Transit Public-Private Partnerships: Legal Issues (2014)

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33 utes are “ineffective vehicles for public-private partnerships given provisions that create risk and uncertainty.”398 Some state laws impose signifi- cant restrictions on the ability of partners to en- gage in effective PPP arrangements, such as pro- hibiting the use of certain types of contracts. Some state statutes prohibit or restrict the use of DB contracts, revenue sharing, innovative fi- nancing methods, or the use of performance-based contracts.399 State competitive bidding laws also may be a barrier to DB-type contracting. State competitive bidding laws generally require that a contract be awarded to the lowest responsible bidder, thus preventing “a combined price plus qualifications procurement.”400 Other types of con- tracts common to PPP projects may be prohibited in some states for use in public procurement.401 Although many states authorize DB contracts to some extent, they may not authorize long-term leases or permit innovative financing arrange- ments. There is considerable variety in the states’ ap- proach to the use of PPPs. Some states may au- thorize PPPs only for a small number of specific projects (e.g., LAX/Palmdale); authorize their use by particular agencies (e.g., Louisiana Transpor- tation Authority, Los Angeles Metro, Maryland Transportation Authority); or permit their use by multiple agencies (e.g., California, Delaware, Ne- vada, Virginia, and Washington).402 Other possible impediments under state law to the use of PPPs include state bonding require- ments for public contracts.403 State franchise laws may preclude private operation of a public transit agency.404 Conflict of interest laws may prohibit a firm that handled a project’s design from entering into a construction contract for the project.405 State law may require the award of separate con- tracts to “trade contractors,” thus precluding a 398 FHWA User Guidebook on Implementing PPPs, supra note 23, at 34. 399 FISHMAN, supra note 11, at 25. 400 Pett, supra note 386 (unnumbered) (see text under caption “obstacle: competitive bidding laws”). 401 E.g., DBOM, DBFO, and DBFOM projects. 402 Pett, supra note 386 (unnumbered) (see text under caption “where to look for legislative precedent”); FISHMAN, supra note 11, at 25–26. 403 Public-Private Partnerships for Transportation Projects, supra note 42, at 3; FTA Report to Congress on PPPs, supra note 5, at 32. 404 Id. 405 Pett, supra note 386 (unnumbered) (see text under caption “obstacle: organizational conflicts of interest”). single contract with a contractor who selects the contractors.406 In some states, contractors may be required “to identify major subcontractors” at the time of the bidding.407 Such requirements may be difficult to meet for a PPP project for which the prime contractor has not completed the design phase.408 Thus, the enabling statutes must be consulted to determine whether the involvement of the pri- vate sector is permitted or feasible for a project’s funding or delivery, asset management, risk man- agement, or value capture.409 In contrast, FTA policy provides for “significant flexibility in its procurement requirements to accommodate de- sign-build and design-build-operate-maintain con- tracting.”410 In response to the survey, the Connecticut DOT advised that its state’s legislation had been amended to allow for private participation in transit projects. New Jersey Transit stated that New Jersey law also encourages the use of PPPs by allowing the agency to enter into DBFOM con- tracts. SEPTA explained that “Pennsylvania’s Guaranteed Energy Saving Act permits public entities to participate in PPPs by eliminating the need to meet the requirements of the State Sepa- ration Act.”411 The latter act “requires the use of multiple prime contractors when public entities undertake capital projects.”412 However, TriMet observed that “changes in Oregon condemnation laws potentially restrict [the] ability to acquire property to be used in a PPP.”413 VIII. STRUCTURING THE FINANCING FOR TRANSIT PPPS A. Introduction The long-term implications of the use of PPPs and the financing of transportation infrastructure “are not widely understood.”414 However, the term “innovative financing” includes a wide array of types of financing that may engage private par- 406 Id. 407 Id. 408 Id. 409 FHWA User Guidebook on Implementing PPPs, supra note 23, at 6. 410 FTA Report to Congress on PPPs, supra note 5, at 24. 411 SEPTA Response. 412 Id. 413 TriMet Response. 414 Geddes & Wagner, supra note 4, at 12.

