Since Fresno Unified School District found itself under fire for a “lease-leaseback” contract, superintendents and developers across the state have been quick to point out that the no-bid alternative is a legal way to build and renovate schools.
And they’re right. Leaseback deals are legal.
So how did California’s fourth-largest school district wind up under a federal grand jury investigation that targets those deals?
Fresno Unified officials maintain that they used the special financing method – in which a district is permitted, by law, to skip the competitive bidding process – the same way as many other districts across the state.
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But critics say what Fresno Unified did was a blatant misuse of an exception to the law that was intended to help poor school districts, and is more black and white than others’ use of the loophole.
Garret Murai, an Oakland-based attorney specializing in construction law, says while districts have been teetering on the legal use of the leaseback exception, Fresno Unified’s case is too obvious.
“Right now, I think a lot of districts and contractors are in that morally gray area where they don’t know what’s OK and what’s not,” Murai said. “But the Fresno case was actually a lot more clear cut. They just did not enter into a true lease-leaseback with a developer, which, when I read it, I thought, that’s a clear no-no.”
The subpoena, served to the district in August by the U.S. Attorney’s Office, doesn’t name individuals. But Superintendent Michael Hanson, Chief Financial Officer Ruthie Quinto and Chief Operations Officer Karin Temple have been scrutinized, since they’re the people who directly oversee all contracts.
Last week, an unplanned school board meeting was held in closed session to discuss hiring a criminal defense attorney to represent the three officials pending the outcome of the investigation, but no action was taken.
The board already has hired Carl Faller, formerly of the U.S. Attorney’s Office in Fresno, to help the district comply with the subpoena’s wide range of demands – which probes any financial dealings between officials and select developers, and requires Fresno Unified to turn over personal emails and phone records.
The Fresno Teachers Association asked the three to step down last week, citing concerns about allegations that documents possibly tied to the investigation are being destroyed. But Hanson said the allegations were false, and stands by his claims that what started all of this was simply routine business.
Lease-leaseback is not subject to competitive bidding laws, and some, perhaps, have taken advantage of that fact. Schools can unilaterally decide who they want to enter into an agreement with, and thereby allow influential contractors to corner the market.
Garret Murrai, construction law attorney
The state Legislature created the leaseback method in 1957 to allow cash-strapped districts to build schools even if they don’t have the money to pay for them upfront. Under leaseback, districts are allowed to circumvent the traditional bidding process and hand-pick a contractor who will agree to build, then accept payments over time. School districts can pay back contractors for a project for up to 40 years.
For Fresno Unified, it all started with Measure Q – a $280 million school bond passed in 2010. Up until then, the district always had taken the traditional route of publicly advertising projects and awarding them to builders who made the lowest offers.
“We knew we were looking for a project-delivery method that would allow us to move quickly to implement multiple, major projects simultaneously in anticipation of Measure Q’s passage,” Temple said. “We talked to many districts throughout the state, and they all had positive experiences. We really did our research.”
Hanson and Quinto declined to be interviewed for this story.
Since 2011, Fresno Unified has spent millions in public bond money on more than 20 leaseback agreements, including the one at the center of a legal fight that could change the way districts in California finance school projects.
The 5th District Court of Appeal ruled in June that Fresno Unified’s contract with Harris Construction to build a $37 million middle school was not a genuine leaseback agreement, even though it was labeled as such.
The court said that plaintiff Stephen Davis, a Fresno contractor, adequately alleged that because Fresno Unified’s leaseback wasn’t used the way that the law intended, it should have been competitively bid out like normal contracts. The district had money available to pay for the project – and it didn’t actually pay it back to the contractor over a long period of time.
Many school districts are now closely watching the Fresno Unified case, which is headed back to Fresno County Superior Court, and are looking to it as a guide for the do’s and don’ts of the now controversial financing option.
A sweetheart deal
Critics allege that Hanson must have abused the leaseback process to make a sweetheart deal with Richard Spencer – owner of Harris Construction. A majority of Fresno Unified’s leaseback projects have been done with Harris.
Fresnans for Responsibility and Ethics in Education – a political action committee created in the wake of the controversy – says that the leaseback issue is just the latest in a pattern of back-door deals headed by Hanson over his decade at Fresno Unified.
