SDV Insights

Overview

Several states utilize a unique statutory mechanism to allow school districts to finance the construction of public-school facilities. This arrangement (known as a “lease-leaseback agreement”) allows a school district to lease property to a contractor/developer, who then constructs or renovates a school facility on the property. Once the work is completed, the contractor/developer leases the school building back to the school district. The school district then makes lease payments over time, often many years, which can be structured in various ways to spread out the cost of construction. The arrangement typically requires a site lease for the land leased to the contractor/developer, a facilities lease for the lease-back of the school building to the school district and a traditional construction agreement. In some ways, the arrangement resembles a Public-Private Partnership (PPP) whereby a public entity collaborates with a private entity for the purpose of financing and delivering a project traditionally provided solely by the public sector.

Potential Impacts on Commercial General Liability Coverage

This project delivery method is attractive for school districts because it allows them to finance the construction over time, alleviating budgetary constraints (significantly, the amounts payable under the multi-year lease are not considered government debt for purposes of the state’s constitutional debt limitation.) The arrangement also facilitates early contractor involvement, which can expedite project timelines. Furthermore, in certain states, such as California, the lease-leaseback arrangement also allows a school district to avoid competitive bidding requirements otherwise mandated by state law. All of these reasons make the lease-leaseback arrangement a very attractive project delivery method for public school construction.
 
However, while lease-leaseback arrangements have financial advantages to towns and municipalities, often enabling the construction of public schools that may not otherwise be financially viable, these types of agreements may have unforeseen consequences with respect to available liability insurance coverage. For example, some have theorized that these agreements render the contractor an “owner” or “lessor” of the project building, potentially implicating property damage exclusions j(1) and j(2) contained within the standard ISO¹  Commercial General Liability (“CGL”) insurance policy. The financial arrangement could also create complications with respect to the CGL’s “completed operations” coverage. A discussion of each of these issues is provided below.

Exclusion j(1) bars coverage for property damage to “property you own, rent, or occupy, including any costs or expenses incurred by you, or any other person, organization or entity, for repair, replacement, and enhancement, restoration or maintenance of such property for any reason, including prevention of injury to a person or damage to another's property…” Thus, insofar as the contractor is considered the “owner” of the school building, exclusion j(1) could apply to a liability claim brought against the contractor.

Certainly, such an argument is subject to challenge on several grounds. First, the statute’s purpose is to allow a flexible financing mechanism for school districts to afford school construction. There is no intent to allow a school district to transfer the fee title of the school or the site to a contractor during school construction. In fact, the various lease agreements executed for this arrangement typically include a provision that makes clear that the school district shall hold fee title to the school site, including the project site for the duration of the lease, and nothing in the lease shall change, in any way, the school district's ownership interest in the site. Second, the contractor does not act like a traditional “owner” in the sense that it doesn't pay taxes on the property as would be expected of a true owner. Finally, none of the relevant statutes seem to refer to the contractor as the owner [or lessor] of the school site or the building itself. 

Relatedly, it also would be improper to consider the contractor as the “lessor” or “lessee” of the construction site for purposes of applying j(1) to deny coverage. Although the lease/leaseback mechanism is built around a “lease,” it is certainly not a traditional lease where one party pays a monthly fee for the quiet enjoyment of a particular space. Instead, the statutory lease/leaseback arrangement was created solely to promote affordable school facilities for public school districts. The contractor/developer utilizes the space for the purpose of construction activities, not the peaceful enjoyment of the site. In other words, the contractor acts as a traditional contractor, not a lessor or lessee.  

There are similar issues with respect to exclusion j(2) which pertains to “premises that you sell, give away or abandon, if the ‘property damage’ arises out of any part of those premises.” In theory, the leaseback arrangement could be considered a sale of the premises. However, for the reasons outlined above, the application of exclusion j(2) to the lease/leaseback construction scenario is also subject to challenge. 

Finally, coverage for risks falling with the products-completed operations hazard may also be challenged. Completed operations coverage pertains to losses occurring after project completion and applies to “all ‘bodily injury’ and ‘property damage’ occurring away from premises you own or rent and arising out of ‘your product’ or ‘your work’…” (emphasis added). Here again, the perceived “ownership” or “lessor” status of the contractor, by virtue of the lease-leaseback arrangement, may present a coverage concern. 

Despite the reasons why the lease-leaseback arrangement should not be considered a traditional sale of property or lease arrangement, contractors engaged in public school construction projects in certain states would, nevertheless, be wise to proactively amend their CGL policies to remove exclusions j(1) and j(2) or modify these provisions such that they do not apply to contractors for those specific projects utilizing the lease/leaseback delivery arrangement. Likewise, adjustments should also be made to the CGL policy’s completed operations language. Contractors should seek an endorsement on their GL programs stating that the premises at which their work is performed for these specific leaseback projects will not be considered a premises the contractor “owns” or “rents” for purposes of accessing completed operations coverage if necessary. This, of course, will take negotiation with the contractors’ insurers to craft the appropriate limiting language to achieve the desired result.  

States Impacted

Lease-lease back agreements are commonly used in California. However, it is not the only state where these agreements are allowed by statute. Other states utilizing the lease/leaseback project delivery method include Florida² , Texas³, New York⁴, Illinois⁵, Virginia⁶, and Maryland⁷. There are subtle differences among the various states regarding the implementation and requirements to achieve the benefits of the lease/lease back mechanism, so contractors involved in such projects in these states should carefully consult the statutory requirements.

Conclusion

Contractors engaged in public school construction that is financed by use of a lease-leaseback agreement should consult with their brokers and general liability insurers to ensure that exclusions j(1) and j(2) are appropriately removed from their policies and that coverage for completed operations exposures is similarly preserved. 

The authors wish to thank Jacquelyn Matthews, Law Clerk, for research assistance with this article.
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¹ISO stands for “Insurance Services Office.”
²Fla. Stat. § 1013.15 and Fla. State § 1013.16 (2023)
³The Texas Public Property Finance Act, Title 8, Subtitle C, Chapter 271, Subchapter A
⁴New York Education Law § 403-a
⁵Illinois 105 ILCS 5/34A-501
⁶Virginia Code § 15.2-1816
⁷Maryland Code, Education Article § 4-126