Appendix — Hansen v. City of San Buenaventura

Supreme Court brief1987

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IN THE

SUPREME COURT OF THE UNITED STATES

October Term, 1986

MAGDALINE M. HANSEN, individually and on

behalf of all those similarly situated,

Appellants,

Vv.

THE CITY OF SAN BUENAVENTURA,

Appellee.

ON APPEAL FROM

THE SUPREME COURT OF CALIFORNIA

APPENDIX TO JURISDICTIONAL STATEMENT

HELENE STONE

STONE AND STONE

A Professional Law

Corporation

Suite 208 D

674 County Square Dr.

Ventura, California

93003

(805) 654-1144

Counsel for

Appellants

APPENDIX Appendix

Page:

Opinion, California Supreme

Goure, FAiGe BOG. 32, 19SEC. ccccrcese 548i

Concurring and

Dissenting Opinion..............52=-73

Order Denying Rehearing,

California Supreme Court,

Pil@G Feb. 3S, 19ST ccccccccccccccccect’h

Opinion Filed April 8, 1985

Court of Appeal

of California, 2d Appellate

DASEELSS, DEVEGION Ga ccccccesceecIS°178

Appendix to Opinion...........179=-221

Opinion on Denial of

Rehearing and Modification

of Opinion Filed

May 7, 1985, Court of Appeal

of California, 2d Appellate

D2GCEISS, DAVABGSOR 6occcsccccessdaa 230

Findings of Fact and Conclusions

of Law, Ventura

County Superior Court, Filed

a eee 231-333

Judgment of Ventura

County Superior Court, Filed

Aug. AZ, OO) ee ee eee Fe

(see next page)

Notice of Appeal to the

United States Supreme Court,

Filed March 23, 1987......... 337-338

Ordinances of the City of

San Buenaventura:

NO. L7IAT ccccccccccesccceses 3397340

NO. TE—{aG acc cccccccccccccs cc 3417343

NO. TVI—ST ccccccccccccscessse sc dhawahd

SUPREME COURT

FILED

DEC. 31, 1986

Laurence P. Gill, Clerk

IN THE SUPREME COURT OF THE STATE OF

CALIFORNIA

L.A. 32091

2 Civ.67886

(Super.Ct. No. 55769)

MAGDALINE M. HANSEN et al.,

Plaintiffs and Respondents,

v. [OPINION]

CITY OF SAN BUENAVENTURA,

Defendant and Appellant.

Defendant City of San

Buenaventura (hereafter referred to as

Ventura) owns and operates a water

company which serves customers who

reside both in and outside the city

boundaries. In 1972, Ventura enacted an

ordinance imposing a 70 percent

surcharge on water supplied to customers

living outside the city limits. Those

nonresident customers brought this class

action to challenge the surcharge,

seeking declaratory relief and damages

on the ground that the rates imposed

were unreasonable, arbitrary, and

discriminatory and that the rate

structure denied them equal protection.

Following a nine-day trial, the superior

court held the 70 percent surcharge was

reasonable and entered judgment for

Ventura. , The Court of Appeal reversed

and remanded for a new trial; Ventura

sought review in this court.

SEE CONCURRING & DISSENTING OPINION

We granted review to resolve the

important question of whether a

municipal utility may recover a

reasonable rate of return on its

investments and to clarify what

circumstances may be considered by a

court in determining whether a rate is

reasonable. We conclude that a

municipal utility is entitled to a

reasonable rate of return and, for

reasons we shall explain, we agree with

the trial court that the 70 percent

surcharge on water supplied nonresidents

in this case was justified.

Accordingly, we reverse the judgment of

the Court of Appeal.

