Nobody knows exactly how much money US states and cities gave away in investment incentives during the 1990s but it must be somewhere north of $40bn. Sometimes the incentives (typically tax breaks and cash grants) were made to persuade multinationals to build a new factory or facility in a particular area.

But most of the time they were paid to stop local companies from moving their factories to locations with lower labour costs like the south or Mexico.

“It was [and still is] standard practice among US companies to blackmail local authorities into giving out tax breaks by threatening to relocate,” says Greg Le Roy, director of Good Jobs First, a Washington DC-based development institute.

When one or two companies began to abuse the system by accepting money and then closing down factories, there was some criticism of the incentive system in liberal newspapers and academic journals.

Money back

So – in the early 1990s – economic development agencies (EDAs) began to include clawback clauses in the incentive agreements stating that if the company concerned did not maintain this many jobs or spend that much capital, then the EDA had the right to ask for the money back.

Few people took the clauses particularly seriously, however. Some EDAs did not even monitor whether capital expenditure or job creation promises made in clawback clauses were being met. In the late 1990s, for example, Minot County of North Dakota gave $10.7m of incentives to a charter tour subsidiary of NorthWest Airlines receiving in return a promise that 600 jobs would be created.

In September 2002 – a year after the company laid off 200 of its workers – the Minot Daily News revealed that the EDA had no documents tracking whether the company had met its job creation promise or not.

Even when companies failed to meet their promises, EDAs rarely exercised their right to ask for the money back for fear that the company would then close down the facility completely. But recently the tendency for EDAs to pursue legal recourse has gathered momentum after many years of turning a blind eye.

As far back as 1984 the City of Chicago sued Play Skool, a subsidiary of Hasbro, after the toy-maker accepted a $1m subsidy to re-equip a factory in the city and then (a few years later) moved the factory to New England.

Eight years later in 1992, the City of Ypsilanti in Michigan took General Motors to court when the car manufacturer closed down a factory (thereby eliminating 4500 jobs) and refused to pay back the $1.3bn it had received in tax breaks.

But these were exceptional cases. “I cannot recall any EDA ever exercising a clawback clause,” says Bill Schaperholter, director of Fluor Global Location Strategies, a leading US location consulting firm.

The overwhelming majority of state and city officials were happy to let companies miss job creation or capital expenditure targets providing they did not abuse the system.

“This was the go-go 1990s when the US economy was booming, cash tills were ringing and money was not a problem,” remembers one location consultant.

“They were too busy doing deals and planning for the future to waste time [as they saw it] poring over old contracts to see if a company had created 300 jobs instead of 350 or whatever.”

As a result, clawback clauses came to be seen by executives, development officials and location consultants as a bit of a joke.

“I viewed them as nothing more than a convenient way for officials to cover their backs in case the press got hold of the story and accused them of being too generous to big business,” remembers one Dallas-based lawyer.

But during 1999-2000, the economic climate in the US changed – growth rates and tax receipts tumbled, and state and city budgets went from million-dollar surpluses to billion-dollar deficits.

Belt tightening

With many states and cities facing their worst financial crises since World War II, government officials across the US began a desperate search for ways to cut spending. It did not take them long to get to the cosy world of investment incentives, and to issue a new set of instructions to economic development agency officials.

“The attitude went from “don’t upset big business, we need the jobs” to “we need money now and I don’t care how you get it,” recalls one EDA official from the southern US.

Across the country, tax authorities (known as Departments of Revenue) began to go through incentive agreements looking for ways to get out of tax breaks they had granted.

If nothing wrong could be found, rebate payments were slowed down. Companies respond to this by taking the tax authority to court but this can be a slow business. “Things that used to get through in three or four weeks are now taking a year or more to come to court and then when they do they are being turned down, says Betty McIntosh, a consultant at KPMG.

Some EDAs began to demand repayment of money – sometimes two or three times the amount received by the firm in the first place (if such a penalty was included in the agreement).

Incredibly – as corporate executives saw it – EDAs were even exercising clawback clauses when companies had made an effort to keep to their agreements. (See below.)

How many companies are now being asked to repay incentives is a hard question to answer mainly because the parties involved are reluctant to discuss the process of clawback enforcement. Worldcom, United Airlines and Alltel, for example, all failed to return telephone requests for interviews on the subject. Dozens of EDA officials contacted by fDI magazine refused to comment.

“Some 99% of all these repayment deals get done in private,” says a leading US location consultant. “They very rarely reach court or get mentioned in press releases since it is not in the interest of either side to publicise the event.”

Consultants say that (depending on the amount of money involved), a senior executive from the company will typically meet with officials from the governor or mayor’s office to discuss the broad terms of a deal.

The details will then be hammered out by a lawyer or accountant representing the company and a senior official from the local Department of Revenue or whatever body is responsible for the relevant incentive.

Past evidence suggests that EDAs will generally pick on firms with small workforces rather than companies with large factories employing thousands of people.

Location consultants, for example, say that many large car manufacturers have failed to meet the capital expenditure promises they made when they accepted huge incentive packages in the mid-1990s.

But – as far as anyone can tell – no EDA has asked any of them to pay back any money, perhaps fearing that such a move would result in the factory being closed down and moved to another state or country.

For much the same reason, economically successful cities and states such as New York, Georgia and North Carolina tend to be more enthusiastic about taking on contract breakers than less dynamic states such as North Dakota or Nebraska.

Personal touch

The personal convictions of the local governor, senator or mayor can also play a part. Last year, for example, the state of Florida (governed by the strongly pro-business Jeb Bush) reduced the clawback penalty levied on companies that failed to meet job creation targets under the QTI business incentive programme.

