Working Toward Gift Clause Clarity in Arizona: Post-Schires v. Carlat Trial Opinion Represents Clarifying News for Economic Development Opportunities

By Brett W. Johnson, Caroline Lutz, Tracy A. Olson and Jody K. Pokorski

In the first quarter of 2021, Arizona has a seen a flurry of legal uncertainty related to the Arizona Supreme Court’s February decision in Schires v. Carlat that has been construed in some quarters as revising and narrowing long-established economic development tools used by governmental entities attracting companies to Arizona. Some would argue the Schires decision caused more confusion than clarity in providing guidance to companies considering developing or expanding in Arizona by leveraging economic incentives that are the norm throughout the country. However, a recent trial court opinion applying the Schires analysis to an economic development agreement may provide organizations with the necessary clarity to assist in crafting economic incentive packages going forward.

In Schires, the Arizona Supreme Court clarified the two-pronged Gift Clause test and held that Arizona courts are limited in the amount of deference they can give to public officials in their dealings with private entities.¹ Specifically, in regard to the consideration prong of the test (which evaluates whether the government is receiving an adequate return on its investment), the Supreme Court announced that it would no longer give as much deference to public officials on the actual value of the transaction and appeared to limit the options available to economic development departments to constitute sufficient consideration. Again, the decision arguably caused more questions than clarity.

On February 22, 2021, however, Arizona saw further development in the jurisprudence surrounding the Arizona Constitution’s Gift Clause when the Pima County Superior Court issued its ruling in Rodgers v. Huckleberry. This is the first lower-court decision to interpret Schires.

In Rodgers v. Huckleberry, taxpayers filed suit against members of the Pima County Board of Supervisors, alleging that a transaction they entered into violated the Gift Clause.² The County entered into a lease purchase agreement with World View Enterprises, a manufacturer of high-altitude balloons used in near-space exploration.³ The Pima County Board of Supervisors approved the agreement, which obligated the County to construct a 142,000 cubic-foot building on a parcel of County land and lease the improved land to World View for 20 years.⁴ In return, World View was obligated to pay $24,850,000 in total rent to the County over the course of 20 years, starting in December 2016.⁵ At the expiration of the lease, World View would have the option to purchase the improved parcel for $10.⁶ In addition to the building, the County also approved the construction of a publicly available launchpad on County property adjacent to the building parcel.⁷ This was governed by an operating agreement in which World View was required to maintain and operate the launchpad at World View’s expense, and to make the launchpad available to others for permitted uses when World View was not actively using it.⁸ The County’s total expense for their obligations under the contracts, including the land itself and the improvements thereon, was approximately $14 million.⁹

The plaintiff taxpayers sued Pima County over these agreements, alleging that the financial arrangements violated the Gift Clause, and that they failed to meet the two-pronged test first set forth in Wistuber v. Paradise Valley Unified School District and Turken v. Gordon.¹⁰ This test dictates that a public expenditure will not violate the Gift Clause if (1) it has a public purpose and (2) the governmental entity received sufficient consideration, meaning that deal was not “so inequitable and unreasonable” that it amounts to providing a subsidy to the private party.¹¹ The plaintiff bears the burden of proof on both prongs.¹²

The Rodgers court found the public purpose prong to be easily satisfied because the agreements provided direct benefits by way of jobs for those in the community over the life of the 20-year lease.¹³ It therefore focused much of its analysis on the second prong. On this point, the Rodgers court distinguished its facts from Schires, where the private parties did not sign an enforceable promise to provide the city with any particular economic impact, and the city did not own the land or receive any rent revenue.¹⁴

In contrast, World View’s promise to pay $24,850,000 in lease payments was provided in return for the County’s investment in the land and the improvements.¹⁵ The court held that this was fundamentally different than Schires, as the transaction benefitting the County was direct: the lease payments over the life of the lease.¹⁶ Therefore, the court held that the agreements fulfilled the criteria of Schires.¹⁷

Furthermore, the court analyzed the consideration compared to the expenditure, and whether it was so inequitable and unreasonable that it amounted to an abuse of discretion.¹⁸ The court relied heavily on the expert testimony presented, and the competence and sophistication of the financial evaluations was key to the County’s success in this case. Both parties presented their own expert witnesses, who provided technical financial valuations of the properties and the related agreements. The plaintiffs' valuation expert analysis, however, did not account for the present value of the full life of the lease, and incorrectly calculated the property value at the end of the lease.¹⁹ These errors and oversights caused the court to doubt the reliability of the plaintiffs' findings, and raised concern as to whether the plaintiffs met their burden of proof.

Ultimately, the court held that the value conferred to World View was not grossly disproportionate to the benefit received.²⁰ Based on the expert testimony, the parties agreed that the fair market value of the building parcel was $14 million as of the commencement date of the lease, while the net present value of the rent payments over the 20-year lease was $11,725,000 (roughly 85 percent of the fair market value of the building parcel).²¹ Although not a dollar-for-dollar exchange, the court held it was not grossly disproportionate, and therefore permissible under the Gift Clause. Interestingly, within this analysis, the court determined that any tax savings realized by World View were indirect benefits not considered.²² While the superior court’s decision in Rodgers provides additional clarity, it is still subject to possible appeal.

Going forward, companies and government economic development departments may want to consider working closely to clearly identify the “consideration” from both parties and memorialize that consideration into definite terms to support the agreement. As reflected by the trial court, the facts matter and objective analysis (using multiple economic testing tools) may be necessary to alleviate a Gift Clause concern. Based on the risks associated with miscalculating the Gift Clause (to both individuals involved and the city, county or state agency), clarity will likely need to be provided by the parties to development transactions.