What Are Certificates of Participation?

Certificates of Participation (COPs) represent a financing method used by governmental entities to fund public projects and acquire assets. These financial instruments allow states, counties, and municipalities to secure funding without issuing traditional general obligation bonds, which often require voter approval. Instead, COPs provide investors with a proportionate interest in the lease payments made by the governmental entity. This structure offers a flexible alternative for public sector financing, enabling the acquisition of essential assets and the development of public infrastructure.

What Certificates of Participation Are

Certificates of Participation, commonly referred to as COPs, serve as a form of municipal lease revenue bond. They are frequently utilized by state and local government bodies, including school districts and various public authorities, to finance capital expenditures.

Unlike general obligation bonds, which are typically backed by the full faith and credit and taxing power of the issuing government, COPs do not represent a direct pledge of the governmental entity’s general taxing authority. Instead, they grant investors a right to receive a share of specific lease payments.

These instruments are structured around a lease-purchase agreement, enabling governmental entities to acquire or construct public assets such as buildings or equipment. The payments made under this lease-purchase arrangement are then “participated out” to investors who hold the certificates.

This mechanism allows governments to fund projects that might otherwise be delayed due to debt limitations or the lengthy process of obtaining voter approval for traditional bond issuances. Essentially, COPs transform a series of lease payments into a marketable security.

How Certificates of Participation Function

Initially, a governmental entity, acting as the lessee, enters into a long-term lease agreement with a separate financing entity, often a non-profit corporation or a public authority, which serves as the lessor. This lessor entity typically acquires or constructs the public asset, such as a new municipal building or a fleet of vehicles.

Following the acquisition or construction of the asset, the lessor issues Certificates of Participation to investors. Each certificate represents a fractionalized ownership interest in the stream of lease payments that the governmental entity will make to the lessor.

An independent trustee, typically a bank, plays a central role in this arrangement. The trustee holds legal title to the leased asset and is responsible for collecting the lease payments from the governmental entity. Upon receiving these payments, the trustee then distributes the principal and interest portions to the COP holders.

Key Attributes of Certificates of Participation

A defining characteristic of Certificates of Participation is their inherent appropriation risk. The governmental entity’s obligation to make lease payments is subject to annual appropriation by its legislative body, such as a city council or state legislature. If the legislative body chooses not to appropriate funds for these payments, the lease agreement may terminate, and investors may cease to receive payments. This condition differentiates COPs from general obligation bonds, which are secured by the issuer’s binding pledge to levy taxes.

COPs are non-recourse to the full taxing power of the governmental entity. Their security is primarily derived from the specific leased asset and the stream of lease payments generated from that asset. Investors’ recourse in the event of non-payment is limited to the leased property itself. The leased asset often serves as collateral, and if the government defaults on its payments, the trustee may have the right to take possession of the asset.

Interest income received by investors from Certificates of Participation is exempt from federal income tax. This interest may also be exempt from state and local income taxes if the investor resides within the state where the certificates were issued.

Common Applications and Issuers

Certificates of Participation are primarily issued by a wide array of state and local governmental entities across the United States. These issuers include county governments, city municipalities, public school districts, and various special purpose authorities created for specific public functions. This financing tool offers these entities a flexible method for funding without always needing to go through a public vote or referendum, which is often required for general obligation debt.

COPs are commonly used to finance a diverse range of public projects and asset acquisitions. Examples include the construction or renovation of public buildings, such as administrative offices, courthouses, and school facilities. They also frequently fund the acquisition of essential equipment, including vehicles for public safety or transportation, and technology systems for governmental operations. While less common for large-scale, multi-component infrastructure, COPs can finance specific elements like correctional facilities or healthcare infrastructure. The decision to use COPs often stems from a need for expediency or to navigate statutory debt limits.