Lease-Leaseback and Davis v. Fresno

In California, Education Code § 17406 allows a school district to lease land to a contractor for a minimum rental of $1 annually for the purposes of building or improving a facility to be used by the school district on that land. After construction is complete, the contractor then leases the facility back to the school district until the lease payments are fully paid, a period that can last for up to 40 years. When payment is completed, ownership of the property reverts back to the school district. This arrangement is meant to serve as a means for school districts to make needed improvements without having to fund the entire cost of construction during the period of construction.  

Unfortunately, this law has been subject to a great deal of abuse over the years. Prior to the law’s amendment in 2017, contractors could be chosen without a competitive bidding process, an unfair situation that presented obvious issues for ensuring the efficient use of public funds. Effective January 1, 2017, AB 2316 required school districts to select lease-leaseback providers on a “best value” basis through a competitive selection process. Its provisions were due to sunset as of the end of June 2022, but they were extended through June 30, 2027, with the passage of AB 486 in October 2021.

Legal Challenges to Lease-Leaseback Projects

Prior to the law’s amendment, a number of legal challenges were filed throughout California, alleging that school districts failed to comply with the statutory requirements in the Education Code, didn’t seek competitive bids, and breached their fiduciary duty, among other grounds for complaint. One such case, Davis v. Fresno Unified School District, filed in 2015, challenged the validity of the lease-leaseback contract between the school district and the contractor because the contract did not include a genuine lease or financing arrangement. The plaintiff argued that because the contract contained only progress payments and was paid off at the conclusion of construction, it should have been subject to competitive bidding requirements.

The Court of Appeal ruled for the plaintiff but did not define what a genuine lease would require. It also held that a lease-leaseback agreement funded by local bond funds is not subject to the validation statutes, which require that a challenge to a lease-leaseback agreement must be brought within 60 days; if the validation statutes do not apply, an interested party has up to 3 years to challenge the validity of a lease-leaseback agreement. Given that these statutes have been used by districts to limit their exposure to litigation, this could pose a significant risk.

Fresno Unified School District and the contractor appealed the case to the state Supreme Court, which granted review but limited it to the question of whether a lease-leaseback agreement that is funded through bond proceeds rather than by or through the builder is considered a contract within the meaning of Government Code § 53511. Issuing its opinion on April 27, 2023, the Court held that the arrangement at issue in the case did not satisfy the requirements; in order to do so, “the contract must be one on which the debt financing of the project directly depends.” They also agreed with the Court of Appeal that the validation statutes did not apply. Their ruling did not decide whether the contractor would have to repay the district the money received for the project; litigation is still ongoing.

Understanding the Law and Potential Risks

For companies involved in public contracting, understanding the current state of the law and the potential impact of ongoing legal challenges is essential for ensuring your business is not exposed to unforeseen risk. Ghassemian Law Group is experienced in helping contractors with lawsuits, defending them against claims to Contractors License Board; as well as preventative measures such as drafting contracts, bid protests, and pre-litigation disputes.  We keep your company  in compliance and help uphold your rights under the law. For the personalized attention of a small firm combined with the expertise and experience of a large firm, reach out to our construction law experts here today.