Contractors who have entered into lease leaseback arrangements with local school districts need to review their agreements in light of the California Fifth District Court of Appeals recent ruling in Davis v. Fresno Unified School District which was decided on June 1, 2015.

Under the lease-leaseback arrangement that was the subject of this case, Fresno Unified School District leased the project site to Contractor for $1 in rent. The Site Lease began on September 27, 2012, and terminated the same day as the Facilities Lease. The Facilities Lease was structured so that Contractor would (1) build the project on the site pursuant to the "Construction Provisions" attached as an exhibit to the Facilities Lease and (2) sublease the site and project to Fresno Unified in exchange for payments under a "Schedule of Lease Payments." The Construction Provisions were a detailed construction agreement (55 pages long) whereby Contractor agreed to build the project in accordance with the plans and specifications approved by Fresno Unified for a guaranteed maximum price of $36,702,876. The project was scheduled to be completed in 595 days. The Construction Provisions also outlined the monthly progress payments for construction services rendered each month, up to 95 percent of the total value for the work performed, with a 5 percent retention pending acceptance of the project and recordation of a notice of completion. Final payment for all of the work was to be made within 35 days after recordation by Fresno Unified of the notice of completion. Once the project was completed and the final lease payment made, the Facilities Lease terminated.

Plaintiff Taxpayer Davis, challenged the lease-leaseback agreement, alleging that the agreement should have been competitively bid because it did not comply with Education Code § 17406. Plaintiff alleged and the Court agreed that 1) the agreement was more akin to a traditional construction contract than a lease, 2) that the agreement did not satisfy the required lease financing requirements of §17406, and 3) the arrangement did not provide for Fresno Unified's use of the new facilities during the lease term.

In substance, the Court ruled that for a valid lease-leaseback agreement under §17406 there must be a genuine lease and financing arrangement. The mere labeling of a construction agreement as a lease is not sufficient and therefore the exception to competitive bidding for true lease-leaseback agreement would not apply.

While this case is not final, may be reviewed by the California Supreme Court, and the Court only decided that the Plaintiff's allegations were legally sufficient for trial on the issues, Contractors should take heed of the Courts opinion when entering into this type of agreement. Will the contractor be acting as a true landlord and the school district as a true tenant while payments are being made? Is the lease a true lease or merely a construction agreement named as a lease? The consequences of the lease-leaseback agreement being invalidated are significant, the Plaintiff in Davis case is seeking the return of the entire $37 million contract amount.

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