   OFF,CE
        OFTHEATTORNEY
                   GENERAL.
                         STATE
                             OFTEXAS
   JOHN CORNYN




                                           May 4,1999



The Honorable Eddie Lucia, Jr.                    Opinion No. JC-0039
Chair, Special Committee on Border Affairs
Texas State Senate                                Re: Whether Texas may implement a Grant
P.O. Box 12068                                    Application Revenue Vehicle program in the
Austin, Texas 7871 l-2068                         absence    of a constitutional   amendment
                                                  (RQ-004%JC)


Dear Senator Lucia:

         You have asked this office to consider whether the State of Texas or an agency thereof could
issue Grant Anticipation Revenue Vehicle bonds (so-called “GARVEE Bonds”), a relatively new
method of highway financing, without the necessity of amending the Texas Constitution.          While
several constitutional provisions may be relevant to your question, you express particular concern
about article VIII, section 7-b, which dedicates federal reimbursement payments for highway
construction to highway construction. Materials which have been furnished to us indicate that it is
the view of the Comptroller of Public Accounts that amendment of section 7-b is unnecessary. On
the other hand, a memorandum prepared by bond counsel for the Texas Transportation Commission
indicates that it is their view that such amendment is necessary. See Memorandum from McCall,
Parkhurst & Horton, L.L.P., to Honorable David Laney, Chairman, Texas Transportation
Commission (Mar. 29, 1999) (on file with Opinion Committee) [hereinafter McCall, Parkhurst &
Horton Memorandum of Mar. 29,1999].

         As a preliminary matter, we caution that the role of the Office of the Attorney General in
issuing advisory opinions concerning questions of law is distinct from our function with regard to
the approval of municipal bonds. We are here concerned solely with the former function, and
nothing in this opinion should be construed as assuring the approval of a particular bond issue,
particularly as no such bond issue is now before this office.

         We note first that, while the approval ofbonds by this office will cure any statutory defects
from which they may suffer, see TEX. REV. Crv. STAT. ANN. art. 717k-8,s 3.002(d) (Vernon Supp.
1999), constitutional defects are another matter, seeMiller v. State exrel. Abney, 155 S.W.2d 1012
(Tex. Civ. App.-Waco         1941, writ refd).   Further, we note that, in order to opine without
qualification that a bond issue was legally valid, bond counsel would be required to conclude “that
it would be unreasonable for a court to hold to the contrary.” NATIONALASSOCIATIONOF BOND
LAWYERS,MODEL BOND OPINIONREPORT, at 7 (1997 ed.). Given the high standard involved here,
and given the risk involved of the potential invalidation of what might in light of the Comptroller’s
The Honorable   Eddie Lucia, Jr. - Page 2           (X-0039)




suggestion be hundreds ofmillions of dollars worth ofbonds, we believe that, while there may well
be merit to the Comptroller’s argument that a constitutional amendment is unnecessary, we cannot
say that no court could reasonably agree instead with bond counsel for the Transportation
Commission.     That being the case, it would in the view of this office be more prudent for the
legislature to seek to amend the Texas Constitution than to authorize the issuance of GARVEE
bonds purely by statute.

        Grant Anticipation Revenue Vehicles are a relatively new phenomenon.         Briefly put, until
1995, “states could use their Federal highway grants to repay only the principal component of debt
service on most projects. This restrictive rule was out of sync with the cash requirements that stem
from real-world bond issues, since the predominant component of debt service during the early years
of debt retirement is interest expense.” 3 FHWA’s INNOVATIVEFINANCE QUARTERLY,No. 2, at
l(Miriam A. Roskin & Max Inman eds., Fall 1997) <http://www.fhwa.dot.gov/imtovativefinance/
ifq32.htm>.

       However, in 1995,23 USC.        5 122 was amended to provide in relevant part:

                (b)     [T]he Secretary [of Transportation] may reimburse a State for
                        expenses and costs incurred by the State or a political
                        subdivision of the State and reimburse a public authority for
                        expenses and costs incurred by the public authority for-


                        (1)     interest payments    under an eligible debt financing
                                instrument;


                        (2)     the retirement of principal      of an eligible     debt
                                financing instrument;

                        (3)     the cost of the issuance of an eligible debt financing
                                instrument;

                        (4)     the cost of insurance   for an eligible debt financing
                                instrument; and

                        (5)     any other cost incidental to the sale of an eligible debt
                                financing instrument (as determined by the Secretary).

