OFFiCE OFTHEATTORNEY

GENERAL STATE

OFTEXAS JOHN CORNYN

June 15,1999

The Honorable Jose R. Rodriguez El Paso County Attorney County Courthouse 500 East San Antonio, Room 203 El Paso, Texas 79901 Opinion No. JC-0068

Re: Whether a hospital district is authorized to execute a contract to hedge against interest rate fluctuations (RQ-1157)

Dear Mr. Rodriguez:

You ask whether the El Paso Hospital District, established under article IX, section 4ofthe Texas Constitution and chapter 281 of the Health and Safety Code, is authorized to execute an interest rate hedge contract that entitles the District toreceive alump sum ifmarket interest rates rise in relation to the interest rate on certain of the District’s outstanding bonds but that requires the District to pay out alump sum if interest rates fall. A hospital district has only such authority as is expressly conferred on itby statute ornecessarily implied from the authority expressly conferred to effectuate the express powers. The District has express authority to manage ahospital system and issue bonds to acquire hospital facilities orto refund outstanding bonds issued for hospital purposes. Because execution ofthe interest rate hedge contract is unnecessary to effectuate issuance ofbonds
orrefunding bonds, itisthe opinion of this office that the District is not authorized to execute such
a contract.
You inform us of the following facts giving rise to your question: In February 1996, the District entered into a Warrant Purchase Agreement (the “Warrant Agreement”) with a financial institution as purchaser of the Warrant (the “Warrant Holder”), an underwriting firm that acted as abroker inthe transaction, and the Warrant Holder’s affiliate, asagent. In exchange for the Warrant Holder placing $1.85 million in escrow (the “Escrowed Funds”) for the benefit of the District, the District issued awarrant (the “Warrant”) that entitled the Warrant Holder orits transferee, in certain circumstances, to receive on July 1, 1998 agiven amount. That amount (“Settlement Amount”) was calculated by a formula whereby itwould decrease as interest rates associated with ahypothetical bond issue having the characteristics of an outstanding bond issue of the District increased or increase as interest rates of the hypothetical bond issue decreased. If interest rates increased sufficiently by July 1, 1998, the District would retain the Escrowed Funds. But ifthe interest rates decreased to or lower than the interest rates ofthe hypothetical bond issue, then the Warrant Holder would be entitled to a Settlement Amount. Interest rates in fact declined, and the District was required to pay a Settlement Amount of approximately $5.6 million to the Warrant Holder, against which amount the District applied the Escrowed Funds, including interest earnings, totaling $1.9The Honorable Jost R. Rodriguez - Page 2 (X-0068)

million. Thus, the District had topay to the Warrant Holder approximately $3.9 million in addition to the Escrowed Funds. Because the Warrant was not abond or abond-related document, itwas not submitted to nor approved by the Office of the Attorney General.’

The Warrant, you inform us, was an attempt to “lock in interest rate savings” with respect to the District’s outstanding General Obligation Refunding Bonds, Series 1988 (the “Outstanding Bonds”) without actually refunding them? The “hypothetical” bonds in the Warrant transaction described above reflected the annual debt service required with respect to the Outstanding Bonds. Interest rates on the Outstanding Bonds issued in 1988 were considerably higher than the prevailing interest rates in 1996. But the District could not redeem the Outstanding Bonds in 1996because they
were not subject toredemption until July 1,1998, and they could notbe “advance refunded”on ataxexempt’ basis under federal tax law.4 (The District did not want to issue refunding bonds in escrow or enter into any forward delivery contract, which were the alternatives to the Warrant transaction for addressing the federal tax limitations.‘) The Escrowed Funds in the Warrant transaction represented the present value of the debt service savings the District would have achieved over the

‘The District’s bonds together with the transcript ofthe proceedings related to thebonds, like those ofother public bodies inthe state, must be submitted to and approved by the Attorney General. SeeTEX.HEALTH &SAFETY CODE ANN.$5281.103, ,105(Vernon 1992);Tex. Fzv. Qv. STAT.ANN.art. 717k-8 (Vernon Supp. 1999).
2Arefunding involves the issuance of new bonds by a governmental entity, the proceeds (either the sale proceeds ortheproceeds andthe investment earningsthereon) ofwhich areusedtopaydebt service (principal, interest, and premium, if any) on and retire an outstanding issue ofbonds. D. FRANKLIN & J.PRENDERGAST,

GLOSSARY

OF PUBLICFINANCE

TERMINOLOGY

35 (1992) [hereinafterGLOSSARY];ARTHURM. MILLER& VALERIEPEAR~ALL ROBERTS,

Refunding Odine, 365 PRACTICING L.INST.,

TAXL. & ESTATEPLANNING COURSEHANDBOOK SERIES,

TAX L. &PRAC.269,271 (1995) [hereinafter PLI]. A governmental entity may undertake arefunding to save on interest cost, stretch out 01otherwise restructure the debt service, 01remove restrictive covenants in the bond documents. GLOSSARY

supra, at35; PLI at274.

