On Monday, April 20, 2015 a California Court of Appeal in the Fourth District issued a decision declaring that the City of San Juan Capistrano’s (“City”) tiered water rate unconstitutional and a violation of California’s Proposition 218.  With local water providers around the state scrambling to impose water conservation measures, the court’s decision in Capistrano Taxpayers Association, Inc. v. City of San Juan Capistrano (“Decision”) eliminates a major tool used by local governments to curtail water usage.  The Decision implies that public water providers using a tiered water rate schedule need to demonstrate that those rates are based on the actual cost of providing service to each tier.

     (1)  Background.

The City used a popular industry manual, M-1, for establishing the rates it charged customers for receiving water service.  The City calculated total costs of providing water service to all customers, including the costs of recycled water capital improvement.  The City then divided all customers into different classes based on lot size.  Within each class of customers, the City established four categories based on the amount of water being used: low, reasonable, excessive, and very excessive.  Each category or tier was assigned a rate as follows: (1) low = base rate; (2) reasonable = base rate + 1/3 of base rate; (3) excessive = base rate + 1/2 of base rate; (4) very excessive = base rate + 5/6 of base rate.  The rates were set at amounts that would allow the City to collect enough funds to cover its cost of providing water services to all customers.  Essentially, the rates were designed so that the excessive water users were paying an increased rate to subsidize a discounted rate for lower water users.

The Capistrano Taxpayers Association sued claiming the rates violated the constitutional requirement under Proposition 218 that fees be limited to the cost of service attributable to the parcel.

     (2)  Capital Costs of Recycled Water.

A lower court found that it was unconstitutional for the City to include the costs of recycled water capital improvements in calculating the water rates since not all customers received recycled water.

The Decision overturned the lower court on this issue and found that a City could include the costs of recycled water capital improvements when calculating water rates for customers not using recycled water.  The Decision stated that water was provided through “holistic distribution system” and that the creation of recycled water for one customer made potable water available to another customer.  However, the Decision stated that the City still needed to show a connection between the customer’s use and the need for the improvement.

     (3)  Tiered Rate System.

The Decision affirmed the lower court determination that the City’s tiered rate system was unconstitutional under Proposition 218.  The Decision noted that a public agency has the burden to prove compliance with Proposition 218 when establishing or increasing a fee.  The court stated that the City could impose tiered rates based on usage levels if it could show that such rates correlated to the actual cost of providing water at those tiered levels.  The court noted that the City did not “try to calculate the actual costs of service for the various tiers.”

     (4)  Implications.

Public water providers using a tiered rate system that escalates based on water usage should ensure that those rates are supported by evidence that they reflect the actual cost of providing water service to customers within each tier and that they are receiving all services they are being charged for.  We will continue to monitor this case to see it if is appealed to the California Supreme Court.

For any questions regarding the Decision and its implications, please contact Doug White at (916) 468-0947 or doug@whitebrennerllp.com.