On December 23, 2008, the Arizona Court of Appeals, Division I, largely invalidated a March 2007 economic incentive agreement between the City of Phoenix and NPP CityNorth, L.L.C. that authorized the sharing of 50% of the sales tax proceeds generated by the CityNorth development. The court concluded that almost all of the $97.4 million incentive offered to CityNorth violates the Arizona Constitution’s “Gift Clause” prohibition against donations or subsidies of public funds to private persons. Only the value of 200 parking spaces exclusively set aside for Park & Ride users for which the City agreed to a 2007 market rate value satisfied the Gift Clause analysis. Pending appeal to the Arizona Supreme Court, this decision undermines the use of economic incentive agreements that offer tax reimbursements for the value of anything other than public infrastructure or uses.
The court adopted a three-part test to evaluate the alleged Gift Clause violation, combining analyses from two previous Arizona supreme court decisions: Wistuber v. Paradise Valley Unified Sch. Dist. in 1984 and Kromko v. Ariz. Bd. Of Regents in 1986. The test requires the City’s tax sharing agreement to: (1) satisfy a public purpose; (2) provide adequate return or consideration to the public; and (3) not unduly promote private or personal interests.
The court analyzed the five public purposes offered by the City and CityNorth for the tax sharing agreement: financing a parking garage that offered free public parking, including 200 Park & Ride spaces; stimulating economic development; creating new retail uses and employment; developing an urban core; and generating increased tax revenues. The court held that only the 200 Park & Ride spaces had a direct public purpose, provided adequate consideration, and did not unduly promote private interests. In contrast, the court found that the non-exclusive public use of the remaining 2,980 parking spaces did not serve a direct public purpose because the “public” using the garage would be the private customers of CityNorth, parking to do their private business with CityNorth’s retail tenants, with no other direct public benefit.
The court also rejected the four other public purposes (creating economic development, new retail uses and employment, urban core, increased taxes) as “laudable goals” but which fail the private interest prong of the Gift Clause analysis. The court observed that because the City will not own the shopping center or use it to provide City services, the City tax sharing would offer only indirect public benefit. More important, the court determined that City tax revenues that go directly to CityNorth to fund its construction of the shopping center unduly promote CityNorth’s purely private interests.
The court’s invalidation of City funding for all CityNorth development activities except the 200 Park & Ride spaces as unduly promoting CityNorth’s private interests in violation of the Gift Clause will effect both existing and future economic incentive agreements. Such agreements will risk legal challenge unless they limit sales tax sharing to reimbursements for public infrastructure such as Park & Ride facilities, roadways, parks, utilities and other public uses that serve more than the development for which the infrastructure is intended. Public funding justifications that rely on indirect benefits alone—such as economic development, new jobs, or increased tax revenues—may be vulnerable to attack without direct measurable public benefit and minimal private gain.
Lewis and Roca’s land use lawyers regularly draft and negotiate economic incentive agreements, pre-annexation development agreements and other types of land use and development agreements between our clients and local governments.
This Client Alert has been prepared by Lewis and Roca LLP for informational purposes only and is not legal advice. Readers should seek professional legal advice on matters involving these issues.
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