‘“The term ‘tax-exempt’ means, withrespect toanybond (orissue), thatthe interest on suchbond (or onthe bonds issued aspart of such issue) isexcluded from gross income [ofthe recipient].” 26U.S.C.A. 5 150(a)(6) (West 1998).

‘Federal tax law distinguishes between “current” and “advance” refimdings. A “current” refunding is a refunding in which the prior bonds are called for redemption OImature within ninety days of the issuance of the refunding bonds; allotherrefundings aretreatedas advancerefimdings. See26 U.S.C.A. $149(d)(3), (d)(5) (West Supp. 1998); Treas. Reg. $!1.150-l(d)(3) & -l(d)(4) (1999). Accordingly, an “advance refunding” is a refinancing of outstanding bonds orobligations-the refunded bonds-by anewissueofbonds-the refunding bonds-more than90 days prior tothe date on which the outstanding bonds or obligations canbe redeemed, anddeposit oftheproceeds of the refunding bonds inescmw to retire the refunded bonds when they canbe redeemed. See 26U.S.C.A. $149(d)(5) (West Supp. 1998); GLOSSARY supra, at 1. Among other restrictions, original new money bonds issued on or after January 1, 1986 (or SUCC~SSOI current refunding bonds) may be advance refunded once. 26 U.S.C.A. 5 149(d)(3) &(d)(6) (West Supp. 1998). Those issuedprior toJanuary 1,1986, maybeadvance refunded hvice. Id. TheDistrict’s Series 1988Bonds had already advance refunded aprior issue andcould not be advance refunded again. Letter from MarkE.Mendel, Mendel Guztin Blumenfeld, LLP, toSarah Shirley, Chair, Opinion Committee (Nov. 17, 1998)(on file with Opinion Committee) [hereinafter Mendel letter of 1l/17/98].

‘Mendel letter of 1l/17/98. at3.The Honorable Jo& R. Rodriguez - Page 3 (~~-0068)

life of the Outstanding Bond if it could have refunded them by the issuance of refunding bonds at the lower 1996 interest rates. The Outstanding Bonds remained outstanding, however, and there was no actual debt service savings with respect to them in 1996. The District did achieve an actual debt service savings ofapproximately $7millionwhen itrefunded the Outstanding Bonds inAugust 1998 in a separate transaction by issuing refunding bonds.6 This savings was, of course, spread out over time-the life of the refunding bonds-and not received as a lump sum payment.

You believe that the District did not have authority to execute the Warrant Agreement orpay the Settlement Amount. In contrast, bond counsel tothe District on the Warrant transaction contends that the District did have such authority derived from the District’s power toborrow money and issue bonds. As bond counsel notes, this office does not interpret or construe particular contracts in an attorney general opinion. Tex. Att’y Gen. Op. Nos. DM-198 (1992) at 10;JM-697 (1987) at 6. This office, however, does address a public entity’s authority to contract with respect to a particular subject or to accept particular terms ifthe question can be answered as amatter of law. Tex. Att’y Gen. Op. No. DM-192 (1992) at 10n.14. Accordingly, while we cannot review the validity ofthe particular transaction giving rise to your request, we can generally address the District’s legal authority to issue an instrument like the Warrant.’
The Warrant is atype of“derivative product,” used tohedge8 against interest rate fluctuations inthe market. Derivative products are specially designed financial instruments such as interest rate swaps, inverse floating-rate products, currency swap agreements, and forward municipal contracts that “derive” their value from the performance of an underlying asset, such as securities,

‘See transcript ofproceedings relating to Series 1998Bonds submitted tothe Office offheAttorney General asrequired by article 717k-8, TEX.REV.CIV.STAT. ANN.(Vernon Supp. 1999)(on file with Office ofthe Comptroller ofPublic Accounts).

