Volume 18, Number 6
STATE AND LOCAL GOVERNMENT LAW
Going Forward with Public-Private Ventures
A Lesson from Ohio
By Stephen J. Smith and J. Corey Colombo
Local government officials are generally elected or hired with the goals of improving neighborhoods, developing and planning new projects to improve infrastructure, attracting more residents to their public entities, and working with local businesses and developers to get projects done. Despite these good intentions, officials must be mindful of state constitutional provisions that could impact how they proceed with development projects with private entities. In a recent Ohio Supreme Court opinion, the court handed down a decision that serves as a warning to local governments in Ohio: Some public-private ventures will be held unconstitutional if certain circumstances do not exist. This decision could be used as a guide for other state courts in considering similar constitutional prohibitions.
In C.I.V.I.C. Group v. City of Warren, the Ohio State Supreme Court held that the public-private financing dynamic in a residential subdivision development project was unconstitutional. The court based its decision on Article VIII, § 6, of the Ohio Constitution, which prevents any county, city, town, or township from "becom[ing] a stockholder in any joint stock company, corporation, or association whatever; or to raise money for, or to loan its credit to, or in aid of, any such company, corporation, or association."
Article VIII, § 6, is a state constitutional provision dating back to 1851, which was originally adopted to prohibit political subdivisions of the state from financing the construction of railroads, turnpikes, canals, and similar enterprises. It was created as a result of private companies that dipped into public funds for risky business schemes. The framers of the constitution intended to prevent municipalities from entering into the general public utility business outside their boundaries, in competition with private enterprise. In the modern era, city council officials and developers in Ohio must be mindful of this provision when engaging in joint ventures. The supreme court has interpreted this provision to prohibit a public entity from being the owner of part of a property that is owned and controlled by a corporation or individual. A union of public and private funds or credit, each in aid of the other, is forbidden.
In C.I.V.I.C. Group, a realty company desired to develop 100 acres in Warren, Ohio, into a subdivision of single-family residences. In response to the developer's requests, the city passed several ordinances to assist in the construction of a new street, sewers, water lines, and other improvements to the property. In conjunction with the passage of one of the ordinances, the city entered into a reimbursement agreement with the developers, whereby the developers would repay 80 percent of the costs within 15 years regardless of how many residences were sold. The city also paid advertising costs, permit fee costs, and legal expenses, as well as a portion of the engineering costs.
Plaintiffs, C.I.V.I.C. Group, a private association, and its members, residents, taxpayers, and property owners, brought an action alleging that the ordinances and reimbursement agreement were unconstitutional. Plaintiffs argued that the ordinances and agreement constituted a loan and gift of public funds to private corporations in violation of Article VIII, § 6. The supreme court agreed with plaintiffs that the city had "raised money for" and "loaned its credit or in aid of" a private corporation, in violation of Article VIII, § 6.
The city argued that Article VIII, § 6, was not implicated because the street and other improvements were dedicated for public use and were city property, and that the construction of streets and utilities was a valid governmental function. Even though the supreme court recognized a municipality's ability to construct streets and improvements, it failed to find any security for the public funds being used in the agreement that was reached between the city and the developers. The court held that under a normal financing plan, the new owner would be responsible for the special assessments, thereby ensuring "that in case of non payment, the municipality has a method to recover its costs."
The court noted that it is generally the developers that would put in the streets and utilities, and recover the cost in the price of each lot sold in the development. Here, however, there was no assessment to the property owners when the lots were sold, and the developers still planned to realize the profits on the lots. Moreover, the city was paying 20 percent of the construction bill and financing the remainder of the developer's costs, and paying advertising costs, permit fees, legal expenses, and a portion of the engineering costs. In this case, if the court agreed with the city, an insolvent bankrupt corporation could leave the city without a remedy to collect on outstanding debts. The court concluded that this method of repayment places taxpayers' funds at risk. The court stated, "If the project fails, the taxpayers are saddled with debt. This is what Article VIII, § 6, was intended to prevent."
The city also argued that the finance agreement was exempt from § 6 by way of Article VIII, § 13, which allows a public and private entity to engage in industry and commerce as partners if the relationship furthers a public purpose. A public entity can avoid having ordinances and agreements struck down if a benefit exists to the city following the construction. A court must make its determination by focusing on the "activities that would occur once construction is complete rather than those occurring during the construction itself." If, however, the court fails to find a benefit to the city, the court "will not stretch the narrow exception found in § 13, Article VIII."
In C.I.V.I.C. Group, the lower courts did find such a benefit to exist, and held that § 13 applied to the construction project. The court of appeals held that a political subdivision can loan public funds to for-profit corporations when the funds will be used for the construction of property improvements that will "benefit the industry and commerce of the state." The supreme court reversed, and took a much narrower view of the "benefit to industry and commerce" clause. It held that the construction of a "street containing two cul-de-sacs and related improvements does not meet the definitions of industry and commerce. Once construction is complete, no one is benefited except the residential property owners." As a result, the city's financing of the construction of the street and reimbursement agreement and its enabling ordinances were unconstitutional.
As with any rule or constitutional provision, there are exceptions. In many respects, several of the exceptions that exist in Ohio's constitution for public-private ventures "swallow the rule" established in Article VIII, § 6. For example, Article VIII, § 14, allows the state to issue bonds for multi-unit housing for persons over the age of 62 and for single-family, owner-occupied dwellings. Article VIII, § 16, permits the state and political subdivisions to make grants, loans, subsidies to loans, loans to lenders, purchase of loans, and guarantees of loans to aid the housing industry in Ohio, and permits the state to issue bonds for that purpose.
In conclusion, in Ohio, courts will closely review business relationships that exist between a public and private entity. Based on C.I.V.I.C. Group, if a public entity contributes payment for and financing to a development project, the city is taking action to "raise money for" and "loan its credit to" private corporations in violation of Article VIII, § 6. In C.I.V.I.C. Group, the court stated that "[a]lthough times may have changed, the reason for the existence of Section 6, Article VIII is as valid today as it was in 1851. Its purpose is to prohibit private interests from tapping into public funds at the taxpayers' expense."
Stephen J. Smith is the Law Director for the City of Dublin, Ohio, and member of Schottenstein, Zox, Dunn. He chairs the firm's public law practice area. J. Corey Colombo is an associate at Schottenstein, Zox, Dunn.
This article is an abridged and edited version of one that originally appeared on page 10 of State and Local News, Winter 2001 (24:2).