Fresno Unified School District is enmeshed in litigation over Rutherford B. Gaston Middle School built using a lease-leaseback method of financing. Photo provided by FUSD.

LOS ANGELES — The California Supreme Court declined to review an appeals court's decision on a contested financing method used by Fresno Unified School District.

The appellate court ruling calls into question potentially billions of dollars of lease-leaseback contracts used by districts throughout California, including the country's second largest, Los Angeles Unified School District.

"Fresno Unified remains optimistic today despite the unexpected action of the California Supreme Court," Amy Idsvoog, a Fresno USD spokeswoman said after the high court declined the case Wednesday.

On June 1, the appellate court ruled in favor of contractor Davis Moreno Construction Inc., which alleged in a lawsuit that Fresno USD improperly used a method of financing called lease-leaseback when it built the Rutherford B. Gaston Middle School.

The construction firm argued the lease-leaseback technique circumvented competitive bidding, unfairly cutting the firm out of the process.

The appellate court ruling is now precedent, so the state Supreme Court's decision not to review the case will have a big impact, said Lewis Feldman, a partner in the Los Angeles office of Goodwin Procter.

School districts are not likely to be impacted retroactively on existing contracts, however, Feldman said.

"The biggest effect is greater transparency," he said.

Kevin Carlin, of Carlin Law Group, who represents Davis Moreno, could not be reached for comment.

Lease-leaseback differs from the competitive process that public agencies typically use to bid out big construction projects. In a lease-leaseback the district picks a general contractor based on qualifications other than just the lowest bid, in a process similar to design-build construction.

The intent was to give cash-poor school districts a way to finance higher quality school construction in increments over time, using certificates of participation or bonds backed by voter-approved bond measures to make lease payments to the contractor, who has agreed to lease the land for a nominal fee.

But the appellate court said that was not the case when Fresno Unified signed a $37 million contract with Harris Construction to build Gaston Middle School. Fresno USD had the money to pay for the project up front and paid the project off as soon as it was completed.

"The fact that Fresno paid the school off immediately is unique, but Fresno did not invent the concept," Feldman said.

Feldman said he received panicked calls from a couple of school district clients, who were on the verge of signing contracts involving lease lease-back deals with developers.

His client's contracts, however, had substantive differences in how bidding was handled, Feldman said.

Districts are also not likely to sole source projects using lease-leaseback financing anymore.

"Sole-sourced deals are not going to be rubber stamped," Feldman said. "Folks are going to be looking at competitive bidding. And bid in accordance with prior custom."

Stephen Davis, a principal at Fresno-based Davis Moreno Construction Inc., alleged in the lawsuit that Richard Spencer, owner of Harris Construction, had a conflict of interest when he took the bid on the $37 million project.

Davis further contended in his lawsuit that Spencer was hired by Fresno USD as a consultant on the school-building project before he was actually awarded the construction bid.

The appellate court didn't rule on the conflict of interest question, but said that Davis had grounds to return to the Fresno County Superior Court on that issue.

LAUSD, which has used the lease-leaseback method on 116 projects totaling $3.6 billion of the district's $19.5 billion school construction program, filed an amicus brief July 29 with the Supreme Court in support of Fresno USD.

LAUSD's attorney David Huff, a name partner with Orbach Huff Suarez & Henderson LLP, said in the filing that the appellate court decision left important questions unsettled regarding the procurement of construction services under the state's Education Code.

The 5th District Appellate Court's ruling contradicts a ruling made by the 4th District Appellate Court in Los Alamitos Unified School District v. Howard Contracting, Inc., Huff said in the filing.

In the Fresno USD case, the court ruled that for it to be a valid lease-leaseback transaction, financing must be involved. The Los Alamitos USD ruling said the opposite, Huff said in his brief.

"This uncertainty and conflict must be resolved to ensure that LAUSD (and other school districts) may continue to appropriately procure construction services utilizing Section 17406 [of the Education Code] without exposure to legal challenges based upon the format of the transactions," Huff wrote.

Fresno USD received nine letters of support from districts, contractors and associations representing hundreds of districts all across the state, Idsvoog said.

In denying the petition, Idsvoog said, the Supreme Court made no ruling regarding the Court of Appeals decision.

"The case returns to the trial court level where the merits of the plaintiff's allegations will be litigated and ultimately decided," Idsvoog said. "At this point in time, no ruling has been made at any level determining that Fresno Unified's contract with Harris was illegal or that Fresno Unified may not continue to use the lease-leaseback process in the future."

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