‘Bond counsel alsoquestions thisoffice’s authority toissue anopinion inresponse to arequest from acounty attorney. See Mendel letter of 1l/17/98, at2. Webelieve thisoffice hastherequisite authority. This oftice hasissued opinions responding to requests from county attorneys since at least 1917,relying on current sections 402.042 and 402.043 ofthe Government Code andtheirpredecessor, article 4399 oftheRevised Civil Statutes. See also 35DAVID B.BROOKS,

COUNTY AND SPECIALD~STRICT

LAW03.19 (Texas Practice 1989)(listing county attorneys asauthorized requesters). No court has questioned that authority.
*Onetax court has described a“hedge” asfollows:
A“hedge” isaninvestment thatismadetooffset anadverse economic performance of another investment. For example, ifthe profit ofaninvestment required arise inmarket prices, ahedge to that investment could be established to profit from a fall in the market prices. Effective use of hedging inshunents requires careful analysis oftheexposure involved. Thecosts ofhedging andthepossibility thatthe hedge may diminish fhe profitability of the program being hedged each require quantification ofthe expense and duration ofthehedging activities asthey relate to the investments hedged.
Seykota v. Commissioner ofInternal Revenue, 61T.C.M. (CCH) 2706,271O (1991)The Honorable Jo& R. Rodriguez - Page 4 (~~-0068)

commodities, currencies, or interest rates. 3 M. DAVIDGELFAND,STATE&LOCAL GOVERNMENT DEBTFINANCING5 11:06.50 (West Supp. 1998); Robert C. Downs & Lenora J.Fowler, Derivative Securities: Governmental Entities As End Users, Bankrupts And Other Big Losers, 65 UMKC L. REV. 483,487 (1997). They are generally used by investors to (1) hedge against adverse changes inthe value ofassets orliabilities, (2)restructure financing terms more favorably, (3) change the mix of assets in aportfolio, and (4) to speculate on the direction interest rates will move in the hope of gaining apure profit. Alexander E. Kolar, Hammersmith Meets Orange County: “Wishing Upon A Star” With Taxpayer Money In TheMunicipal Bond Derivative Market, 49 WASH.U. .I.URB. & CONTEMP.L. 315, 320 (1996). Governmental debt issuers have used these instruments to reduce borrowing costs by taking advantage of declines in interest rates after bonds have been issued, to reduce the risk that interest rates will rise on variable rate bond issues, and to speculate inthe market place. GELFAND,supra 5 11:06.50, at 12-13.

It has been said that while derivatives may have legitimate uses, their use by governmental entities as speculative investments can result in enormous losses from which their investors may not recover, as shown by the recent experience of Orange County, California. Downs & Fowler supra, at483; Kolar supra, at 315. Before the Orange County derivative failure in the United States, the most legally significant derivative loss occurred when the Hammersmith and Fulham London Borough Council, a local authority incorporated by English royal charter, defaulted in 1989 on payments it owed to various banks under a series of swap contracts. The British House of Lords subsequently held that the Council did not have authority to enter into the swap contracts. As one of the leading treatises in the area of governmental debt financing cautions, “[albsent express statutory authorization

. . . local government authority to participate in the derivative products market must be resolved,” noting that the “significant opinion by the British House of Lords [in Hazel1 v.Hammersmith & Fulham London Borough Council, All E.R. 545 (H.L. 1991)] has cast doubt on how astate court might respond” to the argument that the authority toborrow through taxexempt bond financing provides additional powers to enter derivative ,contracts. GELFAND,supra 5 11:06.50, at 13.

We examine Hazel1 v.Hammersmith & Fulham London Borough Council in detail for two reasons. First, no American courts appear to have considered a governmental entity’s authority to execute derivative contracts. Second, and more importantly, the nature ofthe governmental bodies atissue are similar. For instance, as aspecial purpose district, the District has limited authority, TriCity Fresh Water Supply Dist. No. 2 v.Mann, 142 S.W.2d 945,948 (Tex. 1940); Tex. Att’y Gen. Op. Nos. DM-107 (1992) at2; DM-29 (1991) at 3;JM-258 (1984) at 1,and“may exerciseonlysuch powers as have been expressly delegated to it by the Legislature, or which exist by clear and unquestioned implication,” Mann, 142 S.W.2d at 946. It has only such implied powers as are necessary to effectuate the powers expressly granted. Id. at 947. In other words, implied powers are “such as are indispensable to the declared objects ofthe corporation and the accomplishment ofthe purposes ofits creation [,r’ and not those “which are merely convenient oruseful[.]” Id. Likewise, the Council at issue in Hazel1 was not a sovereign body, but could only do such things as were expressly or impliedly authorized by Parliament. HazeN, 1All E.R. at 548.The Honorable Jose R. Rodriguez - Page 5 (X-0068)

