## Facts

- Los Angeles County Waterworks District No. 37 (District) entered into a 1989 master service agreement (MSA) connected to construction and financing of the “Acton III Water Improvements,” a water system funded through Mello–Roos community facilities district (CFD) bonds.
- The MSA contemplated that costs of the improvements would be shared, including a “fair share” concept for future development connected to the system.
- Tower Acton Holdings, LLC and Sierra Highway Partners, LLC (plaintiffs) later acquired interests tied to the project (including defaulted Mello–Roos bonds and real property subject to Mello–Roos special taxes) and claimed rights under the MSA as intended third-party beneficiaries.
- Plaintiffs sought to recover or spread project costs through a “reimbursement agreement” with the District addressing how later development would contribute to the improvements and on what financial terms.
- During reimbursement discussions, the parties executed a confidentiality agreement providing that information derived from the negotiations could not be used in later litigation and that the confidentiality obligations would continue unless terminated in writing by either party.
- The District declined to accept plaintiffs’ proposed reimbursement terms, taking the position that statutory limits in the Public Contract Code constrained the term and interest rate it could agree to and disputing whether certain properties should be included in the reimbursement base.
- Plaintiffs notified the District of a potential claim but continued discussions; they ultimately filed suit alleging breach of contract (the MSA) and breach of the implied covenant of good faith and fair dealing.
- At trial, the court concluded the confidentiality agreement ended when plaintiffs filed the complaint and admitted evidence of negotiation communications occurring after that filing.
- The jury returned a 9–3 verdict for plaintiffs and awarded $10,000,000 in damages; the trial court also entered an attorney-fee award in plaintiffs’ favor.
- The District appealed, arguing (among other points) that the trial court incorrectly treated the Public Contract Code as inapplicable and improperly admitted settlement/reimbursement negotiation evidence.

## Issues

1. Whether the Public Contract Code governed and limited the District’s authority to enter into a reimbursement agreement for the water improvements, such that the District could not lawfully agree to plaintiffs’ requested terms.
2. Whether the trial court erred by admitting evidence of the parties’ settlement/reimbursement negotiations, including evidence covered by the confidentiality agreement, to prove breach and alleged bad faith.
3. Whether, after applying the correct statutory limits and excluding improper negotiation evidence, substantial evidence supported findings that the District breached the MSA or violated the implied covenant of good faith and fair dealing.

## Decision

- The Court of Appeal held the Public Contract Code applied to the District and limited its authority to enter reimbursement agreements for oversized water facilities, including limits relevant to the term and interest rate the District could agree to.
- The court held the trial court committed prejudicial error by instructing the jury that the Public Contract Code did not apply and by admitting evidence of settlement/reimbursement negotiations over the District’s objections.
- The court rejected the view that the confidentiality agreement terminated simply because litigation was filed; the agreement remained effective absent written termination as the parties had specified.
- The court concluded there was no substantial evidence that the District breached the MSA or acted in bad faith; plaintiffs’ theory depended in significant part on the District’s refusal to accept terms the District lacked authority to accept.
- The judgment for plaintiffs was reversed, and the Court of Appeal directed entry of judgment for the District; the attorney-fee award in plaintiffs’ favor fell with the reversal.

## Legal Principles

- A public entity’s contracting power is defined and limited by statute; it cannot be held liable for refusing to enter an agreement on terms the law does not allow it to accept.
- An implied covenant of good faith and fair dealing cannot be used to impose obligations that would require a party—especially a public entity—to act beyond its lawful authority.
- Evidence of settlement or compromise negotiations is not admissible to prove liability on the disputed claim, and it is not made admissible simply by labeling it proof of “bad faith” when bad faith is part of the liability theory.
- Contractual confidentiality provisions governing negotiation communications are enforced according to their terms, including an agreed requirement that termination occur in writing.
- When trial error is prejudicial and the record, under the correct legal rules, lacks substantial evidence to support the verdict, an appellate court may reverse and direct entry of judgment for the appellant rather than order a new trial.

## Conclusion

The Court of Appeal reversed the $10 million verdict for Tower Acton Holdings and Sierra Highway Partners because the trial court wrongly treated the Public Contract Code as inapplicable and admitted settlement/reimbursement negotiation communications despite statutory settlement-evidence limits and a confidentiality agreement that continued absent written termination; applying the correct legal limits, the court found no substantial evidence of breach or bad faith and ordered judgment entered for the District.


Tower Acton Holdings, LLC v. Los Angeles County Waterworks District No. 37, 129 Cal. Rptr. 2d 640 (2002)