AN INTRODUCTION TO PUBLIC PRIVATE PARTNERSHIPS WITH UNCLE SAM

Transcription

1 AMERICAN COLLEGE OF REAL ESTATE LAWYERS 2003 ANNUAL MEETING OCTOBER 25, 2003 NEW ORLEANS, LOUISIANA AN INTRODUCTION TO PUBLIC PRIVATE PARTNERSHIPS WITH UNCLE SAM BY: DAVID L. MILLER, ESQ. SHAW PITTMAN LLP 1650 TYSONS BOULEVARD McLEAN, VA /17/02

2 AN INTRODUCTION TO PUBLIC PRIVATE PARTNERSHIPS WITH UNCLE SAM I. INTRODUCTION Uncle Sam is among the largest owners of real property in the world, with over 400,000 buildings and over half a billion acres of land. 1 Traditionally, real estate deals with the federal government have been highly structured. Federal agencies, however, can be flexible when they want to be. When they want to be flexible, federal agencies often turn to the principles of partnerships to loosen up the normally rigid federal contracting process, to align, as much as possible, the interests of the public and private sector parties, and to create longer term relationships. We can define a public private partnership as a lease or other contract 2 in which the interests of the parties are aligned in ways similar to those in a partnership. Literally, a partnership is the association of two or more persons to carry on as coowners a business for profit.... Delaware Revised Uniform Partnership Act, 6 Del. Code (a). 3 In some cases, the public and private parties may in fact enter into a partnership or become co-members in another form of entity, but in other cases, management controls, profit sharing and other terms are implemented in a lease or other vehicle. After a brief discussion of what motivates the government to partner with the private sector, I will review the two principal ways a public private partnership differs from a more traditional government contract: (i) in the process followed by the government and (ii) in the substance of the ultimate contract. After that, I will provide some examples of public private partnerships. 1 General Accounting Office, Public-Private Partnerships: Pilot Program Needed to Demonstrate the Actual Benefits of Using Partnerships, GAO (July, 2001), at page 3, at 2 I know, I know. A lease is not exactly a contract, or a least not only a contract, but the differences generally are not relevant for this article. Unless I otherwise indicate, when I say contracts I mean to include leases as well. If you want to get into the subtleties of the distinction between leases and contracts, write your own article. 3 A partnership also can be formed for non-profit purposes by persons so agreeing. 2

3 II. deal? FOLLOW THE MONEY What motivates an agency to enter a public private partnership instead of a traditional In a word, money. 1. Money Received by the Federal Government If an agency can reap the financial benefit of a creative deal, the agency will be much more likely to do the deal. In most cases, proceeds paid to the government from disposal of real property end up in the general fund of the United States Treasury or a federal conservation fund. In certain cases, though, agencies can retain and use the revenues they generate. In these latter cases, agencies are much more likely to partner with the private sector than agencies whose revenues go to the general benefit of other agencies Money Paid by the Federal Government On the other hand, if the agency incurs obligations in a transaction, its budget will be affected. If the agency is unduly penalized by a deal, it will avoid the deal. The most common penalty an agency can suffer is adverse budget scoring. 3. Budget Scoring In General One of the things that will stop a proposed public private partnership transaction in its tracks is adverse budget scoring of the transaction. The Office of Management and Budget or OMB has promulgated Circular No. A-11 (2003) 5 setting forth complex rules governing how leases or other contracts are scored against the budget of the contracting agency. Anything scored against an agency s budget in a given year must be included in the funds appropriated by Congress for that agency in that year. Without sufficient appropriations, an agency cannot enter into a contract Budget Scoring Capital Lease One of the key issues in budget scoring of public private partnerships arises when the partnership involves a lease under which the government is a tenant. In that case, OMB rules must be applied to determine whether the lease is an operating lease or a capital lease. These 4 General Accounting Office, Public-Private Partnerships: Key Elements of Federal Building and Facility Partnerships, GAO/GGD (February 1999), at page 11, at 5 Available at 6 Under the Anti-Deficiency Act, an agency official cannot enter into a contract in advance of appropriations or in excess of appropriations. 31 U.S.C See John E. Jensen, Quick Reference to Federal Appropriations Law (Management Concepts, 2002). 3