Like the Warrant about which you ask, the swaps atissue inHazel1 were derivative products used to hedge against interest rate fluctuations in the market. The Hazel1 opinion described swap contracts generally as “‘an agreement between two parties by which each agrees topay the other on aspecified date ordates an amount calculated by reference to the interest which would have accrued
over a given period on the same notional principal sum assuming different rates of interest are payable in each case.“’ Hazel& 1All E.R. at 550; see also BankAtlantic v.Blythe Eastman Paine Webber, Inc., 955 F.2d 1467, 1469 n.1 (1lth Cir. 1992) (An interest rate swap is an agreement by which one party agrees to pay the counterparty a fixed rate of interest on anotional amount for a specified period, and the counterparty agrees to pay to the first party an adjustable rate for the same period.). The specific swaps in question, according to the Hazel1 opinion, “were undertaken in the hope that the burden of interest payable in respect of borrowings by the [Clouncil would be mitigated by profits from swap contracts whereby the council successfully forecast movements in interest rates.” Hazell, 1All E.R. at 550. Generally, the opinion noted, the Council would profit if interest rates fell, but would incur substantial losses ifinterest rates rose. Id. at 545. The Council’s losses totaled approximately $337.4 million. Kolarsupra, at317; see also Hazell, 1All E.R. at 552 (auditor’s calculation of Council’s losses).

The Act ofParliament establishing local governments, including the Council, granted alocal authority express power to borrow money and prescribed the method of borrowing. Hazell, 1All E.R. at 548, 558. Given that a local authority did not have express authority to do the swap transactions, which the banks conceded, the question presented was whether the swap transactions
were incidental to a local authority’s borrowing power. Id. at 553, 556. The opinion summarized the relevant authority on incidental powers asrelevant to the swap transaction as follows:

The authorities also show that a power is not incidental merely because it is convenient or desirable or profitable. A swap transaction undertaken by a local authority involves speculation in future interest trends with the object of making a profit in order to increase the available resources ofthe local authorities. Individual trading corporations and others may speculate asmuch asthey please
or consider prudent. But alocal authority isnot atrading or currency or commercial operator with no limit on the method or extent of its borrowing or with powers to speculate. The local authority is a public authority dealing with public moneys limited by Sch[edule] 13 [setting out the purposes for which itmay borrow money].
Id. at 556. The opinion examined at length alocal authority’s borrowing powers under the Act and the purpose ofthe swap transactions. Itconcluded that the swap transactions were inconsistent with
an authority’s borrowing power and that the contracts were ultra vires. Id. The opinion stated that when alocal authority borrows money, itmust take into consideration the provision of the Act, the method ofborrowing, repayment, prevailing interest rates, and the possibility that interest rates may rise or fall during the loan period. Id. at 558. And, ifthe local authority finds that there has beenThe Honorable Jose R. Rodriguez - Page 6 (X-0068)

a great shift in interest rates that affects a particular borrowing, the opinion explained, it is “not without remedial action”:

It can convert aloan taken out.

. .from avariable rate ofinterest into
afixed rate of interest. It can pay off an expensive loan and take out a new loan. It is said that the cost of paying off an old loan and taking out a new loan would be greater than the cost of entering into swap transactions. But this fact alone cannot render swap transactions legal.

Id. Finally, noting that Parliament had granted certain building authorities express power to enter into swap transactions, Lord Templeman stated:

It is for Parliament and not the courts to decide whether there should be conferred on local authorities unlimited power tohedge or apower limited for the protection of taxpayers and ratepayers. Parliament might decide that it was unnecessary or unwise to confer power on local authorities to enter the swap market at all. The object ofthe doctrine of ultra vires is the protection ofthe public.
Id. at 560.9

With the above background, we consider the general features of the financial transaction about which you ask. This transaction, evidenced by the issuance ofa“warrant,” like the derivatives described above, is undertaken to profit from interest rate movements, which profit may be but is not required to be used to reduce interest payments on existing debt. It gives the issuer an opportunity to obtain alump sum dollar amount ifinterest rates performas the issuer anticipates and requires the issuer to pay out a sum if they do not. It is related to outstanding bonds only to the extent that if interest rates rise, the amount obtained by the issuer theoretically compensates the issuer for the “loss” of potential debt service savings as a consequence of the issuer’s present inability ordisinclination to refund its outstanding bonds atthe lower interest rates. But whether the issuer receives or makes apayment does not affect the outstanding bonds, debt service on those bonds, orthe issuer’s right to refund the outstanding bonds by issuing refunding bonds inthe future. See Hazell, 1 All E.R. at 586 (purpose of swap transaction not to facilitate borrowing because original underlying debts continue in existence and are unaffected by swap transactions; in many

The opinion alsodismissed thecontention thatiftheswaptransactions werenotincidental toborrowing, they were nevertheless authorized asincidental todebt management. The opinion observed that debt management isnota function but away ofdescribing prudent andlawful activities ofalocal authority. Haze/l Y.Hammersmith & Fulham London Borough Council, 1All E.R. 545,558 (H.L. 1991). Thus,ifswaptransactions were lawful, alocal authority would be under a duty to consider entering into swap tmnsactions as part of debt management, “[b]ut if a swap transaction isnot lawful then itcannot be lawful for alocal authority tocarry outaswaptransaction under the guise of debt management.” Id.The Honorable Jose R. Rodriguez - Page 7 (X-0068)

cases, swap transactions are entered into long after borrowing and are not even contemplated attime of borrowing).

