This opinion represents the views of the Office of the State Comptroller at the time it was rendered. The opinion may no longer represent those views if, among other things, there have been subsequent court cases or statutory amendments that bear on the issues discussed in the opinion.
REAL PROPERTY -- Leases (as constituting indebtedness for purposes of the Constitution and Local Finance Law); (as distinguished from installment purchases); (authority of municipal corporation to enter into installment purchase contract)
BONDS AND NOTES -- Certificates of Participation (as constituting indebtedness for purposes of the Constitution and Local Finance Law)
PUBLIC CONTRACTS -- Contracts Requiring Bidding (lease of public facility for use by a municipal corporation in performance of its governmental functions from not-for-profit corporation) -- Installment Purchase (authority for real property acquisition)
INDUSTRIAL DEVELOPMENT AGENCIES -- Powers and Duties (construction of public facility for use by a municipal corporation in performance of its governmental functions)
COUNTY LAW, §215(3); TOWN LAW, §64(2); VILLAGE LAW, §1-102(1); GENERAL CITY LAW, §20(2); GENERAL MUNICIPAL LAW, §§101, 103, 109-b, 854; LOCAL FINANCE LAW, §20.00; NY CONST, ART VIII, §2: A transaction whereby a not-for-profit corporation, without competitive bidding, constructs a public facility for use by a municipal corporation in the performance of its governmental functions and the municipal corporation acquires use of the facility under a lease agreement and has an option to purchase: (a) does not constitute indebtedness for purposes of the State Constitution and Local Finance Law if the lease agreement has an executory clause making the municipal corporation's obligation contingent on annual appropriations, although it is doubtful that a clause providing that, if the municipal corporation fails to appropriate money for the lease payments, the municipal corporation agrees not to purchase, lease or rent property to perform the same functions as the facility, would be enforceable; (b) constitutes a prohibited installment purchase contract if the total character of the transaction is that of a purchase rather than a lease; and (c) violates the competitive bidding requirements of General Municipal Law, §§101 and 103 if the total character of the transaction constitutes a contract for public work of the municipal corporation.
You have requested our opinion with respect to a municipal corporation which has caused certificates of participation ("COPS") to be issued to finance the construction of a public facility for use by the municipal corporation in performance of its governmental functions ("facility"). The COPS evidence a proportionate interest in future lease payments to be made by the municipal corporation under the lease agreement described below.
The parties involved in this transaction are as follows: (1) the municipal corporation; (2) the municipal corporation's Industrial Development Agency (IDA); (3) a not-for-profit corporation created expressly for this transaction (NFP); (4) the trustee; and (5) the developer. The relationship among these parties is set forth in the following agreements entered into by the parties to effectuate the transaction:
(1) a ground lease between the IDA, as lessor, and the NFP, as lessee ("ground lease");
(2) a lease agreement between the NFP, as lessor, and the municipal corporation, as lessee ("lease");
(3) a purchase option agreement between the NFP and the municipal corporation ("purchase option agreement");
(4) an assignment from the NFP to the trustee ("assignment");
(5) a trust and disbursing agreement between the trustee and the NFP ("trust and disbursing agreement"); and
(6) a development agreement between the NFP and the developer ("Development Agreement").
As noted, the IDA, which owns the land upon which the facility is to be constructed, has entered into a ground lease with the NFP. Pursuant to the ground lease, the IDA appointed the NFP as its agent to acquire, construct and install the facility. The rental due from the NFP to the IDA under the ground lease is nominal. Title to the facility will vest in the IDA immediately upon its construction for no additional consideration. Under the lease, the IDA also grants the NFP an option, exercisable at any time, to purchase all of the IDA's title and interest in the leased premises for the purchase price of ten dollars and any other amounts due to the IDA under the ground lease.
Under the lease agreement between the NFP and the municipal corporation, the municipal corporation has agreed to lease the land from the NFP as is without the facility during the construction period and thereafter with the facility. The lease provides that the NFP is responsible for constructing the facility. During the term of this lease, legal title to the facility remains in the IDA and does not pass to the municipal corporation except as is provided in the option agreement between the NFP and the municipal corporation.
The lease between the municipal corporation and the NFP is for an initial fixed term. The lease further provides that it shall be automatically renewable for five successive terms unless the municipal corporation gives notice as provided in the lease agreement. The lease agreement also provides, however, that it may be terminated by the municipal corporation at the end of any fiscal year occurring during a term if the municipal corporation fails to appropriate moneys sufficient to pay the lease payments coming due during the next fiscal year. In the event of a termination by reason of non-appropriation, the municipal corporation agrees not to purchase, lease or rent property to perform the same functions as, or functions taking the place of, those performed by the facility, and agrees not to permit such functions to be performed by its own employees or by any agency or entity affiliated with or hired by the municipal corporation, for a period of ninety days. Finally, the lease agreement provides that, except for the municipal corporation's right to cease to make lease payments because of non-appropriation, the municipal corporation's obligation to make lease payments is absolute and unconditional in all events.
The schedule of lease payments to be made under the lease ascribes an interest and principal component to each lease payment due under the lease. Assuming that the municipal corporation does not decline to renew the lease on any of the five occasions and makes all the lease payments set forth in this schedule, the municipal corporation will have provided the trustee with sufficient principal payments to redeem all but a certain portion of the outstanding COPS. The principal balance still outstanding would equal the purchase price under the purchase option agreement.
Pursuant to the purchase option agreement between the NFP and the municipal corporation, the municipal corporation has the option to purchase the NFP's option to acquire the facility from the IDA. Under the terms of the purchase option agreement, the municipal corporation may only exercise the option upon its compliance with all the terms of the lease, including payment of all the rental payments due thereunder and the payment of the purchase price specified in the agreement.
Under the terms of the assignment between the NFP and the trustee, the NFP has assigned to the trustee all its right, title and interest in the facility, the lease agreement with the municipal corporation, the ground lease with the IDA, and the purchase option agreement between the NFP and the municipal corporation. This assignment agreement, however, specifically provides that all the obligations imposed upon the NFP under the lease agreement with respect to the design, acquisition, construction and installation of the facility may not be assigned to the trustee.
