Hall v. Mayor of Baltimore

Hammond, C. J., delivered the opinion of the Court. In June 1968 Baltimore City officials published a request for bids on a lease and leaseback arrangement under which the successful bidder would construct a one-story warehouse on land owned and to be rented to him by the City at a nominal rent, the completed structure to be subleased back to the City for the same term as the lease at a yearly rent to be submitted with the bid. A form of lease and a form of sublease were published with the request for bids. On July 10, 1968, Calvert General Contractors Corp. (Calvert) submitted a bid in which it proposed to complete the warehouse within seven months and agreed to accept an annual rent of $96,000 for the original term of fifteen years.

Calvert’s bid was accepted by the Board of Estimates after Mr. Charles L. Benton, Director of Finance of Baltimore City, wrote the Board that: “This warehouse is required to enable the Bureau of Purchases to perform the duties imposed upon it by the Charter. It is also needed to allow the Bureau to realize fully the efficiencies and consequent economies inherent in the centralized purchasing principle, while improving the speed and quality of its services to using City agencies. “The Planning Commission as well.as the Department of Finance, has consistently advocated the use of the lease-purchase method to obtain the buildings needed by the City when they are needed and at reduced long term cost. It is my opinion that Your Board’s approval of this proposal will effect substantial savings to the City by comparison with alternative financing methods. These latter methods could not, in any case, be employed on a timely basis.” The lease from the City to Calvert of vacant land near City ⁴¹⁹ Hospitals, and the sublease from Calvert to the City which has appropriate matching, corresponding and supplementing provisions, together provided that Calvert leased the land and completed warehouse thereon to the City at an annual rent of $96,000 payable in monthly installments of $8,000 for a term of fifteen years, renewable for another fifteen years, with an option to the City exercisable at any time after the first six months of the sublease during the original or renewal term to buy Calvert’s leasehold interest at an appraised value of the premises and appurtenances mutually agreed upon by two licensed appraisers who are members of the Real Estate Board of Greater Baltimore, one selected by the City and the other by Calvert, with a similar appraiser to break a tie, if necessary.

If the City does not exercise its option during the original fifteen-year term there will be an automatic renewal for another fifteen years, at a rental determined by licensed appraisers. If the City has not exercised its option at the end of thirty years, Calvert must remove the building within ninety days and restore the land. The documents recite that the parties contemplate that Calvert will finance the project by mortgaging its leasehold interest, first by a construction loan and then by a permanent loan, and it was agreed in the lease and the sublease that all mortgages will be subordinate to the City’s interest as lessor under the lease and its interest as sublessee under the sublease. William G. Hall, who- is a resident, property owner, taxpayer and voter in the City, filed a petition for a declaration, backed by an injunction, that the entire lease-back arrangement and its documentary components are unconstitutional and void because (1) they amount to the creation of a debt by the City forbidden by Article XI, § 7, of the Constitution of Maryland unless authorized by an act of the General Assembly and an ordinance of the City submitted to and approved by the voters of the City; (2) they violate Art. V, Sec. 5, of the Charter of the City (1964 Revision), that the City may lease land only if it is not needed for public purposes; and (3) they violate the competitive bidding requirements of Art. VI, Sec. 4, of the Charter.

Judge Carter considered the documents, the testimony and a stipulation that Calvert had calculated its bid so that the annual ⁴²⁰ rent of $96,000 will (a) pay the installments of principal and interest on the construction and permanent loans as they mature so that there will be no mortgage encumbrance at the end of fifteen years; (b)- pay the ordinary and reasonable expenses related to the warehouse which Calvert is obligated to pay under the arrangement; (c) pay income taxes resulting to Calvert because of the arrangement; and (d) return a reasonable profit to Calvert. The City has not had and will not have any direct part in Calvert’s financing plans. An experienced and concededly competent realtor testified without contravention that not only was the rent of $96,000 a year a fair rent but the City “is actually getting a good value,” since it is paying $1.20 a square foot in cash for space which would bring $1.63 on the open market and (adding 20 cents for taxes which the City foregoes and 8 cents for the value of the land capitalized at 634%) can be considered costing the City a total of $1.48 a square foot. Judge Carter held that the arrangement between the City and Calvert did not create a debt of the City within the meaning of the constitutional provision of Art. XI, § 7, that: “no debt * * * shall be created by the Mayor and City Council of Baltimore * * * unless such debt * * * be authorized by an Act of the General Assembly of Maryland, and by an ordinance of the Mayor and City Council of Baltimore, submitted to the legal voters of the City of Baltimore * * * and approved by a majority of [such votes] * * but rather was a bona fide lease from Calvert to the City at a fair and reasonable rental and not, because of the purchase option, a disguised purchase available to the City at no consideration other than the rentals or a nominal consideration.

His reasons included the fact that the City has no requirement or compulsion to buy; the price, if the City does buy, is determined by an appraisal of fair value at the time the option is exercised and that a real lease with a real option to buy does not create a debt under the authorities. We agree with Judge Carter’s decision on this point, and essentially with his reasons for his decision. ⁴²¹ Constitutional debt limitations throughout the country began at the State level long ago and when such limitations in the public mind unduly restricted the ability of the States to finance needed improvements, the debt-incurring powers of local governments were called upon, and such governments being unrestricted constitutionally could and did go ahead with excessive debt financing. Local debt increased very rapidly until the business crisis of 1873 brought about many municipal defaults caused by excessive and unwise debt. Debt limitations on local governments were imposed between 1851 and 1886 in great numbers, particularly between 1872 and 1879.

