This is a taxpayer's suit to enjoin defendants from entering into a preliminary contract and lease, with option to purchase, for a building to be constructed on state-owned property. The litigation raises complex and difficult issues which, in the factual context here present, have not been fully resolved by our appellate courts.
Put concisely, the problem presented is whether a lease-purchase arrangement whereby a state agency contracts with a builder to erect a facility on state-owned land and lease the same to the State for a term of years at stipulated annual rentals, with an option to purchase at intervals during the term, title to revert to the State at the expiration thereof, violates the debt limitation clause of the State Constitution.
Plaintiff obtained an order directing defendants to show cause why a preliminary injunction should not issue, and defendants countered with a motion for summary judgment.
The court denied the latter motion and granted the application for the preliminary injunction. At the State's request, the court heard further argument on the issuance of a preliminary injunction, during which both sides agreed to have the court adjudicate the issues on the basis of the pleadings, affidavits and exhibits on file, without proceeding to trial.
The basic facts are not in substantial dispute. The State owns a parcel of land in Ewing Township upon which it intends to have constructed a building to be used as a records storage center and printing facility. Through the Division of Building and Construction in the Department of the Treasury it solicited proposals for an agreement of lease, with option to purchase, for a building containing about 60,000 square feet of net usable space, to be designed and constructed by a responsible, qualified "builder-developer," in accordance with plans and specifications prepared by the Division's architect and designated as "performance specifications."
Prospective bidders were advised to base their proposals on private financing, since no progress or other advance payments would be made available. The proposals were to contain, among other things, a fixed annual rental figure as well as lump sum selling prices should the State elect to exercise its option to purchase the building at the intervals set forth in the lease. The successful bidder would be required to enter into a preliminary contract, to be executed by the Director of the Division of Building and Construction, obligating the builder-developer to construct the building and thereafter lease it to the State.
The proposed lease, to be executed by the Director of the Division of Purchase and Property, was to be for a term of 25 years, commencing on the date of the State's acceptance of the building, at an annual rental charge payable in equal monthly installments. Included was an option whereby, at any time during the 10th, 15th or 20th year of the lease, the lessee could purchase the lessor's right, title and interest in and to the demised premises for stipulated fixed prices.
There was a further provision that "[i]n the event of the failure by the Lessee to exercise any of these options, then and in that event all of the Lessor's title in and to the demised premises shall revert to the Lessee upon the expiration of the term of the within lease."
After the receipt and review of bids, the Director of the Division of Purchase and Property issued a letter of commitment accepting, subject to "Legislative and Executive approval," the proposal of the lowest qualified bidder, Lewis C. Bowers and Sons, Inc., to lease the building to be constructed, at an annual rental of $145,763, based upon a square-foot rate of $2.69 for 54,187 square feet, with an option to the State to purchase the building for $866,000 during the 10th year of the term, $669,000 during the 15th year, and $392,000 during the 20th year.
Because of the institution of this suit, nothing further took place. Plaintiff challenges the validity of the plan devised by the State. He contends, in essence, that the aggregate of the rentals to be paid under the agreement constitutes a debt or liability exceeding the debt limitation provision of the State Constitution; that the lease with option to purchase is in reality a purchase agreement; that the Division of Purchase and Property is without authority to enter into the proposed agreement, and that a public building is being constructed in derogation of the public bidding law.
In response the State argues that the debt, if it is one, will not exceed the constitutional limitation; that, in any event, no debt or liability will be created within the meaning of the constitutional provision, and that, since a lease is involved, there is no violation of the bidding law.
At the core of the controversy is the debt limitation clause in N.J. Const. (1947), Art. VIII, § II, par. 3, the pertinent provisions of which are these:
The Legislature shall not, in any manner, create in any fiscal year a debt or debts, liability or liabilities of the State, which together with any previous debts or liabilities shall exceed at any time
one percentum of the total amount appropriated by the general appropriation law for that fiscal year, unless the same shall be authorized by a law for some single object or work distinctly specified therein. Regardless of any limitation relating to taxation in this Constitution, such law shall provide the ways and means, exclusive of loans, to pay the interest of such debt or liability as it falls due, and also to pay and discharge the principal thereof within thirty-five years from the time it is contracted; and the law shall not be repealed until such debt or liability and the interest thereon are fully paid and discharged. No such law shall take effect until it shall have been submitted to the people at a general election and approved by a majority of the legally qualified voters of the State voting thereon. * * *
Over the years the need of government to provide facilities for the burgeoning demands of the citizenry has come into conflict with restrictive and often cumbersome statutory or constitutional provisions limiting the creation of debts or liabilities. On the one hand, there is public pressure for projects requiring long-term financing; on the other, there is the necessity for responsible fiscal management. The result has been the development of plans intended to achieve the desired goals without offending the debt limitation provisions. With particular reference to buildings required for the housing of governmental departments and agencies, two methods have been employed frequently. One involves the creation by the Legislature of public building authorities or commissions empowered to issue bonds, construct facilities, and lease them to governmental units. The other is the lease-purchase contract. Morris, "Evading Debt Limitations with Public Building Authorities: The Costly Subversion of State Constitutions," 68 Yale L.J. 234 (1958); Rogers, "Municipal Debt Restrictions and Lease-Purchase Financing," 49 A.B.A.J. 49 (1952). It is the lease-purchase contract which is involved herein.
