On April 20, 2015, the California Court of Appeal issued an opinion in the Capistrano Taxpayers Association, Inc. v. The City of San Juan Capistrano.[1] In the opinion, the Court of Appeal affirmed, in part, and reversed, in part, the Orange County Superior Court’s September, 2013 decision regarding the City of San Juan Capistrano’s (the “City”) tiered rate system designed to charge varying rates based on the amount of water consumed.[2] The opinion is an important precedent as California seeks to regulate water usage during its historic drought.

The lawsuit arises from a water rate structure adopted by San Juan Capistrano in February, 2011. Specifically, the City constructed four budgets based on historical water usage: low, reasonable, excessive, and very excessive.[3] The City then imposed rates ranging from $2.47/ccf[4] for usage in the lowest tier to $9.05/ccf.[5] Notwithstanding the high rates charged to consumers in the third and fourth tiers, the new rate structure is revenue neutral.[6] Various percentages of the City’s costs were allocated among the rates being charged for each tier.[7] For example, rates paid by consumers in the first and second tiers were allocated entirely to cover fixed costs and source wells.[8] Rates paid by consumers in the third and fourth tiers included allocations to pay costs associated with a groundwater recovery plant, water purchased from other water districts, recycled water, and money set aside for penalties.[9]

In August, 2012, the Capistrano Taxpayers Association, Inc. (CTA) sued the City, challenging the rate structure’s lawfulness under Proposition 218.[10] Proposition 218 prohibits a public agency from charging taxes and fees that are greater than the "cost of service attributable to the parcel."[11] The CTA argued that the City’s rate structure violated Proposition 218 because the City did not incur higher costs per unit when providing water to customers in the higher tiers. The CTA also challenged the legality of fees imposed on all consumers to pay for the city’s recycled water system, arguing that residential customers do not use recycled water, and therefore the fee violated a Proposition 218 requirement that consumers be charged only for service that is actually used by, or immediately available to, him or her.[12] The trial court ruled in favor of the CTA on both issues.[13]

The Court of Appeal reversed the trial court’s finding that the city’s recycling fee violates Proposition 218.[14] The Court of Appeal held that the trial court improperly assumed that providing recycling water is fundamentally different than providing potable water because (1) all consumers are receiving the same service—delivery of water; and (2) a non-residential consumer’s use of recycled water frees up potable water for use by residential consumers.[15]

The Court of Appeal, however, also affirmed the trial court’s finding that the tiered-rate structure violated Proposition 218. The court held that, in order for the rate structure to be lawful, the City “had to do more than merely balance its total costs of service with its total revenues.”[16] The City had “to correlate its tiered prices with the actual cost of providing water that those tiered levels.”[17]

The Court of Appeal’s decision coincides with state and local efforts to address water usage during California’s historic drought. Going forward, public agencies must clearly demonstrate that increased rates directly correlate with increased costs of providing water to their high-volume customers when enacting tiered rate structures. The court’s ruling also does not address limits on use-penalties, which are typically exempted from Proposition 218. In sum, Capistrano Taxpayers Association, Inc. v. The City of San Juan Capistrano is likely one of the first of many high-profile water-related lawsuits to come, as public agencies, developers, businesses, and California’s agricultural industry adapt to drought conditions..