The city of Ventura has owned and

operated its own municipal water system

since 1923 when it bought the facilities

of the public utility corporation that

had previously supplied water to the

city and surrounding areas. Ventura

financed the sale through a $250,000

general obligation bond issue. Between

1925 and 1960, the citizens of Ventura

authorized four additional general bond

issues to improve and modernize the

system. Totalling over $3.6 million,

these bond issues subjected all private

property in the city to a lien: if

funds were unavailable to pay the bonds,

the bondholders had the right to require

Ventura to levy taxes on all private

property to meet the bond indebtedness.

Throughout the years, the

citizens of Ventura demonstrated their

commitment to the system by allowing the

city to use its general fund monies to

help maintain and improve the system.

Ventura used its general fund monies 1)

to provide office space for water system

employees as well as for city employees

who rendered services for the water

system and 2) to pay a portion of the

Salaries of city employees who performed

accounting, billing, administrative, and

legal services for the water systen.

Additionally, Ventura made a number of

transfers from its general fund to the

water system at little or no interest.

Ventura also used power taxes in the

amount of nearly $300,000 to support the

water system in the 1971-1972 and 1976-

1977 fiscal years. These funds

represented transfers to the system from

tax payments made by residents only.

Additionally, Ventura required new in-

city customers to pay upfront connection

and acreage fees to obtain water

service. These contributions, which

were used to benefit the entire water

system, totalled over $600,000 from 1964

until trial, in 1978. No water system

revenues have ever gone to Ventura's

general fund; all water revenues,

acreage and connection fees, power tax

revenues, and contributions from the

city's general fund have been used to

operate and maintain Ventura's water

systen.

In 1966, Ventura purchased the

Mound Water Company (Mound), a small

mutual water company! serving custo»ers

outside the city. At the time of the

sale, Mound represented to Ventura that

the Mound shareholders, that is the

Mound customers, had approved the

transaction. Thus, the sale was truly

consensual in that the very customers

who were to receive water from Ventura

ratified the purchase.

Pursuant to the terms of the

purchase agreement, Ventura agreed to

furnish water "to those customers

heretofore served by Mound who may

desire such service at the regularly

established rates for water service from

the Ventura Water System." However,

nothing in the sale agreement precluded

lpublic Utilities Code section 2725

defines a mutual water company as "any

private corporation or association

organized for the purposes of delivering

water to its stockholders and members at

cost, including use of works for

conserving, treating and reclaiming

water."

Ventura from continuing to apply

reasonable rate differentials between

residents and nonresidents as it had

done for years. 2 The purchase agreement

only assured that Ventura would continue

to provide service at regularly

established rates to customers served by

Mound at the time of the sale.

The water that Mound had supplied

its users prior to the sale came from

wells of poor quality which were below

public health standards. On

acquisition, Ventura abandoned the

polluted wells and commenced supplying

the former Mound customers with water of

2ventura has maintained a

differential in water rate schedules for

over 50 years, with out-of-city

customers required to pay higher rates

than in-city customers. Between 1935-

1952 the average surcharge was 48

percent, while between 1953 and 1972

that figure dropped to 32 percent.

Pursuant to the ordinance enacted in

July 1972 and continuing until the

present, the surcharge imposed on out-

of-city customers has been 70 percent.

substantially better quality. It is

undisputed that the sale of Mound to

Ventura immediately and significantly

improved the quality, availability, and

overall source of supply and service to

the customers previously served by

Mound, customers who all live outside

the city boundaries and are presently

subject to the disputed surcharge.

In 1969, Ventura acquired a second

water company, the Saticoy Water Company

(Saticoy). Saticoy was an investor-

owned public utility, 60 percent of

whose customers were residents of

Ventura, 40 percent nonresidents.

Because of the nature of the ownership

of the utility, the Saticoy customers

were not given an opportunity to approve

the sale. However, they were given the

chance to participate in an election to

approve or disapprove the purchase of

Saticoy by Ventura. Close to 90 percent

of those customers who voted registered

approval. In addition, customers also

had the opportunity to appear before the

Public Utilities Commission (hereafter

referred to as P.U.C.), but it appears

no protests were in fact received.

