Source: s3://data.kl3m.ai/documents/govinfo/USCOURTS/USCOURTS-caed-1_07-cv-01199/USCOURTS-caed-1_07-cv-01199-3/pdf.json

Nature of Suit Code: 190
Nature of Suit: Other Contract Actions
Cause of Action: 28:1332 Diversity-Injunctive &amp; Declaratory Relief

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IN THE UNITED STATES DISTRICT COURT FOR THE

EASTERN DISTRICT OF CALIFORNIA

MODULAR SPACE CORP, fka RESUN )

LEASING, INC., a Delaware corporation,)

)

)

Plaintiff, )

)

v. )

)

SIERRA KINGS HEALTH CARE )

DISTRICT, a California local public )

entity, )

)

Defendant. )

____________________________________)

CV F 07-1199 AWI GSA

ORDER ON DEFENDANT’S

MOTION TO DISMISS

COMPLAINT PURSUANT TO 

F.R.C.P. 12 (B)(6)

Doc. # 12

This is an action in diversity for declaratory relief by plaintiff Modular Space

Corporation, formerly known as Resun Leasing, Inc. (hereinafter “Plaintiff”) against

defendant Sierra Kings Health Care District (“Defendant”). Plaintiff is a Pennsylvania

construction firm that entered into a contract with Defendant to provide specified

infrastructure work on a hospital expansion and improvement project at Defendant’s hospital

birthing center. For reasons not related to this action, Defendant terminated the construction

contract with Plaintiff for cause and filed a claim against Plaintiff’s performance bond. 

Plaintiff’s suit against Defendant seeks declaratory judgment that the construction contract

and a subsequent change order between Plaintiff and Defendant were void ab initio. 

In the instant motion, Defendant moves to dismiss the complaint on the ground that

Plaintiff’s challenge to the validity of the construction contract and the subsequent change

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The resolution, submitted as exhibit “A” to the complaint indicates that Defendant 1

had previously advertised for and received bids, but the bids received were non-conforming to

the bid specifications. 

2

order is time-barred pursuant to California Code of Civil Procedure, section 860. Diversity

jurisdiction exists pursuant to 28 U.S.C., section 1332. Venue is proper in this court.

PROCEDURAL HISTORY AND FACTUAL BACKGROUND

The complaint in this case was filed on August 16, 2007. The instant motion to

dismiss was filed on October 10, 2007, Plaintiff’s opposition was filed on November 2, 2007,

and Defendant’s reply was filed on November 9, 2007. The matter was taken under

submission as of November 19, 2007.

Defendant is a local health care district organized pursuant to California Health and

Safety Code, section 3200 et seq. Defendant operates a public hospital in Reedley, California

named “Sierra Kings District Hospital” (hereinafter “Hospital”). On March 9, 2006,

Defendant past a resolution authorizing the Hospital’s Chief Executive Officer to negotiate

and enter into a contract for construction of an addition to the hospital’s birthing center and

emergency room/radiology/clinic areas (the “Project”) without advertisement or inviting

other contractors to bid. On or about August 25, 2006, the Hospital’s CEO, or his designee, 1

signed a purported cost plus contract (the “Contract”) for a maximum price of $2,496,185.40. 

On or about November 15, 2006, the Hospital’s CEO signed a change order (the “Change

Order”) increasing the scope of Plaintiff’s work and increasing the Contract maximum price

by $9,449,675.50 to a total of $11,945,860.90. At Defendant’s insistence, Plaintiff

purchased payment and performance bonds in the penal sum of the total maximum price of

the Contract after the Change Order.

The complaint alleges that Plaintiff commenced work on the Project in September

2006, and continued work on the Project through April 25, 2007, incurring costs of

approximately $800,000 under the Contract and $500,000 under the Change Order. On April

25, 2007, Defendant issued a notice of termination of the Contract for cause. Immediately

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thereafter, Defendant filed a claim against Plaintiff’s performance bond. Plaintiff has

submitted claims for payment of work done before the termination of the Contract, but has

not received payment. The issue of whether termination of the Contract was proper is

currently in arbitration. However, Plaintiff has requested the arbitration be stayed pending

the outcome of this action.

The resolution of the instant motion to dismiss turns, at least in part, on the nature of

the funding for the Project. Defendants alleged the following with respect to the funding for

the Project in their motion to dismiss. The alleged facts are not disputed unless otherwise

noted.

