State Court Docket Watch: Schires v. Carlat

Note from the Editor: Mr. Avelar served on an outside moot panel for the taxpayers’ attorneys (the Goldwater Institute) in advance of this case's argument to the Arizona Supreme Court. The Federalist Society takes no positions on particular legal and public policy matters. Any expressions of opinion are those of the authors. We do invite responses from our readers. To join the debate, please email us at [email protected].

 

Like many other western states, Arizona’s years as a territory were marked by economic interests—especially eastern-owned railroads, banks, and mines—controlling government for their own benefits. Due both to federal policy and outright corruption, the territorial government funded private enterprises, granted private monopolies, gave away public resources, and regulated for private benefit, not public purpose. When Arizona finally became a state in 1912, several provisions of its constitution sought to prevent such government favoritism of private interests at the expense of the public.[1]

Among these anti-favoritism clauses is the Gift Clause. It provides that “[n]either 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.”[2] The purpose of the clause is “to prevent governmental bodies from depleting the public treasury by giving advantages to special interests or by engaging in non-public enterprises.”[3]

A decade ago, in Turken v. Gordon, the Arizona Supreme Court admitted that its jurisprudence under the Gift Clause had been inconsistent and therefore set out to clarify it. First, it reaffirmed a two-prong test: An “expenditure does not violate the Gift Clause if (1) it has a public purpose, and (2) in return for its expenditure, the governmental entity receives consideration that ‘is not so inequitable and unreasonable that it amounts to an abuse of discretion, thus providing a subsidy to the private entity.’”[4] Second, it clarified the adequacy of the consideration is determined only by the objective fair market value of that which is bargained for as performance, and does not include anticipated indirect benefits when not bargained for as part of the agreement.[5]

Under this test, the Turken court determined the challenged expenditure likely violated the Gift Clause. In that case, a commercial property developer told the City of Phoenix that it needed financial assistance to complete one it its developments. In the name of economic development, the city agreed to pay the developer more than $97 million. In exchange, the developer gave the city, for a period of 45 years, 200 spaces in a parking garage for the exclusive use of commuters and 2,980 spaces for the non-exclusive use of the general public. The city also anticipated increased tax revenue would come from the completed development. But the court held that the anticipated increased tax revenue did not count as part of the bargained-for exchange, only the parking rights did. The court recognized those rights were almost certainly not worth the $97 million paid, but it refused to invalidate the contract and declared its ruling to be “prospective only” because of the confusion in the case law.

Six years later, in Cheatham v. DiCiccio,[6] the court added a gloss on Turken’s consideration prong. The court said it would defer to the decisions of elected officials in Gift Clause cases, both with regard to public purpose and in determining whether consideration received was equitable and reasonable. Cheatham was a challenge to release-time provisions in a police union contract. In a 3-2 decision, the court upheld the release-time provisions because they were part of a bargained-for labor contract to provide a public service, and the challengers had not proven gross disproportionality of consideration of the release-time provisions.

The tension between Turken’s focus on the objective fair market value of bargained-for consideration and Cheatham’s deference to the government on that issue set up the court’s recent decision in Schires v. Carlat.[7]

In 2010, the City of Peoria launched an economic development program. It would pay money to businesses in desirable fields, including higher education and technology, to get them to expand in or relocate to the city. It would also reimburse property owners for making tenant improvements to vacant commercial buildings in the “P83 District.”

As part of this program, in 2015, the city contracted with Huntington University, a private school, to open a branch in the P83 District. HU would lease space in the P83 District for a campus to offer undergraduate degrees in digital media, refrain from offering similar programs in other Arizona cities for seven years, and participate in “economic development activities” with the city to attract other targeted industries. In return, the city would pay HU up to $1,875,000 over a three-year period if HU met specified “performance thresholds” that tracked HU’s progress in opening and operating its campus. In turn, HU leased a building in the P83 District from Arrowhead Equities. The city agreed to reimburse Arrowhead up to $737,596 for renovating its building to suit HU’s needs, contingent on Arrowhead meeting certain “performance criteria” tied to Arrowhead’s performance of its lease obligations.

Both parts of this transaction—city payments to HU and to Arrowhead—were challenged by taxpayers in Schires.

In a unanimous opinion, the court again took steps to clarify its two-prong Gift Clause test. First, it clarified that the party asserting a Gift Clause violation bears the burden of proving it.[8] Second, with regard to the public benefit prong, it directed courts to consider both direct and indirect benefits of an expenditure.[9] Third, it said courts should also defer to the government under the public benefit prong.[10] But, fourth, it maintained that indirect (not bargained-for) benefits are not part of the consideration prong.[11] And fifth, the court clarified that judicial deference to the government’s assessment of value is not appropriate under the consideration prong because that prong is an objective inquiry, and previous statements to the contrary are now “disapprove[d].”[12]

The court held that both parts of the transaction challenged in Schires violated the Gift Clause The expenditures had a public purpose: economic development.[13] But the expenditures failed the “primary check on government expenditures for Gift Clause purposes,” the consideration prong.[14] The amount paid by the city far exceeded the bargained-for return. The city claimed that its expenditures would result in several million dollars’ worth of economic development. But this amount consisted almost entirely of anticipated indirect benefits—the economic development that would come from having HU in P83. These anticipated effects were not bargained-for consideration. Anticipated tax revenue was also not bargained-for consideration because it would separately arise as an obligation under law and was not a part of the contract.[15] In the end, the court found, these agreements were

no different than a hamburger chain promising to operate in Peoria in exchange for monetary incentives paid by the City in hope of stimulating the local economy. A private business will usually, if not always, generate some economic impact and, consequently, permitting such impacts to justify public funding of private ventures would eviscerate the Gift Clause.[16]

Following Schires, therefore, Arizona government entities will still be able to engage in economic development. But they will need to do so without using the outright giveaways to private entities that both Turken and Schires invalidated.