Financing Options

Two major considerations in obtaining credit through conventional lending are: (1) the lenders need to be able to enforce an agreement, and (2) they need to protect their investment in the event of a default. A tribe operating an enterprise as an arm of the tribal government may have difficulty obtaining conventional financing.

Ability to enforce agreements--Lenders will be reluctant to provide credit if they are not certain that they can enforce their contract against a tribal enterprise that is an arm of the tribe because, like the tribe, it will be immune from suit. A tribe and lender can address this in a number of ways. The tribe can waive sovereign immunity for a particular transaction. Or, as addressed later in this Handbook, the tribe can form an II-7 entity separate from the tribal governing body that does not have sovereign immunity from suit or which has been vested with limited sovereign immunity.

Collateral and Security Interest--In addition to sovereign immunity concerns, a conventional lender will also want collateral or a security interest so that its investment is protected if there is a default or the enterprise is not successful. An enterprise operating as an unincorporated instrumentality of the tribe and its governing body will not have separate assets or property to pledge as collateral. Rather, tribal assets would have to be pledged and there will be no limitation of liability.

Collateral and Security Interest--In addition to sovereign immunity concerns, a conventional lender will also want collateral or a security interest so that its investment is protected if there is a default or the enterprise is not successful. An enterprise operating as an unincorporated instrumentality of the tribe and its governing body will not have separate assets or property to pledge as collateral. Rather, tribal assets would have to be pledged and there will be no limitation of liability.

Loan Guarantee Programs:

U.S. Department of the Interior Capital Investment Program. The Department of the Interior, Office of Indian Energy and Economic Development ("IEED") has an "Indian Affairs Loan Guaranty, Insurance, and Interest Subsidy Program" with two key loan programs. The first is a loan guaranty program in which a loan from a lender to a Tribe or an Alaska Native group may be provided a guaranty of up to 90% of a loan if the business activity will contribute to reservation economic development.

The IEED does not make direct loans. Loans may be made to finance Indian-owned businesses organized for profit, provided that Indian ownership constitutes at least 51% percent of the business. In 2006, the maximum loan amount that could be guaranteed for tribes is $12 million dollars. Each year Congress determines the limit on the total amount that IEED may guaranty. In 2006, the Office of IEED had $107 million dollars. In recent years, the Office of IEED has exhausted its limit before the end of the fiscal year. In some circumstances, IEED may subsidize the interest rate guaranty under the program by paying the difference between the yield on outstanding obligations of the United States of comparable maturity and the rate the bank is charging the Indian borrower.

The second is a new loan insurance program that may provide a more efficient process for tribally-owned firms to obtain loans under the $250,000 amount and at a lower cost than the IEED loan guaranty program. Under the insurance program, a bank that has been certified for the program may issue loans up to $250,000 to tribal firms without obtaining IEED approval. The IEED fees for this program are 1% less than the guaranteed loan program. Under this program, IEED will insure the lesser of 90% of the loan or 15% of the total dollar amount of the bank's loan portfolio issued under the insurance program.

U.S. Department of Agriculture ("USDA") Business & Industry ("B&I") Loan Guarantee Program. The Business & Industry Loan Guarantee Program is intended to improve, develop, or finance business, industry, and employment, to improve economic conditions in rural communities. The guarantee fee charged, which may be passed on to the borrower, is two percent of the original loan amount. The fee may be reduced to one percent if certain criteria are met. Eligible borrowers include Indian tribes or federally recognized groups.

Loan proceeds can be used for machinery and equipment, buildings and real estate, working capital, and certain refinancing. Generally, the maximum amount available to a borrower is $25 million; however, the maximum amount for rural cooperatives processing value-added commodities is $40 million. The USDA will guarantee up to 90 percent of the amount of the loan under $2 million, 80 percent of a loan between $2 million and $5 million, 70 percent of a loan over $5 million, and 60 percent of a loan over $10 million.

Small Business Administration ("SBA") 7(a) Program. The SBA 7(a) Program provides commercial loan guarantees to American small businesses for general business purposes.29 Loan proceeds may be used for working capital, machinery and equipment, furniture and fixtures, land and buildings, leasehold improvements, and certain refinancing. The loan term is up to 10 years for working capital, and up to 25 years for fixed assets.

