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Municipal Markets
BY Orrick Herrington & Sutcliffe LLP
Muni Market Special Report: The Texas Muni Market, Guns, and Fossil Fuels
Texas Muni Market Adjusts to Laws Protecting Guns and Fossil Fuels
Passed by the Texas Legislature in 2021, Senate Bill 19 exemplifies an increasingly popular trend for lawmakers: leveraging the contracting power of state and local government in support of preferred policy objectives. SB 19 requires companies to verify in most contracts with Texas governmental entities that they do not discriminate against the firearm industry. If a company is not able to make the required verification, then Texas governmental entities are prohibited from entering into certain types of contracts with the company, including contracts to underwrite the purchase and sale of municipal bonds. Supporters of SB 19 contend that the legislation was enacted as a direct response to banks impinging on the Second Amendment rights of hunters and other law-abiding gun owners by refusing to provide loans to companies that manufacture certain types of ammunition and firearms, including military-style weapons. The law specifically applies to contracts for the purchase of goods or services, with a valuation of at least $100,000, between a state agency or political subdivision in Texas and a company with at least 10 full-time employees, if the contract is paid in whole or in part with public funds. The term “company” is broadly defined and includes virtually all affiliated entities of the contracting company, making compliance particularly challenging for banks and other large enterprises. Certain contracts, however, like those that involve non-profit corporation issuers of bonds for higher education, charter schools, healthcare facilities or industrial development projects, are not covered per guidance from the Texas Attorney General’s Office. Additionally, because only contracts involving goods or services are covered, Texas case law and related legal authorities suggest that at least some real estate contracts and contracts for the purchase or sale of investments would be outside the scope of the statute. The ultimate determination for any such contract would be subject to a fact specific analysis and dependent on the actual terms of the contract in question.
The Texas Attorney General’s Office, which is required to approve most bond issuances in Texas, has issued guidance on compliance with SB 19. For transactions subject to the Attorney General’s approval, companies entering into contracts covered by SB 19 are required to submit “standing letters” confirming that they are able to make the requisite verifications. Standing letters may not contain any qualifying language regarding the company’s understanding as to what the law means. SB 19 requires the company to make the required verification at the time the contract is entered into confirming that it does not discriminate against the firearm industry and further agree that it will not, during the term of the contract, discriminate against the firearm industry. In some cases, such as with credit facilities and reimbursement agreements, the required verification may be in effect for a year or more. As a result, a company may enter into a contract that may become voidable if at any point during the contract’s term the company adopts policies or takes other actions that are determined to constitute discrimination against the firearm industry. Subject to certain exceptions the term “discriminate” generally means a company’s refusal to engage in the trade of any goods or services with gun manufacturers or other entities in the firearm industry, including gun associations such as the National Rifle Association, based solely on the manufacturer’s or other entity’s being in the firearm industry.
SB 19 is not the first legislation of its kind, and it likely will not be the last. In 2017, the Texas Legislature passed a similar law, HB 89, with the same kind of contracting restrictions, but also with divestment requirements, for companies that boycott Israel (as amended, the “Boycott Israel statute”). In 2021, in addition to SB 19, the Texas Legislature adopted SB 13, which is modeled directly after the Boycott Israel statute and imposes both contracting restrictions and divestment requirements on companies that boycott the oil and gas industry.
Muni Market in Texas Impacted by SB 19
Following the passage of SB 19, some financial institutions, including a few prominent Wall Street firms, made the determination to withdraw, at least temporarily, from the Texas municipal bond market while they assessed whether their gun policies complied with the requirements of the new law. Some of those firms likely did so out of an abundance of caution given the uncertainty about how to interpret certain statutory exceptions that permit restrictive gun policies provided they are adopted for “traditional business reasons” or to comply with legal requirements (each of which would mean the policies do not impermissibly discriminate under the statute). For other firms, the burden of compliance may be viewed simply as the price of doing business in Texas. According to recent published reports in Bloomberg, bond issues by state and local governments in Texas totaled $52.57 billion in 2021, an amount second only to California. For firms active in the Texas municipal market over the last year, particularly those capitalizing on sidelined competition, ensuring compliance with SB 19 makes sense from a business perspective, and the absence of restrictive gun policies is proving to be a competitive advantage.
Copycat “FIND” Laws in Other States
Though SB 19 is the first anti-boycotting law protecting the gun industry in the United States, and to date the only one to have taken effect, at least 10 other states have considered similar firearm industry nondiscriminatory legislation, or “FIND” laws, with varying degrees of success, including Wyoming, Arizona, Louisiana and Oklahoma. Generally, proponents of FIND laws assert that denying gun companies access to banking services solely because of their involvement in the firearm industry is an infringement on Second Amendment rights. As reported by The New York Times, a spokesman for a gun rights group stated that the group has provided Congress with proof that the group’s member companies have increasingly been denied access to the banking industry “simply because they make firearms,” thereby illustrating the need for FIND laws.
