May 29, 1998
Via Telecopier and By-Hand
Mr. Haig Farmer, Privatization Coordinator
Municipal Support Division
United States Environmental Protection Agency
401 M Street, S.W. (Mail Code 4204)
Washington, D.C. 20460
Re: EPA Guidance on the Privatization of Federally Funded Wastewater Treatment Facilities
Dear Mr. Farmer:
The Water Industry Council is a not-for-profit trade association representing leading private water and wastewater service providers to municipal and local governments on a contractual basis and through public-private partnerships. We thank you for the opportunity to comment on the United States Environmental Protection Agency's April 1, 1998 draft "Guidance on the Privatization of Federally Funded Wastewater Treatment Facilities" (herein the "EPA Guidance").
We recognize EPA's need, as a federal granting agency, to ensure that wastewater treatment works developed with federal funds will continue to be used for their originally intended purpose, that the public interest will be protected, and that user charges with respect to such federally funded works are preserved at proper levels. We believe that the EPA Guidance goes a long way to assuring these protections. In our view, however, the EPA Guidance could be even better tailored to meet these objectives without conflicting with both the Presidential Executive Order (E.O. 12803) privatization policy and considerations regarding federal/state policy.
We have two specific comments on the EPA Guidance, which are discussed below. First, the EPA Guidance will unnecessarily subject too broad a range of public-private arrangements to EPA review and approval, with a chilling effect on the development of the overall privatization trend, by defining "lease" and "lease-type arrangements" overbroadly through a misconstruction of E.O. 12803. Second, whatever its final scope, the EPA review and approval process of proposed privatization arrangements should be streamlined and made more predictable in its operation.
Comment 1. By defining "lease" and "lease-type arrangements" overly broadly the EPA Guidance will chill future privatization by subjecting many privatization arrangements to EPA review and approval not intended to be within the purview of E.O 12803.
The EPA Guidance requires all "lease" arrangements to undergo EPA review and approval prior to execution by the local government which proposes to enter such an arrangement with a private party. The EPA Guidance defines "lease" broadly to include a privatization arrangement whenever a private entity operator makes a payment to the local government, i.e., pays a "concession fee" for the right to operate the originally grant funded facility for a period of years, i.e. the EPA Guidance deems such as arrangement a "lease" or "lease-type arrangement". It suggests that such a concession fee will result in an encumbrance of the local government's title to the facility. Following this line of approach, EPA considers concession fees to be like a form of lease payment.
However, EPA's definition of "lease" and "lease-type arrangement" is not supported by legal precedent. Consequently, the definition is overly broad And inclusive and creates uncertainty in EPA's review and approval requirements. The consequence will be to chill privatization in the wastewater industry, contrary to the clear spirit and intent of E.O. 12803.
EPA offers no legal precedent for its declaration that the term "lease" includes arrangements wherein an operating agreement also includes a concession fee. In fact, legal precedent is to the contrary. Traditionally, a lease is defined as a "conveyance of exclusive possession of specific property, for a term less than that of the grantor, usually in consideration of rent which vests an estate in the grantee." [Friedman on Leases, Fourth Edition, Milton R. Friedman, 1831 (citing Nahas v. Local 905, Retail Clerks Int'l Ass'n, 144 Cal. App. 2d 808, 302 P.2d 829 (3d Dist. 1956).] The grantor (landlord) has no right to enter during the term except to repair or claim rent. [Id at 1832] The grantee's (tenant's) estate in the property is referred to as a leasehold interest.
A concession fee does not transform the obligation to operate a facility in return for a fee (an operating agreement), into a right of leasehold occupancy (a lease). An operating agreement is merely a contract between two parties, whereby one party (the private entity operator) agrees to operate and manage the assets of another party (the local government). No leasehold interest or estate is vested in the operator. Possession of the property is incidental to the services to be provided. Exclusive possession is certainly not contemplated and full dominion and control of the asset remains with the local government. The operating agreement documentation generally states this clearly, including rights of usage and protection by the local government of the public interest.
The intent of the parties to grant "exclusive possession" of the property and an estate interest in the grantee is determinative of whether a contract is a lease; the mere fact that a payment from the private entity to the local government has been made is not so determinative. It is only if such a payment results in "exclusive possession" and creates an estate interest that such an arrangement could properly be classified as a lease.
