Whether A Municipality Creates Indebtedness When It Enters Into A Lease Purchase Agreement As Part Of A Performance-Based Energy Contract

MUNICIPALITIES—DEBT (GOVERNMENTAL)—LEASES—ENERGY—Whether A Municipality Creates Indebtedness When It Enters Into A Lease Purchase Agreement As Part Of A Performance-Based Energy Contract

An equipment lease purchase agreement under which a municipality is not required to make payments entered into by a municipality relating to a performance-based energy contract under RCW 39.35A would likely not constitute indebtedness for purposes of the municipality’s constitutional debt limit, though each lease would need to be analyzed on its specific facts. Such a lease likely would, however, create debt for purposes of the municipality’s statutory debt limit, depending upon the statutory treatment of the municipality and the specifics of the agreement.

March 30, 2016

Dear Representative Dunshee:

            By letter previously acknowledged, you have requested our opinion on the following paraphrased question:

Does a municipality create “indebtedness” within the meaning of article VIII, section 6 of the Washington Constitution, or under applicable statutes, when it enters into a performance-based energy contract pursuant to RCW 39.35A and a related equipment lease purchase agreement that does not obligate the municipality to make payments under the equipment lease purchase agreement if the municipality does not appropriate money for that purpose?

BRIEF ANSWER

            Current case law makes it impossible to provide an across-the-board answer to this question with any certainty, and we believe that any such contract would need to be carefully analyzed on its own terms to resolve the issue under current law. That said, we can provide some general principles to help guide such an analysis. Our answer distinguishes between a municipality’s constitutional debt limit and its statutory debt limit.

            As to the constitutional debt limit, if the contract imposes no legal obligation on the municipality to make payments, we believe that the contractual relationship likely would not

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create municipal debt. We caution, however, that each contractual arrangement would have to be analyzed on its own facts.

As to the statutory debt limit, the answer to your question would turn upon both the specific contractual arrangement and the nature of the statutory authority under which the municipality enters into that arrangement. Each type of municipality authorized to enter into contracts under RCW 39.35A would need to analyze its specific authority to enter lease agreements. In the case of cities and counties, this could include constitutional authority, but in all cases it would include considering whether any specific statute regulates what qualifies as debt for purposes of such an entity’s statutory debt limit. In each of the examples we have located, the legislature has treated municipal lease purchase agreements as creating municipal debt as a matter of statute, at least in part. In such circumstances, we conclude that an agreement of the type you ask about would likely create debt for purposes of the municipality’s statutory debt limit, even if not for purposes of its constitutional debt limit.

BACKGROUND

            State law authorizes municipalities to negotiate performance-based energy contracts with private contractors selected through a competitive selection process. RCW 39.35A.010, .030.[1] For this purpose, “municipalities” include counties, cities, towns, and a wide range of other local  government entities. RCW 39.35A.020(3) (defining “municipality” by reference to RCW 39.04.010).[2] The legislature has described “performance-based energy contracts” as constituting “a means by which municipalities can achieve energy and water conservation without capital outlay.” RCW 39.35A.010(3) (setting forth a legislative finding).

            The legislature has defined the term “performance-based contract” to mean, as related to energy conservation:

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[O]ne or more contracts for . . . energy equipment and services between a municipality and any other persons or entities, if the payment obligation for each year under the contract, including the year of installation, is either: (a) Set as a percentage of the annual energy cost savings . . . attributable under the contract; or (b) guaranteed by the other persons or entities to be less than the annual energy cost savings . . . attributable under the contract.

RCW 39.35A.020(4). State law establishes a competitive selection process through which potential contractors can submit proposals for the opportunity to negotiate a performance-based contract with a municipality in response to a published announcement describing the scope and nature of energy equipment and services required by the municipality. RCW 39.35A.030. The general idea is that municipalities may enter into performance-based contracts under which the municipality reduces its energy consumption, paying for any necessary equipment and services out of the cost savings achieved through the energy savings.

            You explain in posing your question that these transactions are often structured through two agreements. The first agreement is an energy services agreement between a municipality and an energy services company, in which the energy services company agrees to provide and install certain energy improvement measures for a contracted price. Under this agreement, the energy services company generally guarantees the amount of energy savings to be delivered, and agrees to monitor and report on those savings. The municipality agrees to a contract price, which the energy services company guarantees will not exceed a stated maximum. If the guaranteed savings are not achieved, the energy services company is obligated to pay the municipality the value of the guaranteed energy savings not achieved.

