Transit Public-Private Partnerships: Legal Issues (2014)

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13 nue risk and reward during the operating and maintenance phase of the project.”127 5. Build-Transfer-Operate With a build-transfer-operate (BTO) contract, the private sector owns the project during con- struction, after which time the public sector be- comes the owner.128 The BTO is also known as build-transfer-lease (BTL), build-lease-operate- transfer (BLOT), or build-lease-transfer (BLT).129 In responding to the survey for this digest, the Stark Area Regional Transit Authority (SARTA) in Ohio advised that it has used a DBFO form of procurement. SEPTA has used DBFO for “limited operations.” Both the Connecticut DOT and SEPTA reported using a DBFOM form of contract for a PPP, but the Connecticut DOT stated that its DBFOM contract also permits a design-build- finance-operate-transfer (DBFOT) method of pro- ject delivery. TriMet explained that because it had transferred the property in question to the developer, TriMet used a DBFOM contract. Fi- nally, the Pioneer Valley Transit Authority re- ported that it had used a design-build-lease method. IV. STRUCTURING A PUBLIC-PRIVATE PARTNERSHIP FOR A TRANSIT PROJECT A. Evaluating a Project for a PPP From the outset of a PPP project a transit agency must “take control of the predevelopment process.”130 It is particularly important to struc- ture a PPP correctly so that the transit agency obtains a PPP promising “long-term ‘value for money’ benefits.”131 Structuring a PPP to lower business risk as much as possible will make a pro- ject more attractive to a private partner and to private lenders and investors.132 The most suc- cessful PPPs are likely to have a well-organized structure, a detailed business plan, a guaranteed 127 FISHMAN, supra note 11, at 7. 128 YESCOMBE, supra note 1, at 12. 129 Id. 130 JOHN STAINBACK, PUBLIC/PRIVATE FINANCE AND DEVELOPMENT METHODOLOGY/DEAL STRUCTURING/ DEVELOPER SOLICITATION 33 (2000), hereinafter referred to as “STAINBACK.” 131 PUBLIC-PRIVATE PARTNERSHIPS POLICY AND PRACTICE: A REFERENCE GUIDE 3 (H.K. Young ed., 2010), hereinafter referred to as “Young.” 132 Table Rock Capital, Generating Private Sector Financing, at 18 (July 2009), hereinafter referred to as “Generating Private Sector Financing.” revenue stream, and the support of stake- holders.133 Although favorable state law is essen- tial to a PPP (discussed in Section VII), also es- sential are well-drafted contractual terms, a satisfactory basis for revenue sharing, if applica- ble, and adequate funding.134 More particularly, the structuring of a success- ful PPP project begins by evaluating a project’s technical and engineering aspects;135 conducting due diligence to select the best private partner or partners;136 developing the right legal framework; and determining how to finance the project, in- cluding creating “a debt and security structure acceptable to potential equity and debt inves- tors.”137 When creating a transit PPP, “every deal structure must be customized.”138 As for factors that transit agencies are consid- ering before proceeding with a PPP, the agencies responding to the survey stated that they evalu- ate or consider the following: • Whether a facility will be used for as long as what is determined to be the facility’s useful life.139 • Price, past performance, customer service re- cord, and other factors.140 • The time line for construction and penalties that will apply when the time line is not met.141 • Property value, the projected increase in rid- ership, and projected lease payments, if applica- ble.142 133 See WORLD BANK INSTITUTE, Public-Private Part- nerships Version 1.0 Reference Guide, at 15–33 (2012), available at http://wbi.worldbank.org/wbi/Data/wbi/ wbicms/files/drupal-acquia/wbi/WBIPPIAFPPP ReferenceGuidev11.0.pdf. 134 FHWA User Guidebook on Implementing PPPs, supra note 23, at 1. 135 Young, supra note 131, at 42. 136 The National Council for Public-Private Partner- ships, For the Good of the People: Using Public-Private Partnerships to Meet America’s Essential Needs, at 17 (undated) (stating that there will be governments that “do not practice due diligence in their selection of pri- vate partners and end up choosing a partner who is not ideally compatible for the project in question”), avail- able at http://www.ncppp.org/wp-content/uploads/2013/ 03/WPFortheGoodofthePeople.pdf. 137 Young, supra note 131, at 45. 138 STAINBACK, supra note 130, at 1. 139 Milford Transit District Response. 140 N.J. Transit Response. 141 SARTA Response. 142 TriMet Response.

