GLELC Letter to Council

Below is a well-researched letter sent by the Great Lakes Environmental Law Center to the mayor and council. If you've been following the underground structure project on the Library lot, you know that the purpose of this structure is to subsidize a hotel/conference center to be built on top of the structure. Any hotel developer will want on site parking for guests. The GLEC letter points out a big problem with using the structure as a hotel subsidy. The city risks losing millions in tax credits on the Build America Bonds used to finance the structure.


TEXT OF LETTER

May 5, 2008

April 14, 2010

Mayor John Hieftje and City Council Members
City of Ann Arbor
Guy C. Larcom, Jr. Municipal Building
100 N. Fifth Avenue
Ann Arbor, MI 48104

CC: Susan Pollay, Ann Arbor Downtown Development Authority

Re: Restrictions on Use of Build America Bonds Relating to S. Fifth Avenue Parking Structure Project

Dear Mayor and City Council:

The Great Lakes Environmental Law Center offers the following information regarding restrictions on use of Build America Bonds relating to the S. Fifth Avenue parking structure project. Given our prior litigation and settlement with the city, we wish to make explicitly clear that we do not intend to pursue any further legal action on this matter, either as a party or as attorneys for another party. We are simply providing this information to assist the city in avoiding any potential liabilities resulting from violations of the terms and restrictions of Build America Bonds. As stated in the bond offering, failure to comply with the Build America Bond requirements “may cause loss of the Refundable Credit to be retroactive to the date of issuance of the Bonds.”

In February and July of 2009, the city of Ann Arbor approved a total of $49,420,000 worth of Capital Improvement Bonds to construct a 677 space, 4 story, underground parking structure in the city. The bonds are general obligation bonds and were designated as “Build America Bonds” under section 54AA of the Internal Revenue Code. More specifically, the bonds are classified as Direct Payment Build America Bonds. There are three types of Build America Bonds and the particular type issued for the parking structure provides the issuer, in this case the city, with a Federal subsidy through a tax credit paid by the Treasury Department and the Internal Revenue Service (“IRS”) in an amount equal to 35 percent of the total coupon interest payable to investors in these taxable bonds.¹ Direct Payment Build America Bonds “may be issued to finance governmental purposes for which tax-exempt governmental bonds (excluding private activity bonds under §141) could be issued under §103” of the Internal Revenue Code.² Therefore, sections 103 and 141 of the Internal Revenue Code govern the use of proceeds from Build America Bonds. If the bonds issued for the parking structure would be considered “private activity bonds” under §141, then that particular use for the bonds is impermissible. Just like tax-exempt bonds, proceeds from Build America Bonds must be used for public and not private use.

A bond is a private activity bond if it meets the (A) private business use test and (B) private security or payment test. These are known as the private business tests. If the Build America Bonds are used to finance parking for a private facility such as a hotel, as the city may be considering, there is a risk that the terms of the Build America Bonds will be violated and the City will lose millions of dollars in federal subsidy.

The purpose of the private activity bond tests of section 141 is to “limit the volume of tax-exempt bonds that finance the activities of nongovernmental persons, without regard to whether a financing actually transfers benefits of tax-exempt financing to a nongovernmental person.”³ According to the IRS regulations regarding section 141, that section “may not be applied in a manner that is inconsistent with these purposes.”⁴ Additionally, these tests may be met even if at the exact time of issuance of the bonds the proceeds were planned to be used for not more than 10% private use. If the issuer of the bonds “reasonably expects,” as of the issue date, that the issue will meet either of the private activity bonds tests of section 141, then those bonds are private activity bonds.⁵ Further, if the issuer takes any “deliberate action, subsequent to the issue date, that causes the conditions of either” of the tests to be met, those bonds are also classified as private activity bonds.⁶ A deliberate action is any action that is within the issuer’s control.⁷ Intent to violate section 141 is not necessary for an action to be considered deliberate.⁸ The only reason an action would not be considered deliberate is if it is an involuntary or compulsory conversion or it is taken in response to a directive action made by the federal government.⁹