Under the terms of the agreement,

Ventura was bound for 60 days to

maintain the rates charged by Saticoy

prior to the sale; however, following

the 60-day period, Ventura had the right

to alter the preexisting rates. The

sale contract further provided:

"“(Ventura] agrees that from and after

the closing date it wit serve water

without unfair or unreasonable

discrimination to all customers in the

area wherein [it]} is certified to

provide service by the California Public

Utilities Commission whether such

customers are located within or without

the territorial boundaries of the city

and will continue to serve all of such

customers." Nothing in the sale

agreement, however, specifically

precluded Ventura from applying

reasonable rate differentials between

residents and nonresidents.

Saticoy customers benefited

immediately and substantially from the

sale. Instead of continuing to rely on

four small storage tanks, they suddenly

had available over fifty million gallons

of storage capacity from a vast network

of tanks and reservoirs tied into

Ventura's system. Further, the two wells

formerly owned by Saticoy fell short of

state health standards with respect to

water quality. Ventura abandoned one

well immediately and placed the other on

standby status, to be used only in event

of emergency.

The improvements to both the former

Mound and Saticoy customers were not

without cost. By 1969, Ventura was

serving approximately 2,800 out-of-city

water users, the vast majority of whom

were added in conjunction with the Mound

and Saticoy acquisitions. Because

Ventura did not have sufficient surplus

water of its own and because it did not

acquire any surplus water as a result of

these acquisitions, Ventura was obliged

to purchase additional water. The cost

of the additional water purchased from

the Casitas Municipal Water District

(Casitas) and others was substantially

greater than the cost of Ventura-owned

water sources. In addition to

2water purchased in 1970 by

Ventura from Casitas cost $44 an acre

foot and from Alta Mutual $35 an acre

foot. At the time of the 1978 trial

date, these prices had jumped to $61 and

$56 respectively, vis-a-vis, the $20-$25

price of well water for Ventura. The

cost of Ventura river water, obtained by

Ventura from its Foster Park facility,

is minimal. By virtue of having its own

water sources, Ventura saves

approximately $30-$40 per acre foot of

water that it does not have to purchase.

purchasing additional water to

accommodate the needs of its additional

customers, Ventura was forced to expand

and improve its facilities. Partly

because the facilities purchasec from

Mound and Saticoy were inadequate to

meet the needs of customers previously

served by these two water companies,

Ventura undertook major improvements to

improve and expand its own facilities.?

In 1970, Ventura acquired by

assignment a contract for 10,000 acre

feet of water annually from the State.

Water Project. Under the contract,

As the cost of alternative sources of

water has increased, the water rights of

Ventura have become more valuable.

These water rights were conservatively

set at $5 million in 1978.

3some of the major improvements

made during the 1970's to the Ventura

Water System which benefitted plaintiffs

include the construction of 6.5 million

gallons of additional storage, an 8-mile

transmission main, and a pump station.

In part, these and other improvements

were financed by revenue bond issues

totalling $6.5 million.

—— rt‘ ‘lt!

Ventura obliged itself to make payments

for the next 65 years estimated at $58

million. Althcugh Ventura had yet to

receive any state water at the time of

trial, it had made the required annual

payments for capital and fixed operating

and maintenance costs. Not only must

Ventura make payments irrespective of

whether it receives water, but the

contract provides that it must levy

taxes if revenues should be insufficient

to meet these payments. This tax lien

obviously falls only on property owners

in Ventura; as a class, nonresident

water users do not share the risk of

this obligation. Another burden not

shared by out-of-city users was

Ventura's obligation to construct the

necessary transmission facilities to

bring water from the state system, an

estimated cost at time of trial

exceeding $50 million.

