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Tiered Water Rates and Proposition 218, "Capistrano Taxpayers Ass’n, Inc. v. City of San Juan Capistrano"

Client Alert

On April 20, 2015, the Fourth Appellate District issued its long-awaited decision in Capistrano Taxpayers Ass’n, Inc. v. City of San Juan Capistrano (“San Juan Capistrano”).  The San Juan Capistrano decision expressly rejects the idea that tiered water rates are inherently unconstitutional pursuant to Proposition 218.  However, the decision also holds that a tiered rate structure unsupported by actual cost of service calculations for each tier is unconstitutional.  As a result, unless San Juan Capistrano is reheard by the Fourth District or reviewed by the California Supreme Court, tiered rate structures may be vulnerable to challenge to the extent they are not tied to identifiable, incremental costs correlating to the tiers.

The San Juan Capistrano decision also upholds the practice of charging the costs of future capital projects and the costs of various water sources to all ratepayers, even when those ratepayers do not directly use those projects or water sources.  However, the Court also concluded that those costs can be assessed against ratepayers only to the extent each project or water source is attributable, in some quantifiable manner, to the water service provided to those ratepayers

It is important to note that the San Juan Capistrano Court has not invalidated tiered rate structures in general.  The Court merely invalidated the specific rates before it.  Proposition 218 places the burden of proving the constitutionality of a challenged rate structure on the water service provider.  Here, the Court concluded that the administrative record did not provide sufficient support for each of the tier breaks or for the proportionate allocation of system-wide costs.  Because the water service provider failed to carry its burden, the Court held, the rate structure at issue failed to comply with Proposition 218.

San Juan Capistrano can be summarized as requiring agencies to “show their work.”  Although the Court represents it understands public agencies’ need to conserve water, it rejects the argument that the constitutional prohibition against the waste of water (Art. X, Section 2) requires or allows water service rates that exceed the cost-of-service limitations of Proposition 218.  As the Second District had previously concluded in City of Palmdale v. Palmdale Water District, the San Juan Capistrano Court concluded that both constitutional mandates must be harmonized.  The Court further noted that even if the two mandates could not be harmonized, the more recent Proposition 218 mandate would supersede Article X, Section 2. 

Lastly, it is important to note that the San Juan Capistrano Court also rejected the argument that conservation rates exceeding cost of service are exempt from Proposition 218 because they are “penalty rates.”  The Court reasoned that upholding this theory would create a loophole so large it would virtually repeal Proposition 218.  The imposition of penalties through the volumetric water rates themselves, in the Court’s view, would lead to setting a low water allocation subjecting ratepayers to “penalties” for anything and everything above and beyond that low water allocation.

The San Juan Capistrano decision comes at a time when the Governor has issued an Executive Order to address the drought, which states the State Water Resources Control Board shall direct urban water suppliers to develop rate structures and other pricing mechanisms to maximize water conservation.  While the Board has yet to issue proposed regulations on this directive, public water suppliers are now in the difficult position of harmonizing the competing directives from the State’s judicial and executive branches.  Moreover, they are left with few answers as to how much evidence or analysis would be sufficient to meet Proposition 218’s requirements as they pertain to tiered water rates.

Summary of the San Juan Capistrano Decision

San Juan Capistrano involves a taxpayer challenge to water rates charged by the City of San Juan Capistrano (“the City”).  In August 2012, the Capistrano Taxpayers Association (“the CTA”) challenged the City’s water rates in Orange County Superior Court.  The CTA alleged that two components of the City’s water rates – the tiered rate structure, and a monthly charge to recover the costs of recycled water service – violate Proposition 218, which prohibits fees that exceed the cost of service attributable to the parcel paying the fee, as well as fees for services that are not immediately available to the parcel.

The Orange County Superior Court agreed with the CTA.  As to the tiered rate structure, the Superior Court found that the City failed to carry its burden of establishing that the inequality between its tiers was based on the actual cost of providing service to those tiers.  As to the recycled water charge, the Superior Court found that the plain language of Proposition 218 prohibited the City from charging customers for recycled water if they did not actually receive recycled water.

The Fourth Appellate District affirmed the Superior Court’s holding that the City failed to adequately justify its tiered rate structure through cost-of-service considerations.  It reversed the trial court’s ruling, however, that all customers must directly receive recycled water in order to be charged for that water. 

