What Is Lease-Leaseback Construction and How Does It Work?

Lease-leaseback construction is a project delivery method, authorized by California Education Code Section 17406, that lets a school district hire a builder based on qualifications and best value instead of the lowest bid. The mechanics run through a pair of leases: the district leases its land to the contractor for a nominal rent, the contractor builds the facility on that land, and the district makes lease payments that cover the construction cost until it owns the finished building outright.¹ The method has largely replaced traditional low-bid procurement for complex school modernization and new construction across the state.

The Two Leases and the Construction Agreement

Three documents do the work. The Site Lease gives the contractor a temporary leasehold interest in the property so it has legal standing to enter and build. Section 17406 sets the minimum rent at one dollar per year; the real consideration is the contractor’s promise to deliver the facility. The district never gives up ownership of the underlying land.¹

The Facilities Lease, sometimes called the Leaseback Agreement, runs in the opposite direction. The district agrees to make periodic payments to the contractor over the construction term, covering construction costs, general conditions, overhead, and an agreed fee. The district is, in effect, renting the improving facility back from the contractor while work progresses. When the final payment clears and the project is complete, the contractor’s leasehold terminates and full title to the improvements vests back in the district automatically.¹

A separate Construction Services Agreement carries the actual construction terms: scope, schedule, insurance, change order procedures, and the guaranteed maximum price. Practitioners refer to the three documents together as the LLB Agreements.

Who Can Use Lease-Leaseback

Authority is narrow. K-12 school districts get it from Education Code Section 17406, which expressly overrides the normal competitive bidding rules of Section 17417.¹ Community college districts have a parallel provision under Education Code Section 81335. Cities, counties, and special districts cannot use these Education Code provisions and must rely on traditional bidding, design-build, or other methods authorized by the Public Contract Code.

The legislature kept this tool narrowly scoped on purpose. Active student populations, phased construction around academic calendars, and strict Division of the State Architect safety requirements make lowest-price bidding especially risky on K-12 campuses.

Best Value Instead of Low Bid

Under traditional public works bidding, a school district must award to the lowest responsible bidder once a project crosses the statutory threshold. That system optimizes for price and says nothing about the contractor’s track record on school projects, safety performance, or ability to work around students.

Lease-leaseback flips the selection model. Section 17406 requires the district to award the contract through a competitive solicitation to the proposer providing the best value, evaluated on demonstrated competence and the professional qualifications necessary for satisfactory performance.¹ Price still counts, but it competes alongside experience, safety record, workforce qualifications, and project approach.

The procurement starts with a Request for Proposals that identifies every evaluation criterion, specifies which are scored and which are pass-fail, and states any minimum qualification score. The board must adopt and publish its evaluation procedures and guidelines before soliciting proposals, so the process can be conducted fairly and impartially. Contractors submit sealed proposals; a selection committee scores them, usually interviews the finalists’ project manager and superintendent, and recommends a firm to the governing board. The final award happens by resolution at a public board meeting, after which the parties execute the Site Lease, Facilities Lease, and Construction Services Agreement, and the district issues a Notice to Proceed.

The Preconstruction Phase

Timing is the other big difference from low-bid work. In the traditional model, the contractor arrives after design is finished and builds from completed plans. Lease-leaseback brings the contractor in during design through a preconstruction phase, catching problems on paper before they turn into field changes.

Education Code Section 17400 defines preconstruction services as advice provided during the design phase, including scheduling, pricing, and phasing, to help the district design a more constructible project.² The contractor’s preconstruction fee is part of the original proposal and is scored as a component of best value.¹

In practice, the contractor attends design meetings with the architect and engineers, reviews drawings at each milestone for constructability issues, performs value engineering, and prepares independent cost estimates at schematic design, design development, and construction document stages. The contractor also develops a master critical path schedule and coordinates phasing plans so construction can proceed while students continue using adjacent buildings. The estimates produced during preconstruction form the basis for the guaranteed maximum price, meaning the district enters construction with a price tested against real trade pricing rather than a designer’s rough projection.

Guaranteed Maximum Price and Cost Controls

Most lease-leaseback contracts use a guaranteed maximum price, or GMP, under which the contractor commits to delivering the project at or below an agreed ceiling. The GMP is typically finalized during preconstruction after the work has been priced against actual trade bids and current material costs. It includes direct construction cost, general conditions, the contractor’s fee, and a contingency fund.

The contingency fund covers unforeseen costs within scope, work modifications defined in the construction provisions, and additional financing costs. Any funds remaining in the contingency after the project is complete must be returned to the school district.² Many contracts include shared savings provisions that split the difference between the GMP and the actual cost, giving the contractor a reason to come in under budget.

Because the district is paying cost-plus-fee rather than a hard lump sum, it retains audit rights over the contractor’s costs. This open-book accounting lets the district verify line-item budgets and expenses against the GMP. Change orders for work outside the original scope follow a separate protocol, and the GMP adjusts only when both parties agree to a formal change.