14 Although SEPTA considers its return on in- vestment, its “upfront cost outlay” is the primary factor.143 However, SEPTA stated that it has not undertaken many PPPs.144 Transit agencies may use a Value for Money (VfM) approach to assess whether a PPP offers greater value than a design-bid-build procure- ment. The California Infrastructure Finance Act specifically allows a project sponsor to choose a private partner based on the best value rather than the lowest bid.145 As explained by one source, “VfM is not based on just what is initially the cheapest, but takes account of the combination of risk transfer, whole-life cost and service provided by the Facility.”146 There must be a realistic evaluation of a project’s requirements, costs, and potential revenues so that a decision may be made regarding the best means of procuring a capital project.147 VfM encourages the use of best business prac- tices to accelerate a project and reduce its cost; seeks to reduce long-term costs by providing “higher-quality design, construction, and inspec- tion up front”; and uses “life-cycle asset manage- ment to reduce the frequency and cost of preser- vation.”148 A key element of a VfM analysis is whether there are risks that may be transferred and whether a private entity may manage those risks better than the transit agency.149 VfM may be used during all phases of a project and “refined as more information becomes available.”150 A request for information (RFI), a request for qualifications (RFQ), and a request for proposals (RFP) may assist in structuring a project and re- ducing the time needed to negotiate a contract. The RFI provides a transit agency with feedback 143 SEPTA Response. 144 Id. 145 CAL. GOV’T CODE §§ 5956 et seq.; FTA Report to Congress on PPPs, supra note 5, at 42. See DAVID E. DOWALL & ROBIN RIED, A STRATEGY FOR INFRASTRUCTURE, THE CALIFORNIA INFRASTRUCTURE INITIATIVE (Access No. 32, 2008), available at http://metrostudies.berkeley.edu/pubs/reports/008_ACC ESS_CAInfrastructure.pdf. 146 YESCOMBE, supra note 1, at 18. 147 Implementation of PPPs for Transit, supra note 24, at 14. 148 FHWA User Guidebook on Implementing PPPs, supra note 23, at 41. 149 YESCOMBE, supra note 1, at 18. 150 Implementation of PPPs for Transit, supra note 24, at 14. before it issues an RFP.151 The RFQ permits a transit agency to learn about potential bidders and assists in narrowing the field.152 SEPTA re- ported that an RFQ was used preceding entering into a CMGC contract with a private partner. An FHWA report entitled Value for Money State of the Practice discusses the concepts and principles “which underlie the VfM methodologies of several states, including California, Florida, Georgia, Texas and Virginia.”153 The Common- wealth of Virginia’s Office of Transportation Pub- lic Private Partnerships (PPTA Office), has pub- lished a “PPTA Value for Money Guidance,” with information on how the PPTA Office assesses VfM “when procuring infrastructure projects” as PPTA candidates in comparison with “procuring the pro- jects as public sector projects using traditional project delivery methods”; how the Office assesses “the VfM of selecting a particular structure for a PPTA project”; “the planning stages at which VfM should be assessed;” and a recommended “report- ing framework for presenting the results of the VfM assessment.”154 Transit agencies were asked whether in evalu- ating a prospective project for a PPP the agency undertakes a VfM of the project. Six agencies said that they undertake such an evaluation155 and two agencies indicated that they do not,156 but other 151 Id. at 3. 152 Id. 153 FHWA, Value for Money State of the Practice, at 1 (2011), available at http://www.fhwa.dot.gov/ipd/pdfs/ p3/vfm_state_of_the_practice.pdf. 154 Commonwealth of Virginia, Office of Transporta- tion Public Private Partnerships, PPTA Value for Money Guidance, at 1 (2011), available at http://www.virginiadot.org/office_of_transportation_pub lic-private_partnerships/resources/VDOT%20VfM%20 guidance%20document_final_20110404.pdf. See also Los Angeles County, Metropolitan Transportation Au- thority, Planning And Programming Committee, Public- Private Partnership Program (Oct. 14, 2009), available at http://media.metro.net/board/Items/2009/10_ october/20091014P&PItem9.pdf (stating that certain projects are recommended for Board approval in order to move forward into comprehensive evaluation and development, including a value for money (VFM) analy- sis, and identifying one of the projects as the Wilshire Boulevard Bus Rapid Transitway). 155 La Crosse Municipal Transit Utility Response; Conn. DOT Response; Milford Transit District Re- sponse; N.J. Transit Response; SEPTA Response; and TriMet Response. 156 PVTA Response; SARTA Response.

15 agencies did not respond specifically to the ques- tion. B. Key Legal Issues to Address in PPP Contracts 1. Legal Authority for a PPP As discussed in Section VII, on state legislative provisions affecting PPPs, a transit agency should resolve at an early stage whether applicable state law permits the use of a PPP for a specific project. Indeed, state legislation may authorize, restrict, or even prohibit key elements of a proposed PPP. A transit agency will need to consider, for exam- ple: • Whether state law permits the parties to pro- vide the services in accordance with the structure and arrangements they plan to establish. • The legal ability of the private sector to be involved in the development, financing, operation, or maintenance of publicly owned infrastructure. • Any regulatory or other authority that other government entities have over transit facilities relating to the construction of facilities or exten- sion of services, as well as over rights of access needed by a transit agency. • Authority of the transit agency to regulate services and fares or to engage in revenue shar- ing. • Whether under state law it is legal to trans- fer or whether there are restrictions on the trans- fer of responsibilities of a transit agency to other entities. • The availability under state law of adequate procurement and selection procedures for the pro- ject. • Whether there is sufficient legal authority and capacity for necessary borrowing by the state or local government or by the transit authority for a PPP.157 2. Contractual Issues and Provisions Although a PPP has been described as an “um- brella concept that ‘encompasses a wide range of contractual arrangements,’”158 only a few agencies responding to the survey said that they had used PPP agreements in addition to those described in Section III. One agency reported having used a 157 FHWA User Guidebook on Implementing PPPs, supra note 23, at 31. 