A Municipal Utility District is a special governmental entity of the state of Texas, regulated by the Texas Commission of Environmental Quality and operates pursuant to the Texas Water Code. A MUD’s chief purpose is to make available water, sewage, and drainage services within its boundaries. A MUD may also charge for its services, levy and collect property taxes, issue bonds, create recreational services, condemn property, and promulgate regulations to achieve its goals.
To create a MUD, a majority of property owners in a particular district petition the TCEQ, and the commission then evaluates the petition, holds a public hearing, and grants or denies the petition. After the MUD’s creation, a temporary and permanent board of directors will be appointed. Subject to the regulation and control of the TCEQ, the district will be managed by its board of directors.
Real estate developers often enter into contracts with MUDs for the reimbursement of the costs of construction of water, sewer, and drainage facilities (the “utility facilities”) so the developer can complete the property. Under the terms of a typical contract between a developer and a MUD, the developer will agree to advance the costs of the construction of the utility facilities, which are to be constructed in a good and workmanlike manner, and in accordance with MUD-approved plans and specifications. The developer will then be obligated to comply with the terms of the reimbursement agreement with the MUD to receive reimbursement for the cost of the construction of the utility facilities advanced by the developer from the proceeds of a sale of the district’s bonds. The MUD will use the funds it receives from the sale of the bonds to reimburse the developer for the advancement of the cost of the construction of the utility facilities.
What if the developer assigns its right of reimbursement to a third party? Would that third party have possession of an enforceable assignment of the right of reimbursement of such proceeds? The answer depends upon to whom the developer assigns the right of reimbursement of MUD proceeds. If the developer assigns the proceeds to a construction lender who provides the funds to pay the costs of the construction of the utility facilities, then the lender may have an enforceable assignment of the right of reimbursement of the MUD proceeds.
However, according to Cameron County Savings Association v. Cornett Construction Co., 712 S.W. 2d 580 (Tex. App.-Corpus Christi, 1986), other third parties may not have an enforceable assignment of the right of reimbursement of MUD proceeds. In Cameron, a MUD contracted with a general contractor to install water distribution lines, electrical utilities, sewer lines, and storm drainage in the district. In return for its performance, 70%of the MUD’s reimbursement to the GC was to come solely from the sale of municipal utility district bonds by the MUD. The GC then subcontracted out a portion of the work to Cornett Construction Company. Subsequently, the joint ventures of the GC split up and partitioned the right of reimbursement of MUD proceeds among the individual joint ventures of the GC Thereafter, one of the joint ventures applied for a loan from Cameron County Savings Association, in which they assigned as collateral their interest in the right of reimbursement of MUD proceeds. The loan was unrelated to the construction agreement between the GC and the MUD.
When Cornett was not paid in full for its performance of its contract with the GC, Cornett brought suit against the association and the GC to recover payment. With reference to the right of reimbursement from the MUD proceeds, the court stated: “[A]t the outset, it is important to properly characterize the funds involved; the funds are proceeds from a municipal utility district bond sale earmarked for paying construction improvements. Regardless of what they are called, the purpose of the funds was to pay construction costs, and not as assignable assets to secure other debts.”
The court went on to state that nothing in section 54.501 of the Texas Water Code would allow MUD bonds to be issued to secure other debts, beyond debts for construction work. The assignment of the right to reimbursement of MUD proceeds to the association, as collateral for a loan to the borrower, converted the right to reimbursement into collateral for a debt that did not arise from construction costs on the property where the utility facilities were installed. The right of reimbursement was not an assignable asset to secure other debts, and therefore the court held that the borrower could not assign such right to the association.
Cameron is significant because it should put all assignees on notice that if their assignment of the right of reimbursement of MUD proceeds does not relate to the payment of construction costs, the assignment might be set aside by the courts.
Brett L. Slobin is an attorney in the Houston law firm of Slobin & Slobin PC, and he can be contacted at bslobin@slobinlaw.com. His practice focuses on commercial and residential real estate.
