11 minute read | February.21.2024
For more than 10 years, as the subsidy for direct payment Build America Bonds (BABs) has been less than originally promised due to sequestration, issuers have wondered if sequestration constituted an “extraordinary event” that would trigger their right to seek extraordinary optional redemption.
A recently concluded court case provides favorable guidance for issuers. Although the specific language must be reviewed in each case, we believe extraordinary optional redemption is available for issuers of BABs in most cases.
Key Context
Most BABs were issued with an extraordinary optional redemption feature (less costly) and a make whole call feature (more costly). The extraordinary optional redemption was intended to be available if the 35% subsidy rate was reduced for reasons other than the fault of the issuer.
The 35% subsidy for BABs has been reduced since 2013 through sequestration.
An issuer’s ability to exercise the extraordinary optional redemption turns on whether there has been an “extraordinary event” as defined in the extraordinary optional redemption provision for the specific bonds.
The Issue with Extraordinary Calls
The ability to exercise extraordinary optional redemptions is a matter of contract interpretation, and the specific language of the contract in question is paramount, together with the intent of the parties. A common extraordinary optional redemption provision defines an “extraordinary event” as follows:
An “Extraordinary Event” will have occurred if a material adverse change has occurred to Section 54AA or 6431 of the Internal Revenue Code of 1986, as amended (as such Sections were added by Section 1531 of the American Recovery and Reinvestment Act of 2009 (ARRA), pertaining to “Build America Bonds”) pursuant to which the [Issuer’s] 35% cash subsidy payment from the United States Treasury is reduced or eliminated.
In this formulation, an “extraordinary event” requires a “material adverse change” to §§ 54AA or 6431 of the Code. That material adverse change must result from a reduction in the 35% cash subsidy. The intent was to trigger the extraordinary optional redemption if the cash subsidy payment to the issuer was reduced due to a change in law. As noted, the intent of the parties is critical to interpreting the language of a contract, and based on the intended meaning, sequestration is an “extraordinary event.” However, because the language of §§ 54AA and 6431 has not been amended, many issuers and their counsel have been uncertain on whether sequestration constitutes a change to §§ 54AA or 6431.
The Importance of §§ 54AA and 6431 of the Code and § 1531 of the American Recovery and Reinvestment Act (ARRA)
BABs were created by § 1531 of the American Recovery and Reinvestment Act of 2009, which added §§ 54AA and 6431, the sections containing the principal rules applicable to BABs, to the Code. In addition, ARRA made several conforming amendments to other sections of the United States Code, including amending 31 USC § 1324(b)(2) to provide that necessary amounts are appropriated to make disbursement for “refunds due from credit provisions of the Internal Revenue Code of 1986…(including from section) 6431.”
How Sequestration Changed Direct Payment BABs
After the enactment of §§ 54AA and 6431 in 2009 and after all BABs were issued, Congress reinstated and amended the Budget and Emergency Deficit Control Act of 1985 through the Budget Control Act of 2011. The Budget Control Act requires automatic reductions of certain government spending through sequestration, which “refer[s] to or mean[s] the cancellation of budgetary resources provided by discretionary appropriations or direct spending law.” Although several programs with payment obligations are exempted from sequestration, the BABs program is not among them.
No BABs subsidy payments were reduced, however, until the American Taxpayer Relief Act of 2012 required the implementation of the sequestration provisions “[n]otwithstanding any other provision of law.” Accordingly, in 2013 the United States stopped making payments to issuers of BABs at the full 35% rate.
Neither the Budget Control Act nor the Taxpayer Relief Act resulted in a change in the wording in either § 54AA or § 6431. Instead, as they relate to BABs, these acts required reductions in direct spending. The Office of Management and Budget determined that the payment obligation created by §§ 54AA and 6431 was subject to the sequestration, which meant issuers received cash subsidy payments starting in 2013 that were less than 35%. Is the change to the 35% payment obligation due to sequestration a change to §§ 54AA or 6431 even though the language of neither section was amended?
How the Change in the 35% Rate Impacts Existing Law
For the federal government to make a payment, Congress must authorize or mandate it and appropriate funds. Section 6431 mandates a payment, but it does not include an appropriation to make the payment. Instead, as mentioned above, the legislation enacting §§ 54AA and 6431 also amended 31 USC § 1324(b)(2) to provide a continuing appropriation to fund the BABs program. Thus, to be precise, the sequestration provisions of the Budget Control Act and the Taxpayer Relief Act are a legislative change to either or both the § 6431 obligation to pay or the 31 USC § 1324(b)(2) continuing appropriation to fund the obligation to pay. In both cases, the 35% subsidy rate is reduced, but the former is a more direct change to § 6431.
