California's local water suppliers, hit with reduction requirements varying from 8% to 36% and potential penalties of up to $10,000 per day for noncompliance, are scrambling to figure out how to comply with these severe cutbacks. According to Governor Brown's April 1, 2015, Executive Order, urban water suppliers are to develop rate structures, including surcharges, fees and penalties, to maximize water conservation. But a just-released case may jeopardize efforts to impose conservation-based water supply charges, at least without a careful cost study on which to base the rates.

On April 20, 2015, the Fourth District Court of Appeal issued its widely-anticipated decision in Capistrano Taxpayers Association Inc. v. City of San Juan Capistrano, ruling that tiered rate structures designed to encourage water conservation, such that high users pay a progressively higher fee, violate Proposition 218 if they are not tied to actual costs of service. This decision is likely to have a significant impact on water suppliers attempting to comply with the Governor's April 1, 2015, Executive Order, and the yet-to-be-finalized regulations from the State Water Resources Control Board setting reduction requirements for urban water suppliers.

The City’s Tiered Water Rates

Proposition 218, enacted by California's voters in 1996, imposes certain procedures, requirements and voter approval mechanisms for local government assessments, fees and charges. In the Capistrano Taxpayers Association Inc. case, two of Proposition 218's requirements—that fees for providing a property-related service, such as water delivery, must be proportional to the cost of providing that service, and that fees cannot be charged for a service unless the service is actually used by, or immediately available to, the property owner—were raised in a challenge to the City of San Juan Capistrano's tiered water rates.

To promote water conservation, the rates charged by the City to its customers increased exponentially depending on the level of use by the customer. The rate schedule started with a base rate, Tier 1, aimed at basic water needs for indoor use only. From there, a 33.33% rate increase was imposed for Tier 2 users, a 50% increase from Tier 2 rates was added for those in Tier 3, and another 83.33% increase from Tier 3 was added for the highest-volume users in Tier 4. The taxpayers association contended that the rate increases were not proportional to the cost of providing water service, as required under Proposition 218. Moreover, the association claimed that the City violated Proposition 218 by charging its ratepayers a fee for recycled water services and delivery, even though recycled water was not available to all ratepayers. The City justified its fees by pointing out the additional burdens placed on the system by higher users, characterizing the higher rates as a regulatory penalty designed to change behavior, and noting the benefit provided to all ratepayers from water recycling by displacing demand for local potable supplies. However, the City admitted that the tiered rates were not tied to the actual costs of service.

Progressively Tiered Rates Must Be Tied to the Actual Cost of Providing Service to Each Tier

The court of appeal ruled that the City failed to comply with Proposition 218 in setting its tiered rates. Although a water agency may set rates that go up progressively in relation to usage in compliance with Proposition 218 if the tiers correspond to the actual cost of providing the service at each given level of usage, the City failed to calculate the cost of actually providing water at its various tiers. The City had argued that Article X, Section 2, of the California Constitution, mandating reasonable and beneficial use of water, supported its rate structure, but the court found that nothing in Article X, Section 2 required water rates to exceed the true cost of supplying that water. Indeed, the court concluded that pricing water at its true cost is compatible with conservation and prevention of waste. The court observed that passing on the incrementally higher costs of expensive water to incrementally higher users seemed like a good idea. However, to do so, the water agency must determine the true cost of that more expensive water. Moreover, simply calling the higher-tiered rates "penalties" or "conservation rates" did not exempt the City from constitutional requirements.

The City did obtain some relief, however, as the court found that Proposition 218 did not prohibit it from passing on capital costs of water supply improvement projects, such as a recycling plant, to its customers. Water service is immediately available to all of the City's customers and continued water service is assured by such capital improvements. "Service" need not differentiate between types of water delivered; providing recycled water is not a fundamentally different kind of service from providing traditional potable water. The court threw in an important caveat, though—if fees that include recycling facility costs are imposed on low-level water users such that the fees exceed the cost of service to those customers because their levels of consumption do not make capital investments in recycling necessary, Proposition 218 may be violated.

Implications of Capistrano Taxpayers Association Inc.

The coming months may see an array of new fees and charges imposed on water users as suppliers grapple with the new emergency conservation regulations. Such fees and charges should be carefully reviewed by legal counsel to ensure that they comply with Proposition 218, both procedurally and substantively.