in and of themselves, trigger the lending-of-credit clause. The word "credit" in the constitutional clause means a new financial liability that creates a public debt for the benefit of a private enterprise. Paying a vendor in advance from existing funds does not create a debt, it just spends down cash. Selling on credit does not create a debt either, it just gives the buyer time to pay an existing obligation. Selling property for a subordinated note does not create a debt, even though the city might lose its security in a foreclosure, because the city is not obligated to assume the developer's debt to keep its lien.

The AG noted important caveats. Even though these transactions do not violate the constitution, they could still violate a municipal charter, code, or bond covenants. And selling property at less than adequate consideration, or unreasonably deferring payment, could create separate problems under municipal law.

Currency note

This opinion was issued in 2015. Subsequent statutory amendments, court decisions, or later AG opinions may have changed the analysis. Treat this page as historical context, not current legal advice. Verify current law before relying on any specific rule, deadline, or remedy mentioned here.

Common questions

What does the lending-of-credit clause actually say?

Article II, § 29 of the Tennessee Constitution provides that the "credit of no County, city or town shall be given or loaned to in aid of any person, company, association or corporation, except upon an election to be first held by the qualified voters of such county, city or town, and the assent of three-fourths of the votes cast at said election." So unless the local government holds an election and gets a 3/4 supermajority, it cannot lend its credit to a private party.

Why doesn't paying a vendor in advance count as lending credit?

Because no new public debt is created. The city is using money it already has. Tennessee courts have repeatedly said the lending-of-credit clause is about creating new financial liability, not about spending existing money. As Copley v. County of Fentress put it back in 1972, "credit" implies "some new financial liability upon a county, city or town which in effect results in creation of a public debt for the benefit of private enterprises."

What about selling on credit, isn't that "extending credit"?

It is, but it is the city extending credit to its customer, not the city's credit being lent to support the customer. The Pennsylvania Supreme Court explained the difference in Vitacolonna: a lending-of-credit clause prevents the city from becoming a guarantor or endorser for someone else's benefit; it does not prohibit reasonable collection arrangements with the city's own debtors.

Is the subordinated-note transaction risk-free?

Constitutionally, yes (no lending of credit). Financially, no. If the developer defaults and a senior lender forecloses, the city's lien might be wiped out and it would lose its property interest, even though it would still have the personal obligation on the promissory note. The opinion notes the city could choose to assume the developer's debt to protect its property, but is not obligated to do so. And municipal charters, codes, or bond covenants might independently restrict these arrangements.

Does this opinion mean cities can give favorable financing to anyone?

No. The opinion only addresses the constitutional lending-of-credit clause. Other rules still apply, including statutory limits on municipal lending, fair-consideration requirements for sales of public property, bond-covenant restrictions, and conflict-of-interest rules. The opinion repeatedly flags those as separate concerns.

Background and statutory framework

The lending-of-credit clause in Article II, § 29 of the Tennessee Constitution traces back to 19th-century concerns about local governments going broke by underwriting private ventures, especially railroad investments. Tennessee courts have interpreted the clause narrowly to apply only when the local government takes on a new financial liability that benefits a private party.

The leading Tennessee decision is Copley v. County of Fentress, 490 S.W.2d 164 (Tenn. Ct. App. 1972), which upheld a county building an industrial facility with accumulated funds for use by a private industry. The court looked to similar constitutional provisions in Florida and Idaho, in Nohrr v. Brevard Cnty. Educ. Facilities Auth., 247 So.2d 304, 309 (Fla. 1971), and Engelking v. Investment Bd., 458 P.2d 213, 218 (Idaho 1968), and concluded that "credit" means a new financial liability creating public debt for private benefit. Ragsdale v. City of Memphis, 70 S.W.3d 56 (Tenn. Ct. App. 2001), reaffirmed Copley in the context of accumulated-fund contributions to a sports-arena project.

Out-of-state authorities reinforced the same point. City of Clovis v. Southwestern Public Service Co., 161 P.2d 878 (N.M. 1945), held that selling a city's utility system on a 24-installment deferred-payment basis was not a lending of credit because the city's burden was not increased. Vitacolonna v. City of Philadelphia, 115 A.2d 178 (Pa. 1955), said the same about deferred-payment meter installations. Elliot v. McNair, 156 S.E.2d 421 (S.C. 1967), framed the clause's purpose as protecting local governments from pecuniary liability.

On the subordinated-note transaction, the AG cited Third Nat'l Bank v. McCord, 688 S.W.2d 446 (Tenn. Ct. App. 1985), for the familiar proposition that junior liens may be extinguished by senior lien foreclosures, and Carll v. South Carolina Jobs-Economic Dev. Auth., 327 S.E.2d 331 (S.C. 1997), for the holding that a lending-of-credit clause is not violated unless the governmental entity is obligated to pay off another's debt.

