Limited Liability Companies May Now Hold a Contractor’s License In California

Beginning Jan. 1, 2012, California’s contractor licensing authority must now begin issuing contractor’s licenses to limited liability companies.  Previously, contractor’s licenses were only available to individuals, corporations and partnerships.   

The limited liablity company is the preferred form of entity for most real estate owners, developers and investors.  A limited liability company is a superior form of entity not only because of its limited liability features, but also because of its flexibility and ability to act as a pass-through entity for tax purposes if properly structured.

However, for many years, limited liability companies (or LLCs) could not hold a contractor’s license in California.  As a result, real estate developers often had to form affiliate corporations or limited partnerships with corporate general partners to hold contractor’s licenses issued by California’s Contractor’s State License Board. The formation of these entities and the related flow through accounting and legal issues were an administrative burden for some developers. 

This year the Contractor’s State License Board is required to begin processing applications by LLCs for a contractor’s license.  The law does add some additional requirements for those seeking to license an LLC.  For example, applicants must procure a $100,000 surety bond in addition to the $12,500 contractor bond.  LLC’s wishing to be licensed must also secure liability insurance with a minimum limit of $1 million and an aggregate limit as high as $5 million, depending on the number of employees of record.  Satisfying these additional requirements makes business sense for most sophisticated real estate developers anyway. 

Now that LLCs may hold contractor licenses, real estate developers that typically purchased land or brownfields for development with the LLC form of entity may now consolidate their land ownership and construction activity into the same entity.  It is important to consult with an attorney knowledgeable with your situation to determine whether this consolidation effort is best for you.

There Goes Our Redevelopment Bond Rating . . .

If you are a holder of California redevelopment bonds, you received some unwelcome news from the bond rating agency Moody’s this week.  Moody’s downgraded by one notch all California tax allocation bonds (also known as redevelopment bonds) rated Baa2 and better.  The rating agency also said that all redevelopment bonds could be subject to further downgrades because they will remain under review by Moody’s.

The main reasons given by Moody’s for the downgrade:  “Compliance with the requirements of the new legislative framework may prove challenging, particularly in the near term as affected agencies attempt to interpret the law and comply with its specified timelines. Most significantly, in the new law County Auditor-Controllers are given new auditing requirements to be met by July 1, 2012, and on-going administrative responsibilities that may initially conflict with existing bond indentures. The resolution of any such conflicts according to the new law’s property tax reallocation process could take a substantial amount of time, and it is entirely untested. The limited, one-notch downgrade across the Baa2-and-above rating spectrum reflects the broad-based but modest nature of this new risk. While Baa3-and-lower rated tax allocation bonds also face this new risk, their overall risk profile remains consistent with their current ratings.”

Moody’s action is not a surprise.  Under the redevelopment law, County Auditor-Controllers will be the ones establishing each redevelopment agency’s assets and liabilities, documenting each redevelopment agency’s passthrough payment obligations, and the amount and terms of any indebtedness incurred by the redevelopment agency.  Not only that, but the County Auditor-Controllers determine the amount of property taxes that would have been allocated to each redevelopment agency had the agency not been dissolved.  Thus, the County Auditor-Controllers will have broad authority to establish the initial books and future cash flow for each successor entity.  Therefore, in going through this exercise, the County Auditor-Controller will be deciding not only what debts get paid, but what revenue stream is available for repayment of those debts.  The decisions by the County Auditor-Controllers are, of course, subject to review, by the oversight boards, State Controller, and the Governor’s Director of Finance.

While we are on the subject of oversight, we should quickly mention that while Moody’s release expresses some concern with the powers of County Auditor-Controllers, it is the oversight boards created by the law that dissolved redevelopment agencies, AB 1x 26, that raises further political and legal uncertainty that would be of interest to the rating agencies.  The oversight boards are given broad discretion to approve the actions of the successor entities, including, among other things, “refunding of outstanding bonds . . . in order to provide for savings or to finance debt service spikes,” and “setting aside of amounts in reserves as required by indentures.”   What’s more, each oversight board also has the power to direct each successor entity to “[c]ease performance in connection with and terminate all existing agreements that do not qualify as enforceable obligations [as defined by the law]” and “terminate any agreement, between the dissolved redevelopment agency and any public agency located in the same county, obligating the redevelopment agency to provide funding for any debt service obligations of the public entity for the construction, or operation of facilities owned or operated by such public entity[.]”  The availability of these broad powers further underscore the concern that implementation of the new law could raise “issues” with respect to the interests of bondholders.

If you have an interest in bonds from a California redevelopment agency, whether as the registered owner of the bonds, as the trustee, redevelopment agency or perhaps even a developer in a redevelopment area, now is the time to pull out those bond documents and read them again.  Does a downgrade trigger default?  Does a downgrade trigger the trustee’s recourse to a credit enhancement, such as a letter of credit or other security, if only to hold it? Does the credit downgrade affect the interest rate in any way?  Who will pay for the difference in the interest rate spread, if any?  Those are just some of the questions that should be considered.

Moody’s also gave some guidance as to how future actions by stakeholders in the redevelopment agency transition could further affect bond ratings.  What could make the bond ratings go down further? Moody’s says:

• Implementation of the legislation in a way that does not preserve timely debt service payment

• Continued legal uncertainty and conflict between the law’s requirements and compliance with existing bond documents

• Judicial clarification that compliance with bond documents is subordinate or to be balanced against other objectives of the legislation

What could make the bond rating go up according to Moody’s:

• Implementation of the legislation in a manner that clearly preserves timely debt service payment and enables compliance with bond documents

• Legislative or judicial clarification that compliance with bond documents takes precedence over other, apparently conflicting aspects of the legislation

• In the long-run, assuming resolution of the legal and practical cash flow uncertainties, a sustained resumption of property tax growth

The demise of redevelopment agencies is having ripple effects on the bond markets.  This credit downgrade should be taken as a warning by all stakeholders that the markets are watching.  This is the time to act with deliberate care and prudence to avoid further action by Wall Street and its advisors.