What Is This “Funding” Clause and Why Is It Needed?
Contracting for goods or services is a normal part of the day-to-day operations of a municipality in Texas.
As most City Attorneys already know, there are certain provisions that are required in every contract a municipality in Texas enters into. Some of these provisions can cause confusion and concern for a vendor who is new to contracting with a governmental entity. One such provision is known as the “Funding” clause, which reads as follows:
“The parties understand and acknowledge that the funding of this Agreement is contained in the City’s annual budget and is subject to the approval of the City in each fiscal year. The Parties further agree that should the governing body of the City fail to approve a budget that includes sufficient funds for the continuation of this Agreement, or should the governing body of the City fail to certify funds for any reason, then and upon the occurrence of such event, this Agreement shall automatically terminate as to the City and the City shall then have no further obligation to the Contractor. When the funds budgeted or certified during any fiscal year by the City to discharge its obligations under this Agreement are expended, the Contractor’s sole and exclusive remedy shall be to terminate this Agreement.”
For many vendors new to working with local governments in Texas, this language can be somewhat disturbing as it states that if a municipality doesn’t approve the contract on an annual basis and account for it in their annual budget, then the contract is terminated.
So, why is such a blatantly one-sided clause required in all municipal contracts in Texas? The answer is simple, because according to Article XI, Sections 5 and 7 of the Texas Constitution a city may not create any debt unless they simultaneously levy and collect a sufficient sum to pay the resulting interest of that debt and create a sinking fund of at least two percent. To put it in more simple terms, a debt must be “funded.” Furthermore, while the Texas Constitution does not necessarily define the term “debt”, the 1895 Texas Supreme Court case of McNeil v. City of Waco defines it as “any pecuniary obligation imposed by contract.” This means by simply entering into a contract that extends past the current annual budget that contemplates the funds needed for that contract, the city has effectively created a debt.
As one can see, this creates all types of issues for a municipality that needs to enter into a contract that is binding for more than one year. The city would have to go through the trouble of levying a tax and creating a sinking fund for every single contract they need to enter into that extends past that original year. So, how do cities in Texas avoid this? You got it, the Funding clause! As stated in Municipal Administrative Services v. City of Beaumont, “a contract does not create a debt if the parties lawfully and reasonably contemplate that the obligation will be satisfied out of current revenues or out of some fund then within the immediate control of the governing body.”
By including the above Funding provision in all municipal contracts, cities do not need to go through the burdensome steps involved with levying a tax and creating a sinking fund.
This allows the city and the vendor to enter into a contract in just a matter of days or weeks instead of months. It also saves manpower and money the city could be using for more beneficial purposes. The next time a vendor takes issue with this provision, a simple explanation as to why it is necessary should be all that is needed to alleviate their concerns.
Please do not rely on this article as legal advice. We can tell you what the law is, but until we know the facts of your given situation, we cannot provide legal guidance. This website is for informational purposes and not for the purposes of providing legal advice. Information about our commercial and business litigation practice can be found here.