In sum, the significant features ofthe warrant transaction for the purposes ofour analysis are: (1) that whether the issuer profits under the warrant is wholly dependent on the rise and fall of interest rates; (2) issuance of the warrant is a separate transaction from the refunding of the outstanding bonds; and (3) there is no debt service savings with respect to those bonds unless and until they are actually refunded. See id. at 554 (swap transactions are separate collateral contracts). With this general understanding of the warrant in question, we look at the District’s authority to enter such a contract.
We consider the District’s constitutional and statutory powers. The District is acounty-wide hospital district established under article IX, section 4ofthe Texas Constitution and chapter 28 1of the Health and Safety Code. Article IX, section 4empowers the legislature to authorize the creation of county-wide hospital districts “with power to issue bonds for the purchase, acquisition, construction, maintenance and operation of any county owned hospital” and that “assume[s] full responsibility for providing medical and hospital care to needy inhabitants of the county[,]” in counties with apopulation in excess of 190,000. TEX.CONST. art.IX, $4. Subchapter C of chapter 281 sets out the general powers and duties of article IX, section 4 districts. Such adistrict isrequired to assume “full responsibility for furnishing medical and hospital
care for indigent and needy persons residing in the district.” TEX.HEALTH & SAFETY

CODE ANN. 5 281.046 (Vernon 1992). A district’s board of managers is authorized to “manage, control, and administer the hospital orhospital system ofthe district,” id. §28 1.047, and to adopt rules governing the system’s operations, id. 5 281.048. More specifically, the board is authorized to “construct, condemn, acquire, lease, add to, maintain, operate, develop, regulate, sell, exchange, and convey any property, property right, equipment, hospital facility, or system to maintain ahospital, building, or other facility or to provide a service required by the district.” Id. 5281.050 (Vernon Supp. 1999). To effectuate these powers, itisalso authorized to contract orcooperate with the federal government, the state, another governmental entity, or aprivate hospital. Id. 528 1.05 1. Additionally, the district is authorized to exercise the power of eminent domain, accept gifts and donations, and to sue and be sued. Id. $5 281.054, ,055, ,056 (Vernon 1992 & Supp. 1999). Furthermore, the district may establish a health maintenance organization, id. 3 281.05 17 (Vernon Supp. 1999) and create a charitable organization to facilitate the management of health care services or to provide ancillary support services, id. 5281.0565. Subchapter F of chapter 281 sets out the powers and duties with respect to district bonds. The commissioners court ofthe county, inthe district’s name and on its credit, is authorized to issue general obligation bonds to acquire, construct, equip, or enlarge the hospital or hospital system if approved by the voters. Id. $4281.101 (Vernon 1992). Refunding bonds to refund any outstanding indebtedness of the district may be issued without voter approval. Id. $3 281.102, .103(a). When such bonds are issued, the commissioners court is authorized to levy a tax for the benefit of the district. Id. 528 1.121(a). Proceeds ofthe tax levied may be used for bond debt service payment orThe Honorable Jose R. Rodriguez - Page 8 (~~-0068)

maintenance or operation of the hospital system. Id. 5281.121(c). Before the district’s bonds are delivered to their purchasers in exchange for the purchase price, they must be approved by the Attorney General. Id. $5 281.103, ,105; TEX.REV. CIV.STAT.ANN. art. 717k-8 (Vernon Supp. 1999). Additionally, other statutory provisions relating to the issuance ofbonds orother obligations may also be utilized by the District. A district may issue long-term, contractual obligations to acquire or use personal property. See TEX.Lot. GOV’TCODEANN. $5 271.003(4), (5) (Vernon 1988) (governmental agency included hospital district), 271.005 (authorizing governmental agency to execute contract). A district may issue refunding bonds to refund its outstanding bonds or other obligations utilizing the procedures ofarticle 717k ofthe Revised Civil Statutes. See TEX.F&v.CIV. STAT.ANN.art. 717k $5 1(Vernon 1964 & Supp. 1999) (act applicable to any political district or subdivision having thepower to issue bonds and remnding bonds), 2(authorizing issuer’s governing body to issue refunding bonds and deposit proceeds with Comptroller of Public Accounts to retire outstanding bonds), 7A (authorizing deposit ofrefunding bond proceeds directly with any place of payment for outstanding bonds).