158 O’Steen & Jenkins, supra note 6, at 255 (footnote omitted). development agreement,159 one had used an access and operations agreement,160 and one agency also had used an agreement for the disposition and development of real property, a copy of which is included in Appendix C.161 Nevertheless, the contractual documents for a project may be extensive; for example, a TriMet project described in Appendix A required 85 agreements among the parties.162 In addition to the exhibits attached to the digest, there are other sources of summaries and analyses of PPP agree- ments.163 As for specific provisions, FHWA pro- vides a template for agreements associated with PPP projects.164 Section 20013 of MAP-21 directs the Secretary of Transportation, among other things, to identify the best practices for PPP mod- els, to develop “standard PPP transaction model contracts,” and to conduct financial assessments and benefits of a proposed transaction.165 Contracts for PPP projects commonly identify the type of procurement and include provisions on the term of the agreement; the details of the con- struction, operation, or maintenance of the pro- ject; the handling of changes in design standards or construction specifications during a project’s development; procedures for the administration, oversight, and accountability of the project; leas- ing arrangements, if applicable; required types of insurance and amounts of coverage; a non- compete clause, if applicable;166 performance 159 La Crosse Municipal Transit Utility Response. 160 N.J. Transit Response. 161 TriMet Response. 162 TRIMET, LIVABLE PORTLAND LAND USE AND TRANSPORTATION INITIATIVES 88 (2010), hereinafter re- ferred to as “TriMet Report on Transportation Initia- tives,” available at http://trimet.org/pdfs/publications/ Livable-Portland.pdf. 163 See, e.g., FHWA, USER GUIDEBOOK ON IMPLEMENTING PUBLIC-PRIVATE PARTNERSHIPS FOR TRANSPORTATION INFRASTRUCTURE PROJECTS IN THE UNITED STATES, supra note 21. 164 See, e.g., FHWA Stewardship Agreement: Stew- ardship/Oversight Agreement for Design and Construc- tion (2006), available at http://www.fhwa.dot.gov/ federalaid/stewardship/agreements/tx.cfm; and FHWA, Innovative Project Delivery, Agreements, available at http://www.fhwa.dot.gov/ipd/p3/agreements/index.htm. 165 Estell & Washington, supra note 14, at 37. 166 Noncompete clauses are more likely to be found in contracts for toll roads. Noncompete clauses may take effect if a public partner constructs or improves another facility that competes with the one subject to the PPP. Such competition may cause a reduction in revenue for the private partner; thus, the public agency may be

16 standards; performance guarantees; incentive payments; liquidated damages; performance and payment bonds; the effect of changed conditions or uncontrollable circumstances on the contract; revenue sharing, if any; identification and trans- fer of risks to be assumed by the private partner; acquisition of land by purchase or condemnation, if applicable; restrictions on the use of land that is to be acquired or that is otherwise subject to the agreement; the ability to dispose of land and other property; accounting requirements and proce- dures; responsibility of the private partner for certain taxes and related issues; the handling of intellectual property, including the use of proprie- tary technology or the transfer of know-how; and the consequences when performance standards or other contractual obligations are not met.167 As with any contract, the parties’ agreement should address default, termination, liability, and the method of dispute resolution.168 It is suggested that an agreement should state whether a transit agency’s approval is required of a capital improvement that is needed for the pro- ject to permit compliance with contractual obliga- tions or with applicable law.169 A transit agency may want to provide that, with respect to any loan for a project, the agency will share in any savings resulting from a refinancing.170 One au- thority suggests that a PPP contract should state that the requirements of public law (e.g., account- ability, transparency) apply to the agreement both required contractually to compensate the private part- ner (e.g., a concessionaire). See Tax and Financing As- pects of Highway Public-Private Partnerships, on 110- 1078, Hearings Before the Subcomm. on Energy, Natu- ral Resources and Infrastructure, Comm. on Finance, S. REP. NO. 110-1078, at 15 (2008), hereinafter referred to as “Tax and Financing Aspects of Highway Public- Private Partnerships.” 167 O’Steen & Jenkins, supra note 6, at 288–89. 168 Id. at 287–89, 290; MALLETT, supra note 25, at 21 (commenting on one state’s “costly disputes” with pri- vate partners). See FISHMAN, supra note 11, at 37. 169 O’Steen & Jenkins, supra note 6, at 289–90. 170 U.S. GOV’T ACCOUNTABILITY OFFICE, PUBLIC TRANSPORTATION: FEDERAL PROJECT APPROVAL PROCESS REMAINS A BARRIER TO GREATER PRIVATE SECTOR ROLE AND DOT COULD ENHANCE EFFORTS TO ASSIST PROJECT SPONSORS 34 (GAO-10-19, 2009), hereinafter referred to as “Public Transportation: Federal Project Approval Process Remains a Barrier,” available at http://www. gao.gov/new.items/d1019.pdf. to protect the public interest and to secure politi- cal or public support for a project.171 One issue for a transit agency to consider is whether it will be involved, and, if so, to what de- gree, in a project’s design or construction. One source contends that it is quite “normal for the Public Authority to have a right to review and comment on the detailed designs,” but that the agency should not be obligated to “sign off” on or approve of them.172 Likewise, a PPP contract should provide that when a contract is completed for the construction of a facility, a transit agency’s “acceptance” of the facility does not mean that the facility satisfies the requirements of the con- tract.173 With long-term agreements, there may be cir- cumstances when the contract should authorize government intervention, that is, the exercise of “governmental prerogative,” to protect the public interest.174 Because an agency’s intervention could result in an allegation of breach of contract, it may be advisable for a contract to provide that the transit agency may “periodically revisit” the terms of long-term agreements; for example, if a conces- sionaire fails to meet performance standards or if enumerated conditions or problems occur that ne- cessitate revisions.175 Transit agencies responding to the survey also suggested provisions that PPP agreements should include. However, as New Jersey Transit’s re- sponse observed, the legal issues are “highly de- pendent” on the facts related to the project. The agencies stated that a PPP contract should de- scribe in detail the parties’ responsibilities; in- clude an allocation of costs; address public safety issues in connection with the site;176 provide for an “accounting process” that demonstrates how the financial and investment requirements are being satisfied;177 require compliance with all federal and state laws and regulations;178 and provide for 171 Dominique Custos & John Reitz, Administrative Law: Public Private Partnerships, 58 AM. J. COMP. L. 555, 579–80 (2010), hereinafter referred to as “Custos & Reitz.” 172 YESCOMBE, supra note 1, at 89. 173 Id. at 90. 174 Custos & Reitz, supra note 171, at 575. 175 Public Transportation: Federal Project Approval Process Remains a Barrier, supra note 170, at 33–34. 176 Milford Transit District Response; PVTA Re- sponse. 177 PVTA Response. 178 La Crosse Municipal Transit Utility Response; TriMet Response.

