Unless you’re enjoying an extended President’s Day vacation this week, there’s a good chance you’ve already read Rick Moriarty’s fantastic piece from last weekend’s Syracuse Post-Standard about the latest hurdle facing the developer (Robert Congel) of the star-crossed Destiny USA mega-mall project in Syracuse, New York. If that project sounds familiar to you, it’s because we’ve written about it here at GRELJ previously; as you may recall, in November of 2009, the Appellate Division for the Fourth Department here in New York upheld (in a split 3-2 decision) the Onondaga County Supreme Court’s decision that Destiny was entitled to a preliminary injunction requiring its construction lender, Citigroup, to continue funding Destiny’s construction loan. (Destiny USA Holdings, LLC v. Citigroup Global Markets Realty Corp., 889 N.Y.S.2d 793 (App. Div., 4th Dep’t 2009)).

However, it is the federal “green bonds,” which the Appellate Division specifically identified as so “unique” and “revolutionary” that money damages alone would not be sufficient to compensate Destiny if the injunction were denied, that find themselves as the stars of this chapter of the Destiny saga. The American Jobs Creation Act of 2004 authorized up to $2 billion of green bonds that state or local governments could issue for certain qualified green building projects. (See 26 U.S.C. 142(l)). The Destiny project received $228 million in green bond proceeds, which investors purchased at a lower, tax-free interest rate, effectively giving Destiny a $120 million subsidy over the 30-year term of the bonds. (Interestingly, the USGBC purchased $50,000 in bonds in 2007 “in a gesture of support for the program,” according to Moriarty. The bonds were insured by XL Capital and rated AAA.).

Proposed as a 4.5 million-square-foot, LEED Platinum-certified entertainment destination, Destiny USA was to be constructed as a three-phase expansion of Syracuse’s existing Carousel Center and include 1,300 hotel rooms, an indoor aquarium, a water park, an indoor recreation of the Erie Canal, a stadium and performing arts center, three golf courses, a 100-acre glass-enclosed indoor park, and a 20-acre artificial lake; green features were to include a 45-megawatt biofuel plant and 290,000 square feet of solar panels. At the time, Citi, which underwote the bonds, said that “[t]he financing of the Destiny project using these new Green Bonds is groundbreaking and represents a step forward in addressing climate change in the U.S. because this project incorporates sustainable design, energy conservation and renewable energy sources on a large scale.”

Now, though, after construction stopped before phase one was even completed, Destiny’s tax-exempt financing is in jeopardy. As part of the basic eligibility requirements for the green bonds, Destiny was required to “demonstrate and provide written assurances” in its application to the IRS for the exemption that it would allocate the tax-exempt financing for financing the purchase, construction, integration, or other use of energy efficiency, renewable energy and sustainable design features of the project. As construction has stalled, most of Destiny’s promised green features – including its LEED certification – have failed to materialize. With respect to green building and sustainable design, the IRS explained in Notice 2005-48 that:

[a]t least 75 percent of the square footage of commercial buildings that are part of the project [must be] registered for United States Green Building Council’s LEED certification and [must be] reasonably expected by the applicant (at the time of the designation) to receive such certification, based on all the facts and circumstances, including statements of the United States Green Building Council, opinions of independent experts in green building and sustainable design, and relevant experience of the project developer. The application must include: (1) LEED Letter Templates indicating which LEED credits the applicant plans to pursue and the applicant’s planned approach to pursuing such credits; (2) documentation demonstrating the applicant’s plans to design and construct LEED-certified, sustainably-designed buildings, including, where applicable, architectural plans, drawings and specifications, policy statements, contracts, leases and other applicable documents, and other related applicable information; (3) information on how plans to build LEED-certified, sustainably-designed buildings will be implemented through the management structure, for example, by placing LEED-accredited professional(s) and other experienced green building professionals in positions of authority over the project to ensure that the applicant’s green building plans are realized; (4) information on any plans to attract broader expertise and perspectives to the project that could support the effort to achieve LEED certification through such means as green building design charettes or consultation with additional green building experts; and (5) information on financial incentives and penalties that will be included in the design, construction, engineering and other building contracts and subcontracts to tie a part of the contractors’ and subcontractors’ compensation to their level of success in designing and constructing LEED-certified, sustainably-designed buildings.

Note, however, that there is no requirement that actual, formal certification be achieved; a point that Destiny’s attorneys have made to the IRS in a letter that was sent to the agency last week by the Syracuse Industrial Development Agency (through which the bonds were issued). SIDA wrote the letter because Destiny is facing an end-of-month deadline to provide a compliance report through SIDA (a required submission under the Act, 4 years after issue of the bonds) describing whether it has met – or anticipates meeting – the commitments it made to green building practices in its application for the exemption. Destiny’s letter also argues that the project – when complete – will still satisfy the spirit of the Act, even if its final composition is different than what the developer initially contemplated, and that the developer “remains deeply committed to sustainability and renewable energy goals.”

Regardless of what action – if any – the IRS takes upon receipt of the letter, it is obligated by the Act next year (5 years after issue of the bonds) to determine – after consulting with EPA – whether the project has “substantially complied” with the Act. If not, at that point in time, Destiny would forfeit $2.3 million being held in a Treasury reserve account, and the bonds could lose their tax-exempt status; Destiny would pay a higher interest rate on the bonds to pay the taxes on the interest earned by the investors who purchased the bonds. Note that the IRS has the ability to extend the 5-year period for up to 2 more years before making the “substantial compliance” determination.