23 U.S.C. 5 122(b) (Supp. 1995).

        Section 122 allowed for the creation ofthe GARVEE bond idea. As the acronym suggests,
these instruments are revenue bonds which look to future federal highway reimbursements as the
source of the revenue.
The Honorable   Eddie Lucia, Jr. - Page 3          (JC-0039)




        Municipal bonds are divided broadly into two kinds-general   obligation and revenue bonds.
(There are also certain hybrid obligations with which we do not need to concern ourselves here.)
General obligation bonds are typically instruments backed by the full faith and credit of the issuing
state government. PUBLIC SECURITIESASSOCIATION,FUNDAMENTALSOFMUNICIPALBONDS, at 16,
193 (4th ed. 1990). Revenue bonds, on the other hand, are not and are payable only from a defined
source.    DAVID A. FRANKLIN & JAMES J. PRENDERGAST, GLOSSARY OF PUBLIC FINANCE
TERMINOLOGY,at 36 (4th ed. 1992). In this particular case, the income on which the bond holders
would be depending is the anticipated federal grants.

         (One of the questions that has arisen, because the bonds are for a period longer than the
current guarantee of federal financing, concerns the risk that in later years the federal government
may decide it no longer wishes to continue financing highway construction. This risk appears
negligible. However, negligible or not, it is a risk that for the purpose of Texas law must be borne
by the bondholder.    Any guarantee offered by the state to provide funds the federal government
declines to provide would impermissibly create debt in violation of article III, section 49 of the
Texas Constitution.)

         At this point, some history is in order so as to make the constitutional questions intelligible.
Texas highway construction has historically been financed by the state on a pay-as-you-go basis.
See COMPTROLLEROF PUBLIC ACCOUNTS,CHALLENGINGTHE STATUS Quo-A REPORT FROMTHE
TEXAS PERFORMANCE REVIEW, at 220 (1999) [hereinafter CHALLENGINGTHE STATUS Quo].
Funding for this construction comes from motor vehiclelicense and registration fees and motor fuel
taxes dedicated by article VIII, section 7-a of the Texas Constitution “for the sole purpose of
acquiring rights-of-way, constructing, maintaining, and policing such public roadways, and for the
administration of.      laws     pertaining to the supervision of traffic and safety on such roads,” and
some federal funding. TEX. CONST. art. 8, 5 7-a. In 1988, the voters adopted a constitutional
amendment adding article VIII, section 7-b, which reads, “All revenues received f?om the federal
government as reimbursement         for state expenditure of funds that are themselves dedicated for
acquiring rights-of-way and constructing, maintaining, and policing public roadways are also
constitutionally dedicated and shall be used only for those purposes.” Id. $ 7-b

         GARVEE bond financing would allow the issuance of bonds for eligible highway
construction projects under title 23 of the United States Code. According to the Comptroller, “The
GARVEE bond concept can be applied in one of two ways. In the first, a state issues the bonds for
project construction and uses its future federal assistance to pay the debt service on the bonds. In
[the second], states may use GARVEE bond revenue to pay for expenditures on pay-as-you-go
projects and use their federal funds to pay debt service on other, debt-financed             projects.”
CHALLENGINGTHE STATUS Quo, supra, at 221. The rationale for the second, or indirect, sort of
GARVEE financing is as follows: Federal funds are received as reimbursement of state expenditures
on highways; the concern of the federal government, therefore, is that the state has spent the money,
not what revenue source the state’s expenditure came from.
The Honorable Eddie Lucia, Jr. - Page 4             (JC-0039)




         The constitutional questions which have been raised with regard to GARVEE bonds relate
essentially to four provisions thereof: article III, sections 44, 49, and 50, and article VIII, section
7-b. As an examination of the various arguments which have been presented to us makes clear, the
most serious issue is presented by article VIII, section 7-b. However, it may be helpful first to
review briefly the article III provisions and the questions they raise.

          Article III, section 44, in relevant part, forbids the legislature to “grant, by appropriation or
otherwise, any amount of money out of the Treasury of the State, to any individual, on a claim, real
or pretended, when the same shall not have been provided for by pre-existing law.” TEX. CONS.
art. III, 5 44.

