Earlier this year, we highlighted the California Supreme Court’s decision in Davis v. Fresno Unified School Dist. (2023) 14 Cal.5th 671 (“Davis II”), which held that lease-leaseback construction contracts that do not contain a financing component are not protected by the legal validation procedures. Now, the California Court of Appeal has issued a new decision that recognizes important additional limits on contract validation.
In Westlands Water District v. All Persons Interested (Cal. Ct. App., Aug. 7, 2023, No. F083632) as modified (Sept. 1, 2023)), the Court of Appeal ruled that a water district could not validate its anticipated contract concerning repayment terms for a federal water reclamation project because the draft contract it presented to the trial court lacked essential terms including the amount to be paid by the water district. Although the case dealt with a type of contract unique to water districts, the Court’s reasoning could also apply to the financing terms of a lease-leaseback contract. The takeaway for California school districts is that the financing terms for a lease-leaseback contract should be fixed and stated in the contract before contract validation can apply.
A validation action is a type of judicial proceeding that allows a public agency to seek an expedient court determination of the validity of agency actions within the scope of the validation statutes. (Code Civ. Proc., § 860 et seq.) The validation statutes include within their scope contracts that are dependent on government debt financing. (Westlands Water, supra, 2023 WL 5703295, at *17, citing Davis II, supra, 14 Cal.5th at 691.) A court judgment validating a contract is binding and conclusive against all persons and cannot later be challenged. (Code Civ. Proc., § 870.) This process is known as active validation. Alternatively, if no one challenges the contract within 60 days, then the contract is deemed validated by operation of law and similarly cannot later be challenged. (Code Civ. Proc., §§ 863, 869.) This process is known as passive validation.
A water district brought a validation action (active validation) against all persons interested in its proposed contract with the federal government concerning repayment for a federal water reclamation project. The water district attached to its complaint an unsigned draft version of the contract. Notably, the draft contract failed to state the amount of the water district’s repayment obligation to the federal government.
When the water district moved for validation of its contract, the trial court denied the motion and later dismissed the action. Among other issues, the trial court found the draft contract could not be properly validated because it lacked essential terms including the actual final payment amount and payment schedule. The water district appealed.
The Court of Appeal affirmed the trial court’s judgment dismissing the water district’s validation action. The Court agreed with the trial court that the draft contract could not be validated because it lacked essential terms.
As a general matter of law, a contract is only enforceable if its terms are sufficiently definite so that a court can determine the parties’ obligations and whether those obligations have been performed or breached. Price is typically an essential term that the parties must include for the contract to be sufficiently definite.
The Court noted that not only did the water district’s draft contract attached to the complaint fail to state the water district’s repayment obligations but, in fact, the contract exhibit setting these repayment obligations “did not exist when the complaint and the [motion for validation] were filed.” (Westlands Water District, supra, 2023 WL 5703295, at *20, emphasis original.) Even when the trial court heard the motion for validation, the water district was not able to identify the exact amounts. “Given the circumstances, [the Court] agree[d] the contract presented for validation was missing an essential term and therefore uncertain, i.e., not sufficiently definite to be binding and enforceable.” (Id. at *20.)
Westlands Water District shows that a court will not validate a public agency’s contract unless the contract includes all essential terms. Because the Court of Appeal based its decision on general contract principles, the decision should apply beyond water district contracts to other districts and other types of contracts. Additionally, although the case concerned an active validation, the same concept should apply to a passive validation. If the district cannot bring a validation action (active validation) until the contract’s essential terms are established, then the 60-day time limit (passive validation) for other persons to challenge the contract should also not begin to run until the contract’s essential terms are established.
Taking Westlands Water District together with Davis II, school districts that wish to invoke the validation procedures to protect their lease-leaseback contracts from third-party legal challenges should:
1) Ensure that the lease-leaseback contract contains a financing component in order to be eligible for validation; and
2) Set the loan amount and lease payment schedule in the lease-leaseback contract before seeking active validation or to start the 60-day clock on passive validation.
To be sure, school districts are not presently required to comply with the validation procedures for their lease-leaseback contracts, but DWK recommends that school districts do so to provide their construction projects with greater legal certainty. DWK’s form of lease-leaseback contracts have long contained a financing component, and DWK has long assisted school districts with all aspects of the validation procedures.
If you have questions about your district’s lease-leaseback contracts or the validation procedures, please contact an attorney in Dannis Woliver Kelley’s Construction group.