The most that a "concession fee" could be said to create is a license. Whereas a lease conveys an interest in land and transfers possession, a license does not grant possession but only the right to use the premises. [In re Harbour House Operating Corp., 26 B.R. 324 (Bkrtcy. Mass 1982)] Possession and control of the property under a license remain within the domain of rights held by the landowner. A license does not create an estate interest and merely makes permissible acts on the land of another. Arrangements similar to operating agreements coupled with payments have been held by courts to be more like licenses rather than leases. For example, in In re Application of Rosewell (1979), 69 Ill. App. 3d 996, 387 N.E. 2d 866 the City of Chicago and private companies entered into agreements for the operation of parking facilities. The private entity operators paid "rent" to the City. The agreements transferred possession of the parking facilities to the operators. The court found that an agreement which merely entitles one party to use property subject to the management and control of the other party does not constitute a lease, but rather grants a license. There are numerous other cases which document this distinction between a lease and a license in a manner which emphasizes continued municipal dominion in a variety of concession agreement contexts. [In Charlton v. Champaign Park District,.110 Ill. App. 3d 554, 442 N.E. 2d 915 (1982) , a Concession Agreement which provided for a private entity to build, own and operate a water-slide and related concessions, collecting the admissions and concessin charges and remitting a portion othereof back to thelocal government was ruled a license and not a lease. The court reasoned that a license differs from a lease in that a license merely gives the licensee a ritht to enter upon the licensor's land and use it for a specific purpose. The licensor still has legal possession and control over the premises. In a lease, the lesee possesses an estate interest and controls the property against lessor and all the world. In In the Matter of the Tax Appeal of Frank F. Fasi,634 P.2d 98 (1981), the Supreme Court of Hawaii ruled that a Service Agreement between the State of Hawaii and a private entity operator was not a lease, even though the agreeement itself refers to lease and rent i several places. The court ruled the State retained all incidents of ownership under the operating agreement.] These cases make it clear that the right to use a property is legally distinct from the right of exclusive possession and the creation of an estate interest in such property. An operating agreement coupled with payments is not intended to create a right of exclusive possession and an estate interest. Licenses of infrastructure assets clearly do not under E.O 12803 require federal review and approval, and should be so treated by the EPA Guidance.
While a lease might be said to in effect deprive a municipality of the ownership benefits which it (with the assistance of the Federal Government) financed, an operating agreement with of a concession fee neither has that legal effect, nor even can properly be viewed as presenting a "red flag" that such an event has occurred. Any so-called concession fee merely represents a discounting to present value of the anticipated savings which the private entity operator can offer the local government over the term of its service agreement. Whether the local government receives the economic benefit of such savings on a periodic basis or in the form of the discounted value of those savings in a lump-sum up-front payment, the economic result is the same; up front monetization of guaranteed future savings, which is what the concession fee represents effectively, is no indication of a real property transfer of a leasehold property interest.
Nor, as a legal matter, does any such concession fee payment by a private entity operator to the local government, somehow create an "encumbrance" on the assets. An encumbrance represents a security interest in an asset, which under local mortgage law or the Uniform Commercial Code may be "perfected" in that asset and subsequently may be "executed upon", i.e. if certain events should occur, the owner may be deprived of its ownership of the asset. No such encumbrance is intended by either party to these operating agreements; the documentation for the transactions is crafted specifically to make this clear. The private entity operator has no claim against the asset, as a matter of law, if the operator fails to earn fees over the course of the contract sufficient to recover any payment. If the local government improperly terminates the contract, the private operator's only remedy is a suit for breach of contract and recovery of monetary damages; it cannot claim a lien on the infrastructure asset which it has been operating to provide service itself. Even were the concession fee a "lease like" arrangement as the EPA Guidance suggests, it does not "encumber" the municipal or federal interest.
Recognition of this fact is important from a policy standpoint. It is appropriate that the EPA be concerned with an arrangement which would have the potential to spirit away from public control, without appropriate recognition of the public interest, an asset toward which the Federal Government has contributed. Since, as a legal matter however, no such result can occur in the case of an operating contract, whether or not accompanied by an up-front payment, the policy concern is not one which otherwise would be present.
In sum, consideration of the legal and policy foundations of the "lease-like" and encumbrance" formulations in the EPA Guidance lend to the conclusion that they are overbroadly applied in the EPA Guidance with respect to application of E.O. 12803.
No other policy threat to the Federal interest is created, as close review of Federal guidance does not modify that conclusion. EPA cites OMB Circular A-102 as the basis for the requirement that it establish "barriers to lease and sale types of privatization agreements for local governments which received EPA construction grant funds." The EPA states that under OMB rules [circular A-102 was revised in its entirety on October 7, 1994, and the cited sections of Attachment M and Attachment N do not appear to be included in the revised section], "these types of transactions are viewed as dispositions of federally funded property, because they temporarily or permanently transfer the facilities title or use the title as a form of collateral." While this is certainly the case, the OMB pronouncements do not extend to the concession fee/operating agreement case here under discussion.
a) Circular A-102 does not set forth language in support of the proposition that operating agreements coupled with concession fees are the equivalent of a lease-type arrangement. OMB-A-102 is silent in defining "lease" or "lease-type transaction."
b) Circular A-102 states only that federal agencies need to consider "reviewing and modifying procedures affecting the management and disposition of federally-financed infrastructure owned by State and local governments, with their requests to sell or lease infrastructure assets, consistent with E.O. 12803." Since there is no other reference to the concession/operating agreement privatization of infrastructure assets, the appropriate reference with respect to the need to regulate these "lease-like" and creating jurisdictional "encumbrance" therefore is E.O. 12803.