34 ticipation, such as private activity bonds, bonds issued by qualified 63-20 nonprofit corporations, long-term leasing of transit facilities, and cross- border leasing.415 The primary objectives of the financial struc- turing of a PPP are to utilize fully all sources of public funds, including tax revenue and grants from federal, state, and local sources, as well as credit enhancement techniques; to secure private sources of capital and noncapital financing; to use financing methods to decrease costs and enhance cash flow; and to utilize transit-owned real estate and other assets productively that are underuti- lized.416 Although financing for PPPs in the United States has been described as quite “fragmented,” the United States has been described also as “a virtual PPP laboratory.”417 There are several methods for financing PPP infrastructure projects that embrace participation by the private sec- tor.418 PPPs for transit projects continue to re- quire, however, a “high degree of government fi- nancial assistance.”419 B. Private Activity Bonds 1. Nonqualified Private Activity Bonds Under Section 103 of the Internal Revenue Code there are two types of private activity bonds, nonqualified and qualified. However, only the in- come received by taxpayers from qualified private activity bonds, discussed below in Section VIII.B.2, is exempt from federal income tax under the Internal Revenue Code. As discussed in a report prepared for the Sen- ate Committee on Finance, an issue of bonds must meet two private business use tests to be private activity bonds: 415 Mary A. Collins, Report on Innovative Financing Techniques for Transit Agencies, at 2 (Undated), here- inafter referred to as “Collins,” available at http://www.orrick.com/Events-and-Publications/ Documents/198.pdf (discussing innovative financing tools); FISHMAN, supra note 11, at 7–9; Alternative Transit Funding Sources and Finance, supra note 278, at 3. 416 STAINBACK, supra note 130, at 71–73 (author re- fers to the foregoing as the Stainback Five-Part Finance and Development Approach). 417 Akintoye & Beck, supra note 2, at 200 (some quo- tation marks omitted). See Collins, supra note 415, at 58. 418 Id. at 199. 419 Id. at 202. [A] bond is a private activity bond if it is part of an issue in which both: 1. More than 10 percent of the proceeds of the issue (in- cluding use of the bond-financed property) are to be used in the trade or business of any person other than a gov- ernmental unit (“private business use test”); and 2. More than 10 percent of the payment of principal or in- terest on the issue is, directly or indirectly, secured by (a) property used or to be used for a private business use or (b) to be derived from payments in respect of property, or borrowed money, used or to be used for a private business use (“private payment test”).420 In its section on tax-exempt governmental bonds and private business tests, a Senate Fi- nance Committee report states that “[t]he 10 per- cent private business test is reduced to five per- cent in the case of private business uses (and payments with respect to such uses) that are un- related to any governmental use being financed by the issue.”421 A 5 percent rule applies to an is- sue by a Section 501(c)(3) organization.422 Another source states that “[i]f 5% percent or more of the bond debt service is derived from private business use or is secured by privately used property, the bonds will not qualify.”423 Thus, for a government bond under these circumstances, only 5 percent may be truly unrelated to the governmental pur- pose. 2. Qualified Private Activity Bonds Qualified private activity bonds “are tax- exempt bonds issued to provide financing for specified privately used facilities.”424 An issue of exempt facility bonds is one type of private activ- ity bonds. However, there are annual state limita- tions on the aggregate volume of most qualified private activity bonds.425 To qualify as an exempt facility bond, 95 percent of the net proceeds must be used to finance an eligible facility. Business facilities eligible for this financing include transportation (airports, ports, local mass commuting, 420 Tax Provisions Relating to Financing of Infra- structure, supra note 213, at 29. 421 Id. n.75. 422 See IRC § 145(a)(1), (a)(2)(A) and (B) for details. 423 Debra Kawecki & Marvin Friedlander, 501(c)(3) BONDS—A Mini-Text, at 299 (reprinted from Continu- ing Professional Education Exempt Organizations, Technical Instruction Program (1993)), hereinafter re- ferred to as “Kawecki & Friedlander,” available at http://www.irs.gov/pub/irs-tege/part2h02.pdf. 424 Tax Provisions Relating to Financing of Infra- structure, supra note 213, at 30 (footnotes omitted) (emphasis supplied). 425 Id. at 31 (citing REV. PROC. 2010-40 § 3.09).