17 transparency in environmental planning and mitigation.179 SARTA, SEPTA, and TriMet em- phasized the importance of liability insurance and the inclusion of appropriate remedies and penal- ties if a project is not completed on time. C. Administration and Management of PPPs Although there is some guidance on how a pub- lic agency should administer and manage a PPP project,180 the “underlying culture” of an agency is said to be one of the most important factors.181 PPPs should have appropriate “selection proc- esses” and contracts to avoid losing the flexibility and “efficiency gains” that are possible with PPPs.182 Other administrative and managerial matters important to PPPs are the selection of a qualified DB team for a contract having DB as a component;183 the continuing need to assess whether the public is obtaining the best value with a PPP compared to the traditional, design- bid-build method of procurement;184 and the crea- tion of a government structure (e.g., project man- ager, staffing) to work exclusively with a PPP pro- ject.185 A PPP requires effective and continuous com- munication and coordination throughout a pro- ject’s development, implementation, and opera- tion;186 policies, procedures, documentation, and resources to guide the project’s development and management;187 and periodic monitoring of and reporting on project performance in relation to the terms of the contract to assure the partners’ ac- countability to each other and to the public.188 A transit agency’s oversight may include close scru- 179 Conn. DOT Response. 180 See, e.g., FHWA User Guidebook on Implementing PPPs, supra note 23 (discussing statutory, regulatory, financial, and institutional issues associated with im- plementing and managing PPP projects). 181 FHWA User Guidebook on Implementing PPPs, supra note 23, at 6. 182 Rosenau, supra note 7, at 94; Public Transporta- tion: Federal Project Approval Process Remains a Bar- rier, supra note 170, at 21. 183 H.R. REP. NO. 110-24, Hearings on PPPs, supra note 9, at 90–91. 184 Public Transportation: Federal Project Approval Process Remains a Barrier, supra note 170, at 39. 185 Public-Private Partnerships for Transportation Projects, supra note 42, at 4. 186 FHWA User Guidebook on Implementing PPPs, supra note 23, at 45. 187 Id. at 29. 188 Id. at 45. tiny of a project’s planning and its costs, as well as the approval of principal subcontractors to assure that a private partner will be able to meet its con- tractual obligations. Although a transit agency in a PPP may trans- fer risk and responsibility to a private partner, sources note that a transit agency still may have responsibility for or be involved with applications for approvals, licenses, and permits; periodically review the development phase for compliance with end-user requirements; and perform other responsibilities as provided by the contract.189 A sponsor will want to continue to monitor compli- ance after the completion of the development phase, conduct audits and issue reports as needed or required, continue to monitor finances, and identify and resolve problems or disputes as promptly as possible.190 As a number of commentators have empha- sized, the administration and management of a PPP is “very demanding”; thus, a PPP typically requires an experienced management team and quite possibly a full-time project manager or di- rector.191 Commentators have also pointed out that a transit agency may want its contract to permit the appointment of specialists to monitor compliance with the contract and with land-use, environmental, or other requirements.192 If a PPP project embraces operations and maintenance functions, additional procedures may be needed to monitor the project on an ongoing basis.193 An op- erations manual may be needed.194 For some pro- jects, an external advisor may be necessary, such as a financial or technical advisor.195 Agencies responding to the survey described their methods for managing and administering a PPP. Three agencies had a project manager.196 Although one agency’s project included planning, engineering, and transit, the agency stated that the only outside services needed were legal ser- 189 JEFFREY DELMON, PUBLIC-PRIVATE PARTNERSHIP PROJECTS IN INFRASTRUCTURE, AN ESSENTIAL GUIDE FOR POLICY MAKERS 156–57 (2011), hereinafter referred to as “DELMON.” 190 Id. at 157–58. 191 YESCOMBE, supra note 1, at 75 (emphasis added); DELMON, supra note 189, at 159–60. 192 DELMON, supra note 189, at 161. 193 YESCOMBe, supra note 1, at 76. 194 DELMON, supra note 189, at 159–60. 195 YESCOMBE, supra note 1, at 91–5. 196 Conn. DOT Response; Milford Transit District Re- sponse; PVTA Response; and TriMet Response.

