Florida Supreme Court on Management Agreements and Tax Exemption

In Florida last week, the Supreme Court determined that a profit-sharing management agreement between the City of Gulf Breeze and a private golf course management company did not convert the city-owned golf course into a private enterprise, thereby precluding property tax exemption.  Florida law grants property tax exemption for property owned by a municipality and used “exclusively for municipal or public purposes.”  The taxing authority, Santa Rosa County, never challenged property tax exemption for the City-owned golf course until the City turned over management and operation to a private company called IGC.  As with most management agreements I have seen, the management company’s compensation was variable but essentially consisted of all revenue generated by the golf course over $100,000.  The management company also had an option to purchase the golf course:

Under the monetary terms of the agreement, as noted above, IGC was compensated based on a formula tied to the difference between revenue and expenses. Ultimately, IGC bore the risk of financial loss and was entitled to retain the Profits—as defined— generated from the golf course and related facilities after paying the City an Annual Fee—a defined term determined by a formula but that amounted to no less than $100,000 per annum . . . The agreement also granted IGC the right of first refusal to purchase the golf course and its appurtenant facilities, an option that IGC apparently exercised in 2021.

Governments and charities must compensate vendors and service providers.  But we get nervous when compensation is determined as a percentage of profit, and profit maximization is under the manager's control.  In this case IGC took 100% of revenues, less $100,000, presumably a figure equal to the city's expenses. One reason why management agreements cause a double take is that profit sharing is the sine qua non of partnerships, according to the uniform partnership act.  The Florida Supreme Court kinda got lost in the tax collector’s argument that the management agreement was actually a lease and therefore the property was not owned by the  municipality.  The better issue, whenever a management company operates public or charitable activities for variable profit-based compensation, is whether the private benefit decreases public benefit.  

The uniform partnership act’s treatment of profit sharing as creating a presumption of a partnership [i.e., shared ownership] is outdated, of course.  Employees and independent contractors share profits with principals in lots of circumstances where we don’t think of service providers as “owners.”  The Florida Supreme Court properly looked to other indicia of ownership, namely rights of ultimate control over the managed property.  Daily, sort of operational control cannot logically be sufficient.  If it were, all profit-based management contracts could be viewed as partnerships thereby raising the private benefit issue.

The trick is to give the manager enough incentive and control to do the job efficiently, but not so much that the manager has unfettered ability to manipulate expenses and prices at the expense of public benefit. That much control facilitates diversion of resources from the public or charitable goal.  Management companies necessarily have day to day operational control, but they mustn’t be cloaked with an owner’s authority to decide the ultimate use to which property or charitable assets are placed.  The Florida Supreme Court sensibly found that sort of authority lacking and therefore concluded that the golf course should be tax exempt despite its management by a private owner with a profit-based compensatory interest.

What about a manager's option to buy or a right of first refusal?  Somehow that seems to create an incentive to currently operate and manage the property towards future private benefit. A manager might operate the public benefit activity at a short-term loss, for example, to depress the future sale price.  The Court never mentioned or addressed the potential that a right of first refusal might distort the manager's current decisions.  I would probably advise against such a right in the management agreement. There are probably better ways to effectuate a sale to the management company without the red flags if the goal is to eventually unload the public operation.  Besides, why should an insider have first rights?

So as a general matter, management contracts should not raise questions regarding public benefit if the terms are commercially reasonable and the principal – the charity or public entity – retains sufficient ultimate control so that the management company can’t be deemed a co-owner, as is necessary for a partnership to exist.  It helps, too, that the management company be completely independent from the charity or public entity fiduciaries.  The invariable conflict of interest in those cases raise private benefit questions, too, that should not be dismissed merely because the ultimate payment to the vendor or service provider is reasonable. 

darryll k. jones