A municipality’s ability to impose labor requirements as a condition of a tax break was recently called into question by a federal appeals court decision.  In an apparent “first impression” opinion, the U.S. Court of Appeals for the Third Circuit ruled that the City of Jersey City is acting as a regulator, not a market participant, when it enforces its property tax abatement ordinance. (Associated Builders and Contractors Inc. New Jersey Chapter et als. v. City of Jersey City, Docket No. 2-14-cv-05445).  This ruling could have a significant effect on whether municipalities can adopt ordinances tying property tax exemptions or other incentives to requirements such as PLAs. The decision arguably could even have a ripple effect on state or locally-imposed prevailing wage and affirmative action requirements tied to the granting of incentives.

The ordinance in dispute requires developers who receive property tax exemptions to enter into project labor agreements (PLAs) on project that cost at least $25,000,000, excluding land acquisition costs. Such PLAs require developers to abide by a pre-hire collective bargaining agreement that will cover all employees for the duration of the tax exemption, and will bind developers’ contractors and subcontractors. In addition, such contractors and subcontractors must have an apprenticeship program, and 20% of all labor hours must be performed by apprentices who are Jersey City residents. If developers fail to comply with the PLA, the City may suspend the tax exemption until the developer complies, during which time the City can assess three times the amount of conventional taxes. Failure to comply within six months may result in termination of the tax exemption.

The District Court had dismissed Plaintiffs’ complaint, which alleged that Jersey City’s tax abatement ordinance is preempted by the National Labor Relations Act (“NLRA”), the Employee Retirement Income Act (“ERISA”), or the dormant Commerce Clause. The underlying argument advanced by Plaintiffs was that “the NLRA preempts any state or local law that regulates conduct falling within sections 7 and 8 of the NLRA – sections that safeguard an employee’s right to join, or refrain from joining, a labor union”; ERISA preempts state or local law that relates to any employee benefit plan, including apprenticeships; and the dormant Commerce Clause precludes states from “enacting regulatory measures designed to benefit in-state economic interests by burdening out of state competitors.” The Plaintiffs, a non-profit organization of builders and contractors, argued that they have been “deterred from bidding on projects covered by the Ordinance for various reasons, including because they have no established relationships with any union and have never worked under PLAs; they would have to hire employees through a union hiring hall and not in accordance with their own standards; they would be restricted to hiring only subcontractors that also comply with PLAs; and they would have to force their employees to comply with an agreement negotiated by a union regardless of their employees’ desires.”

On September 12, 2016, the Court of Appeals reversed the lower court, ruling that Jersey City enforces this ordinance in its capacity as a regulator; the Plaintiff’s claims were reinstated. In reaching its decision, the Court of Appeals explained that to trigger the NLRA, ERISA, or the dormant Commerce Clause, “the allegedly unlawful act by the state or local government [must] be regulatory in nature. If a state or local government is acting as a market participant pursuant to a proprietary interest, it is not so constrained by these federal laws or by the relevant preemption doctrines. The market participant exception to these doctrines is rooted in the principle that a government, just like any other party participating in an economic market, is free to engage in the efficient procurement and sale of goods and services. Thus, when a government ‘acts as a ‘market participant with no interest in setting policy,’ as opposed to a ‘regulator’, it does not offend’ federal law.”

The Court of Appeals used a two-part test to determine if Jersey City is acting as a market participant. First, determine whether “the challenged funding condition – here, the Ordinance – serves to advance or preserve the state’s proprietary interest in a project or transaction, as an investor, owner, or financier.” Second, determine whether “the scope of the funding condition [is] ‘specifically tailored’ to the proprietary interest’, or, put another way, whether the action is so broad as to be considered, in effect, regulatory.” Both steps must be met for a government entity to act as a market participant.

The Court of Appeals concluded that Jersey City lacks a proprietary interest in tax abated projects, and therefore, fails the first part of the two-part test. The Court of Appeals cited examples of a government’s proprietary interest in projects that have been recognized by the U.S. Supreme Court, such as when the government owns and manages the property on which a project is located, hires and pays contractors to complete the project, provides funds for the project such as bond financing, or purchases or sells goods or services. However, the Court of Appeals found that none of these activities was present in this case. The Court of Appeals noted that Jersey City “is not selling or providing any goods or services with respect to the Tax Abated Projects, nor acting as an investor, owner, or financier with respect to those projects,” but simply reducing developers tax burden for a period of time.

Likewise, the Court of Appeals did not agree with Jersey City’s argument that the City has a proprietary interest in enforcing its tax abatement ordinance because “the tax abatement functions as a subsidy that finances or invests in each project.” The Court of Appeals noted that such an argument was rejected outright by the Supreme Court in Camps Newfound/Owatonna, Inc. v. Town of Harrison. Thus, the Court of Appeals held that Jersey City is acting as a regulator, and not a market participant, when enforcing its tax abatement ordinance.

The case was reversed and remanded to the District Court to determine if Jersey City’s tax abatement ordinance is preempted by the NLRA, ERISA, or the dormant Commerce Clause.  It can be found here: https://www2.ca3.uscourts.gov/opinarch/153166p.pdf.