San Juan Capistrano’s Water War

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A court battle with state-wide implications is being waged over water rates in San Juan Capistrano (“SJC”). At issue is whether SJC’s water rates violate California’s Proposition 218, which holds that rates for essential services must be based on the actual cost to deliver the service. Proposition 218 is an important protection for rate payers, as it prevents utility agencies from gouging customers for a necessary service like water.

In SJC’s case, the plaintiff claims that the City of SJC is billing more for water than what the actual cost is to deliver it to customers. The City justifies the unusually high rates by pointing to the need to force water conservation.

But the real reason for SJC’s high water rates has mostly to do with the City’s ill-fated decision to get into the water business.

Just prior to 2004, SJC Director of Administrative Services / Assistant City Manager (now City CFO) Cindy Russell said:

“…We need to generate more sources of local water here.  This city has an ace in the hole, a huge untapped local source of ground water.  The catch is that plentiful source is too brackish to use as it is, so the issue is how to capitalize on the water most effectively.”

And so it began…

Despite Russell’s lack of expertise in the area of water, the City forged ahead with building an expensive Ground Water Recovery Plant to process ground water as an emergency water supply in case of natural disaster or drought. The real trouble came when the City decided to try and make the plant produce the town’s supply of drinking water.

The price tag to construct the plant was hefty – an estimated $38 million.  Perhaps the worst part of the deal however, was that SJC customers paid to build it but don’t own it.  Instead, it is owned by the San Juan Basin Authority, from whom the City leases it.  With annual operating expenses of around $8 million, it is too costly for a town of 34,000 to sustain.  As a result, SJC’s water rates are about 40% higher than those of other water agencies like the Metropolitan Water District (“MWD”).

The City was steadily losing money on the water plant due to lost production and increased operating expenses because SJC City employees were now running it.  At last count, the Utilities Department employed 21 people with an average annual salary of $105,000, including pension and benefits.  So, in 2010 the City Council approved a 40% water rate increase, plus an automatic increase of 3% every year for the next five years.

The sharp increases took their toll. Residents, especially those with fixed and low incomes, complained to the council that they could no longer afford their water bills.  Some told the council they had resorted to such measures as flushing their toilets only once a day and bathing every other day.

The impacts from the City’s conservation strategy were predictable; water consumption decreased such that in January 2011 City Treasurer Cindy Russell reported a Water Department deficit of $8.1 million – despite the increased water rates.  The SJC Utility Commissioners were outraged because the reports they had received from Russell gave no indication of a deficit of that magnitude.  As a result, the Commission urged the City Council to hire a special auditor to analyze the Water Department’s operations.  Not surprisingly, the audit report recommended the City raise water rates (again) and cut expenses to recover the current deficit and restore reasonable reserves.

Water customers were reaching the boiling point as rates had already increased 112% since 2004.

Enter local tax watchdog group, the Capistrano Taxpayers Association (“CTA”).  The CTA sued the City of SJC, asserting that SJC’s tiered water rate structure was not cost-based but rather, was designed to “punish” water users into conserving water through a progressively higher-priced tiered rate structure.  They also charged that SJC water users are billed for recycled water that they are not receiving.

In August 2013, SJC’s water rates were declared illegal under Proposition 218 by OC Superior Court Judge Gregory Munoz.  The City was ordered to abandon its water rate structure and to instead base all rates on cost of service, in conformance with the California Constitution.  The court also entered a judgment restraining the City from collecting fees from residents for recycled water that they do not actually use and which is not immediately available to them.  Judge Munoz based his ruling on a section of the California Constitution that deals with “Waste of Taxpayer Funds.”

CTA attorney Ben Benumof said of the ruling:

“Ultimately, we always believed that our case was simple, straightforward, and technically sound.  The City has never provided any cost-based data to support Tiers 2, 3, and 4, which the City admitted at trial are, in fact, penalties.  This is truly a win for the taxpayers, supported by the letter and the spirit of Proposition 218.”

Kramer, Taylor, Allevato. Two down, one to go.

In January 2014, the City Council majority of Sam Allevato, Larry Kramer and John Taylor voted to appeal the ruling to the 4^th District Court of Appeals. The City argued that tiers are really “penalties”, not fees, and as such are not subject to Proposition 218.  They further asserted that the City was justified in forcing domestic (residential) water users to subsidize recycled water users “…because everyone benefits from the use of recycled water because it increases supply.”  In their response, CTA attorneys rejected those arguments, pointing to a number of misstatements and distortions in the City’s appeal and to the fact that Prop 218 forbids charging for services not received by rate payers.

The case was heard by the appellate court on January 21, 2015.  A ruling is expected within 90 days but could come at any time.

During the appeals process, the City Council majority decided to continue billing the illegal rates up until July 2014, exposing the City to the potential of significant refunds of water overcharges.  If the court rules in favor of the CTA, the City may have to refund illegal charges paid by water customers.  Refunds could total millions of dollars.

The City Council majority’s refusal to listen to residents and their failure to adhere to Proposition 218 resulted in a lawsuit and legal expenses that were avoidable.  It also likely contributed to Councilmen Larry Kramer and John Taylor losing their bids for re-election in November and being replaced with their opponents by a wide margin, leaving Councilman Sam Allevato in the minority.

In the meantime, cities and water agencies throughout California await the decision of the appellate court.  Should the lower court’s decision be upheld, many water agencies will be faced with changing the way they bill for water.  The winners will be customers who were previously held hostage by water agencies that charged arbitrary rates for a required, essential service.