The California Supreme Court Sides With a Challenger of Lease-Leaseback Agreements

California law generally requires competitive bidding to award public construction contracts, including for new public schools. And California law permits “any interested person” to bring an action challenging the validity of various public contracts.[1]

For some time now, school districts in California have been nonetheless able to sidestep the competitive bidding process using lease-leaseback agreements. In a lease-leaseback agreement, a school district leases real property to a developer, the developer builds the school buildings, and the developer returns the property back to the school district after the construction is complete.

The practice was explicitly authorized by a prior version of California Education Code Section 17406:

The governing board of a school district, without advertising for bids, may let, for a minimum rental of one dollar ($1) a year, to any person, firm, or corporation any real property that belongs to the district if the instrument by which such property is let requires the lessee therein to construct on the demised premises, or provide for the construction thereon of, a building or buildings for the use of the school district during the term thereof, and provides that title to that building shall vest in the school district at the expiration of that term. . . . (Emphasis added.)

California Education Code Section 17406 was amended, and now provides that a lease-leaseback agreement “shall be awarded based on a competitive solicitation process to the proposer providing the best value to the school district.” See California Education Code Section 17406 (2021).

And, in 2023, the California Supreme Court issued another setback to the lease-leaseback agreement strategy. In Davis v. Fresno, the California Supreme Court took up the question of whether Government Code section 53511 (which allows validation actions for public debts and bonds) also allowed lease-leaseback arrangements to be validated on the grounds that they were “contracts” funded “through bond proceeds.” The California Supreme Court held that a lease-leaseback arrangement was not a “contract” that could be validated under Government Code section 53511. Since the lease-leaseback arrangement could not be validated under Government Code section 53511, the plaintiff’s challenge to the lease-leaseback arrangement was not barred.

In closing, the Court wrote that whether people are best served by “quick validation of construction deals,” or “are best served by a method of school construction that favors price competition among contractors and avoids favoritism, is a policy question best left to the Legislature.” Looking ahead, more challenges to lease-leaseback arrangements may be forthcoming.