The NFP and the trustee have also entered into a trust and disbursing agreement. This agreement authorizes the trustee, at the request of the NFP, to issue COPS. These COPS evidence proportionate ownership interests in the lease payments to be paid by the municipal corporation under the lease agreement with the NFP. According to the agreement, the COPS proceeds received by the trustee are to be deposited as follows: (1) an amount equal to the purchase price under the purchase option agreement in a reserve account; (2) an amount sufficient to pay accrued and capitalized interest in a lease payment account; and (3) the balance of the proceeds in a construction account.
Pursuant to the trust and disbursing agreement, the reserve account may be used by the trustee only for the purpose of making lease payments on behalf of the municipal corporation to the extent that moneys in the lease payment account are insufficient to pay any principal and interest payments then due on the COPS or as a credit against the last remaining installments of lease payments. In this regard, the trust and disbursing agreement defines "lease payments" to mean lease payments due from the lessee under the lease agreement and payments from the lessee to the lessor under the option agreement. The trust agreement further provides that any moneys remaining in the trust fund established by the trust and disbursing agreement may only be paid to the municipal corporation upon the: (1) payment of all lease payments due from the municipal corporation and all amounts owed to trustee; and (2) the payment or redemption of all the COPS.
To provide for the construction of the facility, the NFP has entered into the development agreement with a contractor who has agreed to perform the NFP's obligations under the lease agreement relative to the facility's construction. It should be noted that the developer was hired without complying with the competitive bidding statutes that generally apply to public works projects undertaken by a municipal corporation.
The obvious purpose of the above transaction was to obtain moneys to finance the acquisition, construction and installation of a public facility for use by a municipal corporation in performance of its governmental functions. However, because the facility was financed and constructed in a manner which did not involve the issuance of bonds or notes and which did not comply with the competitive bidding statutes, several legal questions are presented. Specifically, the issues presented are whether the transaction violates any constitutional or statutory provisions relating to the issuance of indebtedness by a municipality; whether the lease of the facility under the above circumstances violates the provisions of General Municipal Law, §109-b which apply only to the acquisition of equipment, machinery and apparatus and which provide that a political subdivision shall have the power to enter into an installment purchase contract only as provided in that statute; and whether the construction of the facility under the above circumstances violates the competitive bidding statutes.
With respect to whether the transaction violates statutory or constitutional provisions relating to the issuance of debt, we note initially that Article VIII, Section 2 of the New York State Constitution provides that "no indebtedness shall be contracted by any county, city, town, village or school district, unless such county, city, town, village or school district shall have pledged its faith and credit for the payment of the principal thereof and the interest thereon." That constitutional provision also provides that every county, city, town, village and school district shall annually, by appropriation, provide for the payment of interest on all indebtedness and the amounts required for the amortization or redemption of term bonds, sinking fund bonds and serial bonds. In the event that the municipality fails to make such an appropriation, a sufficient sum must be set apart from the first revenues thereafter received by the municipality and applied to such purposes.
In addition, section 20.00 of the Local Finance Law provides that a municipality shall only be authorized to issue the types of indebtedness authorized by that statute; that is, serial bonds, sinking fund bonds, bond anticipation notes, tax anticipation notes, revenue anticipation notes, capital notes and budget notes (cf. Local Finance Law, §20.00[d] which expressly provides that nothing therein shall be construed to prevent a municipality from entering into installment purchase contracts pursuant to General Municipal Law, §109-b). The Local Finance Law also contains certain requirements for each type of indebtedness which is authorized to be issued.
As noted above, the municipal corporation's lease with the NFP expressly provides that the municipal corporation may terminate the lease at the end of any fiscal year if the municipal corporation fails to appropriate monies sufficient to pay the lease payments coming due during the next fiscal year. Obviously, such a provision does not comport with the full faith and credit requirement of the Constitution. The lease agreement also may not comply with various other requirements contained in the Constitution and the Local Finance Law.1 It now seems well settled, however, that a lease arrangement which ultimately enables a government to acquire property will not violate State Constitutional or statutory debt restrictions so long as the lease contains an executory clause; that is, a clause which limits the obligation of the municipality to pay periodic rent as it comes due and which provides that the municipality is under no obligation to appropriate monies for the payment of the lease payments in future fiscal years.
In Wein v City of New York, 36 NY2d 610, 370 NYS2d 550 (1975) (Wein v City), the Court of Appeals considered a statutory program, involving the Stabilization Reserve Corporation (SRC), which was intended to assist New York City during its fiscal crisis. Under the relevant statutes, the City would receive money raised by the SRC, a public benefit corporation, through the sale of bonds which were "the obligations solely of the SRC" but which would be repaid through monies to be paid to the SRC, subject to appropriation, by the City. The statutes further provided that the "notes, bonds or other obligations of the corporation shall not be a debt of either the state or the city", and that if the City failed to pay the SRC, the State Comptroller was authorized to pay to the SRC the first moneys available for the next succeeding payments from the Stock Transfer Tax Fund and, if there remained a shortage, to pay over any necessary portion of the City's share of State per capita aid (id., 36 NY2d at 614-615, 370 NYS2d at 552-553). The court found that no indebtedness in the constitutional sense was created because of "the statutory provision that in no way can the city become indebted." (id., 36 NY2d at 618, 370 NYS2d at 556).
Wein v City involved the provisions of Article VIII, which restrict indebtedness of local governments. Thereafter, in Wein v Levitt, 42 NY2d 300, 397 NYS2d 758 (1977) (Wein II), the court extended this reasoning to the provisions of Article VII, which deals with State indebtedness. Wein II involved statutory provisions providing for indemnification of State officers for losses incurred as a result of the investment of moneys of the State Insurance Fund. The court, in holding that such indemnity did not create unconstitutional debt, relied in part on the fact that the Legislature could revoke this indemnity at any time. The court also distinguished between two types of debt: (i) long term debt which is binding upon, and thus creates a burden upon, future generations; and (ii) another type of debt, such as salary under employment contracts and routine purchase orders payable from current appropriations, that does not create such a burden. The Wein II court concluded that only the first type of debt was subject to the constitutional restrictions imposed by section 11 of Article VII, including the referendum requirement (id., 42 NY2d at 304, 397 NYS2d at 761).
