Does the construction of a facility that is subject to a predevelopment lease with a state entity constitute a “public work” under Pennsylvania’s Prevailing Wage Act?
PSP NE, LLC v. Pennsylvania Prevailing Wage Appeals Board, 292 A.3d 1175 (Pa. Cmwlth. 2023), allocatur granted May 22, 2024, appeal docket 38 MAP 2024
In this case, the Pennsylvania Supreme Court will consider whether the construction of a facility by a developer to be leased to the Pennsylvania State Police (PSP) constitutes a “public work” subject to the Pennsylvania Prevailing Wage Act (Act).
The Act requires that workers employed on public works are paid “[n]ot less than the prevailing minimum wages[.]” 43 P.S. § 165-5. The Act defines “public work” as follows:
[C]onstruction, reconstruction, demolition, alteration and/or repair work other than maintenance work, done under contract and paid for in whole or in part out of the funds of a public body where the estimated cost of the total project is in excess of twenty-five thousand dollars ($25,000), but shall not include work performed under a rehabilitation or manpower training program.
43 P.S. § 165-2(5).
PSP NE, LLC (Developer) owned land in Hanover Township, Luzerne County. In 2019, the Commonwealth, through the Department of General Services, executed a 20-year lease with Developer for a facility that Developer would construct that would be used by the State Police as a barracks and training center. Developer financed the construction entirely with private funds, including a bank loan, and bore all financial risks associated with the project. The lease stipulated that upon completion, PSP would lease the facility from Developer and pay rent, which would be used by Developer to service its construction loan.
Developer requested confirmation from the Bureau of Labor Law Compliance (Bureau) that its construction of the facility to be leased to the Commonwealth was not subject to the Act. The Bureau informed Developer that the Act “covers this construction project” and that although Developer “will provide the initial funds for this project, the lease payments from the State Police will reimburse this initial outlay, and, as such, are the ultimate source for this construction.” Slip op at 2-3. Developer filed a grievance with the Pennsylvania Prevailing Wage Appeals Board (Board), seeking review of the Bureau’s determination. The Board issued an adjudication denying Developer’s grievance and affirming the Bureau’s determination, which Commonwealth Court summarized as follows:
In reaching this conclusion, the Board was guided by the Pennsylvania Supreme Court’s holding in Pennsylvania National Mutual Casualty Insurance Company v. Department of Labor and Industry, 552 Pa. 385, 715 A.2d 1068, 1074 (1998) (Penn National I). Therein, the Supreme Court explained that under the Act, a “public work” is one that involves (1) certain work, (2) performed under contract, (3) paid for in whole or part with funds from a public body, and (4) at a cost in excess of $25,000. Id. The Board concluded that Developer’s construction satisfied all four elements. It emphasized that because Developer’s loan agreement required the Commonwealth’s lease payments to be sufficient to cover Developer’s debt service, this established funding by a public body. Board Adjudication, 5/17/2022, at 10. Specifically, Developer would recover its amortized construction costs of $15,615,940 either through rental payments or reimbursement of unamortized costs should the lease terminate early. Id. The Board further observed that the lease required the facility to satisfy State Police design needs; required construction to be completed within a specific timeline; and included a provision, standard in all Commonwealth leases, that “Lessor” had to comply with the Act. For these reasons, the Board concluded that the agreement did not establish a landlord-tenant lease but, rather, a “public work,” or construction contract, subject to the Act.
Slip op. at 3. Developer appealed the denial of its grievance to Commonwealth Court, arguing that the predevelopment lease did not constitute a “public work” within the meaning of the Act because the project would not be financed by public funds.
Commonwealth Court reversed the PWAB, holding that Developer presented a prima facie case that its predevelopment lease was bona fide lease rather than disguised public work. Commonwealth Court found that the construction project was not a “public work” under the Act because the project was privately financed and PSP’s lease payments were for the use and occupancy of the facility, not for its construction. Commonwealth Court explained:
The leading precedent is 500 James Hance Court, 33 A.3d 555, where our Supreme Court considered whether the construction of a building for a charter school was a public work subject to the Act.
The charter school’s non-profit foundation provided financing for the construction of the building through bonds issued by a public authority. The predevelopment lease between the developer and the charter school had a duration of 24 years, with an option to purchase after the first 5 years, and the lease payments were expected to cover the cost of construction within 6 years. The building was to be used exclusively as a charter school, and approximately a quarter of the total construction cost was attributed to customizing the building for the particular needs of the charter school.
The Supreme Court explained that the “labels appended to transactional documents do not exclusively determine the applicability of regulation under the [ ] Act, as the potential for evasion and artifice is too great. Rather, as in other settings, the economic reality of the transaction should control.” 500 James Hance Court, 33 A.3d at 572 (emphasis added). To that end, the Supreme Court considered whether the charter school’s rental payments under the lease, expected to cover construction costs in six years, were tantamount to public financing. In concluding that the rental payments did not constitute public funding, the court explained as follows:
[T]here is little indication that the lease payments by the Foundation were designed to be anything other than compensation for use of the building …. [T]he Bureau of Compliance highlights that, at oral argument, Appellees indicated that the lease payments would allow construction costs to be recouped in six years …. However, it is evident that few office buildings would be built if the construction costs, including the cost of servicing the construction loan, could not ultimately be recouped by anticipated lease payments within a reasonable time frame. Even to the degree this factor focuses on the prospect that the Foundation’s lease payments will, alone, allow for such recoupment, such a circumstance remains of little probative value relative to the question of whether the lease is a disguised construction contract, absent proofs regarding whether a six-year recoupment period is substantially shorter than the industry norm for building shells of the type involved here.