The [P]roject is being funded through a combination of revenue bonds

and general obligation bonds, consisting of : (a) general obligation bonds

issued in 2003, (b) revenue bonds issued in 2006, and (c) general obligation

bonds issued in 2007. With regard to the revenue bonds Resolution No. 208

of the Board of Directors of the District, adopted June 8, 2006, authorized the

issuance of revenue bonds, in an amount not to exceed $9,000,000, of which

an amount not to exceed $4,000,000 was allocated for “financing the

remodeling, expansion, improvement, and equipping of the health facilities

owned and operated by the District and for reimbursing the District for costs

thereof previously made . . .” [citations to requests for judicial notice omitted]. 

The revenue bonds were issued in two series, with Series A in the amount of

$5,940,000 closing on July 31, 2006, and Series B in the amount of

$1,400,000 closing on September 11, 2006. [Citations to requests for judicial

notice omitted].

The purpose of the bond proceeds, as well as the relationship between

the completion of the Project and the repayment of the bonds, is set forth in

the Final Official Statement for each of the Series A and Series B bonds as

follows:

Firstly, the proceeds of the revenue bonds were intended to be used for

the construction of the [H]ospital addition which was the subject of the

Construction Contract [with Plaintiff] and the [C]hange [Or]der. [Citation to

requests for judicial notice omitted]. In that regard the “project Description”

at page 8 of the Final Official Statements describes the project being financed

as including “. . . an approximately 8,000 square foot Birthing Center

expansion and an approximately 16,000 square foot expansion of the

Emergency Department, radiology Department, lobby and laboratory . . .” and

specifically refers to [Plaintiff Construction Company].

Secondly, the Final Official Statements each state, at Page 1, that the

repayment of the bonds is to be solely from the District’s Revenues, and that

the bonds are secured by a pledge of the Revenues. [Citation to request for

judicial notice omitted]. The final Official Statements, at Page 9, each refer to

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the Indenture of Trust for the definition of the term “Revenues,” which term is

defined at Page 12 of the Indenture of Trust as “all revenues, income, receipts

and moneys received by or no behalf of the District, excluding gifts, grants,

bequests, donations and contributions . . .” [Citations to requests for judicial

notice omitted]. As such, “Revenue” is the operating income of the District.

Doc. # 12-3 at 8:1 - 9:3.

DISCUSSION

The resolution of Defendant’s motion to dismiss turns on whether the construction

Contract between Plaintiff and Defendant is subject to validation pursuant to section 860 et

seq. of the California Code of Civil Procedure (hereinafter “section 860"). Pursuant to

section 53511 of the California Government Code (hereinafter “section 53511):

A local Agency may bring an action to determine the validity of its bonds,

warrants, contracts, obligations or evidences of indebtedness pursuant to

[section 860] of the Code of Civil Procedure.

Pursuant to section 860, a validation action may be brought by a public agency “within 60

days of ‘the existence of any matter which under any other law is authorized to be determined

pursuant to [the validation statutes].’” Kaatz v. City of Seaside, 143 Cal.App.4th 13, 29 (6th

Dist. 2007) (quoting section 860). “And where the public agency does not initiate a

validating proceeding under section 860, ‘any interested person may bring an action within

the time and in the court specified by Section 860 to determine the validity of such matter.’

[Citation.]” Id. at 30 (quoting California Code of Civil Procedure, section 863). However, an

individual validation action (sometimes referred to as an “inverse validation action”) is

subject to the same 60-day time limit as a validation action by a public entity. California

Code of Civil Procedure, section 869; Kaatz, 143 Cal.App.4th at 30. “Thus, insofar as

section 863 provides that an interested person ‘may’ bring a validating proceeding, the statute

‘seems innocuous enough . . . section 869 says he must do so or be forever barred from

contesting the validity of the agency’s action in a court of law.’ [Citation.]” Id. (quoting City

of Ontario v. Superior Court, 2 Cal.3d 335, 341 (1970)).

There is no dispute in this case that Plaintiff did not bring the instant action

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challenging the validity of the Contract or the Change Order within the 60-day time limit

imposed by section 869. Thus, there is no doubt that, if the Contract is an agency action that

is subject to the validation process pursuant to section 53511, Plaintiff’s action is time-barred

and Defendant is immunized from any challenge to the validity of the Contract.

The validation procedures provided by California Code of Civil Procedure, sections

860 through 870 serve two basic functions. First and foremost, sections 860 through 870 are

intended “to ensure the ability of public agencies to obtain timely validation of their bonds.”

