Key Points

  • Fresno Unified's 2012 lease-leaseback agreements with Harris Construction for phase 2 of the Rutherford B. Gaston Sr. Middle School did not qualify for Education Code section 17406's exception to competitive bidding because bond proceeds, not the contractor, financed the project.
  • Delays in paying the contractor and retainage held in escrow do not constitute a contractor-financing component under the court's 2015 Davis I interpretation, which binds the case as law of the case.
  • Harris was not an 'officer' or 'employee' of the district under Government Code section 1090 because it advised on the project at arm's length as the intended builder, not on the district's behalf.
  • Under section 17406, subdivision (d), 'profit' means net profit and 'reasonable cost' includes allocated overhead, so Harris must return $236,129 to the district.
  • The 2016 safe harbor allowing payment of a contractor's reasonable costs serves a public purpose and is not an unconstitutional gift of public funds, on its face or as applied.

A California appeals court ruled on Oct. 22 that Fresno Unified School District broke the state's competitive bidding laws when it hired Harris Construction Co. to build a $36 million middle school without seeking bids. The court ordered the builder to return only its $236,129 net profit, not the full contract price a rival contractor had sought.

A three-justice panel of the Fifth Appellate District unanimously reversed a trial judgment for the district and Harris. Franson, writing for the court, held that the 2012 lease-leaseback deal fell outside a statutory exemption from bidding because voter-approved bonds, not the builder, financed the school.

The court said its reading of "profit" and "reasonable cost" in a 2016 safe harbor law, which covers lease-leaseback contracts signed before July 1, 2015, resolved "issues of first impression." Under the ruling, a court may let a builder whose pre-2015 deal is invalidated keep its direct costs and a share of its home-office overhead, refunding only its net profit.

The plaintiff, Steven K. Davis, is president and majority shareholder of Davis Moreno Construction Inc., a Fresno contractor that sometimes competes with Harris. He sued as a taxpayer in November 2012 after his firm's subcontract bid for concrete work on the project was not accepted, and he sought return of the roughly $36 million Harris was paid. The trial court called that demand "evidence of Davis's true motivation, to eliminate his competitor."

Under Education Code section 17406, a school district may lease its land to a builder for $1, the builder constructs a school and leases it back to the district, and title passes to the district when the leases end. The California Supreme Court has described the device as a way for districts to shift construction financing to builders and avoid debt that requires voter approval. Until 2016, the statute also let districts proceed "without advertising for bids."

The project was Rutherford B. Gaston Sr. Middle School in southwest Fresno, where middle school students had been bused to other neighborhoods since 1978. The district's board approved the second construction phase in September 2012 at a guaranteed maximum price of $36,702,876, drawn from two bond measures, and the district paid Harris $36,051,375. Classes began there in August 2014.

In a 2015 ruling in the same case, the Fifth District read section 17406 to require a genuine lease, a financing component, and district use of the building during the lease term. Courts in three other appellate districts have adopted a conflicting reading, and the state Supreme Court said in 2023 that "that split of authority is not before us." Franson wrote that the 2015 reading binds the panel as law of the case.

After a 2024 bench trial, Fresno County Superior Court Judge Jeffrey Y. Hamilton Jr. found that Harris had provided a form of financing by paying subcontractors before the district paid Harris and by waiting until March 2016 for its final payment. Because bonds sold before the deal funded the school, Franson wrote, "we conclude as a matter of law that the delays in payment did not constitute 'financing.'" Retainage the district deposited in escrow, with the interest going to Harris, "did not provide any economic benefit to Fresno Unified," the court added. Davis therefore proved a violation of the bidding laws, the panel held.

Davis lost his conflict-of-interest claim. He argued that Harris's preconstruction advice on design, cost and scheduling made the company a district "officer" or "employee" under Government Code section 1090, which bars officials from holding a financial interest in contracts they make in their official capacity. Franson wrote that "giving advice and having influence is not enough," and the panel upheld findings that Harris dealt with the district at arm's length as the intended builder.

Before 2016, a contractor under a void public contract generally could not be paid at all. In 2016, the Legislature responded to the 2015 ruling and conflicting decisions elsewhere with Assembly Bill 2316, which required a competitive process for new lease-leaseback contracts. For older deals, a court may allow the builder "the reasonable cost, specifically excluding profit" of its work if the builder acted in good faith, the district reasonably found the work satisfactory, the builder committed no fraud and the deal broke no other public-works law. The trial court found that Harris met those conditions.

Davis argued that "profit" meant gross profit. The panel held that the word means net profit. Ryan Diel, Harris's chief operating officer, testified that gross profit on the second phase was $1,498,958, and he allocated $1,262,829 of company overhead to the project using a variation of the Eichleay formula, a method federal courts accept for home-office overhead in government delay claims. Franson wrote that "contractors could not furnish the 'services' needed to complete a construction project without a home office supporting the personnel assigned to that project."

The panel also rejected Davis's argument that the safe harbor violates the California Constitution's ban on gifts of public money, a theory that would have required Harris to return the full $36 million. Educating children provides a public benefit, Franson wrote, and "the construction of buildings for use by school districts serves a public purpose."

Because Davis won only part of the appeal, the court awarded him half his appellate costs. The panel left the trial court to decide who prevailed below.

Davis was represented by Kevin R. Carlin of Carlin Law Group. Raymond A. Cardozo of Reed Smith represented Harris Construction.

The panel sent the case back to Fresno County Superior Court with directions to enter, within 10 days after the appeals court formally returns the case, a modified judgment ordering Harris to return $236,129 to the district and ruling for the defendants on Davis's other claims. The trial court will then decide the prevailing party, costs and any attorney fees.