Citations

• Tenn. Const. art. II, § 29 (lending-of-credit clause)
• Cleveland Surgery Ctr. v. Bradley Cnty. Mem'l Hosp., 30 S.W.3d 278 (Tenn. 2000)
• McConnell v. City of Lebanon, 203 Tenn. 498, 314 S.W.2d 12 (Tenn. 1958)
• Copley v. County of Fentress, 490 S.W.2d 164 (Tenn. Ct. App. 1972)
• Ragsdale v. City of Memphis, 70 S.W.3d 56 (Tenn. Ct. App. 2001)
• Nohrr v. Brevard Cnty. Educ. Facilities Auth., 247 So.2d 304 (Fla. 1971)
• Engelking v. Investment Bd., 458 P.2d 213 (Idaho 1968)
• City of Clovis v. Southwestern Public Service Co., 161 P.2d 878 (N.M. 1945)
• Vitacolonna v. City of Philadelphia, 115 A.2d 178 (Pa. 1955)
• Elliot v. McNair, 156 S.E.2d 421 (S.C. 1967)
• Third Nat'l Bank v. McCord, 688 S.W.2d 446 (Tenn. Ct. App. 1985)
• Carll v. South Carolina Jobs-Economic Dev. Auth., 327 S.E.2d 331 (S.C. 1997)

Source

• Landing page: https://www.tn.gov/attorneygeneral/opinions.html
• Original PDF: https://www.tn.gov/content/dam/tn/attorneygeneral/documents/ops/2015/op15-42.pdf

Original opinion text

STATE OF TENNESSEE
OFFICE OF THE ATTORNEY GENERAL
April 27, 2015
Opinion No. 15-42
Lending of Credit by Municipality

Question 1

Does a municipality lend its credit when it pays a private entity in advance for the purchase of goods?

Opinion 1

Assuming the municipality is advancing payment from accumulated funds, this type of transaction does not come within the purview of article II, section 29 of the Tennessee Constitution.

Question 2

Does a municipality lend its credit when it sells goods or services to a private entity for deferred payment?

Opinion 2

This type of transaction, in and of itself, does not implicate article II, section 29 of the Tennessee Constitution.

Question 3

Does a municipality lend its credit when it sells real property to a developer in exchange for a promissory note, with security subordinated to the developer's other lenders?

Opinion 3

This type of transaction, in and of itself, does not implicate article II, section 29 of the Tennessee Constitution.

ANALYSIS

This opinion addresses whether certain municipal transactions come within the purview of article II, section 29 of the Tennessee Constitution which states, in pertinent part, that the "credit of no County, city or town shall be given or loaned to in aid of any person, company, association or corporation, except upon an election to be first held by the qualified voters of such county, city or town, and the assent of three-fourths of the votes cast at said election." This constitutional provision is commonly referred to as the "lending-of-credit" clause. See Cleveland Surgery Ctr. v. Bradley Cnty. Mem'l Hosp., 30 S.W.3d 278, 284 (Tenn. 2000); McConnell v. City of Lebanon, 203 Tenn. 498, 505, 314 S.W.2d 12, 15 (Tenn. 1958).

Courts have focused upon the meaning of "credit" when deciding whether a transaction implicates this clause.

In Copley v. County of Fentress, 490 S.W.2d 164 (Tenn. Ct. App. 1972), Fentress County proposed to construct an industrial building to be used by a private industry which, in turn, would employ local citizens. The county had accumulated funds that would be used for the construction of the building; no money would be borrowed for the project. Id. at 165-66. The court rejected the complainants' assertion that the proposal violated the lending-of-credit clause. The court observed that the word "credit" is "[a] term of universal application to obligations due and to become due." Id. at 169 (citation omitted). The court then looked to cases from Florida and Idaho, two states that have constitutional provisions similar to Tennessee. The court construed "credit" in the same manner that the high courts had in each of these cases, holding that the word "credit" as used in the lending-of-credit clause of the Tennessee Constitution implies the imposition of some new financial liability upon a county, city or town which in effect results in creation of a public debt for the benefit of private enterprises. Id. at 169 (citing Nohrr v. Brevard Cnty. Educ. Facilities Auth., 247 So.2d 304, 309 (Fla. 1971); Engelking v. Investment Bd., 458 P.2d 213, 218 (Idaho 1968)). Accordingly, the court found that Fentress County had not violated the lending-of-credit clause because the county was not borrowing money for the project and, therefore, not taking on a new financial liability. Id. at 169.

In Ragsdale v. City of Memphis, 70 S.W.3d 56 (Tenn. Ct. App. 2001), the Court of Appeals reiterated its holding in Copley when it held that contributions from the accumulated funds of two local governments for the proposed construction of a sports arena did not constitute lending of credit within the contemplation of article II, section 29 of the Tennessee Constitution. Id. at 68-69. The court emphasized that "[o]ur courts have made clear that lending of credit involves more than the advancement of accumulated funds, since it does not result in the creation of a future indebtedness." Id. at 70.

1. You have asked whether a municipality lends its credit when it pays a private entity in advance for the purchase of goods. There is no mention of the municipality borrowing funds or otherwise taking on a new financial liability in order to make the advance payment. Thus, we assume the municipality is using accumulated funds for the advance payment. Based on the authorities cited above, this type of transaction does not come within the purview of the lending-of-credit clause of the Tennessee Constitution.