            The second contemplated agreement is an equipment lease purchase agreement between the municipality and a bank or other financer. Under this agreement, the bank provides the funds to acquire any necessary equipment, which the bank then leases to the municipality. The municipality then makes rental payments to the bank under the lease. At the end of the lease term, title to the equipment passes to the municipality for little or no additional consideration. Your question specifically concerns lease purchase agreements that contain a clause under which the municipality can stop making lease payments if it declines to appropriate funds for those payments. If that happens, the equipment is returned to the bank and the municipality has no further obligation to pay.

ANALYSIS

            You ask whether a municipality incurs debt within the meaning of article VIII, section 6 of the Washington Constitution or applicable statutes by entering into the agreements described above. We conclude that such agreements likely do not constitute municipal debt subject to constitutional debt limits, assuming that the applicable contracts do not obligate the municipality to make future payments. Const. art. VIII, § 6. The application of statutory debt limits is more nuanced, and depends upon the municipality’s authority under the statutes applicable to that type

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of municipality and that specific agreement, as well as upon the specific terms of the applicable agreements. In the statutory examples we have identified, the legislature has treated municipal lease purchase agreements as constituting debt at least in part, and in such circumstances the municipality’s debt limit would apply to the agreement. This does not mean that a municipality is barred from entering into performance-based energy contracts that include lease purchase agreements, but it does mean that such lease purchase agreements would constitute debt and therefore would be valid only if the municipality remains within its statutory debt limit or receives voter approval to exceed that limit. RCW 39.36.020.

            The Washington Constitution generally limits the debt of counties, cities, school districts, and other municipal corporations to no more than one and one-half percent of the value of taxable property within the municipality. Const. art. VIII, § 6. A municipality can exceed this limit with the approval of a three-fifths vote of its electorate, but even with voter approval the debt cannot exceed five percent of the value of its taxable property. Const. art. VIII, § 6.

            The legislature has established a separate statutory debt limit that varies depending on the type of municipality at issue. The statute generally prohibits municipalities from becoming “indebted in any manner to an amount exceeding three-eighths of one percent of the value of the taxable property in such taxing district[.]” RCW 39.36.020(1).[3] That three-eighths limit applies unless the statute specifies a higher limit for a particular type of municipality, as it does for public hospital districts, counties, cities, and towns. RCW 39.36.020(2), (3). The highest statutory debt limit applies to counties, cities, and towns for which the statutory and constitutional debt limits are the same, except that the statutory debt limit more narrowly restricts debt that can be incurred with voter approval. Const. art. VIII, § 6; RCW 39.36.020(2)(a)(ii). Each type of municipality may exceed the statutory debt limit with three-fifths voter approval, up to further statutory limits that apply even with voter approval. RCW 39.36.020. Any contract made that incurs debt above the debt limit “shall be absolutely void and shall never be the foundation of a claim against a [municipality].” RCW 39.36.040.

            The purpose of a debt limit is to prevent a municipality from “saddling current and future taxpayers with an unmanageable tax burden to support” various ventures that turn out, in retrospect, to be unwise. In re Bond Issuance of Greater Wenatchee Reg’l Events Ctr. Pub. Facilities Dist., 175 Wn.2d 788, 795, 287 P.3d 567 (2012). Debt limits “were enacted to protect future taxpayers from the kind of improvidence that led to state and local government bankruptcies in the 19th century.” Dep’t of Ecology v. State Fin. Comm., 116 Wn.2d 246, 257, 804 P.2d 1241 (1991).

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            State law grants all municipalities the authority to enter into performance-based energy contracts. RCW 39.35A.030. The statutory chapter governing performance-based energy contracts, however, does not address the manner in which such contracts are structured and makes no reference to lease purchase agreements or whether such agreements would be considered debt. See generally RCW 39.35A. We therefore must look well beyond RCW 39.35A to answer your question, as your request recognized.

            We first consider the constitutional debt limit and conclude that if the municipality is not obligated to make payments under the specific terms of the agreement, it likely incurs no debt for constitutional purposes. Two decisions of the Washington Supreme Court lead us to this conclusion, though both were fractured opinions and thus provide less than certain guidance.