‘een inne eer

Because of the impact caused by the

acquisition of the two water companies,

in 1970 Ventura retained the consulting

firm of Wilsey & Ham to analyze the

water rates. The firm initially

recommended and Ventura adopted a 20

percent overall rate increase. At some

later point, after obtaining updated

figures and doing further careful and

lengthy analysis, the firm

recommended: 1) another 10 percent

overall rate increase and 2) the _

imposition of the 70 percent surcharge

on outside customers. It also

recommended a rate scheme recognizing

three separate classes of customers:

1) residents using treated, potable

water; 2) nonresidents using treated,

potable water; and 3) industrial users

of untreated, nonpotable water. All

industrial users of untreated water also

happened to be nonresidents. Ventura

‘

subsequently enacted an ordinance

adopting these recommendations. That

ordinance, along with subsequent

ordinances enacted in 1975 and 1977,

constitute the subject of this

litigation.

After the action below was filed but

before trial, Ventura engaged a second

consulting firm to examine its rate

structure.* That firm, Brown &

Caldwell, concluded that the rates were

more than reasonable and, in fact, an

even greater differential covld have

been justified.

4at trial, plaintiffs' attorney

suggested that the study begun by Brown

& Caldwell in 1976 was irrelevant

because the 70 percent surcharge was

originally imposed in 1972. The lower

court overruled the objection, agreeing

with Ventura that if the study could

provide a reasonable basis for the

rates, there could be no complaint with

the city council's action in enacting

the ordinance. In other words, even if

Ventura arrived at reasonable rates

based on the wrong reasons, the rates

would nonetheless be lawful.

en a

The trial court concluded the rate

structure was reasonable. The Court of

Appeal reversed and remanded for a new

trial, holding that as a matter of law a

municipality is not entitled to a return

on investment and that Ventura erred in

calculating the amount of surcharge to

nonresidents.

A city which acquires the water

system of another community incurs an

obligation to deal fairly with its

customers in that community and to

provide them with service at reasonable

rates. (County of Inyo v. Public

Utilities Commission (1980) 26 Cal.3d

154, 159.) Rates established

by the lawful rate-fixing body are

presumed reasonable, fair and lawful.

(Elliott v. City of Pacific Grove (1975)

54 Aal.App.3d 53, 59; Durant v. City of

Beverly Hills (1940) 39 Cal.App.2d 133,

139.) Thus, plaintiffs bear the burden

of showing that the rates fixed are

unreasonable or unfair. (Elliott,

supra, 54 Cal.App.3d at p. 60.)

A showing that rates lack uniformity

is by itself insufficient to establish

that they are unreasonable and hence

unlawful. To be objectionable,

discrimination must "draw an unfair line

or strike an unfair balance between

those in like circumstances having equal

rights and privileges. ... ‘It is

only unjust or unreasonable

discrimination which renders a rate or

charge unreasonable' ... ." (Durant,

supra, 39 Cal.App.2d at pp. 138-139.)

Unreasonableness will be shown where the

discrimination rests solely on the

nonresident status of the user. (Inyo,

supra, 26 Cal.3d at p. 159, fn. 4.)

Reasonableness,then, is the

beginning and end of the judicial

inquiry.> Clearly, the fact that

nonresident users of public utility

service are subject to a higher rate

than those customers residing within

city limits does not alone prove the

rate unreasonable and hence invalid.

Rather, nonresidents must show that the

discrimination is not based on "cost of

service or some other reasonable basis."

(Inyo, supra, 26 Cal.3d at p. 159, fn.

4, italics added; see Durant, supra, 39

Cal.App.2d at p. 139.)

To determine whether the rates

Ventura imposed on nonresident customers

were reasonable, Brown & Caldwell

°As the court stated in Kennedy v.

City of Ukiah (1977) 69 Cal.App.3d 545:

"Municipal corporations have the

authority and power to establish and

operate works for supplying their

inhabitants with water. They also have

the power to fix the rates to be charged

for the sale of the water. (Citations. )

The only requirement is that such rates

be reasonable. (Citations.)" (Id., at

p. 552.)

compared revenue requirements

(expenses,costs) properly allocable to

nonresident customers with the actual

revenues received from that group. To

ascertain the first element, it

conducted a cost-of-service analysis.

