Protsman v. Jefferson-Craig Consolidated School Corp.

Draper, J.

This is an appeal from a judgment in favor of the defendants, who are the appellees in this appeal, in a suit brought by the plaintiffs, the appellants here, as taxpayers, to set aside a lease entered into between the defendant Jefferson-Craig Consolidated School Corporation, of Switzerland County, Indiana, as lessee, and the defendant Jefferson-Craig School Building Corporation, as lessor, under the authority of ch. 273 of the Acts of 1947 as amended. Burns’ Stat., §28-3220 et seq.¹ The corporations will be hereafter referred to as the “building corporation” and the “school corporation.”

The facts were stipulated. Except as they may be amplified as we proceed, they are condensed as follows:

The building corporation was formed under the laws of the State of Indiana for the purpose of acquiring land, erecting thereon a school building, and leasing the same to the school corporation. On, April 9, 1951, the corporations entered into a lease contract whereby the property is leased to the school corporation for a period of thirty years beginning at the time the building is ready for occupancy.

The lease requires the school corporation to provide all repairs, replacements and maintenance and to provide insurance against loss by fire, tornado and other casualties and to provide rent or rental value insurance for the benefit of the building corporation or such parties as the latter may designate. The annual rental is $16,000.00, payable $8,000.00 on June 30 and December 30 of each year. The school corporation may renew the lease for a further, like or lesser term, upon the same or like conditions.

The lease grants the school corporation an option to purchase the property on any rental payment date at a price equal to the amount required to enable the building corporation to liquidate by payment of all indebtedness, with accrued and unpaid interest, and to redeem and retire any stock at par value plus accumulated dividends, the expenses and charges of liquidation, and the cost of transferring the property.

The lease further provides that “Nothing herein contained shall be construed to provide that Lessee shall be under any obligation to purchase the demised premises, or under any obligation in respect to any creditors, shareholders or other security holders of Lessor.”

The building corporation has no assets except such amounts as are necessary, under the law, to perfect its organization and qualify it to begin business. It intends to issue first mortgage bonds in the amount of $200,000.00 and second mortgage bonds in the amount of $80,000.00 to acquire the land and erect the building. The securities so issued will be secured by a lien on the property and in default of payment of principal or interest the land and improvements will be liable to sale for the payment thereof.

The land and building will cost $280,000.00. The proposed building is of such construction that its useful life will exceed forty years. The value of the taxable property within the school corporation as ascertained by the last assessment for state and county taxes is $1,815,366.00.

The appellants are taxpayers of the school corporation, and the building corporation is threatening and, unless enjoined from so doing, will proceed with the sale of securities and the purchase of said land and erection of said school building, and the school corporation will, unless enjoined, go into occupancy of said property under and pursuant to the provisions of said lease.

The school corporation perfected this appeal after its motion for new trial, which asserts that the decision is contrary to law, was overruled.

The right of the school corporation to rent a school house is not questioned. The problem presented is whether the lease contract is void because it creates a present indebtedness of the school corporation in the sum of $280,000.00 at a time when the limit of indebtedness the school corporation may constitutionally incur is only $36,307.32. The constitutional provision, being Art. 13, §1, is set out in full in the margin.²

It was held in The City of Valparaiso et al. v. Gardner (1884), 97 Ind. 1, that a municipal corporation may lawfully contract for necessary services over a period of years and agree to pay therefor in periodic installments as the services are furnished. In such cases the aggregate of the amounts to be paid as the services are rendered under such contracts are not considered as .an indebtedness of such corporation, and such contracts are not rendered invalid by the fact that the aggregate of the installments exceeds the debt limitation. That decision has been followed by later cases in this jurisdiction,³ and the rule prevails in a majority of the. other jurisdictions. Anno. 103 A. L. R. 1160.