An issue meets the private business use test if more than 10% of the proceeds are to be used for any private business use.¹⁰ Presumably, the parking structure does not itself cause this test to be met, although there is still some uncertainty regarding the amount of bond proceeds being used to support future private development at the site rather than construction of public parking spaces. However, if the parking spaces are used for private facility parking in the future, that could cause the bonds to be classified as private activity bonds. If more than 10% of the proceeds of an issue are used in a business of a nongovernmental person or a combination of nongovernmental persons then the private business use test is met.¹¹ Generally, the private use test is met if a nongovernmental person has special legal entitlements to use the financed property under an arrangement with the issuer.¹² However, a special economic benefit to a private party may also be sufficient.¹³ There are many arrangements that would cause the private use test to be met. For example, if the infrastructure built with the proceeds of the Build America Bonds (such as the parking spaces) are contracted to a private person or entity or if that private person or entity has a special entitlement or priority to use the spaces, rather than being solely available for use by the public, the private use test will be met. It does not matter if this arrangement is fashioned after the issuance of the bonds, or even after construction of the structure. Entering into an arrangement that would provide a special entitlement to a person in a private business, or more simply, to a nongovernmental person, would no doubt be a deliberate action within the control of the city and therefore the bonds would become classified as private activity bonds.

The second private use test is met if the payment of the principal (or the interest on the principal) of more than 10 percent of the proceeds of the issue is either:

(A) secured by any interest in

(i) property used or to be used for a private business use, or

(ii) payments in respect of such property, or

(B) to be derived from payments (whether or not to the issuer) in respect of property, or borrowed money, used or to be used for a private business use.¹⁴

The payment of, or security for, debt service is determined from both the terms of the bond documents and any underlying arrangements.¹⁵ Underlying arrangements may be the result of separate agreements between parties or may be determined by all the facts and circumstances surrounding the issuance of the bonds.¹⁶

If a nongovernmental person engaged in a private trade or business makes a payment to the city, directly or indirectly, for use of parking spaces in the new structure, that would be a private payment for use under section 141.¹⁷ Whether a private payment for use of property is made under an arrangement that is entered into in connection with the issuance of an issue is determined on the basis of all of the facts and circumstances, but is treated as such if: (A) the issuer enters into an arrangement during the three year period beginning 18 months before the issue date; and (B) the amount of payments reflects all or a portion of debt service on the issue.¹⁸ If the City enters into an arrangement within 18 months of the issue date whereby the private owners of a future facility will pay the city an amount at least equal to 10 percent of the proceeds from the bonds used to finance the parking structure, the private payment test will be met. If the arrangement is made after 18 months have passed, all of the facts and circumstances will be considered to determine if the arrangement was entered into in connection with the issuance of the bonds.

As described above, there is a legal risk that the bonds used to construct the parking structure and other infrastructure at the site will violate the private activity test, risking millions of dollars in federal subsidy for the City, if the parking structure spaces are contracted to or if special parking entitlements are provided to a private facility. Further, given statements made by the Downtown Development Authority regarding the significant portion of bond proceeds being used for site infrastructure to benefit a future developer including the private development’s share of costs for Library Lane, the service alley, the 12” water main, site work, and building structural support (which appears to solely benefit the private building), even a limited allocation of parking spaces for a private hotel could put the city at risk of losing millions of dollars in federal subsidies. We urge the City to consider these risks in making decisions about future development arrangements at this site.

Respectfully Submitted,

Noah Hall
nhall@wayne.edu
(734) 646-1400

1 IRS Notice 2009-26, at 1-2.

2 Id. at 4.

3 26 CFR 1.141-2(a).

4 Id.

5 26 CFR 1.141-2(d)(1).