The District may not exercise, however, the powers generally granted to “issuers” by article 717q ofthe Revised Civil Statutes to enter into “credit agreements.” See TEX.REV.CIV.STAT. ANN. art. 717q (Vernon Supp. 1999). This statute authorizes certain issuers to issue obligations “and execute credit agreements in relation thereto to finance project costs of an eligible project, or to refund obligations issued in connection with an eligible project _” Id. 5 2(a). A “credit agreement” is a

loan agreement, revolving credit agreement, agreement establishing
a line ofcredit, letter ofcredit, reimbursement agreement, insurance contract, commitments to purchase obligations, purchase or sale agreements, interest rate swap agreement, or commitments or other contracts or agreements authorized and approved by the governing body of an issuer either in connection with the authorization, issuance, security, exchange, payment, purchase, or redemption of obligations and/or interest thereon, or asotherwise authorized by this Act.
Id. 5 l(6) (emphasis added). Although “issuer” includes numerous entities, it does not include a hospital district established under chapter 28 1ofthe Health and Safety Code. Id. 5 l( 1).Therefore,
we need not determine whether the warrant is acredit agreement authorized under article 717q.

In brief, the District is expressly authorized to acquire and manage ahospital system and to provide medical and hospital care for the needy residents in the county. It may borrow money for hospital purposes. Specifically, the El Paso County Commissioners Court, in the name of and for the District, orthe District may issue bonds orother obligations to acquire orequip hospital facilities
or issue refunding bonds toretire outstanding bonds orother obligations. Inthis regard, we note thatThe Honorable Jose R. Rodriguez - Page 9 (X-0068)

bonds or other negotiable debt can only be issued for the purposes and in the manner expressly authorized. See&n Antonio Union Junior College Dist. v.Daniel, 206 S.W.2d 995,999 (Tex. 1947) (and cases cited therein) (power to issue negotiable paper beyond powers of city or county unless specially granted and when granted, can only be exercised in mode and for purposes specified, concluding that junior college district not authorized to issue refunding bonds); see also Lopez v. Ramirez, 558 S.W.2d 954, 957 (Tex. Civ. App.-San Antonio 1977, no writ) (statutes regarding authority to create debt must be strictly and narrowly construed citing Robertson v.Breedlove, 61 Tex. 316 (1884), and Daniel).

As is evident from the statutory provisions discussed above, the District does not have express authority to undertake a warrant transaction to hedge against interest rate fluctuations as evidenced by the issuance of awarrant. And for the reasons explained below, we conclude that the District does not have the implied authority to issue such a warrant derived from its authority to borrow money, i.e., to issue or retire bonds. Implied powers of the District are those that are indispensable to effectuate the District’s express purposes and not those that are merely convenient oruseful. SeeMann, 142 S.W.2d at947. The District is specifically authorized to issue bonds or other obligations for hospital facilities and equipment. It is true that when agovernmental entity has express authority to acquire or construct facilities and expend money for them, it may have implied authority to finance those facilities by
means other than issuance ofbonds. See, e.g., SanAntonio RiverAuth. v.Shepperd, 299 S.W.2d 920 (Tex. 1957) (county impliedly authorized to enter into long-term contractual obligation to finance flood control facilities based onits express authority to engage in flood-control programs and expend taxes therefor); Lasaterv. Lopez, 217 S.W.2d373 (Tex. 1919) (county impliedly authorized to issue warrant for road improvements; long-standing authority to issue warrant for public improvements not repealed by express authority to issue road bonds); Tex. Att’y Gen. Op. No. JIM-642 (1987) (county and city impliedly authorized toborrow money to improve joint county-city hospital based
on their express authority to maintain and equip hospital and expend tax funds therefor). The warrant, however, is not issued to acquire any hospital facilities, equipment, or even provide a required hospital service. Nor is the warrant related to bonds or obligations issued to acquire hospital facilities. First, it does not change the terms of the outstanding obligations or reduce the interest payments on those obligations. Second, itprovides no benefit or service necessary to the issuance of those bonds-the outstanding bonds in reference to which the profit or loss under the warrant is calculated would have been issued prior to the warrant transaction. In short, given that the warrant does not relate to the acquisition of hospital facilities or the issuance ofbonds for that purpose, it cannot be indispensable to effectuate either of those District purposes,
Nor is the warrant indispensable to effectuate the District’s authority to redeem or refund outstanding bonds. As indicated earlier, the District also has express authority to issue refunding bonds to retire its outstanding bonds or other obligations. The warrant is not issued to retire any outstanding bonds or obligations. Any outstanding bonds are retired only when and ifthe District refunds its outstanding bonds by the issuance of refunding bonds or otherwise retires them with moneys derived from other sources. Moreover, the warrant does not provide abenefit or serviceThe Honorable Jose R. Rodriguez - Page 10 (JC-0068)

necessary to the issuance of the refunding bonds when and ifthey are authorized. Issuance of the warrant is aseparate transaction undertaken in lieu oforprior to the issuance ofrefunding bonds-it isundertaken precisely because the issuer is atthe time unable orunwilling to issue refunding bonds,

