June 22 & 23, 2011  Of Waterfalls, Champagne and Bonuses

On Wednesday June 22 at the Elgin St. Courthouse it was Waterfall Revelation Day— and all about how the financial architecture of the Lansdowne deal discriminates against City of Ottawa taxpayers and overwhelmingly favours the OSEG developer group.

FOL lawyer Steven Shrybman explained to Justice Hackland how the financial hierarchy of the deal is arranged into a tiered structure that gives initial and favoured priority of investment return to OSEG and little if no investment return to the City. Shrybman noted that payments from the Waterfall for the 10 acres of public land will not flow to the City before 2038, some 27 or more years from now, if any flows at all. The overall arrangement is discriminatory in favour of OSEG against all other potential bidders and a clear breach of Sec. 106 of the Municipal Act, which prohibits bonusing of commercial enterprises.

Mr. Shrybman explained how OSEG is always in first position for payment of revenues from the overall scheme and is in a preferred position in the Waterfall scheme. OSEG will be paid an annual return on invested capital of 8%. The City will receive a similar return on its funding equity, which is now estimated to be much less than OSEG’s equity. After receiving the initial 8% return, OSEG will maintain a privileged priority payment position over the City─ the entire capital that OSEG invests will be paid back to it, before the City sees any return payment on its land, which is called “deemed equity” and is valued at only $20 million. The public land will be leased to OSEG at $1 a year for 30 years.

“More worrisome, still,” Shrybman argued, “if there are any losses incurred in the operation of the stadium and sports franchises, losses which are indeed projected in the pro formas advanced by the City, such losses will be capitalized as an equity contribution from OSEG and be positioned in priority position to be repaid from the Waterfall”.

It was more sad than amusing to hear Mr. Shrybman compare the deal to a magnum of champagne being tipped and poured into a pyramid of champagne glasses with the OSEG partners being in the upper levels and nary a drop leftover for the taxpayers of Ottawa, who are at the bottom when it comes to repayment for public land. An important piece of evidence in this regard was the revelation by Mr. Shrybman that the City Manager in cross examination had admitted to making a fundamental error in the complex formula presented to, and approved by, Council that establishes the City’s funding equity. The error amounts to $62 million. “Oh,” he recounted from the City Manager’s testimony, “we made an error in the formula, and we will go back to Council to report that…”. At this point Justice Hackland opined that the present case might possibly be moot if a new by-law were to be passed to accept and rectify the error. The judge encouraged legal counsel on both sides to consider this question, and it was agreed that further discussion between counsel will consider the issue and new submissions to Justice Hackland on the matter could be made if necessary next week.

In any event, Steven Shrybman maintained that the City’s intention to reduce the approved City funding equity by $62 million further skews the financial structure disproportionately in OSEG’s favour.

“You have to avoid the fleecing of public property and public assets at below fair market value,” Shrybman concluded.

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Thursday June 23 was all about the bonuses or preferences offered to OSEG in various areas (such as advertising revenues, naming rights, low rent) and Mr. Shrybman elaborated in great detail how the scheme confers several unfair bonuses to OSEG and why these constitute breaches of the Sec. 106 Municipal Act prohibitions against bonusing.

The various types of financial assistance provided to OSEG in the form of bonuses, which are not permitted under the Municipal Act, were detailed extensively by the FOL lawyer as follows.

OSEG Losses Become Equity

A fundamental breach occurs even before money flows under the Waterfall scheme because any losses incurred by OSEG from the hockey and football operations can be converted into equity and thereby become eligible for repayment from the Waterfall. Very clearly, since these losses are in fact anticipated by the City and OSEG─ and documented in the scheme’s financial pro forma─ money will flow from the stadium and arena operations to pay for the losses. Financial assistance such as this is a breach of Sec. 106 of the Act.

City Equity Undervalued and Given Low Payment Priority

A second breach, again, even prior to the Waterfall payout scheme, occurs because of the undervaluation of the City’s true equity in the project. OSEG gets its $30 million initial investment and any additional equity treated as 100% equity and is entitled for earlier payback in the tiered payback scheme while the City is accorded minimal funding equity valuation (possibly $13 million) despite investing $129 million in the stadium and parking.

City Assets Rented Out At Below Fair Market Value

The lease of city property under the LPP for a nominal rent of $1/annum represents assistance to OSEG, a commercial enterprise, and therefore clearly violates the prohibition set out by s. 106(2)(c) of the Act. Granting assistance by leasing or selling any property of the municipality at below fair market value is prohibited under s. 106(2)(c) of the Act. Yet under the LPP, the City proposes to lease facilities and land owned by the City to OSEG for a period of 30 years for a nominal rent of 1$ per year.

On this single breach alone Shrybman argued that the FOL should win its case, and maintained that the breach is more than sufficient grounds to terminate the inquiry: “The disparity in the advantages conferred to OSEG is stark”, Shrybman said, “and there can only be one conclusion and that is that the scheme is a breach of the Municipal Act and is therefore illegal.”

The FOL lawyer detailed several other breaches with respect to financial assistance provided to OSEG by granting it exclusive naming rights, advertising rights, concession and parking operation rights, all of which is totally contrary to the normal sports industry business standard of the owner of the stadium having such rights, not the tenant. “The City gets no equity allocation for having foregone revenue in giving up such rights”, Shrybman noted, “and with no recognition and no quid pro quo, these revenues constitute financial assistance to OSEG and a breach of the Sec. 106 prohibitions.”

At this point in the proceedings Justice Hackland observed that there might be a problem of justiciability of the case given the nature of the financial and business evidence being adduced. He commented that perhaps he should consider a new proceeding, by way of trial, so that oral evidence could be called from both sides from expert business witnesses such as Chartered Accountants. He explained that, alternatively, he could consider having this Court engage a professional Chartered Accountant to act as financial advisor to him. Justice Hackland reserved his opinions for future consideration of these issues.

Mr. Shrybman then resumed his arguments detailing additional technical breaches of the anti-bonusing provisions of the Municipal Act, including the cost subsidy OSEG would enjoy from the City incurring a $6 million expense to move the Horticulture Building; the urban park renovation expense of some $35million from which OSEG will benefit from the use of the park for marshalling buses during events and from traffic attracted to the park; and several property tax implications that also favour OSEG.

At the end of his Thursday presentation Mr. Shrybman summarized three principal conclusions on the bonusing issue.

• There is, first and foremost, a gross disparity in treatment of the capital contributions of the parties.
• The priority payment structure of the Waterfall payment scheme is tiered to the advantage of OSEG and discriminates against the City’s equity contributions.
• If the Lansdowne partnership plan fails, OSEG’s exposure is capped at $30 million but the City is liable up to $50 million, another obvious disparity in treatment that provides a bonus to OSEG.

Mr. Shrybman also noted during his presentations that the City is investing $129 million in the stadium and parking— and $172 million overall— but is being credited with very little funding equity. Indeed, the City’s intended formula would amount to only $13 million for its equity.

The case resumes in Courtroom Number 37 at the Elgin Street Courthouse on Monday June 27 at 10:00am.