35 high-speed intercity rail facilities, and qualified highway or surface freight transfer facilities).426 (emphasis added) The net proceeds of an issue of exempt facility bonds must be to finance mass commuting facili- ties “owned by a governmental unit.”427 The term “mass commuting facilities” includes real property and all improvements and personal property used in the facility (e.g., machinery, equipment, furni- ture) serving the general public that is commuting on a day-to-day basis,428 but the term does not in- clude mass commuting vehicles.429 As provided in the regulations, “[a]n exempt fa- cility includes any land, building, or other prop- erty functionally related and subordinate to such facility. Property is not functionally related and subordinate to a facility if it is not of a character and size commensurate with the character and size of such facility.”430 As of January 1, 2012, private activity bonds had been issued, for example, for the Denver RTD Eagle P3 Project ($397,835); the CenterPoint In- termodal Center ($150,000 and $75,000) in Joliet, Illinois;431 and for the Capital Beltway high occu- pancy toll (HOT) Lanes ($589,000) and the I-95 high occupancy vehicle (HOV)/HOT project ($252,648), both in Virginia. As of that date, there had been an allocation of private activity bonds, including one for CenterPoint Intermodal Center ($1,086,000) in Joliet and one for the CenterPoint Intermodal Center ($475,000) in Kansas City, Missouri.432 Nevertheless, at times the use of pri- vate activity bonds may be limited because of a lack of demand for BBB-rated financings or if there are other circumstances affecting the credit markets.433 C. Fare Box Revenue Bonds TEA-21 authorized the use of fare box revenues and federal-aid grant funds as security for the issuance of revenue bonds. Revenue bonds may be 426 Id. at 30 (footnotes omitted). 427 26 U.S.C. § 142(b)(1)(A). 428 Treas. Reg. § 1.103-8(e)(2)(d)(iv), available at http://www.gpo.gov/fdsys/pkg/CFR-2012-title26- vol2/pdf/CFR-2012-title26-vol2-sec1-103-8.pdf. 429 Rev. Rul. 88-51, 1982-1 CB 74. 430 Treas. Reg. § 1.103-8(a)(3). 431 FHWA Office of Innovative Program Delivery: In- novative Finance, available at http://www.fhwa.dot.gov/ipd/finance/tools_programs/fed eral_debt_financing/private_activity_bonds/index.htm. 432 Id. 433 Tom Rousakis, Goldman, Sachs & Co., Financing Transit PPPs, at 9 (Sept. 2009) (unpub.). “backed by fare box revenues if the level of State and local funding committed to transit for the three years following the bond issue [is] higher than the funds…committed in the three years prior to the bond issue.”434 However, fare box revenue may not constitute adequate security for the issuance of Fare Box Revenue Bonds.435 Fur- thermore, unless the regulations allow or the FTA approves of an alternate use, program income (e.g., fares or lease payments) is to be used to re- duce program costs. For transit PPPs, because of insufficient fare box revenue, it is likely that pub- lic funding will be needed “to leverage the private investment and/or utilization of other sources of public revenue to pay down the project’s debt.”436 As discussed previously, FTA policy may pose a problem for PPPs when a transit agency proposes to remit fare box or related income to a private partner.437 One exception appears to be for HOV lanes that are converted to HOT lanes as they “may be classified as fixed guideway miles for FTA’s funding formulas.”438 FTA has authorized the use of Program Income from HOT lane tolls to be used to: (a) service debt, (b) provide a reason- able return on private investment, and (c) pay costs of op- erations and maintenance. In addition, if the operating entity annually certifies that the facility is being properly operated and maintained and that the items identified in (a), (b) and (c) above are being paid, Program Income may be used for any other purpose relating to the project.439 Depending on the state, however, there may be an issue whether a transit agency is authorized to issue fare box revenue bonds.440 Nevertheless, transit agencies that have issued fare box revenue bonds include Bay Area Rapid Transit (BART) in San Francisco, the Chicago Regional Transit Au- thority (RTA), Metropolitan Atlanta Rapid Tran- sit Authority (MARTA) in Atlanta, the Metropoli- tan Transportation Authority (MTA) in Los Angeles, the MTA in New York City, and the Port Authority of New York and New Jersey.441 434 FTA, Revenue Bonds, hereinafter referred to as “FTA-Revenue Bonds,” available at http://www.fta.dot.gov/grants/12309_106.html. 435 Collins, supra note 415, at 45. 436 FTA Report to Congress on PPPs, supra note 5, at 11; Collins, supra note 415, at 44. For discussion of the structure of fare box revenue transactions, see id. 437 FTA Report to Congress on PPPs, supra note 5, at 39. 438 Id. 439 Id. 440 Collins, supra note 415, at 45. 441 FTA-Revenue Bonds, supra note 434.