Following the decisions in the Wein cases, various courts of the State have rejected the argument that obligations contingent upon annual appropriations create unconstitutional debt. In N.Y.S. Coalition for Criminal Justice v Coughlin, 103 AD2d 40, 479 NYS2d 850, 854 (3d Dept., 1984), affd on other grds 64 NY2d 660, 485 NYS2d 247 (1984), the court considered the 1983 prison financing whereby the State was to acquire through a lease purchase arrangement prisons from the Urban Development Corporation (UDC), which was to issue bonds to finance the prison. Repayment of the UDC bonds was to come solely from lease payments for the prisons and title was to pass to the State for a nominal consideration when all the bonds were paid off. The court found that since debt service on the bonds was payable only through annual appropriations by the Legislature, no debt was incurred in the constitutional sense.
In a subsequent action challenging the UDC prison bonds, the Albany County Supreme Court held that the bondholders had no recourse against the State and that the State had no obligation to continue the payment stream to UDC. Therefore, the court held that the State had no obligation to UDC's bondholders (Burns v Egan, 129 Misc 2d 130, 135, 492 NYS2d 666, 670 [1985]. Although the Third Department affirmed this case on other grounds, it stated in dictum that were it to consider the merits it would reaffirm its holding in Coughlin, supra (Burns v Egan, 117 AD2d 38, 43, 501 NYS2d 742, 746; see also Congdon v Washington County, 130 AD2d 27, 518 NYS2d 224).
Given existing legal precedent and the executory clause contained in the lease agreement between the municipal corporation and the NFP, we cannot say that the lease between the municipal corporation and the NFP should be deemed to constitute indebtedness for purposes of the New York State Constitution or the Local Finance Law. Accordingly, we do not believe that the lease agreement, or the COPS evidencing a proportionate interest in the payments due thereunder, violates any of the provisions or restrictions contained in the Constitution or Local Finance Law relative to the issuance of indebtedness.
Although we do not believe that the lease agreement constitutes indebtedness for statutory or constitutional purposes, we are concerned by that provision in the lease which provides that, in the event the municipal corporation fails to appropriate moneys for the lease payments, the municipal corporation agrees not to purchase, lease or rent property to perform the same function served by the facility or to permit such function to be performed by its own employees or any agency or entity affiliated with or hired by the lessee for a period of ninety days. We doubt whether such a non-substitution clause would be enforceable if the function fulfilled by the facility is one which the municipal corporation is required by law to perform. If such a clause were deemed to be enforceable, however, the municipal corporation could be compelled to continue making lease payments throughout the lease term thereby casting doubt on the validity of the non-appropriation clause. In our opinion, such a non-substitution clause would be less troublesome if it expressly provided that nothing therein could be construed to prevent the municipal corporation from acquiring such facilities or services as may be necessary to perform any duties or functions imposed upon it by law.
Having concluded that neither the lease agreement nor the COPS violate constitutional or statutory provisions relative to the issuance of indebtedness, we now address whether the transaction constitutes an improper installment purchase contract. In this regard, we note that municipalities generally have the power to acquire real property by lease and by purchase, respectively (see, e.g., County Law, §215[3]; General City Law, §20[2]; Town Law, §64[2]; Village Law, §1-102[1]). On its face, then, the lease between the municipal corporation and the corporation would appear to be authorized as a lease of real property with the municipality having the right of renewal. Under this view of the transaction, the purchase option agreement, which is contained in a separate agreement, constitutes a separate exercise of the municipal corporation's authority to purchase real property. Pursuant to the option agreement, the municipal corporation may, or may not, choose to purchase the facility upon the expiration of the lease and all renewals thereof. The purchase option is believed to be non-compulsory because the municipal corporation may exercise the option only if: (1) it has not previously terminated the lease for non-appropriation or declined to renew the lease and (2) it has made all payments due under the lease.
On the other hand, as was noted above, General Municipal Law, §109-b, which authorizes a political subdivision to "enter into an installment contract to purchase equipment, machinery and apparatus", expressly provides that a "political subdivision shall not have the power to enter into an installment purchase contract except as authorized herein" (General Municipal Law, §109-b[2]). Furthermore, nothing in any other statute of which we are aware authorizes a municipal corporation to enter into an "installment purchase contract" to purchase realty (cf. Education Law, §1726 which authorizes a school district to acquire buildings for school purposes by lease-purchase**). Therefore, if the lease and purchase agreements between the municipal corporation and the NFP constitute an installment contract to purchase realty, it is our opinion that the municipal corporation is without authority to enter into such an agreement.2
The term "installment purchase contract" is not defined in General Municipal Law, §109-b. The sponsor's memorandum in support of this legislation, which was enacted by chapter 699 of the Laws of 1979, however, uses the terms "installment purchase" and "lease-purchase" interchangeably:
This bill will amend the General Municipal Law to provide authorization for political subdivisions . . . to enter into installment purchase contracts for data processing and office copying equipment. Furthermore, the bill will make statutory the existing prohibition upon lease purchase agreements which are not specifically authorized by law. (emphasis added)
Thus, it is our opinion that the provisions of General Municipal Law, §109-b are applicable to all "installment purchase contracts" without regard to whether they are denominated as a "lease-purchase" or an "installment purchase" (see 1980 Opns St Comp No. 80-187, p 49).
Although we are not aware of any judicial decisions which have construed the term "installment purchase contract" for purposes of General Municipal Law, §109-b, we note that the issue of what constitutes an installment purchase has been considered by the New York Courts in other contexts. In addition, the Internal Revenue Service (IRS) has distinguished between a true lease and a "conditional sale" because of the differing tax treatment of each.
