Fasano Proposes Changes to DECD’s Loan Programs Following Another Failed State Investment

Article as it appeared in the Hartford Courant 

There won’t be any more ill-fated state loans structured like the $3.5 million handed by the Department of Economic and Community Development (DECD) to a Suffield company that shut down this past week, leaving more than 100 employees jobless — not if DECD Commissioner David Lehman has his way.

After Windsor Marketing Group (WMG) said in U.S. Bankruptcy Court Tuesday that it’s shutting down and dropping the Chapter 11 reorganization petition it filed in January 2018, Lehman was asked in a telephone interview by Government Watch if he and Gov. Ned Lamont, who appointed him, had ideas about doing things differently than the administration of the last governor, Dannel P. Malloy.
Lehman pointed at one big difference between Lamont’s approach and Malloy’s: “We’re migrating to what I would call ‘earn as you go.’”

“So instead of dollars up front … the burden will be on the companies to create the new jobs first, and then … a portion of that new revenue is rebated or remitted to the company [after] a period of time,” he said.

In other words, if a company in a state-targeted area of the economy creates new jobs, and if it keeps the new people on the payroll long enough, a portion of the state income tax that’s been withheld for those new workers will be rebated to the employer by the Department of Revenue Services.

“I think conceptually that’s something that does work, and it’s what some other states do,” Lehman said, “But importantly, in this example, the burden is on the company to create the jobs, and they’re only benefiting from the incentives after they create the jobs and maintain those jobs.”

“The risk profile [to the state] is very different than if you gave a loan or a grant upfront to a company,” Lehman said. “As you’ve seen with WMG,” he said, there can be problems if the state lends the money upfront, rather than making the company create the jobs and maintain them before getting an “earn-as-you-go” rebate after the fact. The problem, he said, is that the state is “in the capital structure of the company and [is therefore] subject to the business risk of that company.”

Generous to borrowers, risky to taxpayers

The terms of these traditional DECD loans have been generous. One example: WMG got two state loans, $2 million in 2009 and $1.5 million in 2015, and each had “forgiveness” provisions cutting the principal amounts in half if the company met targets for employment levels.

Lehman said he doesn’t foresee any more WMG-style loans to stimulate job creation under Lamont’s DECD, except in the much smaller amounts (sub-$300,000) of the Small Business Express program.

“The forgivable loan or grant is really not something that the Lamont administration is pursuing,” Lehman said.

He said it’s important to “bifurcate” the functions of job-creation incentives and actual investments in companies. The latter should be up to the private sector or a quasi-public state agency such as Connecticut innovations, he said.

“That earn-as-you-go structure that I just mentioned is what, in my opinion, we want to employ going forward as kind of the primary tool when and if [job-creation] incentives are used,” Lehman said.

The DECD will be developing legislation for the General Assembly to consider in 2020 to put the new incentive program into effect, he said. Among variables yet to be determined are: what sectors of Connecticut’s economy a company would need to be in for eligibility; the required number of jobs and pay levels; the percentage of a new employee’s withholding tax that would be rebated to the company; and how long a newly created job would have to be maintained before rebates are paid.

Recovery doubtful on state loans

If the WMG case proves nothing else, it’s this: Once the state lays out millions of taxpayer dollars to a company in an economic development loan, those dollars are at the mercy of the company’s management and market forces.

Now, although the DECD says it will try to recover what it’s owed, its chances aren’t great because WMG’s remaining assets may not even cover the $6 million or so that it owes its single biggest creditor, People’s United Bank. And People’s is first in line legally to recover any funds available, because it holds the strongest liens and collateral. After People’s recovers whatever it can, there will be little or nothing left for the DECD and about 150 “unsecured creditors.”

