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Wholesale Rates and Proposition 26, Newhall County Water District v. Castaic Lake Water Agency

Client Alert

Earlier this year, the Court of Appeal issued its decision in Newhall County Water District v. Castaic Lake Water Agency (“Newhall”). The court held a wholesale water agency’s rate structure, which included a charge for groundwater pumping (despite the fact it did not sell  groundwater to Newhall), violated Proposition 26.  

Summary of Newhall Decision

Newhall, a retail water purveyor, challenged the wholesale water rates adopted by Castaic Lake Water Agency (“Agency”), which sells and delivers water purchased from the State Water Project to four retail water purveyors in the Santa Clarita Valley.

Due to fluctuations in the demand for imported water, the Agency’s volumetric rates resulted in unstable revenues. The Agency examined rate structure options and adopted a rate structure with volumetric and fixed components, common in the industry. The first component was a fixed charge based on each retailer’s three-year rolling average of total water demand, which included the demand for the Agency’s imported water and for groundwater not supplied by the Agency. The second component was a variable charge based on a per acre foot charge for imported water.

The Agency adopted its rates based on the structure. Newhall sought a writ of mandate directing the Agency to rescind the rates, to refund payments, to refrain from charging for its imported water service with respect to  groundwater not supplied to Newhall, and to adopt a new rate structure. Newhall alleged the water rates were not proportionate to its benefits from, and burdens on, the Agency’s service, and violated Proposition 26 (Cal. Const., art. XIII C).

Under Proposition 26, a “tax” is defined to include any levy, charge, or exaction of any kind imposed by a local government, unless it falls within an exception. Under one such exception, government charges are exempt from voter approval if the charge is imposed for a specific government service or product provided directly to the payor, which is not provided to those not charged, and which does not exceed the reasonable costs to the local government of providing the service or product. (Cal. Const., art. XIII C, § 1, subd. (e)(2).) The agency bears the burden of proving, by a preponderance of the evidence, that its charge is not a tax, that the amount is no more than necessary to cover the reasonable costs of the government activity, and that the manner in which those costs are allocated to a payor bear a fair or reasonable relationship to the payor’s burden on, or benefits received from, the government activity.

The trial court concluded that the Agency’s rates did not meet this exception because the Agency based its imported water rate, in large part, on Newhall’s use of groundwater not provided by the Agency. Newhall’s use of its groundwater rights did not burden the Agency’s system, because the Agency  did not sell groundwater to Newhall. The wholesale water cost did not bear a fair or reasonable relationship to Newhall’s burdens on, or benefits from, the Agency’s activity.  The Court of Appeal affirmed this holding.

A.        The Proportionality Requirement

The Court of Appeal held the rates violated Proposition 26 because the method of allocation did not “bear a fair or reasonable relationship to the payor’s burdens on or benefits received from the Agency’s activity.” (Cal. Const., art. XIII C, § 1, subd. (e), final par.) This is referred to as the “proportionality requirement” or “reasonable cost allocation.”  The Court rejected the Agency’s argument that the proportionality requirement is measured collectively, and not by the burdens on or benefits received by the individual purveyor. The demand for a product the Agency does not supply could not form the basis for a reasonable cost allocation method required to be proportional to the benefits the rate payor receives from the Agency’s activities. (Newhall County Water District v. Castaic Lake Water Agency (2016) 243 Cal. App. 4th 1430, 1442.)

The Court also rejected the Agency’s reliance on Griffith v. City of Santa Cruz (“Griffith I”) because that case dealt with a different exemption in Proposition 26, the exemption for regulatory fees. The Court drew distinctions between “specific government service or products” and regulatory fees. It reasoned that a regulatory fee applicable to numerous payors can be related to the overall costs because it would be impossible to assess such fees based on the individual payor’s precise burden on the regulatory program. In Newhall, there were only four payors and no need to group them in classes to allocate costs, compared to the numerous payors in Griffith I. The Court stated, “where charges for a government service or product are to be allocated among only four payors, the only rational method of evaluating their burdens on or benefits received from, the government activity, is individually.” (Id. at 1443.)

B.        Rulings on Groundwater Management and Conservation Arguments

The Agency relied on Griffith v. Pajaro Valley Water Management Agency (Griffith II), in asserting its rates were justified based on the Agency’s role in managing the Basin water supply, including groundwater. The Court rejected this argument. In Griffith II, the defendant agency was created to manage water resources and empowered to levy groundwater augmentation charges. Here, the Agency was created to acquire, sell, and deliver water. The Agency was only authorized to act as a lead agency to develop and implement groundwater management plans but lacked “comprehensive authority” to manage the water resources of a local groundwater basin and levy charges related to groundwater. (Id. at 1447.)

Finally, the Agency argued its rates were justified by the California Constitution’s conservation mandate. The Court held an agency may structure its rates to encourage conservation; however, the conservation mandate cannot be read to eliminate Proposition 26’s proportionality requirements. The Court cited Capistrano Taxpayers Assn., Inc. v. City of San Juan Capistrano, which rejected a similar argument in the context of Proposition 218. 

For further information, please contact Christine Carson from Aleshire & Wynder, LLP'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.