Can a California school district use bond sale premium to pay underwriter fees or bond issuance costs instead of putting it in the debt service fund?
Plain-English summary
When a California school district sells general obligation bonds at a "premium" (above face value), every dollar of that premium has to go into the district's interest and sinking fund, also called the debt service fund. The district cannot route the premium through the underwriter to cover bond issuance costs, the underwriter's own discount, or interest payments on previously issued securities.
Attorney General Rob Bonta concluded that Education Code section 15146(g) and Government Code section 29303 leave no room for districts and underwriters to engineer around the rule by selling bonds at an inflated interest rate and then having the underwriter charge issuance costs against the increased purchase price. The premium belongs to taxpayers in the form of reduced future debt service, not to the district as a substitute funding source for transaction costs.
The opinion also flags an important practical reality: under Code of Civil Procedure sections 860 to 870.5, any challenge to a school bond transaction has to be filed within 60 days. So this opinion does not reach back into closed deals. Going forward, however, structuring a sale to divert premium is contrary to law.
What this means for you
Districts and counties acting on this opinion should still verify that the underlying statutes have not been amended since 2022, and that no later AG opinion or court decision has changed the analysis. Treat the guidance below as the rule the AG identified in 2022.
If you sit on a school board or run district finance
Bond premium is not a flexible funding source. When your underwriter or financial advisor proposes structuring a sale at a higher interest rate so that "issuance costs come out of the premium," that structure is the exact arrangement the AG identified as unlawful. Before approving a bond resolution, ask your bond counsel to confirm in writing that 100 percent of any premium received will land in the interest and sinking fund. Treat this as a board-level diligence question, not a back-office accounting detail.
If you are a county treasurer or county auditor
Government Code section 29303 puts the deposit obligation on you. Premium and accrued interest received on county-administered bond sales go to the debt service fund unless another statute expressly says otherwise. If a school district delivers bond proceeds with the premium netted out at the underwriter level, that is a red flag worth raising with district counsel and county counsel before completing the deposit.
If you are a taxpayer or a watchdog group
Premium reduces the property tax that has to be levied to repay the bonds. When premium is diverted, the future tax burden goes up. If you see an issuance structured at an above-market interest rate paired with the underwriter absorbing issuance costs, ask the district to disclose the dollar amount of premium received and where it was deposited. Education Code section 15146(g) requires premium to land in the interest and sinking fund, full stop.
If you advise districts on bond transactions
The AG's opinion specifically rejects the argument that premium "diverted to the underwriter" is never "received" by the district. The opinion frames that as evading the statute's purpose. Counsel should also note the more-specific over more-general canon: the AG read section 15146(g)'s mandate as controlling over section 15145(a)'s general authorization to pay issuance costs from "proceeds." A bond opinion or tax certificate that relies on the broader "proceeds" framing to justify diverting premium is on shaky ground.
Common questions
Q: What is bond "premium"?
A: Premium is the amount a buyer pays for a bond above its face (par) value. Districts can generate premium by setting an interest rate higher than the market would otherwise require, which makes the bond more valuable to investors.
Q: If our district has already closed a bond sale that diverted premium to issuance costs, are we exposed now?
A: The opinion notes Code of Civil Procedure sections 860 to 870.5 give challengers only 60 days to attack a bond transaction. If the 60-day window has run, the opinion expressly does not reach back. New issuances after this opinion's release are the exposure.
Q: Can premium ever be used for anything besides debt service?
A: Only when another statute expressly authorizes it. Government Code section 29303 itself contains the exception clause: premium goes to the debt service fund "unless it is expressly provided by law that they be deposited in some other fund." The AG cited Education Code section 15150(d) (interest on bond anticipation notes) as one such authorized use. There is no general authorization for issuance costs or underwriter discount.
Q: What is the "underwriter's discount" or "underwriter's spread"?
A: It is the difference between what the underwriter pays the district for the bonds and what the underwriter resells them for to investors. It is the underwriter's compensation, typically deducted from proceeds at closing rather than billed as a separate fee.
Q: Does this opinion apply to community college districts too?
A: Yes. Education Code section 15146 applies to both school districts and community college districts, and the AG saw no material difference between them for purposes of this analysis.
Background and statutory framework
California school construction is largely funded by general obligation bonds, repaid through ad valorem property taxes assessed against real property in the district. Under Education Code section 15146(g), proceeds of the bond sale (excluding premium) go to the building fund for capital projects, while premium and accrued interest go to the interest and sinking fund. Government Code section 29303 sets the parallel rule for bonds whose accounts are kept by the county auditor and treasurer.
