A three-judge panel of the California Court of Appeal for the Third District heard oral argument last week in the longstanding companion cases challenging the legality of AB 32’s cap and trade auctions. California Chamber of Commerce v. California Air Resources Board and Morning Star Packing Co. v. California Air Resources Board. The questions most frequently posed by the Justices related to the nature of payments made for greenhouse gas (“GHG”) emission credits, a contributor in the billions of dollars to the state general fund for programs designed to reduce greenhouse gasses.

The plaintiffs in the lawsuits, the California Chamber of Commerce and Morning Star Packing, a processor of bulk tomato products, claimed that the auction scheme created by AB 32, and in particular revenues generated by the auctions, constituted either illegal taxes (since the auction process and revenues had not been approved by the voters or the legislature by the required two/thirds vote) or were illegal regulatory fees under the standards established by the California Supreme Court in its Sinclair Paint Co. v. State Board of Equalization decision (since the State had failed to demonstrate the necessary nexus between the charges and the regulatory purpose of the GHG law.)

While the California Air Resources Board (“CARB”) disputed the plaintiffs’ assertion that the auction revenues violated either Prop 13 or the standards in Sinclair Paint, in a Supplemental Letter Brief to the Court and during oral argument, CARB raised a novel, but not unique, argument that the auction process generated neither taxes or regulatory fees, but rather was “something else,” referred to in the Letter Brief as “compliance instruments” that were neither taxes nor regulatory fees. Plaintiffs asserted in counter argument and in their Supplemental Letter Briefs to the Court that there were no legal options other than a tax or a regulatory fee under California law as set forth in Sinclair Paint. However, in response to a question from the Court, CARB argued that Sinclair Paint had not established a “binary world,” asserting that the auctions performed regulatory functions such as providing equity and transparency outside the tax/regulatory fee analytical framework.

AB 32, enacted by the California State Legislature in 2006, put in place a system of greenhouse gas auctions as a way to facilitate the reduction of GHG emissions in the State by requiring emitters to purchase credits as a way to allow them to exceed GHG reduction targets. Emitters can purchase, through an auction process held quarterly, credits allowing them to emit greenhouse gasses in excess of the allowances permitted to them by the State. The intent of the program is to reduce allowable emissions over time, forcing emitters to purchase additional allowances, reduce GHG emissions through improved technologies or by finding other ways to reduce greenhouse gasses.

A decision of the Court of Appeal is expected by April 24. Based on the Justice’s questions, observers believe that the Court will affirm the trial court decision allowing the program to continue.