6 Id.

7 26 CFR 1.14102(d)(3).

8 Id.

9 26 CFR 1.141-2(d)(3)(i).

10 Id.

11 26 CFR 1.141-3(a)(1).

12 26 CFR 1.141-3(b).

13 26 CFR 1.141-3(b)(7)(ii).

14 26 U.S.C. § 141.

15 26 CFR 1.141-4(a)(3).

16 Id.

17 26 CFR 1.131-4(c)(2)(i)(A).

18 26 CFR 1.141-4(c)(3)(iv).

Ann Arbor Democratic Party RFP Resolution

While PLPP has not taken any position regarding a particular use for the Library Lot, we are encouraged by a resolution passed by the Ann Arbor Democratic Party at its monthly meeting on February 13, 2010. The resolution calls for an open space or town square, which goes beyond the scope of PLPP's efforts. Nonetheless, the Party's resolution recognizes that the Library Lot RFP has proceeded without appropriate public participation. We hope the Democrats on Council will be mindful of the Party's Resolution when the RFP comes before them.

The resolution passed by the Ann Arbor Democrats:

___________________________________________________

A RESOLUTION CONCERNING DEMOCRATIC PROCESS AND THE

DISPOSITION OF PUBLIC PROPERTY WITHIN THE CITY OF ANN

ARBOR COMMONLY KNOWN AS THE "LIBRARY LOT".

Whereas, the Administrator oft City of Ann Arbor has issued a Request for Proposals (RFP) concerning the disposition of the public land commonly known as the Library Lot and the issuance of this RFP has been approved by the City Council, elected by the citizens of Ann Arbor to represent their interests; and

Whereas, the citizens of Ann Arbor have long held the hope that the Library Lot would one day be reclaimed by the public as a commons or town square because it is recognized that a city needs a physical center and Public space for the perpetuation and enhancement of its civic life; and

Whereas, the recent use of the surface of this public land as public parking will change with the construction of an underground parking structure; and

Whereas, the sale or long-term lease of any public land, should be accomplished only with robust involvement of the community in deciding the eventual uses and costs to the community of the loss of the land to the public; and

Whereas. the process for determining that the Library Lot parcel should be sold or leased for purposes of private development has been neither transparent nor responsive to long-standing community concerns for the future of this parcel; and

Whereas, the citizens of Ann Arbor have neither assented to the sale or lease of this property nor indicated that a partnership between our city and a private developer would be beneficial; and

Whereas most studies on the subject have shown that partnerships of this nature for convention/conference centers, stadiums and other such projects have not been proven to be financially sound forms of community investments; and

Whereas, that the selling or leasing of the Library Lot to any private parties would irreparably harm the citizens of Ann Arbor and that no sum of money could recompense the citizens for the loss of a central place of convivial community engagement.

Now be it Resolved by we, the Democrats assembled here today at this monthly meeting of the Ann Arbor Democratic Party, that the City Council of Ann Arbor institute and support a public process for determining the future use of this property that must include robust public involvement, which has not, to this date been accomplished; and it is further

Resolved that we encourage the city government to support the development of a commons or town square in the center of the city for the promotion of civic virtues which are central to citizen centered democracies; and

Resolved that the selling or leasing of the Library Lot to any private parties should not happen without approval of the voters of Ann Arbor; and it is further

Resolved that the City Council, as our elected representatives, should not approve investment of any public funds in any private development of the Library Lot, and that any private use or development of the Library Lot must be proven sound enough to be financed through private funding.

The Library Lot Parking Spaces and the Developers

One of the open questions surrounding the proposals for development on the Library Lot is just how many of those new parking spaces will be allocated to the development, if it proceeds, and how many will be for public parking. Comments from the two proposers of hotels and conference centers seemed to indicate that they were expecting to use a substantial part of the parking structure to support their development.

Another aspect of the city’s financing of the parking structure is that costs of site preparation and structural hardening that a developer would normally bear are included in the city’s construction costs, and therefore constitute a developer subsidy.

