Reported / Citable
Background
Steven K. Davis, a taxpayer and the owner of a competing construction firm, sued Fresno Unified School District and Harris Construction Co., Inc. over 2012 lease-leaseback agreements for a $36 million middle school. He alleged the agreements evaded competitive bidding statutes and violated the conflict of interest prohibition in Government Code section 1090. Defendants invoked Education Code section 17406, which lets a district use a lease-leaseback without advertising for bids. In Davis I (2015), the court held that exception applies only to a genuine lease with a financing component that gives the district use of the facilities during the lease term. After the Supreme Court's 2023 Davis III decision held the validation statutes did not bar the taxpayer action, the case went to a 2024 bench trial.
The trial court found the leases genuine and found Harris Construction provided a form of financing by paying subcontractors before reimbursement and waiting for final payment. It also found Davis failed to prove Harris Construction was an officer or employee of the district, and entered judgment for defendants. The record showed the project was paid for with proceeds of voter-approved general obligation bonds. In the alternative, the trial court said that if the arrangement were invalid, the 2016 safe harbor in section 17406, subdivision (d), would limit disgorgement to $236,129, the net profit Harris Construction's chief operating officer calculated after allocating overhead.
The Court’s Holding
The court affirmed rejection of the conflict of interest claim. Under Sahlolbei, an outside advisor is an officer or employee under section 1090 only if it has duties to engage in or advise on public contracting on the government's behalf. Stipulated facts showed Harris Construction could not enter into or approve contracts for the district. Davis did not show its preconstruction advice was given for the district rather than for itself as the contractor expected to build the project, and the board's power to reject the leases supported an arm's-length relationship. The court assumed without deciding that Harris Construction helped make the contracts.
The court reversed on competitive bidding. It applied Davis I as law of the case, noting the Supreme Court in Davis III said the split of authority over section 17406 was not before it. It read "financing component" to mean how construction funds were raised, and the project was fully funded by bond proceeds. Payment delays and escrowed retainage were not financing as a matter of law, because they did not change the funding source and gave the district no benefit. The exception therefore did not apply.
Because the leases predate July 1, 2015, subdivision (d) governed the remedy. The court held the trial court has discretion to allow reasonable costs, that "profit" means net profit, and that reasonable cost includes a reasonable share of overhead. It found no abuse of discretion, since the four statutory conditions were met, and found substantial evidence supported the $236,129 figure derived from an Eichleay-style allocation. It rejected the constitutional gift-clause challenge, inferring a public purpose in paying for satisfactory school construction. The court reversed and directed a modified judgment requiring Harris Construction to return $236,129 to the district, with judgment for defendants on remaining claims. Davis recovers half his appeal costs, and the trial court must decide the prevailing party for trial costs and attorney fee issues.
Key Takeaways
- Under Davis I, which remained binding here as law of the case, a bond-funded lease-leaseback with no contractor financing does not qualify for the section 17406 competitive bidding exception.
- Payment delays and escrowed retainage do not amount to financing when bond proceeds fund the construction.
- Giving advice that influences price or scope does not make a contractor an officer or employee under section 1090 unless it advises on public contracting on the public entity's behalf.
- For covered pre-July 2015 instruments, subdivision (d) lets a court allow reasonable costs, including allocated overhead, while requiring return of net profit.
- The court did not resolve the Court of Appeal split over section 17406 and did not decide how subdivision (d) applies to a conflict of interest violation.
Why It Matters
The opinion is published and addresses, as questions of first impression, how subdivision (d) of section 17406 treats net profit versus gross profit and whether reasonable cost includes overhead. Its competitive bidding holding, however, rests on law of the case, so it does not settle the broader disagreement among districts about whether section 17406 requires builder financing.
For section 1090, the decision follows Taber II in treating a contractor expecting to build the project, and giving preconstruction advice in that role, as not an outside advisor acting for the public entity. It leaves open the remedy for a lease-leaseback that also violates conflict laws, since the court did not address that point.