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Partners of Necessity: P3s in the Post-Recession World

February 11, 2015

By: Bill Brian

Post-recession economic realities are forcing developers and local governments to collaborate on financing the infrastructure needed to support private real estate projects. Although some states, such as North Carolina, may present a treacherous legal landscape for such collaboration, that landscape can be traversed with courage, patience and good lawyering.

A number of elements have come together in the wake of the Great Recession to force local governments and real estate developers to work closely as partners in order to build projects that yield profits to both the public and the private sectors. Banks are no longer willing or able to lend money freely. Therefore, capital for development is coming from private sources. Unless an asset is guaranteed to yield substantial returns, private investors are not interested. Moreover, infrastructure, such as parking garages, rarely produces the necessary rates of return.

At the same time, development patterns have shifted from relatively inexpensive (but sprawling) low-density greenfield projects to high-density mixed-use projects that tend to have more expensive public infrastructure requirements for parking, public transit and roads.

Also, decades of political resistance to raising taxes have resulted in deferred maintenance on existing public infrastructure. Plus, there is considerable political and market pressure to locate new mixed-use projects in redevelopment areas where the existing infrastructure is inadequate or in need of repair and must be replaced or upgraded at costs that are greater than what they would be on greenfield sites.

However, the public sector’s desire for economic development, the desire of private developers for profitable real estate investments, and the demands of the market for new housing, shopping and employment opportunities remain unabated. Given the relative scarcity of available financing, new approaches must be found and new alliances between the public and private sectors must be forged.

Available financing techniques are varied and some have been used for years. Most approaches raise money for public infrastructure supporting private development through bond sales or loans secured by the pledge of future tax revenues anticipated to be raised from the new project. However, Tax Increment Financing (TIF) bonds, Special Assessment District (SAD) bonds, synthetic TIFs and other similar tools have been viewed with caution in some fiscally conservative states.

For example, North Carolina traditionally has been wary of these techniques. This conservatism is born of depression era defaults by local governments on public bonds, which led to the establishment of the existing system in which local government finances are carefully monitored by the state Local Government Commission. Contributing to this conservative environment are the state constitution, which prohibits the use of public money for private purposes, as well as court decisions, which strictly construe the power granted to local governments by the state legislature. Local governments are mere creatures of the state legislature that only have the powers specifically granted to them by statute. The courts have strictly construed those enabling statutes to limit local authority in a series of cases stretching back to the 1920s that spectacularly invalidated local government actions (and the private contracts based upon them) that were deemed to have exceeded that authority. This conservatism has been good for North Carolina, where the state and many local governments have AAA bond ratings as a result. However, the traditional approach is problematic now when maximum flexibility is needed.

The North Carolina legislature recently enacted laws permitting public-private collaborations to finance infrastructure. The state constitution was amended to permit TIFs and then the necessary enabling legislation was passed to permit local governments to enter into long-term agreements with private developers, to issue SAD bonds, and to participate in synthetic TIFs and other activities supporting economic development. Yet, the conservative legal tradition continues to cast doubt on the validity of these schemes because the unique circumstances of each project make cookie-cutter approaches difficult. Therefore, to an extent, the wheel must be reinvented for every project.

Local governments and private developers need the guidance of creative lawyers with expertise in state-specific local government law to help them do what is necessary to finance their projects. They must have courage to dive deep into largely untested legal waters. They also need faith that the courts will not act eccentrically to invalidate transactions that are so necessary to creating the level of prosperity and progress to which the state aspires. With that guidance, courage and faith, such projects can be and have been completed successfully.

Contractors and other third-party consultants that are interested in working on projects being financed through public-private partnerships must be aware of a number of potential legal issues. For example, projects of this type often are subject to the competitive bidding statutes that govern public construction contracts because they involve public money. Likewise, it may be necessary for a contractor to post a performance bond or other security insuring that the work it commences will be completed. There may be public oversight of the process for making contract payments, which can complicate and slow down payment.

Although some states have created exceptions to the usual public contracting process for public-private projects, those exceptions often are a compromise or a reduction of the usual public contracting standards, rather than a full waiver of those rules. Therefore, a careful analysis of the applicable law should be undertaken before any contractor bids on a project of this type. An ounce of legal prevention generally is worth a pound of cure later on.