The fallout if Destiny loses its tax-exempt status would read very much like a law school hypothetical. Complicating matters further is that there are – at least as far as I can tell – no Treasury Regulations or other IRS rulings interpreting or applying the Act as it relates to the loss of tax-exempt financing for green bonds – not surprising given that the program was created specifically for Destiny and three other large-scale, brownfield remediation demonstration projects across the country. Indeed, Moriarty notes that Senators Clinton and Schumer “helped to insert the [green bonds] program into [the Act] . . . and [it] was specifically written to favor Destiny USA and three projects in other states” (Colorado, Georgia, and Connecticut). Accordingly, whether the Section 142(l) issues confronting Destiny will have any broad-based applicability for other types of similar financing arrangements remains to be seen.

More generally speaking, Destiny’s woes remind me very much of those that have plagued the Xanadu project in the New Jersey Meadowlands. Similarly conceived for, and commenced during, a much different economic climate, the project stalled, changed hands several times, and after some political wrangling appears close to getting back on track. Given the political clout behind the Destiny project, lack of any precedential Treasury Regulations, and the somewhat improving lending climate, it seems premature to assume that Destiny is slated to become a white elephant. That’s not to say what’s happening right now in Syracuse isn’t troubling from a policy perspective, or an indictment of how the language in the Act providing for the green bonds program was crafted, but I do think it remains to be seen what the ultimate legacy of these financing issues will be from a green legal perspective.

Nevertheless, there is no doubt that a messy situation is brewing in Syracuse; we’re looking forward to Mr. Moriarty’s continued excellent coverage on the project and we’ll be following it closely in the weeks and months ahead here at GRELJ.

In New York (like most jurisdictions), one of the elements for obtaining a preliminary injunction is whether there will be irreparable injury to the moving party if the court denies provisional relief. However, if the court can calculate the moving party’s damages with precision, there can be no irreparable injury while the action is pending because the moving party would be adequately compensated by money damages if it were to prevail at trial. The Destiny court, however, found two exceptions to the irreparable injury test based explicitly on the project’s green features. It held that

“an exception is warranted because the Project’s unique character renders it difficult to calculate any damages sustained by Destiny Holdings. Citigroup stated through its managing director at a U.S. Green Building Council Presentation on November 8, 2007 that the Project is a ‘visionary project’ that has created a ‘new financing paradigm for green economic development’ that is ‘revolutionary.’ Citigroup Chairman and Chief Executive Officer Charles Prince called the use of newly-created Federal Green Bonds [created under the American Jobs Creation Act of 2004 and authorizing up to $2 billion in tax-exempt, private activity bonds to be issued by state or local governments for qualified green building and/or sustainable design projects] in financing the Project ‘groundbreaking [and] a step forward in addressing climate change in the U.S. because the Project incorporates sustainable design, energy conservation, and renewable energy sources on a large scale. He further commented that the Project ‘is good for economic development and good for the environment.’ Thus, the unprecedented nature and scope of the Project makes it unique, so that it has no established market value and any damages sustained could not be calculated with reasonable precision.”

The court also found a second exception to the general rule because of the project’s highly touted green features, stating that “Destiny Holdings has established the enormous potential for harm to its reputation and the reputation of the entire ‘Destiny USA’ project. Harm to business reputation is harm for which money damages are insufficient and for which injunctive relief may be appropriate.” I don’t think it’s unreasonable to infer here that the court was connecting the project’s green features to its “reputation” in order to carve out another exception to the general rule barring injunctive relief in similar contexts. For both of the foregoing reasons, the Appellate Division upheld the trial court’s decision, but modified the order granting the preliminary injunction to require Destiny to post a bond in order to compel Citigroup’s performance under the loan agreement.

Interestingly, two justices joined in filing a dissenting opinion that ignored the project’s green features. The dissent stated that “there is no support in the record for the majority’s conclusion that an ‘enormous potential’ for harm to the reputation of Destiny Holdings exists, other than the bald assertion of a principal of Destiny Holdings that its reputation would be damaged as a result of its failure to complete the project. The core of the majority’s argument is that the nature of the project makes it unique and thus that Destiny Holdings would be entitled to specific performance [of the construction loan agreement]. While the scope of the Project may be unique to the region in both its size and impact, the record clearly establishes that the [construction loan agreement] itself is simply one to loan money in order to finance construction.”

I think that there are a few important things to take from this opinion. First, notwithstanding the Destiny project’s massive scope, the Appellate Division has given owners a basis for arguing that green building projects – regardless of their financing mechanism – are inherently unique.  In the event of any type of dispute, owners or other parties which might be seeking provisional remedies or are engaged in other motion practice (that, like in Destiny, is unrelated to the project’s green design features) can now rely on appellate authority that green building projects are different and deserve different treatment under applicable law.

Conversely, the opinion suggests why construction and real estate attorneys need to be well-versed in the green building space; if you were asked to oppose a similar motion where the movant was arguing that “green buildings are different,” you would likely want to argue in opposition how, to date, many green building projects have not resulted in such different outcomes from conventional projects (i.e, by identifying the ongoing LEED performance gap and studies analyzing the alleged rental and asset premium for different types of certified green buildings).

The decision is also important to note from a lender’s perspective. If potential borrowers looking to finance a green construction project have the ability to argue that their projects deserve special treatment in connection with any lending dispute, lenders may consider, for example, revisiting the terms of their construction loans or otherwise pricing this type of risk into the loan itself.

Are there other green real estate-related legal issues arising out of this opinion that you might anticipate arising in connection with these types of construction lending disputes?

My thanks to Kevin Garrison of Baker Donelson for forwarding a copy of the Appellate Division’s opinion in this matter to my attention. Either of us would be happy to forward you a copy of the opinion upon request.