In WMG’s case, everything went bad because the company’s business was printing full-color, high-definition signs for displays inside big-box stores like Toys R Us and major supermarkets such as Stop & Shop — and things went very badly for some key customers in recent years. Leaving aside Stop & Shop’s losses due to a recent strike, the big-box stores have taken a horrible beating from Amazon and other online retailers. When Toys R Us entered Chapter 11 in 2017 and closed a year later, it became a tidal wave in a storm of ill fortune from which WMG never recovered.

WMG’s owner/CEO Kevin Armata posed proudly for a photo in 2015 with Malloy, the Democratic governor, and others, including Malloy’s DECD commissioner, Catherine Smith, to mark the DECD’s second loan to WMG — the $1.5 million to expand the company’s state-of-the-art headquarters in Suffield. The first loan, of $2 million, came when Republican M. Jodi Rell was governor in 2009.

Whether or not Malloy and his people should have seen the trouble coming in 2015, time has shown the investment was a bad one.
Both loans were made on the DECD’s customary favorable terms — including a low interest rate and a long period before repayment installments began. Theoretically, there were financial penalties for companies that failed to maintain specified numbers of employees, but such penalties have always been fairly lenient and easy to avoid.

The “forgiveness” provisions said $1 million would be cut from the principal of the first loan, and $750,000 from the second, if the company maintained certain employment levels for two-year periods. Companies are allowed to hire their own accounting firms to perform “job audits” verifying their employment levels. WMG needed to maintain an average of 165 employees for 24 consecutive months to get the credit, and its audit firm earlier this year used a two-year period ending in mid-2017 to verify that WMG met the requirement.

At the time of that audit, WMG’s actual workforce had shrunk below 110, but the DECD accepted it anyway based on the two-year-old numbers.

As of Tuesday’s announcement of WMG’s shutdown, the company hadn’t repaid any of the $1.5 million loan from 2015, DECD spokesman Jim Watson said. The company had paid a total of $780,349 in principal on the first loan, along with $284,942 in interest and $20,591 in late fees. That left $1,219,651 in unpaid principal, but DECD’s Watson said the company only owed $219,651 because it had been awarded the $1 million forgiveness credit.

GOP Senate leader responds

WMG’s collapse prompted a letter from state Senate Republican leader Len Fasano to Lehman Wednesday, proposing a new “community bank loan” program, backed by the state, as an economic development mechanism.

Fasano wrote that he’d read in The Courant that “the state is unlikely to recover any of these [loan] funds,” and “[u]nfortunately, this is not the first time DECD has awarded funds to a business that was not a successful investment for the state.”

“I know these questionable loans predate your time serving as commissioner,” Fasano wrote, listing “some of the more egregious loans awarded under the prior administration.” These included $5 million to the failed Back9Network, a Hartford-based cable TV network with 24/7 “golf lifestyle” programming that, although boosted publicly by the Malloy administration, was widely considered unwatchable.

Fasano said a 2018 state auditors’ report on DECD, “again before your time as commissioner,” had raised “questions about the agency’s misreporting of information and inflation of job creation and retention numbers.” He also said “a Hearst Media report from January 2019 … found that more than a third of businesses awarded assistance by DECD did not fulfill the promised job commitments they made to the state, whether in hiring or maintaining their workforce levels.”

“DECD’s track record under the prior administration is littered with problems that have severely damaged public trust,” Fasano wrote. “While our history may not be good, as a new commissioner you now have an opportunity to reshape the policy and procedures to rebuild trust and confidence in Connecticut.”

“Therefore, I would like to request that DECD consider replacing Connecticut’s current state subsidized loan programs with a community bank loan program, backed by the state, to increase success rates for state business investments and provide greater protections for taxpayer-backed funds. I propose the state partner with community banks to offer loans to businesses guaranteed by the state. Our local community banks across Connecticut are far better equipped than the state to conduct needed background checks, understand their local communities, and follow up on the loans they provide to ensure success.”

Fasano proposed that he and Lehman “work together to develop a plan that implements stronger protections for taxpayers, but still accomplishes our shared goal of supporting small business growth whenever possible.”