36 D. Grant Anticipation Notes Another form of revenue bond is a Grant An- ticipation Revenue Vehicle (GARVEE) for a high- way project or a Grant Anticipation Note (GAN) for a transit project.442 Transit agencies use GANs as a source of short-term financing during the im- plementation of a project by borrowing against their future federal-aid funds allocated by formula under 49 U.S.C. § 5307 or by project under 49 U.S.C. § 5309.443 Formula funds represent two- thirds of federal aid for transit; discretionary funds allocated by Congress account for the re- maining third of federal-aid funding for transit.444 GANs are referred to as notes, because federal transit formula funds may be anticipated only on a short-term basis and the funds “are subject to the annual Congressional appropriation proc- ess.”445 The credit risks for a GAN backed by a discretionary FFGA may be higher than for a GAN backed by formula funding.446 As with GARVEEs used for highway projects, a transit agency may issue GANs secured by a pledge of federal-aid assistance to obtain up-front capital and thereafter pay the GANs over time as the agency receives federal funds.447 A GAN also may be used for the local matching funds for a transit project.448 The principal and interest on GANs are eligible to be repaid with FTA capital funding.449 Unlike federal-aid highway funding, federal transit funding usually is provided to transit agencies or to local government units rather than to the states.450 442 Id. 443 Midwest Regional Rail Initiative Project Note- book, supra note 201, at 9-13. 444 FTA, Revenue Bonds (discussing Transit Grant Anticipation Notes), hereinafter referred to as “Transit Grant Anticipation Notes,” available at http://www.fta.dot.gov/printer_friendly/12863.html. See also AASHTO, Transit Grant Anticipation Notes, avail- able at http://www.transportation-finance.org/ funding_financing/financing/bonding_debt_ instruments/municipal_public_bond_issues/gans.aspx. 445 FHWA, Innovative Program Delivery, Tools & Programs: Federal Debt Financing Tools, “Grant An- ticipation Revenue Vehicles (GARVEEs),” available at http://www.fhwa.dot.gov/ipd/finance/tools_programs/fed eral_debt_financing/garvees/. 446 Transit Grant Anticipation Notes, supra note 444. 447 Id. 448 FTA-Revenue Bonds, supra note 434. 449 Id. 450 Transit Grant Anticipation Notes, supra note 444. Although FTA reports that there are GANs with longer maturities, one source states the ma- turity of a GAN may be for less than 1 year up to a maturity of 2 or 3 years,451 and that if a GAN is issued in the second year of a 5-year authoriza- tion, the term should not exceed 4 years.452 Be- cause tax-exempt bonds may not be guaranteed directly or indirectly by the federal government (e.g., an FFGA), additional security for the issu- ance of a GAN may be necessary to “enhance” its credit rating.453 The shorter maturities of GANs usually mean that they are “issued at a rate that is approximately one percent less than that for general obligation bonds.”454 FTA reports that as of 2008 over $3.2 billion in GANs had been issued in principal amounts from $18 million to $450 million for terms of 3 to as many as 15 years.455 Examples of their use include the Alaska Railroad in 2006 for $78.4 million to purchase rail assets; the BART Airport Extension in 2001 for $385 million; the Chicago Ravenswood Line in 2003 for $128 million; the Chicago Transit Authority for $250 million in 2004 to purchase rail rolling stock; the Massachusetts Bay Trans- portation Authority (MBTA) in Boston in 2004 for $77.8 million for compressed natural gas buses; and the New Jersey HBLR line in 2000 for $248 million.456 E. Certificates of Participation Another means of leveraging federal funding for a transit project is by the issuance of tax- exempt bonds known as Certificates of Participa- tion (COP).457 COPs represent an investor’s par- ticipation in the payments made pursuant to an underlying obligation, such as a lease or sales 451 Midwest Regional Rail Initiative Project Note- book, supra note 201, at 9-13. 452 Id. 453 Id. 454 Id. 455 Elizabeth Martin, FTA, Innovative Financing: Meeting the Needs for Capital (May 2008), available at http://www.fta.dot.gov/documents/Day_1_-_IId_- _Innovative_Finance_-_Martin.pdf. 456 Id. 457 AASHTO Center for Excellence in Project Fi- nance, Certificates of Participation, hereinafter referred to as “AASHTO—Certificates of Participation,” avail- able at http://www.transportation-finance.org/funding_ financing/financing/bonding_debt_instruments/ certificates_of_participation.aspx .

