Another Court of Appeal Affirms that Lease-Leaseback Contracts are Exempt from the Competitive Bidding Processes and Rejects Requirements for a "Genuine Lease" and "Contractor Financing"

05.04.2017

In the most recent case challenging the validity of lease-leaseback agreements, the First District Court of Appeal (San Francisco) agreed with the Fourth District Court of Appeal (Santa Ana) and the Second District Court of Appeal (Los Angeles) rulings that the lease-leaseback procedures are exempt from the competitive bidding requirements and that the plain language of the statute does not require a "genuine lease" and "contractor financing."

On May 2, 2017, in an unpublished opinion, the First District Court of Appeal issued its opinion in California Taxpayers Action Network v. Mt. Diablo Unified School District, et al., affirming the dismissal of six of the seven causes of action on the grounds that the lease-leaseback statutes, Education Code section 17400 et seq., are exempt from the competitive bidding requirements. In this case, California Taxpayers Action Network filed a reverse validation action challenging a $14,000,000 lease-leaseback agreement with Taber Construction for heating, ventilation, and air-conditioning work at eight different school sites. The court reasoned that the plain language of Education Code section 17406, which provided that the lease-leaseback project delivery method could be procured "without advertising for bids" and that the competitive bidding requirements found in Education Code section 17417 were inapplicable because section 17406 begins with the phrase "notwithstanding section 17417." The court’s opinion was further supported by the 1973 California Attorney General opinion that concluded that lease-leaseback arrangements were exempted from the competitive bidding process, and the fact that past legislation attempted to include a competitive bidding requirement in the lease-leaseback statute, which was ultimately vetoed by the Governor. This was consistent with past rulings in the lease-leaseback challenges in Los Alamitos Unified School District v. Howard Contracting, and McGee v. Torrance Unified School District. All three of these cases made it clear that the only requirements under the lease-leaseback statute, Education Code section 17046, was that the District leases property it owns to the contractor, the contractor agrees to construct buildings for the District’s use and leaseback the property and buildings to the District, and that at the end of the lease title to both the property and buildings vests in the District.

Similar to McGee, the First District Court of Appeal specifically rejected the ruling in Davis v. Fresno Unified School District, that the lease-leaseback statute, Education Code section 17406, required a "genuine lease" and "contractor financing." Again relying on the plain and unambiguous language in Section 17406, the court expressly rejected the Davis analysis about whether a lease-leaseback agreement was "genuine" and required "contractor financing" stating that,

We decline to follow Davis, which went far beyond the language in section 17406 in adopting ill-defined additional factors to determine whether the leaseback portion of a lease-leaseback agreement is a "true" lease and imposing a requirement that the contractor provide financing for the project.

The sole remaining cause of action that was sent back to the trial court was the conflict of interest cause of action. As in McGee, the court rejected the contractor’s argument that a taxpayer association lacked standing to bring a conflict of interest cause of action relying on a recent decision that held that only a party to the contract had standing to bring a conflict of interest cause of action. In declining to follow that case, this court reasoned that several other cases, including the California Supreme Court, have allowed third parties to file suit for conflict of interest. The court allowed the conflict of interest cause of action to proceed because the challenger alleged that the contractor performed the functions of an officer or employee of the school district, and was in a position to advise and provide considerable influence on the school district board and staff as to the actions the school district should take on the project. This simply means that the challenger must now prove those allegations in the trial court in order to prevail.

In the wake of the lease-leaseback litigation, the Legislature passed AB2316, which modified the lease-leaseback statute, Education Code section 17406, to require that lease-leaseback agreements awarded after January 1, 2017, select the lease-leaseback contractor through a competitive process providing the best value to the school district, and expressly authorizing preconstruction services by the same lease-leaseback contractor. Many of the issues that were raised in the lease-leaseback challenges have been addressed in AB2316.

For school districts, the lease-leaseback delivery method continues to remain a viable delivery method for the construction of school facilities. However, AB566 with its labor requirements and now AB2316 with its competitive proposals have made significant changes to the lease-leaseback procurement procedures. We urge all parties who are considering utilizing the lease-leaseback delivery method to consult with their legal counsel concerning the requirements of AB2316 and the other continued challenges to this construction delivery method.