Franchises Versus Service Contracts, Codes Versus Agreements

Jan. 1, 2002
Franchising might have constitutional implications for flow control (designation clauses) and federal preemption of local regulation of commercial waste collection. Alternatives include collection service contracts. If you franchise, consider including franchise provisions in a bilateral agreement rather than solely in a regulatory solid waste code or as a term of a license or permit. A franchise agreement may legally and practically provide flexibility, timeliness, and ease of franchise administration and enforcement. The Nature of the BeastBut what is a franchise? Mere utterance evokes emotional responses in elected officials, waste generators, and haulers alike. A franchise is not necessarily mandatory collection or exclusive, both of which suggest lack of customer choice. It often means that haulers collect rates, fees, and charges directly from customers, but other billing options (such as inclusion on municipal utility bills) can be used. It usually involves payment of a franchise fee, but other revenue sources might be substituted: infrastructure-impact fees, contract administration fees, permit or license fees, or solid waste business taxes.Historically, franchises were privileges granted by governments to private parties who could exploit them for profit (envision English royal monarchs). More recently, franchises have connoted functions delegated by local governments to private companies, albeit subject to varying degrees of public control in the public interest (think of garbage collection and cable TV). Not surprisingly, the United States Supreme Court has articulated a definition: “A franchise is a right, privilege or power of public concern, which ought not to be exercised by private individuals at their mere will and pleasure, but should be reserved for public control and administration, either by the government directly, or by public agents, acting under such conditions and regulations as the government may impose in the public interest, and for the public security” (California v. Central Pac. R. Co., 127 US 1, 40).Constitutional ImplicationsThe US Supreme Court invalidated regulatory flow control in the Carbone case, but other courts have upheld contractual facility designation against interstate commerce clause challenges. When state or local governments are “market participants,” they are not subject to interstate commerce clause restraints. For example, the Second Circuit Court of Appeals held that the contracts between Smithtown, NY, and private haulers, which required waste disposal at a named waste-to-energy (WTE) facility, survived interstate commerce clause challenge because the contracts constituted Smithtown’s participation in both the waste collection and disposal markets rather than regulation of commerce. On the same day it upheld Smithtown’s contractual designation, the Second Circuit Court of Appeals also applied the market participation doctrine to uphold a user-fee/zero tip-fee system in Babylon, NY. Other courts have since also applied the market-participation exception to solid waste cases. The rationale is that the interstate commerce clause does not apply to private entities, so if public entities engage in business the way private entities do rather than regulate the way governments do, then they should be able to do so on a level playing field with the private entities. Courts applying the market-participation exception often speak of the local entities as taking over or taking back collection. If local governments grant the privilege–or delegate the function–of solid waste collection through a franchise to a franchisee, are they still market participants? If they allow a franchise holder to collect fees, they may undercut their status as market participants, since such cases as Smithtown and Babylon involve the payment of user fees, benefit assessments, or broadly described tax dollars or public money. The Supremacy Clause and Federal PreemptionA federal district court in Oregon has invalidated local regulation of certain commercial waste, but other courts have upheld analogous local regulation against supremacy clause (federal preemption) challenges. When state or local governments are market participants or “municipal proprietors,” they may be exempt from federal preemption constraints. For example, the Ninth Circuit Court of Appeals upheld the City of Santa Ana, CA’s arrangements for towing abandoned vehicles based on this exception. The rationale for the municipal-proprietor exception is the same as that for market participation: placing the public sector on par with the private sector. Again, if local governments grant franchises, can they qualify for the municipal-proprietor exception? Especially if local governments place the risk of customer account delinquencies for unpaid fees on the franchised hauler, they might damage their position as public proprietors, since such cases as Santa Ana stress that local governments cannot use the guise of privity of contract to circumvent federal preemption.Service Contract Alternative to FranchisingContracting rather than franchising may strengthen the local government’s hand to assert market participation or municipal proprietorship. Consider hiring a contractor to provide collection services instead of granting a franchise the ability to do so. Service can be mandatory or nonmandatory, commercial, and/or residential. It can be exclusive or nonexclusive. Your contractor can collect rates from customers to pay itself the service fee, if you retain strong and detailed audit rights. Or preferably, the contractor can act as a collection agent to invoice, bill, and collect rates on your behalf, which you can then use to pay your contractor its service fee. (This also gives you the ability to offset service payments for liquidated damages, reimbursements, or other sums the contractor might owe you. It further protects collected rates from being swept up by a trustee in event of the hauler’s bankruptcy.)If you collect fees through property-based assessments or taxes or as part of a municipal utility bill, you already have accepted risk of account delinquency. Delinquency risk is minimal when you can place a lien on property for the delinquent payments or threaten to turn off power or water service. Alternatively, if you hire your hauler to collect fees from customers, your delinquency risk may nevertheless be minimal where state laws prescribe procedures for placing delinquent solid waste fees on annual property tax bills. (In California, however, it might strengthen the argument that solid waste fees are more closely tied to property than to use, making them subject to Proposition 218.)You might also place the delinquency risk on your service provider by contractually limiting your liability to pay contract service fees from collected rates, making your liability a limited, special-fund obligation. However, this might undercut your position as a municipal proprietor under the Santa Ana case that cautions against nominal contracts and threatens to ignore form and respect the substance of a relationship.A final note on franchise fees: In some states, taxpayers’ groups are increasingly scrutinizing fees and charges to uncover hidden taxes. (Given franchise fees’ heightened vulnerability, you