President Obama Signs Sequestration Order

     In response to the debt ceiling crisis of 2011, Congress passed the Budget Control Act of 2011 (“BCA”) as a legislative compromise to control the federal deficit while simultaneously raising the debt ceiling. As you may be aware, the recent failure of Congress to enact a deficit elimination bill under the BCA has triggered automatic spending cuts commonly known as “sequestration.”

Under the BCA, the President is required to issue an order each year implementing the cuts identified by the federal Office of Management and Budget. On March 1, 2013, the President signed the “sequestration order,” which will, in part, reduce federal aid to Michigan school districts and cut a portion of subsidy payments to issuers of “direct pay” bonds. On the state-wide level, Michigan schools will lose approximately $22 million in Title I and Title II funding and approximately $20.3 million for special education funding under the Individuals with Disabilities Education Act (“IDEA”). Other funding, such as the Perkins Career and Technical Education and Work-Study allocations also will be reduced.

For the most part, the cuts will not be retroactive. The majority of federal education programs are advance-funded where the State receives the allocations on July 1 at the end of the federal fiscal year. The United States Department of Education (“USDE”) has indicated that advance-funded programs will not be retroactively cut back. Thus, 2012- 2013 allocations likely will not be reduced mid-year, with the first reduction taking place in the 2013-2014 allocations. However, some cuts, such as federal subsidy payments to issuers of “direct pay” bonds, will be immediate. Issuers of direct pay bonds receive a federal subsidy from the U.S. Treasury Department to assist with debt service payments. Specifically, certain Build America Bonds (“BABs”), Qualified School Construction Bonds (“QSCBs”), Qualified Zone Academy Bonds (“QZABs”), and Recovery Zone Economic Development Bonds (“RZEDBs”) have been issued as direct pay bonds.

In a statement issued March 4, 2013, the IRS announced that the bond subsidy payments to be paid by the federal government between March 1, 2013, and September 30, 2013, will be reduced by 8.7%. As a result, unless the federal government intervenes in the near future to restore funding and end the sequestration, school districts across the state that issued direct pay bonds face an 8.7% reduction in the anticipated federal subsidy for the May 1, 2013, debt service payment.

On March 27, 2013, Thrun Law Firm sent an E-Blast to all affected clients notifying them of the sequestration order, the reduction to the direct pay subsidy, and specific actions that must be taken. If your district has an outstanding direct pay bond, we recommend that school officials contact the district’s financial advisory firm as soon as possible to determine how the subsidy reduction may affect the district’s ability to make the May 1, 2013, debt service payment. School officials should, in conjunction with the district’s financial advisor, determine the amount that the district has available in its debt retirement fund for the May 1, 2013, debt service payment on any direct pay BAB, QSCB, QZAB or RZEDB. That analysis should consider the impact of the potential 8.7% reduction of the subsidy payment and determine whether that reduction can be offset by funds available in the district’s debt retirement fund. If the analysis determines that insufficient funds will be available in the debt retirement fund for the May 1, 2013, bond payment, or if you are uncertain of your situation, please contact your district’s bond attorney at Thrun Law Firm to discuss the matter further.

As the current sequestration ends September 30, 2013, it is uncertain whether there will be an impact on future direct payment subsidies (e.g., November 1, 2013, and beyond). That will depend on any intervening Congressional action.

Please note that for many direct pay bonds issued with our firm serving as bond counsel, the school district preserved the right to refund the bonds in the event that the federal government either determined that the district would not receive the full subsidy payments or there was an actual reduction in subsidy payments. The federal sequestration may trigger your district’s ability to refund its direct pay bonds by issuing traditional tax-exempt bonds if an economic savings would result.

We will provide further information to our clients in the near future regarding the possibility of refunding direct pay bonds. However, as detailed above, we urge school officials to take immediate action to determine the impact of the potential subsidy payment reduction on the ability to make the May 1, 2013, debt service payment in order to avoid a default or other adverse result.