While the EPA Guidance states that pursuant to E.O. 12803, all leases of infrastructure assets (without reference to term) require federal review and approval before a local government may enter a lease agreement when EPA grant funds have been used to finance the subject asset, E.O. 12803 does not. E.O 12803 states that privatization means the disposition and transfer of infrastructure assets by sale or long-term lease. Only the disposition and transfer of a federally funded infrastructure asset in this manner requires federal review and approval. The specific language of E.O 12803 does not direct OMB or empower EPA to review and approve privatization arrangements that are merely believed by regulators to be in the nature of a lease or that might be considered to encumber the assets. The plain meaning of E.O. 12803 is clear: where no disposition or transfer has in fact occurred, no federal review and approval is required. As emphasized above, an operating agreement coupled with a concession fee is not a disposition or transfer of an asset.
E.O. 12803 makes no reference to operating agreements, or to the need for agencies to shepherd operating agreements when accompanied by concession fees. This effect is enhanced by the fact that the EPA Guidance provides for the creation of a platform for extensive information questions and the potential for delay. The inevitable consequence of EPA's overly broad interpretation of the term "lease" therefore is to subject more transactions to federal review and approval than were contemplated by E.O 12803. In this regard, the EPA Guidance is inconsistent with the direct purpose of E.O. 12803 which is to provide state and local governments greater freedom to privatize infrastructure assets. E.O. 12803 seeks to remove barriers to the achievement of economic efficiencies through additional private market financing. Federal agencies are required by E.O. 12803 to "review those procedures affecting the management and disposition of federally-financed infrastructure assets owned by State and local governments and modify those procedures to encourage appropriate privatization of such assets...." (emphasis added) While appropriately seeking to protect the public interest, EPA has in effect created a barrier to the privatization of infrastructure assets by requiring federal review of any operating or management agreement that also includes an up-front payment or periodic payments from the private entity.
Comment 2. The EPA review and approval process of proposed privatization arrangements should be streamlined and predictable. Despite our disagreement with EPA's overly inclusive definition of "lease" and "lease-type arrangements," we nonetheless recognize EPA's responsibilities as a granting agency to protect the public interest. As stated in E.O. 12803, the EPA must ensure that: (i) the infrastructure asset or assets will continue to be used for their originally authorized purposes, as long as needed for those purposes; and (ii) user charges will be consistent with any current Federal conditions that protect users and the public by limiting the charges. Some of the burden which application of EPA jurisdiction to so-called "lease like" arrangements could be assuaged if there was some assurance of light and expedited review focused on policy concerns and consistent with other guidance.
In order to achieve this goal, EPA's review and approval process should be streamlined and predictable. EPA Guidance should specify precisely what documentation is required, how long EPA's review process will take, and what the approval standard will be. EPA's review and approval process should be specifically tailored to relate to EPA's and E.O. 12803's policy objectives. At least where no clear-cut sale or lease is apparent, deference to municipal decision makers ought to be extended, consistent with traditional EPA standards. Broadly speaking, deference to municipal decision makers would be consistent with E.O. 12803 as well as established principles in EPA administrative practice of Federal/State comity.
EPA should not become involved in the minutiae related to private financial structuring and data; that is the role which E.O. 12803 assigns to the private party in the first instance and then to local government in its review capacity. EPA Guidance should be results oriented, i.e., if the local judgment with respect to its operating contract is satisfaction with net rate payer and other citizen benefits (and local government is, after all, the agency which must answer to the rate payer and to the local voters), EPA should not seek data or introduce a procedure which, in effect, makes it a consumer protection agency in that regard. To do so is to impair the benefits of E.O. 12803 without materially improved public interest protection.
It is our belief that EPA has chosen an overly broad definition of "lease" and "lease-type arrangements", which, because it is not supported by legal precedent in commercial or public law, is vague and arbitrary. We do not find support for its approach in Circular A-102 or E.O 12803. The effect of EPA's definition is likely to place a barrier on the privatization of wastewater treatment facilities by subjecting more transactions to federal review than were contemplated by E.O. 12803 and subjecting them to detailed information and possibly delay-inducing requirements. Such discouragement of privatization and reduction of the flexibility of state and local governments to make effective use of it is contrary to the direct intent of E.O. 12803.
One way to alleviate the adverse impact of the scope of the EPA Guidance is for EPA to adopt a streamlined review and approval process of sale and lease arrangements, with predictable results, i.e. the level of reviews and nature of outcomes are specifically designed to address EPA's policy objectives as established in Circular A-102 and E.O. 12803.
The Water Industry Council would welcome the opportunity to work with EPA in the refinement of the EPA Guidance and the formulation of appropriate administrative guidelines to assure that privatization achieves municipal and Federal policy goals in all respects, while being undertaken in a manner consistent with the Federal interest. Please feel free to call me at (202) 778-3181 or Lawrence Chertoff, the Executive Director of the Water Industry Council, at (718) 625-6500 in that regard or with any questions or comments.
Roger D. Feldman
Counsel to Water Industry Council