         Article III, section 49 forbids the creation of debt by or on behalf of the State, except :

                (1)     to supply casual deficiencies of revenue, not to exceed in the
                        aggregate at any one time two hundred thousand dollars;

                (2)     to repel invasion, suppress insurrection,   or defend the State in
                        W&K



                (3)     as otherwise authorized by this constitution;    or

                 (4)    as authorized by Subsections     (b) through (g) of this section.

Id. $ 49(a).   (Subsections   (b) through (t) outline the procedure     for statewide bond proposition
elections.)

         Article III, section 50 forbids the legislature “to give or to lend, or to authorize the giving
or lending, of the credit of the State in aid of, or to any person, association, or corporation.” Id. 5 50.

         On a number of occasions in the past, Attorneys General of Texas have asserted that a
particular bond issue violated one or more of these constitutional provisions, and have therefore
refused to approve the bonds. See Texas Nat ‘1Guard Armory Bd. v. &Craw, 126 S.W.2d 627 (Tex.
1939) (orig. proceeding); Texas Turnpike Auth. v. Shepperd, 279 S.W.2d 302 (Tex. 1955) (orig.
proceeding); Texas Public Bldg. Auth. v. Mattox, 686 S.W.2d 924 (Tex. 1985) (orig. proceeding).
In all these cases, because the bonds at issue were revenue bonds, and for the most part lease revenue
bonds (that is, revenue bonds payable solely from the lease of certain properties), the Texas Supreme
Court held that their issuance did not violate the relevant constitutional provisions. The fact that
generally the bonds themselves recited that they were not general obligations of the State of Texas,
but that the bondholder could look only to a certain defined revenue, though not conclusive, was
persuasive evidence to the court that their issuance did not create a debt.

      Lease revenue bonds, so long as they are in fact revenue bonds, do not constitute debt.
However, article III, section 44 prohibits the payment of “revenue” bonds by direct legislative
The Honorable   Eddie Lucia, Jr. - Page 5           (JC-0039)




appropriation. In Attorney General Opinion JM-970, this office considered whether the Texas Public
Finance Authority could issue bonds denominated as revenue bonds, the principal and interest on
which was, however, payable from direct legislative appropriation. Opinion JM-970 held that such
an appropriation would violate article III, section 44 because, the bonds being revenue bonds, “not
only would an appropriation      for the purpose of paying principal and interest on [them] be
unauthorized by pre-existing law, it would be an appropriation to pay for something that the
legislature had expressly proclaimed itself unobligated to pay.” Tex. Att’y Gen. Op. No. JM-970
(1988) at 7.

         Generally speaking, pursuant to section 404.094 of the Government Code, all grants to the
state, such as the federal funds involved here, are deposited in the treasury. See TEX. GOV’T CODE
ANN. 5 404.094 (Vernon 1998). Moneys in the treasury may, under article VIII, section 6 of the
Texas Constitution, be removed only by legislative appropriation. See TEX. CONST.art. VIII, 3 6.
Accordingly, an article III, section 44 problem might arise if the grants were directly deposited in
the treasury. However, the section 404.094 requirement is merely statutory; therefore, the section
44 problem could, we believe, be obviated by the statutory creation of a separate fund outside the
treasury to hold these moneys if not otherwise restricted. The precise manner in which such a
statutory scheme might be constructed is, of course, beyond the scope of this opinion. However, if
such a fund is created and if it is clear that the proposed bonds are indeed revenue bonds which are
not backed by Texas’ full faith and credit and do not create constitutional debt, we believe that the
potential article III, section 44 problems that have been suggested by the Transportation
Commission’s bond counsel can be resolved.

       The more difficult issue is the argument that the use of the federal reimbursements        here to
pay debt service on the bonds would violate the requirements of article VIII, section 7-b.

        At the time section 7-b was added to the constitution in 1988, the kind of financing
instruments under discussion here did not exist. When section 7-b came into being, its reference to
federal reimbursements for dedicated funds meant, essentially, all federal reimbursements, because
the money spent to build highways was generally section 7-a money.