            In the first case, the Court held that a particular lease purchase agreement entered into by the Department of Ecology did not create debt subject to the constitutional debt limit. Dep’t of Ecology, 116 Wn.2d at 254. The plurality reasoned in part that no debt was created because the agreement included a non-appropriation clause under which the State did not pledge its full faith and credit and was not obligated to continue making payments. Id. at 254-55 (“Under DOE’s plan the nonappropriation clause and the express language of the lease and trust agreements make it clear that there is no obligation on the part of the State to appropriate any funds in connection with the lease agreement. . . . There is nothing in the lease agreement or the financing scheme that binds the State to any future course of action. Therefore, there is no ‘obligation’, and no ‘debt’.” Id. at 255 (citation omitted).). The plurality also cited a statute, RCW 39.94.030, that made clear the legislature’s intent “that this financing plan does not amount to debt” under the constitution. Id. at 253. The concurrence emphasized the narrow nature of this holding, pointing to a wide range of factors that led it to conclude that the agreement at issue did not create debt, including the statute and the fact that Ecology “may vacate the leased premises without further liability in the event the Legislature determines not to continue funding.” Id. at 261 (Guy, J., concurring).

            In the second case, the Court summarized its precedent as to what does, or does not, constitute debt in terms of where the risk of loss lies in any particular transaction. “Nearly all of our public debt doctrines and decisions can be explained by determining who bears the risk of loss in the underlying obligation.” Greater Wenatchee Reg’l Events Ctr., 175 Wn.2d at 797. That is, “[n]early every time we have determined that ‘debt’ exists, the obligation in question places the risk of project failure on the taxpayer (independent of the consideration received) rather than the creditor or bondholder.” Id. And “[c]onversely, where the risk of project failure lies not with the taxpayer but with the creditor or bondholder, we have found that there is no debt.” Id. (citing Dep’t of Ecology, 116 Wn.2d at 257-58). While this decision articulates a “risk-of-loss” rule, only four justices joined the majority’s reasoning, with one Justice concurring solely in the result, making it unclear whether the “risk-of-loss” rule is really the controlling principle in Washington.

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            While these fractured decisions make it difficult to say with confidence how the Court would address a future debt-limit case, we think the better view is that where a municipality is under no obligation to continue making payments, as assumed in your question, the municipality creates no debt for constitutional purposes. We should note that this conclusion is debatable, not only because of the fractured opinions but also because the Court’s analysis in Department of Ecology turned in part on RCW 39.94.030(4), which in the context of state contracts expressed a legislative intent not to create debt. Dep’t of Ecology, 116 Wn.2d at 257. Here, there is no similar provision. That said, the Court’s focus on debt as an ongoing obligation to pay, coupled with the Court’s later decision in the Greater Wenatchee case, lead us to conclude that a contract like the one you describe would likely not be treated as creating debt for constitutional purposes.

            One possible way to make such a contract less likely to create debt for constitutional purposes would be to make clear that the only possible source of payment to the lender would be from energy savings achieved by the improvements financed by the lender. Under that approach, a municipality could argue not only that it created no debt under the “risk-of-loss” rule, but also that it created no debt under the more longstanding “special fund doctrine,” which generally holds that “obligations payable solely from nontax revenue deposited into special funds do not constitute a debt.” Greater Wenatchee Reg’l Events Ctr., 175 Wn.2d at 813 (Fairhurst, J., dissenting) (internal quotation marks omitted); see also id. at 797-98 (majority op.) (recognizing special fund rule). Our point is not that such an arrangement would be certain to make such a contract create no debt, but rather that the more steps a municipality can take to make clear that there is no ultimate obligation on future taxpayers to repay funds, the less likely that a court would be to treat the contract as creating debt for constitutional purposes.

            This analysis highlights a crucial point. Ultimately, whether any given contract creates debt for constitutional purposes will turn on the precise language of the agreement. While a clause making clear that the municipality is not obligated to continue payments if it does not appropriate funds (what your request calls a “non-appropriation clause”) would be one strong indication that no debt was created, a court would presumably look at the contract as a whole to make that determination. And several features of the contract could affect the analysis, including, for example, the point just noted: if the contract limited the sources of funds the municipality would use to make payments.

            This brings us to the question of whether the arrangement might constitute debt for purposes of the municipality’s statutory debt limit even if it is not debt for purposes of the constitutional limit. Here again, we think the answer would turn in large part on the specific language of the agreement, but we think the ultimate result in most cases is more likely to be that such contracts would create debt for statutory purposes.