might find it prudent to move toward fee accountability: justifying fees by tying them to demonstrated contract administration costs, infrastructure impacts, recycling, and household hazardous waste programs. Such fees might be deposited in special solid waste enterprise funds.) Often franchise fees are unabashed revenue-raisers, based on percentages of gross revenues and deposited in the general fund. If you shift from franchises to contracts, you might have to consider what alternative vehicle you would use to collect a franchise-fee equivalent. You can explore franchise-fee substitutes for general-fund subsidies, including solid waste permit and license fees (which have traditionally been nominal and related to the cost of permit and license administration) or solid waste business taxes.Franchise EnforcementIf you reject the service-contract alternative to franchising, consider whether you will (1) embed franchise terms and conditions in your solid waste code or ordinance, or (2) incorporate them into a bilateral franchise agreement between you and your franchised hauler, or (3) both. There may be administrative and enforcement advantages in choosing the franchise agreement option.(1) Regulatory Enforcement. Violations of solid waste ordinances or codes often constitute infractions (punishable by fines) or misdemeanors (punishable by fines and imprisonment). State laws may place upper limits on the amount of fines and penalties. Infractions and misdemeanors may be enforceable not by the city attorney or county counsel, but rather by district attorneys who have strained resources and limited interest and expertise in solid waste matters. Their priorities might be violent crime. Solid waste cases might have a low urgency on their court calendars. And to obtain criminal convictions, the violation must be proven beyond a reasonable doubt.Alternatives to criminal prosecution might be available. First, state and local law may allow for you (or a specially authorized and created body) to institute civil actions to recover penalties in civil court proceedings. Codes sometimes provide that each day constitutes a separate violation, but nevertheless penalties may be limited by law. Second, state or local law may prescribe an administrative protocol for levying fines. For example, the city council or county board may hold a hearing and make findings on alleged violations; appeals may be made directly to the appropriate civil court. As another example, the public works director may make a decision, which the hauler can appeal to the elected officials or specified hearing officers for further hearing; their decision may be final and conclusive. Third, certain violations might be characterized as public nuisances that your city attorney or county counsel could sue to abate. Fourth, codes sometimes allow the city attorney, county counsel, or district attorney to seek temporary injunctions or restraining orders for violations or potential violations. And last, though rarely, codes may authorize payment of liquidated damages for listed violations, subject to specified appeals protocol. But it is unusual for codes to include all, or even most, of these alternatives to criminal sanctions for infractions and misdemeanors. In practice, experience shows that code and permit enforcement often proves time-consuming, unwieldy, and ineffectual. This might be particularly true where enforcement protocols involve elected officials who can be heavily lobbied by the franchised hauler. Staff who administer the franchise often cannot as easily access to elected officials to explain the administrative, fiscal, or health and safety issues raised by alleged violations.(2) Contractual Enforcement. By contrast, enforcing the terms of a bilateral franchise agreement might prove more flexible, timely, streamlined, and–ultimately–successful. Breaches of solid waste collection franchise (or service) agreements are more likely to trigger the franchised hauler’s obligation to pay liquidated damages (e.g., scheduled sums for missed collections, litter, noise) or compensatory damages (e.g., lost recovered materials revenues, excess transfer haul costs and disposal tip fees, for failure to meet diversion guaranties) than violations of solid waste codes are. Liquidated damages cannot be so excessive as to be tantamount to penalties. But otherwise neither liquidated nor compensatory damages, unlike many criminal penalties or civil fines, need be capped.Breaches of solid waste franchise agreements may further give you grounds for specific enforcement (e.g., securing an injunction to deliver waste to a designated disposal facility). Equitable relief is almost always a remedy included in agreements, but is found much less often in regulation.If a franchised hauler contests the occurrence of a breach in a civil court proceeding, the standard of proof would be a preponderance of the evidence. This is an easier burden of proof than the burden a district attorney would bear when prosecuting infractions or misdemeanors. (3) Regulatory and Contractual Enforcement. Some local governments create a loop, like cross-defaults, between ordinance and franchise (or service) agreements to maximize their enforcement options. Agreements provide that breaches are code violations, and codes reciprocally provide that violations constitute contract breaches. Arguably, however, if violations constitute infractions or misdemeanors you would have to secure a conviction beyond a reasonable doubt before you could trigger an agreement breach. In practice, this might not realistically enhance your ability to quickly deal with a breach of contract. In conclusion, first ask yourself whether you need to designate facilities. Do you own landfills, WTE facilities, material recovery facilities, or composting sites and need to internalize waste collected within your jurisdiction? Or do you contract for services with any such facilities, perhaps with put-or-pay commitments? Do you want to ensure delivery to certain facilities that have better environmental records than others? If you want to strengthen your case for designation, consider contracting for collection services rather than granting a franchise in order to strengthen your claims to the market-participant exception under the interstate commerce clause.Next ask yourself–especially if you are in the Ninth Circuit (California, Oregon, Washington, Arizona, Montana, Idaho, Nevada, Alaska, and Hawaii)–if you want to regulate commercial rolloff and debris boxes, or commercial waste generally, including collection times, routes, frequency, customer charges, diversion requirements, collector fees, and facility designation. If you want to provide for these aspects of public health, safety, and fiscal protection, consider contracting rather than franchising to strengthen your qualifications as a municipal proprietor under federal preemption doctrine and the supremacy clause. And finally, if you do choose to franchise, consider including desired franchise provisions in a bilateral franchise agreement rather than solely in a regulatory solid waste code incorporated as a term of the franchise. A franchise agreement could legally and practically provide flexibility, timeliness, and ease of franchise administration and enforcement.

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