N.C. Local Government Finance Policy Manual

17.0 Introduction

Constructing, acquiring, and maintaining the facilities, equipment, and other capital infrastructure needed to perform public services (collectively, capital projects) are important responsibilities of county and municipal officials. Capital projects also present unique challenges. A capital asset is an asset that is of significant value and has a useful life of more than a single year. This broad definition covers everything from the acquisition of office furniture to the construction of a water treatment facility or a new high school. Thus, in any given year, the capital projects a unit undertakes may vary substantially in number, cost, complexity, and timing. The tools that local governments use to budget and finance capital assets, therefore, are different from those used to budget and finance current assets or operating expenses.

This policy presents the tools available to North Carolina local governments to finance capital projects. It focuses on funding public infrastructure—that is, capital outlay used for (or primarily for) governmental purposes. Chapter 2: Budgeting discusses the capital budgeting process. The financing mechanisms can be broken into roughly five categories—current revenues, savings, special levies, borrowing money, and grants and partnerships. This policy also discusses most of the specific funding mechanisms, detailing the authority to use each method as well as its procedural requirements and limitations.

17.1 Current Revenues

Current revenues are revenues collected by the local unit each fiscal year. The largest source of current revenue in the general fund is property taxes, followed by sales and use taxes. Current revenues in an enterprise fund typically encompass user fees and other specialty charges. Current revenues are used primarily by a local unit to fund government programs and activities and to cover annual operational expenses, including salaries, utilities, and supplies. Most units, however, also use a portion of their current revenues to fund capital projects each year.

Two categories of capital projects are typically funded with current revenues. The first includes capital expenditures that fall below a certain dollar amount. Some units set a capital budget threshold amount in the annual budget ordinance, using current revenues to fund any capital outlay that costs less than that amount. The second category includes capital expenditures that recur on a regular basis, such as maintenance and repair expenditures on existing capital assets. These expenditures may or may not fall below the capital budget threshold but are nevertheless funded in the annual budget ordinance with current revenues.

17.2 Savings

Often a unit must save current revenues over several years to fund a capital expenditure. North Carolina local governments can do this in two ways. One is to allow money to accumulate in fund balance. The other is to allocate revenue to a capital reserve fund.

17.2.1 Fund Balance

Local governments use fund accounting to track assets and liabilities. An accounting fund is a separate fiscal and accounting entity, with its own set of self-balancing accounts. Thus, a fund has its own assets, liabilities, equity, revenues, and expenses. There are several types of funds, the most common being the general fund, which accounts for most of the general government revenues and expenditures. The equity associated with a fund is referred to as “fund balance.” In the simplest terms, fund balance is an accumulation of revenues minus expenditures. (See Chapter 3: Fund Balance for a detailed description of the components of fund balance).

Fund balance generally serves three purposes. The primary purpose is to provide the unit with cash flow. A local government’s fiscal year begins on July 1. Most units, though, do not receive the majority of their operating revenue in the form of property tax proceeds, until late December or early January. Because of this delay, a local government typically must rely on cash reserves from the prior fiscal year to finance several months of expenditures. The second purpose of fund balance is to provide a unit with an emergency fund, often referred to as a “rainy day” fund. It is difficult for local governments to raise additional money quickly during the fiscal year. Fund balance can provide a local unit available cash to finance unexpected operating or capital expenses. Some units use fund balance for a third purpose—to facilitate saving money over time for anticipated capital expenditures. If a unit knows, for example, that it needs to engage in a capital project in the next several years, it might allow its fund balance to grow each year and then appropriate the accumulated funds to finance the project.

The Local Government Commission (LGC) encourages counties and municipalities to “develop a fund balance policy to maintain a fund balance that is consistent with their peers that provide similar services.” (NC Dep’t of State Treasurer, The Myth of 8% (LGC Staff Guidance on Fund Balance Available). The LGC also maintains a financial reports and analysis tool that lists the fund balance available for all counties and municipalities (the term “municipality” is synonymous with “city,” “town,” and “village”) to help local governments determine a unit-specific amount of fund balance to maintain on an annual basis. The LGC recommends that each local government adopt a fund balance policy that can be used to develop operating budgets and provide for corrective action should fund balance drop below the intended level at the close of a fiscal year. (NC Dep’t of State Treasurer, The Myth of 8% (LGC Staff Guidance on Fund Balance Available). See Chapter 3: Fund Balance for examples of fund balance policies.

The benefit of using fund balance to save money for future capital projects is that it provides a local governing board with a great deal of flexibility. While fund balance often includes resources that are restricted to certain purposes, a governing board may generally use accumulated resources to fund either operating or capital expenditures. It is not locked in to spending its unrestricted fund balance on a particular project or asset. For example, assume that a county board of commissioners wishes to expand its solid waste disposal facility in approximately five years. The board begins to purposefully accumulate fund balance toward this goal. In year three, a major economic recession hits the county. The county board may divert the accumulated fund balance to pay for operating expenses or more pressing capital expenses. The only exception is if a portion of the fund balance includes earmarked resources (by grant or state statute) such that they may be used for only the solid waste disposal facility expansion. (See Chapter 3: Fund Balance for more on fund balance categories).

To expend fund balance, a governing board must amend its budget ordinance or a project ordinance to appropriate the fund balance and authorize its expenditure for one or more projects. (See Chapter 2: Budgeting for more information on amending budget and project ordinances). Using fund balance as a savings account for future capital outlay is controversial in some units. Citizens may question why a local unit continues to raise revenue (through taxes and fees) when the unit has sufficient reserves to meet its cash flow needs. They may not trust that the governing board ultimately will spend the accumulated fund balance appropriately.

17.2.2 Capital Reserve Funds

Instead of accumulating fund balance, a unit’s governing board may establish a capital reserve fund and periodically appropriate money to it. A local government may establish and maintain a capital reserve fund for any purpose for which the unit may issue bonds. (G.S. 159-18). And a unit may issue bonds for any capital project in which it is authorized to engage (G.S. 159-48). The local government, however, does not have to issue bonds to fund a project for the project to qualify for inclusion in a capital reserve fund.

Local government utilities must account for system development fee proceeds in a capital reserve fund, regardless of the type of capital projects the moneys will fund. [G.S. 162A-211(d)]. There is an exception to the capital reserve fund requirement if the unit has pledged system development fee revenues as security in a bond financing. In that case, the local government may deposit the proceeds of system development fees in the funds, accounts, or subaccounts in accordance with the relevant bond order, bond resolution, trust agreement, or similar instrument that secures the relevant bonds. [G.S. 162A-211(d), e)].

To establish a capital reserve fund, a unit’s governing board must adopt an ordinance or resolution that states the following:

1. The purposes for which the fund is being created (a board may accumulate moneys for multiple capital projects within a single capital reserve fund, but it must list each project separately);
2. The approximate periods of time during which the moneys will be accumulated and expended for each capital project;
3. The approximate amounts to be accumulated for each capital project; and
4. The sources from which moneys for each purpose will be derived (a board must indicate the revenue sources it intends to allocate to the capital reserve fund to finance each project—for example, property tax proceeds, utility fees, local sales and use tax proceeds, grant proceeds, and so forth).

(G.S. 159-18).

A unit’s governing board may make its appropriations from its annual budget ordinance to the capital reserve fund at any time. Each time it makes an appropriation, the board also must amend the capital reserve fund to account for the additional revenue. The board may not set up an automated appropriation for future fiscal years; it must make the appropriation from each year’s budget ordinance.

Establishing a capital reserve fund affords a unit’s governing board a more formalized mechanism than fund balance to save moneys for future capital expenditures. Arguably, it is more transparent because the governing board must specify the capital projects for which it is accumulating funds. However, appropriating money to a capital reserve fund is a less flexible savings option. Once moneys are appropriated to a capital reserve fund, they must be used for capital expenditures. The moneys may not be used to fund operating expenses, even in an emergency.

A governing board must list specific capital projects in the capital reserve fund. It may not simply establish the fund to raise money for general capital expenditures. A governing board, however, may amend its capital reserve fund at any time to add new capital projects, delete capital projects, or change the nature of the capital projects. (G.S. 159-19).

The board is not required to expend the accumulated moneys for the capital projects initially identified in the reserve fund. For example, assume that a municipality is growing fairly rapidly. The governing board anticipates needing a water system expansion within the next eight to ten years to accommodate new growth. The board establishes a capital reserve fund and allocates moneys to the fund each year for the water system expansion project. Five years later a major recession hits the municipality. Growth slows significantly. It now appears that a water system expansion will not be necessary. The governing board could amend the capital reserve fund to delete the water system expansion project and substitute one or more new capital projects, such as road improvements, building maintenance, vehicle acquisition, or a new recreation building.

How are moneys expended from a capital reserve fund? The governing board must adopt an ordinance or resolution authorizing the withdrawal of moneys from the fund, the transfer of moneys to another fund (such as the general fund or an enterprise fund), and the expenditure of moneys for one or more of the capital projects or assets identified in the capital reserve fund. (G.S. 159-22).

17.3 Special Levies

Local units derive most of their current revenue and savings from general fund revenue sources. The largest source of general fund revenue for both counties and municipalities is the property tax. And the hallmark of property taxation is that all property owners (except those whose property is statutorily exempt) pay the tax, regardless of whether they directly benefit from the projects or services funded with the tax proceeds. Citizens trust their local elected leaders to expend the proceeds for the general benefit of the community. Local elected leaders, however, often feel pressure to provide and fund an ever-increasing number of projects and services while maintaining or reducing the property tax levy. Thus, units have come to rely on targeted revenue-generation mechanisms, such as user charges, that are paid only by the citizens or property owners who most directly benefit from specific services or projects. For example, in the past many municipalities funded solid waste services, including disposal facilities, convenience centers, and even curbside pickup, with property tax proceeds. Now, these units typically assess user charges to cover some or all the costs associated with these services. Other common user charges levied by counties and municipalities are for water and wastewater utilities services, recreational and cultural activities, health and mental health services, ambulance services, parking, public transportation, stormwater, cemeteries, and airports. Units also rely on fee revenue to fund certain regulatory activities, such as inspections and plan reviews. Generally, user charges are feasible for any service that directly benefits individual “users” and can be divided into service units and when the charges can be collected at a reasonable cost.

What about funding capital projects or acquisitions with user charges? Although dividing capital projects or assets into divisible units with defined beneficiaries can be difficult, some units attempt to apportion some of the capital costs associated with a particular service among the users of that service. For example, a unit’s water or sewer customer is assessed a monthly or bi-monthly charge for the utility service. The charge typically consists of two components—a usage charge, which varies based on actual usage, and a fixed overhead charge. The fixed charge covers both operating overhead and at least some capital outlay expenses. In addition to user fees, the law allows for targeted revenue generation to fund capital projects through four different types of special levies—traditional special assessments, critical infrastructure assessments, special taxing districts, and, to a limited extent, development exactions.

17.3.1 Special Assessments

A special assessment is a charge levied against property to pay for public improvements that benefit that property. It is neither a user fee nor a tax but has characteristics of both. Like a user fee, a special assessment is levied in some proportion to the benefit received by the assessed property. However, like a property tax, it is levied against property rather than persons and is a lien on each parcel of real property assessed. The lien may be foreclosed in the same manner as property tax liens. [See Chapter 7: Property Tax Administration (forthcoming) for more information on enforcing property tax liens].

Special assessment authority provides local units a potentially important tool for funding capital projects. The ability to recoup some or all the costs of a particular project from those property owners who most directly benefit from the project makes sense both financially and politically, at least in some instances. Levying assessments also allows a local government to collect revenue from property owners who benefit from the capital projects but whose properties are exempt from property taxation (A unit may not levy assessments on state or federal government property, however, without the consent of the property owner). And using special assessments as a part of its revenue mix allows a governing board to direct property tax proceeds and other general fund revenues to services or capital projects that benefit a broader subset of the unit’s citizens.