As will be seen, any determination as to whether the lease and purchase transactions in question constitute two separate transactions or a single installment purchase contract depends, not only on the form of the transaction, but also on the intent of the parties at the time of entering into the transaction and whether the lessor retains sufficient elements of ownership with economic substance to be considered the owner of the facility. Thus, if the intent of the parties was for the lessee to acquire ownership of the property and the lessor has retained few incidents of ownership, we believe that the lease is more properly categorized as an installment purchase of realty that is prohibited under General Municipal Law, §109-b. On the other hand, if the parties, at the time of entering into the transaction, did not necessarily intend for the lessee to eventually acquire ownership of the property and the lessor retains meaningful economic incidents of ownership, there would be no impediment under State law.
In Marine Midland Trust Co. v Village of Waverly, 42 Misc 2d 704, 248 NYS2d 729 (Sup Ct, Broome Co., 1963), affd 21 AD2d 753, 251 NYS2d 937 (3d Dept., 1964), the court considered whether a transaction which had been characterized by the parties as a lease was actually a purchase. Unlike most New York cases, the court did not consider whether the competitive bidding statutes had been evaded but rather, whether the lease constituted an improper method of financing the acquisition of a parking lot.3
In Marine, supra, the parties had entered into an agreement whereby a parking lot was to be leased to a municipality for 20 years, after which the lessee had an option to purchase the parking lot for one dollar. The court in Marine stated:
Although the parties labeled this agreement a lease, this alone does not establish the existence of one. As the Supreme Court of the United States has written: "What then is the true construction of the contract? The answer to this question is not to be found in the name which the parties may have given the instrument, not alone in any particular provisions it contains disconnected from all others, but in the ruling intention of the parties gathered from all of the language they have used. It is the legal effect of the whole which is to be sought for. The form of the instrument is of little account." (Heryford v Davis, 102 U.S. 235, 243-244, 26 L.Ed. 160). (42 Misc 2d 704, 705, 248 NYS2d 729, 731)
The court further stated:
Since, clearly, the substance of an agreement must prevail over the form (citations omitted), a careful study of the language of this agreement reveals an intention by the parties to create a purchase agreement of the premises, though entitled a lease . . . By no stretch of the imagination can this Court conceive of the village not exercising the option for this nominal amount. (42 Misc 2d 704, 705-6, 248 NYS2d 729, 731).
Thus, the court in Marine found that the purchase option contained in the lease agreement was illusory and did not serve to change the character of the transaction from that of an installment purchase to that of a lease with a subsequent option to purchase. It was the court's opinion that one must look to the substance of the transaction and not the characterization assigned to it by the parties to determine what the parties intended. Presumably, the court would have viewed the transaction differently if the purchase price had more closely approximated the fair market value of the property at the time the option was to be exercised (see 1982 Opns St Comp No. 82-51, p 65).
Other relevant New York cases have considered whether a transaction constitutes a true lease or the granting of a license for the purpose of determining the applicability of the competitive bidding requirements of section 103 of the General Municipal Law. In this regard, we note that it is well established that leases, licenses to use and purchases of real property do not constitute "purchase contracts" or "contracts for public work" within the meaning and intent of section 103 and, therefore, are not subject to the competitive bidding requirements of that statute (Davies v Mayor, 83 NY 207; Albion Industrial Center v Town of Albion, 62 AD2d 478, 405 NYS2d 521; Citiwide News v NYCTA, 62 NY2d 464, 478 NYS2d 593). It is equally well established, however, that competitive bidding requirements cannot be avoided by simply casting an agreement which is truly a purchase contract or a contract for public work as a lease, license to use or purchase of real property (Exley v Village of Endicott, 51 NY2d 426, 434 NYS2d 922; Citiwide, supra). In determining whether a contract having attributes of both a lease or license and a purchase contract or contract for public work falls within the scope of the competitive bidding statutes, the Court of Appeals has examined the "total character" of arrangements to determine their essential nature or focal point (Exley, supra; Citiwide, supra).
With regard to the "total character" of agreements purporting to be leases of real property with options to purchase, the leading case in New York is Albion, supra. In Albion, an agreement was entered into between a town and a partnership for the partnership to erect a building suitable for the town's needs on a parcel of land owned by the partnership. The land and building was to then be leased to the town for use as a town garage and offices for an initial five-year term at a rental of $1,000 per month for the first six months, and $3,875 for the remaining 54 months. The town had a one-time option to purchase after the sixth month for $141,200.
In addressing whether the agreement contravened General Municipal Law, §103, the court first noted that the agreement must be carefully examined since it had the obvious potential of serving as a device to circumvent the competitive bidding statutes. The court also noted the strong policy considerations underlying the enactment of section 103. Finally, the court concluded that the agreement, although entitled "lease", could only be construed as a contract for construction and purchase of a building to be used for a public purpose and that the clear intent of the parties was to circumvent the mandate of section 103.
The court's rationale in Albion was as follows:
The nature of the option to purchase is such that its exercise by the town effectively would have been compelled. [Footnote omitted] That conclusion is premised upon a fair reading of the agreement. If the option was exercised, the town would acquire the land and building for a total payment of $147,200, which sum we may properly assume would have represented the fair value of the property including, at the very least, a reasonable profit to the plaintiff. The purchase of the premises would not have resulted in risk or expense to the town greater than that already assumed by the terms of the "net lease".
On the other hand, should the town have failed to exercise its option, its rental for the remaining 4 1/2 years would have been increased to $215,250 over the five-year term, at the end of which it would have neither ownership of the property nor the right to its continued occupancy. It is inconceivable that the parties intended such an absurd result for not only would the plaintiff then be the sole owner of the improved property after the short space of five years, but it would also have fully recovered the cost of the improvement, the profit on the construction and a very substantial return on its investment, all at the expense of the taxpayers of the town. Additionally, it is not unreasonable to assume that the need for a town garage and offices would persist at that time and that the town would be left to renew this "net lease" on the plaintiff's terms and conditions or, alternatively, to arrange for other facilities. Obviously, the parties were aware that none of these events would come to pass because the option to purchase would be exercised. (62 AD2d 478, 484, 405 NYS2d, 521, 525)
Thus, the court found that the arrangement was intended to inevitably involve the purchase of the completed structure by the town from the partnership. Based on the fact that the contract was far more favorable as a purchase than a lease, combined with the probability that the facilities would continue to be needed by the town, the court further found that the parties from the outset understood that the town, in essence, had no discretion to refuse to exercise the option. Therefore, the court concluded, in effect, that the agreement was not only a town contract for public work subject to competitive bidding, but also an installment purchase of real property.
