Supreme Court Says ‘Lease-Leaseback’ Deal Between Fresno Unified and Harris Construction Was Illegal

A Fresno-based construction firm may need to return $36.7 million, which it received from Fresno Unified for the construction of Gaston Middle School. This is a major legal development in an 11-year-old case over the use of “lease-leaseback” agreements to avoid competitive bidding.

In 2011, FUSD sold over $100 million in voter-approved bonds to finance school upgrades. A year later, the district awarded a $36.7 million contract for a new middle school to Harris Construction Co. The company had contributed to the district’s bond campaign. The company’s president also had a close relationship with former superintendent Michael Hanson, who was later fired from the district.

The deal was structured as a lease-leaseback, whereby the district leased the site to Harris and then took the property back after the new school was built. A competitor of Harris named Stephen Davis sued the district alleging that the lease-leaseback deal was an attempt to subvert competitive bidding.

Last week, the California Supreme Court sided with a lower court in determining that the lease-leaseback agreement used to build Gaston was illegal because FUSD used voter-approved bonds to finance the project. 

In its unanimous decision (see here), the court wrote the following:

We granted review to address a single question: “Is a lease- leaseback arrangement in which construction is financed through bond proceeds rather than by or through the builder a ‘contract’ within the meaning of Government Code section 53511?” We conclude that the specific lease-leaseback arrangement at issue here is not a “contract[]” within the meaning of Government Code section 53511 (section 53511). A local agency contract is subject to validation under section 53511 if it is inextricably bound up with government indebtedness or with debt financing guaranteed by the agency. To satisfy this standard, the contract must be one on which the debt financing of the project directly depends. The lease-leaseback arrangement at issue here does not satisfy this standard because the underlying project was fully funded by a prior sale of general obligation bonds, and payment of the debt service on the bonds was from ad valorem property taxes. Therefore, payment did not depend on the lease-leaseback arrangement or even on completion of the project. In light of this conclusion, we affirm the judgment of the Court of Appeal.

The case will be sent back down to the lower courts for judgment, and it’s possible that Harris will have to return the bond funds to Fresno Unified. 

Read more about the ruling and its implications at CalMatters.