Can an Arkansas city sign a 25-year lease with a financial institution for a building, then sublease most of it to a private college, without violating the Arkansas Constitution's restrictions on aid to private entities and on multi-year debt?

Plain-English summary

A first-class Arkansas city wants to do an unusual real estate deal: a financial institution buys vacant land from the city at fair market value, builds a multi-building campus on it, then leases the campus back to the city for 25 years. The city uses some of the buildings for its own animal services and offices. The city subleases the rest to a private college for the college's veterinary and dental programs. The college's monthly sublease payments to the city cover at least the city's monthly lease payments to the financial institution. The city and college also cooperate on animal services.

Representative Evans asked the AG to test that arrangement against four constitutional guardrails. The AG said the arrangement is generally permissible if structured carefully, but every answer comes with a fact-specific caveat:

1. Article 12, § 5 (no city aid to private entities). A municipal lease is not a prohibited gift if it is supported by adequate consideration. Consideration can be financial or nonfinancial. The facts described suggest valid consideration, but whether the deal actually has adequate consideration is a factual question the AG cannot decide.

2. Amendment 78 (no multi-year city debt without specific authorization). The AG was unsure whether the 25-year lease falls within Amendment 78's "short-term financing obligation" cap of five years. A pure rental probably does not. A financing instrument disguised as a lease probably does. Implementing legislation (the Local Government Short-Term Financing Obligations Act, A.C.A. § 14-78-101 et seq.) suggests the constitutional provision was aimed at financing instruments, not standard rentals. An escape clause letting the city withdraw at any time may also pull the lease outside Amendment 78. Judicial clarification needed.

3. Article 12, § 4 (city revenue cap on long-term obligations). Article 12, § 4 bars cities from contracting for amounts exceeding annual revenue. But the Arkansas Supreme Court has held this does not prohibit debt secured solely by income from a "special and separable activity" (Hink v. Beaver Water; Lead Hill). If the city pledges payment under the lease solely from sublease revenue from the college, and does not pledge the city's full faith and credit, a court could find no Article 12, § 4 violation.

4. Public-purpose doctrine. Arkansas's public-purpose doctrine (rooted in due process under Ark. Const. art. 2, § 8) requires every public expenditure to serve a public purpose. Whether a particular project meets that test is a question of fact for the judiciary, but courts give "great weight" to legislative determinations. If the city council formally finds the project serves veterinary and dental education, expanded community health programs, and job creation, a court would likely defer.

What this means for you

City council members and municipal attorneys

This kind of public-private partnership is on a constitutional knife's edge. The AG's answer is "probably permissible" but the operative word is "probably." Five concrete things to do before signing:

First, document adequate consideration. List in the council's findings (in writing) what the city receives from the financial institution in exchange for the lease (the campus, the build-out, the financing structure) and what it receives from the college in exchange for the sublease (rent that covers lease payments, plus cooperative use of the animal services and clinic). Both sides need to look like real exchanges, not gifts.

Second, check Amendment 78 by structuring as a clear rental. The AG flagged that whether your 25-year lease is a "short-term financing obligation" subject to Amendment 78's five-year cap is unsettled. Two structural protections: (a) make the lease a true rental without a purchase option, no buyout, no equity build-up; (b) include an unqualified escape clause letting the city withdraw at any time without penalty. Either may pull the lease outside Amendment 78, but both are belt-and-suspenders.

Third, pledge sublease revenue, not full faith and credit. If you pledge the city's general fund or general taxing authority, you raise an Article 12, § 4 problem with a 25-year obligation that exceeds annual revenue. If you pledge solely the sublease revenue from the college as the source of lease payments, you fit within the Hink/Lead Hill exception for debt secured by a "special and separable activity."

Fourth, formally find a public purpose. The council should adopt a written resolution at the time of approval that lists the specific public purposes (veterinary and dental education access, expanded community health programs, jobs created). Articulating multiple specific purposes (rather than a generic "promotes economic development") gives a court more to defer to in any later illegal-exaction suit.

Fifth, expect litigation risk. Public-private partnerships involving private colleges have drawn illegal-exaction suits before in Arkansas. Build the record now, with a careful resolution and supporting findings, so you have something to defend.

