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November 27 2019

Michigan Supreme Court Finds Building Permit Fee Revenue Surplus Unlawful

In Mich Ass’n of Home Builders v City of Troy, the Supreme Court found that the City of Troy’s use of inspection fee revenue to pay for past budgetary shortfalls was unreasonable because the fees were not reasonably related to the operation of the Building Department.

After operating its building department at a deficit, the City of Troy entered into a contract with SAFEbuilt of Michigan for SAFEbuilt to perform the majority of the Building Department’s functions, such as inspections and plan reviews. In exchange for performing these tasks, SAFEbuilt would receive 80% of the building inspection fee revenue collected by Troy for Building Department services. The remaining 20% was deposited into the general fund to be used for repaying past building department deficits that had been absorbed by the general fund. If fees totaled more than $1,000,000—which has been the case every year since 2011—for a fiscal year, SAFEbuilt would only receive 75% and Troy would receive 25% of the fees. As a result, Troy has had a surplus from its permit fees every year since 2011.

The objection raised in the City of Troy litigation was that the City was overcharging builders and developers to cover costs not associated with the operation of the Building Department. The Court of Appeals upheld the City’s practice, but the Supreme Court disagreed, stating that “the City established fees that were not intended to ‘bear a reasonable relation’ to the costs of acts and services necessary to justify the City’s retention of 25% of all the fees collected.” The 25% retention rule led the Court to conclude that the City was attempting to profit off its fees to generate revenue for other purposes, instead of charging the amount necessary to cover the cost of building code enforcement services.

Municipalities can take several lessons from the City of Troy case. First, a “revenue sharing” formula with a private firm will be suspect, unless the municipality can prove its share is used exclusively for building code enforcement purposes. Revenues from building permits and related fees may be used only for purposes of building code enforcement, and surplus revenue should not be transferred to other funds or sources. If a surplus is increasing, the community should consider reducing its fees. In addition, although a direct transfer to the general fund is not permissible, a community could, using verifiable accounting practices, charge a portion of overhead, administrative costs, building code enforcement, and similar costs against building code revenues.

The case does not present a concern for the practice of charging “escrow” fees for zoning review, or similar fees which are based upon actual costs. These escrow fees typically reimburse the community for its actual costs of engineering, legal, and similar professional review. By design, these escrow fees do not result in significant surplus revenues, if any at all.