Litigation Alert. Arizona Supreme Court Clarifies Gift Clause Limits on Public Payments to Private Parties. Executive Summary

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1 ALBANY AMSTERDAM ATLANTA AUSTIN BOSTON CHICAGO DALLAS DELAWARE DENVER FORT LAUDERDALE HOUSTON LAS VEGAS LONDON* LOS ANGELES MIAMI NEW JERSEY NEW YORK ORANGE COUNTY ORLANDO PALM BEACH COUNTY PHILADELPHIA PHOENIX SACRAMENTO SHANGHAI SILICON VALLEY TALLAHASSEE TAMPA TYSONS CORNER WASHINGTON, D.C. WHITE PLAINS Strategic Alliances with Independent Law Firms** MILAN ROME TOKYO ZURICH Arizona Supreme Court Clarifies Gift Clause Limits on Public Payments to Private Parties Executive Summary On January 25, 2010, the Arizona Supreme Court issued its decision in Turken v. Gordon, et al, Ariz. S. Ct. No. CV PR, addressing the limits imposed by the Arizona Constitution s Gift Clause on public payments to private parties. In the context of a development agreement providing for a tax reimbursement payment to a private developer, the Court affirmed and clarified the parameters of the socalled Wistuber test, under which a governmental payment to a private party complies with the Gift Clause only if the payment both (1) has a public purpose and (2) is not grossly disproportionate to what is received in return. With regard to the first prong of the test, the Court reaffirmed a broad view of what constitutes a public purpose, one that evolves to meet the conditions of the time. The Court further reaffirmed the rule that the courts may not disturb elected officials determination that a specific purpose constitutes a public purpose absent proof that the elected body s discretion has been unquestionably abused. In Turken, the Phoenix City Council adopted an ordinance authorizing an agreement the stated purposes of which were the purchase of certain parking space use rights and the opportunity to realize certain retail development with attendant planning, tax and economic development benefits. The Court determined that the Council had not abused its discretion and, accordingly, held that the agreement satisfied the public purpose prong of the test. With regard to the second prong of the test, the Court rejected the argument that indirect benefits (e.g., projected increases in tax revenue) can automatically be counted as the consideration for a public payment. Rather, the Court held that only "the objective fair market value of what the private party has promised to provide in return for the public entity's payment" can be taken into account. Since the developer in Turken did not contractually commit to provide anything other than the parking space use rights, the value of those rights was all that could be counted as consideration for the City payment. The Court also questioned whether the value of the use rights could be anywhere near the amount of the City payment potentially required under the agreement, concluding that the agreement probably violates the Gift Clause. This is curious, as the City payment is entirely contingent and could be zero or any amount up to $97.4 million depending on whether and to what extent the developer manages to satisfy the conditions to payment, unless the Court also intended to say that, for this purpose, the highest possible public payment must be assumed. There is no explicit guidance on this point and, ultimately, the Court determined not to apply its new consideration test in Turken, reasoning that prior decisions may have led to confusion concerning what can be counted as consideration, and limited application of its decision to future transactions.

2 In terms of Turken s practical implications, the decision confirms, at minimum, that there is no Gift Clause concern in most instances where a public payment is made to a private party for public infrastructure. Beyond that, and using the circumstances presented in Turken as an example, the Court s reasoning suggests that, if the Turken developer had contractually committed to provide indirect benefits (for example, guaranteeing payment of projected new tax revenue), or to provide something that would result in the City s realization of indirect benefits (for example, promising to build the retail space), the value of such indirect benefits could have been taken into account for purposes of determining whether the agreement violated the second prong of the Gift Clause test. Discussion The Gift Clause provides that: Neither the State, nor any county, city, town, municipality or other subdivision of the State shall ever give or loan its credit in the aid of, or make any donation or grant, by subsidy or otherwise, to any individual, association, or corporation, or become a subscriber to, or a shareholder in, any company or corporation, or become a joint owner with any person, company or corporation, except as to such ownerships as may accrue to the State by operation or provision of law or as authorized by law solely for investment of the monies in the various funds of the state. Arizona Constitution, Art. 9 7 (emphasis added). The Gift Clause challenge in Turken was based on a development agreement between the City of Phoenix and the developer of a large mixed-use project (CityNorth) wherein the City has agreed to pay the developer up to $97.4 million on account of: (a) the developer's grant to the City, for a 45-year period, of a non-exclusive public use right to 2980 parking spaces and the exclusive public use of 200 "park and ride" spaces in a parking structure to be constructed by the developer; (b) anticipated tax and economic development benefits from CityNorth based on a fiscal and economic impact analysis prepared by a third-party consultant; and (c) as required by state statute, independently verified findings that tax revenue generated by CityNorth will exceed the payment to the developer and that, without the payment, the developer would not have located CityNorth in the City in the same time, place or manner. The City's obligation to make the payment is expressly conditioned upon the developer's construction of certain minimum retail improvements within a specified period of time and the payment is capped at 50% of the applicable tax revenues generated from the project during a specified period of time (11 years and 3 months). Consequently, there is no possibility that the public payment will be made unless the additional retail space is provided or that the amount of the payment can exceed the amount of new revenue reserved to the City. The superior court granted summary judgment to the defendants on the Gift Clause challenge, relying on the Wistuber test but counting the anticipated increase in tax revenues as part of the relevant consideration, as well as the plaintiffs allegation that the agreement violated the Equal Privileges and Immunities Clause, Ariz. Const. art. 2, 13, and the Special Laws Clause, Ariz. Const. art. 4, pt. 2, 19. The court of appeals reversed, interpreting prior decisions to graft a third requirement onto the Wistuber test: under the realities of the transaction, a challenged governmental expenditure must not unduly promot[e] private interests. Turken, 220 Ariz. at 467, 207 P.3d at 720. The court of appeals identified six questions as pertinent to that inquiry and