The Court of Appeals examined a different type of arrangement in the competitive bidding context in Exley v Village of Endicott, 51 NY2d 426, 434 NYS2d 922 (1980). This case involved a contract alleged to be a true lease between a municipality and a phone company. The court, after examining the "total character of the arrangement", found this to be a true lease without "the slightest hint of subterfuge in this arrangement". (id., 51 NY2d at 433, 434 NY2d at 925). In concluding that the agreement constituted a true lease, the court relied primarily on those provisions in the agreement which provided that: (1) title was to remain with the phone company throughout the term of the lease with no provision for transfer thereof to the municipality; and (2) the phone company assumed all risk of loss and responsibility for repair of the equipment. (id., 51 NY2d at 432-433, 434 NYS2d at 924-5).
The Court of Appeals demonstrated again in Citiwide News, supra, that it considers the intent of the parties in determining whether a purchase is contemplated. In discussing an agreement for the licensing by the Transit Authority (Authority) of the right to establish newsstands in subway stations, the court held that it was "surely not the purpose of the arrangement that the Authority acquire title to these facilities. The ownership of the newsstands appears to be of only incidental benefit to the Authority." Rather, "the focus and purpose" of the arrangement was "to provide for the maintenance and operation of newsstands in the subway system." The fact that the arrangement would require some construction that would remain after the expiration of the agreement, to which the Authority would acquire title, was "insufficient . . . to alter the essential character of the transaction . . . from that of a license agreement into a contract for public work." (62 NY2d 464, 473, 478 NYS2d 593, 597).
Prior opinions of this Office have been consistent with the above judicial opinions (see, e.g. 1980 Opns St Comp No. 80-187 p 49; 1982 Opns St Comp No. 82-51, p 65; 1984 Opns St Comp No 84-57, p 71). In Opn No. 82-51, supra, we stated that a transaction involving a lease with an option to purchase constitutes an installment purchase contract within the meaning of section 109-b of the General Municipal Law if the option price does not reflect the reasonable value of the property at the time the option is to be exercised. On the other hand, we further stated that a lease-option arrangement entered into in good faith at a reasonable rental probably would not constitute an installment purchase contract so long as the option was truly non-compulsory and the option price approximated the fair market value of the property at the time the option may be exercised.
Opn No. 82-51, supra, also sets forth other contract provisions which we believe are indicative of an installment purchase contract. These provisions included those which: (1) ascribe an interest and principal component to each payment; (2) require the municipality to purchase insurance on the property; and (3) require the municipality to repair and maintain the property during the term of the lease.
In 1984 Opns St Comp No. 84-57, p 71, we considered whether an agreement constituted a lease or a purchase contract for purposes of the competitive bidding statutes. In that opinion, we noted that the Court of Appeals, in Exley, supra, apparently found it significant that title never passed to the municipality under the agreement. We also noted, however, that, if the agreement had extended over the useful life of the property and the municipality had assumed risk of loss and responsibility for maintenance during the agreement, it was possible that the court would have found that the agreement constituted a purchase agreement for purposes of the competitive bidding statutes even though title to the property never passed to the municipality. It was our opinion, therefore, that "[l]ocal officials must examine each agreement in its totality... to determine whether it is properly characterized as a lease or a purchase for purposes of the competitive bidding statutes." We believe that the same approach must be utilized to determine whether an agreement constitutes an installment purchase transaction for purposes of General Municipal Law, §109-b.
The Internal Revenue Service has often considered for federal tax purposes whether an arrangement constitutes a true lease or a "conditional sale" and has set forth factors, through various revenue rulings and procedures, for distinguishing between the two. This distinction is important to the transaction in question since a lease will only constitute a tax exempt obligation under federal law if it is determined to be a conditional sale rather than a true lease (Gelfand, State & Local Govt Debt Fin, §3:08).
In Revenue Ruling 55-540, the IRS provided guidelines for determining, for federal income tax purposes, when a "purchase and sale rather than a lease or rental agreement may in general be said to exist" in the context of equipment procurement. This ruling reiterates the views expressed by the New York courts:
Whether an agreement, which is in the form of a lease, is in substance a conditional sale contract depends upon the intent of the parties as evidenced by the provisions of the agreement, read in light of the facts and circumstances existing at the time the agreement was executed.
Revenue Ruling 55-540 sets forth several factors to aid in ascertaining the intent to effect an installment purchase, rather than a true lease. The ruling states:
no single test, or combination of tests, is determinative . . . However . . . it would appear that in the absence of compelling persuasive factors of contrary implication an intent warranting treatment of a transaction . . . as a purchase and sale rather than a lease or rental agreement may be said to exist if, for example, one or more of the following conditions are present:
(a) Portions of the periodic payments are made specifically applicable to an equity to be acquired by the lessee.
(b) The lessee will acquire title upon the payment of a stated amount of 'rentals' which under the contract he is required to make.
(c) The total amount which the lessee is required to pay for a relatively short period of use constitutes an inordinately large proportion of the total sum required to be paid to secure transfer of the title.
(d) The agreed 'rental' payments materially exceed the current fair rental value. This may be indicative that the payments include an element other than compensation for the use of property.
(e) The property may be acquired under a purchase option at a price which is nominal in relation to the value of the property at the time the option may be exercised, as determined at the time of entering into the original agreement, or which is a relatively small amount when compared with the total payments which are required to be made.