The type of incentive enjoyed will be of importance. Those relating to tax breaks, say consultants, are more likely to be challenged than cash and loan grants – mainly because of the larger amount of tax law precedents.

Naturally, EDAs will focus first on stopping the flow of future incentives (such as tax breaks for the financial year 2003) before trying to get back money handed out in the past.

The financial health of the company may also be a consideration. If the company is in trouble, a clawback-related fine is not going to make much difference as to whether the facility concerned is closed down or relocated.

On the other hand, EDAs will probably seek to make their move before the company goes into bankruptcy on the grounds that (once the courts are involved) they will be not be the only creditor.

“It is pretty easy to get money back from the company that has signed and broken a clawback agreement,” says Mr McInley. “But it becomes more difficult if there is a long line of creditors in front.”

Getting tough

The new found toughness of EDA officials towards contract breakers raises some interesting questions. Will companies continue to accept clawback clauses now that they know they actually mean something?

Most EDA officials say that they will. “I think clawbacks will remain an important part of what we do,” says Stewart Dickinson, director of industrial financing at the North Carolina EDA.

“Firms understand what they are and why they are there. They appreciate that they are there to ensure that things work out properly, not to punish them.”

But location consultants take a very different view. “Under no circumstances would I accept an incentive that had a clawback attached,” says David Donovan, a partner of Wadley Donovan, a location consulting firm.

“No company can predict what will happen to one of its facilities in three let alone 15 years’ time. There may be a merger. They may need to outsource. It is a lose-lose proposition. If you don’t meet the targets, you end up in protracted negotiations and perhaps bad publicity that can cost your company dearly.”

Mr Dickinson of North Carolina says this is bad advice. “Clawbacks are going to be more pervasive throughout the EDA world in the coming years. If you stay away from jurisdictions that use clawbacks you are going to end up with very few good sites left.”

Matthew Maguire, a senior executive at the New York EDA also seems willing to take a firm line. “I don’t think clawbacks will put off the kind of company we want to attract. If a company opposes a clawback, it calls into question its commitment.”

If large numbers of companies take Mr Donovan’s advice (and his company’s strong reputation indicates that they might) then an interesting battle of wills could soon emerge. This battle is likely to be fought on several issues such as the job creation to incentive dollar ratio.

“Historically, companies have treated it as a bit of a game,” says one consultant. “They throw out a big job creation number in the opening stages thinking it will encourage the EDA to make them a better offer.

“Then when they get down to the nitty-gritty during final negotiations they try to lower the number. The EDA then responds by reducing the size of the incentive package so the company goes back up. The final number rarely has anything to do with the company’s actual plans. “Now that companies know that they will get penalised if they don’t meet the targets, I think they will do a bit more analysis at the start and then start low.”

Another area of debate could be the wording of clawback clauses. Following the United case, it seems likely that companies will attempt to have force majeure sub-clauses introduced. It may also encourage EDAs to use a graded penalty system such as that currently used by the City of New York’s EDA. Under this system, the size of the repayment claim is linked to how soon the company missed the target and by how much.

All the consultants interviewed by fDI seemed confident that the recent aggressiveness of US EDAs will not undermine the incentive system but then as the saying goes “they would say that wouldn’t they?”

EDAs get tough with big business

In January 1991, United Airlines signed a deal with the EDAs of Indiana and Indianapolis under which it would receive nearly $300m of tax breaks and grants in exchange for building a maintenance facility at the Indianapolis International Airport. “The deal was that United would spend $800m on the facility within 10 years and create 7500 jobs,” recalls Tom McKenna, a former official at the state EDA office.

During the 1990s United spent more than $500m on the facility and created more than 3000 jobs. But in the late 1990s the company began to lose money because of increased competition in the airline sector. It decided to halt construction and stop new hiring. By the autumn of 2001, it was clear that the company was not going to meet its promises. So the EDAs asked United to pay back some of the money it had received. The demand could not have come at a worse time. United was close to bankruptcy and – post 9/11 – the outlook for the industry was extremely bleak. But the contract was clear, and in January 2002, the company agreed to pay the state $32m in compensation.

United is not the only company to have been targeted by Indianapolis’ EDA. Last year, Bindley Western Industries, the pharmaceutical distributor, was forced to pay back nearly $400,000 to the City after it was taken over by Cardinal Health, a local rival, and its facility closed.

Nor is Indiana the only state now playing hardball with incentive agreements. “Across the country there has been a significant increase in the number of EDAs willing to exercise clawback clauses,” says one location consultant.

The City of New York has been particularly active. Last year Climate Control, a Canadian air conditioning firm, that was asked to return the $4m it received from the City of New York in 1997 after it created only 30 jobs in the City not the promised 100. Matthew Maguire, a senior executive at the New York EDA, says that the City now has a permanent three-man team dedicated to monitoring compliance with incentive agreements.

The state of Georgia has not been idle either. “It has become much more aggressive about challenging tax-related incentives,” says one consultant. “And it has shown itself willing to take things all the way.” Its approach has ruffled some feathers. “They are saying that a company cannot collect job and capex incentives in the same year. But they never challenged companies about this before. It is ludicrous,” complains one local lawyer.

But it seems to be working. Alltel, a large telecom company, for example, recently volunteered to repay $11.5m of the $13m it got from Georgia two years ago to set up a call centre in the state.

The EDAs of Houston, Fort Worth and St Louis are all rumoured to be in the process of trying to extract money from Worldcom, the telecom giant that recently went bankrupt.

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