3 concluded that the agreement violated the Gift Clause. The City and private developer petitioned the Arizona Supreme Court which granted review. In its decision, the Court affirmed and purported to clarify the parameters of the so-called Wistuber test, which holds that a governmental payment to a private party does not violate the Gift Clause if it (1) has a public purpose, and (2) is not "grossly disproportionate" to what is received in return. Wistuber v. Paradise Valley Unified School District, 141 Ariz. 346, 687 P.2d 354 (1984). Addressing the first prong of the test, the Court stated [i]n taking a broad view of permissible public purposes, we have repeatedly emphasized that the primary determination of whether a specific purpose constitutes a public purpose is assigned to the political branches of government, which are directly accountable to the public and that [w]e find a public purpose absent only those rare cases in which the governmental body's discretion has been 'unquestionably abused'". [ 27-28] Considering the facts presented by Turken, the Court determined that, as there is no question that the City could have erected a parking structure of its own without violating the Gift Clause, [i]t follows that the City may instead pay for spaces for public use. [ 23] The Court also affirmed that the public purpose prong of the Gift Clause test can be met by indirect public purposes such as those cited by the City (providing the financial support necessary for the developer to complete the planned retail development so as to realized the expected increase in the City s tax base, denser development, decreased pollution and increased employment opportunities). Under this rationale, the Court found that the Turken agreement thus satisfies this prong of the Wistuber test. [ 29] Addressing the second prong of the test, the Court affirmed that the proper inquiry is whether a government payment is grossly disproportionate to what is received in return from the private party. The Court also clarified that, in order for the private party's performance to be counted as consideration for this purpose, it must be "bargained for as part of the contracting party's promised performance" and only "the objective fair market value of what the private party has promised to provide in return for the public entity's payment" can be taken into account. [ 33] The Court also suggested that, where a public payment is made without competitive proposals, there may be heightened scrutiny of the value of the consideration. [ 32] Notably, the Court rejected the argument that indirect benefits can automatically be counted as consideration, distinguishing Turken from prior decisions where intangible or indirect benefits were provided in return for a public payment on the basis that, in those cases, the intangible or indirect benefit was bargained for and promised in return for the public payment, e.g., Wistuber (consideration for a public payment was certain duties performed by a teachers union representative in lieu of teaching); and Kromko v. Arizona Board of Regents, 149 Ariz. 319, 718 P. 2d 478 (1986) (consideration for the conveyance of a public hospital to a nonprofit corporation was the perpetuation of an educational relationship). We note that this requirement narrows the scope of permissible consideration more than was necessary under these facts in that, having agreed that the indirect benefits constituted a valid public purpose, the Court could have determined that, since the public payment was structured so that no monies would be paid to the developer unless and until the City received the benefit of its bargain, the proportionality requirement was met. The Court did not address this point in the decision nor was it briefed so it is not known whether this interpretation was considered by the Court. Rather, since the developer in Turken did not contractually commit to provide anything other than the parking spaces, the Court s new consideration test meant that only the value of the parking space use rights could be counted for purposes of determining whether the City payment is "grossly disproportionate" to what it got in return.

4 In that context, the Court also said it was difficult to believe that the value of the parking space use rights was anywhere near the payment potentially required under the Agreement and concluded that the Agreement therefore quite likely violates the Gift Clause. [ 43] This is curious since the amount of the City payment will not be established until a future date; at this point, it could be zero, if the developer fails to timely construct the retail space, and otherwise any amount up to $97.4 million depending on the developer s success in generating activity that will lead to the City s receipt of the desired tax revenue. The Court did not provide explicit guidance on this point including whether it intended to say that, for this purpose, the highest possible public payment must be assumed. Instead of remanding the matter to the superior court to determine the value of the parking space use rights and apply the new consideration test, the Court limited its clarification of the consideration test to transactions occurring after the date of this opinion, stating that the consideration prong of the Wistuber test has been widely misunderstood and that our cases have never squarely addressed that issue. [ 45, 49] Consistent with this reasoning, the Court vacated the Court of Appeals opinion and affirmed the superior court s dismissal of Turken s Gift Clause claim. The Court also remanded the case to the Court of Appeals for consideration of the plaintiffs other claims, that the agreement violates the Equal Privileges and Immunities Clause, Ariz. Const. art. 2, 13, and the Special Laws Clause, Ariz. Const. art. 4, pt. 2, 19. This GT Alert was prepared by Rebecca Lynne Burnham, Rob Mandel and John Overdorff. Questions about this information can be directed to: Rebecca Lynne Burnham (burnhamr@gtlaw.com) Rob Mandel (mandelr@gtlaw.com) John Overdorff (overdorffj@gtlaw.com) Or your Greenberg Traurig attorney

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