The legislative choice to sequester premium for debt service has deep roots. The AG traced Education Code section 15146 back to School Code section 4.975 in 1931, and Government Code section 29303 back nearly word-for-word to Political Code section 4087a in 1919. The 1919 enactment specifically reversed an earlier 1913 rule that had directed premium to the building fund, signaling a deliberate policy that bond premium should benefit taxpayers through reduced debt service rather than serve as flex capital for the district.
Education Code section 15145(a) lists items that may be categorized as costs of issuance. The AG read the more-specific section 15146(g) to control over the more-general "proceeds" authorization in section 15145(a), and rejected the textual argument that premium routed to the underwriter is never "received" by the district.
Citations and references
Statutes:
- Education Code section 15146(g) (premium to be deposited in interest and sinking fund)
- Education Code section 15145(a) (items categorized as costs of issuance)
- Education Code section 15150(d) (interest on bond anticipation notes payable from premium)
- Education Code section 15143 (permissible interest rates)
- Government Code section 29303 (premium and accrued interest deposit rules)
- Code of Civil Procedure sections 860 to 870.5 (validation actions; 60-day challenge window)
- Government Code section 53511 (bonds subject to validation process)
Cases:
- San Lorenzo Valley Community Advocates for Responsible Educ. v. San Lorenzo Valley Unified Sch. Dist., 139 Cal.App.4th 1356 (2006)
- Hanover Bank v. C.I.R., 369 U.S. 672 (1962)
- McGee v. Torrance Unified School Dist., 49 Cal.App.5th 814 (2020)
- City of Oakland v. Williams, 107 Cal.App. 340 (1987)
- State Dept. of Public Health v. Superior Court, 60 Cal.4th 940 (2015) (specific provision controls over general)
- People v. Vanvleck, 2 Cal.App.5th 355 (2016) (same)
Source
- Landing page: https://oag.ca.gov/opinions/yearly-index
- Original PDF: https://oag.ca.gov/system/files/opinions/pdfs/14-202_0.pdf
Original opinion text
TO BE PUBLISHED IN THE OFFICIAL REPORTS
OFFICE OF THE ATTORNEY GENERAL
State of California
ROB BONTA
Attorney General
OPINION
of
ROB BONTA
Attorney General
SUSAN DUNCAN LEE
Deputy Attorney General
No. 14-202
May 19, 2022
THE HONORABLE DAWYN R. HARRISON, ACTING LOS ANGELES COUNTY COUNSEL, has requested an opinion on questions related to school bonds.
QUESTIONS PRESENTED AND CONCLUSIONS
- Must "premium" from the sale of school general obligation bonds be deposited in a school or community college district's interest and sinking fund, also known as a debt service fund?
Yes, all premium from the sale of school general obligation bonds must be deposited in the district's interest and sinking fund.
- May premium be used to pay bond-related expenses such as bond issuance costs listed in Education Code section 15145(a), an underwriter's discount, or interest on previously issued securities?
No, bond premium may not be diverted to another purpose, such as to pay bond issuance costs, an underwriter's discount, or interest on previously issued securities.
BACKGROUND
This opinion request asks us to address questions relating to the issuance of bonds by school districts and community college districts. The most common means of financing new school construction in California is for a school district to issue general obligation bonds. Sale of the bonds supplies the school district with immediate funds to apply to construction projects, and then the district repays the bonds over time, with interest, by levying an ad valorem tax based on the appraised value of real property in the district.
The specific questions presented here involve bond "premium," which is the amount a purchaser pays for a bond in excess of the face (or "par") value of the bond. Typically, the initial purchaser of school district bonds is an underwriter, usually an investment bank dealing in municipal securities, that resells the bonds to investors. Sometimes bonds sell at a premium, that is, a price above par value, because the interest rate exceeds the interest rate that would attract willing purchasers of an otherwise identical bond offered at a price of par. In other words, bonds that offer a higher interest rate are more valuable than equivalent bonds that offer a lower interest rate. To receive this higher interest rate, the purchaser pays a premium when making the investment.
The opinion request asks about this premium and, more specifically, how school districts may lawfully use these extra proceeds of a bond sale.
Two statutes, Education Code section 15146 and Government Code section 29303, largely control the proceeds of school bond sales. Both statutes direct that a school district must deposit any premium it receives from bond sales into a fund dedicated to debt service, generally known as an "interest and sinking fund." That fund also receives the property-tax revenues that are assessed to pay off the bonds. The more premium is deposited into the interest and sinking fund, the less tax revenue is required to service the bond debt. When properly deposited in the fund as required by section 15146 and section 29303, bond premium thus redounds to the benefit of local taxpayers. When premium is diverted to other uses, however, those uses benefit at the expense of paying down the bond debt.
