Supreme Court Resolves Key Issue in CityNorth Controversy

April 14, 2010 Stephen Aron Benson Real Estate Law

Indirect benefits do not constitute consideration for purposes of the Gift Clause, Arizona high court rules

Many in the real estate community have been awaiting the final decision regarding the CityNorth project. On January 25, 2010, the Arizona Supreme Court issued its decision, a thorough analysis of which is a necessity for any developer or municipality that intends to utilize development agreements in the future. See Turken et al. v. Phil Gordon et al., 223 Ariz. 342, 224 P.3d 158 (2010).

CityNorth is a large mixed-use development in the Desert Ridge master-planned community that, when completed, will consist of retail, residential and commercial uses. To entice CityNorth to develop its project in Phoenix, the City of Phoenix entered into a Parking Space Development and Use Agreement with CityNorth. The Development Agreement consisted of the dedication by CityNorth of 3,180 public parking spaces, including at least 200 park-and-ride spaces, that would be free to the public for 45 years. In return, the City would pay CityNorth for the use of such parking spaces in an annual amount equal to 50% of the annual sales tax collected by the City from the retail portion of the project for a period not to exceed 11 years 3 months, or until the City had paid $97.4 million. The payments were intended to approximate the market rates for the 45 years of use of public parking.

A collection of taxpayers and businesses filed suit against the City of Phoenix, and CityNorth intervened. The plaintiffs argued that the Development Agreement violated the Equal Privileges and Immunities, Special Laws, and Gift Clauses of the Arizona Constitution. The trial court granted summary judgment in favor of CityNorth and the City, finding in part that the Gift Clause was not violated since there was adequate consideration and various public purposes were being served.

On appeal, the Arizona Court of Appeals found, among other things, that the Development Agreement violated the Gift Clause to the extent that the City made payments for non-park-and-ride spaces (the Court of Appeals declined to consider the other possible violations of the Arizona Constitution). In its ruling, the Court of Appeals adopted a three-factor standard for determining whether there is a Gift Clause violation: whether a public purpose is being served; whether the consideration is adequate; and whether any private or personal interest is being served. The Court of Appeals found that the 200 parking spaces set aside for park-and-ride purposes satisfied these tests, but that the remaining almost 3,000 parking spaces did not, since they would be used by the public only in the context of being private customers of CityNorth. Thus, the Court of Appeals reversed the trial court.

The Arizona Supreme Court reversed the appellate court’s decision and affirmed the trial court’s dismissal of the Gift Clause claim. The Court found that the appellate court had misread the precedent, as the test for a Gift Clause was only a two-prong test, consisting of whether (i) the expenditure served a public purpose and (ii) whether the payment to the private party was “grossly disproportionate” to the consideration received by the public. The Court found that the public purpose requirement was satisfied in this case, due to the direct and indirect public benefits involved. Also, courts will generally defer to the government’s determination of whether there is a public purpose unless it has “unquestionably abused” its discretion.

However, the Supreme Court held that indirect benefits (such as sales tax revenues to the City or increased jobs) could not be considered for purposes of determining the adequacy of consideration. Only benefits that are bargained for by the parties, and that the private party promises to provide, constitute consideration. The Court found that the only consideration under the Agreement was the right to use the parking spaces once they were built. CityNorth and the City had argued that the construction of improvements also constituted consideration, but the Court dismissed this argument, since, under the Development Agreement, CityNorth had not promised to build anything. Only if CityNorth built the improvements, including the parking garage, did the reimbursement arrangement between the parties arise. The Court stated that it doubted the objective fair market value of these parking spaces – particularly since the use of 2,980 spaces was non-exclusive – would equal the maximum amount of $97.4 million promised by the City, although that would be a determination for the trial court.

In spite of these findings, the Court held that this application of the law (i.e., that indirect benefits could not be considered in measuring adequacy of consideration) could only be applied prospectively since the law had been previously unclear. Thus, the Supreme Court reversed the opinion of the appellate court, affirmed the dismissal of the Gift Clause claim, and remanded the case to the appellate court to consider the other two Constitutional claims alleged.

The Arizona Supreme Court’s decision apparently will not apply to development agreements already in existence, rather, only those entered into after January 25, 2010. While the facts of this case are rather unusual, in terms of how the Development Agreement was structured, some practice points can be derived from the decision.

Specifically, development agreements need to clearly express the benefits that the municipality or public entity will receive under the agreement. In addition, the obligations of the developer need to be promised, not open-ended or discretionary. Obviously, this raises some concerns given the respective timing of when a development agreement is entered into versus when financing is obtained. However, this goal could possibly be achieved by promising to commence construction subject to satisfaction of certain conditions precedent; of course, this approach is not addressed by the Court and thus is not “guaranteed” to comply with its decision.