California Court of Appeal Allows Taxpayer Lawsuit Against Contractors on Public Works Projects
Public works contractors: Beware of accusations of corruption. In Gilbane Building Company v. Superior Court, 223 Cal.App.4th 1527 (2014), an appellate court cleared the way for taxpayers to sue contractors for engaging in allegedly unlawful marketing activities. Specifically, a private taxpayer association was permitted to sue a group of contractors for the disgorgement of payments received under contracts for public works construction projects alleged to have been obtained by corruption.
Gilbane involved alleged misconduct by several construction companies (collectively, the “Contractors”) and officials of the Sweetwater Union High School District. The San Diego District Attorney’s Office investigated allegations that certain District officials failed to report gifts and travel funds and misused the District’s credit card. The investigation revealed a “pay to play” culture within the District in which the Contractors allegedly gave gifts to District officials and their family members in exchange for millions of dollars worth of construction contracts.
San Diegans for Open Government (https://www.facebook.com/sandiegansforopengovernment/info) (“SanDOG”), a nonprofit organization that claims an interest in “open, transparent, government decision making,” ultimately learned of the allegedly improper gifts and informed the District that it intended to sue the Contractors. SanDOG asked the District to join the lawsuit, but the District never responded.
SanDOG sued the Contractors on its own behalf and for the benefit of its members, all taxpayers within the District, and the District. It asserted standing to sue based on the fact that its members paid taxes within the District and had an interest in ensuring that the District operated within the confines of the law.
The Contractors challenged the complaint, arguing that SanDOG did not have standing to sue because the association itself, as opposed to its members, did not pay taxes within the District. The Contractors also argued that the association’s lawsuit was improper because the decision whether to sue the Contractors was within the District’s sole discretion. The trial court found that SanDOG properly alleged associational standing and overruled the Contractors’ challenge, and the Contractors petitioned the court of appeal for a writ of mandate.
The Contractors asserted two arguments in their writ petition. First, they argued SanDOG could not piggyback on the taxpayer standing of its members. The court rejected this argument and held that even if SanDOG itself did not pay taxes, it had standing because its members were taxpayers and residents within the District. Second, the Contractors argued that SanDOG failed to allege that, before filing suit, it made a demand on the District to sue the Contractors and the District refused. The court also rejected this argument. The court explained that California Government Code section 1090 prohibits public officials from having a financial interest in contracts made in their official capacities (i.e., contracts made by any board of which they are members). Contracts made in violation of Section 1090 are void. If a contract violates Section 1090, a public entity may “avoid the contract,” which includes recovering any compensation it paid under the contract; the public entity is not required to restore any benefits it received under the contract. California law also permits taxpayers to sue the private parties to such a contract.
The Gilbane court noted that, ordinarily, taxpayers may not bring actions on behalf of a public entity unless the public entity has a duty to act and refuses to do so. But where a public entity has misappropriated funds and the officials accused of wrongdoing are in control of the entity, taxpayers are not required to make a demand on the entity to sue or to wait for it to refuse. Otherwise, whenever a public entity’s conduct was at issue, it could prevent a taxpayer action by refusing to respond to a demand to sue. Accordingly, the court denied the Contractors’ writ petition, awarded SanDOG its costs, and remanded the case back to the trial court.
Gilbane makes it clear that even unproven allegations of an illegal contracting scheme can result in costly civil litigation with private “watch dog” groups. Contractors may also face potential civil and criminal penalties under applicable state and federal law. Ideally, contractors should review their marketing policies and develop best practices to help manage the potential risks associated with such taxpayer lawsuits.