Ghost of Schwarzenegger stalks Brown administration over lease-back

Just weeks after Jerry Brown was elected governor, the Schwarzenegger administration was smacked with a lawsuit challenging its hotly contested effort to sell and lease back 11 state buildings. To make matters worse, the Legislature’s nonpartisan fiscal adviser reported that the complicated, $2.3 billion deal was bad business for California.

“In our previous analysis, we pointed out that the sale-leaseback was poor fiscal policy and represented one imperfect option among many for balancing the state’s budget,” Michael Cohen, then of the Legislative Analyst’s Office, wrote in a letter to former Sen. Denise Ducheny, a San Diego Democrat and budget committee chairwoman. “We recommended the Legislature strongly consider other alternatives to the sale-leaseback in putting together the 2010-11 budget,” added Cohen, who now serves with the Department of Finance.

Not much has changed since then. Almost three years later, the Brown administration is still grappling with litigation surrounding the same deal. The difference is that Brown, unlike Schwarzenegger, agreed with the LAO that the deal was foolish and, in February 2011, put a stop to it – only to find his administration embroiled in a new lawsuit with those in favor of the sale.

“Certainly the lawsuit [filed in November 2010] created complications, but there’s no question that except for the lawsuit, they all wanted to close the deal,” said Angela Agrusa, the attorney for California First, the real estate group that is now suing the state.

While Agrusa’s client claims that despite the legal challenges, the deal was moving forward, the Department of General Services believes the contract was breached and the deal ended with the legal challenges it faced in late 2010.

Earlier that year, the sale of the buildings seemed all but certain, with Legislative approval for Schwarzenegger’s $2.3 billion deal and California First selected as the winner of the competitive bid process. The real estate group put down its first deposit of $5 million and was scheduled to put down a second $50 million deposit in November.

But the first few weeks of November, the election of a new Democratic governor, the LAO’s objections and a lawsuit that challenged the deal’s constitutionality made the sale anything but certain.

What happened next became a tangled web of confusion regarding whether or not the deal was moving forward. The “he said, she said” of that tangled web is the crux of the case that is now before the San Francisco County Superior Court.

Agrusa says that due to that chaos created by the initial lawsuit, her clients failed to put down the second deposit until two weeks later. She says that the state is arguing that that failure to meet the contract’s requirements terminated the deal.

Despite that breach of contract, however, the state continued to vigorously defend the deal, despite bad news from the courts. The appellate court issued a stay on the deal just two days before the sale was required to close on December 15, 2010.

Brown stayed silent on the deal in his time as governor-elect, while the Schwarzenegger administration continued scrambling to lift the court’s stay on the transaction.

After the denial of the state’s emergency appeal on December 28, 2010, it seemed the deal had died. Brown mentioned its possibility in his initial budget summary in January 2011, but in early February held a press conference that was the sale and leaseback agreement’s final death knell. Brown terminated the deal.

But Agrusa argues that although the deposit was late, Calfornia First did make the second $50 million deposit into an escrow account, and the state’s attempts to continue the deal indicate an implied agreement. Her client is seeking not only monetary damages but specific performance as well, meaning that if California First wins the suit, it is possible the state will be expected to carry out the sale.

Further complicating matters is the existence of the original lawsuit, that, if the contract is deemed valid and the deal moves forward, will pose a challenge to the constitutionality of the contract.

According to Anne-Marie Murphy, one of the attorneys that represented the taxpayers, Jerry Epstein and A. Redmond Doms, who filed the suit, even if the contract was ruled valid, it was unconstitutional for several reasons. A primary argument was that the buildings included courthouse facilities and therefore required the approval of the judicial council, which it had not received. Another it constituted a waste of public funds and would have cost the taxpayers somewhere from six to ten billion dollars, Murphy said.

Looking forward, if the deal goes through, it will occur in a far different fiscal context than the budget crisis it was intended to alleviate.

Agrusa argued that the deal was positive for California in any case, in that the one time revenue of the buildings’ sale would provide immediate cash flow for the state to pay off existing debt and allocate funds elsewhere. She added that despite the lease costs, the arrangement would save the state money otherwise spent on renovations and maintenance.

That argument, however, was based on the DGS’ analysis, while the LAO’s assessment painted the deal in a far dimmer light. In the Nov. 2010 letter that followed the LAO’s initially-skeptical April 2010 analysis, Cohen wrote that the DGS analysis that suggested $2 million of savings from the first 20 years was insufficient because it did not consider costs beyond those first years and its estimates for savings on renovations were too high

After presenting numbers that considered the cost of the deal over 35 years, in the Nov. 2010 letter concluded that the sale would cost the state $1.4 billion in the long term, an estimate that was $800 million higher than its April 2010 estimate.

Now, given the potential costs of litigation and the reduced need for a quick one-time revenue source, the deal to sell these 11 buildings, known as the “Golden State Portfolio,” has become even politically less popular.

Another possible outcome in favor of California First that does not require specific performance (the completion of the deal) would still cost the state hundreds of millions. According to Agrusa, it is possible that the court would rule to provide the real estate group with monetary damages equivalent to the earnings California First would have reaped had the deal gone forward.

But DGS remains confident in their case that the deal was no longer valid starting with the plaintiffs’ failure to make a timely deposit on Nov. 18, 2010. Eric Lamoureux a spokesperson for the Department of General Services (DGS) said, “DGS has not yet briefed or introduced evidence on the substantive question of why plaintiffs’ claims fail as a matter of fact and law.  When it has that opportunity, DGS is confident that it will prevail.”