The question as it involves leases is not new. Similar problems have been before this court on at least three occasions. In City of South Bend v. Reynolds (1900), 155 Ind. 70, 57 N. E. 706, 49 L. R. A. 795, the city entered into an agreement with one James Oliver whereby Oliver agreed to build a city hall on land owned by the city, and to rent the same to the city for twelve years at a rental of $7,200 per year to be paid annually as the same accrued from year to year. The city reserved an option to purchase the building at the termination of the lease, or at any time during the term, at a price equal to the original contract cost with interest, less the total of rentals already paid, and if the city failed to exercise its option to purchase, Oliver could either remove the building or purchase the ground. The city was to pay taxes and insurance, but in case of fire the insurance was to be invested in repair of the old building or the erection of a new one.

In that case it was noted that the rental was a fair one. In the course of the opinion this court said:

“It is settled in this State that if a city contracts for water, light or other things which pertain to its ordinary and necessary expenses, and agrees to pay for the same annually or monthly as furnished, such contract does not create an indebtedness for the aggregate sum of all the annual or monthly payments, because the debt for each year or month does not come into existence until it is earned. But if the indebtedness of the city already equals or exceeds the constitutional limit, and the current revenues are not sufficient to pay such indebtedness when it comes into existence, including other expenses for which the city is liable, an indebtedness is thereby created and the Constitution is violated.”

In Hively v. School City of Nappanee (1930), 202 Ind. 28, 169 N. E. 51, 171 N. E. 381, 71 A. L. R. 1311, a lease contract was made between the school city and the Nappanee Building Company under the provisions of Acts of 1927, ch. 223. The school city owned real estate which it leased to the building company for twenty-five years at a rental of $1.00 per year. The building company proposed to erect a school house on said property and to lease the property to the school city for a like' term of years at a stipulated rental payable semi-annually. The school city further agreed to pay as rental all taxes, special assessments and levies of every kind, including water rentals, and to keep the improvements insured in an amount equal to the par value of all outstanding bonds that might be issued by the building company. The lease gave the school city an option to renew the lease and to purchase the property at a price equal to the amount necessary to enable the building company to pay its debts and redeem its outstanding securities, said purchase price not to exceed the amount actually invested in the property by the building company. If the buildings were destroyed by fire that fact would in no wise affect the rental to be paid by the school city.

Citing for its authority City of South Bend v. Reynolds, supra, this court there said

“. . . where an ordinary lease is entered into, at a reasonable rental, for a term of more than one year, a present indebtedness is not created in the aggregate sum of all the annual payments of rent to become due under the lease, and such a leáse contract, even though it includes an option to purchase the property, does not violate Art. 13 of the Constitution, if the annual rental installments, as they become due, do not bring the indebtedness to a point beyond the constitutional limit.”

But it was alleged in that case that the rentals provided for in the lease were in excess of a fair and reasonable rental, and said payments so reserved were, in truth and in fact, payment of a part of the purchase price for said school building. It was further alleged that said lease was entered into for the purpose of evading the constitution and thereby causing the school city to become indebted in an amount in excess of its constitutional limit.

The court below sustained a demurrer to the complaint. In holding the demurrer should have been overruled, this court observed that in that case (unlike this one) the failure of the school corporation to pay the indebtedness would result in the loss to the school corporation of its own property, and indicated that in the court’s opinion the allegations of the complaint, taken together with the terms of the lease contract, disclosed an arrangement for the purchase of property which was pledged for the payment of an indebtedness, and that the contract was entered into for the purpose of accomplishing an evasion of the Constitution by indirection.

Jefferson School Twp. v. Jefferson Twp. S. Bldg. Co. (1937), 212 Ind. 542, 10 N. E. 2d 608, is the last case on the subject. There the building company was also organized pursuant to Acts 1927, ch. 223, for the purpose of erecting a school building to be used by the township under a lease-contract arrangement. The object of the arrangement was not only to furnish an adequate school building for the school township, but also to enable the township eventually to become the owner of the building. The demised term was for twenty-six years at an annual rental payable semiannually. The lessee agreed to pay taxes, keep the buiding insured, pay for repairs and replacements and pay for alterations and improvements. In the event rental payments at any time exceeded the amount necessary to meet incidental corporate expenses and pay dividends and interest on lessor’s outstanding indebtedness, the excess was to be used and applied in the redemption of its outstanding securities at their par value, and in event the total excess of rental payments was sufficient to redeem all outstanding securities of the lessor with interest or dividends, the lessor was to convey the premises to the lessee. The lessee also had an option to purchase the property at- any time prior to the expiration of the lease term at a price not to exceed the amount actually invested by the lessor corporation.