Ann Arbor attorney and CPA Karen Sidney has been watching this issue carefully, especially with regard to the legal questions this raises with regard to the city’s bond offering. There are some special twists due to the city’s using the Federal stimulus Build America Bonds, which carry some restrictions.

Here is part of the summary she has prepared, and the questions she asked Ann Arbor Chief Financial Officer Tom Crawford. (The text of her original email has been shortened and lightly edited.)

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The on-line offering for the LTGO capital improvement bonds of $49,420,000 indicates that the city will elect to have these bonds treated as direct payment Build America Bonds. Among the requirements for direct payment Build America bonds under the statute and IRS Notice 2009-26 is that the bonds cannot be private activity bonds (IRC 141). This means that costs to support private interests (including non-profits) cannot be more than $13.8 million (the total of the fund equity used plus 10% of the bond proceeds). (Ed. note: “fund equity” refers to money the city puts in directly from local fund accounts, in this case the DDA TIF and parking funds.)

The project includes footings to support a 25 story building and other items designed to benefit a private development partner... The IRC 10% limit could easily be exceeded if a portion of the parking structure or the parking spaces themselves are leased to or otherwise benefit the developer.

The bond offering indicates the city will pay up to 8% interest on the bonds. The city will receive a federal tax credit for 35% of the coupon interest. As stated in the bond offering, failure to comply with the Build America Bond requirements “may cause loss of the Refundable Credit to be retroactive to the date of issuance of the Bonds.” The federal credit is worth nearly $20 million over the life of the bond. It would seem prudent to take every precaution that these bonds will not cross the line to become private activity bonds with $20 million at stake.

Questions:

1. Has the city calculated how much of the parking structure could be leased to a private business and still avoid classification of the bonds as private activity bonds? Will this information be included in the RFP for the library lot site?

2. The Council resolution authorizing these bonds includes a provision allowing the city to ask for a private letter ruling. Has the city applied for a private ruling? If the city has not applied for a private ruling, has the city asked bond counsel for an opinion on whether the bonds will qualify as Build America Bonds under specific fact situations that include any contemplated use of the parking structure by a private party under specific lease arrangements?

3. The Advisory Committee on Tax Exempt and Government Entities recommends that governments have procedures to monitor compliance with bond requirements during the life of the bonds, including advance review of contemplated sales, leases or other contractual arrangements involving bond-financed property. Does the city have such procedures? In the case of parking structure bonds, is the city or DDA staff responsible for compliance?

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Sidney never received a reply in writing, other than to say that the city was aware of the limit, though Crawford told her verbally that some permit parking assigned to the developer could be shifted to the Liberty Square (fully paid up) parking structure. She has since received estimates that indicate that total development subsidies (not including use of the parking spaces) are about $10.8 million. Those include the extra supports needed for a large building (which apparently cost about $5.3 million), and the construction of Library Lane. Additionally, the city is charging an administrative bond fee (that will be returned to the General Fund), that may be part of the limitation amount.

As the City Council contemplates the risk and expense to the city of financing a development above the Library Lot parking structure, this is just one more factor they will have to consider.

An Interview with Chuck Skelton

Chuck Skelton is the President of Hospitality Advisors Group of Ann Arbor. As such, he is an authority on hotel business, especially in Michigan. He was quoted at length in an article in Ann Arbor Area Business Monthly. Here is a quote from that article, originally published in 2006:

"Hotel occupancy rates averaged about 67 percent for 2005, up 4.5 percent from the previous year. The average daily rate was $89.00, says Charles Skelton. President of Hospitality Advisors Group of Ann Arbor. The city's hotels achieved an occupancy rate eight points higher than the Southeast Michigan area as a whole (59 percent), and an ADR of one dollar higher. "

The following is an account of an interview a member of our group, Leslie Morris, conducted with Chuck Skelton on January 22, 2010. ("I" refers to Leslie.) Her account is presented verbatim with minor editing for typography.

