San Diegans for Open Government v. City of San Diego (2015) 242 Cal.App.4th 416

Why It Matters: Since the dissolution of redevelopment agencies, cities have been scrambling to find alternative ways to finance the enormous costs of public infrastructure improvements without violating the State's constitutional debt limitation. The Fourth District Court of Appeal recently affirmed that a lease-back financing plan adopted by the City of San Diego to fund infrastructure improvements does not run afoul of the constitutional debt limitation because the bonds were issued by a separate Joint Powers Agency (JPA), of which the City was a member, and because the City had no obligation to pay the outstanding balance upon a default.

Facts: When the Redevelopment Agency of the City of San Diego was dissolved in 2011, the City established a Successor Agency made up of the nine members of the San Diego City Council. In 2013 the City, the Successor Agency, and the City's Housing Agency renewed a Joint Exercise of Powers Agreement to collectively operate a separate Financing Authority as a JPA. Under State law the JPA is a separate public entity.

The Financing Authority then issued $130 million in lease revenue bonds to finance various public capital improvements such as fire stations, lifeguard stations, libraries, storm drains, and the like. The lease revenue bonds were based on lease-leaseback where the City would lease property to the Financing Authority for nominal rent and the Financing Authority leases the improved facilities back to the City for a rent equal to the annual debt service on the bonds.

San Diegans for Open Government (SDOG) brought a reverse validation action claiming the financing plan was an "artifice" designed to circumvent the debt limitation in the California Constitution. The constitutional debt limitation is a constitutional provision that prohibits a county, city and other specified agencies from incurring indebtedness exceeding, in any year, the income and revenue provided for such year unless it is approved by a two-thirds vote of the public.

SDOG's main argument was that because the Financing Authority was created by the City and two other agencies that are subordinate to the City, it was the alter ego of the City and therefore subject to the constitutional debt limitation. SDOG also argued that the Housing Authority was not authorized to participate because the bonds were not for housing projects.

The Decision: The Court of Appeal concluded that the Financing Authority is an independent agency, and because it is not one of the agencies enumerated in the constitutional debt limitation, it is not subject to the limitation or the voter approval requirement. The court noted that various legislation specifies that all three of the agencies involved in the JPA are legally separate entities regardless of the fact that there are overlapping decision makers between them.

As to the debt limitation on the City, the court found that the City did not assume the liability of the Financing Authority. There was no ability to accelerate the base rent upon default, and, according to the court, bond holders understood the risk. Consequently, any obligation by the City to make payments was contingent upon its annual budget, even if it meant that a default on the payments could sacrifice the property.

As to the Successor Agency, the court held that although the Successor Agency stepped into the shoes of the redevelopment agency as a preexisting member of the JPA, the legislation that required the dissolution of redevelopment agencies specifically authorizes successor agencies to enter into contracts, unlike a redevelopment agency.

With regard to SDOG's argument that the Housing Authority could not participate because the bonds were not for housing projects, the court held that because the Financing Authority could someday issue housing bonds, the Housing Authority was authorized to join in the JPA. Moreover, because the Financing Authority was a separate legal entity, the Housing Authority did not issue the bonds or authorize the issuance of the bonds.

Practice Pointers: Generally, courts will not treat separate governmental agencies as an alter ego of each other, even if the agencies share the same decision makers. Accordingly, cities and counties can participate in JPAs that issue lease revenue bonds without implicating the constitutional debt limitation. However, in a lease-leaseback arrangement where a city or county is required to pay the debt service on the bonds as rent payment, a clause in the lease that permits the acceleration of the base rent in the event of a default may violate the constitutional debt limitation for the agency making the payments.