Currently, there are two different statutory methods for levying special assessments in North Carolina—traditional special assessments and critical infrastructure assessments. Under both methods, a governing board defines an area within a unit that includes all properties that will directly benefit from a certain capital project. And under both methods a unit must follow a detailed statutory process to determine and impose the assessments.

Traditional Special Assessment

The traditional special assessment method has not been widely used by North Carolina local governments due to several factors. First, the authority to levy assessments is limited to only a few categories of projects. Counties may levy assessments to fund water systems, sewage collection and disposal, beach erosion control and flood and hurricane protection, watershed improvement, drainage, water resources development projects, local costs of Department of Transportation improvements to subdivision and residential streets outside municipalities, and streetlight maintenance. (G.S. 153A-185). Municipalities may levy assessments to finance public improvements involving streets, sidewalks, water systems, sewage collection and disposal systems, storm sewer and drainage systems, and beach erosion control and flood and hurricane protection. (G.S. 160A-216; G.S. 160A-238). Second, as detailed below, the process to levy the assessments is fairly onerous. Third, a local unit must front all the costs of the project, which can be high. Only after a project is complete may a unit levy the assessments, and assessments often are paid in installments over a number of years (up to ten). Some local units have set up special assessment revolving funds, using yearly special assessment payments from former projects to fund new projects. Establishing a sufficient revolving fund, however, often takes several years.

For most projects, a unit’s governing board may levy assessments within its own discretion. Street and sidewalk projects first require that the unit receive a petition signed by a certain percentage of affected property owners. Before a county may fund street improvements, it must first receive a petition signed by at least 75 percent of the owners of property to be assessed, who represent at least 75 percent of the lineal feet of frontage of the lands abutting the street or portion of the street to be improved. [G.S. 153A-205(c)]. Similarly, for street and sidewalk improvements, a municipality must receive a petition signed by a majority of the owners of property to be assessed, who represent at least a majority of all the lineal feet of frontage of the lands abutting the street or portion of the street to be improved. [G.S. 160A-217(a)].

The amount of each assessment must bear some relationship to the amount of benefit that accrues to the assessed property. The most common basis of assessment is front footage: each property is assessed on a uniform rate per foot of property that abuts the project. Other common bases include the size of the area benefited and the value added to the property because of the improvement. All the permissible bases of assessment mandate that the basis rate be equal across properties. A unit, however, may set up benefit zones—setting different assessment rates in each zone according to the degree of benefit to the properties in the zone. (G.S. 153A-186; G.S. 160A-218). For example, for a beach re-nourishment project, a local unit may assess a higher assessment rate on properties that directly abut the beach than on properties that do not have direct beach access.

To impose the assessments under the traditional method, a unit’s governing board must do the following:

• for street and sidewalk assessments only, receive a petition from at least a portion of the affected property owners;
• adopt a preliminary assessment resolution that includes, among other things, a description and estimated cost of the project, the percentage of the cost to be funded through assessments, the basis of assessment, and the terms of payment of the assessments;
• hold a public hearing on the preliminary assessment resolution, after providing proper notice to the affected property owners;
• adopt the final assessment resolution (which locks in project scope);
• begin and complete the project;
• prepare a preliminary assessment roll that describes the lots to be assessed, the amount assessed against each lot, the basis of the assessment, and the terms of payment;
• hold a public hearing on the preliminary assessment roll, after providing proper notice to the affected property owners; and
• confirm the assessment roll.

The requirements for the assessment processes can be found in Chapter 153A, Article 9 (for counties) and Chapter 160A, Article 10 (for municipalities).  

Once the unit has confirmed the assessment roll, the assessments become a lien on the real properties assessed. (G.S. 153A-195; G.S. 160A-228). The unit may demand full payment of the assessments within thirty days of publication of the confirmed assessment roll. (See G.S. 153A-200; G.S. 160A-233). More often, a board will allow assessments to be paid in up to ten yearly installments, with interest. A unit may assess up to 8 percent interest per year on outstanding assessment balances. (G.S. 153A-195; G.S. 160A-228).

Critical Infrastructure Assessment

During the 2008 and 2009 legislative sessions the General Assembly temporarily bestowed the newer special assessment authority—entitled special assessments for critical infrastructure needs—on counties and municipalities to fund a wide range of capital projects. [See G.S. Ch. 153A, Art. 9A (counties); Ch. 160A, Art. 10A (municipalities)]. The legislature has since extended the authority for the newer assessment method several times, most recently to July 2025. (Note that as of the publication of this chapter in July 2025 the legislature has not amended the law to extend the sunset deadline. That means that no new projects may begin pursuant to this authority. The information below only applies to critical infrastructure assessment projects that began before July 1, 2025.)

The purpose of the critical infrastructure assessment authority, modeled on legislation from other states, is to help local units fund public infrastructure projects that benefit new private development. It allows a unit to impose assessments, with payments spread out over a period of years, with the expectation that most assessments will be paid by the eventual property owners (instead of the developer or the local government). As with traditional assessments, the unit can front the costs of the project and recoup its investment over time with the yearly assessment payments. Under the critical infrastructure assessment method, though, the unit can borrow money, pledging the assessment revenue as security, and use the yearly assessment payments to meet its debt service obligations. Alternatively, the unit may contract with the developer to fund and construct the capital project and use the assessment revenue to reimburse the developer over time (These agreements may be subject to LGC approval).

Conceptually, the critical infrastructure assessment authority functions like an impact fee. An impact fee is imposed on new development to pay for infrastructure costs necessitated by the new development. The fees usually are assessed on developers upon the issuance of a building permit. Special assessments also may be used to fund infrastructure projects necessitated by new development. The critical infrastructure assessment method typically imposes fewer costs on the developer than an impact fee. Many, if not most, of the payments are collected once the development is completed (assuming, of course, the development results as expected).

A much broader array of public infrastructure projects may be funded through the critical infrastructure assessment method than through the traditional method. The authorized projects are almost exclusively government infrastructure projects, ranging from constructing and maintaining public roads to building public schools. The list includes most capital projects in which a unit is authorized to engage. [See G.S. 153A-210.2 (counties); G.S. 160A-239.2 (municipalities)]. For more information on critical infrastructure assessments, see Kara Millonzi, “An Overview of Special Assessment Bond Authority in North Carolina,” Local Finance Bulletin No. 40 (Nov. 2009) and two of Kara Millonzi’s blog posts “Recent Amendments to Special Assessment Authority,” and “Special Assessments for Economic Development Projects”.

A potential benefit of the critical infrastructure assessment method is that it allows a unit to borrow money to front the costs of a project. Thus, the unit can avoid committing any of its general fund revenues to the project.

Of course, there is a risk that the unit will not be able to collect all the assessment revenue needed to meet the debt service obligations. The assessments are a lien on the properties assessed, and a unit has the same remedies available to collect delinquent assessments as it does delinquent property taxes. (The bonds likely will include a covenant requiring the unit to use all available collection remedies in the case of nonpayment by a property owner. This may pose some cost to the unit.) Despite the robust collection authority, the debt is relatively risky for investors. And the riskier the debt, the more expensive the borrowing. Thus, special assessment–backed revenue bonds often carry a very high rate of interest. The interest does not burden the unit’s general fund directly, however.

To impose an assessment under the critical infrastructure assessment method to pay for a capital project, a unit must first receive a petition signed by a majority of the owners of property to be assessed, who also represent at least 66 percent of the value of the property to be assessed. [G.S. 160A-239.3 (cities); G.S. 153A-210.3 (counties)]. In setting this fairly onerous petition requirement, the legislature envisioned that there would be a single owner or, at most, a few owners (developers) of the real property at the time the assessments are imposed. The petition must include a description of the public infrastructure project, its estimated costs, and the percentage of that cost to be assessed. [G.S. 160A-239.3 (cities); G.S. 153A-210.3 (counties)]. These details, as well as the basis of assessment, the assessment repayment period, and any issues related to borrowing money to pay for the project, typically are negotiated in advance between the developer and the unit.

Once a unit receives a petition, it must follow the same detailed statutory process to impose the assessments as under the traditional method. There are a few differences in the nature of the assessment resolution and project timing. The project need not be completed before the assessment roll is confirmed. Assessments are based on estimated costs. The process takes time but, assuming the developer does not change its mind, it is relatively straightforward.  One key difference between critical infrastructure and traditional assessments is that a unit may allow installment payments over a twenty-five-year period. [See G.S. 153A-210.5(a) (counties); G.S. 160A-239.5(a) (municipalities)]. If a unit borrows money to front the costs of the project, the number and amount of installment payments will correspond to the unit’s debt service obligations.

17.3.2 Special Taxing Districts

Another targeted revenue-generation mechanism available to a local unit to fund capital projects is to establish one or more special taxing districts. Article V, Section 2 of the state constitution requires that a local government’s property tax rates be uniform throughout the jurisdiction, but it also authorizes the General Assembly to allow a local government to carve out one or more areas within the unit as special taxing districts. The unit may levy a property tax in each district additional to county- or municipality-wide property taxes and use the proceeds to provide services or fund capital projects in those districts. (See N.C. Const. Article V, Section 2).

Like special assessments, special taxing districts derive from the benefit principle—those who most directly benefit from a government function should pay for it. Special assessments are assessed on a project-by-project basis. Special taxing districts, however, are established to fund a variety of projects and services that benefit properties in the district over time.

17.3.3 County and Municipal Service Districts

The General Assembly has authorized counties and municipalities to establish service districts, G.S. Ch. 153A, Art. 16 (counties); G.S. Ch. 160A, Art. 23 (municipalities), which are defined areas within a unit on which additional property tax rates can be imposed to fund certain services and capital projects. All counties are authorized to define a service district for the following functions. (G.S. 153A-301):

• beach erosion and flood and hurricane protection;
• fire protection;
• recreation;
• sewage collection and disposal;
• solid waste collection and disposal;
• water supply and distribution;
• ambulance and rescue services;
• watershed improvement, drainage, and water resources development; and
• cemeteries.

A few additional purposes are authorized for specified counties in G.S. 153A-301.

And all municipalities may establish a municipal service district (MSD) for any of the following functions (G.S. 160A-536):

• beach erosion and flood and hurricane protection;
• downtown revitalization projects;
• urban area revitalization projects;
• transit-oriented development projects;
• drainage projects;
• sewage collection and disposal systems;
• off-street parking facilities; and
• watershed improvement, drainage, and water resources development projects.

A few additional purposes are authorized for specified municipalities in G.S. 160A-536.

Counties typically use service districts to fund the operational and capital expenses of fire and rescue services. For more information on taxing districts for fire services, see Kara Millonzi, “County Funding for Fire Services in North Carolina,” Local Finance Bulletin No. 43 (May 2011). Municipalities most often use service districts to fund projects and programs in their central downtown areas. For more information on taxing districts for downtown revitalization, see Kara Millonzi’s blog post “A Guide to Business Improvement Districts in North Carolina”.

Taxing Authority

A service district is in no way a separate unit of government. It is simply a geographic designation—a defined part of a county or municipality in which the government levies an extra property tax and provides extra services or undertakes capital projects that more directly benefit the properties within that district. Service district taxes are subject to the same exemptions and exclusions as the general property taxes (that is, property that is exempt from property taxes also is exempt from service district taxes). [G.S. 153A-307; G.S. 160A-542(b)].

A unit’s governing board sets the service district tax rate each year in its annual budget ordinance. The rate, combined with the unit’s general property tax rate, may not exceed $1.50 per $100 assessed valuation of property in the district, unless the unit’s voters have approved a higher maximum rate. [See G.S. 153A-307; G.S. 153A-149(c); G.S. 160A-542(c); G.S. 160A-209(d)].

All the revenue generated by the service district tax must be used to provide the services or undertake the capital projects in the district. A unit also may supplement the district tax revenue with other unrestricted revenues. The district tax proceeds and any other moneys allocated to the district may not be diverted to other purposes. [See G.S. 153A-307; G.S. 160A-542(a)].