4 rules have similarities to the rules for distinguishing capital leases from operating leases under generally accepted accounting principles for non-government transactions. 7 Agencies like operating leases because the rent payments under operating leases generally are spread out and scored in each year when the rent is paid. The tenant agency only needs to include in its budget one year of rent in each of its budget years. Agencies do not like capital leases because the present value of all the rent that ever will come due is scored up front. 8 A determination that a lease is a capital lease easily can kill a deal. As defined by OMB, a lease to the government of an asset is a capital lease if it is not an operating lease (or a lease purchase); and a lease is an operating lease only if it meets all of the following criteria: 9 5. Legislation a. Ownership of the asset remains with the lessor during the term of the lease and is not transferred to the Government at or shortly after the end of the lease term. b. The lease does not contain a bargain-price purchase option. c. The lease term does not exceed 75 percent of the estimated economic life of the asset. d. The present value of the minimum lease payments over the life of the lease does not exceed 90 percent of the fair market value of the asset at the beginning of the lease term. e. The asset is a general purpose asset rather than being for a special purpose of the Government and is not built to the unique specification of the Government as lessee. f. There is a private sector market for the asset. Of course, money does not explain everything. In many public private partnership transactions there has been special legislation granting authority to enter a non-traditional transaction. It is not obvious that legislation is required in all cases, but a government agency will hesitate more than a little bit before entering into what it views as an unusual transaction in the absence of authority or at least precedent for such a transaction. 7 Accounting For Leases, Statement of Financial Accounting Standards No. 13 (Financial Accounting Standards Bd. 1976). 8 OMB treats a lease-purchase in a similar way to a capital lease under its Circular No. A OMB Circular No. A-11, Appendix B, page 6. 4

5 III. CONTRACTING PROCESS The traditional federal government contracting process is strict and cumbersome. In the traditional process, the government decides what it wants, writes a very detailed request for proposal or other solicitation document seeking bids from the private sector, picks the winning bidder, and enters into the contract on the terms prescribed by the government. The process, called the contract procurement, is very prescriptive, with the government as the prescriber. The federal government contracting process (and contract forms) are laid out in great detail in statutes and agency regulations, most notably the Federal Acquisition Regulation, 48 C.F.R et seq., which governs most government contracts. Regulations of the General Service Administration govern leases to the federal government. 48 C.F.R et seq. As noted in the excellent companion article by Joe Fries and Phil Horowitz, when the General Services Administration wants to lease real property for occupancy by federal agencies, it issues an extremely detailed set of procurement documents packaged as a Solicitation for Offer or SFO. There is relatively little room for negotiation by the bidding landlords from the prescribed government process and forms. In these lease SFOs, and more broadly in traditional federal government contract procurements generally, the government prescribes what the private party will provide, then seeks a private party to provide it. In contrast, in many public private partnership transactions, the government first focuses on who it wants, then works jointly with the selected private party, the contractor, to develop in more detail a statement of what the contractor will provide. In this sort of a public private partnership, the government issues a much less detailed procurement document. This approach has been advocated for many years 10 and used by the United States Postal Service, National Institutes of Health, Department of Defense and others, and recently has become much more prevalent as federal agencies move, from selecting contractors strictly based on the price bid for a specified scope of work, to selections of contractors based on the overall best value to the government, wherein price is not the sole factor in a selection. 11 IV. CONTRACT SUBSTANCE Public private partnerships can take a variety of forms. The government can take a true equity stake in an entity that will develop property: a true partnership (or more recently a limited liability company or LLC but that doesn t sound as poetic as a partnership). 10 See, e.g., Patrick J. Keogh and Kim McCarson, Procurement: The Enemy Within, Government Executive (August 1, 1997), at 11 See Michael W. Mutek, Implementation of Public-Private Partnering, 30 Public Contract Law J. 557 (2001). 5