Kaatz, 143 Cal.App.4th at 39. Second, these sections are intended to “‘“clarify the time

within which an appeal may be taken in a validation proceeding, and thus accelerate the

finality of these proceedings.” [Citation.]’ The Senate committee analysis noted that

validation actions are most commonly used to secure a judicial determination that a

government entity’s proposed issuance of bonds is valid.” Id. (italics in original). 

“Assurance as to the legality of the proceedings surrounding the issuance of municipal bonds

is essential before underwriters will purchase bonds for resale to the public,” Friedland v.

City of Long Beach, 62 Cal.App.4th 835 842 (2nd Dist. 1998). 

The validation procedure does not identify what actions of public entities are subject

to validation proceedings. Government Code section 53511 is the section referenced in the

instant case as authorizing the validation procedures of sections 860 through 870 with respect

to the Contract and Change Order. Although Government Code section 53511 places no

express restriction on the word “contract,” California courts have determined that the

legislative history of the statute necessitates a restricted meaning. See City of Ontario, 2

Cal.3d at 343-344 (reasoning a restricted interpretation of “contracts” in section 53511 based

on stated legislative intent, statutory context, and legislative history). In general, California

courts have held that the “contracts” referred to by section 53511 are restricted to those

contracts involve financing and financial obligations. Friedland, 62 Cal.App.4th at 843. 

Contracts, such as vendor contracts, that do not involve bonds, indebtedness or financing are

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not normally considered subject to validation. Fontana Redevelopment Agency v. Torres,

153 Cal.App.4th 902, 909 (4th Dist. 2007). 

Defendant relies primarily on Graydon v. Pasadena Redevelopment Agency, 104

Cal.App.3d 631 (2nd Dist. 1980) (“Graydon”) for the proposition that the Contract and the

Change Order are agency actions that fall within the scope of actions subject to validation

pursuant to section 53511. In Graydon a taxpayer filed an action for mandamus seeking to

invalidate a construction contract that was awarded without competitive bid for the

construction of an underground parking facility over which a shopping area would be built by

other contractors as part of a community redevelopment plan. Id. at 634-635. The project in

Graydon was financed by tax allocation bonds that were to be repaid partly from tax

increments generated by the Retail Center that was to be built on top of the underground

parking structure. Id. at 638. 

After hearing and consideration of facts submitted by the parties, the Graydon court

issued findings of fact and conclusions of law wherein the court found, “[t]he ability of the

[redevelopment agency] to operate and accomplish its statutory purpose and the purposes of

the [redevelopment] Plan would be substantially impaired unless the [no-bid construction

contract being contested] is subject to a prompt validation procedure.” Id. at 639. Based on

the trial court’s factual determinations, the appellate court in Graydon concluded the bonds

for the construction project:

 “. . . were intimately and inextricably bound up with the award of [the]

contract. Delay in the completion of the retail center because of the delay

which would inevitably have resulted if the contract had been competitively

bid would have a direct bearing on the financial ability of [the redevelopment

agency] to meet its financial obligations and statutory purpose.

Id. at 646. Based on this conclusion the Graydon court held the no-bid contract at issue in

that case was subject to the validation procedure commencing with section 860. Id.

Defendant’s basic argument is that the factual situation in the instant action places the

Contract and Change order within the scope of Graydon and the more recent case of

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California Commerce Casino, Inc. v. Schwarzenegger, 146 Cal.App.4th 1406 (2nd Dist.

2007). In both these cases, the contracts being challenged created either directly, as in

California Commerce Casino, or indirectly, as in Graydon, revenue streams that funded

repayment of bonds. As such, the contracts in these cases were found by their respective

courts to be “‘inextricably bound up’ with the use of the income stream created by

[contractual agreements] and with the bonds to be issued.” California Commerce Casino,

146 Cal.App.4th at 1430 (quoting Graydon, 104 Cal.App.3d at 646). Defendant contends the

Contract being challenged in this case comes withing the scope of contracts subject to the

validation procedure because, as in Graydon and California Commerce Casino, the Contract

and Change order are “ inextricably bound up” with the revenue stream that will be generated

to guarantee payment of that portion of the Project being funded by the revenue bonds. This

court disagrees.

