Those who have been waiting for the California Supreme Court to rule on what has been touted as the longest-pending undecided case will only be partially mollified by the high court's decision.

On January 31, 2011, the Supreme Court decided California Farm Bureau Federation v. State Water Resources Control Board (Supreme Court Case No. S150518), in which a collective of California water right holders challenged the State Water Board's water right fee program on the grounds that the fees impose an unconstitutional tax, in violation of Proposition 13, rather than a permissible user fee. The unanimous ruling, by Justice Carol A. Corrigan, affirmed the Court of Appeal's conclusion that the water right fee statutes are facially constitutional, but remanded for further fact finding on the question of whether the user-fee program is unconstitutional as applied.

This lawsuit began in 2003, when the California State Legislature passed amendments to the Water Code requiring the State Water Resources Control Board ("Water Board") to collect user fees necessary to support the work of its Water Rights Division. The Water Code amendments require the Water Board to adopt a schedule of annual fees to be paid by each state permit and license holder, and for the federal contractors regarding the rights held by the U.S. Bureau of Reclamation ("Bureau"). The amendments provide that the Water Board shall set the schedule of fees so that the total amount of fees collected equals the amount necessary to recover costs of administering the water rights program. These amendments shifted the funding of the State's water rights program from the general fund to these annual user fees.

In response to the legislative amendments, the Water Board adopted emergency regulations setting forth formulas to calculate the fiscal year 2003-2004 annual fees for permit and license holders. Fee notices were sent to water right permit and license holders in January 2004, and hundreds of water right holders responded by paying the fees under protest, and by joining in the lawsuit to challenge the constitutionality of the fee program. Each year since, the Water Board has adopted an annual fee schedule and many water right holders have responded by paying under protest, while they awaited a decision in this case.

Plaintiffs argued that the fee program was unconstitutional on its face and as applied. Regarding the facial challenge, plaintiffs argued that the fee imposed a tax, not a regulatory fee. Proposition 13 requires, in part, that all new taxes in California be adopted by a two-thirds vote of the Legislature. The Water Code amendments establishing the fee system were adopted by a vote of 53%. Stated generally, a "tax" is imposed to generate revenue, unconnected to any specific benefit enjoyed or conferred. A "fee" pertains to the reasonable costs of providing services necessary to regulate the activity for which the fee is charged. Plaintiffs' argument was based, in part, on the assertion that water rights are a property right and the fees, therefore, are based by virtue of real property ownership. A fee based merely on ownership of real property, they argued, is a tax. The Supreme Court dismissed this argument, finding instead that the water rights at issue are "usufructuary" only, and the water rights regulatory program results from disputes over the right to use water. The Court concluded, therefore, that the fee program establishes a regulatory fee for the purposes of paying the costs of administering a regulatory program, thus requiring a simple majority vote of the Legislature.

Plaintiffs also argued, however, that the fee is unconstitutional as applied by the Water Board, because the adopted fee schedule is disproportionate to the benefit derived by the fee payors and, therefore, the fee operates as a tax that is subject to the two-thirds vote. In particular, plaintiffs argued that the activities of the Water Rights Division benefit all water right holders and the general public, and that the Water Board is required to recover the Division's total operating costs. However, the legislation authorizes the Water Board to collect 100% of the fees from only 40% of water right holders. This is because the Water Board has authority to regulate water rights that are not subject to permits and licenses, but only permit and license holders are required to pay fees. This is also because of the way the fee system imposes fees against water users who have contractual rights to the delivery of water from the Bureau under the permits and licenses held by the Bureau. Specifically, the water right contractors have rights to about 5% of all the Bureau's permitted and licensed water rights, but the fee regulations require the contractors to pay the entire amount of annual fees that would otherwise be imposed on the Bureau. The Supreme Court found that there was insufficient factual evidence to determine whether the fees are disproportionately assessed on water right permit and license holders and on federal contractors. The Court noted that the question is further complicated by the fact that not all water right holders are required to pay the fee.

Ensuring that this fiercely contested saga will continue, the Supreme Court directed the Court of Appeal to remand the case to the trial court for further factual findings concerning (1) the amount of time the Water Board spends servicing and regulating water right permit and license holders as compared to other water users and, therefore, whether the fees are reasonably proportional to the costs of the program, and (2) the federal contractors' beneficial interest in the water right program and the value of that interest.

In the seven years since this battle began, water right holders subject to the fees have paid those fees under protest, with the hope that fees will be refunded if they prevail in the lawsuit. Those water right holders will have to keep waiting—and keep paying—while the trial court makes additional findings to determine whether the fee statutes, as applied, are reasonably apportioned. One thing is certain: the fee program will continue in some form. Plaintiffs did not achieve their primary goal of having the entire fee program invalidated. Their only hope now is to obtain modifications to the fee regulations that shift the fee burdens so that fees are proportional to the benefits received. Fee shifting, however, may result in some water users shouldering an increased burden and others having a decreased burden. This decision has the potential, therefore, to pit water permit and license holders against federal contractors to allocate fair share.

In this age of budget deficit and financial crisis, the legislative determination to shift funding from the general fund to regulatory fee programs is not limited to the water right fee program. This decision highlights that regulatory agencies must carefully develop their fee programs, but it can also be viewed as a green light for the Legislature to continue looking for opportunities to shift funding sources away from the general fund. Of course, the Legislature will have to proceed more carefully than it did in 2003, following the November 2, 2010 voter approval of Proposition 26, which requires a two-thirds approval to enact certain fees.