Measure Q has increasingly become a part of the leaseback conversation because Spencer helped pass it. He was the bond campaign’s largest donor, contributing $30,000, and for the 2012 school board election, he, his family and company employees pitched in nearly $10,000 to the campaigns of select trustees.
Both Measure Q and Harris are named in the subpoena. The investigation zeros in on the district’s relationship with Harris and Bush construction firms. Neither firm has responded to The Bee’s multiple requests for comment.
After the state Supreme Court refused to take up the 5th District opinion despite Fresno Unified’s call for review, school leaders across the state have backed away from leaseback – including L.A. Unified, which has spent billions on leaseback agreements in recent years.
Critics say that leaseback is easily manipulated: It’s a way for districts to guarantee that expensive projects land in the lap of the contractor of their choice, and perpetuates a “pay-to-play” atmosphere.
Proponents say it’s often cheaper, more efficient and hassle-free compared to traditional bidding.
Both groups say it’s complicated.
Frankly, we think we get more value for the taxpayer dollar. But it’s not an easy concept to understand.
Karin Temple, Fresno Unified chief operations officer
‘More value for the taxpayer dollar’
Temple said in Fresno Unified’s case, using the leaseback method has been incredibly beneficial: it promises a guaranteed maximum price and allows districts to hire local workers and pick who they think are the best quality builders.
But questions have been raised about that guaranteed capped price since the district posted copies of its leaseback contracts to its website in July.
A project to renovate Bullard High School, for example, asked contractors to adhere to a budget of $26 million in the pre-construction contract, but the final contract amount ended up being more than $35 million. The Hoover High School pool project, unveiled this school year, had a proposed budget of $4 million, according to the pre-construction contract, but finished with a total of $5.5 million.
The pre-construction contracts say that contractors are required to ensure that the project can be completed within that preliminary budget. But Temple said that those numbers are not the project budget or the guaranteed maximum price.
“They were preliminary estimates based on initial project concepts,” she said, and the district knew there could be additional project components and costs down the road.
The guaranteed maximum price comes later, and is based on competitively bid subcontractor costs, the primary contractor’s general conditions and a district-controlled contingency allocation for “unforeseen work and changes in scope,” Temple said.
While leaseback deals are not subject to the mandatory competitive bid process, there are elements of the hard-bid process inside of the leaseback process, Temple said. Contractors for leaseback projects are selected from a pre-qualified list approved by the school board, and all subcontractor jobs for a project are publicly advertised.
“Frankly, we think we get more value for the taxpayer dollar. But it’s not an easy concept to understand,” Temple said. “We have been doing lease-leaseback in the same manner as other districts and have been using very similar, if not identical, contract documents.”
This is a pretty stinky thing that happened, and it involves friends of the establishment
Michael Turnipseed, CALBOC president
Statewide, there are similar leaseback court cases pending involving Torrance Unified School District in Los Angeles County and Mount Diablo Unified School District in Contra Costa County. Sanger Unified has continued using the method in the face of scrutiny, saying it’s too good to pass up.
But some say that Fresno Unified officials knew what they were – or weren’t – doing.
“What was supposed to happen was Fresno Unified was supposed to pay rent for a number of years to pay it back. That’s where they blew up the lease-leaseback,” said Michael Turnipseed, president of the California League of Bond Oversight Committees. “You cannot have a lease-leaseback with the benefits of a lease-leaseback without leasing it back.”
His organization is a nonprofit that works to hold school districts accountable for the use of public bond dollars. Turnipseed said that Fresno Unified isn’t alone, but that doesn’t make it right.
“This is a pretty stinky thing that happened, and it involves friends of the establishment,” he contended. “It’s like a big frat: architects, contractors, schools. They have a working relationship. It’s a big money deal, you just have to look up the donations. And Harris isn’t the only contractor in on this. We’re dealing with a statewide issue here.”
Murai – who helps run a blog about California construction law for his firm, Wendel, Rosen, Black & Dean – said that lawmakers’ intentions for the leaseback process were good, but it’s since been used in many different ways.
“Lease-leaseback is not subject to competitive bidding laws, and some, perhaps, have taken advantage of that fact. Schools can unilaterally decide who they want to enter into an agreement with, and thereby allow influential contractors to corner the market,” he said.
“What makes this Fresno case unique is that it’s more black and white than your typical lease-leaseback scenario. Not only do they not have a true lease-leaseback, but also there’s this overarching issue of, was this kosher to even begin with, given that the pre-construction consultant ended up being the same company that did the project?”