(f) Some portion of the periodic payments is specifically designated as interest or is otherwise readily recognizable as the equivalent of interest. [citations omitted]
In addition, the ruling states:
In the absence of compelling factors indicating a different intent, it will be presumed that a conditional sales contract was intended if the total of the rental payments and any option price payable in addition thereto approximates the price at which the equipment could have been acquired by purchase at the time of entering into the agreement, plus interest and/or carrying charges.
Although the above criteria are obviously not binding for purposes of determining whether an agreement constitutes a lease or a purchase for state law purposes, they nonetheless are helpful insofar as they reflect some of the same factors which have been considered by the New York Courts and this Office. Also, since the COPS in this transaction were issued as tax exempt obligations, the above guidelines by the IRS are helpful for purposes of ascertaining the intent of the parties.
The Marine Midland and Albion courts, supra, inferred an intent to exercise a purchase option where, as a practical matter, it was inconceivable that the municipality would forego the benefits of the option. It appears that the arrangement in question resembles the contracts considered in those cases in this respect.
As was explained above, assuming the municipal corporation renews the lease on all five occasions and makes all its scheduled lease payments, it will not have paid sufficient money to redeem all the COPS. The moneys remaining in the reserve fund, however, will be sufficient to redeem the COPS then outstanding and will also equal the purchase option price. Under these circumstances, since the trust and disbursing agreement would preclude the trustee from paying any moneys in the trust fund to the municipal corporation unless and until all the COPS have been paid or redeemed, it appears that the moneys in the reserve fund will not be available for payment to the municipal corporation even if the municipal corporation chooses not to exercise its purchase option. Rather, the trustee presumably will be required to apply them as a credit against the last remaining installments of lease payments, which are defined by the trust and disbursing agreement to include payments from the lessee to the lessor under the option agreement. Therefore, if and when the municipal corporation is permitted to exercise its purchase option, it appears that the municipal corporation's only real choice will be to accept title to the facility and have the moneys in the reserve fund applied towards the payment of the purchase option price so that outstanding COPS can be redeemed. Consequently, we believe that the purchase option is largely illusory.
In addition, while we will not speculate whether the predetermined option price is a reasonable approximation of what the fair market value of the facility will be at the time purchase option can be exercised by the municipal corporation, we note that the option price, which represents approximately 10% of the aggregate principal amount of the COPS, is relatively small when compared with the total cost of the project. In our view, this factor also suggests that the municipal corporation's option to purchase is not really non-compulsory.
We also note that the lease agreement ascribes a principal and interest component to each lease payment. As stated above, this factor has been recognized by both this Office and the IRS as evidencing a purchase rather than a lease transaction (see Opn No. 82-51, supra; Rev Ruling 55-540).
This transaction has various other factors which, in our view, suggest that the parties intended to transfer ownership of the facilities to the municipal corporation and therefore that this transaction constitutes an installment purchase. First, we note that the municipal corporation has assumed various obligations which could be viewed as incidents of ownership. These include the obligation to procure liability and property insurance; the transfer of risk of loss to the lessee; and the obligation to maintain and repair the facility (see Exley, supra). In this regard, we note that the lease between the municipal corporation and the NFP provides that, except in the event of non-appropriation, the municipal corporation's obligation to pay rent is unconditional. In our view, this provision of the lease, which obligates the municipal corporation to pay rent without regard to whether the facility is actually available for its intended purpose, strongly infers that the lease is intended not only to provide the municipal corporation with the use and occupancy of the property, but also to transfer all risks of ownership to the municipal corporation as well.
Based on all of the above features of the transaction in question, it is our opinion that the parties to the transaction intend for the municipal corporation to ultimately acquire ownership of the facility and that the municipal corporation, rather than the NFP, has assumed most of the economic incidents of ownership. Therefore, we believe that the instant transaction constitutes an installment contract to purchase real property that is prohibited by the limitation contained in General Municipal Law, §109-b(2). As noted, that limitation precludes a municipality from utilizing installment purchase contracts to purchase anything other than "equipment, machinery and apparatus".
Sections 101 and 103 of the General Municipal Law contain the basic competitive bidding requirements for municipalities. General Municipal Law, §103 provides that, except as otherwise expressly authorized by the State Legislature or by local law adopted prior to September 1, 1953, all contracts for public work involving an expenditure in excess of $7,000 and all purchase contracts in excess of $5,000 shall be awarded to the lowest responsible bidder by the appropriate officer, board or agency of a political subdivision after public advertisement for sealed bids. Section 101 of that statute provides that if the entire cost of work for the construction, reconstruction or alteration of a building exceeds $50,000, separate specifications must be drawn and separate contracts awarded for: (1) plumbing and gas fitting; (2) steam heating, hot water heating ventilating and air conditioning; and (3) electric wiring and illuminating.
With respect to the monetary thresholds in sections 101 and 103, we note that the courts have held that the bidding statutes apply to both direct and indirect expenditures of public funds for purchases and contracts for public work (Citiwide, supra; Signacon v Mulroy, 32 NY2d 410, 345 NYS2d 527). Although moneys for the construction of the facility in question are paid initially from the construction account funded by COPS proceeds, it is clear that the municipal corporation's lease payments used to re-pay the COPS constitute at least an indirect expenditure for competitive bidding purposes (see Empire v Fabber, 71 Misc 2d 167, 335 NYS2d 540; Albion, supra). Therefore, since the transaction clearly involves an expenditure of moneys of the municipal corporation in excess of the thresholds of sections 101 and 103, the competitive bidding statutes would be applicable if the transaction constitutes a contract for public work of the municipal corporation (Citiwide, supra). In determining whether the transaction in question constitutes a contract for public work, we will not only consider Exley, Albion and Citiwide, supra, which were discussed above, but also two other cases relating to so-called "turnkey" arrangements.
In North Country Development Corporation v Massena, 65 Misc 2d 105, 316 NYS2d 894, a housing authority determined to complete a housing project by inviting developers to submit proposals for the erection of low income housing units. Financing was to be through federal aid from the U.S. Department of Housing and Urban Development ("HUD"). The proposals were based on a so-called "turnkey" contract under a HUD program. The "turnkey" arrangement involved the authority providing land for a stated amount and contracting to re-purchase the land after the dwelling units were constructed and made ready for occupancy according to specifications set forth by the authority.
