Voice from the Past
Chapter 2

Industrial Development Bonds started out in Mississippi as general obligation bonds voted by the people at elections and subject to statutory or constitutional debt limits. They were by no means the first bonds to be issued for the benefit of private corporations; indeed, the railroad bonds of the second half of the 19th century were issued for that purpose. Abuses of the power to issue such bonds were responsible for the existence of most State debt limits and election requirements as well as the prohibitions against the loan of the credit of a State or political subdivision. The same reaction inspired the Michigan Constitutional prohibition against bonds for works of "internal improvement" -- a provision that can shock a young bond lawyer trying to work on a water revenue bond issue in that State.

However, things were different in the depression in the deep South, where young people could find no way to make a living on the farms or in rural towns and villages. Even after World War II many of these municipalities were dying because their young adults were going to the cities for whatever work could be found. Few factories were locating anywhere. And the produce of the farms often lacked a market because no processor was nearby. It appeared that the problem should be addressed by the citizens using the borrowing power of a town to help some entrepreneur build a factory that would use local employees to make products of local farms. At first the Mississippi Supreme Court turned down bonds voted for such a purpose as a loan of credit, but then upheld an issue in which the factory would remain the property of the municipality whether or not the tenant-operator stayed in business and paid the rent. This led Charles and Trauernicht (who approved most Mississippi municipal bonds then) to take the position that bonds for such purpose could not be secured by a mortgage.

I started working on such bonds issued by political subdivisions in Louisiana, where Chapman and Cutler approved most issues in the 1950's. One issue was for a dairy operation that bought milk from local farmers; another plant was to be built to make things out of bagasse. On asking what bagasse was, I was told that it is the residue left over from harvesting and squeezing the juice out of sugar cane. Both were small issues in a day when a $100,000 issue was considered a large one. They were voted at elections and sold at advertised public sales. No one worried about any requirement for registering them with the Securities and Exchange Commission because the bonds were secured by and sold on the credit of the taxing power of the issuer. They were also sold to local investors, mostly banks, I suspect. The Internal Revenue Service showed no curiosity about such bonds. I don't know what happened to the projects later, I hope they prospered. At least I have not heard of any default.

I recall a deal (perhaps for a shoe factory) that did not get done because, after the bonds had been voted and sold, the mayor refused to sign them. He had looked at the company's most recent balance sheet and found it unsatisfactory: the company was losing money and almost bankrupt; the mayor was not going to subject his town to this sort of burden. The dealer asked if there was any way to force the mayor to sign the bonds and deliver them in accordance with the town's contract. I recalled that when test litigation is to be brought, the form of the lawsuit may be a writ of mandamus to compel a mayor to sign bonds that he conveniently refuses to sign, but did not recommend the practice in this case. As I had been hired by the issuer, I could not participate in any suit against it, but suggested to the dealer that he make a list of his expenses in the deal and send it to the mayor with a request for reimbursement. I don't recall getting paid either, though I may have sent a bill for the usual $25 for issues that didn't go through.

The practice of issuing general obligation industrial development bonds moved north like the spring, but slower. In time my partners were working on them in Arkansas, Tennessee and Kentucky. All were small. Then a funny thing happened. Someone realized that if a company had good enough credit to sell bonds on its own, the bonds could be revenue bonds, payable solely from the rentals of the industrial facility, and the issuer's credit need not be involved. Industrial development bonds had to be first approved in a test case by each State Supreme Court, so it was not difficult to include in such litigation the question of whether the company could buy the project, after the revenue bonds issued for its construction were paid, for nominal consideration. The large issues that existed mainly for the purpose of obtaining tax-exempt interest rates attracted attention from the Internal Revenue Service and then the Congress after several years during which the IDB business bloomed and boomed.

I recall my big lesson in the difference between the Louisiana Civil Code and the common law at that time. When it was suggested that such revenue bonds be issued in Louisiana pursuant to newly enacted legislation, a local lawyer, on reading the proposed documents, ascertained that the company would get the plant after the revenue bonds were paid for only $1,000. "But that's lesion beyond moiety!" he exclaimed. I gulped and asked, "What's that?" Lesion beyond moiety turned out to be a Civil Code doctrine to the effect that if a piece of immovable property is sold for less that one-half its value, a court can set the transfer aside. This question, with whatever else we thought should be decided by the State Supreme Court, was included in the test litigation. The Court came to a sensible decision: that the transaction was in fact a long term sale agreement (a characterization supported by the Civil Code) and that the price the company would pay was well in excess of half the value, and besides, the lesion-beyond-moiety doctrine was intended to protect widows and orphans, not cities and parishes.

Manly W. Mumford