Formation

The procedures for establishing a service district vary between counties and municipalities. A county’s governing board creates a district by adopting a resolution. A municipality’s governing board, however, must create a service district by adopting an ordinance. And the ordinance must be enacted by majority vote at two consecutive board meetings. (G.S. 160A-537). Both boards must first follow detailed procedural requirements. (The procedural requirements are described in detail in Kara Millonzi’s blog posts, “Municipal and County Service Districts” and “2016 Changes to Municipal Service District (MSD) Authority”). Among other things, a municipal board must find that the district needs the proposed functions “to a demonstrably greater extent” than the rest of the municipality. [G.S. 160A-537(a)]. A county board must consider several statutory factors, see G.S. 153A-302(a), and make the following findings:

1. There is a demonstrable need for providing one or more of the authorized services or projects in the district.
2. It is impossible or impracticable to provide those services or projects on a countywide basis.
3. It is economically feasible to provide the proposed services or projects in the district without unreasonable or burdensome annual tax levies.
4. There is demonstrable demand for the proposed services or projects by residents of the district.

[G.S. 153A-302(a1)].

Both counties and municipal boards may initiate the process. No petition from affected property owners is required, though a governing board could establish a policy of defining districts only when it receives such a petition. The municipal service districts (MSD) statutes provide for an optional property owner petition process. If a municipal board receives a proper petition, it must consider the request, but it is not required to establish the district. [G.S. 160A-537(a1)]. The MSD statutes also allow a property owner to request that their property be excluded from a proposed district. [G.S. 160A-537(c1)]. A voter referendum need not be held within the district to create it. In fact, there is no authority to hold a vote even if the governing board thinks one is desirable.

In practice, most governing boards also factor in the level of support for the services or projects by the affected property owners. With limited exceptions, a county or municipality must set the effective date for a new service district at the beginning of a fiscal year. [G.S. 153A-302(d); G.S. 160A-537(d)].  If a municipality plans to issue general or special obligation bonds to fund capital projects in a service district, it may specify a different effective date of the district to facilitate the borrowing process. Even in that case, though, it may not levy a district tax until the beginning of the next fiscal year. [G.S. 160A-537(d)].

Projects and Service Provision

A local government has broad authority to provide services, facilities, functions, or promotional and developmental activities in a service district with its own forces and/or through contracts with external entities. If a unit levies a district tax, the unit must provide, maintain, or let contracts for the service or services involved within a reasonable time, not to exceed one year. A municipality that contracts with another governmental agency or a private agency must include the following provisions in the contractual agreement:

• Specify the purposes for which municipal funds will be used.
• At the end of the fiscal year (or other appropriate period of time), require an appropriate accounting of the moneys paid out under the contract.
• If the contract is with a private entity, require that the periodic accounting include certain information about any subcontractors, including “the name, location, purpose, and amount paid to any person or persons with whom the private agency contracted to perform or complete any purpose for which city moneys were used for that service district.”

[G.S. 160A-536(d), as amended by S.L. 2016-8. Although not statutorily required to do so, a county should include similar provisions in its contracts with outside entities].

Additional contracting requirements and limitations apply when a municipality contracts with a private entity to provide services or projects in certain types of MSDs—those created for downtown or urban area revitalization, including the following:

• Solicit input from the residents and property owners as to the needs of the district.
• Use a bid process to select the private entity that will contract to provide services or undertake projects in the district.
• Hold a public hearing before entering the contract.
• Require the contracting entity to report annually to the municipality.
• Specify in the contract the scope of the service to be provided by the private entity.
• Limit the contract to five years or less.

[G.S. 160A-536(d1)]. Although not statutorily required to do so, a county should include similar provisions in its contracts with outside entities.

Funding

Generally, a local unit may borrow money to fund capital projects located in a service district to the same extent, and in the same manner, as it funds similar projects outside a service district. Municipalities, however, have some expanded borrowing authority—they may issue special obligation bonds for any capital projects in an MSD. (G.S. 159-146).

Counties and municipalities typically are subject to an additional procedural requirement when issuing general obligations to fund a capital project in a service district. If the general obligation bonds are subject to voter referendum, a majority of the voters registered and voting in the district must approve the bonds, in addition to a majority of the voters within the municipality. (G.S. 160A-543; G.S. 153A-308).

 17.3.4 Additional Special Taxing Districts

In addition to the service district authority, counties also are allowed to set up special taxing districts for rural fire protection services, see G.S. Chapter 69, public schools, see G.S. Chapter 115C, Article 36, and water and sewer services, see G.S. Chapter 162A, Article 6. These taxing districts provide counties an additional mechanism to fund both capital and operating expenses associated with the specified functions. A county must hold a successful voter referendum before establishing a special taxing district for the first two purposes.

17.3.5 Development Exactions

Development exactions comprise the final category of special levies for funding public infrastructure projects. Developer exactions can take two forms, either requiring the developer to pay money to the local unit to cover capital expenses incurred by the government to support the new development or requiring the developer to construct certain public infrastructure directly. North Carolina local governments have limited statutory authority to impose development exactions. For more information on development exactions, see Adam Lovelady’s blog posts “Exactions and Subdivision Approval” and “The Koontz Decision and Implications for Development Exactions.” And constitutionally, development exactions must be rationally related and roughly proportional to the impacts created by the development [See Nollan v. Cal. Coastal Comm’n, 483 U.S. 825 (1987); Dolan v. City of Tigard, 512 U.S. 374 (1994)].

17.4 Borrowing Money

The most common method to finance large or costly capital projects is to borrow money. Current revenues, savings, or even special levies are unlikely to generate sufficient revenues to finance a significant construction project or capital acquisition without borrowed funds. Borrowing money allows a local government to leverage future revenue streams—providing the unit cash in the short term that is repaid over time.

When a local unit borrows money, it has a contract with its lenders. The contract typically is referred to as a debt instrument or a debt security. Under that contract, the local unit agrees to pay the principal and the interest on the loan as they come due and to honor any other promises it has made as part of the loan transaction. This contract is enforceable by a lender should the local government breach any obligation.

The traditional debt instrument through which a local government borrows money is the issuance of bonds. A bond is simply evidence of a debt. Local governments are authorized to issue general obligation bonds, revenue bonds, special obligation bonds, project development bonds, and limited obligation bonds. North Carolina local governments also may borrow money through installment finance contracts.

17.4.1 Security

The major distinguishing feature among the different borrowing methods is the nature of the primary security pledged by the unit. The most fundamental promise made when a local unit borrows money is to pay the money back. Closely associated with and reinforcing this promise is the pledge or the designation of one or more forms of security. The security for a debt is defined by reference to the contractual rights of the lender—what the lender can require the borrowing government to do, or give up, should it fail to repay the loan. If the government does not repay its loan, the lender may look to the security to compel repayment or otherwise protect itself.

The security for a borrowing affects what form the loan transaction takes, whether voter approval is required, whether LGC approval is required, and how the bond will be marketed and at what cost. Each of the five authorized borrowing methods involves a distinct primary security pledge. For most of the borrowings, however, state law allows secondary security pledges. Pledging additional security may be necessary to satisfy lenders and make the borrowing feasible, or more affordable, for the unit. The primary securities for each borrowing transaction are discussed in greater detail below.

17.4.2 Entities Involved

When a unit borrows money, it typically requires the assistance of a variety of outside entities, including bond counsel, financial advisors, underwriters, and rating agencies. And most local government borrowings are subject to approval by the LGC. Not all borrowings involve these entities, however; local governments complete many simple, lower-dollar borrowings without any outside guidance or oversight.

Bond Counsel

Bond counsel is a lawyer hired by the local unit to assist in many debt authorization and issuance processes. Bond counsel is one of the key participants involved with issuing debt and usually is selected in the very early stages of the process. The essential role of bond counsel is to issue a legal opinion as to the validity of the bond offering. A typical opinion letter does the following:

1. Describes the bond issue in detail,
2. States that in the bond counsel’s judgment the bonds are valid and binding obligations of the borrowing unit,
3. Describes the nature of the security behind the debt, and
4. Indicates the status under the federal tax laws of interest being paid on the debt by the local government and may also indicate other aspects of the taxability of the debt securities or any income derived from holding the securities.

Local units and the purchasers of their bonds typically require this legal opinion as a condition of closing a bond transaction. Prior to issuing its legal opinion, bond counsel guides a local government—in concert with a unit’s regular attorney—through the procedural steps required to issue debt under state law. Bond counsel also prepares most of the legal documents required to complete a bond issuance. Through its involvement in this process, bond counsel can provide its approving legal opinion when a transaction is completed. After an issuance occurs, bond counsel also might advise a local government about how to comply with complex provisions in the federal tax code that regulate how a unit may spend or invest proceeds of “tax-exempt” bonds. (For more information about the distinction between “tax-exempt” and “taxable” bonds, see Section 17.6 below).

Bond counsel also might advise a local government about its obligations under federal securities laws to disclose certain facts affecting bonds issued or the local government’s financial condition. The terms of an engagement letter between a unit of local government and a private law firm providing bond counsel services will dictate whether and at what expense these services will be provided. If a unit of local government is contemplating a bond issuance, it should hire reputable bond counsel with prior experience advising a North Carolina local government in the issuance of debt. In doing so, a unit should seek to understand the specific functions bond counsel will perform during the initial issuance of the bonds and after the debt has been issued. (Although North Carolina law does not require local governments to undertake a competitive process to select bond counsel, many units of local government issue requests for proposals (RFPs) to seek information about prior experiences of potential bond counsel).

Financial Advisor

A financial advisor advocates for the borrowing government and provides its officials the information necessary to make informed decisions. A financial advisor often advises the unit on how to structure the financing to get the best interest rate and may coordinate the bond issuance process. A financial advisor that advises a local government in connection with the issuance of its debt—including advice with respect to the structure, timing, and similar matters of debt—must register as a “municipal advisor” with the federal Securities and Exchange Commission (SEC). [See U.S. SEC, Registration of Municipal Advisors, Final Rule, 78 Fed. Reg. 67,468 (Nov. 12, 2013)]. Providing such advice while failing to register as a municipal advisor violates federal law. [See 15 U.S.C. § 78o-4(a)(1)(B)]. Municipal advisors have fiduciary duties under federal law to act in the best interests of their clients. [See 15 U.S.C. § 78o-4(c)(1)].

A local government can engage a municipal advisor for a single debt issuance or for a range of services that extend beyond a particular transaction. Although North Carolina law does not require local governments to undertake a competitive process to select a municipal advisor, many units of local government issue RFPs to select such a firm. The Government Finance Officers’ Association has issued guidance that can assist in creating this type of RFP. The staff of the LGC can assist a local government in considering the structure of its debt or the proper mechanism for financing a project, but unlike a private municipal advisor, these staff may assist in commission decisions to approve or deny a particular debt issuance.

Underwriter

A bond underwriter is a financial institution that purchases a new issue of municipal securities for resale. The underwriter may acquire the bonds either by negotiation with the borrowing unit or by award based on competitive bidding. The underwriter essentially functions as a middleman in the borrowing transaction, bringing together the borrowing government and the investors who ultimately purchase the government’s bonds or certificates of participation. General obligation bond sales typically are conducted competitively, with underwriting firms submitting sealed bids to buy the bonds. In a public sale, the underwriter is the formal lender or buyer of the securities; the title to the securities passes to that entity. The underwriter bears the risk of finding enough investors to whom to sell the securities. Other bond sales (revenue bonds, special obligation bonds, project development bonds, limited obligation bonds) and certificates of participation generally are sold by negotiation. The unit selects one or more underwriters at the beginning of the process and negotiates the structure of the financing and the sales price with the underwriters.

Underwriters that purchase and resell a local government’s bonds to investors must comply with certain federal securities regulations, including the SEC’s “Rule 15c2-12.” [See, e.g., 17 C.F.R. § 240.15c2-12 (hereinafter Rule 15c2-12)]. With some exceptions, these underwriters must (1) obtain disclosure documents from the local government that describe the bonds to be sold and provide certain information about the issuer of the bonds, see Rule 15c2-12(b)(1) (2) distribute these disclosure documents to potential investors, see Rule 15c2-12(b)(2), and (3) reasonably determine that the issuer has agreed to provide continuing disclosure of certain information after the bonds are issued, see Rule 15c2-12(b)(5).