First, the court must conclude, based on the fairly small number of cases interpreting

the issue of applicability of the validation procedure to contracts, that each case is based on

an individualized examination of the demonstrated effects of the contract at issue on the

income stream that secures the bond being issued. For example, in Graydon there are

findings of fact that both the trial court and appellate court rely upon to show that the

challenge to the contract will result in a delay in the project of a specified number of months

that will result in a loss to the revenue stream of an identified amount of money. See

Graydon, 104 Cal.App.3d at 645-646 (concluding that a loss of $1,556,000 would occur if

plaintiffs challenge to the contract in question was successful). Similar analyses are

undertaken in Kaatz and California Commerce Casino. In other words, a contract is not

subject to validation because it falls within a certain class of contracts, it is subject to

validation because there is a demonstrated impact of a challenge to the contract on the

income stream that supports the bond or debt.

In the instant case, there is an allegation that the Contract and Change Order are

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“inextricably intertwined” with the income stream supporting payment of the bonds, but there

is absolutely no offer of evidence to show how, under the facts of this case, a challenge to the

validity of the Contract or Change Order will have any effect at all on the Hospital’s income

stream. The Project is funded, so far as the court can discern, from bonds that have already

been sold and are to be repaid in part from revenues generated by operation of the Hospital,

not from revenues that are confined to operation of the Project. Defendant does not allege the

extent to which the Project, when completed, is expected to enhance the revenue stream

produced by the Hospital, if at all. There is consequently no indication to what extent the

revenue stream would be diminished by a delay caused by a challenge to the Contract, or that

a challenge would cause any delay in Project completion or diminution of revenue at all. 

Even if Defendant had presented facts to show how a delay caused by a challenge to

the Contract or Change Order might have cause a diminution of the income stream at some

time in the past, there is no indication of how a challenge to the Contract or Change Order

now could possibly cause delay or a loss of income now. As facts now stand, if there is any

delay, it has been caused by Plaintiff’s non-performance, not by a challenge to the validity of

the Contract or Work Order. If work is to resume, it will presumably resume as a result of a

new construction contract that will be entered into by a different construction firm, and

Plaintiff’s suit does not challenge the validity of any third party contract that might later be

executed.

The court’s focus on the situation as it now stands is purposeful. Implicit in

Defendant’s argument is the proposition that, if the Contract or Change Order were subject to

the validation procedure of section 860, et seq. at the inception of either, then both are subject

to the restrictions of the validation procedure now, regardless of the current facts. The court

finds this implicit argument unsupported by the authority reviewed, and further finds that the

legal theory implicit in Defendant’s argument would, if implemented, work a disservice on

the policy purposes served by the validation procedure. Through the validation procedure,

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the concerned citizen wishing to challenge the validity or wisdom of an agency action gives

up substantial leeway in deciding when to bring an action so that the agency issuing bonds

does not suffer undue financial impediment due to uncertainty as to the validity of the bond

offering or uncertainty as to its ability to repay the bonds. The substantial restriction on the

interested citizen’s right to sue is justified by the public benefit that is realized. Conversely,

it is difficult to justify restrictions on the right of an interested citizen to challenge the validity

of a public action where there is no actual purpose to be served by the restriction. That is the

case here.

The court is struck by the fact that in this case Plaintiff is not trying to challenge an

agency improvement project or the funding thereof; Plaintiff is simply trying to defend

against Defendant’s claim against the performance bond. Similarly, Defendant is not an

agency whose ability to fund or complete its project is being threatened by a challenge to the

validity of its actions. Whether the Contract or Change Order might be challenged or

ultimately found invalid is completely immaterial to project funding or project completion, so

far as the court can tell. If the Project is currently delayed, it is delayed because of Plaintiff’s

non-performance, not because of any challenge to the Contract or Work Order. Defendant

does not contend that its ability to generate revenues to pay the bonds depends on its ability

to successfully make a claim against Plaintiff’s performance bond.

California’s validation process serves an important purpose, but does so at no small

cost to concerned taxpayers. This court is disinclined to apply California’s validation process

in a situation where there is no discernable benefit to the important policy considerations

served by the validation process.

Because the court finds California’s validation procedure is inapplicable under the

facts of this case and will deny Defendant’s motion to dismiss on that basis, the court

declines to address Plaintiff’s alternative arguments in opposition to the motion to dismiss.

The court hereby grants Defendant’s request for judicial notice to the extent that the

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materials submitted support Defendant’s factual allegations set forth in their motion to

dismiss and response to Plaintiff’s opposition to the motion to dismiss.

THEREFORE, for the reasons discussed, Defendant’s motion to dismiss Plaintiff’s

complaint is hereby DENIED.

IT IS SO ORDERED.

Dated: January 31, 2008 /s/ Anthony W. Ishii 

h2ehf UNITED STATES DISTRICT JUDGE

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