In a fairly important decision affecting commercial real estate developers in Arizona, Turken v. Gordon(pdf), the Arizona Court of Appeals today overturned the prior Arizona Superior Court decision, saying that the City of Phoenix did in fact violate the "gift clause" of the Arizona Constitution (Art. 9, Sec. 7) in granting certain payments to the developers of CityNorth - a partially-built 144 acre mixed-use development in north Phoenix. Plaintiffs/Appellants in the case were led by the Goldwater Institute.
In this case, the City of Phoenix agreed to make payments of up to $97.4 million over an 11 year period to the developers of CityNorth - Thomas J. Klutznick & Co. and its joint venture partner The Related Companies - for a parking facility that the developers were to build on the CityNorth site. The parking structure would provide free public parking - not restricted to use by CityNorth customers, but for all practical purposes for the customers of CityNorth. The payments would be made out of sales taxes collected by the city from retailers, restaurants and other groups associated with the CityNorth development - limited to 50% of the taxes collected annually. Without the $97+ million of assistance, the developers had indicated the project would not be viable. Phoenix felt it was necessary to step up to the plate to provide the payments in order to keep the sales tax revenues from slipping away to Scottsdale (the city estimates it will receive up to $1 billion in sales tax revenue over a 99 year period). So as E.J. Montini pointed out tonight, essentially the developers played the city v. city game and Phoenix ponied up the tax incentive money to attract the developer (a pretty standard thing these days).
The gift clause of the Arizona Constitution states:
Section 7. 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 courts have ruled over the years that in order for the government benefit to be constitutional under the gift clause, it generally must be for a public purpose (not primarily benefiting a private enterprise) and adequate consideration must be received by the government. The courts disagreed in this case, with the Superior Court applying solely the foregoing two prong test, and the Appeals Court clarifying that it would priimarily look at whether public funds are used to foster purely private or personal interests.
The Superior Court ruled that the agreement between Phoenix and CityNorth did not violate the gift clause because it met the public purpose requirement by providing sales tax revenues, employment, free public parking, development of an urban core, etc. Furthermore, because the city was only required to pay 50% of every dollar of tax revenue collected to the developers up to the $97.4 million and the city was going to collect millions in additional tax revenues, adequate consideration was being received.
The Appeals Court disagreed and looked primarily to whether the payments benefitted purely private or personal interests. In their decision, they ruled that 200 spaces that had been set aside for park and ride for public transportion were indeed for a public purpose and were constitutional, but that the additional 2,900+ parking spaces in the parking garage - even though designated as open and free parking for the public - were in fact solely to benefit the private interests of the developer and to service CityNorth. Furthermore, the other public purposes that the city argued it was gaining (economic development, employment, urban core, etc.) were simply indirect benefits as a result of private development and did not rise to the level of directly benefitting the public. The court found that while the deal was structured so as to avoid the possibility of the city losing money (payments were made only out of CityNorth sales taxes), the payments were still using public funds to foster or promote the purely private or personal interest of an individual (in this case the developer) and were therefore unconstitutional.
Following this decision, the City of Phoenix needs to decide whether to appeal to the Arizona Supreme Court or to go back to the drawing board with the agreement to try to make it constitutional (perhaps through tax breaks instead of payments). And Klutznick & Co. needs to determine how to move forward with development under the assumption that the $97.4 million incentive may be lost.
But, beyond the immediate ramifications to CityNorth, if the case stands on further appeal, more questions now remain about how far a city in Arizona can go in giving financial benefits, tax incentives, etc. to private developers to encourage development. And it potentially calls into question other deals in Arizona where cities have agreed to pay a portion of new sales tax revenue streams from a specific development to the developer - the Prasada project in Surprise comes to mind. Developers should keep a close eye on the next steps in this case.
I can't say that this decision particularly surprises me, given Arizona's renegade status in being the only state in the U.S. without TIF financing. The CityNorth deal acted sort of like a TIF deal by paying a portion of a new tax stream to a developer - presumably allowing Klutznick & Co. to secure construction financing backed by the payment stream (in place of what would otherwise be municipal bonds in a typical TIF deal). And I have been to the newly constructed parking garage in questions - and, frankly, there is no doubt that it is situated in a location that seems to benefit only CityNorth visitors and tenants. So it seems like a case of Phoenix getting creative to try to get around our lack of TIF financing.
It will be interesting to see the next steps/fallout from this decision and I will try to keep readers updated on this blog.
Stories from the Arizona Republic and Phoenix Business Journal on the decision can be read here and here. Full text of the decision can be read here (pdf).
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