This article is part two of a series of three articles by the author regarding public-private partnerships.

By Edward B. Lozowicki 

The advent of public-private partnership agreements in turn gives rise to potential conflict with other statutes regulating procurement of public works projects. For example, is the P3 infrastructure project a "public work," and are "public funds" used to fund the project? If the answer to one or both of these questions is yes, then the private entity may incur liability if the design, construction and/or operation of the project would result in the violation of any local regulations pertaining to public works. For example, a "public work" could be subject to state prevailing wage laws, whereas a privately funded work would not.[1] Thus, the definition of "public work" and "public funds" as applied to P3s may lead to litigation if not addressed up front.

For example, in the case of Greystone Homes, Inc. v. Cake, the determination of whether the project was a public work and hence subject to California’s prevailing wage law turned on the definition of "publicly funded."[2]  Although not specifically a P3 case, it is illustrative of the care that must be taken when structuring funding for private-public works, and may be analogous in the context of P3s.  In that case the appellate court held that the development at issue, although built on land purchased with public funds, was not a public work under state law.  The holding of the case turned on the definition of "construction," which, under the law at the time of the developer agreement (former California Labor Code § 1720(a) (amended 2000 and 2001)), did not include pre-construction design efforts, but "only the actual physical act of building the structure."[3]  Because "construction" by the private developer, as was then legally defined, did not begin until after conveyance of the property from the public sector to the developer, no public funds were used in construction, the development was not a "public work," and hence no liability for prevailing wages accrued to the developer.

Subsequent to the amendment of California Labor Code § 1720(a) [4] and at the time of this writing, the issue whether there was public funding of pre-construction efforts of a P3 or otherwise private project (thus making it subject to prevailing wage laws) has been little litigated in California.  City of Long Beach is one case in which the public agency’s financial contribution to the project was limited to pre-construction expenses, in this case design and architecture.[5]  The case was litigated after amendment of § 1720(a) and its broadening of the definition of "construction."  Based on the public funding of pre-construction expenses, the appellate court held that the project was a public work, and hence subject to the prevailing wage law.[6]  However, the Supreme Court of California reversed.  Similar to the project in Greystone, the Supreme Court held that this project was not a public work as defined by the statute in effect at time of the conveyance of public funds.  Because no publicly funded construction was involved, the court reasoned that the project was not subject to the prevailing wage law.[7]

Clearly, companies considering a P3 agreement in California today must take note that the term "construction" now encompasses the pre-building phases of a project.  If funding of the Greystone and City of Long Beach projects were at issue today, under the current statute their respective holdings might be different.  One might argue that "construction" of the Greystone project, for example, began at conveyance of public land to the developer ("pre-construction phase"), thus turning it into a "public work" for purposes of prevailing wage laws.  And the project in City of Long Beach initially was held to be subject to the prevailing wage law, but was ultimately held not subject to that law because the public funding occurred before the amendment was enacted.  Query whether the private developer of a California P3 agreement that includes project design could be subject to prevailing wage liability if design efforts or land conveyance is publicly funded, even where the actual construction is privately funded.

Public funding

As demonstrated above, careful structuring of a P3 transaction may be needed to avoid the possible creation of statutory "public funding" for a project and the liability this entails. San Antonio Bldg. and Constr. Trades Council v. City of San Antonio illustrates the point.[8]  In this case, the city created a non-profit finance corporation to issue bonds, including some tax-exempt, expressly "for the purpose of financing a portion of the costs required to construct . . . a privately-owned hotel . . . ."[9]  Proceeds of the bonds were loaned to a private developer, who entered into a design-build-operate-lease agreement with the city for a convention center hotel.  During the lease term, possession of all improvements on the premises would remain with the tenant developer, but would revert to the city at expiration of the lease.[10]