Principles of Interpretation
When considering conflicting statutes, the courts have established several principles that apply.
As discussed below, these principles support the conclusion that the sequestration acts are a legislative change to § 6431. In fact, these principles are examined in the context of the BAB program in Indiana Municipal Power Agency v. U.S., a case that recently was decided in the Federal Claims Court, affirmed by the Federal Circuit and on November 20, 2023, denied certiorari by the Supreme Court.
Overview of Indiana Municipal Power Agency v. U.S.
In Indiana Municipal Power Agency, a group of local power agencies that had issued BABs sought to restore their full 35% subsidy payments, past and future, that were reduced as a result of sequestration. The agencies made two arguments:
The court held that “[t]he government was statutorily required to reduce its payment obligations” and that “[t]he Taxpayer Relief Act expressly modifies the government’s existing payment obligations, and it does so in a way that directly conflicts with the earlier payment program created by section 1531 of the ARRA.” The court repeatedly said that the sequestration statues altered the government’s payment obligation with respect to BABs by reducing the amount the government must pay.
The question then became whether an alteration to the payment program constitutes an “extraordinary event” for purposes of the extraordinary optional redemption provisions of BABs.
Sequestration as an “Extraordinary Event”
Section 6431 states that the Secretary shall pay the 35% subsidy. Sequestration provided that, notwithstanding any other provision of law, the budgetary resources sequestered from any account shall be permanently cancelled. The principles of interpretation set forth earlier require that when two statutes are irreconcilable, the later statute prevails. As a result, the provisions of sequestration are given effect and the 35% subsidy rate established in § 6431 is suspended. This is evidenced by the fact that when Congress enacted the sequestration provisions and started sequestration, the U.S. Treasury began paying at the lower sequestration rate. As supported by the reasoning in Indiana Municipal Power Agency and a consistent body of older case law, that change was an alteration in the federal government’s obligation to pay. That change is materially adverse to issuers of BABs – an “extraordinary event” has occurred and is continuing.
If instead the sequestration acts are technically considered changes to the 31 USC § 1341(b)(2) continuing appropriation for the obligation to pay, the change to the appropriation is in direct, irreconcilable conflict with the 35% statutory rate set forth in § 6431. In addition, Congress clearly expressed its intention that sequestration was intended to override other existing laws by stating that sequestration would apply “notwithstanding any other provision of law.” As discussed earlier, the Supreme Court has referred to similar changes made by appropriations in less than the full amount mandated by other statutes as “suspending” or “repealing” the inconsistent provisions in the prior law. It is reasonable to think that a court would reach a similar result here.
Specific Focus on Extraordinary Call Language
Under the definition of “extraordinary event” in common extraordinary optional redemption provisions, a formal amendment of §§ 54AA or 6431 is not required. Instead, this formulation only requires a “material adverse change” to either section that results in the reduction or elimination of the 35% subsidy payment. The reference to “material adverse change” rather than “amendments” makes it clear that the “extraordinary event” language was intended to be triggered by actions that might not constitute an amendment to §§ 54AA or 6431. The sequestration statutes may not have altered the text of these two sections, but they reduced the 35% payment rate. Section 901(b) of the Taxpayer Relief Act required the reduction in the cash subsidy payments “notwithstanding any other provision of law.” The court in Indiana Municipal Power Agency held that this was an express alteration of the BABs program and thus, the corresponding reduction is a material adverse change to § 6431.
The same is true for most “extraordinary event” definitions that we have reviewed. The wording of the definitions varies significantly, with some being more restrictive and some less. Some documents use the defined term “tax law change.” The language examined herein is a simple formulation, chosen to facilitate the discussion. Another common formulation requires a “modification” instead of a “change.” That and similar differences are not material to the conclusion. This article does not address the impact of “extraordinary event” language that includes a “determination” by the issuer, because that language only helps to reach the favorable conclusion, being intended to give issuers more flexibility to find an “extraordinary event” has occurred. This article also does not address the impact of “extraordinary event” language that includes as a separate “extraordinary event” a determination or guidance by IRS/Treasury. There may be such an act by IRS/Treasury, but we leave that for another article.
Conclusion
Since 2013, issuers have questioned whether sequestration constitutes an “extraordinary event” that allows them to exercise their extraordinary optional call right. The Indiana Municipal Power Agency case supports the conclusion that sequestration resulted in a materially adverse change to the cash subsidy payment obligation established in § 6431. As a matter of contract interpretation, taking into account the intent of the parties and the above analysis, it is clear that a material adverse change has occurred to Section 6431.