The Internal Revenue Service ("IRS") has reached a favorable conclusion in a long-awaited Technical Advice Memorandum in connection with its audit of tax-exempt bonds issued by the Montana Facility Finance Authority for the benefit of Mission United, Inc., and its retirement community, Mission Ridge. An issue raised in the audit was whether entrance fees paid by new residents that were part of a general pledge of all revenues for the benefit of bondholders were replacement proceeds for purposes of the arbitrage rules. In finding that they were not replacement proceeds, the IRS concluded on the basis of the facts presented that there was no reasonable assurance that the entrance fees would be available for the benefit of bondholders if the company encountered financial difficulties.

In connection with the bond issue, the company had granted to the bond trustee a first-priority security interest in all its revenues, including the entrance fees. The entrance fees were commingled with other revenues and were able to be spent without restrictions under the bond documents. The cash of the company, including the entrance fees, was spent on operating deficiencies, replacement of facilities and other capital needs. In fact, the company showed that the amount of cash invested at year-end was less than half the cash raised through entrance fees for the year. Although the pledge of revenues created a nexus between the entrance fees and the bond issue, neither it nor the terms of the other bond documents created a reasonable assurance that the funds would be there if the company encountered financial difficulties.

This Technical Advice Memorandum should eliminate concerns that a general revenue pledge results in replacement proceeds, absent provisions of the pledge or other financial covenants that require the maintenance of a specific amount of funds.