Sep 172013

Property Tax Abatement in Tennessee via PILOTs

On December 4, 2012, Metro Council passed an economic incentive for Nashville-based HCA Holdings, Inc. (“HCA”) that is estimated to total $66 million over 20 years and is one of the largest Metro Nashville has ever offered to a company. See “HCA incentives package sails through final council vote,” Nashville City Paper, December 4, 2012. One of the components of this package authorized the Industrial Development Board of the Metropolitan Government of Nashville and Davidson County (“Metro Nashville IDB”) to enter into a payment-in-lieu-of-taxes (PILOT) agreement for the benefit of West End Summit Development, LLC (the “Developer”) and the HCA affiliates known as Parallon Business Solutions, LLC, HealthTrust Purchasing Group, LP, and Sarah Cannon Research Institute, LLC (collectively, the “HCA Affiliates”). See Ordinance No. BL2012-297 (Matthews & Langster). The agreement provides for a one hundred percent (100%) real property tax abatement of up to $3 million per year for fifteen years, with an additional five year extension so long as an HCA Affiliate continues to occupy the project. If extended for five years, the total potential amount of the property tax abatement would be $60 million over the life of the agreement.

However, as of today, the project has stalled and HCA is reportedly exploring its options. See “HCA ‘exploring all options’ as West End Summit stalls,” Nashville Business Journal, September 13, 2013. Given this recent development, I thought I would go back and revisit what HCA stands to lose should this project fall through. This article will only review the PILOT terms of the HCA incentive package and outline how property taxes are abated in Tennessee through the use of PILOTs.

PILOTs – Generally

A PILOT agreement is, generally, an agreement that is used to transfer a public or local government’s tax exempt status to a private entity. The property is not on the local government’s tax rolls because it belongs to a tax exempt entity, even though the property is being leased to and used by a private entity, and the private entity receives the benefit of this tax abatement. These agreements are typically used by local governments as an incentive to induce the relocation of a new business or the expansion of an existing business in the community.

How They Work

The Metropolitan Government of Nashville and Davidson County (“Metro Nashville”) cannot directly abate property taxes for private entities as an absolute waiver of ad valorem taxes is illegal under the Tennessee Constitution. The Tennessee Constitution generally prevents local governments from directly abating property taxes stating that “all property, real, personal or mixed shall be subject to taxation.” See Tenn. Const. Art. II, § 28.

However, the Tennessee Constitution also recognizes that property owned by a local government can be exempt from taxation. See Id. Relying on this exemption, a property tax incentive program can be achieved by titling property in the name of the local government and then leasing the property back to the private entity. Ergo, the local government owns the property which is now exempt from property taxes and the private entity receives the benefit of this abatement.

Tax abatement agreements in Tennessee are generally implemented through industrial development boards (“IDB”s). Pursuant to the Industrial Development Corporations Act, codified at Tenn. Code Ann. §§ 7-53-101 – 316 (the “Act”), the State of Tennessee authorizes the incorporation of public nonprofit corporations, IDBs, by cities and counties in Tennessee. Under the Act, these IDBs have the authority to acquire, whether by purchase, exchange, gift, lease or otherwise, and to improve, maintain, equip and furnish, land or building “projects” in Tennessee, and to lease such projects to a private entity. Because IDBs serve a public function, these projects are therefore exempt from taxation. See Tenn. Code Ann. § 7-53-305. Therefore, the ownership interest in any property conveyed to an IDB and leased to a private entity will be exempt from property taxes.

Thus, in Tennessee, private entities may receive economic incentives through tax abatement agreements with IDBs. Through these PILOT agreements, projects are exempt from property taxes and instead make a payment-in-lieu-of-taxes.

To create an incentive through a bond-lease transaction, an IDB will issue industrial development revenue bonds to finance the acquisition, construction and development of a project that it will ultimately lease back to the private entity. Using the proceeds of the bonds that it issues, the IDB acquires title to the project to which the tax incentives will apply. The lease payments amortize the bonds and the private entity typically will own the project at the end of the lease. This is what has been proposed in the HCA incentive package.

HCA’s Incentive Package

In accordance with Ordinance No. BL2012-297, the Developer will enter into a PILOT agreement with the Metro Nashville IDB to lease the project who will in turn sublease 475,000 to 500,000 square feet of the project to the HCA Affiliates. As noted above, this PILOT agreement provides for a one hundred percent (100%) real property tax abatement f up to $3 million per year for fifteen years, with an additional five year extension as long as an HCA subsidiaries continues to occupy the office space. If extended for five years, the total potential amount of the tax abatement would be $60 million over the life of the agreement. The tax abatement would take effect upon the execution of the lease with the Metro Nashville IDB at the time the Metro Nashville IDB issues the industrial development revenue bonds required to finance the costs associated with this project.

After accounting for the $60 million tax abatement, Metro Nashville will still potentially net $17,599,215 in new real property taxes over the life of the PILOT agreement, plus approximately $2 million in additional personal property taxes.

Unique terms found in this PILOT agreement:

  • Section 3(a)(ii) & Section 3(c) – The PILOT Deduction and PILOT Deduction Credit. If the property taxes that would otherwise be owed to Metro Nashville fall below $3 million in a given year, the lessee will have the ability to “bank” the difference and apply it against PILOT payments in future years. This means that the HCA Affiliates would get the benefit of the full $3 million abatement per year even if the property value falls or the tax rate is lowered.
  • Section 3(a)(iii) – Job Benchmarks. It is required that a certain number of employees work in Davidson County as a result of the project in order for the HCA Affiliates to receive the full amount of the abatement. The job benchmarks are 1,000 full-time equivalents (“FTEs”) in 2016, 1,300 FTEs in 2017, and 1,500 FTEs in 2018 and subsequent years. Failure to meet these benchmarks would result in a $300,000 reduction in the amount of the abatement for every shortfall of 100 incremental positions. Employees that are currently working in Metro Nashville do not count toward the benchmark.
  • Section 5 – DBE Requirements. This is the first time a Metro Nashville PILOT ordinance would require the creation and implementation of a small, minority, and disadvantaged business program (“DBE Program”). The DBE Program must have a participation target of at least 20% of the project’s hard construction costs. The Developer will be required to make periodic reports regarding the DBE Program to the Metro Nashville council and the minority caucus.