How Subcontractors Get Selected

Subcontractor selection is one of the more nuanced parts of lease-leaseback. The general contractor may identify some subcontractors in the original proposal, and those listed subs are locked in under the Subletting and Subcontracting Fair Practices Act. For any subcontract exceeding one-half of one percent of the price allocable to construction work that was not identified in the original proposal, the contractor must run a specific competitive process.¹

That process requires public notice of the available work, using the same publication methods the district would use for its own competitive bids. The contractor sets reasonable qualification criteria and can award each subcontract either on a best value basis or to the lowest responsible bidder. Prequalification or short-listing is permitted. Subcontractors awarded through this process receive full Fair Practices Act protection, so the general contractor cannot swap them out without cause.¹ Smaller specialty packages below the threshold leave the contractor with more discretion.

Prevailing Wage and Labor Compliance

Lease-leaseback school projects are public works. Every worker on site must be paid prevailing wages set by the California Department of Industrial Relations, and projects of $30,000 or more must meet DIR apprenticeship requirements. The lease structure does not change the classification of the work.

Federal funding adds a second layer. The Davis-Bacon Act applies to federally funded or assisted construction contracts over $2,000 and requires locally prevailing wages and fringe benefits. For prime contracts over $100,000, the Contract Work Hours and Safety Standards Act also requires time-and-a-half for hours worked beyond 40 in a workweek.³

Expect to submit workers’ compensation experience modification rates, apprenticeship program participation data, and detailed safety records with the proposal. Inaccurate or missing labor compliance documentation is a common basis for disqualification, and districts take it seriously because violations can jeopardize the project’s public works classification and any associated state funding.

Paying for the Project With Certificates of Participation

Districts often fund lease-leaseback projects through certificates of participation rather than general obligation bonds. A COP represents an investor’s share of the lease payment stream. A trustee issues the securities, investors receive pro-rata distributions as the district makes its scheduled lease payments, and the sale proceeds finance the construction.

The main advantage of COPs is that they do not require voter approval. Because the payments are structured as lease obligations subject to annual appropriation by the school board, they fall outside the constitutional debt limitations that apply to bonded indebtedness. The trade-off: COPs typically carry a credit rating one notch below the district’s issuer rating because of the appropriation risk, so investors price that risk into a slightly higher interest rate than a GO bond backed by property tax revenue.

Interest on these instruments generally qualifies for federal tax-exempt treatment under 26 U.S.C. Section 103, which excludes interest on obligations of a state or political subdivision from gross income.⁴ That exemption fails if the obligation is classified as a private activity bond that does not meet qualified bond standards, or if it is an arbitrage bond that violates the rules against reinvesting tax-exempt proceeds at a higher yield. Districts issuing COPs must comply with SEC Rule 15c2-12 continuing disclosure requirements and engage underwriters and fiscal agents to manage the offering.

Legal Exposure After Davis v. Fresno Unified

The most significant legal challenge to lease-leaseback reached the California Supreme Court in Davis v. Fresno Unified School District. The question was whether lease-leaseback contracts fall under the expedited validation procedures of Government Code Section 53511, which would have given districts a short window to immunize their contracts from challenge. The Court held that validation applies only to contracts inextricably bound up with the debt financing guaranteed by the public entity. Because Fresno’s general obligation bonds had been sold nearly a year before the lease-leaseback award and were repaid through property taxes, the lease-leaseback contract was not tied to the bond financing in the required way.

Practically, taxpayers can challenge lease-leaseback contracts as alleged illegal expenditures or waste of public funds under Code of Civil Procedure Section 526a, without the shortened limitations period that validation would provide. For districts, lease-leaseback contracts stay exposed to taxpayer lawsuits for longer than many administrators assumed, which raises the stakes on documenting the procurement thoroughly and following Section 17406’s best value requirements to the letter.

Finishing the Project and Transferring Title

When construction wraps up and the district makes its final lease payment, the contractor’s leasehold interest under the Site Lease terminates. Title to the improvements vests fully in the district without any additional conveyance. The district then records a Notice of Completion with the county recorder, either on the date of completion or within 15 days afterward.⁵

Recording that notice is not a formality. It shortens the mechanics’ lien filing window to 30 days for subcontractors and 60 days for the general contractor, cutting the district’s exposure to post-construction lien claims. The notice must be signed and verified by the public entity or its agent and must state the date of completion.⁵ A minor error in the stated completion date does not invalidate the notice, as long as the true date falls within 15 days of recording.

After completion, any remaining contingency funds revert to the district, shared savings are distributed per the contract terms, and the contractor’s performance bond and payment bond obligations continue through the applicable warranty and lien periods. Districts should retain project records and cost documentation for audit purposes, particularly when the project was financed with COPs or received state facility funding that requires post-completion reporting.

1
California Legislative Information. California Education Code EDC 17406
2
Los Angeles County Office of Education. Lease-Leaseback Contracts
3
U.S. Department of Labor. Davis-Bacon and Related Acts
4
Office of the Law Revision Counsel. 26 U.S. Code 103 – Interest on State and Local Bonds
5
California Legislative Information. California Civil Code CIV 9204