Lease-Leaseback Fight Continues

It’s like the rematch between Rocky Balboa and Apollo Creed.

In the right corner we have the California Taxpayers Action Network. In the left corner, Taber Construction, Inc. The title in contention: Construction of California’s Lease-Leaseback Program and, specifically, whether a construction firm can provide both pre-construction services as well as perform construction or, whether doing so, would be an impermissible conflict of interest under the Lease-Leaseback Law.

In their first appellate court match, California Taxpayers Action Network argued that a lease-leaseback arrangement between Taber Construction and the Mount Diablo Unified School District, whereby the District agreed to lease the site to Taber Construction one dollar (which is permissible) and to pay Taber a “guaranteed project cost” of $14,743,395 comprised of “tenant improvement payments” totaling $13,269,057 prior to the District taking delivery of the project (which was the issue in dispute) and six “lease payment amount[s]” of $345,723 plus interest paid in 30-day intervals, violated the Lease-Leaseback Law because the bulk of the payments by the District to Taber Construction occurred during construction rather than during the lease-term which could only “truly” occur after the District took delivery of the project. The 1st District Court of Appeal sided with Taber Construction, and in doing so created an appellate court split with the 5th District Court of Appeal’s decision in Davis v. Fresno Unified School District, 237 Cal.App.4th 261 (2015), which held that contractor who received all payments prior to turnover of the project to the district violated the Lease-Leaseback Law.

In the rematch between California Taxpayers Action Network  and Taber Construction, California Taxpayers Action Network v. Taber Construction, Inc., Case No. A155803 (November 27, 2019), California Taxpayers Action Network claimed that Taber Construction, by performing both pre-construction services as well as performing construction, had a conflict of interest in performing both roles.

Factual Background

In 2013, the Mount Diablo School District issued two RFPs s for the modernization of HVAC systems at five elementary schools and three middle schools. The two RFPs differed only in the schools covered by the RFPs.

The RFPs stated that the District intended to a select a firm or firms to complete the modernization project but that the process would involve two contracts entered into at different times. The first contract would be a reconstruction services agreement (PSA) in which the successful bidder would “provide reconstruction services that will lead to the Firm providing to the District a Guaranteed Maximum Price (GMP) for the project” and would include “reviewing existing documents and site conditions, scheduling, estimating, constructibility review, subcontractor bidding, and development of the GMP.” The second contract would be a lease-leaseback agreement “with the successful Firm.”

Taber Construction submitted a bid in response to both RFPs and was awarded the projects. In the PSAs signed by Taber Construction and the District, the recitals stated “WHEREAS, District and Developer intend to enter into a lease-leaseback arrangement for the development of the Project . . . after Developer’s performance of its duties as set forth in the Agreement and pending both the approval of the Plans and Specifications by the California Division of State Architect (‘DSA’) and approval by the District and Developer of the Lease Agreements.” The District and Taber Construction later entered into a lease-leaseback agreement for the project.

California Taxpayers Action Network’s Complaint

In its complaint, California Taxpayers Action Network contended that the lease-leaseback agreement entered into between Taber Construction and the District was illegal because Taber “was legally precluded from being awarded those contracts due to conflicts of interest that arose from [Taber’s] prior contract(s) with the [School District] related thereto.”

The “prior contract(s)” referred to by California Taxpayer Action Network were the PSAs. And, according to California Taxpayer Action Network, “[I]n performing its duties under the [PSAs] . . . [Taber] performed the functions and filled the roles and positions of officers, employees and agents of [the School District] under the [PSA] relative to the Projects,” and as a result of filling this role, “conflicts of interest arose between [Taber] and [the School District] under the common law conflict of interest doctrine applicable to [the District’s] contracts, Government Code, Section 1090 et seq., and/or other applicable conflict of interest laws when [Taber] was subsequently awarded the Lease-Leaseback Contracts . . .”

Taber Construction’s Motion for Summary Judgment

During the litigation, Taber filed a motion for summary judgment contending, among other things, that there was no conflict of interest because the PSAs and lease-leaseback agreements were essentially formed as one transaction. Specifically, Taber argued that PSAs and lease-leaseback agreements were contemplated as “one fluid transaction in which one contractor would carry out the entirety of the work, but in different phase,” and as such, that “Taber had no ability to influence the award of the Lease-Leaseback Contract to itself, as it was already selected.” Taber Construction also noted that Lease-Leaseback Law was amended in 2017 to “avoid this catch-22” by allowing lease-leaseback contracts to include reconstruction services.

In opposition, California Taxpayer Action Network countered Taber Construction’s “one fluid transaction” argument by contending that the District was not required to enter into the lease-leaseback agreements with Taber Construction until the District’s Board approved the lease-leaseback agreements, which it did on March 26, 2014.

The trial court ruled in favor of Taber Construction explaining that, while it was true that the District retained an ‘out’ from entering into the lease-leaseback agreements, it was “really no different from a unitary contract containing various ‘outs’ for the District if the need should arise, or simply making the contract terminable at the District’s convenience. And more germanely . . . none of that was an open topic for decision on which Taber could have improperly influenced the District through its PSA consulting work . . .”

The Appellate Court Decision

On appeal, California Taxpayers Action Network argued that the trial court had misunderstood the basis of its conflict of interest claim and that its claim was premised on Taber Construction, as the preconstruction contractor, “participating in the making of” the subsequent lease-leaseback agreements, which it was prohibited from being awarded “under Government Code § 1090 and California’s common law conflict of interest prohibitions.” In short, by providing preconstruction services under the PSAs, Taber Construction was precluded from entering into the lease-leaseback agreements because to do so would be a conflict of interest.

The Court of Appeal disagreed. As Government Code section 1090, the Court explained that Section 1090 only prohibits a contract made by a financially-interested party when that party makes the contract in an “official capacity,” and that where the financially-interested party is an independent contractor, Section 1090 only applies if the independent contractor “can be said to have been entrusted with ‘transact[ing] on behalf of the Government.'” Here, however, explained the Court, “[t]he School District did not contact with Taber in the PSAs for Taber to select a firm to complete the HVAC project. Rather, the School District contracted with Taber for Taber to provide reconstruction services in anticipation of Taber itself completing the HVAC project.”

Conclusion

So there you have it. Not quite Rocky v. Apollo in terms of endings. But we do continue to have a split decision between the 1st and 5th District Courts of Appeal.