Legal Update

North Carolina's explosive population growth continues to outpace the ability of local governments and school boards to provide adequate governmental and educational facilities. For example, the State Department of Education estimates that North Carolina currently faces approximately $6.5 billion in unmet school construction and major renovation needs. Unfortunately, relatively conservative public construction laws have left our local public school systems poorly equipped to finance, deliver, and administer large numbers of new construction projects. However, the General Assembly, which normally prefers highly regulated traditional public construction projects, has attempted to provide an innovative method to finance and construct public school facilities.

Pursuing New Opportunities in School Construction

The General Assembly's recent attempt to provide much needed public construction flexibility has come in the form of a 2006 law called the Act to Allow Capital Lease Financing for Public Schools (the "Act"). The Act may appear to be a good opportunity for developers and the construction sector to expand the number and size of their public school projects, but there are several potential pitfalls that a developer should evaluate before pursuing a capital lease project under the Act.

The Act allows a school board to seek proposals from private developers to build school facilities that then would be leased back to the school system. The resulting building would be privately owned, and the developer generally would treat the school system as a typical tenant. To accomplish this, the Act provides that the project will be a hybrid public-private venture where the construction management and ownership remain private, but the school board, the board of county commissioners, and the North Carolina Local Government Commission would have significant input and approval powers.

Potential Advantages

The Act's public-private project is a departure from typical North Carolina school construction in several ways that provide developers with expanded opportunities. For example:

• The property can be owned by the developer or a third party.
  
  
• Build-to-suit capital lease projects are allowed. In addition, a school board may enter into predevelopment agreements with a developer to better define each party's respective responsibilities. For instance, predevelopment agreements may include provisions for site selection and building design.
  
  
• A school board may transfer real property to the developer for the purpose of completing a build-to-suit project.
  
  
• The capital lease can be used for either new construction or existing buildings.
  
  
• The developer may lease the property to the school system for up to 40 years.
  
  
• The construction or renovation would be under the control of the developer; ordinarily the school system must control and direct the project.
  
  
• Approval by the State Superintendent and the North Carolina Historical Commission is not required before the school system can invest in the project.
  
  
• The project need not follow the State Board of Education's facility guidelines or approval process.
  
  
• The state's Energy Guidelines for School Design and Construction are waived. A performance bond is not required; the only financial guarantee required of the developer or prime contractor is an irrevocable letter of credit that will cover at least 5% of the project's total cost.

Potential Pitfalls

Although the Act creates additional opportunities for developers, there are several requirements and restrictions that may result in headaches and delays during the planning and implementation phases of a project. For example:

• Both the school board and the board of county commissioners must approve the capital lease.
  
  
• The capital lease cannot require the school board or the county commissioners to pledge any taxing power as security for the lease. However, the capital lease entered into under the Act would be a continuing contract for capital outlay and would be subject to the state's typical appropriation requirements.
  
  
• A capital lease may not contain a nonsubstitution clause that restricts the right of a local school board to stop using the facility.
  
  
• Deficiency judgments against the school board or county commissioners are prohibited.
  
  
• Capital leases entered into under the Act must receive approval by the North Carolina Local Government Commission.
  
  
• The Act forbids developers and school boards from making bargains about the assignment of students to the school being built.
  
  
• The state's lien laws apply to the capital lease in the same manner and to the same extent as if the property were owned by a private entity.

Short Timelines

The authority granted to school boards by the Act will expire on July 1, 2011. Given the long lead times often necessary to finalize an agreement with a school board, especially when the agreement is outside the norm, developers and contractors should act soon to take advantage of the opportunities contained in the Act. In addition, the North Carolina Local Government Commission, which has not yet approved a lease project based on the Act, should be consulted early during the process. Developers and contractors would be wise to consider both the advantages and potential pitfalls before pursuing the opportunities presented by a public-private school board capital lease project.

Conclusion

Successful developers and contractors cannot rely solely on technical expertise and good business sense when it comes to drafting and entering into a capital lease subject to the Act. A successful public-private partnership also is linked to an understanding of the special rules in the Act as well as the standard statutory procurement and construction process.

Ward and Smith, P.A. serves as counsel for more mid- and large-sized businesses in the region than any other law firm. The firm has 69 attorneys who serve clients locally, regionally, nationally, and internationally from offices in Greenville, New Bern, Raleigh, and Wilmington. Ward and Smith, P.A. also is home to 16 attorneys included in the publication The Best Lawyers in America and nine attorneys selected as "Legal Elite" from peer-review surveys published in Business North Carolina. The firm is recognized in BTI's Client Service A-Team for Law Firms, and one attorney, David L. Ward, Jr., is a member of the BTI Client Service All-Star Team.

For further information regarding the issues described above, please contact Deborah B. Andrews, Thomas S. Babel, John P. Crolle, Donalt J. Eglinton, Merrill G. Jones, II, Cheryl A. Marteney, James W. Norment, William A. Oden, III, Clifford P. Parson, C. H. Pope, Jr., Stanley M. Sams, Jason T. Strickland, Ryal W. Tayloe, or Kenneth R. Wooten.