It was there held that the only relationship existing between the contracting parties was that of lessor and lessee, and the transaction did not impose upon the lessee a present indebtedness in excess of its constitutional debt capacity. The court observed that compliance by the lessee with the terms of the lease would enable the school corporation eventually to become the owner of the school building, but said that this did not change the nature of the obligation incurred under the lease contract insofar as the nature of the obligation related to the question of the amount of the indebtedness, and further said:

“The fact that the building company was willing to give the school building to the Jefferson School Township when the building company had been paid an amount equal to its investment and a reasonable return thereon does not change the lease-contract into a contract to purchase. It is true that the Jefferson School Township, through the device of a long term lease providing for annual rental payments, may become the owner of a school building which, in view of Article 13 of the State Constitution, it could not have acquired in 1928 by issuing bonds. But it does not follow that either the arrangement or the result constitutes an evasion of the limitations of Article 13 of the State Constitution. The lease-contract is not in contravention of Article 13 unless it necessarily created a legally enforceable debt obligation for an amount in excess of the amount permitted by Article 13.”

Hively v. School City of Nappanee, supra, was distinguished in the Jefferson School Township case. It was not overruled. It was pointed out that by the demurrer filed in the Hively case it was admitted that the annual rentals provided for in the lease were in excess of a fair and reasonable rental; the payments so reserved were in truth and in fact payments of the part of the purchase price for said school building; the lease was entered into for the purpose of evading the Constitution and thereby causing the school city to become indebted in an amount in excess of its constitutional limit; and by the execution of the lease the city would become indebted to the building company in the total sum of $180,300, which exceeded the two percent limit of indebtedness.

We are unable to distinguish the Jefferson Township case from the case at bar. The appellants make no effort to do so. They rely on the Hively case, and seek to dispose of the Jefferson Township case by saying it is subject to criticism in that the court should not have taken as true allegations of conclusions in the complaint in the Hively case which were in conflict with the provisions of the lease in that case, which lease was attached to the complaint as an exhibit.

We think we need not discuss the validity of the criticism. Rightly or wrongly the court did assume in the Hively case that the above mentioned allegations of the complaint must be taken as true. So far as the case before us is concerned, the important consideration is that the Hively case was decided on the basis of the facts so assumed to be true. On that basis the decision was clearly right, and it and the decision in the Jefferson Township case can stand together. In the case before us no such admissions have been made and no such facts can be assumed.

As noted in the Jefferson Township case, considerable emphasis was placed in the Hively case upon the allegations of the complaint in that case that the annual rental payments were in excess of a fair rental. Such is not the case here. The complaint here does allege that to be a fact, but there is no evidence whatever to support that allegation. It is stipulated that notice of the execution of the lease was given by publication and remonstrances were filed thereto, and thereafter the State Board of Tax Commissioners found that a necessity existed for the execution of said lease, and that the rental therein was fair and reasonable and said remonstrances were denied. Thus the only evidence before the court was to the effect that there was a necessity for the execution of the lease, and that the rental was fair and reasonable. If that be true, it follows as a matter of course that no part of such rental payments could be payments of purchase price in disguise. The case is apparently one where the lessor voluntarily relinquishes to the lessee the profits which usually flow from the ownership of leased real estate.

We are reminded that the building corporation is limited in its purposes to acquiring a site, erecting a suitable school building, leasing it to the school corporation and collecting the rentals and applying them as provided by statute; that the school corporation pays any taxes or assessments levied against the property, pays for insurance, and is responsible for maintenance, repairs, alterations and improvements; that the building corporation cannot make a profit; but in effect it merely collects money from the lessee with one hand and pays it to the security holders with the other. From these facts it is argued that the building corporation is merely a “dummy” corporation, and we are asked to look to the substance of the transaction and find that we are dealing with nothing more than an arrangement for the purchase of a school building on the installment plan.