If the District does not have the authority to issue a warrant derived from its specific authority to issue bonds and refunding bonds to which the warrant would purportedly relate, that authority cannot be inferred from the general authority to manage and control the hospital system. See Mann, 142 S.W.2d at 947 (when powers are granted by specific statutory provisions, they are not enlarged by general language elsewhere inthe statute); cf. Canales v.Laughlin, 214 S.W.2d 45 1, 457 (Tex. 1948) (“The specific statutes covering this particular matter [employment of person to supervise county road system] are controlling in this case over the general provisions

. . .“). A contrary rule-that the general authority to manage and control authorizes any specific financial vehicle or means the District finds useful or convenient-would render most specific statutes providing for or limiting governmental borrowing powers superfluous. See Mann, 142 S.W.2d at 947; Canales, 214 S.W.2d at 457.

Our interpretation here, that the authority to issue awarrant or undertake other derivative transactions cannot be implied from the specific authority to issue or refund bonds or from the general authority “to manage and control,” is supported by legislative enactments. The legislature has expressly authorized certain governmental entities to enter into particular derivative contracts in prescribed circumstances. See, e.g., TEX.REV.Crv. STAT.ANN.art. 717q (Vernon Supp. 1999) (authorizing certain issuers to enter into swap contracts inconnection with issuance ofbonds orother obligations that are subject to Attorney General approval); TEX.NAT.RES.CODEANN. 5 161.074 (Vernon Supp. 1999) (authorizing Veterans Land Board to enter into interest rate swap agreements, currency swap agreements, or forward payment conversion agreements in order to place Board’s bonds on desired interest rate basis); TEX.TRANSP. CODEANN. 8 452.102 (Vernon Supp. 1999) (authorizing regional transportation authority to invest its funds in interest rate swap or similar agreements); TEX. GOV’T CODEANN. 4 2306.351 (Vernon 1999) (authorizing Department of Housing and Community Affairs to enter into interest rate swap agreements, currency swap agreements, or forward payment conversion agreements in order to place Department bonds on desired interest rate basis); but see TEX.GOV’TCODE ANN. $4 2256.009(b), .024(b) (prohibiting governmental bodies, other than those specifically named, from investing incollateralized mortgage obligations on which interest rate is tied to index that adjusts opposite market index). Thus, when the legislature intends that a governmental body have the authority to undertake derivative transactions it so expressly provides.

As indicated earlier, the District’s bond counsel forthe Warrant transaction contends that the District has implied authority to issue an interest rate hedge warrant based on its express authority to issue bonds and refunding bonds, relying on Texas cases and attorney general opinions that, according to bond counsel’s letter brief, have recognized “a variety ofpowers
.in the context of public finance, even where anexpress grant ofthe power does not exist.” Mendel letter of 1l/l 7/98, at 7(citing Lasater, 217 S.W.2d 373; Shepperd, 299 S.W.2d 920; Tex. Att’y Gen. Op. Nos. JM-697 (1987), JM-642 (1987)). The cited authority is inapposite. These cases and attorney generalThe Honorable Jose R. Rodriguez - Page 11 (X-0068)

opinions recognize political entities’ implied authority only to acquire public improvements by
means other than the issuance ofbonds, derived from the governmental entities’ express powers to acquire and expend money for those improvements. See Lasater, 217 S.W.2d 373; Shepperd, 299 S.W.2d 920; Tex. Att’y Gen. Op. Nos. JM-697 (1987), JM-642 (1987). For example, in the leading
case in this area, Lasater V.Lopez, 217 S.W.2d 373, the Texas Supreme Court upheld counties’ implied authority to issue interest-bearing, time warrants to finance public improvements. This wellestablished, legislatively-sanctioned authority to issue non-negotiable warrants for road improvements, the court stated, was not abrogated implicitly by the more recent express authority to issue negotiable bonds for the same purpose. Id. at 376-77. Similarly, in San Antonio River Authority v.Shepperd, 299 S.W.2d 920, the Texas Supreme Court, relying on Lasater among other cases, upheld a county’s implied authority to enter into along-term contract payable from taxes to finance construction of flood-control facilities given the county’s express constitutional authority to engage in and expend tax funds for flood control programs. Id. at 924. Likewise, in Attorney General Opinion JM-697, this office determined that acounty has implied authority to finance ajail by a long-term, lease-purchase contract in view of its express authority and duty to provide ajail, relying on Shepperd and Lasater. See Tex. Att’y Gen. Op. No. JM-697 (1987); see also Zimmelman
v.Harris County, 819 S.W.2d 178 (Tex. App.-Houston [lst Dist.] 1991, no writ) (county impliedly authorized to use nonprofit corporation to finance jail by lease-purchase arrangement). Finally, in Attorney General Opinion JM-642, this office determined that a city and a county have implied authority to borrow money from abank to finance joint city-county hospital improvements given their express powers to maintain and equip ahospital and to issue bonds. See Tex. Att’y Gen. Op. No. JM-642 (1987) (also relying on Shepperd and Lasater). The warrant in question is not issued to acquire hospital facilities or improvements.

