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COVER STORY, JUNE 2007
PUBLIC-PRIVATE PARTNERSHIPS
Know the risks and benefits of development agreements.
Timothy J. Tryniecki
In the current era of real estate development, municipalities act more as business counterparts to developers than traditional top-down authorities. Local officials no longer simply react to requests with thumbs up or down. The term “public-private partnership” is now a cliché, and virtually every significant project is the result of active negotiation of incentives and approvals by the government. In exchange, the developer may promise to finance and build a specific project, accept phasing deadlines and use restrictions, pay impact fees, convey real estate for public use or all of the above. The accepted vehicle for these and other negotiable considerations is the development agreement.
The development agreement is in fact a legally enforceable agreement. It is, however, a contract with the government, which also makes law (ordinances). Ordinances may be amended, of course, and the question arises whether the government can legislate its way out of a contract. There is no bright line between the proper subject of ordinances and many of the provisions of the average development agreement. For the developer, operating under and relying on a development agreement is therefore often like playing a football game in which the opposing team is also the referee, and even the rules committee. As such, the development agreement carries significant legal risk — certainly a very different kind of risk than the private contract.
Risks
Does the Municipality Have the Authority to Make These Promises?
The most basic and significant risk is that the agreement is unenforceable and therefore subject to nullification or, more likely, incremental renegotiation. Municipalities exist only as creatures of state statute, and may only enter into agreements that are authorized by statute or state constitution. The law holds that a party entering into an agreement with a municipality is assumed to have knowledge of the limitations on the power of the municipality to enter into contracts. The developer striking a deal with the government must be sure that the transaction, and every aspect of it, is one that the city may properly enter into.
Generally, the municipality or county may not bargain away, for any price, its discretion to make public policy as a mini-legislature. A contractual promise by a governmental authority to approve a rezoning, for example, is generally not enforceable. In the vernacular, the government may not sell its zoning or other discretionary, “police power” approvals, no matter how high the bidding. Nor may the municipality waive prescribed hearings, notice periods and other processes, which are designed by statute to insure opportunity for democratic input.
Even experienced attorneys may not be certain about the legal line between authorized government promises and unauthorized, unenforceable ones. The staffs of many cities and their attorneys have an expansive, enthusiastic view of their legal authority, but do not bare the investment risks which the developer bares.
While the U.S. Supreme Court has held that an ordinance enacted contrary to a contract it has entered into is subject to “strict scrutiny” as to the “reasonableness and necessity” of the ordinance, the developer and its lender may not be willing to tolerate the risk of a court’s definition of “reasonableness and necessity.” Municipalities are also subject to limitations on the power to tax and levy fees, and may not achieve revenue-raising results by development agreements that would otherwise be barred by limitations on the taxing power.
Does the Municipality Have a Political or Business Incentive to Change its Mind? Are There Pending Elections That May Change the Political Bases of Support?
Second, even if every promise in the development agreement is authorized by statute, the government may change its mind. There are a number of judicial decisions that approve such changes, even in the face of expenditure by the developer of hundreds of thousands or millions of dollars in reliance upon an approval. Political attitudes and elected officials change, and the longer the project schedule, the greater the risk of public remorse. With numerous constituents and increased public scrutiny — especially in infill, condemnation or other high-exposure projects — this risk can become exponential. Some attorneys will negotiate recitals and covenants in a development agreement that reduce or manage the risk of changes in position or adverse litigation after commencement of development.
A related legal concept is the notion of “vested rights.” When, if ever, does an owner have a vested right in an approval, in the sense that it may not be taken back by the government? The 50 states vary on when a vested right has been established. Some states require actual use of the property in accordance with the approvals. Other states, at the other end of the spectrum, hold that development rights are vested immediately upon receipt of a building permit. As a middle ground, some states require expenditure of significant sums of money in reliance upon the permit. For example, Illinois applies a relatively subjective “balancing test,” weighing the public good against harm to the developer. In any event, the development agreement may be used to create or at least enhance vested rights at an earlier stage than would apply with no agreement.
Statutory Schemes Dealing with Development Agreements
A number of state legislatures have enacted statutory specific procedures and authorizations for development agreements in certain contexts.
Who Has Legal Standing to Enforce the Development Agreement?
The problem of enforceability of development agreements is exacerbated by broad rules of legal standing that permit parties with remote connection to the project, including in some cases the mere fact of being a taxpayer, to sue to invalidate such agreements. To make matters still worse, the statutes of limitation and other notions of expiration of rights to invalidate such projects may be unclear legally or, in any event, run for many years after initial construction of the project. Title insurance companies, for their part, will not insure the validity of rights under a development agreement, but only real property rights. In any event, title insurance is a poor substitute for legal diligence and certainty. Financing also may be impaired by an improperly negotiated and drafted development agreement.
Benefits
The use of a development agreement carries great benefits for both parties, however. The agreements commit both parties politically to certain deal terms. As to legal risks, the agreement may be used to make clear and comprehensive statements of background fact — for example, finding that the development is good for property values — and to make legal conclusions by the city, which typically are at least relevant in subsequent proceedings. The agreement may allow for the termination by the developer in the event of third-party zoning, blighting or other litigation attacking a project or may provide for the sharing of costs in defending such litigation. Many developers have used the development agreement to attempt insulation from initiative and referendum, a growing phenomenon.
The city may use a development agreement to exact conditions, fees and other considerations from the developer that would have been unconstitutional if attempted outside the context of a legal contract. Many courts have held that a party who enters into a development agreement with a city may not subsequently challenge the requirements of the agreement as an unconstitutional “taking” without due process of law.
The city also may negotiate for indemnities from the developer against any liability to third parties for injuries or damages in connection with the project, providing it with much greater protection than would otherwise be available by default under the applicable common-law principles of negligence or intentional acts.
For the developer, one of many goals is to make its obligation to construct the overall project contingent upon subsequent approvals and absence of contesting litigation, thereby keeping the city completely in the game to defend the project. Some developers and their counsel, however, may reject such a strategy as sending the wrong message to the municipality that the deal is anything but firm.
The developer may also seek commitments by the city to provide utility connections or other infrastructure build-out with or without state or federal funding.
In summary, the development agreement is here to stay, and it serves many useful and legal enforceable functions. In recent years, however, the variety and scope of government promises has grown steadily and the legal envelope pushed aggressively. The risks of renegotiation, impairment and outright nullification of the deal are multiplied by the growth in third-party litigation, including even litigation funded by competing developers. The essential problem is that one of the parties is the government itself, which is subject both to political pressure and state laws that require adherence to unchangeable processes and exercise of discretion independent of any bargain struck with the developer.
Timothy J. Tryniecki is a partner and leader of the Real Estate Practice Group at Armstong Teasdale LLP in St. Louis.
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