Redevelopment Law Unconstitutional Because of Impairment of Contract?

by Sheppard Mullin Richter & Hampton LLP

Author: Geoffrey Willis

Largely lost in the noise and furor surrounding the decision by the California Supreme Court upholding AB 1X 26 (California Redevelopment Association v. Matosantos (2011) 53 Cal.4th 231, which terminated the functions of local redevelopment agencies, is that there are strong arguments the new law violates state and federal constitutional provisions prohibiting legislation that results in impairment of existing contracts. Neither side in the Matosantos case raised the impairment of contracts argument and the Supreme Court chose not to raise the issue sua sponte. If AB 1X 26 was found to violate the Impairment of Contract clauses of either the state or federal constitutions, the violative provisions are so deeply woven throughout the fabric of the act that severance of non-offending provisions would be difficult at best, potentially resulting in the entire act being struck. While a successful impairment argument would possibly lead to the voiding of the legislation, it would not necessarily mean that the California Legislature could not enact a narrower RDA "abolishment" statute that terminated future and further contracts while better protecting the enforceability of existing contracts.

California Constitution Article 1, Section 9 provides in pertinent part that "a bill of attainder, ex post facto law, or law impairing the obligations of contracts may not be passed." In similar fashion the United States Constitution Article 1, Section 10 provides "No State shall . . . pass any Bill of Attainder, ex post facto law, or law impairing the Obligation of Contracts . . .." Legislation running afoul of these constitutional protections can be stricken. Teachers Retirement Board v. Genest (2007)154 Cal.App.4th 1012; Valdes v. Cory (1983) 139 Cal.App.3d 773 These constitutional provisions were put into place to prevent the legislative branch from enacting bills that prevented the performance of existing contractual obligations.

AB 1X 26 appears to violate constitutional contractual impairment prohibitions in several ways. First, billions of dollars of bonds have been issued through the actions of RDAs, and many of the contracts establishing the rights of bondholders are still in effect. Virtually all of those bonds were secured by the RDA's obligation to repay the bond debt through constitutionally protected tax increment sources, and that source of funds was specifically identified in those contracts. Cal.Const. Art. XVI, Sect. 16. The new law transforms the repayment source from constitutionally protected tax increment sources to simple property taxes, which lack constitutional protection and are potentially subject to shortfall. Yet, people buying the bonds reasonably and materially relied upon the stable repayment source provided by tax increment and valued the bonds accordingly. Changing the repayment source from the stable and secure tax increment source to the unstable and unsure property tax source immediately reduces the value of the bonds, thereby impermissibly impairing the bondholders constitutionally protected contractual rights. Nothing in the Montasantos opinion addressed this argument.

Second, AB 1X 26 imposes an entire, potentially flawed process to terminate, challenge and attempt invalidation of existing RDA obligations. This process includes:

  • A requirement to create enforceable obligation schedules. As a result, an agency’s failure to include an agreement on the applicable schedule could result in that agreement’s being deemed unenforceable. Thus, the developer or other counter-party’s rights would be terminated for no reason other than the change in law and administrative oversight.
  • An obligations statement review process, which allows oversight boards, county controllers, other taxing authorities and the State Department of Finance to challenge the enforceability of scheduled obligations. Each of these bodies/agencies/departments has the right to demand and review all documentation, ask for more time, and challenge inclusion on the schedules.
  • Reviews of successor agency action by oversight boards, county controllers, other taxing authorities and the State Department of Finance, which can potentially lead successor agencies to ignore or overlook requirements of good faith and fair dealing. For example, a typical Disposition and Development Agreement providing for the sale of RDA property to a developer requires the developer to provide project designs and financing plans for agency review. The oversight board (or county controller or State controller) could simply direct the successor agency to refuse to approve the plans, and then terminate the contract because the plans have not been timely approved.
  • Oversight board obligation to review and, if possible terminate existing agreements where default payments would cost less than performance costs. This provision would literally require successor agencies to breach existing agreements.
  • Certain specific RDA obligations, such as issuance of new bonds, have been expressly prohibited. Many redevelopment agreements contemplate the issuance of bonds on satisfaction of certain conditions, such as completion of a project or phase.

The law thus creates numerous situations in which successor agencies could overlook or ignore existing contractual rights in violation of both state and federal Impairment of Contract prohibitions.

These two categories of possible impairment—bondholder interests and partially completed contracts—are just two of the many types of agreements potentially impaired by AB 1X 26 and the termination of which may be legally challengeable. Impairment challenges could be brought as either a facial challenge or as an "as applied" challenge. Given the facts necessary to prove other impairment actions, it is more likely that they will be brought "as applied."

The drafters of AB 1X 26 understood and tried to protect the legislation from a challenge based upon an impairment argument. Section 34172(c) provides that the Redevelopment Property Tax Trust Fund is deemed a special fund to pay principal and interest of debt, and Section 34172(d) earmarks revenues that would have been allocated pursuant to Cal. Const. Art. XVI, Section 16 to the Redevelopment Property Trust Fund, such that only the amounts in excess of what is needed to pay obligations of the former redevelopment agency are deemed property tax revenues. Additionally, Section 34173(b) is a savings clause giving the successor agencies all the powers of redevelopment agencies that was not expressly stripped away by AB 1X 26.

However, these measures may not be sufficient to overcome an impairment challenge to AB 1X 26. Among other things, the savings clause in 34173(b) may not provide sufficiently clear authority for successor agencies to issue debt. Thus, to the extent a DDA contains a pledge of tax increment, the failure of a successor agency to issue debt in response to a demand under such a pledge could set up an impairment claim.

In order to avoid an Impairment of Contract claim, a court would first seek to read the statute in a way to avoid the constitutional problems. In this case—since elimination of tax increment, the review process for all agency obligation and of the minimization of redevelopment agency liabilities are all core parts of AB 1X 26—it may be impossible for the court to do so. Alternatively, the court could try to sever the constitutionally infirm provisions from the other parts of the statute. While this may work for some provisions, e.g., eliminating the statutory requirement for oversight boards to require successor agencies to breach contracts, it seems unlikely that the court would be able to sever many other provisions, such as those relating to tax increment pledges (because the elimination of tax increment is the primary economic purpose of AB 1X 26). As a result, the only remaining remedy available to the court would be to strike all of AB 1X 26 as unconstitutional.

The Impairment of Contract prohibition does not prevent the legislature from terminating RDAs or preventing RDAs from incurring new obligations or entering into new agreements. The prohibition simply prevents the legislature from terminating executed and existing contracts in violation of the state and federal constitutions. Appropriate modifications to the legislation could better protect the rights of existing parties, saving litigation expense and uncertainty, at a cost to the state of only a small portion of the tax increment revenues of the redevelopment agencies over the next several years.

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