Id. at 574 (emphasis added). The Supreme Court further explained that the Bureau of Compliance had given no weight to the fact that the premises reverted to the developer at the end of the lease:
Absent a finding – or even an allegation – that the building’s useful life is likely to be no greater than the 24-year lease term, we find this reasoning counter-intuitive because such reversion facially supports Appellees’ position that the lease is a bona fide one and not a construction contract.
Id. at 575. In short, under 500 James Hance Court, a developer’s recoupment of its costs of construction through rental payments does not transform a lease into a “disguised construction contract.” Id.
In Ursinus College v. Prevailing Wage Appeals Board, 280 A.3d 1113, 1123 (Pa. Cmwlth. 2022), petition for allowance of appeal granted, (Pa., No. 18 MAP 2023, filed February 22, 2023), this Court considered whether a $23,000,000 construction project undertaken by a private college, but financed by bonds issued by a public authority, constituted a public work subject to the Act. The Board determined that because the construction was funded by loans from a public authority, it was paid for by a public body. Accordingly, the prevailing wage requirements of the Act applied to the construction. This Court reversed the Board’s adjudication. The bond documents required the public authority to transfer the funds to a trustee, which transfer occurred before the college received any funds. Accordingly, the college used funds disbursed by the trustee, and not by the public authority, to pay for the project. The economic reality of this transaction was that the project was not funded “out of the funds” of a public body. We rejected the Board’s reasoning that the project was subject to the Act because the college “would not have had this funding stream available but for the existence of the [a]uthority and its coordination of the funding through its statutory powers as a public body.” Ursinus College, 280 A.3d at 1123 (emphasis added). We explained that Section 2(5) of the Act is not triggered by a “but for” test but, rather, requires the work be paid for “out of the funds” of the public body. The college, not the public authority, bore the risk for repayment of the bonds. As such, the economic reality of the transaction revealed that the project was not a public work subject to the Act.
Slip op. at 7-10. Applying the above precedent to the facts of this case, Commonwealth Court reasoned:
Here, as in 500 James Hance Court, the predevelopment lease states that the State Police shall pay rent “for the use and occupancy of the [p]remises” and not for construction. Reproduced Record at 37 (R.R. ––––). As in Ursinus College, Developer has funded the cost of construction and solely bears responsibility for the repayment of the construction loan. Developer and the Bureau of Compliance stipulated:
[T]he Project has been purchased and funded totally through the use of [Developer’s] private funds, and that no funds will be provided directly by the Commonwealth for the purchase, development and construction of the facilities.
Stipulated Facts, ¶20; R.R. 30 (emphasis added). The parties agreed that Developer bears the “risk of losing substantial funds” notwithstanding the Commonwealth’s agreement to reimburse Developer for unamortized costs should the lease be terminated early. Stipulated Facts, ¶11; R.R. 30. In short, the economic reality is that Developer provided the funds for the construction of the facility to be leased to the Commonwealth.
Although the predevelopment lease requires the Commonwealth to reimburse Developer for any unamortized costs after “the expiration of at least fifty percent (50%) of the initial term of this Lease,” i.e., 10 years, this did not transform the lease into a disguised construction contract. Lease, III, ¶8; R.R. 38. An early termination of the lease at the end of year 10, for example, would leave unamortized costs substantially below $15,615,940, possibly as little as half that amount. See Developer Brief at 19-20. Should the Commonwealth become responsible for the unamortized portion of the costs, Developer will nevertheless be liable for as much as $10 million on the bank loan. Id. As in Ursinus College, construction of the facility does not come out of funds of a public body, and the risk for repayment of the loan is not borne by a public body.
The Board erred in holding that the lease was not a bona fide lease. Improperly, the Board gave no weight to the fact that the Developer holds a reversionary interest in the building under construction. In 500 James Hance Court, 33 A.3d at 575, our Supreme Court observed that such a reversionary interest in a predevelopment lease to the developer “facially” supports the conclusion that “the lease is a bona fide one and not a construction contract.”
Because Developer established a bona fide lease, the burden shifted to the Bureau of Compliance. It did not present any evidence that the contractual arrangement was not as it seemed. The Bureau presented no evidence, for example, that the reversionary interest was fictional because the building would cease to be useful by the end of the lease term. Likewise, it presented no evidence that Developer’s recoupment of construction costs by rental payments was “substantially shorter than the industry norm.” 500 James Hance Court, 33 A.3d at 574.
Slip op. at 10-12 (emphasis in original). The court concluded:
Developer made a prima facie case that its lease was a bona fide lease by showing that funding for construction of the facility to be rented did not come from a public body. Rather, Developer bears the financial risk, and it retains a reversionary interest in the land and the buildings. It was the Bureau of Compliance’s burden to present evidence to “establish that the economic reality of the transaction is different from its appearance,” 500 James Hance Court, 33 A.3d at 573-74, and it did not do so. That Developer expects, in time, to recover costs of construction did not convert the bona fide lease into a construction contract. As our Supreme Court has explained, if developers did not expect to cover their construction costs with rental payments, few commercial buildings would ever be built. Id. at 574. The Bureau of Compliance presented no evidence that the timeline for Developer’s expected recoupment of construction costs was “substantially shorter than the norm.” Id.
Slip op. at 13-14.
The Pennsylvania Supreme Court will consider the following issues:
- Is risk allocation the only consideration in determining whether a pre-construction lease is covered by the Prevailing Wage Act?
- How much risk must a developer bear to ensure that public funds do not “in part” pay for construction under 500 James Hance Court v. Pa. Prevailing Wage Appeals Bd. [613 Pa. 238], 33 A.3d 555 (Pa. 2011), such that a pre-construction lease does not implicate the Prevailing Wage Act?
- Under Hance, what is the distinction between a grievant’s burden to prove a “facially legitimate lease” and the Board’s burden to prove “that the economic reality of the transaction is different from its appearance?”