            Several statutes authorize either all municipalities, or selected types of municipalities, to enter into lease purchase agreements. All of them, however, treat those lease purchase agreements as creating debt, at least in part. We discuss each of them in the following paragraphs. The bottom line is that because all of the statutes treat lease purchase agreements for

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municipalities as creating debt, we conclude that such agreements do generally create debt for purposes of the municipality’s statutory debt limit, although whether any particular lease-purchase agreement creates debt would still turn on the details of that agreement. Cf. Dep’t of Ecology, 116 Wn.2d at 253 (concluding that a lease purchase agreement entered into by the State did not create debt, based in part upon a statutory declaration to that effect).

            The first statute applies to all municipalities, including counties, cities, towns, and special districts. RCW 39.94 authorizes the State to “enter into financing contracts for itself or on behalf of an other agency for the use and acquisition for public purposes of real and personal property.”[4] RCW 39.94.030(1). The types of “other agency” on behalf of which the State may enter into such a contract include municipalities authorized to enter into performance-based energy contracts. RCW 39.94.020(4) (defining “other agency” similarly to the definition of “municipality” in RCW 39.04.010). RCW 39.35A.010 authorizes municipalities to enter into performance-based energy contracts. Read together, RCW 39.35A.010 and RCW 39.94.30 authorize a municipality to use a lease purchase agreement entered into by the State on behalf of the municipality as a vehicle for entering into a performance-based energy contract.

            The contrast between financing contracts entered into by the State on its own behalf and those entered into by the State on behalf of a municipality suggests that for municipalities, financing contracts entered into under RCW 39.94.030 constitute debt. By statute, financing contracts entered into by the State on its own behalf “do not constitute a debt or the contracting of indebtedness under any law limiting debt of the state.” RCW 39.94.030(4)(a). The legislature further explained that, “[i]t is the intent of the legislature that such contracts also do not constitute a debt or the contracting of indebtedness under Article VIII, section 1 of the state Constitution.”[5] RCW 39.94.030(4)(a). When the State enters into a financing contract on behalf of a municipality, however, the statute contains no parallel declaration that such a contract does not constitute municipal indebtedness. RCW 39.94.030(4)(b).

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            Because the statute expressly provides that a financing contract entered into by the State on its own behalf is not debt, but makes no similar statement regarding a financing contract entered into on behalf of a municipality, the legislature presumably intended that a municipality’s lease purchase agreement entered into under RCW 39.94.030(4)(b) is debt. Were this not the case, it would have been unnecessary for the legislature to provide that a state contract is not debt.[6] Statutes are construed to give effect to all words, which is best achieved if under RCW 39.94.030 a financing contract entered into on behalf of a municipality constitutes municipal indebtedness. See G-P Gypsum Corp. v. Dep’t of Revenue, 169 Wn.2d 304, 309, 237 P.3d 256 (2010) (statutes must be construed to give effect to all language).

            A second statute addresses only lease purchase agreements entered into by a city or town. RCW 35.42.200 authorizes any city or town to execute leases with or without an option to purchase. That statute specifies, however, that the portion of a lease purchase agreement allocable to principal shall constitute debt. It therefore provides cities or towns an alternative to asking the State to enter into a lease purchase agreement on its behalf under RCW 39.94.030, but if a city or town pursues this option the statute explicitly provides that such an agreement would create debt to the extent payments are applied to principal. RCW 35.42.200.

            A third statute applies to any county, city, town, metropolitan park district, or library district. RCW 39.30.010. That statute authorizes those types of municipalities to acquire property by contract, but only if doing so does not result in exceeding the statutory debt limit. Assuming, as the text of the statute suggests, that the contracts could include lease purchase agreements, this alternative again treats the contract as creating debt. RCW 39.30.010.

            We have identified only one other statute that authorizes municipal acquisition of property through lease purchase agreements. RCW 28A.335.200 authorizes school districts to enter into contracts for property acquisition. But again, as with the others, the statute treats such contracts as debt. RCW 28A.335.200.

            Because RCW 39.35A includes no explicit mention of lease purchase agreements, and because the statutes that address lease purchase agreements generally treat them as creating debt, we think it likely that a court would treat such agreements as creating debt, even if the agreement included what you term a “non-appropriation clause.” Though this conclusion is open to question, we think it is the most accurate reading of all that the legislature has said on the topic. See Dep’t of Ecology v. Campbell & Gwinn, L.L.C., 146 Wn.2d 1, 11, 43 P.3d 4 (2002) (statutes should be construed in light of all that the legislature has said in the statute and in related statutes).