Actually we are required only to examine the transaction for the purpose of determining whether the school corporation becomes indebted by the lease-contract in excess of constitutional authority, but should it appear that such is in reality the case, it would be our duty to so find, regardless of any subterfuge or attempt at concealment no matter how plausible.⁴ But the particular question before us is not an open one in Indiana. On the authority of the Jefferson Township case we feel constrained to hold otherwise. It was said in that case that the fact the school corporation could, by paying a reasonable rental over a period of years, become the owner of the building, did not change the lease-contract into a contract to purchase a building, nor create a present indebtedness where none actually existed. We may add that, in our opinion, the limitation of the activities in which the parties may be required or permitted to engage during the life of the lease are equally impotent to effect such a change.

If the school corporation is unable to build a school house it must lease one. If, as it appears here without contradiction, the school corporation can lease a new building at a fair and reasonable rental, this court would not be unwarranted in striking the arrangement down merely because the school corporation can, at its option, but without compulsion so to do, acquire ownership of the property on favorable terms.

Much stress has been laid upon the fact that a tax must be levied each year to pay the lease rentals. Burns’ Stat. §28-3230. But such is also the case where necessary services are contracted to be furnished each year over a period of years. If the school corporation executed a lease without option to purchase it would still be required to pay rent. It does not seem to us that the contract can be rendered invalid because provision has been made for compliance with its terms. In any event we think the inclusion of that provision in the statute would not change the nature of the transaction, and consequently could not affect the validity of the lease.

We have examined cases cited from other jurisdictions by the parties to sustain their respective positions. We think it would be fruitless to analyze them here for we consider the Jefferson Township case as controlling. We may say, however, that from our examination of those cases we believe that the following editorial statement found on page 1362 of 145 A. L. R. is supported by the authorities. It is as follows:

“The recent cases on the point tend to confirm the general principle stated in the original annotation, that the leasing of property by a city, county, or other political subdivision, with an option to purchase the same, does not give rise to an indebtedness or liability of the public body for the stipulated optional purchase price or for the aggregate of all the rentals for the entire term, provided the instrument is in fact a lease, and not a contract of purchase on the instalment plan.”

No other question was presented.

The judgment is affirmed.

Gilkison, J., dissents with opinion.

1 The lease between the building corporation and the school corporation purports to have been made on April 9, 1951, under the authority of Acts 1947, ch. 273, as amended by Acts 1949, ch. 177. Further amendments were made by Acts 1951, ch. 273, which took effect March 7, 1951. The lease is at variance with the 1951 amendment in only one material respect. It is conceded that this variance has no effect upon the real issue in this case, so it will not be further noticed.

2 “Limitation on indebtedness—Excess Void.—No political or municipal corporation in this State shall ever become indebted in any manner or for any purpose to an amount in the aggregate exceeding two per centum on the value of the taxable property within such corporation, to be ascertained by the last assessment for State and County taxes, previous to the incurring of such indebtedness; and all bonds or obligations, in excess of such amount, given by such corporations, shall be void: Provided, that in time of war, foreign invasion, or other great public calamity, on petition of a majority of the property owners, in number and value, within the limits of such corporation, the public authorities, in their discretion, may incur obligations necessary for the public protection and defense, to such an amount as may be requested in such petition.”

3 Crowder v. Sullivan (1891), 128 Ind. 486, 28 N. E. 94, 13 L. R. A. 647; Foland v. Frankton (1895), 142 Ind. 546, 41 N. E. 1031; Seward v. Liberty (1895), 142 Ind. 551, 42 N. E. 39; LaPorte v. Gamewell (1897), 146 Ind. 466, 45 N. E. 588, 58 A. S. 359, 35 L. R. A. 686; Board of Commissioners v. Gardner (1901), 155 Ind. 165, 57 N. E. 908; Town of Gosport v. Pritchard (1901), 156 Ind. 400, 59 N. E. 1058.

4 Cerajewski v. McVey (1947), 225 Ind. 67, 72 N. E. 2d 650, 171 A. L. R. 723; Rappaport v. Dept. of Public Health (1949), 227 Ind. 508, 87 N. E. 2d 77, 88 N. E. 2d 150; and see interesting discussion in 25 Ind. Law Journal, p. 325.