According to evidence, the cost-of-

service analysis calculates the share

each customer should pay for utility

service proportional to actual use of

the system. Revenue requirements are

allocated to various classes based on

each group's proportionate use of the

system, including use of physical plant

facilities and consumption of water,

among other elements. A preliminary

step in determining revenue requirements

is the establishment of appropriate

Classes among which costs will be

allocated. The next step is to

calculate the costs which properly

should be assessed each group. For this

analysis, two alternative methods exist:

the cash basis and the utility basis.

Very generally, the cash method sets

revenue requirements based on actual

operating and maintenance expenses plus

allowable charges for system

replacement, debt principal repayment,

and other capital costs. The utility

method also considers actual operating

and maintenance expenses, but instead of

looking to cash expenses such as system

replacement and debt principal

repayment, the method focuses on

depreciation attributable to outside use

and on rte of return on investment.

The utility-method is commonly used

to establish revenue requirements where

a class of customers owned the utility

and another class uses the facilities

owned by the others. It is nationally

recommended by the American Water Works

Association for determining water rates

of municipal customers located outside a

city. Brcwn & Caldwell used the utility

method to determine revenue

requirements. Significantly, the rate

of return it employed was much lower

than that granted a number of companies

regulated by the California P.U.C.

Based on its analysis, it found a

surcharge of 98.5 percent was justified.

Nonetheless, Ventura continued

to impose the 70 percent surcharge it

had established in 1972.

As noted, the utility method focuses

on depreciation and rate of return on

investment.© Depreciation is

6In its opening brief, Ventura

argued that a rate of return or return

on investment is not a profit. However,

in its subsequent answer to plaintiffs’

opening brief, Ventura apparently

retracted this argument and acknowledged

that "[sjome cases have referred to

[return on investment], acceptably, as

'‘prorit. '" ln any event, the trial

court found on rehearing that a return

on investment is a profit: "We are not

impressed by counsel's attempt to

distinguish between a rate of return and

‘

typically defined as a recovery of cost

over the life of the facility as it is

used; it does not provide for the

replacement of the facility.’ Partly

for this reason, a rate of return is

allowed.

In the context of the utility

method, return on investment allows a

municipal utility to raise necessary

replacement funds and to pay debt on the

system. It also allows the municipality

to be compensated for having invested

its money and incurred the risks

associated with building and maintaining

a water system. Moreover, it compensates

the municipal utility for foregoing the

a profit. The terms are synonymous.

(Citations.)"

’The project manager of Brown &

Caldwell testified that the consultants

considered depreciation on an original

cost basis, as is proper, rather than on

the projected replacement cost of new

facilities.

opportunity to use its money in some

other manner. Rate of return is, in

essence, payment for the use of property

of another.

Municipal utilities have

historically incorporated a return on

investment on rates charged customers. ®

Certainly, the existence of a practice

is not dispositive of its iegitimacy,

but while no case squarely establishes

the proposition that municipal utilities

may recover a return on investment

through rates charged to nonresidents,

Saccording to the August 1911 issue

of Pacific Municipalities, the official

monthly publication of the League of

California Municipalities, the return on

Pasadena's municipal light and power

plant was between 9 and 11 percent on

total investment; Sacramento's water

system yielded an annual net return of

approximately $100,000; and Los Angeles

derived sufficient revenue in its first

nine years of operation to rebuild the

inadequate system it had acquired, to

address the demands of growth, to meet

the interest and sinking fund

requirements of the water bonds, and

still "to leave the city a profit" of

about $125,000.

case law does suggest such a practice is

permissible. Moreover, common sense and

basic economic principles dictate the

necessity of such a rule.

