By William W. Abbott

The dividing line separating which privately undertaken improvements are subject to prevailing wage requirements from those which do not, has become less clear over time. The result is that some contractors, after bidding a project as a purely private undertaking, learn that they incorrectly bid their labor costs. It is common practice in construction agreements that this financial risk is borne by the contractor. Earlier this year, this blog reported the Azusa Land Partners decision. The most recent chapter in the story of prevailing wage comes from a challenged ground lease between the San Diego Unified Port District and a hotel developer.

The Port District was interested in developing a hotel on one of its parcels, and in 2002, issued a request for proposal for developing a “four star quality convention center headquarters hotel” with 1,000 to 1,200 rooms and related amenities. Four proposals were submitted, and upon review, the Port entered into serious negotiations with one developer. At the outset, the developer identified that public investment, as part of the overall project, was likely. Deal points evolved during the negotiations, with one of the provisions allowing for a rent credit to the developer, and the amount of the proposed credit increased as the developer refined project costs during negotiations. These negotiations eventually led to the Port District executing a long term lease. The lease specified minimum rents with separate provisions for rent credits and called for the Port to approve project plans and specifications. The project developer eventually contracted with Hensel Phelps Construction Company as construction manager. The Port District required that Hensel Phelps execute a completion guarantee, which assured completion of the project in accordance with the terms of the lease and construction plans.

The Carpenters/Contractors Cooperation Committee and similar interested parties (“CCCC”) then sought a determination from the Department of Industrial Relations as to whether the project fell within the parameters of the California Public Works Law (“PWL”). In April 2008, the Director of Industrial Relations issued an initial determination that the project was subject to PWL, a determination affirmed two months later. Hensel Phelps and the project developer then filed a writ in superior court challenging the determination. The trial court looked only at the issue of whether there were public funds used or if a public subsidy was involved. The trial court concluded that there was no baseline upon which to conclude that the rent credits were a subsidy, and that the transaction, with the rent credits, was otherwise an arms-length transaction reflecting fair market value. The CCCC, an intervenor in the trial court proceeding, then appealed. The issue on appeal was how should the provisions of California Labor Code section 1720 (b), which the Legislature amended in 2002 to define the phrase “paid for in whole or in part out of public funds” be interpreted.

The appellate court first addressed the threshold question of whether or not there was a “construction …. done under contract.” Labor Code section 1720 (a)(1). Although Hensel Phelps argued the District had only entered into a ground lease, the totality of documentation (relatively specific provisions of the project to be built and District approval of plans and specifications, along with the District required completion guarantee) was such that the appellate court concluded there was a contract for construction.

The contractor also argued there was no connection between the public funds and the actual construction. The appellate court also disagreed, finding that based upon the evolution of negotiations, the credits were increased as a result of increased construction/development costs associated with developing the hotel project, and as a result, there was a connection between the construction and the public funds.

The court then turned to whether public funds had been paid in whole or part of the project. Looking at all of the evidence, including the history of the negotiations over an anticipated public contribution to the project, the separate provisions of minimum rent as distinguished from the contract terms applicable to rent credits, lead the appellate court to conclude that the credits operated as “rents…that are paid, waived or forgiven…” (Labor code section 1720(b)(4).) The contractor also contended that total rents, paid over the term of the ground lease reflected fair market value. In the face of the express terms of the ground lease which separated minimum rent from the credits, the appellate court declined to look at the overall economic relationship as an alternative interpretation of what the parties actually negotiated.

On October 12, 2011, the California Supreme Court denied review.

Comment: Obviously, the terms of the agreement play a significant role in resolving how the Department of Industrial Relations, or a reviewing court, should characterize public funds which may be associated with a development project. Even artful drafting however, can still be challenged under a theory that a transaction is simply a cleverly disguised subsidy. With the 2002 amendments to the Labor Code, as illustrated by this decision, the prevailing winds are clearly spreading the potential application of Public Works Law. Hensel Phelps Construction Company v. San Diego Unified Port District (2011) 197 Cal.App.4th 1020

William W. Abbott is an attorney at Abbott & Kindermann, LLP.  For questions relating to this article or any other California land use, real estate, environmental and/or planning issues contact Abbott & Kindermann, LLP at (916) 456-9595.

The information presented in this article should not be construed to be formal legal advice by Abbott & Kindermann, LLP, or the formation of a lawyer/client relationship. Because of the changing nature of this area of the law and the importance of individual facts, readers are encouraged to seek independent counsel for advice regarding their individual legal issues.