By David Evenhuis
Municipalities under financial pressure from rising budgetary costs and long-term obligations are increasingly looking to monetize their public assets. Monetization is the process of converting assets into economic value. Looking for options to generate greater revenue, many municipalities and public sector entities are considering transfers of municipal water and wastewater systems to private operators.
Monetization is usually accomplished by entering into a long-term lease with a private operator under what is known commonly as a concession agreement. Municipalities might instead opt for an outright sale of assets. Whatever the process, it almost always involves the conveyance of significant real estate interests necessary to support the facilities in question. Too often, however, public sector entities jump into deals before undertaking thorough due diligence and without resolving thorny real estate issues to ensure a smooth transition.
With some of the nation’s oldest municipalities, Pennsylvania presents attorneys with unique and unusually complex real estate issues when advising clients about public assets. While a concession or sale has the potential to relieve budgetary pressure for many years into the future, municipalities often must resolve a tangled web of title issues that have gone unchecked as properties were donated, dedicated, or acquired through eminent domain over years, if not decades. Moreover, the sheer number of properties involved in a typical concession greatly increases the odds of uncovering title problems.
Before a private operator can move forward with a deal, it will need to obtain a commitment for title insurance covering the affected real estate. The standard for resolving title issues is generally set by the insurance underwriter. A title company may require a municipality to obtain quitclaim deeds or deeds of dedication, or even require it to bring actions for declaratory judgment or to quiet title for portions of water or wastewater systems with no clear record of dedication or public acquisition. Such assets may not be insurable without some additional confirmation of municipal ownership.
The preferred title cure option may also depend upon which third party is granting the remedy. For example, where undedicated water mains run through a planned community or condominium development, a quitclaim deed may be preferable to a deed of dedication, a conveyance which likely would trigger the need to obtain approval from a prohibitively high percentage of community members. Attorneys representing a public entity may also have to track down builders, developers, lenders, and homeowner associations to obtain approvals or releases required by the title company. However, negotiating alternative remedies with the title company to cure such issues—and knowing what options are available—can save a municipal client significant time and money.
Deed restrictions may also present a major roadblock as to the available use of the property. Since municipal real estate is often acquired by donation or dedication, many granting instruments restrict the use of land exclusively to public purposes or, say, for the storage and distribution of public water only. In such circumstances, title companies may require amendments to deeds, which can sometimes involve obtaining court approval. Even where a municipality is not contemplating the transfer of a large utility system, use restrictions still may have to be modified. Additionally, where a deed conveys only a ground lease to a municipality, the term of the ground lease may need to be extended to accommodate the entire term of the concession.
Realty Transfer Tax
The fact that a municipality or public entity is party to a transaction does not necessarily make the transaction itself exempt from realty transfer tax. The United States and Pennsylvania and its instrumentalities, agencies, and subdivisions are all parties exempt from the payment of realty transfer tax. The exempt status of a municipal party, however, does not relieve any other party to a transaction from liability for the tax. In general, municipal transactions are excluded only where real estate is transferred to a municipality for no or nominal consideration or where all parties to the transaction are exempt parties. Any transfer to a private entity or corporation when seeking to monetize public assets likely will be taxable.
Realty transfer tax notably applies to real estate leases of 30 years or more, since such durable interests qualify as “title to real estate” under the transfer tax statute. Moreover, any writing or document transferring title to real estate is subject to the tax. Under a concession agreement, where the typical lease term will exceed 30 years, the parties should anticipate the imposition of realty transfer tax based upon the computed value of all affected parcels. As noted above, municipal ground leases may need to be extended before entering into a concession agreement. Where the extended lease terms exceed 30 years, additional transfer taxes may be triggered prior to the close of the concession.
Transfers of permanent easements are also subject to realty transfer tax, since easements represent an express taxable interest in real estate. In grants of permanent easements, transfer tax is based upon the actual consideration paid for the easement or its actual monetary worth. There is an exemption excluding any transfer of an easement to a public utility, and easements less than 30 years are not subject to realty transfer tax.
Parties must also be careful when assigning any interest in a concession or purchase agreement. If not handled properly, an assignment may trigger the imposition of additional realty transfer tax. Even if assigned to a subsidiary, the assignment may constitute a taxable transfer. While there are effective ways to avoid such additional taxation, any solution should be carefully reviewed by an attorney experienced with complex realty transfer tax matters.
Strategies for Closing
It may be obvious, but the development of a transaction plan should be the first priority, setting forth the requirements for closing upon the conditions that will achieve your client’s objectives. The plan should guide contract negotiations, so that the concession or purchase agreement reflects the objectives and any steps needed for closing or post-closing use. If zoning modifications or easements are needed—or environmental remediation or regulatory clearance—the transaction plan and final agreement should address those issues and include all applicable requirements as conditions to close.
Parties should plan on unexpected issues arising on the path to closing, which may require creative solutions and further negotiation. Sometimes these issues arise as a result of facts learned during due diligence investigations. Other times they arise because third parties affected by the transaction have interests adverse to those of the parties or the lender. When obstacles arise, tailored solutions may be required to accommodate the needs of all concerned parties so that the transaction can move forward.
Controlled chaos leading up to closing is typical when transferring public assets. Whether dealing with lenders; appraisers; local planning, zoning or taxing authorities; project surveyors; environmental consultants; title companies; adjoining property owners; engineers; or other third parties, it will often be the case that attorneys must wait for them to react before being able to proceed. Regardless of the obstacles, however, the benefits to a municipality of monetizing assets, when structured properly, can be significant and lasting.
McNees Wallace & Nurick LLC
David Evenhuis is a real estate attorney at McNees Wallace & Nurick LLC in Harrisburg. His practice focuses on acquisitions and dispositions, commercial leasing, and realty transfers within corporate mergers and acquisitions. He can be reached at email@example.com.
Featured in Commercial Real Estate Review – Fourth Quarter 2019