The exemptions to Rule 15c2-12 include, among others, primary offerings of municipal securities sold in authorized denominations of $100,000 or more and to no more than thirty-five sophisticated investors meeting certain criteria. [See Rule 15c2-12(d)(1)].  

An underwriter typically hires legal counsel to advise it on the structure of the offering and the underwriter’s responsibilities, and a local government typically pays for the cost of such legal counsel at closing out of bond proceeds. In some cases, a financial institution may not purchase a local government’s bond or debt to resell it to other investors. Instead, it may hold this debt on its own balance sheet. A financial institution participating in such a “private placement” may be referred to as a “lender” rather than an “underwriter.”

Rating Agencies

When a unit sells bonds publicly, it is subject to disclosure requirements considerably more extensive than those required by a private placement. In addition, as a practical matter, securities that are publicly sold must be rated. Bond ratings play a crucial role in the marketing of bonds. According to The Department of State Treasurer’s Guidelines on Debt Issuance, the LGC will not approve a public offering of bonds without an “investment grade” rating from a nationally recognized credit rating agency. Investment-grade ratings are those above Baa3 (Moody’s) and BBB- (S&P Global Ratings and Fitch). Many investors, particularly individuals, cannot personally investigate the creditworthiness of a government’s securities. Bond ratings are an accepted indication of the creditworthiness of a particular issuance. The bond rating often is the single most important factor affecting the interest cost on bonds.

Three national agencies rate local government bonds and certificates of participation for the national market—Moody’s Investors Service, Standard & Poor’s, and Fitch Ratings. Each agency uses a slightly different formula for determining its ratings. All the agencies assess the following factors—the economy; the particular debt structure; the unit’s financial condition; the unit’s demographic factors; the management practices of the governing body and administration; and, if applicable, the user charges supporting the issuance and any covenants and other protections offered by the bond documents.

Trustee

A trustee is a corporate entity—typically an arm of a financial institution—that is involved in some, but not all, issuances of local government debt. Trustees are most commonly involved in issuance of revenue bonds or special obligation bonds. Subject to the terms of the bond documents under which bonds are issued, a bond trustee usually takes several actions throughout the life of a bond. It might act on behalf of bondholders in the event a local government defaults under the terms of the bond documents, obtain certain disclosures from the local government over the life of the bonds, and, as a “paying agent,” collect a local government’s payments of principal and interest and ensure their proper application. For helpful general information on the role of a bond trustee, see UMB Financial Corporation’s blog “Defining the Role of a Bond Trustee or Paying Agent” (September 9, 2024).

Local Government Commission

As discussed in Chapter 1, Section 1.8 the LGC approves most local government borrowings and sells bonds on a unit’s behalf. All general obligation bonds, revenue bonds, special obligation bonds, and project development bonds must be approved by the LGC. The same is true of some installment financings, certain leases, and other financial agreements. A unit must determine if LGC approval is mandated by statute for its proposed borrowing transaction because if approval is required and a unit fails to obtain it, the entire borrowing transaction is void. For more information on the types of financial agreements subject to LGC approval, see Kara Millonzi’s blog post about LGC approval of bonds, installment financings, leases, and more.

In reviewing proposed issuances, the LGC must consider statutory criteria, which vary somewhat depending on the type of borrowing. Generally, however, the LGC must determine if the amount being borrowed, when added to the existing debt of the unit and at the rate of interest the unit probably will have to pay, is an amount the unit can afford. LGC staff members will work with a unit from the outset of the borrowing process to help local officials determine the best borrowing method for the project being funded. The staff also will identify any deficiencies in the unit’s financials or management practices that might prevent the unit from receiving commission approval. For more guidance, see The Department of State Treasurer’s general guidelines on issuing debt. Thus, local officials should contact LGC staff very early in the unit’s internal process—preferably immediately after the scope of the capital project is determined and preliminary engineering studies are completed.

Joint Legislative Committee on Local Government

In 2011, the General Assembly created the Joint Legislative Committee on Local Government as a standing interim legislative study committee [Section 1.8(a) of S.L. 2011-291]. The purpose of the committee, among other things, is to review and monitor local government capital projects that require both approval by the LGC and an issuance of debt exceeding $1 million. The committee’s directive does not apply to capital projects related to schools, jails, courthouses, and administrative buildings. (G.S. 120-157.2). It also does not apply to the re-funding of existing debt. Furthermore, the committee’s authority is limited to reviewing and monitoring the capital projects and debt issuances within its purview; it is not authorized to approve or reject a capital project or financing.

The committee has promulgated guidelines to carry out its statutory responsibility. A local unit seeking approval from the LGC to borrow money for a capital project subject to the committee’s oversight must submit a letter to the committee at least forty-five days prior to the unit’s formal presentation before the LGC. The letter must include (1) a description of the project, (2) the debt requirements of the project, (3) the means of financing the project, and (4) the source or sources of repayment for project costs.

The committee may meet at the discretion of its chairs to review a proposed capital project. (G.S. 120-157.3). It may send a letter of objection or support to the LGC for a particular project. It also may ask to speak at an LGC meeting on a particular project. In addition, the committee may make periodic reports and recommendations to the General Assembly for proposed new legislation related to local government debt authority. (G.S. 120-157.2).

17.5 Types of Authorized Debt

The General Assembly may bestow borrowing authority on local units only by general law. (N.C. Const. Article V, Section 4). Any local acts or charter provisions purporting to grant borrowing authority are void. The main five debt mechanisms available to local governments are general obligation bonds, revenue bonds, special obligation bonds, project development financings, and installment financings. A local government has additional borrowing authority under certain circumstances. (G.S. 160A-512(8); G.S. 160A-17.2). Some public authorities also have (limited) borrowing authority. [G.S. 162A-8 (revenue bond authority for water and sewer districts); G.S. 162A-90 (revenue and general obligation bond authority for county water and sewer districts); G.S. 130A-61 (general obligation bond authority for sanitary districts); G.S. 159-210 (lease-backed financings by airport authorities)]. Each debt mechanism, including the primary security, the projects which may be funded, and any significant limitations, is described below. However, a county or municipality is not limited to the above-listed mechanisms when borrowing from the state or federal government. (G.S. 160A-17.1).

17.5.1 General Obligation Bonds

The Local Government Bond Act, in G.S. Chapter 159, Article 4 authorizes the issuance of general obligation (GO) bonds. State law specifies the types of capital projects a county or municipality may fund with GO bonds, which includes most, if not all, capital projects in which a unit is authorized to engage. (See G.S. 159-48).

Security

GO bonds involve the strongest form of security a county or municipality can pledge for debt—the unit’s full faith and credit. All the resources of that government stand behind such a pledge, but specifically, a full-faith-and-credit pledge of a North Carolina county or municipality is a promise to levy whatever amount of property tax is necessary to repay the debt. (G.S. 159-46). By law, a general obligation pledge is not subject to the $1.50 per $100 valuation property tax rate limitation. [G.S. 153A-149(b)(2) (counties); G.S. 160A-209(b)(1) (municipalities)]. Thus, a general obligation pledge is a pledge of the unlimited taxing power.

Requirements and Limitations

The legal authority to issue GO bonds is very broad. Practically it is much more limited, as the North Carolina Constitution generally requires that a unit hold a successful voter referendum before pledging its full faith and credit. [N.C. Const. Article V, Section 4(2)]. State law also places a limit on the amount of outstanding GO debt a unit may have at any one time, referred to as the net debt limit. [ G.S. 159-55(c)]. Finally, all GO borrowings must be approved by the LGC.

Voter Approval

The voter approval requirement can be a significant hurdle to issuing GO bonds. For example, voters are unlikely to vote for controversial or less popular projects, such as jails or landfills. Even referenda for popular projects, such as schools or parks, sometimes fail. Thus, although issuing GO bonds is a relatively simple form of borrowing, and generally the cheapest, local units often look to one of the other authorized borrowing mechanisms to avoid the voter-approval requirement. (The state constitution does not require voter approval if any other form of security is used, and therefore voter approval is never necessary for loans secured by the other authorized borrowing methods.) Voter approval is not always necessary for GO bonds. The constitution carves out a few exceptions, the most significant of which are refunding bonds and two-thirds bonds For a list of all the purposes for which a local government may issue GO bonds without voter approval, see N.C. Const. Article V, Section4(2) and G.S. 159-49.

Refunding Bonds

Refunding bonds are issued to retire, or pay off, an existing debt, replacing it with a new one. They typically are used to refinance existing debt because interest rates have fallen, and the county or municipality wants to reduce its debt service payments. No new debt is being created; rather, a unit merely changes the evidence of an existing debt. Therefore, the constitution excuses refunding bonds from the requirement of voter approval. [See N.C. Const. Article V, Section 4(2)].

Investors typically seek to protect their investment against refunding for as long as possible. GO bonds often include provisions that prohibit the call, or early retirement, of a bond issue for a period of time. A unit may still take advantage of falling interest rates during the prohibited call period. It must utilize a device known as an advanced refunding, wherein the local government issues refunding bonds. Rather than use the proceeds to retire the refunded debt immediately, however, the unit places them in an escrow account (sinking fund) controlled by an independent party. The moneys are invested and used for two purposes—they pay debt service on the original issue until the bonds can be called, and, when allowed, they retire the original debt. Recent changes in federal income tax laws have decreased the usefulness of advance refunding. Prior to January 1, 2018, interest paid to holders of refunding bonds was exempt from federal income tax if the bonds were issued at least ninety days prior to the call date of refunded bonds. In December 2017, Congress repealed that exemption for refunding bonds issued after January 1, 2018—making interest paid on refunding bonds federally taxable. [See Pub. L. 115-97, § 13532, 131 Stat. 2154 (Dec. 22, 2017)].

To compensate for the loss of the tax exemption, issuers must pay relatively higher rates of interest to holders of advance refunding bonds issued after January 1, 2018. If interest rates are low enough, an issuer still might be able to issue advanced refunding bonds on a taxable basis at a lower rate than existing tax-exempt debt. In N.C. Department of State Treasurer guidelines on debt issuance, the LGC has stated that the present value of savings from a refunding should exceed 3 percent of the refunded bonds to receive LGC approval.

Two-Thirds Bonds

The state constitution also excepts from the voter-approval requirement certain additional debt issuances resulting from principal reductions in outstanding GO issuances. Specifically, Article V, Section 4(2)(f) specifies that no voter referendum is required when GO bonds are issued

for purposes authorized by general laws uniformly applicable throughout the State, to the extent of two-thirds of the amount by which the unit’s outstanding indebtedness shall have been reduced during the next preceding fiscal year. [This exception is statutorily authorized by G.S. 159-49].

In determining the amount of debt reduction during a fiscal year, a local unit counts only principal payments; interest paid is irrelevant. And only the net reduction in principal is counted. If a county or municipality borrows during a fiscal year, it may actually have a net increase in outstanding debt and therefore no two-thirds capacity at all.

A local unit must use its two-thirds capacity in the fiscal year immediately following the year in which the debt was reduced. In using its two-thirds capacity, the government generally is not restricted by the purposes for which the retired debt was issued. State law requires, however, that new GO debt incurred for certain purposes always be approved by the voters. These purposes include auditoriums, coliseums, stadiums, convention centers, and similar facilities; art galleries, museums, and historic properties; urban redevelopment; and public transportation. (G.S. 159-49).

Once a county or municipal governing board announces its intention to use its two-thirds capacity to issue new GO bonds without voter approval, the unit’s citizens can force a referendum by submitting a petition signed by at least 10 percent of the unit’s registered voters. The petition must be filed with the county or municipal clerk within thirty days after the date of publication of the bond order as introduced. (G.S. 159-60).