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            That said, we recognize a possible counterargument that would distinguish counties, cities, and towns from other municipalities. Article XI, section 11 of the Washington Constitution gives broad legislative authority to counties, cities, and towns; they operate as general purpose local governments, and have the same powers as the legislature, unless the legislature limits their power. See, e.g., Snohomish County v. State, 97 Wn.2d 646, 649, 648 P.2d 430 (1982) (discussing breadth of county authority); City of Seattle v. Sisley, 164 Wn. App. 261, 266, 263 P.3d 610 (2011) (“First-class cities, including Seattle, are self-governing bodies, and the only limitation on their power is that their actions cannot contravene constitutional provisions or legislative enactments.”); City of Port Angeles v. Our Water–Our Choice!, 170 Wn.2d 1, 14 n.7, 239 P.3d 589 (2010) (discussing the broad authority of cities organized under the optional municipal code). In contrast, the powers of other municipalities are limited “to those expressly granted [by statute], those necessarily or fairly implied in or incident to the powers expressly granted, and those essential to its declared purposes.” Lane v. Port of Seattle, 178 Wn. App. 110, 117, 316 P.3d 1070 (2013). See generally Hugh D. Spitzer, “Home Rule” vs. “Dillon’s Rule” for Washington Cities, 38 Seattle U. L. Rev. 809, 809 (Spring 2015) (contrasting the authority of counties, cities, and towns with that of special purpose districts).

            Because of this dichotomy, the starting presumption is that counties, cities, and towns have direct authority to enter into lease purchase agreements unless the legislature has taken that power away, while other municipalities could only enter such agreements based on legislative authorization. Every instance of legislative authorization we have found treats such agreements as creating debt at least in part (see, e.g., RCW 28A.335.200, RCW 39.30.010, RCW 35.42.200), so any municipality relying on such authorization would have to comply with that statutory treatment. But if counties, cities, and towns need not rely on such statutory authorization, they could arguably characterize such agreements differently. This point is subject to two important caveats, however.

            First, whether the legislature has preempted counties, cities, and towns from entering lease purchase agreements in particular ways is a complex question beyond the scope of your opinion request. Any county, city, or town asserting ongoing inherent authority to enter such agreements would have to carefully analyze the relevant statutes (e.g., RCW 39.30.010, RCW 35.42.200), to evaluate whether those statutes limited its authority.

            Second, even if counties, cities, and towns are not preempted from entering lease purchase agreements beyond those authorized by statute, the relevant statutes governing lease purchase agreements (e.g., RCW 39.30.010, RCW 35.42.200) arguably preempt local governments from declining to treat them as creating debt. That is, a local government would need to consider not only whether the State has restricted its authority to enter a particular type of lease purchase agreement, but also the related question of whether the State has preempted its ability to decline to treat the contract as creating debt.

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            We recognize that this answer is frustratingly uncertain, but the complexity of the statutes at issue and the lack of any specific direction as to the treatment of such contracts in RCW 39.35A require caution. As to the statutory debt limit, it is important to note that the legislature could resolve this uncertainty. If the legislature provided that a contract like the one you describe would not constitute debt for purposes of the statutory debt limit, then that would be dispositive as a matter of interpreting the statutory debt limits. It would also provide greater certainty as to our answer regarding the constitutional debt limit, given the attention the Supreme Court paid to the statutory treatment of the contract in Department of Ecology, 116 Wn.2d at 257.

            We trust that the foregoing will be useful to you.

ROBERT W. FERGUSON

   Attorney General

JEFFREY T. EVEN

    Deputy Solicitor General

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[2]  The statute defines “municipality” to mean

every city, county, town, port district, district, or other public agency authorized by law to require the execution of public work, except drainage districts, diking districts, diking and drainage improvement districts, drainage improvement districts, diking improvement districts, consolidated diking and drainage improvement districts, consolidated drainage improvement districts, consolidated diking improvement districts, irrigation districts, or other districts authorized by law for the reclamation or development of waste or undeveloped lands.

RCW 39.04.010(3). We include counties in our references to “municipalities” because RCW 39.04.010 does so. Whether a county is a municipal corporation has more generally been a vexed question in Washington law. See AGO 2010 No. 10, at 3 (discussing case law and concluding that, in Washington, counties are regarded as municipal corporations).

[5]   Article VIII, section 1 of the Washington Constitution establishes the State’s debt limit, and is a counterpart to article VIII, section 6 for municipal debt.

[6]  See discussion of these provisions in Department of Ecology, 116 Wn.2d at 253-256, addressing the express statutory language providing that financing contracts do not amount to debt within the meaning of article VIII, section 1 of the Washington Constitution.