New Appellate Court Decision Exempts Lease-Leasebacks from Competitive Bidding Process

May 2016

In another decision addressing whether school districts must obtain competitive bids when entering into lease-leaseback agreements to improve school property, the California Court of Appeal, Second Appellate District, rejected a claim that lease-leaseback agreements between Torrance Unified School District (“District”) and a construction company were void as a sham to bypass the competitive bid process.  (McGee v. Balfour Beatty Construction, LLC, et al. (4/12/16, No. B262850).)

In this case, the contracts for the construction of two schools in the District were awarded to Balfour Beatty Construction LLC (“Balfour”) and were funded through a general obligation bond.  Balfour was required to pay $1 per year for the lease of the site.  The sublease provided that Balfour would lease the property to the District and the sublease payments would be determined by the cost of the construction not to exceed the guaranteed maximum price.  The arrangement was challenged in Los Angeles County Superior Court.

Affirming the Superior Court’s judgment in the District’s favor, the Court of Appeal stated that “the plain language of [Education Code section 17406] does not require use of the competitive bid process, and, although the legislature has amended the statute, it has not amended it to require competitive bidding in lease-leaseback agreements.”  In reaching its decision that the parties complied with the requirements of section 17406, the court followed  the Fourth Appellate District’s decision Los Alamitos Unified School Dist. v. Howard Contracting, Inc. (2014) and rejected the more recent decision by the Fifth Appellate District in Davis v. Fresno Unified School Dist. (2015). (For the F3 NewsFlash summary of the Los Alamitos decision and an overview of the lease-leaseback construction delivery method, click here.  For the F3 NewsFlash summary of the Davis decision, click here.)

The court observed that the decisions in Los Alamitos and Davis disagreed regarding whether section 17406 applies only to “genuine” leases, defined by Davis as “something more than a document designated by the parties as a lease.”  The Davis decision also held that the leases in any lease-leaseback arrangement must include a financing component and must provide for a district’s use of the facility during the term of the lease.

Disputing the added obligations imposed by Davis, the court examined the requirements of section 17406 and agreed with the holding in Los Alamitos, which found that the following evidence was sufficient to uphold a lease-leaseback agreement:

·    The school district owns the land to be leased;
·    The contractor  agreed to construct the project for a guaranteed maximum price; and
·    Title to the site and all improvements made by the project will vest in the District at the end of the lease term. 

According to the court, “plaintiffs’ efforts to engraft additional requirements—such as the timing of the lease payments, the duration of the lease, and the financing—are not based on the plain language of the statute.”

The court also noted that the California Legislature, in 2004, sought to amend section 17406 to require that districts solicit competitive bids for lease-leaseback arrangements.  However, the proposed legislation was vetoed by the Governor, who stated that the bill “imposes restrictions on lease-leaseback contracts that could limit competition, inadvertently limit schools’ flexibility, and drive higher administrative costs; thereby potentially increasing the overall cost of school facility construction.” 

In addition to alleging the District was required to obtain competitive bids, plaintiffs asserted a conflict of interest in violation of Government Code section 1090.  The court rejected the District’s arguments that the plaintiffs lacked standing to raise the issue and that section 1090 always excludes all independent contractors.  It concluded that, at least in the early stage of the proceedings, plaintiffs have alleged a cause of action for conflict of interest.

Although this decision might bolster the argument for the continued use of lease-leasebacks by school districts, it is important to note that a split remains within the Court of Appeal over the requirements of such agreements.  Also, there is a possibility that the legislature will revise or clarify section 17406 in future sessions. In the interim, however, districts are strongly encouraged to consult their legal counsel to determine the feasibility of any proposed lease-leaseback structure, including all component parts of the contract(s).

If you have any questions regarding this matter, please call one of our six offices.

F3 NewsFlash™ prepared by Paul G. Thompson, Kimberly A. Smith and John W. Norlin.
Paul is a Partner in the F3 Sacramento office.
Kimberly is a Partner in the F3 Los Angeles office.
John is Special Counsel in the F3 San Diego office.

This F3 NewsFlash™ is a summary only and not legal advice.  We recommend that you consult with legal counsel to determine how this legal development may apply to your specific facts and circumstances.  Information on a free NewsFlash subscription can be found at www.f3law.com.

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