Rent credit from Port District triggered prevailing wage; $8 Million in back wages paid by Hensel Phelps Construction Company

In California Prevailing Wage Law, “public funds” come in many forms. In the case of the Hilton San Diego Bayfront Hotel, the Hotel learned the hard way that a “rent credit” can transform a $350 million, privately funded project into a “public work.”

In 2005 the Hotel signed a ground lease with the Port of San Diego. The lease required the construction of a hotel and convention center by the end of 2008. Rent would be a minimum of $2.25 million per year during construction and $4.5 million per year thereafter. To help support the project, the Port agreed to a “rent credit” of up to $46.5 million during the first eleven years of the lease.

Does a rent credit = the payment of public funds?

The Hotel claimed that project was privately funded and not a “public work.” It argued that the rent credit was not the “payment…of public funds” because the overall lease—including the credit—was at fair market value (FMV).

The unions disagreed. They argued that a “rent credit” falls squarely within the statutory definition of “public funds,” which includes “rents…that are paid, reduced, charged at less than fair market value, waived, or forgiven” by the government.

In 2006 the unions asked the California Department of Industrial Relations (“DIR”) to issue a public works determination. In April 2008, DIR sided with the unions and held that the hotel project was a public work subject to prevailing wage requirements. DIR’s reasoning was that the statute did not require that “rent be reduced and be for less than its fair market value.” The rent reduction, by itself, was sufficient to trigger prevailing wage, regardless of whether the lease was below FMV. In June 2008, DIR affirmed its decision on administrative appeal.

The case then wound its way through the court system. At first, the San Diego Superior Court reversed DIR’s decision and held that the project was not a public work. Then in June 2011, the Court of Appeal reversed the Superior Court and held—once and for all—that the hotel project was a public work subject to prevailing wage. The Court said, “The rent credit provided in the Lease constitutes a reduction and waiver of rent within the plain meaning of the statute.” In reaching its decision, the Court was very focused on the fact that the lease itself described the rent payments as being subject to a rent credit.

In 2013 the Hotel’s general contractor paid $8 million in back wages to DIR, plus administrative and investigative costs.

What is the lesson? Language matters!

The (expensive) lesson in this case is: whether a project is subject to prevailing wage often depends on how the underlying agreement is written.

If the lease had not used the term “rent credit,” but had characterized the exact same rent structure as an escalating set of rent payments, the outcome of this case could very well have been different. Developers need to carefully draft their agreements to ensure there are no prevailing wage “surprises” in store for them down the road.

Note: A copy of this post on LinkedIn includes citations and links to supporting material.