California cases indicate that

utility rates need not be based purely

on costs. In Golden Gate Bridge &

Highway Dist. v. Luehring (1970) 4

Cal.App.3d 204, the court stated that

"the (California) Constitution does not

inhibit an entity of local government

from collecting fees for services it

performs and using the net proceeds of

enterprises such as municipal utility

systems for the benefit of its own

general fund." (Id., at p. 215, italics

added.) In Beard v. City and County of

San Francisco (1947) 79 Cal.App.2d 753,

the Court of Appeal noted "parks,

playgrounds, public utilities, and

other facilities in aid of health and

welfare of the community ... . may be

operated for profit." (Id., at p. 755,

italics added.) Finally, acccerding to

Dyke Water Co. (1963) 61 Cal. P.U.C.

315, “it is for the local governing body

to determine precise rates and whether

the system should be subsidized or

profitable." (Id., at p. 321, emphasis

added.) Plaintiffs' contention that

Ventura must provide service to

nonresident customers at "cost" without

an opportunity to recover a reasonable

rate of return is incorrect.

Plaintiffs urge that a rule

requiring municipal utilities to provide

service to nonresident customers at cost

is necessary to protect the interest of

out-of-city users. Whereas consumers of

services provided by private utilities

are protected by the P.U.C., plaintiffs

would have us believe nonresident users

of municipal utilities are left to the

mercy of the municipality. Although

judicial review of rates is not

comparable to regulation by the P.U.C.,

it does "protect consumers against

plainly unfair rates... ." (Inyo,

supra, 26 Cal.3d at pp. 159-160.)

Significantly, the present case appears

to be only the second municipal utility

rate case in California history. The

paucity of such litigation suggests that

existing law functions sufficiently.

wever, even if existing law is

inappropriate or inadequate, it would

seem to be the Legislature's role to

revise it. Despite our statement that

there is no constitutional barrier to

bringing municipal utilities within

P.U.C. jurisdiction (Inyo, supra, 26

Cal.3d at pp. 163-167) the Legislature

has to date declined to modify the

existing system.

The rule sought by plaintiffs would

have a negative impact on the expansion

of California municipal utilities.

Without the opportunity to obtain

revenue necessary for system replacement

and expansion, there would be little

incentive for municipal utilities to

expand in order to service nonresident

users. Moreover, without a chance to

recover a reasonable rate of return, a

municipal utility would be foolish to

increase its business risk by expanding

service to nonresidents without

demanding a commensurate increase in

“return.

S52

The trial court in the instant case

concluded an 8.67 percent rate of return

charged nonresidents was reasonable vis-

a-vis the 3.0 percent return charged

residents. We agree. A higher rate of

return for nonresidents is justified

because (1) the in-city customers (as

residents of Ventura) incurred

substantial risks and obligations not

shared by out-of-city users and (2) in-

city sources of revenue both directly

and indirectly financed the system in

ways that out-of-city revenues did not.

More specifically, only property of

residents was subject to the general

obligation and the State Water Project

liens, and only Ventura and its

taxpayers bore the responsibility for

management of the system, for repairs

and replacement in event of disaster,

and for construction of the transmission

system to bring state water to the city.

As for a difference in sources of

revenue, residents paid taxes that

contributed to the system, while

nonresidents did not, and only resident

customers had to pay connection fees.

Moreover, Ventura's city government

provided support and stability for the

water system over the years: general

monies of Ventura were used to provide

office space and to pay salaries of the

city employees who performed accounting,

billing, administrative, and legal

services for the water system; Ventura

made a number of transfers from its

general fund to the water fund at either

little or no interest; and only Ventura

and its taxpayers bore the

responsibility fo. (1) management of the

system, (2) repairs and replacement, and

(3) construction of the transmission

system to bring state water to the city.