18 vices for a development agreement.197 The Con- necticut DOT stated that it has used outside spe- cialists, whereas New Jersey Transit stated that it manages its own PPP projects with the objective of providing good customer service with “less reli- ance on the taxpayer.” TriMet stated that it relied on its own staff for engineering and legal support. D. Acquisition of Property and Land-Use Issues Although successful PPP projects may require the involvement of real estate developers, local governments, and citizens,198 the private partner in a PPP is “usually an engineering firm,” not a real estate developer.199 The inclusion of real es- tate makes a project more complex in part be- cause of the timing. Real estate development op- portunities may not necessarily be available or be feasible when building a transit project.200 It may be noted that TEA-21 authorized “the fair market value of land lawfully obtained by the state or lo- cal government to be applied to the non-federal share of project costs.”201 Some PPPs include long- term leasing of existing facilities without the need to acquire land.202 An example of the importance of development to a transit PPP is TriMet’s MAX Red Line, a $125.8 million project, to Portland International Airport, “the first train-to-plane connection on the West Coast when it opened on September 10, 2001. It also was the first public/private light rail/real estate development project in the coun- try.”203 Besides the use of tax increment financing (TIF) and other funding, discussed in Section X.B, it was possible to arrange $125 million in financ- 197 La Crosse Municipal Transit Utility Response. 198 American Public Transportation Association, Forming Partnerships to Promote Transit-Oriented De- velopment and Joint Development, at 1 (2009), hereinaf- ter referred to as “Forming Partnerships to Promote TOD and Joint Development,” available at http://www.apta.com/resources/standards/Documents/ APTA%20SUDS-UD-RP-002-09.pdf. 199 Capturing the Value of Transit, supra note 10, at 29. 200 Id. 201 Midwest Regional Rail Initiative Project Note- book, at 9-10 (June 2004), hereinafter referred to as “Midwest Regional Rail Initiative Project Notebook,” available at http://michigan.gov/documents/mdot/ MDOT_MWRRI_Project-Notebook-Final-2004_ 291983_7.pdf. 202 STAINBACK, supra note 130, at 27. 203 H.R. REP. NO. 110-24, Hearings on PPPs, supra note 9, at 71. ing when the private partner (Bechtel) agreed to accept development rights to 120 acres at the en- trance to the airport.204 As for right-of-way acquisition, MAP-21 amended 49 U.S.C § 5332 to provide that if an acquisition is permitted under federal law, a re- cipient of federal funds may receive assistance in acquiring right-of-way prior to “the completion of environmental reviews for any project that may use right-of-way.”205 The Secretary of Transporta- tion may establish appropriate restrictions on an acquisition that the Secretary determines are necessary and appropriate.206 However, right-of- way acquired under the section may not be devel- oped in anticipation of the project until all re- quired environmental reviews for the project have been completed.207 MAP-21 also provides that the Uniform Relocation Assistance and Real Property Acquisition Policies Act of 1970 is applicable to FTA financial assistance for capital projects.208 When eminent domain is used to acquire prop- erty, post-Kelo reform legislation in some states may apply.209 The laws in some states may impose restrictions on the taking of property for economic development. Moreover, under state law, a con- demnor may have to pay compensation in excess of what is determined to be the amount of just compensation that ordinarily would have to be paid for the property. Only two agencies responding to the survey stated that they had encountered any issues re- garding the acquisition of real property or other land-use issues in connection with their PPP pro- jects. In one instance a variance was required from the city because the need for zoning approval for parking had not been anticipated in the par- ties’ joint development agreement.210 Another agency had experienced some issues relating to zoning, to the relocation of tenants of a prior facil- ity, and to encumbrances on the property.211 204 Id. at 71. See discussion of the MAX Red Line in App. A. 205 Estell & Washington, supra note 14, at 42. 206 Id. 207 Id. 208 Id. at 41. 209 THE RAMIFICATIONS OF POST-KELO LEGISLATION ON STATE TRANSPORTATION PROJECTS (National Highway Cooperative Research Program, Legal Research Digest No. 56, Transportation Research Board, 2011). 210 PVTA Response. 211 TriMet Response.

19 E. Taxation 1. Tax Treatment of PPPs in General Few, if any, PPPs for transit projects are “part- nerships” in the legal or tax sense. A transit PPP itself, thus, has no special tax significance.212 The organizers of a PPP typically avoid being a part- nership for tax purposes because of adverse con- sequences, including possible limits on “deduc- tions allocable to property used by governments and tax-exempt entities as well as differences in the tax depreciation rules for the assets.”213 The tax consequences for a private partner in a PPP depend on the “facts and circumstances of each transaction” and the terms of the PPP con- tract.214 Under federal tax law, a company’s in- vestment in a PPP is treated the same as a com- pany’s investment in any other business; nevertheless, “[a] private entity…must evaluate the federal tax implications” of a PPP and allocate any “up-front payment…among various rights…to determine the federal tax consequences.”215 As must any U.S. or non-U.S. taxpayer conducting a trade or business in the United States, a private party in a PPP has to report and pay tax on in- come earned from all sources. As do other taxpay- ers, a partner in a PPP has the usual deductions for business expenses incurred, including lease payments, the cost of repairs, interest on indebt- edness, and depreciation on property owned by the entity.216 As for property taxes, although legis- lation in Connecticut exempts eligible PPPs from property tax, generally a private entity in a PPP that is leasing a transit-owned facility would not qualify for an exemption for property taxes.217 212 Tax and Financing Aspects of Highway Public- Private Partnerships, supra note 166, at 4. 213 Joint Committee on Taxation, JCX-29-11, “Over- view of Selected Tax Provisions Relating to the Financ- ing of Infrastructure,” at 23 (2011), hereinafter referred to as “Tax Provisions Relating to Financing of Infra- structure,” available at https://www.jct.gov/ publications.html?func=startdown&id=3789. 