Net Debt Limitation

The other restriction on issuing GO bonds is the net debt limitation. A proposed GO borrowing (as well as a proposed installment financing) contract must satisfy this requirement. The limitation recognizes that both GO bonds and installment financings are retired with property tax proceeds, and it therefore restricts the net debt of a unit to 8 percent of the appraised value of property subject to taxation by the unit. Net debt is calculated by taking gross GO and installment financing debt and then deducting the amount of this debt that in most units is repaid from sources other than the property tax. There is a complicated statutory formula for both calculating gross debt and determining the appropriate deductions. (G.S. 159-55).

For most local units, the net debt limitation is more of a theoretical than an actual limitation. The net debt of any unit rarely exceeds 2 percent. To retain good credit ratings, many units set a target net debt threshold at an even lower percentage. The finance officer must file a statement of net debt with the clerk to the board and the LGC as part of the debt approval process.

LGC Approval

The LGC must approve all issuances of GO bonds—even those that do not require voter approval. (See G.S. 159-51). When reviewing a GO bond issuance, the commission considers several factors to help it determine if the unit will be able to repay the debt. Such factors include the unit’s outstanding debt, its debt and financial management practices, its tax base and the projected tax rates needed to repay the debt, and the proposed interest rates and total cost of the borrowing. (G.S. 159-52).

State law directs the LGC to approve the debt issuance if it determines:

1. That the proposed bond issue is necessary or expedient.
2. That the amount proposed is adequate and not excessive for the proposed purpose of the issue.
3. That the unit’s debt management procedures and policies are good, or that reasonable assurances have been given that its debt will henceforth be managed in strict compliance with the law.
4. That the increase in taxes, if any, necessary to service the proposed debt will not be excessive.
5. That the proposed bonds can be marketed at reasonable rates of interest.
6. That the assumptions used by the finance officer of the unit in preparing the statement of estimated interest filed with the clerk pursuant to G.S. 159-55.1(a) are reasonable.

(G.S. 159-52). If the commission denies the application, it must notify the unit. At the unit’s request, the commission must hold a public hearing on the application. The commission may revisit its decision based on testimony or other information presented at the hearing. (G.S. 159-52).

Issuance Process

The process to issue GO bonds that require voter approval is lengthy and requires detailed planning and coordination among a unit’s staff, bond counsel, the LGC, and other third parties (for example, financial advisors or ratings agencies). Form LGC-107, available from the LGC upon request, lists the major steps necessary for counties and municipalities to authorize the issuance of GO bonds requiring voter approval. Bond counsel typically assists a unit’s staff in the preparation of public notices, required statements a finance officer must prepare or file, and documents to be approved by the governing board and the LGC.

Application for LGC Approval

To initiate the process, a unit must file with the LGC an application for the approval of a GO bonds issuance. (See G.S. 159-51). The LGC may require the unit’s staff to meet with LGC staff prior to the acceptance of the application. (G.S. 159-51). Typically, commission staff will meet with unit representatives to aid in structuring the deal and advise the unit on the likelihood of commission approval.

Bond Order

The central document in a GO bond issuance is the bond order. The bond order is adopted by the governing board and serves a double purpose. First, it authorizes issuance of the bonds, stating the purpose for which the proceeds will be spent and the maximum amount of bonds that may be issued. If a unit is proposing bonds for more than one unrelated purpose, it will need a separate bond order for each purpose. [G.S. 159-48(g)]. Second, the order publicizes the bond issue, not only setting out the purpose and amount but also indicating the security for the bonds. The bond order is “the crucial foundation document which supports and explains” the issue. [Rider v. Lenoir Cnty., 236 N.C. 620, 631 (1953)].

The statutory procedure that leads to adoption of a bond order serves two primary purposes: (1) it concludes with the governing board’s formal authorization of the bond issue and (2) it provides an opportunity for the public to learn about and comment on the proposed issue and the project(s) it will finance.

Most of the formal steps in the process are largely pro forma. Much of the work to prepare the issuance, obtaining informal approvals from all required parties, typically happens well in advance of the adoption of the bond order. Occasionally testimony at the public hearing will cause a board to modify, delay, or drop its plans, but the real opportunity for citizens to comment on the bond issue is the referendum.

Sworn Statement of Debt

After a unit’s governing board has introduced a bond order authorizing the issuance of GO bonds, the unit’s finance officer must prepare and file with the clerk to the governing board a sworn statement of debt. [G.S. 159-55(a)]. This statement reflects the unit’s net debt, the assessed value of property subject to taxation by the unit, and the percentage of net debt compared to that assessed value. [G.S. 159-55(a)(3)–(a)(5)]. As discussed previously, that percentage may not exceed 8 percent.

Statement of Disclosures

The finance officer of a unit intending to issue GO bonds also must file a statement of disclosure with the LGC and the clerk to the governing board that contains (1) an estimate of the total interest that will be paid on the bonds over their expected term, if issued, and a summary of the assumptions upon which that estimate is based; (2) an estimate of the increase in property tax rate, if any, necessary to service the proposed debt; and (3) the amount of two-thirds bonds capacity the unit has available for the current fiscal year. [G.S. 159-55.1(a)]. The statement of disclosure also must be posted online but need not be published in a newspaper. [See G.S. 159-55.1(c)].

In November 2022, the LGC adopted a “safe harbor policy” to govern its assessment that a unit’s finance officer used reasonable assumptions in the statement of disclosure when determining the total interest to be paid over the expected term of the bonds. Under that policy, the LGC will find such assumptions reasonable if they assume that (1) principal will be paid in twenty annual equal principal installments, (2) the interest rate on the bonds will be equal to a Bond Buyer 20 index (BB20) rate published within twenty-five days prior to the introduction of the bond order plus at least 200 basis points (2 percent), and (3) the interest rate on the bonds will be equal to the highest interest rate charged for similar debt over the maximum bond issuance term.  A unit’s finance officer may use alternate assumptions, and in that case, the LGC will consider the reasonableness of those assumptions when it reviews the unit’s application for approval.

Voter Approval and Issuance

The governing board of a unit of local government must call for a referendum on the bonds to be held within one year after the bond order’s passage. [See G.S. 159-61(b)]. In 2023, the legislature amended G.S. 159-61(d), which provides the form of the ballot question to be used for local government general obligation bond referenda. [Section 36.3.(a) of Session Law 2023-134]. LGC staff has issued a memorandum to provide guidance to units in complying with the modified ballot question requirements—specifically, the requirements of both clause (1) and clause (2) of G.S. 159-61(d), as amended. The ballot must include certain information about expected cumulative cost of the bond issuance and whether, and to what extent, a tax rate increase will be required to service the debt. [G.S. 159-61(d)]. After the bond order is approved by voters, the unit may issue bonds authorized under the order within seven years of the date the bond order takes effect. A unit may obtain a three-year extension, from seven to ten years, with approval from the LGC. (See G.S. 159-64). After the unit adopts a resolution establishing the details of the bonds to be issued, see G.S. 159-65(a), the LGC sells GO bonds on behalf of the unit, typically on a competitive basis. [See G.S. 159-123(a) (authorizing competitive sale); G.S. 159-127 (setting forth procedure for award of sale)].

17.5.2 Revenue Bonds

The State and Local Government Revenue Bond Act authorizes the issuance of revenue bonds. (G.S. Chapter 159, Article 5). Revenue bonds are most commonly issued to fund water and sewer utility projects, though legally they may fund a variety of other revenue-generating capital assets, including gas facilities, solid waste facilities, parking, marine facilities, auditoriums, convention centers, economic development projects, electric facilities, public transportation, airports, hospitals, stadiums, recreation facilities, and stormwater drainage (See G.S. 159-81).

Security

The primary security for a revenue bond is the revenue generated by the financed asset or the system of which the financed asset becomes a part. By law such a pledge creates a lien on the pledged revenues in favor of the bondholders, G.S. 159-91, and normally the bondholders have the contractual right to demand an increase in the user charges generating the revenues if those revenues prove inadequate to service the debt. If the revenue pledge is the only security, however, the bondholders have no right to demand payment from any other source, or to require an increase in taxes, if facility or system revenues remain inadequate even after charges are increased. As discussed above, a unit also may pledge special assessments levied under the critical infrastructure assessment authority as security for revenue bonds used to finance specially assessed projects. (G.S. 153A-210.6; G.S. 160A-239.6).

North Carolina law allows units of local government to pay debt service on revenue bonds only from revenues pledged as security for the bonds. [G.S. 159-94(a)]. For example, a municipality that issues revenue bonds to finance the construction of a public parking deck may use only revenues generated by the operation of that parking deck (for example, parking fees) to pay principal and interest to revenue bondholders. In most cases, holders of revenue bonds have no right to mandate that a local government raise taxes or demand payment from any source other than the revenues of the financed asset or system. A local government is authorized to pledge its taxing power as additional security for some types of revenue bond projects. (See G.S. 159-97). Such pledges are uncommon.

Requirements and Limitations

A vote of the people is not required to issue revenue bonds. If a unit covenants or otherwise agrees to effectively pledge its taxing power as additional security for a revenue bond, the unit must first hold a voter referendum. (See G.S. 159-97). However, other requirements effectively limit the types of projects that revenue bonds may be issued to fund. The requirements are reflected in covenants. Revenue bonds also are subject to LGC approval. [G.S. 159-83(b)].

Covenants

Because the security for the debt is revenue from the debt-financed asset, or the system of which it is a part, lenders are naturally concerned about the construction, operation, and continued health of the financed asset or system. This concern is expressed through a series of covenants, or promises, the borrowing government makes to the lenders as part of the loan transaction. The most fundamental of these is the rate covenant, under which the unit promises to set and maintain the rates, fees, and charges of the revenue-producing facility or system so that net revenues will exceed annual debt service requirements by some fixed amount or percentage. For example, a common requirement is that the rate structure generate annual net revenues at some specified level—usually between 120 and 150 percent—of either the current year’s debt service requirements or the maximum annual debt service requirements during the life of the loan. This margin of safety required by the rate covenant is referred to as times-coverage of the loan. The times-coverage requirement serves as a practical limitation on the types of projects that may be funded with this loan structure.

Because prospective investors typically will want independent verification that revenues will be adequate to service the bonds, a borrowing government normally is expected to commission a feasibility study by a consulting an engineer or other independent professional. The professional will evaluate the demand for the services the financed facility or system will provide, look at likely operating costs, and suggest the net revenue stream likely to result.

Issuers of revenue bonds also typically agree to certain restrictions on their ability to issue additional revenue bonds secured and payable from the same source of revenues as previously issued bonds. Known as an “additional bonds test,” this covenant generally permits the issue of additional bonds secured by and payable from the same source of revenues as outstanding revenue bonds only if the issuer can demonstrate that the net revenues have been and will continue to be sufficient to service the additional debt.

Lastly, revenue bond issuers also commonly agree to maintain various funds in connection with the bonds (for example, a revenue fund, a debt-service fund, a construction fund, and a debt-service reserve fund). Each of these funds is restricted by the terms of the bond documents under which the revenue bonds are issued. An issuer will commonly agree that a third-party trustee will maintain the proceeds of the revenue bonds and will disburse the proceeds of those bonds only upon the issuer’s submission of proper documentation, for example, relevant evidence of construction pay applications. G.S. 159-89 provides a full list of covenants to which an issuer of revenue bonds may agree.

State Approval

A unit of local government seeking to issue revenue bonds must submit an application for approval to the LGC. [See G.S. 159-85(a)]. As with GO bonds, the commission will consider the feasibility of the bond issuance and the likely ability of the unit to repay the loan. And, as with GO bonds, the LGC may require the unit’s staff to meet with LGC staff prior to the acceptance of the application. [See G.S. 159-85(b)]. Once the LGC accepts the unit’s application, it may consider, among other things, whether the probable net revenues of the financed assets will be sufficient to meet the debt service on the proposed revenue bonds. [See G.S. 159-86(a)]. The LGC must approve the borrowing if it determines the following:

1. The proposed revenue bond issue is necessary or expedient.
2. The amount proposed is adequate and not excessive for the purpose of the issue.
3. The proposed project is feasible.
4. The unit’s debt management procedures and policies are good, or reasonable assurances have been given that its debt will henceforth be managed in strict compliance with the law.
5. The proposed revenue bonds can be marketed at a reasonable cost to the unit.