6 The government can ground lease property it owns to a developer who agrees to pay an equity participation as part of the rent: economically similar to a partnership, but not a true partnership (or a true LLC). Or, a contract can include the sort of mutual, long term alignment of interests that mirror the relationship in a typical partnership. These forms can be understood best by a review of the more specific examples below. V. UNITED STATES POSTAL SERVICE 1. Yes, It s the Government Let s get one thing out of the way at the outset. The Postal Service is a part of the United States government, not a private company. Its enabling legislation, the Postal Reorganization Act of 1970, creates the United States Postal Service as an independent establishment of the executive branch of the Government of the United States U.S.C Like all other federal entities, the Postal Service has procurement regulations. The Postal Service, however, is set up to be more entrepreneurial than a more typical government agency. Perhaps most notably for our purposes, the Postal Service keeps the revenues it generates. Other federal agencies who must turn any revenues they generate over to the U.S. Treasury have very limited incentives to maximize revenues. By contrast, the revenue ownership of the Postal Service gives the Postal Service a powerful incentive to maximize revenues. 2. Surplus Properties Beginning in the 1980s, the U.S. Postal Service decided to partner with private real estate firms to redevelop the surplus properties it owned in prime locations in cities throughout the country. The properties included many huge mail sorting facilities, many of which are historic landmarks, located near train stations in prime downtown locations. Among the properties were the Grand Central Station Post Office in New York City, the Rincon Center in San Francisco, and the City Post Office in Washington, D.C. Over time, many postal operations had moved to suburban locations and these downtown locations seemed extremely valuable. The Postal Service could have simply sold the properties but decided that it would do best with long term leases in which it shared in revenues of the underlying project. In fact, the Postal Service earned hundreds of millions of dollars more by entering into long term leases than what it estimated it would have earned from sales. And, of course, at the end of the term of each lease, the Postal Service gets back the leased property Two of the Postal Service projects, and several other public-private partnerships, are described in General Accounting Office, Public-Private Partnerships: Key Elements of Federal Building and Facility Partnerships, GAO/GGD (February 1999), at 6

7 3. Contract Process In each of its earliest projects, the Postal Service issued a traditional Request for Proposal or RFP seeking bids describing in great detail the terms and conditions on which the private developer would be willing to lease the Postal facility for re-development. In these early stages, the Postal Service did not select a bidder until it had a very comprehensive set of terms and conditions for the engagement. It knew what the deal was before it engaged a developer. This called for a relatively extensive and expensive diligence and planning process by each bidding developer. In time, the Postal Service determined that the most significant factor for success of the outlease projects was not what the deal was but who the developer was. Sharing in the upside with the right developer would yield more for the Postal Service as partner than a deal that looked better on paper with the wrong developer. This allowed the bids to be much more abbreviated and inexpensive for the bidding developers and brought the successful developer and the Postal Service together at a much earlier stage of the process. In effect, the Postal Service, over time, became willing to select a developer at an earlier stage of the developer s design and business planning process. This is better for the bidding developers in that they have to spend less time and money to prepare their bids than if a complete set of plans and specifications and a comprehensive business plan were required. Of course, if the developer is selected on the basis of less detailed information, the government agency will want to maintain approval rights as the plans are being developed. 4. Contract Substance The Postal Service entered into long term ground leases with the private developers. In the earliest deals, the leases were for 99 years; in later projects, the terms dropped to as short as 30 years. In each project, the developer paid the Postal Service some minimum fixed rent plus a share of the revenues realized by the developer from the project. Throughout the planning and development of these projects, the Postal Service had a seat at the table as a partner as the design and business plans were developed, financed and implemented. In addition to a share of the cash flow, the Postal Service obtained facilities for use by itself or other agencies. Perhaps most notably, in the Washington City Post Office project, now known as Postal Square, the Postal Service reserved space for use as a retail post office as well as space for one of the most important museums of the Smithsonian Institution, the National Postal Museum, which now is located in the renovated historic building. VI. MILITARY HOUSING 1. The Statute The Army, Navy and Air Force Departments had over 150,000 obsolete and inadequate housing units for service men and women and their families all over the country when Congress enacted the Military Housing Privatization Initiative as part of the Department of Defense appropriations legislation for The statute initially was set to expire after just three years but now has been extended to the year 2012 and codified at 10 U.S.C et seq. 7