Private college administrators

If you are negotiating the sublease side of an arrangement like this, your interest is durable occupancy. The constitutional risk is on the city side, but if a court strikes the lease, your sublease is at risk too. Two protections to negotiate: (a) a continuation clause letting you continue occupancy directly under the financial institution if the city's lease is invalidated; (b) representations and warranties from the city that it has authority to enter the lease and that all required findings have been made.

Also, document the cooperative components (animal services, animal clinic, community programs) carefully. The city's nonfinancial consideration from the partnership matters to the constitutional analysis. If the cooperation is real and substantial, the lease is more defensible. If it is window dressing on a financing transaction, less so.

Public finance attorneys

The AG cited Ark. Att'y Gen. Op. 2016-128 for the proposition that Amendment 78 was not intended to prohibit "simple rental agreement[s]." The Local Government Short-Term Financing Obligations Act (A.C.A. § 14-78-101 et seq.) treats short-term obligations as instruments with "proceeds" that are "negotiable instruments" (§§ 14-78-103(a)(4), 14-78-107), which suggests a more financing-instrument frame than a real-property-rental frame. But there is no controlling Arkansas Supreme Court decision either way. If you are advising a city on a long-term lease with bond-like features, flag the unsettled-law risk and consider a declaratory-judgment action before closing.

Economic development officials

The deal pattern described here (a financial institution as landlord, the city as tenant with anchor use, a private college as subtenant funding the lease) is novel in form but answers a recognizable need: keeping a private institution's expansion in town when the city does not have building-finance capacity but does have the credibility and control to be the long-term tenant. Two structural factors made the AG comfortable: the city's own use of the campus space and the cooperative animal-services component. If you are pitching a similar deal in another Arkansas city, replicate those factors. A pure pass-through where the city is just a credit-enhancement layer is more vulnerable.

Common questions

Why do cities have to worry about Article 12, § 5 in a lease deal?
Because Article 12, § 5(a) forbids cities from "obtain[ing] or appropriat[ing] money for, or loan[ing] their credit to, private individuals or entities." The Arkansas Supreme Court read this in Halbert v. Helena-West Helena Indus. Dev. Corp. (226 Ark. 620, 1956) to forbid donations of "financial aid" to private individuals or entities, including indirect aid through favorable contract terms. A lease without adequate consideration looks like a disguised donation.

What's the difference between a lease and a "short-term financing obligation" under Amendment 78?
Amendment 78, § 2(b)(1) defines "short-term financing obligation" to include "a debt, a note, an installment purchase agreement, a lease, a lease-purchase contract, or any other similar agreement, whether secured or unsecured." So leases are textually included. But the AG read the Local Government Short-Term Financing Obligations Act (A.C.A. § 14-78-101 et seq.) to suggest the constitutional provision was aimed at financing instruments, not standard real-property rentals. The AG calls this an unsettled question.

Why would the 25-year lease's length matter?
Amendment 78, § 2(a) caps short-term financing obligations at "a period of, or having a term, not to exceed five (5) years." A 25-year lease that qualifies as a short-term financing obligation would violate that cap. A 25-year lease that is just a rental is unaffected.

How does pledging only sublease revenue help with Article 12, § 4?
Article 12, § 4 bars cities from contracting for amounts exceeding "the revenue of the city or town for the fiscal year in which the contract is entered into." A 25-year lease commits payments over decades, which clearly exceeds any single year's revenue. But Hink v. Beaver Water (235 Ark. 107, 1962) and Town of Lead Hill v. Ozark Mountain Reg'l Pub. Water Auth. (2015 Ark. 360) recognize an exception for debt "secured by and payable solely out of the income or assets of a special and separable activity." Sublease revenue from the college is such an income stream. If the city pledges that revenue alone, not its general fund or full faith and credit, the obligation falls within the exception.

What's the public-purpose doctrine and how do courts decide whether a project meets it?
Arkansas roots the public-purpose doctrine in due process under Article 2, § 8. Chandler v. Bd. of Trs. of Teacher Ret. Sys. (236 Ark. 256, 1963) declared "no principle of constitutional law is more fundamental" than the rule that the state cannot appropriate public funds to a private purpose. Whether a specific project meets the test is a question of fact for the judiciary, but Turner v. Woodruff (286 Ark. 66, 1985) requires courts to give "great weight" to legislative determinations of public purpose. Make the legislative finding specific.

What are the litigation risks if we get this wrong?
Two main paths: (1) an illegal-exaction suit by a taxpayer under Barker v. Frank (327 Ark. 589, 1997), challenging the deal as misapplication of public funds; (2) a quo warranto-style challenge by the AG or another official challenging the city's authority. Either can void the lease retroactively.