(G.S. 159-86).

A denial of an application by the LGC is considered a final decision. (G.S. 159-87).

Issuance Process

Revenue bonds usually are sold by negotiation rather than by competitive bid, and the borrowing government will select an underwriter or placement agent at the beginning of the process. Each revenue bond financing is unique; the details of the financing and the bond order differ from one financing to another. Typically, the details emerge from a series of negotiating sessions attended by representatives of the borrowing government, the bond attorney, one or more underwriters or placement agents and their attorney, and LGC staff members.

Unlike with GO bonds, a unit’s governing board may introduce a bond order for revenue bonds at any regular or special meeting and adopt it at the same meeting, as long as the unit has submitted its application for approval to the LGC. It may be adopted by a simple majority of those present and voting if there is a quorum. To approve a revenue bond issuance, state law does not require the unit to publish notice of a referendum or take any other procedural action other than approving the bond order. [See G.S. 159-88(a)–(b)].

17.5.3 Special Obligation Bonds

North Carolina law authorizes certain units of local government to issue “special obligation” bonds for a limited number of purposes. (See G.S. Chapter 159, Article 7A). In particular, counties, municipalities, and regional solid waste management authorities may issue these bonds for solid waste management projects; certain water supply, conservation, and reuse projects; and wastewater collection and treatment projects. [G.S. 159-146(a) (authorizing issuance of special obligation bonds to finance or refinance a “project”); G.S. 159-146(b)(7) (defining “project”)]. Municipalities also may issue special obligation bonds to finance or refinance projects that they may otherwise undertake in an MSD. [See G.S. 159-146(b)(7)].

Security

A special obligation is secured by a pledge of any revenue source or asset available to the borrowing government, except the unit’s taxing power. In a broad sense a revenue bond is a type of special obligation bond. The term “special obligation,” as used in North Carolina, however, refers to debts secured by something other than (or in addition to) revenues from the asset or system being financed. For example, a county might pledge proceeds from fees charged for building rentals or from special assessments. A county could not pledge local sales and use tax, animal tax, privilege license tax, or property tax proceeds because these are locally levied taxes. A municipality could pledge local sales and use tax because it is not a unit-levied tax.

Requirements and Limitations

As with revenue bonds, there is no statutory process for issuing SO bonds. Because the debt market perceives the security for special obligation debt as weaker than that for general obligation debt, the market normally demands of special obligation debt some of the same safeguards demanded of revenue bonds. And the process for issuing SO bonds is similar to that for issuing revenue bonds.

The LGC must approve all SO bond issuances. [G.S. 159-146(k)]. The commission may consider the same criteria as it does for a GO bond issuance, a revenue bond issuance, or both. [See G.S. 159-146(k)]. The LGC sells special obligation bonds on behalf of an issuing unit, typically in a privately negotiated sale. [See G.S. 159-123(b)(3) (authorizing the private sale of special obligation bonds)].

17.5.4 Project Development Financings

As a specialized borrowing structure, North Carolina law authorizes local governments to engage in project development financings. (See S.L. 2003-403). Project development financing is structurally equivalent to a type of borrowing prevalent in other states known as tax increment financing, or TIF. For more detailed information on project development financings, see William C. Rivenbark et al. “2007 Legislation Expands Scope of Project Development Financing in North Carolina,” Local Finance Bulletin No. 36. In fact, North Carolina practitioners often refer to this form of borrowing as TIF or TIF bonds.

Project development financing is a method of increasing the overall property value in a currently blighted, depressed, or underdeveloped area within a county or municipality. A unit borrows money to fund public improvements within the designated area (development district) with the goal of attracting private investment. (See G.S. 159-103). The debt incurred by funding the improvements is secured and repaid by tax increment revenue—the additional property tax proceeds resulting from the district’s new development. (See G.S. 159-107). The Project Development Financing Act, G.S. Chapter 159, Article 6, permits counties and municipalities to issue project development financing bonds and to use the proceeds for many, but not all, of the purposes for which either taxing unit may issue GO bonds. (G.S. 159-103). For more information on project development financing authority in North Carolina, see this SOG FAQ microsite about Tax Increment Financing in NC. The act also allows local governments to use the proceeds for any service or facility authorized to be provided in an MSD, though no district actually need be created. See G.S. 160A-536 and the discussion about MSD purposes detailed above.

Security

The security for a project development financing bond is the incremental increase in property tax revenue in a defined area. (G.S. 159-110). The tax increase results from private development incentivized by the public infrastructure financed with the loan proceeds.

Requirements and Limitations

There are detailed procedural requirements for issuing project development bonds. A unit must define a financing district, adopt a financing plan, and secure various approvals from governmental entities.

Financing District

At the outset of a project development financing project, a county or municipality must establish a development financing district. A county district must consist of property that is

1. Blighted, deteriorated, deteriorating, undeveloped, or inappropriately developed from the standpoint of sound community development and growth[;]
2. Appropriate for rehabilitation or conservation activities[; or]
3. Appropriate for the economic development of the community.

[G.S. 158-7.3(c)].

A municipal district must consist of property that meets at least one of the conditions set forth for a county district as detailed above or that meets the criteria of an urban redevelopment area as defined by G.S. 160A-503. Under G.S. 160A-503, a municipality’s planning commission may designate the following types of property as a redevelopment area:

1. property that is blighted because of dilapidated, deteriorated, aged, or obsolete buildings; inadequate ventilation, light, air, sanitation, or open spaces; high density of population or overcrowding; or unsanitary or unsafe conditions;
2. a nonresidential redevelopment area with dilapidated, deteriorated, aged, or obsolete buildings; inadequate ventilation, light, air, sanitation, or open spaces; defective or inadequate street layout or faulty lot layout; tax or special assessment delinquency exceeding the value of the property; or unsanitary or unsafe conditions;
3. a rehabilitation, conservation, and reconditioning area in present danger of becoming a blighted or nonresidential redevelopment area; or any combination of the above types of areas.

Additional limitations apply to a plan for a development financing district established pursuant to G.S. 158-7.3 and located outside a municipality’s central business district. [G.S. 158-7.3(a)(1)].

The total land area within a financing district may not exceed 5 percent of the total land area of the taxing unit. [G.S. 158-7.3(c); G.S. 160A-515.1(b)]. Counties also are specifically prohibited from including in a development financing district land located within a municipality at the time the district is created, even though a county and municipality may jointly agree to create such a district. [See G.S. 158-7.3(c); G.S. 159-107(e)]. In the absence of such an agreement, any land included in a development financing district established by a municipality that issues debt instruments to be repaid from the incremental valuation does not count against the 5 percent of unincorporated land in that county that may be included in a development financing district. Conversely, land in a county district subsequently annexed by a municipality does not count against the municipality’s 5 percent limit unless the county and municipality have entered into an increment agreement; in such an agreement, the municipality agrees that municipal taxes collected on part or all of the incremental valuation in the district will be paid into the reserve increment fund for the district. [G.S. 159-107(e); G.S. 158-7.3(c); G.S. 160A-515.1(b)].

If a county and municipality jointly create a development financing district, with each unit pledging its incremental tax revenue in support thereof, the area included within the district likely counts against the 5 percent limit for both the county and the municipality.

Financing Plan and County Approval

Once it identifies the development financing district, a unit must adopt a financing plan that includes the following:

• a description of the boundaries of the district;
• a description of the proposed development, both public and private;
• the costs of the proposed public activities;
• the sources and amount of funds needed to pay for the proposed public activities;
• the base valuation of the district;
• the projected increase in the assessed valuation of property in the district;
• the estimated duration of the district [the earlier of thirty years from the effective date of the district or when the bonds are repaid, see G.S. 159-107(g)];
• a description of how the proposed public and private development of the district will benefit district residents and business owners in terms of jobs, affordable housing, and services;
• a description of appropriate ameliorative activities if the proposed projects negatively impact district residents or business owners in terms of jobs, affordable housing, services, or displacement;
• a statement that the initial users of any new manufacturing facilities included in the plan will be required to pay certain wages, unless the users are exempted by the secretary of commerce.

[G.S. 158-7.3(d)–(e); G.S. 160A-515.1(c)–(d)].

The unit must hold a public hearing on the proposed financing plan. The unit must publish notice of the public hearing in a newspaper of general circulation and mail notice to all affected property owners in the proposed district. After the public hearing, a county board may approve the plan, with or without amendment, unless the plan has been disapproved by the secretary of the North Carolina Department of Environmental Quality (NCDEQ). [G.S. 158-7.3(a)(2), (h); G.S. 160A-515.1(g)]. Municipal boards must also provide notice to the governing board(s) of the county or counties in which the proposed district is located. County governing boards have twenty-eight days to disapprove the plan. If it is not disapproved by the county board(s), the municipal board may proceed to adopt the plan. [G.S. 160A-515.1(e)].

State Approval

The plan and district are not effective until the LGC approves the issuance of project development financing bonds for the district. The LGC may consider any matters it deems relevant to whether the bond issuance should be approved, including

1. whether the projects to be financed from the bonds are necessary to secure significant new project development for the district;
2. whether the proposed projects are feasible (taking into account additional security, such as credit enhancement, insurance, or guarantees, as discussed below);
3. the unit’s debt management procedures and policies;
4. whether the unit is in default in any debt service obligation;
5. whether the private development forecast in the development financing plan is likely to occur without the public project or projects to be financed by the bonds;
6. whether taxes on the incremental valuation accruing to the development financing district, together with any other revenues available under G.S. 159-110, will be sufficient to service the proposed project development financing debt instruments;
7. whether the LGC can market the proposed project development financing debt instruments at reasonable rates of interest.

[G.S. 159-105(a); see also G.S. 159-105(b) (establishing the criteria used by the LGC to approve proposed project development financing bonds)].

Two other state agencies must approve some project development financings. If a development financing plan involves the construction and operation of a new manufacturing facility, the plan must be submitted to the secretary of NCDEQ. The secretary’s review will determine whether the facility will have a materially adverse effect on the environment and whether the company that will operate the facility has previously complied with federal and state environmental laws and regulations. [G.S. 158-7.3(g); G.S. 160A-515.1(f)].The plan also must be submitted to the Secretary of Commerce. The secretary must certify that the average weekly manufacturing wage required by the plan to be paid to the employees of the initial users of the proposed new manufacturing facility is either above the average weekly manufacturing wage in the county in which the district is located or not less than 10 percent above the average weekly manufacturing wage paid in the state. The secretary may exempt a facility if certain criteria are met. [G.S. 158-7.3(e); G.S. 160A-515.1(d)].

17.5.5 Bond Anticipation Notes

A unit of local government may, in certain cases, issue “bond anticipation notes.” As the name suggests, bond anticipation notes are promissory notes a unit issues in anticipation of a future bond issuance. Bond anticipation notes may be issued as general obligation bond anticipation notes, revenue bond anticipation notes, special obligation anticipation notes, or project development bond anticipation notes. To issue general obligation bond anticipation notes, a unit must follow the statutory procedures for authorization of a general obligation bond issuance in the Local Government Bond Act. See Section 17.5.1 above. They are secured primarily by the proceeds of future bonds issued and typically mature in less than two years [See G.S. 159-162 (security for general obligation bond anticipation notes); G.S. 159-163 (security for revenue bond anticipation notes); G.S 159-163.1 (security for project development-financing debt instrument anticipation notes); G.S. 159-146(c), (e) (security for special obligation notes)].

A unit might issue bond anticipation notes if it has authorized a bond issue but does not wish to borrow the full sum at one time. It also might issue bond anticipation notes if it intends to use note proceeds for construction financing. A unit must obtain short-term construction financing when it intends to sell an issue of future bonds to the U.S. Department of Agriculture’s Rural Development unit (USDA-RD). USDA-RD offers long-term (up to forty-year) financing for the construction or repair of certain types of public infrastructure in rural jurisdictions. To be eligible for such long-term financing, a unit typically must (1) obtain short-term construction financing from a lender other than USDA-RD (for example, a private financial institution) and (2) substantially complete the project to be financed. A unit issues a bond anticipation note to obtain short-term financing, and when the unit issues a long-term bond to USDA-RD, it uses the proceeds of that financing to pay off the initial short-term loan evidenced by the bond anticipation note.