214 Id. at 24. See Tax and Financing Aspects of High- way Public-Private Partnerships, supra note 166, at 4, 11, 16, and 25. 215 FISHMAN, supra note 11, at 36. 216 Id. 217 CHH, Connecticut—Multiple Taxes: Jobs Bill Creates New Credit, Encourages Investment (Oct. 28, 2011), available at http://www.cchgroup.com/wordpress/ index.php/tax-headlines/state-tax- headlines/connecticut-multiple-taxes-jobs-bill-creates- new-credit-encourages-investment/. 2. Tax Treatment of Long-Term Leasing of Transit Facilities a. Flow-Through Entities.—An important issue for a private entity in a PPP concerns the tax treatment of long-term leases of transit facilities. The Senate Committee on Finance, when conduct- ing hearings on the tax and financing aspects of PPPs for highways, considered the tax conse- quences of three kinds of transactions common to PPPs. First, a private partner in a PPP may pur- chase existing infrastructure owned by a public agency and lease it back to the public agency. Second, a private entity may enter into a long- term lease with a public agency in a PPP; for ex- ample, to operate and maintain a transit facility. Third, a private entity may enter into an agree- ment with a public agency; for example, for the collection of tolls or fees.218 It is the second transaction between a private entity and a public agency involving a long-term lease that allows a private party to receive a tax benefit that the average taxpayer does not re- ceive. Certain private entities when leasing prop- erty qualify as a “flow-through entity” not subject to federal tax.219 Certain business set-ups (e.g. S corporations and partner- ships) are “flow-through entity” structures, simply mean- ing that the business income is not taxed at the corporate level, but instead flows through to the shareholders’ in- come statements, avoiding double taxation. Foreign busi- nesses that have invested in highway PPPs in the U.S. have largely been structured as flow-through entities.220 The flow-through feature that avoids double taxation makes PPPs attractive to private compa- nies interested in leasing public assets such as transit facilities.221 Nevertheless, the shareholders of a private entity (or the partners in a partner- ship) participating in a PPP with a transit com- pany are subject to federal taxes on their distribu- tive share of income earned from their company’s (or partnership’s) lease of publicly owned property subject to a PPP. b. Constructive Ownership of Leased Facili- ties.—A private entity will want to ascertain whether the IRS will treat the private entity as the owner of the leased property or as the lessee of the property.222 The duration of a long-term lease may be “exceedingly long” to enable a pri- vate lessee “to recover capital outlays on an accel- 218 Tax and Financing Aspects of Highway Public- Private Partnerships, supra note 166, at 4. 219 Id. at 10. 220 Id. 221 Id. at 2. 222 Id.

20 erated schedule” and to take advantage of the tax code’s 15-year cost recovery.223 Because of the ex- tended duration of such a lease, the IRS may con- sider the private lessee to be the constructive or de facto owner of the leased property. For exam- ple, because the service life of highways and streets is estimated to be 45 years, a private part- ner in a PPP project for a toll road would be re- garded as the constructive owner if a lease ex- ceeded 45 years.224 As for a transit facility, the service life probably is “equated” with the service lives of railroad equipment, replacement track, and structures, which are, respectively, 28 years, 38 years, and 54 years.225 When a private-entity lessee is deemed to be the constructive owner, it is subject to different treatment under the Internal Revenue Code. By leasing “infrastructure assets for a period that clearly exceeds their expected economic life…firms can treat themselves as the tax owners of the infrastructure. As owners, they are then eligible to claim tax deductions for the deprecia- tion on their investments, just as other asset own- ers do.”226 Although a private lessee is not “an out- right purchaser” of an asset for tax purposes, a lessee becomes the constructive owner of the asset when the lessee has acquired “all the benefits and burdens of ownership” for a term exceeding the expected remaining useful life of the asset.227 3. Allocation of a Private Partner’s Up-Front Contribution to a PPP A private partner may make a payment to a transit agency in connection with the acquisition of a long-term lease or to acquire the right to de- velop transit-owned property. One issue is the federal tax treatment of any private up-front payment or contribution that may be part of the funding of a PPP. It appears that the parties should allocate the private partner’s payment as provided in 26 U.S.C. § 1060(a)(1) and (2), which applies to acquisitions. Section 1060 provides: In the case of any applicable asset acquisition, for pur- poses of determining both— 223 Id. 224 Tax Provisions Relating to Financing of Infra- structure, supra note 213, at 24 (citing BEA Deprecia- tion Estimates, available at http://www.bea.gov/ national/FA2004/Tablecandtext.pdf). 225 Tax and Financing Aspects of Highway Public- Private Partnerships, supra note 166, at 4. 226 Id. 227 Tax Provisions Relating to Financing of Infra- structure, supra note 213, at 23. (1) the transferee’s basis in such assets, and (2) the gain or loss of the transferor with respect to such acquisition, the consideration received for such assets shall be allocated among such assets acquired in such ac- quisition in the same manner as amounts are allocated to assets under section 338 (b)(5). If in connection with an applicable asset acquisition, the transferee and transferor agree in writing as to the allocation of any consideration, or as to the fair market value of any of the assets, such agreement shall be binding on both the transferee and transferor unless the Secretary determines that such al- location (or fair market value) is not appropriate.228 As a report by the Joint Committee on Taxation explains with respect to an allocation of an up- front payment in connection with PPPs and high- ways: The large up-front payment made by the private party to the transaction is treated as paid to acquire different bundles of business assets. As a result, the parties must allocate the initial consideration to the following catego- ries: (1) the acquisition of infrastructure assets, such as land improvements, computers, toll booths, and other property used to operate and maintain the highway; (2) a lease of the underlying land; and (3) the acquisition of in- tangible assets, such as a franchise and license for the right to collect tolls (along with any generally unstated goodwill or going concern value).229 The allocation rule in § 1060(a) could apply, for example, when a private partner lessee is treated for federal tax purposes as the constructive owner of a facility and is therefore entitled to depreciate the asset. A private partner may recover the cost of its payment for property used in a trade or business to produce income by claiming an annual deduc- tion for depreciation based on the cost of the asset as determined under the Modified Accelerated Cost Recovery System (MACRS).230 However, if a transit agency used tax-exempt bonds to construct or acquire an asset that is leased to a private partner in a PPP, the depreciation would be calcu- lated under the Alternative Depreciation System using a straight-line method that extends over a longer recovery period than depreciation calcu- lated under the MACRS.231 Whether a private entity in a PPP will be treated as the constructive owner of leased prop- erty for federal tax purposes may influence the 228 26 U.S.C. § 160(a)(1) and (2). 229 Tax Provisions Relating to Financing of Infra- structure, supra note 213, at 24 (2011). 230 Id. at 25, n.58 (citing 26 U.S.C. § 168; Rev. Proc. 87-56, 1987-2 C.B. 674). 231 Id. at 25–26, n.64 (citing Treas. Reg. § 1.168(i)- 4(d)(2)(ii)(B)).

21 term of a lease of transit property.232 Whether a private party wants to be treated as the construc- tive owner rather than as a lessee may depend on the percentage of the asset that is depreciable and on the depreciation schedule that applies to the asset, as well as on the entity’s other tax circum- stances. It may be noted that no agency respond- ing to the survey reported being aware of any fed- eral or other tax issues affecting a private partner’s participation in a PPP. Notwithstanding constructive ownership from a tax perspective, it may be noted that FTA’s Grant Management Requirements (GMR) provide for the protection of the federal interest in any real and other property acquired with FTA funds. In FTA’s Circular C 5010.D (November 1, 2008, revised August 27, 2012), Chapter IV ¶ 3(e)(1) states that a “grantee agrees to maintain continu- ing control of the use of project property and con- structed improvements to the extent satisfactory to FTA” and that the grantee “will not execute any transfer of title, lease, lien, …or any other obligation pertaining to project property, that in any way would affect the continuing Federal in- terest in that project property, without written FTA approval.” The GMR in Chapter IV ¶ (j) states that “[i]n all instances in which the grantee is a Lessor…, the grantee must obtain FTA’s writ- ten concurrence…before leasing FTA funded as- sets to others.” Chapter I ¶ 5(fff) of the GMR de- fines the term “remaining federal interest for real property” as “the greater of the Federal share of the fair market value of the property, or the straight line depreciated value of improvements plus the Federal share of the current appraised land value.” F. Bonding Requirements Under the Federal Miller Act, general contrac- tors on public works projects are required to pro- vide performance and payment bonds.233 A per- formance bond “must be in an amount the contracting officer considers adequate for the pro- tection of the government.”234 A payment bond guarantees that a “contractor will pay subcontrac- 232 Tax and Financing Aspects of Highway Public- Private Partnerships, supra note 166, at 7. 233 FTA Report to Congress on PPPs, supra note 5, at 29 (citing 40 U.S.C. § 313, et seq.) (noting that payment bonds serve as a substitute for subcontractors’ and sup- pliers’ mechanics liens). 234 Id. (citing 40 U.S.C. § 3131(b)(1)). tors and vendors for labor and materials.”235 A payment bond must be for the “total amount pay- able under the contract, unless the contracting officer makes a written determination…that a payment bond in that amount is impractical.”236 FTA recognizes the need for more bonding flexibil- ity for PPP projects. Not only is there limited availability in the bond market, but also bond re- quirements in high amounts limit the number of companies able to compete for larger projects. Ac- cording to several sources, sureties may be unwill- ing to issue a bond for more than $250 million. [S]enior members of the surety industry have stated that there is currently no limitation on the amount of a bond that can be provided for a single project. However, it is clear that in the not-too distant past the surety market had an informal “cap” on how much of a penal sum any individual surety would provide for a single project, par- ticularly on DB projects. While the amount of that “cap” was never directly ascertainable, it appears to have been in a range of $250 to $350 million. The reality of this bonding “cap” is reflected in several periodicals that have been issued to address the use of DB, turnkey, and PPP contracting methods in the transportation sector.… FTA has taken this particular surety issue seriously, as it has regularly consulted with the business community to reduce unnecessary bonding and has granted waiver re- quests by grantees of the 100 percent surety bond re- quirements.237 Nevertheless, the necessary bonding may be obtained by using multiple sureties and “the right contractor team.”238 As one article explains, [I]t should be noted that several owners have handled this situation by descoping large contracts into smaller packages. Strategic contract packaging is done not only on alternatively delivered projects, but also on conven- tional DBB projects. A prime example is how the New York City MTA handled its DBB process for three megaprojects procured during the mid-2000s….239 FTA has stated that “state and federal law re- quire performance bonding well beyond what is commercially feasible for project sponsors (or re- 235 O’Steen & Jenkins, supra note 6, at 291 (stating that the parties “usually establish specified liability limits, which are typically a percentage of either con- tract value or capital installed”). 236 FTA Report to Congress on PPPs, supra note 5, at 29 (citing 40 U.S.C. § 3131(b)(2)). 237 MICHAEL C. LOULAKIS, SHANNON J. BRIGLIA & LAUREN P. MCLAUGHLIN, LEGAL ISSUES INVOLVING SURETY FOR PUBLIC TRANSPORTATION PROJECTS 40–47 (Legal Research Digest 40, Transportation Research Board, 2013) (footnote omitted), hereinafter referred to as “Legal Research Digest 40.” 238 H.R. REP. NO. 110-24, Hearings on PPPs, supra note 9, at 49. 239 Legal Research Digest 40, supra note 237, at 41.