Many localities had gone into debt heavily to finance railroads. The crisis of 1873 revealed the weakness of many of these financings and as a result almost every State now lias limitations on the extent to which local government may incur indebtedness. See Magnusson, Lease-Financing by Municipal Corporations, 25 Geo. Wash.

L. Rev. 377 , 381 (1957) ; Rogers, Municipal Debt Restrictions and Lease-Purchase Financing, 49 A.B.A.J. 49 (1963). 1 Maryland did not escape the epidemic of financial illness, in fact had quite a severe case, and State and local constitutional debt limitations followed here as elsewhere. Johns Hopkins Univ. v. Williams, 199 Md. 382 ; Pressman v. Baltimore, 200 Md. 107 . To escape the strictures of such debt limitations, local governments engaged private contractors to perform municipal services over a period of years for a compensation to be paid annually or as the services were rendered. A number of cases sustained such contracts and their reasoning pointed the way to the next step, which was to convert the contracts for services into contracts leasing the facilities that produced the services.

Originally, water for hydrants and gas for street lighting often wrere obtained by municipalities on an annual basis. In acquir ⁴²² ing the facilities, a way around a debt limitation was to lease the hydrants and lampposts at a fixed rental per hydrant or post, with the right in the municipality to acquire the water or light system when the aggregate rentals reached a certain sum or upon paying a balance due. City halls, court houses and jails were built under the same financial scheme. The annual payment rule was held in many cases to sustain the rent transaction, although there were holdings to the contrary.

See Magnusson, supra, pp. 382-384, “History of Lease-Financing in the Courts.” The appellant argues earnestly that the City, by binding itself to a long-term lease and reserving an option to purchase, is creating a debt under another name and supports his position that the arrangement constitutes an integrated transaction for the long-term financing and ultimate permanent acquisition of the warehouse by the City with these arguments: (a) “If the City itself had borrowed funds secured by a mortgage or issued its general obligation bonds to raise funds for the Project, clearly a debt within the meaning of Section 7 would have been created. Instead, it has chosen to convey the realty to Calvert which will borrow the necessary funds, construct the Project and then rent it back to the City over its entire useful life. Obviously, Calvert serves in the arrangement as a borrowing conduit for the City, and an expensive one at that, because it is apparent that the City will pay a much higher rate of interest on the funds Calvert borrows (interest on Calvert’s loan is actually paid by the City through the $96,000 a year rental payments) than would the City had it issued its general obligation bonds to raise funds for the Project. Interest on the City’s bonds is tax exempt and it is common knowledge that such bonds bear a lower rate of interest than do evidences of indebtedness, the interest on which is not tax exempt.

(b) “The amounts paid as rent are not necessarily the use value of property as true rent would be, but are designed to equal debt amortization * * *. ⁴²³ (c) “Any prudent investor or securities analyst would consider ‘rental payments’ on lease-financing contracts, along with outstanding bonded indebtedness, as repayment of a long-term debt and not as current expenses. (d) “This type of financing is, in reality, an attempt to anticipate income of future years. Note, Constitutional Limitations on Indebtedness of Local Governments in Missouri, 1957 Wash. U.L.Q. 59, 67 [and see Magnusson, supra, pp. 390-393, 'IV.

Lease Financing is Borrowing Not Renting,’ ‘The Leases are in Practice Non-Terminal,’ and ‘Direct Relation of “Rent” to Debt Service on Bonds’]. As is pointed out below, therein lies its most serious disability, for the true lesson in Baltimore v. Gill, 31 Md. 375 (1869), the first and probably foremost case construing Section 7, is that it is the possibility of future taxation which determines whether a Section 7 debt has been created. The City’s lease-financing arrangement, presents not the possibility but the absolute certainty of future taxation.” As forceful as the arguments of the appellant abstractly may be, we find the law to be against him in the case at bar. The City has the power to become a lessee of and pay rent for buildings needed in or for the performance of its ordinary and regular municipal functions.

Charter of Baltimore City (1964 Revision), Art. I, Sec. 1, Art. II, Sec. (2), and Art. V, Sec. 5 (a). If the City had leased the warehouse in question for two, three or five years at the fair rental value of $96,000 a year, the effect necessarily would have been to require imposition of taxes to raise the rent money in each subsequent year of the lease term but this would not have made the agreement to pay rent over a term of years legally a debt. At common law, rent to fall due beyond the current period is not a present debt. 3 Tiffany, Real Property (3rd Ed.), § 879 ; 2 American Law of Property, § 9.44. Not only was this the law when the constitutional debt limitation come into being, but our predecessors have at various times held that this rule of the common law is still ⁴²⁴ the law of Maryland.

It was said in Real Estate Board of Baltimore v. Page, 164 Md. 500 , 504 : “[A] covenant to pay rent creates no debt until the time stipulated for the payment arises.” In Boulevard Corp. v. Stores Corp., 168 Md. 532, 539 , Chief Judge Bond for the Court said that the common law conception of rents prevails in Maryland and went on to hold that: “According to that