8 The statute is highly unusual for the breadth of authorities it grants to facilitate the renovation and construction of housing for the military. To facilitate military housing, the military departments can, among other things, sell or lease their real estate to private developers; lend money; guarantee loans to military housing developers; invest in private entities; guarantee rent against base closures or other events; and subsidize rents. Like the Postal Service, but unlike most other agencies, each military department can keep the revenues generated from its sales or leases and apply the revenues to facilitate military housing. After a bit of a slow start, the military departments have awarded contracts for construction or renovation of over 30,000 housing units with more than an equal number to come. The awarded contracts cover military bases from all three of the military service departments, the Army, Navy and Air Force, and for bases all over the country, including in Texas, Washington, California, Louisiana, South Carolina, Georgia, Alaska, Ohio, New Mexico, Colorado, Maryland and Virginia Contract Process At first there was a central office within the Department of Defense office, the Housing Revitalization Support Office, that was set up to provide expertise and help coordinate housing privatization. Over time, each of the military service departments has developed its own process for military housing projects. The Army s Residential Communities Initiative, follows processes that derive in part from the Postal Service s process, with a focus, especially in the early stages of a procurement process, on the quality of the developer. The Army has used a two-step procurement process. In the first step, the service issues a Request for Qualifications or RFQ. The RFQ is a much slimmer solicitation than an RFP. The RFQ focuses on the qualifications of the bidders, especially the track record of the bidders on similar projects. In the second step, the service allows a small group of selected developers to bid on the actual contract for specified housing projects with the bidders providing more details of a project and business plan. Once the award is made, the service and the selected developer for a given project work together to develop and approve a more detailed business plan, which the Army calls the Community Development and Management Plan. 14 The other services also have focused on the development partner in the early stages of the procurement, with more project details developed in cooperation with the developers. The Air Force Center for Environmental Excellence coordinates housing privatization for that service department. 15 The Navy Housing is coordinated by the Naval Facilities Engineering Command Office of the Deputy Under Secretary of Defense (Installations and Environment), at 14 United States Army, Residential Communities Initiatives, at 15 Air Force Housing Privatization, at 16 Navy Housing, at 8

9 3. Contract Substance Given the broad authorities of the statute, there is no one fixed model for these projects. In a number of deals, the military service has leased real estate to a limited liability company in which the military service itself is one of the members along with a private sector development partner. The LLC then grants a leasehold mortgage (or similar security) to secure financing that will pay for construction and other project costs and the LLC builds and operates the housing in accordance with specifications provided by the military. At the end of the lease term, the property reverts to the government. In most cases, the improvements are conveyed to and owned by the LLC during the lease term and so the mortgage is in part a fee mortgage, as to the improvements. Each housing unit is available for lease (or in a sense, sublease) to a service man or woman. Under certain conditions the units not leased to service members can be leased to the general public. Each service member receives an amount called the basic allowance for housing or BAH which is available for the payment of rent. The BAH varies in amount based on the rank or pay grade of the military member, indexed for differences in housing costs from place to place. The combined total of all of the rent allowances of these tenant service members is available to pay rent. The rent is available to pay debt service on financing for the construction of these housing units and other project costs. With appropriate due diligence and protections, credit enhancement can be obtained for debt secured by a military housing project. If structured properly, it is possible to obtain a favorable rating from credit rating agencies, and lower interest rate and related capital costs than with traditional bank debt, for debt secured by military housing projects. 4. Budget Scoring The simple sale or lease of property owned by the government is not scored against the budget of the agency involved. The use of one or more of the broad authorities granted in the Military Housing Privatization Initiative, however, does require a budget scoring analysis. Cash investments by a military service as a member of a venture are easy: they are scored at 100% of the cash invested. Much more complex are guarantees of debt. Military services may guarantee debt against all risks, or just against more specific risks such as the risk of base closure. In any case, a portion of the guaranteed debt will be scored against the budget of the guarantor military service. The scored portion is determined by OMB and the military services. 9

10 VII. SOUTHEAST FEDERAL CENTER In addition to the multi-project programs discussed above, there have been a number of one-off public-private partnerships. One large project under way is the Southeast Federal Center in Washington, D.C The Site The Southeast Federal Center is an approximately 44 acre site along the Anacostia River, within a mile of the United States Capitol building. The site had been part of the U.S. Navy Yard and now is largely undeveloped. The remaining balance of the Navy Yard and other nearby properties are undergoing extensive redevelopment. 17 A detailed description of the project, and the full text of the RFP and RFQ, are available at 10