Background and statutory framework

City contracting authority. A.C.A. § 14-54-101 makes cities "bodies politic and corporate" with authority to "[c]ontract and be contracted with." A.C.A. § 14-54-301 authorizes cities to "acquire and hold real estate." A.C.A. § 14-54-302(a)(1) authorizes cities to "sell, convey, lease, rent, let, or dispose of any real estate or personal property."

Article 12, § 5 (no aid to private entities). Prohibits cities from becoming stockholders in any company, lending credit to private parties, or appropriating money for them. Halbert v. Helena-West Helena Indus. Dev. Corp. (1956) extended this to indirect aid. AG opinions (2023-036, 2017-088, etc.) have applied this to property donations as well.

Amendment 78 (short-term financing). Adopted in 2000. Section 2(a) authorizes cities and counties to incur short-term financing obligations not exceeding five years for acquiring property. Section 2(b)(1) defines "short-term financing obligation" broadly. The Local Government Short-Term Financing Obligations Act (A.C.A. § 14-78-101 et seq.) implements Amendment 78.

Article 12, § 4 (revenue cap). Bars cities from contracting for amounts exceeding annual revenue. Hink v. Beaver Water (1962) and Lead Hill (2015) recognize an exception for debt secured solely by income from a "special and separable activity." McGehee v. Williams (1935) and Williams v. Harris (1949) (later modified by City of Hot Springs v. Creviston, 1986) are earlier applications.

Public-purpose doctrine. Rooted in due process under Article 2, § 8. Chandler v. Bd. of Trs. of Teacher Ret. Sys. (1963) sets the principle. Turner v. Woodruff (1985) requires courts to give "great weight" to legislative determinations of public purpose. Barker v. Frank (1997) creates the illegal-exaction private right of action.

Citations

• A.C.A. § 14-54-101 (city contracting authority)
• A.C.A. § 14-54-301 (acquire and hold real estate)
• A.C.A. § 14-54-302(a)(1) (sell, convey, lease real estate)
• A.C.A. § 14-78-101 et seq. (Local Government Short-Term Financing Obligations Act)
• A.C.A. § 14-78-103(a)(4) (proceeds of obligations)
• A.C.A. § 14-78-107 (negotiable-instruments treatment)
• Ark. Const. art. 12, § 4 (revenue cap on city contracts)
• Ark. Const. art. 12, § 5(a) (no aid to private entities)
• Ark. Const. art. 2, § 8 (due process; root of public-purpose doctrine)
• Ark. Const. amend. 78, § 1 (redevelopment districts)
• Ark. Const. amend. 78, § 2(a) (short-term financing 5-year cap)
• Ark. Const. amend. 78, § 2(b)(1) (definition of short-term financing obligation)
• Halbert v. Helena-West Helena Indus. Dev. Corp., 226 Ark. 620, 291 S.W.2d 802 (1956)
• City of Dardanelle v. City of Russellville, 372 Ark. 486, 277 S.W.3d 562 (2008)
• Hink v. Bd. of Dirs. of Beaver Water Dist., 235 Ark. 107, 357 S.W.2d 271 (1962)
• Town of Lead Hill v. Ozark Mountain Reg'l Pub. Water Auth., 2015 Ark. 360, 472 S.W.3d 118
• McGehee v. Williams, 191 Ark. 643, 87 S.W.2d 46 (1935)
• Williams v. Harris, 215 Ark. 928, 224 S.W.2d 9 (1949)
• City of Hot Springs v. Creviston, 288 Ark. 286, 705 S.W.2d 415 (1986)
• Chandler v. Bd. of Trs. of Teacher Ret. Sys., 236 Ark. 256, 365 S.W.2d 447 (1963)
• Barker v. Frank, 327 Ark. 589, 939 S.W.2d 837 (1997)
• Turner v. Woodruff, 286 Ark. 66, 698 S.W.2d 527 (1985)

Source

• Landing page: https://arkansasag.gov/divisions/opinions-foia/attorney-general-opinions-search/

Original opinion text

Opinion No. 2024-032
March 18, 2024
The Honorable Brian S. Evans
State Representative
Post Office Box 1365
Cabot, Arkansas 72023
Dear Representative Evans:
I am writing in response to your request for my opinion on four questions relating to the potential sale, lease, and sublease of property. You set forth the following factual background:

A Financial Institution intends to purchase land from a city of the 1st class (the City). The land is vacant and will be sold for not less than fair market value. The Financial Institution intends to build a multi-building campus on the purchased land.

