Court Holds Corporate Consultants May be Subject to “1090” Conflict-of-Interest Prohibition

by on June 16, 2015

posted in Ethics,

Consultants are fixtures in the world of local government.  Engineers, architects, lawyers, and many other professionals routinely contract with local agencies to provide a wide range of services.  A recent court opinion, Davis v. Fresno Unified School District, warns the companies that employ these professionals of their potential for conflicts of interest.

The Case Facts

Davis involved a contractual arrangement unique to school facilities known as a “lease-leaseback.”  The lessor in this arrangement, Harris Construction Company (“Harris”), had earlier developed construction plans and specifications for middle school buildings and facilities.  Under its lease with the school district, Harris agreed to construct these improvements per the plans and specifications it had developed; once this project was complete, Harris agreed to then lease the improvements back to the school district for “lease” payments that were essentially construction payments.  Harris received nearly $37 million for the work it performed.

The Court’s Holding and Reasoning

Much of Davis was devoted to allegations concerning the legality of the lease-leaseback arrangement.  But in a portion of the opinion that will have broader implications for public agencies, the court found that Harris, a corporate party, was subject to the “1090” conflict-of-interest prohibition.

Government Code section 1090 states that local agency “officers or employees” shall not be “financially interested” in any contract “made by them in their official capacity…”  This “1090” prohibition exists to ensure individuals are not forced to choose between “two masters”—that is, between their own personal financial interest and their official governmental interest.  Section 1090 exists to eliminate even the appearance of a conflict, so if a conflict exists, the contract is automatically invalid (absent limited exceptions, which were not involved in the case).

Applying section 1090, the Davis court observed that previous cases had defined the term “employee” in the section to include private consultants.  But noting that the consultants in the previous cases were individuals, the court considered whether the term could be extended to include corporate consultants. The court held the term “employee” could be so extended.  Its reasoning on this point was terse (and somewhat circular), but the court observed that corporate consultants are capable of influencing agency decisions just as much as individual consultants.  Because Section 1090 exists to prevent even the possibility of a conflict, the court reasoned that corporate consultants should be held to the same standards as individual ones.

Takeaways from the Ruling

The Davis case has important implications for the companies that employ the professionals who do business with local government:

  • Although the contractor at issue in Davis was a corporation, there is no reason to conclude other types of business entities—such partnerships, LLPs, and LLCs—would not also be subject to Section 1090. Because the court’s interpretation of the word “employee” was not based on a precise reading of statutory text, but on a policy of maximizing Section 1090’s reach, all types of business entities would appear to be subject to its ruling.
  • What does the case mean for companies and firms that do repeat business with local agencies? Often, companies and firms enter into multiple agreements with agencies over a span of several months or years.  If a company or firm becomes an “employee” under section 1090 by contracting with an agency, can it enter into subsequent contracts with the agency?  Generally, yes.  The key is whether there is a nexus between the original contract and the subsequent contract.  The “1090” prohibition prevents companies from being financially interested in contracts “made by them.”  In Davis, Harris had “made” a contract by drawing up the plans for the buildings and facilities it constructed per a subsequent agreement.
  • In light of the prohibition against “making” contracts, there are some obvious examples of transactions that would be prohibited under Davis’ reasoning. As in Davis, companies that assist in developing plans and bidding documents for public works projects cannot later serve as contractor for the same projects.  Similarly, law firms cannot assist in developing a request for proposal for city attorney services and then later contract with the city to provide those services.
  • To avoid problems under section 1090, companies and firms that contract with agencies should take great care to avoid any participation—even through preliminary activity or discussions—in the formulation or development of future contractual services they may wish to provide. Section 1090 can be enforced criminally and civilly, and can result in the voiding of any contract that violates its prohibition. As always, an ounce of prevention is worth a pound of cure.

tags: conflicts of interest, Public Contracting, Section 1090,

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