37 agreement.458 COPs may be used to finance the purchase of transit equipment or facilities for transit projects. COPs are “sold as securities to investors in both private placements and public offerings.”459 Under the regulations, a capital lease is any transaction by which an entity that receives FTA financial assistance “acquires the right to use a capital asset without obtaining full ownership regardless of the tax status of the transaction.”460 Under 49 C.F.R. Part 639, although COPs typi- cally have been used by transit agencies to ac- quire buses, potentially any capital asset may be leased rather than built or purchased.461 A “capi- tal asset means facilities or equipment with a use- ful life of at least one year” that is eligible for fed- eral financial assistance under § 5307.462 The term “facilities” mean real property, including land, improvements, and fixtures, whereas the term “equipment” means nonexpendable personal property.463 Section 639.11(a)(1)–(3) is controlling and pro- vides that a lease may qualify for capital assis- tance when the lease satisfies three criteria: • The capital asset to be acquired by lease is otherwise eligible for capital assistance. • There is or will be no existing federal interest in the capital asset as of the date the lease will take effect (unless as determined pursuant to § 639.13(b)). As for the second criterion, § 639.13(b) states that “[a] recipient may request FTA to determine the eligibility of a certain finan- cial arrangement if the recipient believes it might not meet the requirements of this part.” Section 639.13(c) also states that FTA has the “right to disapprove any arrangements” when it has not 458 FTA—Certificates of Participation (“Section 9”) Funds, at 1, hereinafter referred to as “FTA— Certificates of Participation,” available at http://www.transportation-finance.org/pdf/funding_ financing/financing/mechanisms/bonding_ debt_instruments/transitcop_details.pdf. 459 Collins, supra note 415, at 4. 460 49 C.F.R. § 639.7. 461 TRANSTECH MANAGEMENT, INC. & PA CONSULTING, INC., FINANCING CAPITAL INVESTMENT: A PRIMER FOR THE TRANSIT PRACTITIONER 69 (Transportation Cooperative Research Program Report No. 89, Transportation Re- search Board, 2003), hereinafter referred to as FINANCING CAPITAL INVESTMENT: A PRIMER FOR THE TRANSIT PRACTITIONER, available at http://onlinepubs. trb.org/onlinepubs/tcrp/tcrp_rpt_89a.pdf. 462 49 C.F.R. § 639.7. 463 Id. § 639.7. been “demonstrated that the recipient will have control over the asset” and that “FTA may require the recipient to submit its cost-effectiveness com- parison for review.” • The lease of the capital asset is more cost- effective than the purchase or construction of the asset. As for the third criterion, § 639.21 sets forth what is needed for a determination that a lease is more cost-effective. Section 639.13 describes the eligible type of leases. Although FTA will advise whether a spe- cific leasing transaction qualifies,464 the regula- tions provide that in general “[a]ny leasing ar- rangement, the terms of which provide for the recipient’s use of a capital asset, potentially is eli- gible as a capital project under Chapter 53 of Title 49 of the United States Code, regardless of the classification of the leasing arrangement for tax purposes.”465 Even leases that were in existence prior to November 14, 1991, “may be eligible for capital assistance for costs incurred after approval of such a lease by FTA under this part.”466 Transit agencies may enter into a contract for a transit facility or may order vehicles such as buses. • The assets are owned by the provider and leased to a transit agency at terms that are suffi- cient for the repayment of the holders of the COPs.467 • The rental payments made by the govern- ment entity approximate the full rental value of the property and equal the principal and interest represented by the COPs.468 • When a COP is used to acquire or construct a facility, the “interest with respect to the COP will need to be capitalized until the acquisition or con- struction of the property is complete.”469 464 Id. § 639.13(b). 465 Id. § 639.13(a). 466 Id. § 639.13(d) and (d)(1)-(3) (providing that three conditions must be satisfied: The lease is otherwise eligible under this part; (2) The recipient can demonstrate that the lease, when entered into, was more cost effective than purchase or construc- tion; and (3) The procurement of the asset by lease was in accordance with Federal requirements that applied at the time the procurement took place. 467 AASHTO—Certificates of Participation, supra note 457. 468 FTA—Certificates of Participation, supra note 458, at 2. 469 Id. at 1.