The City would like to lease the completed campus and would use some of the buildings to house its animal service department, animal clinic, and certain administrative offices. The City would then sublease the rest of the building to a private college (the College) to house its upcoming veterinary and dental programs. Both the lease and the sub-lease would be for twenty-five years. The monthly sub-lease payments from the College to the City would cover at least the total costs of the City's monthly lease payments to the Financial Institution. Additionally, the City and the College would cooperate in various ways, especially in regard to animal services and the animal clinic. The College's veterinary program would not be able to exist in the form it desires without the City's cooperation as described herein.

Against this background, you ask the following questions:

1. Would the lease and/or sublease discussed herein violate Article 12, § 5 of the Arkansas Constitution?

Brief answer: As long as the lease and sublease are supported by adequate consideration, they would not violate Article 12, § 5 of the Arkansas Constitution. The facts you have provided suggest that the lease and sublease are likely supported by adequate consideration, but this is ultimately a factual question that is beyond the scope of an Attorney General opinion.

2. Assuming that the City's lease agreement with the Financial Institution had no interest component and no interest payments of any kind, would the lease constitute a form of financing and therefore violate Amendment 78 of the Arkansas Constitution and other applicable law on municipal short-term financing?

Brief answer: For reasons explained below, the answer to this question is not clear.

3. Assuming that the sublease payments from the College are dedicated by City Council legislation to pay the City's lease payments to the Financial Institution and assuming that the City's lease with the Financial Institution has a clause that would allow the City to withdraw from the lease at any time, would the City's lease with the Financial Institution violate Article 12, § 4 of the Arkansas Constitution?

Brief answer: For reasons explained below, if the city pledges payment under the contract solely from the sublease payments the city receives from the college, a court could find that the contract does not offend Article 12, § 4.

4. Would the lease and sublease discussed herein constitute a valid public purpose? (You have asked me to assume, for purposes of this question, that the City Council has formally designated the lease and sublease to be in the public benefit and to further several specific public purposes.)

Brief answer: Based on the information you have provided, I believe a court would likely defer to the city council's determination that the lease meets the public-purpose requirement.

DISCUSSION

Because this office is not a factfinder when issuing opinions, I cannot opine on whether any specific contract or lease agreement is constitutional. I can, however, explain the constitutional principles that apply and respond to your questions in a general manner.

Question 1: Would the lease and/or sublease discussed herein violate Article 12, § 5 of the Arkansas Constitution?

Cities have specific statutory authority to lease city property. Under state law, cities are considered "bodies politic and corporate" with express authority to "[c]ontract and be contracted with." Cities are also authorized to "acquire and hold real estate" and to "sell, convey, lease, rent, let, or dispose of any real estate or personal property owned or controlled by the municipal corporation."

Yet Article 12, § 5(a) of the Arkansas Constitution prohibits cities from becoming stockholders in any company, association, or corporation, or obtaining or appropriating money for, or loaning their credit to, private individuals or entities. The Arkansas Supreme Court has interpreted this constitutional provision to bar municipal donations of "financial aid" to private individuals or entities, which would allow a city to do "indirectly what the Constitution forbids to be done directly." As a result, this office has consistently opined that Article 12, § 5 prohibits not only the donation of public money but also prohibits the donation of any public resources, including property, to private individuals or entities.

Thus, any purported city lease must be just that, a lease, not a donation. And all leases, in order to be valid and enforceable contracts, must be supported by adequate consideration. Consideration can be either financial or nonfinancial benefits that the city receives from the lease. The facts you have described above suggest that the lease and sublease are valid contracts supported by adequate consideration, but this is ultimately a factual question that is beyond the scope of an Attorney General opinion.

Question 2: Assuming that the City's lease agreement with the Financial Institution had no interest component and no interest payments of any kind, would the lease constitute a form of financing and therefore violate Amendment 78 of the Arkansas Constitution and other applicable law on municipal short-term financing?

Section 2 of Amendment 78 allows municipalities and counties to "incur short-term financing obligations maturing over a period of, or having a term, not to exceed five (5) years" if the obligations are undertaken "[f]or the purpose of acquiring, constructing, installing or renting real property or tangible personal property having an expected useful life of more than one (1) year." A "short-term financing obligation" is defined as "a debt, a note, an installment purchase agreement, a lease, a lease-purchase contract, or any other similar agreement, whether secured or unsecured."