In Massena, supra, the authority accepted the highest proposal and the developer submitting the lowest proposal brought an action to rescind the award for failure to comply with the competitive bidding requirements of Public Housing Law, §§151 and 151-a, which are analogous to the requirements of General Municipal Law and §§101 and 103. The authority argued that the transaction was not a construction contract, but rather, a contract with a developer for the repurchase of improved land at an agreed upon price. In holding that the competitive bidding statutes were violated, the court stated as follows:
The court feels that such argument is without merit. It goes without saying that the purpose of such statutes as section 151 and 151-a, Public Housing Law is designed to promote the public interest and economy and prevent favoritism in the procurement of work and supplies. Any attempt to circumvent the requirement for sealed proposals or bids on construction contracts, no matter how well intended, cannot be looked on with favor by this Court. Whether this project involved a straight construction contract or the so-called "turnkey" procedure, the result is the same, and the statutes for the protection of the taxpayers should be strictly followed; and this regardless of whether the project is financed through the federal government, state government or by local taxes. (citations omitted; 65 Misc 2d at 112, 316 NYS2d at 902)
In Marino v Town of Ramapo, 68 Misc 2d 44, 326 NYS2d 162, a similar transaction was the subject of litigation in the Supreme Court, Rockland County. In holding that the project was not subject to competitive bidding, the court distinguished Massena, supra, primarily on the ground that the property in Massena was at all relevant times owned by the authority. The court further stated as follows:
... Massena merely represents an illustration of a local authority attempting to avoid New York bidding requirements on public works, in the guise of compliance with Federal regulations. * * * However, in the pure 'turnkey' situation competitive bidding pertaining to the same location is a virtual impossibility since each proposed developer offers bids regarding separate parcels of real property. It is the uniqueness of the location of the project, therefore, which precludes competitive bidding in the traditional sense. (68 Misc 2d 44, 53-4, 326 NYS2d 162, 176).
In reaching its conclusion, however, the court in Marino, supra, also stressed that the "turnkey" procedure was sanctioned by the federal government and that the project itself was fully federally funded. Further, the court concurred with the Massena court that "the source of funding is irrelevant where, in fact, the local authority owns the subject property" (68 Misc 2d at 54, 326 NYS2d at 176). In our view, this reference to the sources of funding suggests that the court may have reached a different result if local funds were used to pay for the project where the project is not owned by the local entity. Therefore, we do not believe that Marino, supra, supports the conclusion that an exception to competitive bidding exists for a "turnkey" project on lands owned by a developer if local funds are used to construct the project (see 1975 Opns St Comp No. 75-692, unreported).
We also note that the Marino court rested its conclusion alternatively on the "supremacy clause" of the Federal Constitution, which states that the "(L)aws of the United States *** shall be the supreme Law of the Land" (art. VI, ch 2). The court noted that the "turnkey" program was designed by HUD regulations to alleviate local financial burdens so as to provide federal funds for low-income housing and concluded that, even if no exemption for competitive bidding requirements could be read into the State statute, the State bidding statute must yield to the HUD regulations as they apply to pure "turnkey" projects to the extent of any conflict.
It is our opinion that the instant transaction, like Albion and Massena, contains several elements which, when taken together, make the total character strongly resemble a contract for public work that is subject to competitive bidding requirements. Although the agreements in this transaction are structured as separate lease and purchase transactions, we believe, as was discussed above and as was the case in Albion, that the purchase option is largely illusory.
The transaction also has characteristics of a contract for public work because of the municipal corporation's participation during the construction phase. Like Massena, the construction is performed in accordance with plans and specifications approved by the municipal corporation (see Empire, supra; cf. Application of NYS Chapter, Inc, 73 Misc 2d 859, 343 NYS2d 33, affd 41 AD2d 821, 343 NYS2d 558). Also, the construction is subject to approval by the municipal corporation and the municipal corporation has the right to approve the surety providing the performance bond. A further factor which makes this transaction appear to be more a construction contract for a public building than a lease is the requirement that if the municipal corporation has not delivered a completion and acceptance certificate for three consecutive months or if the architect certifies that the work cannot be completed by the occupancy date, then the municipal corporation may complete the project using moneys held under the Trust and Disbursing Agreement.
We further believe this transaction is distinguishable from the one at issue in Marino, supra. Unlike Marino, supra, the project is not being built by the developer on its own land pursuant to its own specifications. The municipal corporation here has acquired the land by lease prior to the commencement of construction. Also, this project is neither undertaken pursuant to a federal program which prescribes a procurement procedure, nor is it fully federally funded as was the "turnkey" transaction in Marino, supra. Finally, we note that, while the authority in Marino, supra, did not comply with the letter of the competitive bidding statute, it did utilize a formal procedure for soliciting competition which, the court noted, seemed to achieve the same salutary objectives as the competitive bidding statute (68 Misc 2d at 56, 326 NYS2d at 178, footnote 3). Therefore, based on the principles recited in Albion, Massena and the other cases discussed herein, we believe that the transaction constitutes a contract for public work rather than a lease of realty.
Although it is our opinion that the transaction in question constitutes a contract for public work within the meaning of the competitive bidding statutes, the IDA's involvement in the project makes it necessary to consider Article 18-A of the General Municipal Law (§§850 et seq.), which relates to the powers and duties of industrial development agencies. As was noted in our description of the transaction, title to the facility will remain in the IDA during the term of the lease between the municipal corporation and the NFP. Further, the IDA, in the ground lease with the NFP, designated the NFP as its agent for purposes of constructing the facility.
General Municipal Law, §884 provides as follows:
The provisions of any law relating to the requirement of public bidding with respect to the construction of public facilities or projects shall not be applicable to the acquisition, construction, reconstruction, improvement, maintenance, equipping and furnishing of projects authorized by this act.