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I asked if it would be normal in the hotel feasibility business for RFP's to exclude any firm with a local office, as it seemed to me that local experience would be valuable. He said he had had experience only in responding to RFP's, and not in writing them, but that he had not seen such an exclusion before. I said it seemed strange to me that only a week was allowed to respond to the RFP. He said it was an indication that the RFP was "wired". His firm would be unable to turn around to respond in such a short time, and he thought others would have difficulty also.

(Ed. note: Leslie and Chuck are evidently referring here to the RFQ that the City of Ann Arbor issued for a financial consultant to help evaluate proposals from the RFP for the Library Lot.)

He recounted an experience he had about twenty years ago. He was asked to serve on a citizen committee, which was formed to react to a study that the city (Ann Arbor) had commissioned to assess feasibility of a convention center. The study was done by a nationally known firm, but was so poorly executed, and included so many erroneous assumptions, that he refused to sign off on it. As an example, he said that the producers of the study had assembled a list of all the groups that meet at large midwestern conference centers, including McCormick Center in Chicago and other convention centers in cities like Cleveland (I didn't get down all the names). He said they then claimed that an Ann Arbor convention center would have access to 100% of these groups. He said his opinion was that Ann Arbor would be lucky to have access to 1% of the groups that meet at the McCormick Center, which is very large, and can accommodate big trade shows. He thought that Ann Arbor might have access to 10% of the groups that meet at the other larger midwestern convention centers. He thinks that this poorly-done study is the one that Jesse Bernstein is carrying around and citing currently.

He brought up the Valiant proposal, which he said he was familiar with. He said the ADR (average daily rate) in Ann Arbor is about $100, that we are not a "high end" market. He had noticed that the Valiant proposal had indicated an ADR that was $80 above the Ann Arbor average, and that they had projected an 80% occupancy rate. He thinks this is unrealistic and impossible to achieve. He had talked earlier with some of the Valiant proposers, as indicated in Sabra Briere's memo on her meeting with him. They thought it was very difficult to get a room in Ann Arbor, and that the rate was $200 a night. He asked when they had this experience, and they said "homecoming and graduation". He said those were among the highest occupancy and highest rates of the entire year, and that the winter business was nothing like that. They did not believe him.

I asked Chuck to react to the Acquest hotel proposal, which projected a $135 ADR, rising to $150 by 2016, with occupancy to begin at 55% and rising to 67%. He answered that this is noticeably above the $100 ADR of other Ann Arbor hotels. Faced with this competition, local hotels like Weber's would be likely to cut their rates to keep up their own occupancy, and that the new hotel would not be able to reach its projected occupancy figures.

He described the Ann Arbor hotel season: May, June, July, August, September, and weekends in October. This is less than half the year, and hotels have to survive through the very meager and long Michigan winter. Another local problem is the University of Michigan's insistence on its $85 per night rate, which it can demand because it is the "gorilla". Much of the winter hotel occupancy is generated by the UM. They have refused to back any of the current proposals, and based on past history would refuse to pay the projected rates.

(Ed. note: some individuals from the UM have written supportive letters attached to proposals, but according to Jim Kosteva, the UM's public spokesperson, the UM as an institution does not back any proposal.)

He said another problem with the Valiant convention center is that it is too small. It is similar in size to other private or University-owned meeting spaces, and would not bring in new business in the form of larger groups, but would essentially move existing business around, causing other facilities to be under-utilized. The conundrum is that small conference facilities won't bring in much new business, and larger convention centers (60,000-80,000 sq. ft.) would be empty much of the year, during the long, unpleasant Michigan winter.

Convention business across the country is down not only because of the poor economy, but because of the increasing popularity of video conferencing. This trend is expected to continue. All Michigan convention centers are subsidized. The Grand Rapids convention center could not survive without the generous private support from the Van Andel family.