When school districts pay the costs of bond issuance, they ordinarily charge these costs to the school district's general fund or to its construction fund, reducing the amount of money available for operating expenses or for construction. That reduction can be substantial. To avoid those outcomes, some districts have chosen to sell their bonds at a higher (premium) price by inflating the interest rate, and then to contract with the underwriter to charge the costs of issuance against the increased purchase price. In this way, some of the bond value that would otherwise have been "premium received by the district" is instead diverted to the underwriter and converted to pay costs of issuance. We are asked whether this diversion of premium is lawful.
Before turning to our analysis, we note that to provide the certainty necessary for agencies to manage their financial operations and attract bond buyers, Code of Civil Procedure sections 860 through 870.5 limit the period for filing any action to challenge a school bond to just 60 days. Accordingly, nothing in this opinion implicates a school bond transaction for which the 60-day period has already run.
ANALYSIS
The request first asks whether premium received from the sale of school general obligation bonds must be deposited in a school or community college district's "interest and sinking fund." To answer this question, we look to Education Code section 15146 and Government Code section 29303, which govern the proceeds of school bond sales.
Education Code section 15146(g) states:
The proceeds of the sale of the bonds, exclusive of any premium received, shall be deposited in the county treasury to the credit of the building fund of the school district, or community college district as designated by the California Community Colleges Budget and Accounting Manual. The proceeds deposited shall be drawn out as other school moneys are drawn out. The bond proceeds withdrawn shall not be applied to any purposes other than those for which the bonds were issued. At no time shall the proceeds be withdrawn by the school district or community college district for investment outside the county treasury. Any premium or accrued interest received from the sale of the bonds shall be deposited in the interest and sinking fund of the school district or community college district.
Government Code section 29303 states:
Whenever any bonds issued by any county or by any school, drainage, or other district in any county, whose accounts are required by law to be kept by the county auditor and treasurer, are sold at a premium or with accrued interest, or both, the amounts received for the premiums and accrued interest shall be deposited in the debt service fund of the county or district unless it is expressly provided by law that they be deposited in some other fund.
The plain text of these provisions requires that school bond premium be deposited in the "interest and sinking fund" or the "debt service fund," not used for issuance costs or other uses.
This legislative policy choice has deep roots. Education Code section 15146 originated as School Code section 4.975 in 1931, which stated that "[a]ny premium or accrued interest received from the sale of the bonds shall be deposited in the interest and sinking fund of the district." And Government Code section 29303 traces back nearly word for word to the enactment of Political Code section 4087a in 1919.
It is noteworthy that Political Code section 4087a's mandate to deposit premium into the interest and sinking fund superseded a 1913 statute providing that premium would be deposited in the building fund. The enactment of Political Code section 4087a in 1919 reflects a deliberate policy change by the Legislature to make bond premium of schools and other districts unavailable for any use other than debt service, absent express statutory authorization for another use.
We note that other statutes make bond premium available for other uses in addition to relief of debt service. These other statutes are consistent with Government Code section 29303, which requires premium to be deposited in a debt service fund "unless it is expressly provided by law that they be deposited in some other fund." These other statutes also demonstrate that, when the Legislature intends to allow premium to be used for other purposes, it specifies the permissible uses in statutes. The Legislature has not specified other purposes here, however. To the contrary, Education Code section 15146(g) expressly provides that premium shall be deposited in the interest and sinking fund, and does not authorize any other use.
Some districts posit that if premium is diverted to the underwriter to pay costs of issuance then it is never actually "received" by the district within the meaning of Education Code section 15146 or Government Code section 29303. We do not agree. This appears to us to be an attempt to conform to the letter of the law while evading its purpose. The manifest purpose of Education Code section 15146 and Government Code section 29303 is that a bond's premium value should accrue to the benefit of taxpayers. School districts may choose to set interest rates that generate premium value, but the additional value must be used to benefit taxpayers, not the district.
The second question submitted to us asks whether premium may be used to pay bond-related expenses such as bond issuance costs listed in Education Code section 15145(a), an underwriter's discount, or interest on previously issued securities. For all of the reasons already given, we conclude that bond premium value may not be diverted to any other purpose.
We acknowledge a possible argument cutting the other way. In 1959, the Legislature first enacted a statute allowing school districts to pay costs of issuance "from the proceeds of sale of the bonds." If taken out of context, this language might be used to support an argument that costs of issuance are payable from premium because the term "proceeds" includes premium. We agree that bond premium is generally a component of bond proceeds. According to a longstanding rule of statutory construction, however, the more specific mandate of section 15146(g) should take precedence over the more general authorization of section 15145(a).
In sum, we conclude that all of the premium from the sale of a general obligation school bond must be deposited in the district's interest and sinking fund, and any agreement between a district and bond purchaser to circumvent that requirement by diverting bond premium value to some other purpose, such as to pay bond issuance costs, underwriters' discounts, or interest on previously issued securities, is contrary to the meaning and purpose of Education Code section 15146(g).