Alert January 13, 2011

California Appellate Court Expands Prevailing Wage Obligations to Privately Financed Public Improvements

A recent California Court of Appeal decision expanded the application of prevailing wage laws to the construction of public improvements that are privately financed. In Azusa Land Partners v. Department of Industrial Relations (Dec. 21, 2010, No. B218275), the appellate court affirmed a lower court’s ruling that the acceptance by a developer of Mello-Roos bond proceeds to pay for a portion of public improvements in a mixed-use project rendered the entire project a “public work” under the California Labor Code (the “Code”). The consequence: All public improvements required to be constructed as a condition of regulatory approval – including those financed privately without public funds – are subject to prevailing wage laws.

Background

In 2005, Azusa Land Partners, LLC (“ALP”), undertook the completion of a development in the City of Azusa, California (the “City”), called “Rosedale” (the “Project”). The Project is a master-planned community located on approximately 517 acres in the City that originally contemplated a development of over 1,200 dwelling units, commercial uses, parks and open space, a school, a fire station, and a light rail transit center.

In June 2006, the City formed the City of Azusa Community Facilities District No. 2005-1 (Rosedale) (the “CFD”) under the Mello-Roos Community Facilities Act of 1982. The City designated two improvement areas within the CFD known as Improvement Area No. 1 and Improvement Area No. 2 and authorized a special tax levy and bond authorization for each Improvement Area. On February 7, 2007, the CFD issued Mello-Roos bonds (the “Mello-Roos Bonds”) secured by special taxes levied on the property within Improvement Area No. 1 to finance certain public improvements for the Project.

In October 2005, in response to an inquiry, the Department of Industrial Relations (the “Department”) launched an investigation as to whether, due to the proposed funding of a portion of the public improvements with the Mello-Roos Bonds, the entire Project constituted a “public work” under Section 1720 of the Code, which would subject the Project to the prevailing wage provisions of Section 1771 of the Code.

In October 2007, the Department issued a letter ruling (confirmed in July 2008), concluding:

  1. proceeds from the Mello-Roos Bonds constitute “public funds” for purposes of Section 1720(b)(1) of the Code;
  2. because it is to be partially funded with public funds, the Project constitutes a “public work” for purposes of Section 1720(a)(1) of the Code; and
  3. pursuant to an exemption provided under Section 1720(c)(2) of the Code, the private development portion of the Project is not subject to prevailing wage requirements, but all of the public improvements required as a condition of regulatory approval are subject to the prevailing wage requirements, regardless of whether publicly or privately funded.

In October 2008, ALP filed a lawsuit challenging the Department’s determination that public improvements that are not financed in whole or in part with the proceeds of Mello-Roos Bonds are subject to prevailing wage requirements. ALP argued that improvements constructed solely with private funds that are later dedicated to the public are not public works subject to prevailing wages. Following briefing and hearings, the trial court upheld the Department’s original conclusions.

ALP appealed the trial court’s decision. The appellate court granted leave to the California Building Industry Association (“CBIA”) and to Rancho Mission Viejo (“RMV”) to participate as amici curiae in support of ALP. Along with ALP, both CBIA and RMV provided briefs in favor of ALP’s position.

In an opinion filed on December 21, 2010, the Court of Appeal for the Second Appellate District rejected the arguments of ALP, CBIA, and RMV and confirmed the trial court’s ruling. In so doing, the court determined that the Department’s conclusions are the correct interpretation of the prevailing wage provisions in the Code.

Ramifications

The appellate court’s decision, which can be downloaded here, clearly favors a broad application of prevailing wage laws in connection with any type of financial assistance from governmental entities. Questions remain, however, as to exactly how the decision will affect projects currently in development, projects in the planning stages, unfinished projects that have one or more completed phases, and projects that have been completed. The decision has prompted several specific questions from the development community:

  • Development Fees. If a developer and a municipality enter into an agreement to defer certain fees for a project, does the credit or offset for fees constitute “public funds” for purposes of the prevailing wage analysis? Also, if a developer finances development fees through a community facilities district or other public financing district, but does not finance any other improvements through the financing district, does that financing subject the project to prevailing wage laws?
  • School Financing with Mello-Roos Districts. If a developer finances school fees or improvements through a Mello-Roos community facilities district formed by a school district, does the funding of those fees or improvements with bond proceeds trigger a public works determination for the overall project? And, if so, will developers be reluctant to pay school fees in excess of their statutory SB50 fees through Mello-Roos districts, thus depriving school districts of needed funding?
  • Public Improvements Not Required for Approval. If a project is deemed a public work due to the receipt of public funds, are the public improvements that are not a condition of approval and that do not receive any public funds subject to prevailing wage laws?
  • Downstream Developers. If a merchant builder purchases a tract from a master developer who previously has accepted public moneys for the project, is the merchant builder required to pay prevailing wage for any public improvements required as a condition of that builder’s approvals, notwithstanding that such improvements do not receive any public funds and were never a condition of the master developer’s approvals?
  • No Development Agreement. If no development agreement has been executed for a project deemed a public work, are the public improvements that constitute conditions of development (e.g., final map conditions) the only public improvements subject to prevailing wage laws?
  • Acquisition Agreement. If a developer has entered into a funding and acquisition agreement pursuant to which a municipality has agreed to form a Mello-Roos community facilities district or other public financing district and issue bonds to help pay for project infrastructure, but the bonds have not yet been issued, is the project considered a “public work” upon the execution of the acquisition agreement?
  • Charter Cities. Will this decision impact the ability of charter cities to determine if prevailing wages are payable on projects that fall under their municipal jurisdiction?
  • Retroactive Application. If a developer applies for public moneys after the construction of a project has commenced, are the prevailing wage laws applicable retroactively to all public improvements previously constructed as a condition of approval? Also, will the Department take any enforcement actions with respect to project components previously accepted by a municipality, the costs of which were not paid in accordance with the prevailing wage laws?

The Future

Reaction to the decision may include filing an appeal to the California Supreme Court, seeking advisory rulings from the Department, or pursuing legislative changes. Notwithstanding the legal remedy sought, some industry participants fear the decision will have a chilling effect on current development by increasing development costs, which will in turn exacerbate the current downturn in construction and development. The decision is also certain to affect the development process going forward, including underwriting, valuation of property, the implementation of indemnification and cost-sharing agreements, and the structure of project financing packages.