In order to qualify under this exception to competitive bidding, therefore, a project must be authorized under article 18-A.
Section 854(4) defines "project" to mean:
...any land, any building or other improvement, and all real and personal properties located within the state of New York and within or outside or partially within and partially outside the municipality for whose benefit the agency was created, including, but not limited to, machinery, equipment and other facilities deemed necessary or desirable in connection therewith, or incidental thereto, whether or not now in existence or under construction, which shall be suitable for manufacturing, warehousing, research, civic, commercial or industrial purposes ... and which may include or mean an industrial pollution control facility, a recreation facility, educational or cultural facility, a horse racing facility, a railroad facility, or a civic facility ... (emphasis added)
It would appear that, in order to constitute a project under article 18-A, the only two listed categories into which the construction of the facility could fall would be "civic" or "commercial" facility.
The term "civic facility" is defined in subdivision 13 of section 854 as follows:
"Civic facility"--shall mean any facility which shall be owned or occupied by a not-for-profit corporation organized and existing under the laws of this state or authorized to conduct activities in this state. Such facilities shall not include convention centers, housing facilities or medical facilities which are predominately used for the delivery of medical services, except that such facilities shall include habilitation centers and hospices.
Under a literal reading of this definition, the instant transaction would not appear to qualify as a civic facility because the facility will neither be occupied nor owned by the NFP. Further, a review of the legislative history of chapter 905 of the Laws of 1986, which added the definition of "civic facility", makes it clear that it was primarily intended to authorize IDA financing of the headquarters for not-for-profit organizations. Although the Sponsor's Memorandum in support states that the bill would also enable IDA's "to finance private commercial projects which would accommodate public sector tenants ... as anchor tenants in some of its more important and larger projects", it was anticipated that any public agency occupying the facility would be only one of several tenants. In this case, the municipal corporation will be the only tenant here, not an "anchor tenant" as anticipated by the Legislature.
We also do not believe that the facility would qualify as a "commercial" facility within the meaning and intent of section 854. Initially, we note that the policy and purposes of article 18-A are:
to provide the economic, welfare, recreation opportunities and prosperity of its [the State's] inhabitants and to actively promote, attract, encourage and develop recreation, economically sound commerce and industry ... for the purpose of preventing unemployment and economic deterioration * * *
Although the term "commercial" is not defined in article 18-A, it is well-established that the word "commercial" denotes a trade or profit-making activity (e.g., Imbergamo v Barclay, 77 Misc 2d 188, 352 NYS2d 337; Steinbach v Gerosa, 4 NY2d 302, 175 NYS2d 1). When this general definition is read in conjunction with the purposes of the Article 18-A, we believe it is clear that a public facility for use by a municipal corporation in performance of its governmental functions would not fall within the scope of a "commercial" facility.
Since it is our opinion that the construction of the facility is not a "project" within the meaning of Article 18-A, we do not believe that the exemption from competitive bidding requirements set forth in section 884 is applicable in this instance. Further, since it is our opinion that the total character or focal point of the transaction is not that of a lease and purchase of real property, but rather the construction of a municipal public work, we believe that the construction of the facility by the NFP without competitive bidding violates the competitive bidding requirements of General Municipal Law, §§101 and 103.
In summary, it is our opinion that neither the lease agreement nor the COPS evidencing a proportionate interest in the payments due thereunder violate any of the provisions or restrictions contained in the New York Constitution or Local Finance Law relative to the issuance of indebtedness. It is also our opinion, however, that the lease between the municipal corporation and the NFP constitutes an installment contract to purchase real property that is prohibited by the limitation contained in General Municipal Law, §109-b(2). Finally, we believe that the construction of the facility without competitive bidding in this instance violates the bidding requirements contained in the General Municipal Law.
April 7, 1989
Cornelius F. Healy
Deputy State Comptroller
*This opinion was originally issued as an inter-office memorandum in 1989. It was not published as an opinion at that time because legislation then pending would have altered some of the conclusions expressed therein. Similar legislation is still pending and may be enacted during the 1991-92 legislative session (see also L 1990, ch 190, §374). However, because we continue to receive frequent requests for copies of the inter-office memorandum, we are publishing it as an opinion at this time.
**(see also Energy Law, §9-103 as amended after the date of this opinion by L 1989, ch 638).
1 See, e.g., NY Const art VIII, §2 which provides that no installment due on certain indebtedness shall be more than 50% in excess of the smallest prior installment and art VIII, §4 which prescribes debt limits for municipalities; also see Local Finance Law, §33.00 which requires that certain types of indebtedness be approved by a two-thirds majority of the governing board.
2 We note that the presence of the executory clause, while preventing a lease-purchase or installment purchase from constituting debt within the meaning of the Constitution and the Local Finance Law, would not exempt an installment purchase from the proscriptions contained in section 109-b since that statute specifically requires installment purchase agreements made thereunder to contain a broad executory clause. Also, in addition to the prohibition contained in General Municipal Law, §109-b, we note that the court in Marine Midland Trust Co. v Village of Waverly, 42 Misc 2d 704, 248 NYS2d 729, discussed infra, suggested that a municipality could not enter into an installment purchase contract to purchase realty in the absence of statutory authority (see also Gardner v Town of Cameron, 155 App Div 740, 140 NYS 634 affd 215 NY 682). The court stated that "[t]here is no authority granted to a village to finance the purchase of property for public parking in the manner attempted here. None of the provisions of the Local Finance Law establish the method of financing an obligation by a purchase agreement with installment payments. [citations omitted]" 42 Misc 2d, 704, 707, 248 NYS2d 729, 732.
3 In this respect, we note that there is no indication in the decision whether the lease included an executory clause. Therefore, it is unclear whether the holding, insofar as it suggests that an installment purchase contract with an executory clause is indebtedness, would still be valid after the decisions in Wein v City of New York, supra and NYS Coalition for Criminal Justice v Coughlin, supra. As we noted above, however, the presence of an executory clause is irrelevant to our consideration of whether an agreement is an installment purchase for purposes of General Municipal Law, §109-b.