A unit of local government must obtain approval from the LGC to issue bond anticipation notes, see G.S. 159-161, and the LGC will sell any notes approved on behalf of the unit. (See G.S. 159-165).

 17.5.6 Installment Financing

The final borrowing method, installment financing, is the borrowing structure most often used by North Carolina local governments. It differs from the other mechanisms in that it often does not involve the issuance of bonds. Both counties and municipalities (along with several other local entities) may borrow money by entering into installment financing agreements. (G.S. 160A-20). G.S. 160A-20(h) lists the local entities (including municipalities, counties, water and sewer authorities, sanitary districts, local airport authorities, area mental health authorities, and regional transportation authorities, among others—collectively referred to as “unit of local government”) authorized to enter into installment-purchase contracts. In addition, G.S. 115C-528 provides (more limited) authority for local boards of education to enter into installment purchase agreements for certain purposes.

An installment finance agreement is a loan transaction in which a local government borrows money to finance or refinance the purchase of a capital asset (real or personal property) or the construction or repair of fixtures or improvements on real property owned by the local unit. Specifically, G.S. 160A-20 allows a unit of local government to “purchase, or finance or refinance the purchase of, real or personal property by installment contracts that create in some or all of the property purchased a security interest to secure payment of the purchase price[.]” The statute also allows an authorized entity to “finance or refinance the construction or repair of fixtures or improvements on real property by contracts that create in some or all of the fixtures or improvements, or in all or some portion of the property on which the fixtures or improvements are located, or in both, a security interest to secure repayment of moneys advanced or made available for the construction or repair.”

Security

The unit of local government must grant a security interest in the asset that is being purchased or in the real property or fixtures and improvements to that real property (or both) being financed with the borrowed funds. A unit of local government may not grant a security interest in real or personal property that is not part of the financing transaction. To illustrate, take a routine construction project of a maintenance garage that will be located on property owned by a county or municipality. The government may borrow money to finance the cost of constructing the maintenance garage and may pledge as security the garage structure itself or the real property on which the garage is built (or both). The unit may not pledge as security any other property it owns, however, such as city hall or the county library. The authority for this type of borrowing transaction, as well as its procedural requirements and limitations, is found in a single statute—G.S. 160A-20. Thus, installment financings often are referred to as “160A-20s.”

A unit of local government can grant a security interest in only real or personal property it owns. Therefore, an installment financing agreement is valid under North Carolina law only if a unit takes legal title to the financed property when the financing term begins. The vendor, bank, or other financier may not take title to the asset at the outset of a transaction and retain title until the loan securing the purchase price is repaid. This type of transaction is known as a lease-purchase arrangement, a borrowing structure in which North Carolina’s local governments are not generally authorized to engage. Even a lease-purchase arrangement that provides a local government an option to purchase an asset at the conclusion of the lease term will not comply with G.S. 160A-20. For example, if a municipality purchases a vehicle and obtains vendor financing with a five-year repayment term, the municipality must acquire a certificate of title to the vehicle when it takes possession of the vehicle—not at the conclusion of the financing term. North Carolina law does not identify particular sources of revenue a local government must use to repay debt incurred in an installment financing arrangement. Local governments may use any unrestricted funds to repay the debt.

 Forms of Installment Financing

Installment financings can take several general forms, each of which is described below.

Vendor Financing

The simplest form of installment financing is commonly referred to as vendor financing. The parties enter a contract under which the vendor conveys the equipment or property to the local government and the local government promises to pay for the equipment or property through a series of installment payments. The contract gives the vendor a lien on the equipment or a deed of trust on the property to secure the government’s payment obligations under the contract. If the government defaults under the contract, the vendor may repossess the equipment or foreclose on the property.

Lending Institution Contracts

A more common form of an installment finance contract transaction involves two different contracts—one between the unit of government and the vendor or contractor and one between the unit of local government and a lending institution. The government enters a purchase contract with a vendor or contractor, who is paid in full upon delivery of the asset or completion of the construction project. The government enters a separate installment finance contract with a financial institution; under this contract, the institution provides the moneys to pay the vendor or the contractor and the local government agrees to repay those moneys in installments with interest. The financial institution takes a security interest in the asset being purchased or constructed (or the land on which it is constructed) to secure the government’s payment obligations under the installment finance contract.

Bond Market Financing

Most installment finance contracts are arranged with a single bank or financial institution. If the project is particularly large or if the local government has borrowed a significant amount of money during the current calendar year, however, a single institution usually is unwilling to make the loan and retain it within its loan portfolio. This is because of certain federal tax advantages for a financial institution that loans money to a government that borrows less than $10 million within a calendar year. Governments that fall below this borrowing threshold (and meet certain other criteria) are classified as bank qualified. If a local government is not bank qualified, it typically turns to the bond market—the installment financing is publicly sold. That is, rather than the government borrowing the money from a single bank or vendor, the loan is sold to individual investors through the issuance of limited obligation bonds (LOBs) or certificates of participation (COPs):

• Limited Obligation Bonds: Limited obligation bonds are issued by a local government to either an individual purchaser (for example, a bank) or to one or more underwriters (which resell the bonds to other investors) to (1) purchase real or personal property from a third-party seller or (2) contract to construct or repair fixtures on or make improvements to real property. In an LOB financing, a borrowing government directly enters a “trust agreement” or “indenture” with a third-party trustee, under which the local government grants a security interest in the financed asset (typically land and any improvements constructed thereon) to the trustee for the benefit of the bondholders. If the borrowing government fails to make scheduled installment financing payments to the trustee, the trustee may foreclose on the property and use the proceeds of any foreclosure to pay bondholders. In this structure, each bond is considered a separate “installment purchase contract.”
• Certificates of Participation: A COP is a financing in which a nonprofit corporation makes a “loan” to a local government to finance the unit’s (1) purchase of real or personal property from a third-party seller or (2) contract to construct or repair fixtures on or make improvements to real property. In a contract between a unit of local government and a nonprofit corporation, the local government agrees to repay the loan to the corporation and grant the corporation a mortgage on any real property improved, if any. In turn, the nonprofit corporation issues “certificates of participation” in the loan (that is, rights to receive the revenues from the unit of local government) on the public market and assigns its granted rights to a trustee for the benefit of the purchasers of the certificates.

Synthetic Project Development Financings

Because of the risk to investors, project development financing often is the most expensive way for a unit to borrow money to fund public infrastructure. What makes the financing attractive to units, and particularly to governing boards, however, is that a unit does not pledge or obligate any of its current revenues. Instead, it pledges future revenue streams generated by new development.

A synthetic project development financing occurs when a local government determines that the projected increment revenue from proposed new private development in the unit justifies issuing debt to fund a public infrastructure project that will benefit or incentivize the new private development. The unit does not issue project development bonds, however. It uses another form of financing, usually an installment financing—whereby the unit pledges the financed asset as security for the loan—to fund the public improvement. If the private development occurs according to projections, the unit is able to use the new revenue generated to repay the loan. Because local governments in North Carolina can get relatively good bond ratings on installment financing debt, synthetic project development financing is often a cheaper, and thus more attractive, alternative to a formal project development financing.

Requirements and Limitations

A local government must satisfy some constitutional and statutory requirements before entering an installment financing contract. These requirements apply no matter what form the installment finance transaction takes (simple installment financing, COPs, or LOBs).

Non-Appropriation Clause

An installment purchase contract must include a non-appropriation clause. The clause makes all loan repayment obligations subject to yearly appropriation decisions by the unit’s governing board. The non-appropriation clause is necessary to avoid an inadvertent pledge of the unit’s taxing power. Such a pledge, even a limited pledge, likely would violate the North Carolina Constitution’s prohibition against contracting debts secured by a pledge of a unit’s faith and credit without obtaining voter approval. [See generally Wayne Cnty. Citizens Ass’n v. Wayne Cnty. Bd. of Comm’rs, 328 N.C. 24 (1991)]. G.S. 160A-20(f) further provides that “no deficiency judgment may be rendered against any unit of local government in any action for breach” of an installment finance contract.

No Nonsubstitution Clause

An installment finance contract may not include a nonsubstitution clause. Specifically, the contract may not restrict the right of the local government to “[c]ontinue to provide a service or activity” or “[r]eplace or provide a substitute for any fixture, improvement, project, or property financed, refinanced, or purchased pursuant to the contract.” [G.S. 160A-20(d)].

Public Hearing

A unit of government entering an installment purchase contract “involving real property” must hold a public hearing on the contract. [G.S. 160A-20(g)]. At a minimum, contracts to finance the acquisition of land or construction of improvements on land would involve real property. A unit must publish notice of any required public hearing in a newspaper of general circulation in the jurisdiction at least ten days prior to the date on which the hearing will be held. [G.S. 160A-20(g); see G.S. 160A-1(7) (providing definition of “publish”)]. A unit of local government may, but is not required to, hold a public hearing on an installment financing contract that concerns only the acquisition of personal property.

LGC Approval

Some, but not all, installment financings are subject to LGC approval. [G.S. 160A-20(e); G.S. 159-148]. And different thresholds apply for local units on the LGC’s Unit Assistance List. For a guide to when LGC approval is required see Kara Millonzi’s blog post on LGC approval of bonds, installment financings, leases, and more. For more information on LGC approval of certain public enterprise agreements see this blog post from Kara Millonzi. If LGC approval is required, the commission considers the same factors as for a GO debt issuance. The commission must approve the financing if it determines the following:

1. That the proposed contract is necessary or expedient.
2. That the contract, under the circumstances, is preferable to a bond issue for the same purpose.
3. That the sums to fall due under the contract are adequate and not excessive for its proposed purpose.
4. That the unit’s debt management procedures and policies are good, or that reasonable assurances have been given that its debt will henceforth be managed in strict compliance with the law.
5. That the increase in taxes, if any, necessary to meet the sums to fall due under the contract will not be excessive.
6. That the unit is not in default in any of its debt service obligations.

[G.S. 159-151(b)]. The commission need not find all these facts and conclusions, however, if it determines that “(i) the proposed project is necessary and expedient, (ii) the proposed undertaking cannot be economically financed by a bond issue and (iii) the contract will not require an excessive increase in taxes.” [G.S. 159-151(b)]. If the commission denies the application, it must notify the unit. At the unit’s request, the commission must hold a public hearing on the application. The commission may revisit its decision based on testimony or other information presented at the hearing. [G.S. 159-151(b)].

17.6 The Taxability of Interest Paid to Holders of Local Government Debt

Units of local government in North Carolina can enjoy a substantial advantage in the capital markets when they borrow money. They may, with proper structuring, issue debt on a “tax-exempt” basis, meaning that any interest paid on such debt is not subject to federal income tax. [See generally 26 U.S.C. § 103(a) (noting that, with exceptions, “gross income does not include interest on any State or local bond”); 26 U.S.C. § 103(c)(1) (“The term ‘State or local bond’ means an obligation of a State or political subdivision thereof.”)]. Interest paid on an obligation of a “political subdivision of [the] State, or a commission, an authority, or another agency of [the] State or of a political subdivision of [the] State” is also exempt from North Carolina state income tax. [See G.S. 105-130.5(b)(1a)a.]. Because such interest is exempt from federal income tax, holders of this debt will accept a lower rate of interest than on comparable taxable debt.

Issuing tax-exempt debt creates administrative costs. To preserve the tax exemption, local governments must comply with complex provisions in the Internal Revenue Code (the Code) and regulations promulgated by the Internal Revenue Service. The relevant provisions of the Internal Revenue Code generally can be found in 26 U.S.C. § 103 and 26 U.S.C. §§ 141–150. Among other things, these provisions regulate the following:

1. the allocation and expenditure of the proceeds of tax-exempt debt,
2. the sources of and security for repayment of tax-exempt debt,
3. the investment of the proceeds of tax-exempt debt, and
4. the use and disposition of property financed by the proceeds of tax-exempt debt.

