SEATTLE — Questions about the legality of obscure leases that for two decades turned Washington’s oldest ferries into floating tax shelters remain a source of friction as lawyers for the state and a Tacoma shipbuilder begin trying to negotiate an end to a messy federal lawsuit.
Lawyers for the J.M. Martinac Shipbuilding Corp. and the state are scheduled Thursday to meet with federal mediators, said Bryce Brown, chief assistant attorney general in the state’s transportation and public construction division.
The attorneys will explore whether a resolution can be negotiated to a 2006 lawsuit Martinac filed out of frustration with Washington State Ferries’ handling of long-delayed construction contracts for new boats.
Although Martinac is now part of a consortium of shipyards in line to build up to six new ferries, Martinac’s case against the state remains alive but stayed in U.S. District Court in Seattle.
If no agreement can be reached to end the case, “we’ll lift the stay and proceed with the lawsuit,” Martinac attorney Jed Powell said.
The shipbuilder has alleged ferry officials cost the company millions of dollars and engaged in conduct that amounted to civil racketeering in how it earlier managed competition for boat-building contracts.
A key Martinac allegation — hotly disputed by the state — is that ferry officials deliberately delayed construction of new boats because of tax shelter agreements reached with private investors in the 1980s, and secured by continued operation of four 1927-vintage Steel Electric-class vessels.
State Transportation Secretary Paula Hammond pulled the Steel Electrics in November, citing safety concerns about corrosion and cracks in their 80-year-old hulls.
Ferry officials initially thought the state would have to pay at least $3 million to compensate two investment companies with Safe Harbor Leases. The money would cover lost tax credits based on the value of the vessels’ depreciation.
A review of the leases by the Attorney General’s Office has the state now convinced that they can be transferred from three of the vessels — the Illahee, Quinault and Nisqually — and instead attached to another ferry, the Kittitas. Those leases expire in 2014.
The lease on the remaining Steel Electric, the Klickitat, is set to expire in 2010, and the state is proposing no action at this time.
Powell said he’s convinced the leases were improperly entered into by the state in the 1980s, and that they can’t now legally be shifted to other vessels without exposing Washington taxpayers to significantly greater liability than the $3 million likely owed if the agreements were terminated.
The attorney has spent years poring over documents related to the transactions, and he said he’s long anticipated grilling state officials about the paper trail.
Among other things, Powell said, he wants to know why the state over a period of weeks entered, then amended, leases for these transactions, and why the reported value of the Steel Electrics during that time shot up millions of dollars on each vessel without any obvious improvements being made.
Documents Washington State Ferries provided under public records laws confirm the existence of two versions of the leases. The amended version recalculates, by millions of dollars in the state’s favor, the amount of money taxpayers would be required to pay lease holders if the agreements were suddenly terminated.
Tim McGuigan, an attorney and director of legal services and contracts for the ferry system, said he’s noticed the differences between the original and amended versions of the leases, but has no explanation.
Is it a case of somebody earlier correcting a significant error?
“You might surmise that, that somebody caught something,” he said.
The state received close to $25 million for Safe Harbor Leases entered into on the Steel Electrics and other vessels in the fleet. The tax shelter program was designed to direct private investment into public transportation systems and reward corporations with tax write-offs. The federal law authorizing such agreements expired in the late 1980s.
In late July, when ferry officials were quietly preparing for the possibility that the Steel Electrics might be abruptly pulled from service, McGuigan wrote an e-mail to others in the ferry system saying he didn’t “see any possibility” the lease agreements could be transferred to other boats in the fleet.
McGuigan said subsequent legal analysis by tax lawyers hired to advise state attorneys now supports attempting to transfer the leases, and potentially saving the state millions of dollars.
Brown said the state sought expert help from tax attorneys when it made a similar lease transfer in the mid-1990s involving leases on other ferries. He declined to respond in detail to questions about the proposed lease transfers involving the Steel Electrics, citing attorney-client privilege and the litigation involving Martinac.
While there always is some risk in attempting a transaction involving potential tax liability, Brown said the lawyers the state consulted believe there is a reasonable basis to move ahead.
“I think you have to take (Martinac’s lawyer’s) non-tax-attorney analysis for what it is worth and his vested interest in the issue,” Brown said. “The state hired an independent law firm to take a look at the exchange.”
Reporter Scott North: 425-339-3431 or north@heraldnet.com.
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