38 • FTA’s guidance on capital leases states that capital leases may not be for longer than the use- ful life of the asset nor for less than 75 percent of the useful life of the leased asset.470 • The government entity’s lease payments are assigned to a trustee who acts on behalf of the holders of the COPs.471 Federal law and FTA regulations allow transit agencies to receive federal funds and use COPs for long-term financing of capital facilities and equipment.472 As a result of Section 308 of the Surface Transportation and Uniform Relocation Assistance Act of 1987 (STURRA), FTA funding under 49 U.S.C. § 5307, the urbanized area for- mula grants provision, also referred to as § 9 funds, may be used for leases of facilities and equipment at an 80 percent matching level.473 Lease financing may be an attractive way to avoid paying a higher price for an asset or to obtain bet- ter prices by making “larger, one-time pur- chases.”474 The elements a transit agency must meet to have a qualifying capital lease are: • The capital asset to be acquired by lease must otherwise be eligible for capital assistance. • There must be or “will be no existing Federal interest in the capital asset as of the date the lease will take effect unless as determined” under the regulations.475 The regulations state that “[a] recipient may choose to receive capital assistance for a capital lease approved in a single grant, under which lease payments may be drawn down periodically for the life of the lease, or in increments that are obligated by FTA periodically.”476 In the latter in- stance, a recipient must certify to the FTA that it has the financial capacity to meet its obligations if federal funds are unavailable for capital assis- tance in later years.477 Lease payments, including interest, are capital expenses that are eligible for reimbursement un- 470 FTA, Capital Leasing, available at http://www.fta.dot.gov/grants/12865.html. 471 FTA—Certificates of Participation, supra note 458, at 2. 472 Collins, supra note 415, at 3, 5. 473 Id. at 5. 474 Id. at 5. 475 49 C.F.R. § 639.11(a). 476 Id. § 639.15(a) and (b). 477 Id. § 639.15(b)(1). der 49 U.S.C. § 5307 when leasing is shown to be more cost effective than purchasing the equip- ment or constructing the facilities required by a transit agency.478 A transit agency may issue COPs for the “full value of the project, including both the federal and local share of costs.”479 As stated, on the termination of the lease, the COP “is retired” and the ownership of the equipment or facilities “reverts to the state or issuing author- ity.”480 In most jurisdictions, COPs may be used by “governmental entities to finance capital projects without technically issuing long-term debt” that otherwise would require voter approval.481 Capital leases have been held not to constitute a “debt” because a government lessee in a lease-back ar- rangement is not required to pay for the entire term of the lease but only to pay each year that the leased “property is available for use during such year.”482 However, in some jurisdictions, there may be an issue regarding whether the use of COPs without voter approval is permitted for constitutional or statutory reasons.483 Because COPs involve additional risk and are generally considered less creditworthy than gen- eral obligation bonds, issuers of COPs may have to pay a higher interest rate to investors who pur- chase them.484 Moreover, because FTA funding is subject to congressional appropriation each year, “there is no guarantee that sufficient funds will always be available to pay the full 80 percent match of lease payments. Thus rating agencies and capital market participants do not treat sec- tion 9 funds as a guarantee.”485 The security of COPs may be enhanced by bond insurance, letters of credit, or other guarantees to make the COPs more attractive to investors.486 AASHTO observes that although transit agencies may not pledge formula grant funds “formally” as security, transit 478 Id. § 639.11(a). 479 Financing Capital Investment: A Primer for the Transit Practitioner, supra note 461, at 68. 480 Midwest Regional Rail Initiative Project Note- book, supra note 201, at 9-14. 481 Collins, supra note 415, at 3. 482 Id. at 3. 483 Id. at 5. 484 Id. at 4. 485 Id. at 5; Midwest Regional Rail Initiative Project Notebook, supra note 201, at 9-14. 486 Collins, supra note 415, at 4.