7(a) loans are only available on a guaranty basis. This means they are provided by lenders who choose to structure their own loans by SBA's requirements and who apply and receive a guaranty from SBA on a portion of this loan. The SBA does not fully guaranty 7(a) loans. The lender and SBA share the risk that a borrower will not be able to repay the loan in full. The guaranty is a guaranty against payment default.

Tribally-owned businesses may be eligible to receive loan guarantees if they meet other SBA requirements regarding size, nature of the business, use of proceeds, and lack of available credit elsewhere. SBA regulations provide that businesses deriving more than one-third of their gross annual revenue from "legal gambling activities" are ineligible to for SBA loans.

Tax-exempt Bonding. Section 103 of the Tribal Governmental Tax Status Act permits tribal governments to issue tax exempt bonds. When a tribe issues tax exempt bonds, the investors in such bonds are able to earn interest free of tax. Thus, all other factors being equal, such bonds should yield lower interest rates than taxable debt. Bond financing (whether taxable or tax-exempt) also has the advantage of allowing the borrower to spread repayment of principal and interest over a longer period.

Only Indian tribal governments and their political subdivisions are qualified issuers of tax exempt debt. Furthermore, the IRS has ruled privately that certain entities that qualify as "integral parts" of the tribe may also issue such debt.

In addition, the IRS has ruled that Indian entities qualifying as an "instrumentality" of one or more government units may use tax exempt financing, and such use will not constitute a "private business" use.32 In addition to meeting these tests, which focus on the identity of the person issuing the bonds (or on whose behalf the bonds are issued), all tribal tax-exempt debt must finance facilities that serve an "essential governmental function." Section 7871 does not define an essential government function, but Section 7871 states that it does not include functions not customarily performed by state or local governments. The II-9 interpretation of the "essential governmental function" test has spawned a number of controversies between the IRS and tribes. Recently, the IRS announced a proposed rule making to bring more clarity to this area of the law.

Tax Credit Financing. The Energy Policy Act of 2005 includes authority for nonprofit utilities and governmental entities, including tribal governments, to issue tax credit bonds to finance the cost of renewable energy projects--known as Clean Renewable Energy Bonds ("CREBs"). These entities may issue a total of up to $800 million in tax-credit bonds between January 2006 and the end of December 2007 to finance solar, wind, biomass, landfill gas, geothermal, and small irrigation power facilities that generate electricity. No more than $500 million of the CREBs can be allocated for projects of government entities. The project must be owned by a governmental entity or non-profit entity. Initial applications for allocation of these bonds were due April 26, 2006.

H.R. 6408, the Tax Relief and Health Care Act of 2006, recently extended and expanded the availability of CREBs. Section 202 of the bill authorizes an additional $400 million of CREBs and extends the authority to issue such bonds through the December 31, 2008. The bill is expected to be signed into law by President Bush. Assuming that the bill is enacted, it is expected that there will be a new round of applications that eligible issuers may submit.

Project Financing/Non-Recourse Debt Financing. Project financing involves non-recourse financing of the development and construction of a particular project in which a lender looks primarily to the revenues expected to be generated from the project for the repayment of its loan and to the assets of the project as collateral for its loan rather than the general credit of the project owner or developer. Capital-intensive projects requiring large investment of funds such as power plants, pipelines, and power generation facilities, are increasingly funded using project finance. Developers of these projects are frequently not sufficiently creditworthy to obtain traditional financing or are unwilling to take the risks and assume the debt obligations for traditional financing.

Project financing permits the risks associated with such projects to be allocated among a number of parties at levels acceptable to each party. For example, for an energy generation facility, there usually has to be a long-term off-take agreement or power sales agreement and the purchaser has to have good credit.34 A tribe developing wind power generation may obtain a power sales agreement from a utility who agrees to purchase the power generated by the project for a stated term. Any utility that agrees to purchase the product must have good credit. The power sales agreement and the anticipated revenues could be pledged as security to obtain a loan for the construction and development of the project. The tribal developer would not have an obligation to make payments on the project loan if the revenues generated by the project are insufficient to cover the loan payments. This type of financing allows the developer to finance the project on a highly leveraged basis. Often, projects are financed using 80 to 100 percent debt financing. A developer’s funds are at less risk as it permits a developer to finance the project without diluting its equity investment in the project.