Questions of Constitutionality Still Unsettled
Opponents of the anti-boycotting laws allege that they result in compelled speech in violation of the First Amendment to the U.S. Constitution. Two lawsuits have been filed in Texas where federal district courts have questioned the constitutionality of the Boycott Israel statute. In 2019, a federal district court in Austin issued a preliminary injunction blocking a Texas public school district from requiring a speech therapist to make the anti-boycotting of Israel verification in a renewal contract. While the case was pending the Texas Legislature amended the law by, among other things, narrowing its application to exclude companies with fewer than 10 full-time employees. As a result, the plaintiffs in this lawsuit, all sole proprietors, were no longer affected under the law as amended, and the case was dismissed as moot. The dismissal occurred after the district court issued an order calling into question the constitutionality of the statute on First Amendment grounds and temporarily enjoining its enforcement with a statewide injunction. Subsequently, in January 2022, a federal district court blocked Texas from requiring an engineering firm to make the anti-boycotting of Israel verification in a contract with the City of Houston after concluding that the verification requirement violated the free speech rights of the contractor. Notably, the district court issued a narrow injunction that applies only to the contract at issue. The Texas Attorney General’s Office has appealed the district court’s ruling, and this case remains pending. While the ultimate outcome of this litigation could impact the enforceability of the other anti-boycotting laws, including SB 19, it is important to note that there are enough differences between the structure and substance of SB 19 and the Boycott Israel statute that an adverse outcome might have little impact on the enforceability of SB 19. Moreover, as was the case with the prior constitutional challenge that was dismissed as moot in 2019, the current litigation challenging the Boycott Israel statute may help the Texas Legislature tailor amendments to the anti-boycotting laws in order to increase the possibility that they would survive constitutional challenges in the future.
SB 13 Divestment Review Ongoing, Related Market Impacts
As noted previously, SB 13 protects against boycotts of the oil and gas industry by requiring verification statements in government contracts and imposing divestment requirements on boycotting companies. (Conversely, SB 19 only has a contract verification requirement and not a divestment requirement.) To help ensure compliance with SB 13, the Texas Legislature tasked the Texas Comptroller with developing a divestment list of publicly offered financial companies that boycott the oil and gas industry. Earlier this year, the Comptroller sent out inquiries to more than 150 financial services firms or their affiliates, including several active in underwriting bond transactions in Texas, as a preliminary step in preparing the divestment list. The companies under review were required to issue responses within 60 days clarifying their positions on fossil fuel investment and to provide a list of funds in their portfolios that prohibit or limit investment in fossil fuels. If a company did not respond within the 60-day period, then it is presumed to be boycotting the oil and gas industry.
Though the 60-day response period has expired, the Comptroller’s review of the responses in ongoing. Once the review is complete, the Comptroller is required to publish the SB 13 divestment list and then begin a process of divesting Texas pension funds, school endowments and other state investment accounts from the companies on the list. A company or its affiliate that received an inquiry letter from the Comptroller may be able to avoid being placed on the divestment list by establishing that its policies on fossil fuels were adopted for “ordinary business purposes.” This is a permitted exception in SB 13 for companies that have imposed restrictions on transactions involving the oil and gas industry. Unfortunately, while the review process by the Comptroller is ongoing, the firms under review have encountered significant difficulties originating and retaining underwriting business in Texas. This difficulty is the net result of the Comptroller’s ongoing review, coupled with guidance issued by the Texas Attorney General’s Office in April that has caused issuers some hesitancy in awarding underwriting business to firms that ultimately may get placed on the SB 13 divestment list prior the closing of the bond transaction. Because of the uncertainty about which firms may get placed on the list and the timing of the publication of the list, some of the firms under review have been removed from underwriting syndicates or removed from consideration for transactions where they otherwise may have been selected. While issuers, bond counsel, underwriting firms and other market participants are working to adjust to the market disruptions caused by SB 13, the expectation is that the Comptroller will publish the divestment list on or before September 1, 2022, which is the one-year anniversary of the effective date of the legislation. At that time, the uncertainty surrounding the firms that received a Comptroller inquiry will be, at least for the time being, resolved. However, the Comptroller is charged with updating this list periodically, and it is unclear whether the same uncertainties will arise again in the future. Based on the implementation of the Boycott Israel statute in Texas and preliminary indications from the Texas Attorney General’s Office, it is expected that a company on the Comptroller’s SB 13 divestment list will be unable to provide the required verification statement for state and local government contracts.
The Toll on Texas Taxpayers
It appears that the market disruptions caused by SB 13 and SB 19, though likely indicative of success to the proponents of the legislation, have nevertheless increased the burden of borrowing on Texas taxpayers, at least according to an academic study referenced in a recent Bloomberg article. According to Bloomberg, in a research paper titled “Gas, Guns, and Governments: Financial Costs of Anti-ESG Policies,” Daniel Garrett, a professor at the University of Pennsylvania, and Ivan Ivanov, a principal economist at the Federal Reserve, have concluded that Texas issuers will bear an additional $303–$532 million in interest on the $32 billion in debt issued during the first eight months since SB 13 and SB 19 took effect. In the study, Garrett and Ivanov assert that affected issuers, especially those most reliant on the targeted banks, have increasingly opted to issue bonds through negotiated rather than competitive sales, have generally received fewer and less competitive bids from underwriters and have been negatively impacted by the loss of access to national distribution networks. Ultimately, they conclude that Texas taxpayers can expect roughly $445 million a year in added borrowing costs, assuming no other underwriters exit the market.
Trend Likely to Continue
In the face of deeply divided political constituencies that are motivated by unspeakably tragic events, such as the recent mass shootings in Uvalde, Texas and Buffalo, New York, it appears that the recent trend of legislation designed to leverage governmental investing and contracting authority in support of various (often divisive) public policy objectives will continue. In fact, in response to recent news reports about a financial services firm indicating it would provide travel benefits to employees seeking abortions outside of Texas, a state representative vowed to introduce legislation in 2023 that would bar governmental entities from contracting with any company that pays abortion-related travel expenses of its employees. If this trend continues, with lawmakers linking contracting decisions to hot button social issues, the Texas municipal market may be forced to make further adjustments to deal with reduced access to credit, the loss of national distribution networks and increased borrowing costs, as financial services firms are further confronted with a choice between making greater efforts to avoid issues that may be socially divisive or partisan or instead risk losing Texas underwriting business to regional competitors.