Arizona Supreme Court Holds Agreement Violates Gift Clause: What Gilmore v. Gallego Teaches Us About Multi-Party Service Contracts Between Public and Private Parties

By Nicholas J. Wood, Joyce K. Wright, Brett W. Johnson, P.C., and Tracy A. Olson

Economic incentive agreements are tools used by city, county, and state actors to facilitate public goals with the help of private actors. States that provide incentives to developers to promote economic growth have a comparative advantage over other states. In Arizona, these transactions are tested by the Constitution’s Gift Clause that essentially asks: (1) does the transaction serve a real public purpose; and (2) does the public party get something in return for what it gives to the private party to incentivize the deal?

The Arizona Supreme Court has issued several recent decisions that define the parameters of the Gift Clause. In Gilmore v. Gallego, the Arizona Supreme Court considered a deal struck between the City of Phoenix (City) and a Labor Union regarding “release time” provisions in a Collective Bargaining Agreement that allowed police officers to work for the union while on paid time for the City. The Court concluded that the arrangement violated the Gift Clause.¹ In doing so, the Court provided valuable lessons regarding the scope of a Gift Clause analysis, especially when there are more than two (direct or indirect) parties to the transaction.

Facts of the Case. In 2019, the City and the American Federation of State, County, and Municipal Employees, (AFSCME), Local 2384 (Union) entered into a memorandum of understanding (MOU) regarding “release time” provisions.² Release time provisions generally fund the use of City employees to be “released from their normal job duties” for other purposes.³ The release time provisions were specifically excluded from the members’ compensation package.⁴

The MOU provided for (a) four full-time release employees, (b) banks of release hours for union members to engage in “union activities,” and (c) a fund to reimburse the Union for member attendance at various trainings and conferences.⁵ The full-time release employees are authorized to spend time on a variety of Union tasks, including activities like Union recruitment.⁶ Under the MOU, release employees are also required to participate in various City task forces and committees, but “because serving on these committees takes time away from the expected Union tasks” the MOU provides additional banked hours to compensate for these commitments.⁷ The MOU also authorizes stewards to represent employees in grievance proceedings.⁸ Although the “City ordinarily controls and supervises employee activities, it does not control or supervise how released employees spend their time and released employees do not report their activities to the City.”⁹

Two non-Union employees sued the City, alleging that, among other issues, the MOU violated the Gift Clause of the Arizona Constitution.¹⁰ The employees argued that because the City pays for the release time and the time benefits the Union, “such payments violate the Gift Clause.”¹¹ The Union and City argued that there was no violation because under Cheatham v. Diciccio,¹² when the MOU is considered as a whole, the release time “provisions serve a public purpose and are supported by adequate consideration.”¹³

The Arizona Supreme Court agreed with the employees.

The Court’s Reasoning. The Gift Clause prohibits public entities like the City from “giv[ing] or loan[ing] its credit in the aid of, or mak[ing] any donation or grant, by subsidy or otherwise, to any individual, association, or corporation.”¹⁴ Courts apply a two-part test to evaluate Gift Clause violations that asks: (1) Does the transaction serve a public purpose, and (2) is the public expenditure supported by adequate consideration of direct benefits?¹⁵

In analyzing transactions under the Gift Clause, courts look at a “panoptic view of the facts.”¹⁶ However, the Court warned that despite considering the totality of circumstances, the reality of the transaction still matters and “an illegal subsidy cannot be sheltered from scrutiny merely because it is embedded within an otherwise valid contract.”¹⁷

Under a “panoptic view,” the Union argued that the Court should look at the MOU as a whole; in doing so, the City receives the benefit of the collective bargaining (i.e., member employees agree to provide services to the City), in return for the release time.¹⁸ The Court rejected this argument, reasoning that the “overall contract is one for services, and no one has challenged the monetary compensation and benefits provided by the City to the employees in return for their services to the City.”¹⁹ Rather, the employees challenged the City’s payment “to employees to provide services to the Union.”²⁰

The City and the employees had a bargained-for transaction: in exchange for employee services, the City compensated those employees. But, because the MOU “specifically exclude[d] the union payments from employee compensation,” the employees’ services could not be consideration for the release time.²¹

When the employees’ services to the City are removed from the analysis, and the MOU is looked at as “a standalone contract between the Union and the City, the release time provisions … plainly violate the Gift Clause for lack of consideration.”²² Namely, in addition to banked hours for Union trainings, the “Union receives four full-time employees, who are released from their public duties but paid as if they were performing public work.”²³ In exchange, the Union receives “cooperative labor relations” which the Court determined were “at best … anticipated indirect benefits.”²⁴ Moreover, the Court concluded that release-time employee participation in committees and grievance proceedings cannot be considered adequate consideration.²⁵ The former fails because this service is separately paid for by the City through the bank of hours.²⁶ The latter fails for two reasons. First, union representation is already guaranteed by Phoenix law, so the inclusion is a “preexisting legal obligation” that “cannot constitute consideration for Gift Clause purposes.”²⁷ Second, the release-time is not in any way tied to the actual performance of grievance hearing duties, and is accordingly “too indefinite to enforce, much less value.”²⁸

Though the consideration prong was dispositive, the Court also raised serious concerns regarding the public purpose of the MOU.²⁹ Here, the Court concluded that the only function of release-time employees is “lawful union activities” and they are “released from the City’s direct control and supervision” to do so.³⁰

Takeaways for Parties to Public-Private Transactions. While the Court was careful to clarify that not “every provision in every contract must be scrutinized for Gift Clause purposes,” courts will still look at the “reality” of the contract and the totality of the circumstances of the agreement.³¹ But, when a contract may benefit more than two parties, the Court may examine what was exchanged between each party (distinguishing between direct and indirect benefits) and determine whether the applicable benefit was actually bargained for by each party. If not, a court may (like it did in Gilmore) separately analyze specific portions or line items of an overall transaction for Gift Clause compliance.

The Court’s skepticism regarding there being a public purpose is also notable, as courts typically defer to the public entity’s determinations of public purpose. Further, courts may scrutinize “side agreements” that may not be a part of the formal agreement (and that may benefit a third party — even if serving a public purpose).

The Gilmore v. Gallego decision highlights the importance of government entities and beneficiaries of economic incentive agreements documenting the economic “give and get” of their agreement, for example, by commissioning an independent economic analysis of the transaction. Their agreements should include statements that clearly describe the public purposes being achieved and the traceable benefits being exchanged. In addition, they should complete a legal analysis of the Gift Clause considerations of their agreements before they are finalized.