2. You have also asked whether a municipality lends its credit when it sells goods or services to a private entity for deferred payment. As explained by the Supreme Court of New Mexico in City of Clovis v. Southwestern Public Service Co., 161 P.2d 878 (N.M. 1945), a municipality generally does not take on a new financial liability in this type of transaction. In City of Clovis, the court considered whether a utility company's agreement to pay a city for its light and water system in twenty-four annual installments constituted a lending of the city's credit. The court found that it did not because "[t]he debts and liabilities of the City, and the burden on its taxpayers, were not increased." Id. at 881. The court reasoned:

Nothing in this phase of the transaction possessed any element of guaranty, suretyship or pledge by the City of Clovis whereby the City became liable to do or perform any act or thing, or to incur any obligation, or pay any sum of money, in behalf of, or for the benefit of, the utility company, or to become liable for, or assure the performance of, any obligation, or the discharge of any liability of the utility to any third person.

Id.

The court concluded that any pledge of credit created by the transaction was a pledge of the utility company, not the city. Id. "The most that [the city] did was to give time" to the utility company for the payment of an obligation owed by it to the city. "This is an entirely different matter from the City of Clovis 'lending or pledging' its credit." Id. (emphasis original).

Similarly, in Vitacolonna v. City of Philadelphia, 115 A.2d 178, 190 (Pa. 1955), the Supreme Court of Pennsylvania rejected a lending clause challenge to a city water regulation that proposed a deferred payment plan for meter installation on the premises of water consumers. The court reasoned:

The City is not lending its credit to the consumer, but rather is at most extending credit to the consumer in a transaction between the consumer and the City. This constitutional provision was designed, inter alia, to prevent the City from becoming indebted as a guarantor or endorser for the benefit of any individual, it does not prohibit reasonable collection arrangements with the City's debtors.

Id.

For the reasons stated above, a municipality does not lend its credit when it sells goods or services to a private entity for deferred payment. Accordingly, this type of transaction, in and of itself, does not implicate article II, section 29 of the Tennessee Constitution. For this type of transaction to come within the purview of this constitutional provision, the transaction would have to involve the municipality assuming some new financial liability that is not ordinarily associated with a standard deferred payment agreement.

3. Lastly you ask whether a municipality lends its credit when it sells real property to a developer in exchange for a promissory note, with security subordinated to the developer's other lenders. As stated above, "credit" as used in article II, section 29 of the Tennessee Constitution implies the imposition of some new financial liability upon a county, city or town which in effect results in creation of a public debt for the benefit of private enterprises. Copley, 490 S.W.2d at 169 (relying on Nohrr, 247 So.2d at 309; Engelking, 458 P.2d at 218). In Nohrr, the Florida Supreme Court explained that "[i]n order to have a gift, loan or use of public credit, the public must be either directly or contingently liable to pay something to somebody." Nohrr, 247 So.2d at 309. In short, the purpose of the lending-of-credit clause is to protect local government entities from pecuniary liability. Elliot v. McNair, 156 S.E.2d 421, 427 (S.C. 1967).

In the transaction you describe, the municipality is a junior lienholder. It is well settled that "[i]t is in the nature of the infirmity of a junior mortgage or lien that it may be extinguished in the enforcement of a superior mortgage or lien." Third Nat'l Bank v. McCord, 688 S.W.2d 446, 450 (Tenn. Ct. App. 1985). Consequently, if a senior lienholder were to foreclose on the property upon a default of the developer, the municipality would face the extinguishment of its lien if the foreclosure sale produced insufficient proceeds. Id. at 450-51. While the developer's obligation to the municipality on the promissory note would remain, the municipality confronts the loss of its interest in the real property. Id. To prevent the loss of its property in this situation, the municipality would have to assume the debt of the developer. Nevertheless, the municipality would not be obligated to do so. Accordingly, this type of transaction does not implicate article II, section 29 of the Tennessee Constitution. See Carll v. South Carolina Jobs-Economic Dev. Auth., 327 S.E.2d 331, 335 (S.C. 1997) (lending-of-credit clause not violated if governmental entity not obligated to pay off another's debt). For this type of transaction to come within the purview of this constitutional provision, the municipality must have a contractual obligation to assume the developer's debt in case of default.

HERBERT H. SLATERY III
Attorney General and Reporter

ANDRÉE SOPHIA BLUMSTEIN
Solicitor General

LAURA T. KIDWELL
Senior Counsel

Requested by:
The Honorable Todd Gardenhire
State Senator
11-A Legislative Plaza
Nashville, Tennessee 37243-0227

Footnotes:

1. Municipal charters and codes, though, generally require a sale of property to be in good faith, upon adequate consideration, and upon reasonable and lawful terms. The same is true with respect to the services that it sells. Thus, a municipality could violate a provision of its charter or code if it unreasonably defers payment for the goods and services that it sells.

2. Municipal charters and codes, though, may prohibit this type of transaction. Moreover, there may be restrictions on the property that would prevent this type of transaction. For example, if a municipality has issued bonds and used part of the proceeds to renovate the property or construct a building upon the property, there may be bond covenants that restrict the sale or use of the property until the bonds are fully paid.