Although a "lease" is included in this definition of a "short-term financing obligation," it is not entirely clear whether the situation you describe would implicate this constitutional provision. Amendment 78, which was proposed by the General Assembly and adopted by Arkansas voters in 2000, has been the subject of very little caselaw. But this office has previously opined that Amendment 78, § 2 should not be read to prohibit cities and counties from entering "simple rental agreement[s]." Instead, it should be read in conjunction with § 1, which permits counties and municipalities to form redevelopment districts and issue bonds to help finance development projects within those districts. Reading these two sections together suggests that § 2 was intended to broaden "the constitutionally permissible range of financing options for making public improvements." Amendment 78's implementing legislation, the Local Government Short-Term Financing Obligations Act of 2001, also appears to support this interpretation, as it suggests that the "obligations" have "proceeds" and are "negotiable instruments." Under this interpretation of what constitutes a "short-term financing obligation," a standard lease agreement for real property would not be the sort of short-term financing obligation contemplated by § 2. As such, the proposed lease would not run afoul of this provision. But because it is not clear that this interpretation of § 2 is proper, judicial clarification is warranted.

Even if the city's lease with the financial institution falls within Amendment 78's definition of a "short-term financing obligation," it is also possible that the lease's 25-year duration would not violate Amendment 78 if the lease contained a clause (as suggested by your third question) allowing the city to withdraw from the lease at any time. A court might determine that such an escape clause prevents the lease from violating the five-year limitation found in § 2. But, again, this is a question of fact that will depend on the exact terms of the lease.

Ultimately, the terms of any proposed lease agreement must be scrutinized by local counsel to determine whether the agreement complies with Amendment 78.

Question 3: Assuming that the sublease payments from the College are dedicated by City Council legislation to pay the City's lease payments to the Financial Institution and assuming that the City's lease with the Financial Institution has a clause that would allow the City to withdraw from the lease at any time, would the City's lease with the Financial Institution violate Article 12, § 4 of the Arkansas Constitution?

Article 12, § 4 of the Arkansas Constitution requires cities to conduct their fiscal affairs on a sound financial basis, and it prohibits any city from entering into a contract for an amount that exceeds its annual revenue for the fiscal year in which the contract is made. But the Arkansas Supreme Court has held that this constitutional provision "does not prohibit the creation of a debt exceeding current annual revenues if the debt is secured by and payable solely out of the income or assets of a special and separable activity." That is because such contracts only pledge generated revenue, not "the full faith and credit of the town." Consequently, the Court has affirmed the authority of cities to purchase water through multiyear contracts and to issue bonds payable solely from a city's electric light and power plant revenues, even when the amount exceeds the city's total fiscal year revenues. Assuming that the city in this case pledges payment under the contract solely from the sublease payments the city receives from the college and that it does not pledge its full faith and credit, a court may similarly find that such a contract does not offend Article 12, § 4.

Question 4: Would the lease and sublease discussed herein constitute a valid public purpose? (You have asked me to assume, for purposes of this question, that the City Council has formally designated the lease and sublease to be in the public benefit and to further several specific public purposes.)

The public-purpose doctrine, which the Arkansas Supreme Court has rooted in due process, requires that all public transactions serve a public purpose. This doctrine acts as a safeguard against the misuse of tax dollars for private ends. Consequently, any city contract involving the appropriation or expenditure of municipal funds must further a public purpose. Whether any specific contract or expenditure meets this requirement is a question of fact to be decided by the judiciary, but courts afford "great weight" to "legislative determinations of public purposes." That is because the legislature is tasked with determining whether a particular expenditure is for a public purpose.

You have asked me to assume that the city council has formally designated the lease and sublease to be in the public benefit and to serve multiple public purposes. You also include a list of the specific public purposes that would be served by the lease and sublease, including furthering access to veterinary and dental education and care, allowing for additional community health programs, and creating hundreds of jobs. Based on the information you have provided, I believe a court would likely defer to this municipal determination that the lease and sublease fulfill the public-purpose requirement.

Senior Assistant Attorney General Kelly Summerside prepared this opinion, which I hereby approve.

Sincerely,
TIM GRIFFIN
Attorney General