A.        Tiered Rates Must Reflect the Cost of Service to Each Tier.

Under Proposition 218, the fee levied on an individual parcel may not exceed the proportional cost of service attributable to that parcel.  Proposition 218 places the burden of demonstrating compliance with this limitation on the agency charging the fee.

Applying these principles to the fee in San Juan Capistrano, the Fourth Appellate District found that the City had made no attempt to correlate the price of water at each tier with the cost of providing water service at that tier level.  Instead, the City had merely assigned to each tier a percentage of the total revenue it needed to cover its costs of providing water service.  The Court found that the City’s failure to correlate tier prices with costs of service – which the City acknowledged at oral argument – plainly violated the text of Proposition 218.

The Court rejected the City’s argument that another constitutional provision – Article X, Section 2’s conservation mandate – justified its rate structure, holding that while that mandate may justify the imposition of tiered water rates generally, Proposition 218 restricts the manner in which those tiered rates may be calculated and structured.  The Court also rejected the City’s reliance on an earlier Proposition 218 case, Griffith v. Pajaro Valley Water Management Agency, finding that Griffith could not be read to excuse water agencies from their duty to determine the actual costs of supplying water to various tiers of water usage.  Finally, the Court rejected the City’s characterization of its higher tiered rates as “penalty rates” outside the scope of Proposition 218, finding that accepting this characterization would create a loophole in Proposition 218 so large it would virtually repeal it.

B.        Recycled and Potable Water are Part of the Same Water Service.

Proposition 218 provides that fees may only be imposed for services that are actually used by the property owner paying the fee.  The Superior Court found that the City’s monthly recycled water charge – which was imposed on all customers – violated this mandate, since only some customers actually received and used recycled water.

The Fourth Appellate District rejected the Superior Court’s holding, finding that it was based on the unsupportable premise that providing recycled water is fundamentally different than providing traditional potable water.  Instead, the Court found each of these two types of water make up a part of the single service – water service – being provided by the City.  The Court further noted that providing non-potable water to some customers freed up potable water for other customers.  Finally, the Court cited to the new definition of “water” in the Government Code that recognizes water service is made up of a complex water portfolio involving the acquisition of water “from any source.”  This definition, the Court noted, does not distinguish between potable and non-potable water, and supports treating water service as including water procured through various sources and processes, including recycling and desalinization.

Although the Court found that levying the recycled water charge on customers who did not physically receive recycled water did not violate Proposition 218, it also found that the record was insufficient to determine whether the charge required low-consumption ratepayers to pay for new sources of water made necessary by other, higher-consumption ratepayers.  The Court noted that, if the recycled water charge did do this, it would violate Proposition 218, and remanded the case back to the Superior Court for resolution of this factual issue.

Conclusion

Tiered water rates have been one of the most common tools used to encourage water conservation.  The San Juan Capistrano decision limits the use of tiered rates for this purpose.  Perhaps anticipating backlash against its decision in light of California’s prolonged drought, the Fourth Appellate District’s introduction in San Juan Capistrano urges legislative action to address the dire circumstances the state finds itself in, while acknowledging its own duty to assess compliance with water plans put in place by voters and legislators of the past.  Governor Brown has already framed the San Juan Capistrano decision as “put[ting] a straitjacket on local government at a time when maximum flexibility is needed,” and a legislative or executive response to the decision is possible.[1]  Our office will continue to monitor the San Juan Capistrano proceedings, and keep our clients apprised of any judicial, legislative, or executive developments.

Full text of the decision: www.courts.ca.gov/opinions/documents/G048969.PDF

For further information, please contact June Ailin or Miles P. Hogan from Aleshire & Wynder's Water Practice Group at (949) 223-1170.

Disclaimer:  Aleshire & Wynder, LLP legal alerts are not intended as legal advice.  Additional facts or future developments may affect subjects contained herein.  Please seek legal advice before acting or relying upon any information in this communication.


[1] Sacramento Bee, “Jerry Brown calls tiered-water ruling ‘a straitjacket’ for conservation efforts” (April 20, 2015), available at http://www.sacbee.com/news/politics-government/capitol-alert/article19098585.html