Additional information on various PILOT programs in Tennessee:

Aug 222012

The Condo Hotel: The Worst of Both Markets

I stayed in a condo hotel this past weekend which you do not hear too much about anymore. Condo hotels tend to mainly be found near beach and mountain destinations. In Tennessee, they are primarily found near the Smoky Mountains in towns such as Gatlinburg, Pigeon Forge, and Sevierville.

In 2002, the Securities and Exchange Commission (SEC) issued a “no-action letter” which contained specific guidelines, or “safe harbors,” for how to market and sell a condo hotel product without engaging in the sale of a security under U.S. securities laws. Many developers viewed the letter as SEC guidelines on how to develop condo hotels and the result was an immediate boom in the industry. However, the condo hotel sector took a beating in the financial downturn (“the of the real-estate bubble”) and it has been dormant ever since.

At first glance a condo hotel appears to represent the best of both the residential and commercial real estate markets. A buyer owns the specific condo unit and pays the property taxes, insurance, and maintenance fees for it, while a management company rents out the rooms and splits the revenue with the owners (typically around fifty percent). Even though the buyer owns the condo unit, they are limited on how often they can use the unit. With taxes, insurance, maintenance fees, tough financing, and rental market fluctuations, condo hotels are actually one of the more dangerous investments. Thus, many condo hotels were unable to close on unit sales when the real estate bubble burst and prospective buyers were faced with these tough economic challenges.

Although not specifically addressed by the Tennessee Condominium Act of 2008, the formation of a condo hotel is similar to that of a standard condominium regime. They are created by a Declaration and normally accompanied by a set of bylaws. They typically also require the approval of a shared facilities agreement, a rental management agreement, and a unit maintenance agreement. The structure of the agreements, and the advertisements and representations made in the sales process, are important because at some point the buyer is no longer just purchasing real estate but is instead investing in a business enterprise triggering U.S. securities laws.

Aug 062012

Tennessee Court of Appeals: Unlicensed Contractors and the Importance of Contract Review

The Devil is in the details. In Friday’s opinion of Anchor Pipe Company, Inc. v. Sweeney-Bronze Development, LLC et al., the Tennessee Court of Appeals reviewed the priority of two liens, a mechanic’s lien and a bank’s deed of trust, filed in connection with development of the Enoch Hill subdivision in Gallatin, Tennessee. The Circuit Court for Sumner County awarded summary judgment to the bank and granted it priority over the mechanic’s liens. The Court of Appeals disagreed.

The Court of Appeals first addressed whether a contractor who contracts for work above the monetary limit applicable to his license is an “unlicensed contractor” for purposes of the Contractors Licensing Act of 1994, Tenn. Code Ann. § 62-6-101 et seq. This act requires persons or entities performing activities defined as “contracting” to have a license, and makes it unlawful for a person or entity to engage in contracting without a license. Tenn. Code Ann. §§ 62-6-101, 62-6-103(a). An unlicensed contractor is only permitted to recover actual documented expenses upon a showing of clear and convincing proof.

Traditionally, a contractor is unlicensed for purposes of Tenn. Code Ann. § 62-6-103(b) if the contractor does not maintain a valid contractor’s license throughout the entire time contracting services are performed under the contract. Kyle v. Williams, 98 S.W.3d 661, 666 (Tenn. 2003). In the present case, the contractor had a contractor’s license throughout its work on the project and this license authorized it to perform the type of work it performed (underground piping, grading and drainage, and base and paving work). However, the monetary limit on the contractor’s license was only $750,000, whereas its bids exceeded two million dollars. Thus, the bank argued that the contractor was unlicensed because it bid on and performed work in excess of the limits of its license. The Court of Appeals disagreed and drew a distinction between contractors who are completely unlicensed and those who have complied with the licensing laws and may in some manner violate the provisions or limitations of their licenses.

Even if the Court had found that the contractor was unlicensed, outside the context of single-family residential construction, the fact that a contractor is unlicensed does not result in forfeiture of the contractor’s lien in Tennessee. See Tenn. Code Ann. § 62-6-128.

The final issues reviewed by the Court of Appeals touched on the importance proper document review and execution.

In the first avoidable error, the developer failed to properly establish a subordination agreement with the contractor. While working on the bank loan, the developer asked the contractor via e-mail if it would subordinate its lien to the bank’s lien rights. In its response, the contractor stated it would sign a release. However, a release was never finalized. An agreement to agree to something in the future is generally not enforceable. Thus, the e-mails alone were not sufficient to establish a contract and the contractor’s lien was never properly subordinated to the bank’s lien rights.

In the second avoidable error, the bank identified the wrong grantor of the bank’s deed of trust meaning the deed was void and the bank did not properly perfect its security interest. Although the identified grantor was a wholly owned subsidiary of the parent company (the correct grantor to the bank’s deed of trust), there was nothing in the record to suggest that the identified grantor had acted on behalf of the parent company in executing the bank’s deed of trust. When an agent fails to reveal his status, he alone is bound as principal. The bank later corrected this error and identified the correct grantor but only after the contractor’s date of visible commencement of operations had occurred. Thus, the contractor’s lien once again took priority over the bank’s lien rights.