11 Recognizing the importance and development potential of the site, Congress enacted the Southeast Federal Center Public-Private Development Act of giving the General Services Administration broad authority: to enter into agreements (including leases, contracts, cooperative agreements, limited partnerships, joint ventures, trusts, and limited liability company agreements) with a private entity to provide for the acquisition, construction, rehabilitation, operation, maintenance, or use of the Southeast Federal Center.... GSA could have simply offered the property for sale to the highest bidder but instead has worked with other federal and District of Columbia government agencies in an effort to assure that the project is developed in a way that will meet the broader public interest. 2. Land Use and Other Laws These agencies have developed a land use and zoning plan that will guide future development. As federally-owned property, the local zoning ordinance does not now apply but, if the site is sold, the local zoning kicks in and so the zoning framework being developed now will apply to future development. In addition, the site includes several historic or potentially landmark structures. Also, like many former other former military installations, the site raises environmental issues. 3. Contract Process GSA is using a two-step procurement process. In the first step, it issued a Request for Qualifications. The RFQ focuses primarily on the skills and experience of interested developers, and secondarily on each bidding developer s general vision and strategy for development. From this step, the most highly qualified developers were placed on a short list of bidders eligible to participate in the second step. In the second step, GSA issued a Request for Proposal, seeking more detailed bids, including land use plans a financial offer for a sale, and a separate offer for a lease. These bids are due shortly. 4. Contract Substance As contemplated in the RFP, the transaction structure will involve the government conveying or leasing the site in three phases to the selected developer, with the government retaining a participation in sales or refinancing proceeds and with the government continuing to have a role in the design and development of the project which is anticipated to take many years. 18 Public Law , 114 Stat

12 VIII. FEDERAL PROPERTY ASSET MANAGEMENT REFORM ACT OF 2003 On the late breaking news front, new legislation is pending that would amend the Federal Property and Administrative Services Act of 1949, 19 the venerable principal legislation governing management of federal properties. The amendments, which if enacted would be called the Federal Property Asset Management Reform Act of 2003 (the PPP Act ), would allow GSA and other federal agencies that hold real property to apply more modern and flexible business practices in management and disposal of their properties. 20 The new contract authorities are similar in some respects to those in the Military Housing Privatization Initiative. 1. Enhanced Asset Management Tools The PPP Act would allow agencies to use what the Act would call enhanced asset management tools including public private partnerships with the private sector and other flexible acquisition and disposition structures. The structures can include sale-leasebacks and the government can receive not just cash but other property in exchange for any property it sells or leases Local Law The PPP Act also very specifically would address an issue that arises in most public private partnerships, whether the partnership must comply with local zoning and building codes and similar state or local laws. Under the PPP Act, if the federal agency does not retain authority over any decision to construct or alter buildings then the partnership must comply with the state and local laws. Otherwise, the federal agency must consider the state and local laws but in the end the federal agency has discretion to determine to what extent it will comply. 22 It s good to be the sovereign. 3. Proceeds Perhaps most significant in bringing federal agency conduct into modern business world practices is the treatment of proceeds. Like the other examples discussed above but unlike the normal rule where proceeds go into the general fund of the United States Treasury, the new legislation would credit to the real property holding agency the proceeds from any dispositions or other transactions under the statute. This would give agencies a much more direct incentive to maximize returns, acting in a more business-like manner U.S.C. subtitle I. 20 Federal Property Asset Management Reform Act of 2003, House Resolution 2548, 108 th Congress, 1 st Session. 21 PPP Act PPP Act 624(d)(7). 23 PPP Act

13 4. Budget Scoring In a number of deals, the government has leased property to a private entity which obtained financing, constructed improvements and leased-back some or all of the improved property to the government. As noted above, under the OMB scoring rule, this lease back would be a capital lease. The PPP Act would include a rule that would trump the OMB rule that a lease-leaseback of property on government land is a capital lease. Under the PPP Act, if the government agency leased property on government land from a private venture in which the private partner exercised management control and held a majority interest, the property would not be deemed to be constructed on government-owned land for purposes of the OMB scorekeeping rules and thus not a capital lease (assuming the other operating lease criteria were satisfied). 24 IX. CONCLUSION Public private partnerships are where public values meet the business approach of the private sector. It will not always be easy but federal agencies will increasingly look to public private partnerships for creative ways to meet the needs of the government, consistent with the public trust. 24 PPP Act