As a citizen, Chuck has major problems with the proposition that the city government should aid one commercial business venture at the expense of other existing businesses. In his view, this is simply not fair. And as a citizen, he does not want to have the city (and its taxpayers) involved in a risky, speculative business. The hotel and conference business is extraordinarily risky right now. The proposers could not do their projects without city aid.

Chuck thinks anybody who wants to build a hotel on the library lot should get their own financing, buy or lease the land from the city at a fair price to the city, and take all the risk themselves. If this is not possible now, the city should wait until it is possible. In the meantime, the land could be a nice park, or even a surface parking lot, as it is now.

Cities Should not be in the Hotel Business

We'll accumulate a series of links in this post about the experience of cities in funding local convention centers and hotels. It gives you an idea of what Ann Arbor might experience with the Valiant proposal, and probably the Acquest.

Governing Magazine, December 2009

"Critics, though, don’t merely say that hotel ownership is beyond the proper scope of government. They argue that cities have placed bets on a declining stream of revenue based on impossibly rosy forecasts. And, there is reason for caution. Some publicly funded convention-center hotels have been solid successes, but others have been colossal failures."

Brookings Institute 2005

"The overall convention marketplace is declining in a manner that suggests that a recovery or turnaround is unlikely to yield much increased business for any given community, contrary to repeated industry projections. Moreover this decline began prior to the disruptions of 9-11 and is exacerbated by advances in communications technology. Currently, overall attendance at the 200 largest tradeshow events languishes at 1993 levels."

Domestic Policy Subcommitee (U.S. Congress)

"The public justification for public financing, including construction financing with tax exempt bonds, is that this is an investment that brings jobs and consumers to a city’s downtown. Academic research on the value to economic development, however, has universally concluded that sports stadiums, convention centers and hotels do not increase economic activity in downtown areas."

Testimony - Domestic Policy Subcommittee (March 2007)

"These cases of public hotel development and ownership present an intriguing case of public projects, making use of the low interest rates available with tax exempt bonds directly competing against privately-owned and operated competitors, often directly across the street."

Economic Impact of Convention and Conference Centers (Steven Spickard, 1998)

"What if you build it, and they do not come? For one thing, the community is stuck with debt service that continues for 15 to 25 years. You may very well achieve negative economic impacts."

Statement of Principles

· When land that is owned by the public (the citizens of Ann Arbor) is being considered for a project or change in use, the process should be fully open. This includes an opportunity for public discussion of its purpose or use, publication of all documents involved in the process, and meetings that are open to the public at all stages. The public discussion should occur before any RFP is issued, and the RFP objectives and requirements should incorporate or acknowledge points brought forth by the public.

· The public process is different from that with a privately owned piece of land, where a developer might have private discussions with staff and city officials in the course of working out details of the development. When public land is to be used, the public record should include preliminary discussions with potential developers. The public process should not be limited to public hearings after the presentation of a site plan as is customary with private developments. It should not be not limited to adherence to existing zoning regulations.

· The use of public land should be considered in the broadest possible context. For example, area planning should be employed to determine the effect on the immediate area (adjacent streets and neighborhood) of a particular use. In addition, long-term value to the entire community should also be considered, incorporating environmental, financial, aesthetic and functional impacts of any change in use.

· When estimating the value to the community of the land and of a changed use, discussion should not be limited to extracting the top dollar value from the project. The city should not be acting as a venture capitalist or a dealer in real estate. Rather, broader public benefits must be considered. These would include enhanced services, enhanced local environment, and enhanced vitality of the area for residents and businesses.

· The public process should include a full analysis of financial and economic factors bearing on the decision. This might include benefits, risks, market conditions, and other factors. A change in use should not create a financial burden to taxpayers, beyond the ordinary use of taxes to provide services as directed by city program budgets and public millage and referendum votes.