Lease-purchase contracts have engaged the courts throughout the country for many years, with results that, even today, have been far from uniform. Fundamentally, the concern is whether such contracts create a debt or liability
which is prohibited unless incurred in accordance with the procedures set forth in the applicable debt limitation provisions. Because of variations in the plans, as well as differences in the types of debt limitations involved, the extracting of specifically applicable principles of law is difficult. In addition, sympathetic courts have, on occasion, ruled favorably on the plan under consideration by a somewhat strained construction or interpretation of the facts and the law. A widely accepted test for determining the validity of a lease-purchase contract is the one set forth in the case of City of Los Angeles v. Offner , 19 Cal. 2d 483, 122 P. 2d 14 (Sup. Ct. 1942):
It has been held generally in the numerous cases that have come before this court involving leases and agreements containing options to purchase that if the lease or other agreement is entered into in good faith and creates no immediate indebtedness for the aggregate installments therein provided for but, on the contrary, confines liability to each installment as it falls due and each year's payment is for the consideration actually furnished that year, no violence is done to the constitutional provision. [citing cases] * * *. If, however, the instrument creates a full and complete liability upon its execution, or if its designation as a "lease" is a subterfuge and it is actually a conditional sales contract in which the "rentals" are installment payments on the purchase price for the aggregate of which an immediate and present indebtedness or liability exceeding the constitutional limitation arises against the public entity, the contract is void.
See also Annotation, "Lease of property by municipality or other political subdivision, with option to purchase same, as evasion of constitutional or statutory limitation of indebtedness," 71 A.L.R. 1318, 1326 (1931), supplemented 145 A.L.R. 1362 (1943).
The use of lease-financing to evade debt restrictions has been criticized by writers on the subject, and it has been observed that the courts have had difficulty in applying the test of City of Los Angeles v. Offner, supra , with any degree of consistency. See Rogers, "Municipal Debt Restrictions and Lease-Purchase Financing," supra; Magnusson, "Lease-Financing by Municipal Corporations as a Way around Debt
Limitations," 25 Geo. Wash. L. Rev. 377 (1957); Bowman, "The Anachronism Called Debt Limitation," 51 Iowa L. Rev. 863 (1967); Lillich, "Lease-Purchase Agreements by New York Municipalities," 34 N.Y. State B.J. 459 (1962). In a large number of cases in which leases to governmental bodies have been upheld, the courts have found some reason, not always sound or realistic, for declaring the instrument under review to be a bona fide lease. Bowman, op. cit., supra , comments that the "rapidly growing volume of court cases offers a bewildering array of judicial rulings on the concepts and issues involved in these various approaches to the avoidance of debt limitations."
A proper analysis of the problems presented herein requires, first, a consideration of whether the state agency concerned has the authority to lease or purchase real property. If it has, then one must examine the arrangement to determine whether it is a lease, or lease with an option to purchase, or whether it is an installment contract of purchase. The ultimate inquiry is whether the debt or liability created thereby, if any, exceeds the permissible debt limit.
If the transaction now before the court is a bona fide lease not in contravention of the constitutional debt limitation, there is no question of the competence of the Division of Purchase and Property to enter into it. The Division*fn1 is empowered to "lease from time to time such office space as may be required for the conduct of the state's business at such terms and under such conditions as it may deem
appropriate." N.J.S.A. 52:20-7. It may also maintain and operate warehouses and other storage places. N.J.S.A. 52:25-13. A purchase, contract or agreement may, with the written approval of the State Treasurer, be made, negotiated or awarded by the Director of the Division of Purchase and Property without advertising, when the subject matter consists of "the lease of such office space, office machinery, specialized equipment, buildings or real property as may be required for the conduct of the State's business." N.J.S.A. 52:34-8, 52:34-9(c).
By implication, if not expressly, the Division also has authority to purchase real property. The Director may, with the written approval of the State Treasurer, make, negotiate or award, without advertising for bids, any purchase, contract or agreement, when the subject matter thereof consists of "the acquisition of any real property by gift, grant, purchase or any lawful manner in the name of and for the use of the State for the purpose of the administration of the State's business." N.J.S.A. 52:34-9(d). The significant limitation, however, is that such acquisition must be "in accordance with appropriations made therefor when moneys are required for the acquisition." Id.
The document, called an "Agreement of Lease with Option to Purchase," is substantially in the form of a standard lease and purports to demise to the lessee for a term of 25 years the designated number of square feet of office, records storage, printing and related space, "in a new building which has been constructed by the lessor in accordance with plans and specifications heretofore prepared by the Lessee and approved by both Lessor and Lessee." The annual rental is calculated on the basis of the square feet of space within the exterior walls. Boiler rooms and machine rooms for heating and air conditioning equipment are excluded from the rentable areas.
The lessee is obligated to maintain the demised premises, except for damage by fire, the elements, or other causes beyond its control, and to provide heat, power and light. It
is the lessor's responsibility to make all structural repairs. In the case of damage or destruction by fire, rent is suspended until the structure is restored by the lessor, but if the time for restoration will exceed six months, the lessee has the option of terminating the lease upon written notice.
In the event a mortgage is placed on the premises, the lease is subordinated thereto, with the proviso that the lease cannot be terminated so long as the lessee is not in default.
Provision is made for the upward or downward adjustment of the rent in case of increases or decreases in realty ...