Court of Appeal Affirms That Lease Leaseback Agreements are Exempt from Competitive Bidding Processe

05.05.2016

The Second District Court of Appeal recently held that the plain language of Education Code section 17406 does not require a competitive bidding process for lease leaseback agreements and specifically rejected the requirements of a "genuine lease" and "contractor financing" were also required under section 17406.

Three separate lease leaseback challenges have been filed by a local resident and a taxpayer association seeking to invalidate certain projects that were constructed using the lease leaseback procedures in Education Code section 17406 by the Torrance Unified School District. On January 23, 2015, in McGee v. Torrance Unified School District ("McGee 1"), the Court of Appeal, in an unpublished opinion, held that lease leaseback agreements under Education Code section 17406 were exempt from competitive bidding requirements and affirmed the dismissal of six causes of action seeking to invalidate the lease leaseback agreement on the grounds that it failed to comply with the requirements of Education Code section 17406 under various theories. In affirming the dismissal of the six causes of action, the Court followed the holding in Los Alamitos Unified School District v. Howard Contracting, 229 Cal.App.4th 1222 (2014), that lease leaseback agreements were indeed exempt from competitive bidding requirements and that section 17406 only required that the school district own the land, that the contractor agree to build the buildings on the land, and that at the end of the lease term title to the buildings and land vest in the school district.

On May 4, 2016, the Second District Court of Appeal certified its opinion for publication in McGee, et al. v. Torrance Unified School District, et al. ("McGee 2"), which again followed the holding in Los Alamitos Unified School District v. Howard Contracting and specifically rejected the holding in Davis v. Fresno Unified School District, 237 Cal.App.4th 261 (2015) that the lease must be "genuine," which it defined as a lease not to avoid the competitive bidding process by subterfuge or sham, and that includes contractor financing. Unfortunately, in Davis, the Court did not further define what constitutes a "genuine lease" or "contractor financing" and left school districts with many unanswered questions as to what the Court believed would be required for a lease leaseback agreement. In specifically rejecting Davis today, the Court stated that the plain language of Education Code section 17406 does not support the Davis requirements of a "genuine lease" or "contractor financing". Instead, the Court held that the plain language of section 17406 only required that the school district own the land, that the contractor agree to build buildings on the land, and that at the end of the lease term title to the buildings and land vest in the school district, which is precisely what the Los Alamitos Court held. Additionally, the Court held that the legislative history of section 17406 buttressed the Los Alamitos interpretation that a competitive bidding process was not required. The Legislature twice included a competitive bidding process before in bills and each time the bill was vetoed by the governor who stated that he was in favor of competitive processes for public works projects, but that the bills could impose restrictions on lease leaseback agreements that could limit competition and increase administrative costs. The Court further opined that the Legislature amended section 17406 in 2014, and chose not to include a competitive bidding requirement. All of this coupled with the unambiguous terms in section 17406, "without advertising for bids" and "notwithstanding section 17417" further supported the Court’s finding that lease leaseback agreements are exempt from competitive bidding processes.

The sole remaining cause of action in the McGee 1 and McGee 2 cases are actions for conflict of interest under Government Code section 1090. In both McGee 1 and McGee 2, the Court held that because the cases were still in the very early stages of the litigation, and McGee had alleged that the contractor was acting as a "District officer or employee" when it provided the District with program management, construction management, and/or preconstruction services prior to the award of the lease leaseback agreement, this was sufficient to state a cause of action. This does not equate to finding that a conflict of interest exists, or that the lease leaseback agreements are illegal in any way. This simply means that the plaintiff must now prove that a conflict of interest exists as it has alleged in the complaints.

The ruling is significant because the Court has now ruled that the District has met the requirements of Education Code section 17406 and those requirements do not require a "genuine lease" or "contractor financing" as defined by the Davis decision. Notwithstanding the above, it is important to note that AB2316 was amended on April 26, 2016, to include a competitive process in lease leaseback agreements under Education Code section 17406, which would require school districts to use a best value procurement to select its lease leaseback contractor.