22 quired by private investors) and disregard the availability of other forms of security.”240 Flexibil- ity may permit a private partner to furnish an alternative form of security such as a financial guarantee by a private patner’s parent com- pany.241 Because the requirements for perform- ance bonds increase costs, a “public partner should assess this issue on a cost-benefit basis.”242 Although FTA requires performance bonds for 100 percent of the contract price,243 there is a slid- ing scale for payment bonds based on the size of the contract, with payment bonds in the amount of $2.5 million required for all contracts of $5 mil- lion or more,244 requirements that have been waived for “larger design-build and DBOM pro- jects.”245 FTA Circular C 4220.1F on Third Party Contracting Requirements permits a grantee to seek FTA’s approval of a grantee’s bonding pol- icy.246 Most states have “Little Miller Acts,” similar to the Federal Miller Act, that require performance and payment bonds be obtained for the total amount of the contract.247 State statutes offer lit- tle or no flexibility based on the scale of a PPP project or “structural differences” that exist be- tween PPPs and traditional public procurement.248 Small and mid-size construction companies have difficulty obtaining bonds needed to compete with large firms on DB projects or to back warranties 240 H.R. REP. NO. 110-24, Hearings on PPPs, supra note 9, at 85. 241 Id. at 39, 46. 242 O’Steen & Jenkins, supra note 6, at 291. 243 FTA Report to Congress on PPPs, supra note 5, at 38–39, available at http://www.fta.dot.gov/legislation_ law/12349_8641.html. See FTA Circular C 4220.1F, ch. IV, at IV-26 (Nov. 1, 2008; revision 3, Feb. 15, 2011), hereinafter referred to as “FTA Circular on Third Party Contracting Guidance, C4220.1F,” available at http://www.fta.dot.gov/documents/FTA_Circular_4220.1 F.pdf. 244 FTA Circular on Third Party Contracting Guid- ance, C4220.1F, supra note 243, at IV-26. 245 FTA Report to Congress on PPPs, supra note 5, at 29 (citing, e.g., the $1.1 billion T-Rex Project in Colo- rado and the New Jersey Transit River Line). 246 FTA Circular on Third Party Contracting Guid- ance, C4220.1F, supra note 243. See FTA Report to Congress on PPPs, supra note 5, at 38–39. 247 FTA Report to Congress on PPPs, supra note 5, at 29 (citing, e.g., ARIZ. REV. STAT. § 34-222; N.C. GEN. STAT. § 44A-26; OR. REV. STAT. § 279C.380; and VA. CODE § 2.2-4337). 248 Id. at 29. that are required in the event of a firm’s insol- vency.249 Six agencies responding to the survey reported that for their PPP projects the contractor was re- quired under federal or state law to provide per- formance and payment bonds for the full amount or value of the applicable contracts.250 The San Diego Association of Governments (SANDAG) stated that neither bond was required for its par- ticular project. SEPTA stated that for one of its PPP projects neither bond was required. G. Insurance and PPP Projects PPP projects may involve complex insurance arrangements and project-specific policies. A typi- cal contractual provision for a PPP project is a requirement for minimum levels of certain kinds of insurance that must be obtained and main- tained, such as for property and casualty risks, comprehensive general liability risks, workers’ compensation, and automobile liability.251 The sponsor of the Hiawatha Corridor Light Rail Transit (LRT) project used an owner-controlled insurance program (OCIP),252 but according to the FTA one of the “drawbacks” of the OCIP was that contractors had limited incentive to resolve work- ers’ compensation claims.253 Several agencies responding to the survey re- ported that the private partner assumed respon- sibility for the insurance coverage,254 whereas two agencies said that the private partner had not had any responsibility for insurance.255 New Jersey Transit provided a copy of its insurance and in- demnity provisions.256 Although the private part- ner did not assume the responsibility for insur- ance for the Milford Transit District’s PPP, a 249 H.R. REP. NO. 110-24, Hearings on PPPs, supra note 9, at 46. 250 La Crosse Municipal Transit Utility Response; Conn. DOT Response; Milford Transit District Re- sponse; N.J. Transit Response (also stating that no waiver was requested); PVTA Response. 251 O’Steen & Jenkins, supra note 6, at 291. 252 FTA Report to Congress on PPPs, supra note 5, at 16. 253 Id. 254 Conn. DOT Response; SEPTA Response (stating that coverage included liability, pollution, worker’s compensation, and automobile insurance); SARTA Re- sponse; and TriMet Response. 255 Response of San Diego Association of Govern- ments (SANDAG), hereinafter referred to as “SANDAG Response”; Milford Transit District Response. 256 See App. C, item 3.