Conflict of interest
The conflict-of-interest aspect of the Fresno Unified case is the most crucial element or totally irrelevant, depending on the source. The appellate court ruled that Davis could move forward with his allegations that Fresno Unified broke conflict-of-interest laws by allowing Harris Construction to perform pre-construction services for a project that it was ultimately rewarded.
Critics say it’s like having the fox guard the hen house; proponents contend it’s just good business sense.
Rick Marshall, CFO of the California Taxpayers Action Network, is another critic of leaseback deals.
“We recognize the value in having a construction firm consulting with a district to tell us what to be concerned about. But to turn back around and award them the contract is a problem,” Marshall said. “It may not be the best advice – it may be the advice that will help them make money. It’s very difficult to give good construction advice when they know they’re going to be getting the contract anyway.”
Kevin Carlin, the San Diego attorney representing Davis, compares Fresno Unified leaders’ relationship with contractors to the Stockholm syndrome – when hostages develop positive feelings for their captors.
“School board members and administrators have drank the Kool-Aid and are so enamored with these contractors that they’re not making good, independent business decisions for their school districts,” Carlin said. In the Davis case, Carlin is asking for Harris Construction to return the millions of dollars spent on the leaseback contract to Fresno Unified, calling the entire agreement a sham.
Lease-leaseback is just a different delivery system, but where there’s a lot of money, there’s a way that people will try to rig the system so that they get the contract.
John Smoot, attorney
But Matthew Dildine, the attorney representing Fresno Unified in the Davis case, says that the allegations are “an unfair characterization of the entire process” and school districts simply use leaseback contracts because it’s the better business option.
“Across the state, every single (leaseback contract) I’ve looked at looks very similar to Fresno Unified’s. It’s about saving money and building better schools, plain and simple,” Dildine said. “School districts keep fighting for it because there’s substantial value in it. And you don’t have to deal with the hassles of the competitive bid process. Which would you choose if it were you?”
The conflict-of-interest piece of the Fresno Unified case is why it’s been tied to a case involving Sweetwater Unified School District in San Diego – even though that case did not involve leaseback contracts.
There, Superintendent Jesus Gandara was sent to jail for his role in a pay-to-play scandal involving contractors. Sweetwater school board members also were indicted for accepting gifts like dinners, vacations and sports tickets in exchange for their votes on multimillion-dollar construction projects that were paid for with public bond money.
“The potential problem is with lease-leaseback, if the person who’s advising the district is the same person who’s getting the contract, are they not wearing two hats? Are they answering to two different masters?,” said John Smoot, the attorney involved in the Sweetwater Unified case.
“Lease-leaseback is just a different delivery system, but where there’s a lot of money, there’s a way that people will try to rig the system so that they get the contract. Any construction-delivery system except hard-bid can be manipulated. That’s why the public construction code provides for these contracts to the lowest bidder.”
The law is permissive. The provisions are not extensive and therefore, districts can be creative with those.
Tom Duffy, CASH director
An ambiguous law
The chief complaint of school districts and contractors has been that the leaseback law is unclear about the specifics, like how long a district must pay back a project in order for it to qualify as a genuine leaseback. There also have been conflicting court rulings.
The 4th District Court of Appeal ruled in favor of the Los Alamitos Unified School District in a similar case regarding a leaseback contract. The recent 5th District decision has now provided some framework for schools to work with, but that could change depending on the outcome of the Davis case.
Organizations like the California Coalition for Adequate School Housing have called for more clearly defined guidelines in the law. Harris Construction has sponsored CASH events, including its annual conference and golf tournament.
“The law is permissive. The provisions are not extensive and therefore, districts can be creative with those,” said CASH director Tom Duffy. “If you’re not told you can’t do it, if it appears to be in the best interest of your school district, then you can go forward with it.”
Fresno Unified officials have been unclear about whether they will proceed with leaseback in the meantime, but the latest projects proposed to the school board are traditional bids.
“We have a law in California that says every student has to be in school, and there’s another law that says schools have to be the safest buildings, structurally,” Duffy said. “And yet we always seem to have a struggle in trying to build and finance these buildings because of all these other things in legislation.
“This is a big enterprise, and it’s a complicated enterprise … We’ll see what the trial court says.”