Bond counsel’s brief also contends that “[i]n the area of public finance, State courts have been particularly expansive in construing the powers ofpolitical subdivisions, concluding long ago that political subdivisions should have powers similar to private persons in matter pertaining to indebtedness” to support its contention that ahospital district is impliedly authorized to issue an interest rate hedge warrant. Mendel letter of 1l/17/98, at 7 (citing Dallas County v.Lockhart, 96 S.W.2d 60 (Tex. 1936); Frio County v. Security State Bank ofPharr, 207 S.W.2d 231 (Tex Civ. App.-Waco 1947, no writ)). The authority cited does not support this proposition or the authority to issue the warrant. The cases cited actually deal with express statutory authority to elect the method of redeeming bonds that best served the issuer’s purposes.
In one of the cases, Dallas County v. Lockhart, 96 S.W.2d 60 (Tex. 1936), the Texas Supreme Court upheld a county’s statutory authority to redeem bonds with the cash proceeds of refunding bonds against a contention that such refunding could be accomplished only by an exchange of the old bonds for the new ones. In this context, the court stated:

All of the statutes with reference to redeeming and refunding are complementary to one another and should be considered together. Thus considered, they clearly evidence a legislative intent to vest counties and municipalities, asnearly asmay be, with the same rightsThe Honorable Jose R. Rodriguez - Page 12 (JC-0068)

asother creditors, by providing aflexible, equitable, and businesslike plan for financing their bonded indebtedness to meet changing conditions.

Id. at 63. Similarly, inthe other case, Frio County v.Security State Bank ofPharr, 207 S.W.2d 23 1 (Tex Civ. App.-Waco 1947, no writ), the court considered astatute that allowed acounty toreserve the right to redeem bonds prior to maturity asthe county determined, “in order that itmight handle its business affairs with reference to the issuance ofrefunding bonds in such manner aswould seem to [its] best advantage

. .” Id. The county had reserved aright to redeem some of its bonds prior to maturity but not others. Id. The court held that the county was bound by its election and could not redeem prior to maturity those bonds that were not subject to early redemption. Id. Thus, contrary to bond counsel’s assertion, the courts in these cases did not conclude that political subdivisions have financing powers similar to private persons; rather, those cases address statutes whereby the legislature provided political subdivisions with “powers similar to private persons in matters pertaining” to governmental debt with respect to the specific available methods forrefunding bonds. The legislature has not afforded similar powers with respect to derivative contracts to hospital districts. Accordingly, the cases cited are inapposite.

In conclusion, although an interest rate hedge warrant may be adesirable financial product toprofit from interest rate fluctuations in the market to mitigate the burden ofinterest payments on outstanding bonds, itis not indispensable to effectuate the issuance ofnew money bonds, refunding bonds, or otherwise effectuate the redemption of outstanding bonds. Accordingly, the authority to issue the warrant may not be inferred from the authority toborrow money and issue bonds. Nor can that authority be inferred from the District’s general authority to manage and control the hospital system. Therefore, itisthe opinion ofthis office that the District does not have authority to execute a contract to hedge against interest rate fluctuations evidenced by the issuance of awarrant.The Honorable Jose R. Rodriguez - Page 13 (JC-0068)

SUMMARY

Ahospital district isnot authorized to execute an interest rate hedge contract that entitles the district to receive a lump sum if market interest rates rise in relation to the interest rate on certain outstanding district bonds but that requires the district to pay out a lump sum if interest rates fall.

Attorney General of Texas

ANDY TAYLOR First Assistant Attorney General

CLARK RENT ERVIN Deputy Attorney General - General Counsel

ELIZABETH ROBINSON Chair, Opinion Committee Prepared by Sheela Rai Assistant Attorney General