For a high-level overview of these provisions, see Internal Revenue Service, Publication 4079: Tax Exempt Governmental Bonds (Sept. 2019). For a high-level overview of restrictions on investments of bond proceeds, see Internal Revenue Service, Publication 5271: Complying with Arbitrage Requirements: A Guide for Issuers of Tax-Exempt Bonds (Sept. 2019). Bond counsel can assist a local government in understanding these provisions, but ultimately the responsibility for compliance falls on local government staff.

17.6.1 Tax Certificates

When a local government issues tax-exempt debt, bond counsel typically prepares a “tax certificate” that the unit’s ranking officials execute on the unit’s behalf. This potentially lengthy document usually sets forth the following, among other things:

1. how the unit intends to expend tax-exempt bond proceeds,
2. from what sources and with what security it intends to repay and secure the tax-exempt debt,
3. how it intends to invest any proceeds of tax-exempt bonds, and
4. how it intends to operate the financed facility.

In each case, bond counsel drafts the certificate to ensure that, by strictly following its requirements, a local government can preserve the tax-exempt status of interest on its debt.

17.6.2 Taxable Debt

A unit of local government that otherwise has authority to issue debt under state law is not necessarily required to issue tax-exempt debt. In some cases—particularly when interest rates have fallen substantially—a local government may decide that an issuance of taxable debt, in lieu of tax-exempt debt, is worthwhile. Local governments should consult with their financial advisors, the LGC, and bond counsel when seeking to issue taxable debt.

17.7 Federal and State Loans

In addition to the borrowing options discussed above, counties and municipalities may borrow money from an agency of the federal government or from the State of North Carolina “for constructing, expanding, maintaining, and operating any project or facility, or performing any function, which such city or county may be authorized by general law or local act to provide or perform.” [G.S. 160A-17.1(a)]. On the state level, counties and municipalities commonly obtain loans from NCDEQ to finance the construction or repair of water or sewer infrastructure. On the federal level, counties and municipalities typically obtain loans from the U.S. Department of Agriculture to finance the construction or repair of a variety of public infrastructure in rural areas.

17.8 Grant Funding

North Carolina law authorizes counties and municipalities to accept grants from the federal or state government to construct, expand, maintain, and operate any project or program state law permits the unit to provide or perform. [See G.S. 160A-17.1(a)]. Local governments commonly use these grants to finance—in whole or in part—many types of capital projects, including the acquisition, construction, and equipping of affordable housing, water and sewer facilities, parks or recreation facilities, and other types of public infrastructure. The availability of federal and state grant funding can fluctuate according to the respective willingness of Congress or the General Assembly to appropriate grant funds.

17.8.1 Federal Grants

Federal agencies may award a federal grant to a non-federal entity, which includes a local government (among other entities), see 2 C.F.R. § 200.1 (defining non-​federal entity), only when Congress has (1) enacted legislation authorizing an agency to make a grant for a specific purpose and (2) appropriated money to the agency to provide the grant. [See generally Robert M. Lloyd, A Practical Guide to Federal Grants Management—From Solicitation Through Audit 20 (Jerry Ashworth ed., 3d. ed.) (describing grant-making authority of federal agencies)]. For a more-detailed treatment of the appropriations process for federal grants, see U.S. Government Accountability Office (GAO), Office of the General Counsel, Principles of Federal Appropriations Law 10-1 through 10-144  (Vol. 2, 3d ed. 2006) (including entirety of Chapter 10: “Federal Assistance: Grants and Cooperative Agreements) and U.S. GAO, Office of the General Counsel, Principles of Federal Appropriations Law Annual Update of the Third Edition 10-1 through 10-8 (March 2015) (providing updates to the content in Chapter 10 in the above-referenced pages). Once an agency has authority to fund a federal grant, it will announce the availability of the funding opportunity.

In most cases, an agency that awards a federal grant must release a public notice—termed a “notice of funding opportunity” or NOFO. A NOFO includes the following:

• detailed information about the award,
• the types of entities eligible to apply,
• the evaluation criteria for selection,
• required components of an application,
• and how to apply.

[See 2 C.F.R. § 200.204 (requiring federal awarding agencies to release notices of funding opportunities for competitive discretionary grants); 2 C.F.R. § 200.1 (defining notice of funding opportunity)].

NOFOs are accessible at grants.gov, a website maintained by the federal Office of Management and Budget. Local governments can use this website to identify and apply for federal funding opportunities.

Local Government as Recipient

A local government can receive grant funding directly from a federal awarding agency as a “recipient” of a federal grant [See 2 C.F.R. § 200.1 (“Recipient means an entity that receives a Federal award directly from a Federal agency . . . .”)]. If a federal agency selects a local government to receive a federal grant as a recipient, the agency typically will issue a notice of award, termed an NOA, and require the local government to execute a grant agreement. A grant agreement is a legal instrument that reflects the terms and conditions upon which a non-federal entity may use awarded funds. (See 31 U.S.C. § 6304). Once a local government executes a grant agreement or accepts federal grant funds, it is contractually bound to the awarding agency to abide by the terms and conditions of the award. In some cases, a representative of a non-federal entity need not actually sign a grant agreement. Instead, the entity becomes bound to the terms and conditions of a grant agreement by accepting a disbursal of federal funds.

Local Government as Subrecipient

A local government also might receive federal grant funding indirectly by obtaining a “subaward” of federal funding from another non-federal entity—a “pass-through entity”—that is a recipient of federal grant funds. [See 2 C.F.R. § 200.1 (“Subrecipient means an entity that receives a subaward from a pass-through entity to carry out part of a Federal award.”)]. A pass-through entity is a “recipient or subrecipient that provides a subaward to a subrecipient . . . to carry out part of a Federal program.” (See 2 C.F.R. § 200.1). For example, federal agencies commonly make a variety of grants to state government agencies. In turn, these state agencies commonly act as pass-through entities and subaward federal funds to local governments. For example, the U.S. Department of Housing and Urban Development awards Community Development Block Grant (CDBG) funds to the North Carolina Department of Commerce (DOC). DOC “passes through” the CDBG grant funds to eligible subrecipients—including county or municipal governments—to enable them to undertake authorized projects with CDBG funds. For more information about the CDBG program, see Chapter 15, “Financing and Public-Private Partnerships for Community Economic Development,” of Introduction to Local Government Finance, edited by Connor H. Crews (UNC School of Government, 2023). A local government acting as a subrecipient will use awarded funds to carry out the objectives of the federal grant program and is obligated to use the funds according to the terms and conditions of a subaward agreement and any other laws and regulations applicable to the awarded funds. For general requirements that pass-through entities must follow in making subawards, see 2 C.F.R. § 200.332.

Terms and Conditions

As a recipient or subrecipient of a federal grant, a local government must act as a steward of federal funds. It must administer those funds in accordance with the federal statutes that authorized the grant and other governing laws, regulations, and terms and conditions specified in the grant agreement.

Although the laws and regulations that apply to each federal grant are unique, the federal Office of Management and Budget has recently consolidated and streamlined many of the rules governing the expenditure of federal grants into a single title of the Code of Federal Regulations: 2 C.F.R. Part 200. Entitled the “Uniform Administrative Requirements, Cost Principles, and Audit Requirements for Federal Awards” and known popularly as the “Uniform Guidance” or “UG,” 2 C.F.R. Part 200 attempts to establish a uniform framework for the administration of federal financial assistance that federal agencies and non-federal entities must follow.

The Uniform Guidance

The Uniform Guidance addresses, in significant detail, (1) the obligations of federal agencies prior to awarding federal financial assistance to non-federal entities and (2) how non-federal entities must manage the expenditure of that assistance. In general, recipients and subrecipients of federal grants must adhere to applicable provisions of the Uniform Guidance unless a granting agency has established an exception to those provisions in separate regulations or in a particular grant agreement.

Local governments that receive federal financial assistance, including federal grants, must be familiar with the compliance obligations the Uniform Guidance imposes on their expenditure of federal moneys. Among other things, the Uniform Guidance does the following:

1. dictates and restricts which direct and indirect costs a non-federal entity may charge to a federal award. [See 2 C.F.R. §§ 200.400-.476 (outlining “cost principles” for federal grants)];
2. requires that a non-federal entity adopt and implement internal controls to ensure proper management of federal funds. [See 2 C.F.R. §§ 200.302–.305]. The Uniform Guidance directs non-federal entities to model their internal controls after the Standards for Internal Control in the Federal Government (Green Book) or the Internal Control-​Integrated Framework issued by the Committee on Sponsoring Organizations (COSO). (See 2 C.F.R. § 200.303);
3. requires that a non-federal entity, when acquiring property or services with the proceeds of federal financial assistance, adopt and follow documented procurement procedures and a conflict-of-interest policy consistent with state law and procurement standards provided in the Uniform Guidance. (See 2 C.F.R. §§ 200.317–.327). Non-federal entities may award contracts only to responsible contractors and must ensure that contractors satisfactorily perform under a contract’s terms. (See 2 C.F.R. §§ 200.318(b), (h));
4. mandates that a non-federal entity follow certain standards for the use, maintenance, and disposition of real property, equipment, or supplies acquired using federal financial assistance. (See 2 C.F.R. §§ 200.310–.316);
5. requires that a non-federal entity retain records related to an award of federal financial assistance for a minimum of three years. [See 2 C.F.R. § 200.334 (requiring maintenance of financial records and supporting documentation pertaining to federal awards for a minimum of three years from the date of the submission of the final expenditure report)]; and
6. requires that a non-federal entity undergo a single audit or program-specific audit if it expends $1,000,000 or more in federal financial assistance during a single fiscal year. (The threshold was increased from $750,000, effective October 1, 2024. This lower threshold applies to federal grants issued before that date, unless the granting agency specifies otherwise.) (See 2 C.F.R. §§ 200.500–.521).

Depending on the grant, other portions of the Uniform Guidance may apply. Prior to accepting a federal award, a local government should confirm all provisions applicable to its expenditure and management of federal funds. Due to the complexity of complying with federal grant conditions in applicable federal laws and regulations, some units of local government that receive these grants have begun to develop and implement comprehensive grants-management compliance programs.

Remedies for Noncompliance

Failure to comply with the terms and conditions of a federal grant or other federal laws or regulations applicable to the expenditure of federal financial assistance can have severe consequences for a local government. Among other things, a federal awarding agency may withhold cash payments from a noncompliant local government, disallow improper costs charged to a federal award, or even partially or completely terminate an award. (See 2 C.F.R. § 200.339). For more egregious acts of noncompliance, a federal awarding agency can initiate suspension or debarment proceedings against a unit of local government, which could prohibit the unit—either temporarily or permanently—from receiving federal grant funds. (See 2 C.F.R. § 200.339). For more information, see 2 C.F.R. Part 180.

17.8.2 State Grants

In addition to passing through federal funds to units of local government, the North Carolina General Assembly and various state agencies also regularly make state funds available to local governments for various purposes. The State of North Carolina regularly publicizes a variety of grant opportunities and also has created a database where users can explore available state grant programs.  When expending state grant moneys for capital projects, local governments may be required to execute a grant agreement with a state agency and follow principles and restrictions contained in the North Carolina Administrative Code similar to those in the Uniform Guidance. (See, e.g., Uniform Administration of State Awards of Grants, Title 09, Subchapter 3M, Sections .0101–.0802 of the N.C. Administrative Code).

17.9 Conclusion

Local governments face unique challenges when funding capital projects. The projects are often very expensive. They also typically last for many years, raising equity issues as to whether current or future citizens should bear the costs. Operating and maintaining capital assets also imposes costs that a unit must anticipate and account for as ongoing operating expenses. Local officials have an array of financing tools available to help fund the initial (and some recurring maintenance) costs of a capital project. A unit must choose the appropriate mix of funding mechanisms based on its community goals, needs, and current and future financial capacity.