39 agencies may “promise the use” of such future funds to enhance creditworthiness.487 F. 63-20 Nonprofit Corporations State and local governments may use “estab- lished conduit issuers” or create not-for-profit cor- porations to raise money through the issuance of tax-exempt bonds for a project.488 (Conduit reve- nue bonds are also known as private activity bonds.489) Qualifying nonprofit corporations issu- ing tax-exempt bonds on behalf of a public transit agency permit “most of the benefits of private de- velopment” to be retained.490 Section 103 of the Internal Revenue Code allows only states or po- litical subdivisions to issue bonds that pay holders dividends that are excluded from taxation for fed- eral income tax purposes. The IRS regulations provide that “[o]bligations issued by or on behalf of any State or local governmental unit by consti- tuted authorities empowered to issue such obliga- tions are the obligations of such a unit.”491 The cost of debt is lower for tax-exempt bonds because the federal income tax exclusion in effect subsi- dizes the bonds’ cost by making them attractive even though they pay a lower rate.492 PPPs have used nonprofit corporations to facili- tate the development of transportation projects, including transit projects “financed with tax- exempt bonds.”493 The nonprofit corporation is created with various powers, including the powers to acquire and develop sites “through contracts with private contractors,” to arrange for public or private financing, and to contract with another 487 AASHTO Center for Excellence in Project Fi- nance, Certificates of Participation, available at http://www.transportation-finance.org/funding_ financing/financing/bonding_debt_instruments/ certificates_of_participation.aspx. 488 Akintoye & Beck, supra note 2, at 202. 489 Kawecki & Friedlander, supra note 423, at 264 (stating that “[u]nder the Tax Reform Act of 1986[] his- torically government bonds are treated differently than conduit revenue bonds”). 490 O’Steen & Jenkins, supra note 6, at 285 (quoting Karen J. Hedlund, The Role of 63-20 Nonprofit Corpora- tions in Public/Private Infrastructure Financings, 113 PUB. WORKS FIN. 20 (1997) (quotation marks omitted)). 491 26 C.F.R. § 1.103-1(b). 492 Akintoye & Beck, supra note 2, at 202. 493 Id. (listing examples of projects). See Nossaman LLP, The Use of “63-20” Nonprofit Corporations in In- frastructure Facility Development (May 1, 2001) (un- numbered), hereinafter referred to as “Nossaman,” available at http://www.nossaman.com/the-use-6320- nonprofit-corporations-infrastructure-facility. party to operate the facility upon completion.494 Such nonprofit corporations may qualify to issue tax-exempt bonds as long as the company satisfies the requirements of the Internal Revenue Code. As FHWA describes 63-20 nonprofit public benefit corporations, [p]ublic sector agencies in the United States may finance capital projects by issuing tax-exempt debt…. Using this type of debt keeps interest costs low and generates attrac- tive opportunities for both private and corporate inves- tors. One method of reducing the borrowing costs to the private partner is to issue debt through a nonprofit public benefit corporation pursuant to Internal Revenue Service (IRS) Rule 63-20 and Revenue Proclamation 82-26. The nonprofit corporation is able to issue tax-exempt debt on behalf of private project developers. In general, to facilitate the financing needs of a third party, state and local governments can issue tax-exempt revenue bonds either through established conduit issuers or creation of nonprofit corporations pursuant to IRS Revenue Ruling 63-20. While governments normally pre- fer to utilize an established entity for conduit issues, such as a state finance authority, IRS Revenue Ruling 63-20 provides a viable alternative and has been used to finance several highway and transit projects around the coun- try.495 IRS Revenue Ruling 1963-20 referred to by FHWA applies to obligations issued on behalf of a political subdivision by a 63-20 nonprofit corpora- tion, the income from which is excludable under federal income tax law.496 Under the ruling, obli- gations are issued “on behalf” of a political subdi- vision as long as the 63-20 nonprofit corporation satisfies the following requirements: (1) the corporation must engage in activities which are essentially public in nature; (2) the corporation must be one which is not organized for profit (except to the extent of retiring indebtedness); (3) the corporate income must not inure to any private person; (4) the state or a political subdivision thereof must have a beneficial interest in the corporation while the indebted- ness remains outstanding and it must obtain full legal ti- tle to the property of the corporation with respect to 494 Nossaman, supra note 493 (unnumbered) (see text under caption “powers and operation of a nonprofit cor- poration”). 495 FHWA, Innovative Program Delivery, P3 Defined, 63-20 Nonprofit Public Benefit Corporation, available at http://www.fhwa.dot.gov/ipd/p3/defined/dbfo_6320. htm (emphasis supplied). 496 If the obligations are issued by a nonprofit corpo- ration for the purpose of stimulating industrial devel- opment within a political subdivision of a state, the ob- ligations may meet the test established under Revenue Ruling 1963-20.