California Governor's Budget Zeros Out All Redevelopment Agency Funding

Following the California Supreme Court’s decision upholding legislation to eliminate redevelopment agencies, the state budget proposed by Governor Jerry Brown yesterday takes full credit for the tax revenues that would have gone to redevelopment agencies, dealing a further blow to efforts by redevelopment agency proponents to reach a quick legislative solution prior to the elimination of redevelopment agencies on February 1, 2012.

The Governor’s Budget Summary references the California Supreme Court’s decision in California Redevelopment Association et al. v. Matosantos, in which the court affirmed the power of the governor and the legislature to eliminate redevelopment agencies, freeze current transactions between redevelopment agencies and third parties, and transfer responsibilities and assets to successor entities for performance of any remaining legal obligations. In addition, the court stuck down as unconstitutional companion legislation that would have allowed a redevelopment agency to continue to exist, if the redevelopment agency made substantial remittance payments to local school, fire and transit districts. The court reasoned that the legislature could not condition the existence of redevelopment agencies upon the diversion of redevelopment tax increment for state purposes without running afoul of a state constitutional amendment enacted by the voters by initiative in 2010, Proposition 22.

In preparing the new budget released January 5, 2012, Governor Brown’s Budget Summary notes that revenues that would have been directed to redevelopment agencies will be distributed to make limited “pass through” payments to local governments in the amounts they would have received under prior law, and to successor agencies for retirement of redevelopment agency debts and for limited administrative costs. The remaining revenues will be distributed as property taxes to cities, counties, school and community college districts and special districts. The governor’s budget reflects an estimate that approximately $1.05 billion in additional property tax revenues will be received by K-14 schools in 2011-12, which will offset the state’s Proposition 98 General Fund obligation. Additional property tax revenues that would have been used by redevelopment agencies will also be made available to counties ($340 million), cities ($220 million) and special districts ($170 million) under the governor’s budget. Those amounts are expected to grow in future years as property tax values increase and former redevelopment agency debt is retired. The governor’s reliance on these figures in his proposed budget reflect the uphill political battle that proponents of redevelopment agencies will face in proposing legislation to save them from elimination.

Redevelopment Agency Wind Down and Transition to Successor Agencies

In light of the governor’s budget and the California Supreme Court’s decision to uphold the legislation that permits the elimination of redevelopment agencies, stakeholders will now focus on the process for the turnover of redevelopment agency assets to successor entities under AB 1x 26. See California Redevelopment Legislation Enacted After Months of Wrangling, Environment alert, August 9, 2011. Because the California Supreme Court stayed implementation of the legislation affecting redevelopment agencies pending its final decision, the court extended by four months the effective date or deadline for most compliance steps arising under the legislation before May 1, 2012. For example, redevelopment agencies were to be dissolved as of October 1, 2011; this deadline has been extended to February 1, 2012. Redevelopment agency obligations under the legislation that occur after May 1, 2012, and subsequent years were not revised. Accordingly, the wind-down process will be instituted as follows:

1. Suspension of Activities

Redevelopment agency powers are now effectively permanently suspended. This includes a redevelopment agency’s ability to incur new or expand existing monetary or legal obligations. Redevelopment agencies are, however, required to make scheduled payments and perform obligations established pursuant to any enforceable obligations. Enforceable obligations are defined to include “any legally binding and enforceable agreement or contract that is not otherwise void as violating debt limit or public policy.” Currently-existing bond repayment obligations incurred by the redevelopment agency that are funded by redevelopment tax increment are perhaps the best example of an enforceable obligation that will not be disturbed by the elimination of redevelopment agencies. However, legal counsel should be consulted to advise redevelopment agencies or third parties as to whether the promises set forth in their contracts satisfy the “enforceable obligation” test set forth in the new legislation.

2. Creation and Delegation of Duties to Successor Agencies

As of February 1, 2012, redevelopment agencies will be dissolved and, in their place, “successor agencies” will be designated. Generally, a successor agency will be the county, city, or city and county that authorized the creation of each redevelopment agency. All authority, except for those provisions of the Community Redevelopment Law that are repealed, restricted, or revised, will be vested in the successor agencies. Successor agencies will be responsible for redevelopment agency obligations and will wind-down the affairs of each agency. Assets of the former redevelopment agency will be transferred to the successor agency. Successor agencies are to dispose of assets with the proceeds transferred to the county auditor-controller for distribution to taxing agencies.

Successor agencies remain responsible for “enforceable obligations.” However, successor agencies will have the right to terminate any existing agreements so long as they provide “necessary and required compensation or remediation for such termination.” The successor agency must prepare a recognized obligation payment schedule on a semi-annual basis that identifies obligations and sources of payment payable during each period.

3. Distribution of Funds

By July 1, 2012, the county auditor-controller for each county in which a redevelopment agency is located must prepare an audit of each agency’s assets and liabilities and provide those audits to the state controller by July 15, 2012. The auditor-controller must then determine the amount of property taxes that would have been allocated to each redevelopment agency in the county had the agency not been dissolved and deposit that amount in the Redevelopment Property Tax Trust Fund. The auditor-controller will allocate money in the fund according to a designated order of priority: (1) to each local agency and school entity pursuant to the redevelopment law in effect as of January 1, 2011, assuming the redevelopment agency continued to exist; (2) to each successor agency for payments listed in a “Recognized Obligation Payment Schedule;” (3) to each successor agency for an administrative cost allowance; and (4) to local agencies and school districts. In the event there are insufficient funds to make all payments, lower priority funds may be used, or, in the worst case scenario, the county treasurer may loan any funds from the county treasury that are necessary to ensure payment of redevelopment agency debt.