          It is clear from the legislative history that the intent of section 7-b was that federal highway
funds would stay dedicated to highways. The Legislative Budget Board’s fiscal note, dated July 15,
 1987, asserts, “The fiscal implication to the State would be to restrict the use ofcertain federal funds
to specific purposes thereby limiting the future choices ofthe Legislature.” FISCALNOTE,Tex. S.J.
Res. 8,7Oth Leg., 2d C.S. (1987). The bill analysis of the House Committee on Ways and Means
describes the purpose of the amendment as “[t]o constitutionally                dedicate federal highway
reimbursements for highway purposes.” HOUSECOMM.ONWAYS &MEANS, BILLANALYSIS,Tex.
S.J. Res. 8, 70th Leg., 2d C.S. (1987). In explaining the background for the amendment in its
Analyses ofProposed Constitutional Amendments, the Legislative Council wrote, “Under the federal
program of aid for public highways, states are required to pay almost all costs of planning, land
acquisition, and construction on a highway project. If a project meets federal aid specifications, the
state is then reimbursed from federal money for amajor portion ofits expenses (generally 90 percent
The Honorable Eddie Lucia, Jr. - Page 6            UC-0039)




of all costs of an interstate highway.)  The reimbursements have traditionally then been used in
Texas to replenish thededicatedpoolofstatemoney.”     TEXASLEGISLATIVECOUNCIL,INFORMA~ON
REPORTNO.88-1, at 15 (July, 1988) (emphasis       added). Among the arguments for the amendment
listed by the Legislative Council is, “If federal reimbursements of state highway expenditures are
not required to be dedicated to highway and highway policing purposes, the dedicated pool of state
money could easily be spent each year, and the availability of unrestricted money would be
unforeseen from one fiscal biennium to another.” Id. at 16. Based on all that, it is clear that the
intent of section 7-b was to assure that federal highway reimbursements        were to be spent on
highways, and on nothing else.

        With this in mind, the Transportation Commission’s bond counsel assert that, “The use [of]
federal reimbursements to pay debt service arguably avoids the will of the people as expressed in
Sections 7-a and 7-b.” McCall, Parkhurst & Horton Memorandum of Mar. 29, 1999, supra, at 6.

         The Comptroller has responded to that argument by asserting that the reimbursements     are
not, in fact, reimbursements of dedicated funds. If what is being paid back is reimbursement for the
expenditure of bond proceeds, then one escapes the section 7-b issue because the language of the
section dedicates reimbursements for expenditure of “funds that are themselves dedicated.” TEX.
CONS. art. 8, 5 7-b; see GARVEE Discussion from the Office of the Comptroller of Public
Accounts, to the Opinion Committee, Offtce of the Attorney General (Mar. 1999) (on tile with
Opinion Committee).

        The Comptroller’s argument seems,        on the face of it, a more than plausible one. If the
reimbursements pay back the bond proceeds,     they are not subject to the 7-b constraints, and arguably
ought not to be because the reimbursements     are not replenishing the 7-a pool, which-to     the extent
the projects are funded by the bonds instead    - is not being drained.

         However, bond counsel’s argument is also an attractive and plausible one, particularly in
light ofthe history of the constitutional provision. Morever, the Comptroller’s argument may prove
too much. If funds may be paid for debt service because they are not dedicated, the reason is that
they are not dedicated, and therefore may be expended for any proper purpose.

         As is apparent from our discussion, the Comptroller’s and the bond counsel’s arguments are
plausible interpretations ofthe constitutional question, which would be a question of first impression
if considered by a court. Even were we to conclude that the Comptroller has the better argument,
our conclusion cannot guarantee judicial approval should the bonds be challenged in court. Unlike
a statutory defect which may be cured by the Attorney General’s approval ofbonds, assuming such
approval would be forthcoming, a constitutional defect cannot be so cured. Under the circumstances,
we are compelled to advise you that the more prudent course of action for issuing GARVEE bonds
is to secure an amendment of the Texas Constitution specifically permitting federal reimbursements
to be used for paying debt service on GARVEE bonds. Issuing such bonds only upon statutory
authorization risks the potential invalidation of hundreds of millions of dollars worth of bonds.
The Honorable   Eddie Lucia, Jr. - Page 7      (JC-0039)




                                      SUMMARY

                         The amendment of the Texas Constitution specifically to
                permit federal highway reimbursements to be used for paying debt
                service on Grant Anticipation Revenue Vehicle (“GARVEE”) bonds
                would be more prudent than the issuance of such bonds with merely
                statutory authorization.




                                             Attorney General of Texas



ANDY TAYLOR
First Assistant Attorney General

CLARK RENT ERVIN
Deputy Attorney General - General Counsel

ELIZABETH ROBINSON
Chair, Opinion Committee

Prepared by James E. Tourtelott
Assistant Attorney General