The San Antonio hotel project was challenged as a public work, based on its being partially funded through bonds issued by a local government corporation, and thus subject to Texas’ prevailing wage law.  The wage law applied "only to the construction of a public work . . . paid for in whole or in part from public funds . . . ."[11]  The court held that the funds from bonds raised for hotel construction by a local government corporation were not "public funds," mainly because the government did not remain liable for repayment to bondholders if the corporation defaulted[12], and no funds from the state or city were used to secure or pay the bonds.[13]  Because no public funds (as the court interpreted the term) were used in this project, it was not a "public work"; thus, the prevailing wage law did not apply.[14]

However, the dissent in this case would have viewed the arrangement in question as one that did involve public funding; thus the project was, in its view, a public work and subject to the prevailing wage law. The dissent strongly criticized the majority’s definition of public funding as "very restrictive,"[15] and the majority’s holding as against public policy in Texas.[16]  In the dissent’s opinion, the arrangement between the city and developer was a P3, the hotel project was publicly funded, and the city was merely seeking to avoid the reach of the prevailing wage statute through an artfully crafted contract.[17]

In a similar case in Pennsylvania, the court came to the opposite conclusion from that of the San Antonio majority.  In Lycoming County Nursing Home Assoc., Inc. v. Commw. of Pa., Dep’t of Labor & Indus., Prevailing Wage Appeal Board, county commissioners set up a non-profit corporation to build and operate a project, in this case a nursing facility.[18]  The county authorized the issuance of bonds, loaned the proceeds to the newly established corporation to develop the facility, and the corporation contracted with a developer to construct the facility.  The court held that the project was a public work for purposes of the prevailing wage law[19], because the project was paid for, at least in part, with public funds.[20]

The primary rationale for the Lycoming court’s determination that public funds were used in the project at issue was that the county remained liable on the bonds if the non-profit corporation defaulted.[21]  In San Antonio, however, no political subdivision of the state would have been liable for default.[22]

The take-home message from Lycoming and San Antonio is that P3 agreements must be carefully drafted, with an eye to the legal ramifications of the funding structure selected; and even then, the definition of what makes a work "public" may be open to interpretation and subject to skilful advocacy.

To read Part I of this series please click here. To read Part III of this series please click here.

Authored By:
Edward B. Lozowicki
(415) 774-3273

Edward B. Lozowicki is a partner in the Business Trials Practice Group in Sheppard Mullin’s San Francisco office. He has over 35 years’ experience in construction law and litigation, renewable energy cases, and complex commercial litigation, on diverse public and private projects.  

[1] See, e.g., Cal. Lab. Code § 1771 ("[N]ot less than the general prevailing rate of per diem wages . . . shall be paid to all workers employed on public works.")

[2] 135 Cal. App. 4th 1, 3 n.1 (2005).

[3] Id. at 9 (citing City of Long Beach v. Dep’t of Indus. Rel., 34 Cal. 4th 942, 950 (2004)).

[4] Cal. Lab. Code § 1720(a)(1) (2002) ("'[C]onstruction’ includes work performed during design and preconstruction phases of construction including, but not limited to, inspection and land surveying work.").

[5] City of Long Beach at 948.

[6] Id. at 949.

[7] Id. at 954.

[8] 224 S.W.3d 738 (Tex. App. 2007).

[9] Id. at 741 (quoting Ordinance No. 100685).

[10] Id.

[11] Id. at 746 (quoting Tex. Gov’t Code Ann. § 2258.002 (Vernon 2000)).

[12] Id. at 747.

[13] Id. at 749.

[14] Id. at 751.

[15] Id. at 752.

[16] Id. at 751.

[17] Id. (The hotel project as "a prime example of a public-private venture" wherein, "[t]hrough artfully crafted project documents, the City [sought] to avoid application of the prevailing rate statute . . . on publicly-funded public projects.").

[18] 627 A.2d 238 (Pa. Commw. Ct. 1993).

[19] 43 P.S. § 165-3.

[20] Lycoming at 243.

[21] Id.

[22] San Antonio at 749.