4. New and Increased Roles for Oversight Boards, State Controller and Department of Finance

Finally, oversight boards appointed by various constituencies will be created to ensure that debts are repaid and will remain in existence until all of the indebtedness of the dissolved redevelopment agency has been repaid. The state controller and Department of Finance will play important roles in supervising the oversight boards and may become involved in decisions about how a successor agency structures repayment schedules.

The new law represents a significant shift in the ultimate decision-making authority over the use of property taxes in former redevelopment areas. Decisions formerly made by local elected officials (often sitting in a dual capacity as members of a redevelopment agency) will now be subject to review by oversight boards consisting of not only local officials, but also representatives of the largest special district, the local school district, local community college and local public employee union. Almost every action by a successor agency is subject to review and approval by the oversight board. In addition, the governor’s director of finance and the state controller also have approval authority over certain actions of the oversight boards, including ultimate approval of what former redevelopment obligations may be paid from property taxes within a former redevelopment area.

Implications for Developers, Property Owners and Local Governments

The actions by the governor, legislature and now Supreme Court have completely changed the methods and means of redeveloping property in California. In addition, property owners, investors, developers and redevelopment agencies need to re-evaluate any existing rights and duties they have in light of the Supreme Court’s decision. Some redevelopment agreements are many years old, predating the economic hardships the California economy is experiencing today. Redevelopment agreements were entered and redevelopment plans were adopted with significant financial assumptions. Those assumptions may no longer be valid, jeopardizing the political and economic expectations of the parties. The scope of the unresolved legal issues posed by the elimination of redevelopment agencies is vast, but the following are some critical issues to be considered:

• In the summer of 2011, several redevelopment agencies transferred assets to other entities in anticipation of the proposed elimination of redevelopment agencies. The state controller has the power to undo any asset transfers by a redevelopment agency to the local government that created the redevelopment agency or any other public agency that occurred after January 1, 2011. Under these “clawback provisions,” the state controller has the power to order the assets to be returned to the redevelopment agency or, on or after February 1, 2012, to the successor agency. If the state controller decides to exercise this power, there will likely be litigation over the validity of the prior transfer.
• To what extent are promises in redevelopment agreements enforceable against the new successor agencies? What agreements may be “rejected” by successor agencies?
• How will local governments, as successor agencies, cope with the increased responsibilities of owning, managing and maintaining former redevelopment assets? What will the decision-making process look like for the short-term and long-term disposition of these assets? What opportunities do these assets present for neighboring property owners, investors and developers?
• Redevelopment plans and related instruments have been recorded against property to provide notice and to govern future development. What is the legal effect of those plans and how does one “get them off title”?
• Redevelopment agencies were frequent users of the Polanco Act contained in the redevelopment law to effectuate clean up and reduce liability for environmental contamination of land in redevelopment areas. Redevelopment agencies can no longer enter contracts to remediate property. Property owners and local governments will need to evaluate whether the benefits of Polanco can be enjoyed in the aftermath of the elimination of redevelopment agencies.
• Without the housing fund set aside provided from redevelopment tax increment funds, it will be increasingly difficult for local governments to satisfy their obligations under state planning laws to provide low/moderate income housing. In addition, the legal grounds for new inclusionary for-rent housing has been put in question because of other recent California court decisions. Because of these factors, local governments will be searching for new tools to fund affordable housing in their communities.
• The elimination of redevelopment agencies may have potential negative ramifications for state and local credit ratings. The bond markets may perceive increased political risk of lending in California, now that the governor and the legislature have shown the willingness to completely eliminate a mechanism for producing a stable income stream (redevelopment tax increment) if necessary to meet state objectives. If a state-created entity is not a constitutionally-created government body, the legislature may wipe out the entity that is providing the revenue stream for bonds to be repaid (however, the obligation to repay is not necessarily wiped out). In addition, because payment decisions by the oversight boards are subject to review by the governor’s director of finance and state controller, bond lenders may require new or additional credit enhancement if allowed under their bond indenture and other loan documents.
• The California Redevelopment Association has not given up and continues to lobby for legislation that would save redevelopment agencies. Recent proposals have included redevelopment agencies with more limited powers and without the so-called “ransom” payment, reforms to low and moderate income housing requirements and relinquishment of redevelopment tax revenues to school districts. Enactment of such legislation may be an uphill battle in the face of the successful lobbying by the governor, the decision by the Supreme Court, and the vested interests of school districts, counties and special districts in the resulting financial windfall.
• The use of redevelopment tax increment to finance capital improvements in a redevelopment area is dead. New public finance tools will have to be deployed to achieve such redevelopment ends. One such tool is an infrastructure financing district, which has been recently used in San Francisco to bridge the financing gap.

Resolution of these and many other issues will undoubtedly be shaped by public agency actions, regulatory and legislative solutions, and future litigation. The fallout from the death of redevelopment agencies will be felt for some time.