Plaintiffs contend that any contribution

made from Ventura's general fund should

be disregarded because it was a source

of revenue from the city government and

not the city ratepayers. But, the use

of city funds cannot be disassociated

from its citizens. When a city uses its

funds to support the water system, out-

of-city customers can fairly be expected

to pay higher rates. (See Dyke. supra,

61 Cal. P.U.C. at p. 321.) Second,

evidence showed some of the general fund

originated from taxes, and all in-city

ratepayers are also taxpayers. Thirc,

the evidence is plain that the citizens

themselves bear certain significant

risks. Unlike those living outside the

city, residents are uniquely responsible

for the general obligation bonds that

built and improved the system, for the

reason that Ventura must levy taxes on

private property within the city

boundaries if revenue is insufficient to

meet that requirement. For the same

reason, residents bear the risk of

Ventura's long-term contractual

commitment with the state to pay an

estimated $58 million for water from the

State Water Project. ?

9Plaintiffs contend that the issue

of property tax liens arising from

‘Ventura's general obligation bonds and

In its 57 pages of findings of fact

and conclusions of law, the trial court

implicitly found thar a difference of

rate of return was justified. It also

specifically found that the rates

charged nonresident customers were fair

and reasonable and were commensurate

with the cost of service provided for

the following reasons: the costs of

providing services to nonresidents were

greater, in part because Ventura had to

purchase more expensive water to supply

the former Mound and Saticoy customers;

these same nonresident customers used up

surplus capacity, which had been

its State Water Project contract is an

obligation of city property owners, but

not on in-city residents. Obviously,

many in-city ratepayers are city

property owners and hence property

taxpayers. As for those in-city

ratepayers who do not own their homes,

it is reasonable to assume that they

will bear some of the burden of an extra

property tax in the form of higher

rents.

previously provided by Ventura, without

making any capital contributions;

Ventura substantially improved the water

service to the former Mound and Saticoy

customers and such service fully

justified the rates charged; the

nonresidents have not made and do not

make the same financial contributions to

the maintenance of the water system as

do residents; only residents are charged

acreage and connection fees, which raise

funds for the water system; nonresidents

do not have the same obligations and

responsibilities for the replacement and

repair of the system in the event of

disaster or to provide for the expansion

to meet population growth; Ventura

continues to use its general fund and

its credit to support its water system;

nonresidents, having foregone nothing

and shared in no risk in building up the

plant, cannot expect to share in the

benefits accruing from city ownership; a

municipality is entitled to recover the

cost of fire protection from

nonresidents, standby water demand being

greater by the addition of outside

areas; and a municipality is entitled to

earn a return on its plant and

facilities devoted to nonresident users.

Contrary to the Court of Appeal, we

agree that most of these justifications

are appropriate.

Miscellaneous Benefits

There is no question that after

acquisition the former Mound and Saticoy

customers immediately received

substantial benefits such as improved

water quality, increased water storage,

upgraded fire protection due to

Ventura's pumping stations, and major

transmission lines. These improvements

used up both reserve and growth capacity

in facilities previously provided at the

expense of in-city customers.?° If

Ventura had not charged nonresident

users a higher rate of return than it

charged its own residents, then in-city

ratepayers would be subsidizing out-of-

city ratepayers for the latter group's

proportionate share of these expenses.

Plaintiffs argue that it was improper

to pass on the additional cost of

purchasing more expensive water directly

to nonresidents. They vehemently insist

that whatever new water supplies

benefited nonresidents who were former

l0plaintiffs argue that residents

alone did not pay for the facilities.

They argue that all operating expenses,

bond obligations, and State Water

Project contract payments have always

been paid solely from revenues of both

resident and nonresident ratepayers.

However, plaintiffs fail to realize that

the vast majority of nonresident

consumers did not spring into being

until 1966 and 1969 #hen Ventura

purchased the Mound and Saticoy

companies. For some 45 years prior,

only a handful of nonresidents had

contributed to the acquisition,

maintenance, and improvement of the

water systen.

Mound and Saticoy customers also

benefited residents who were former

Saticoy customers. This is true, but

plaintiffs fail to mention that the

cost allocated to nonresidents covered

only the cost required to supply then.

Nonresidents were not charged with the

cost of supplying new expensive water to

resident customers. These additional

costs of in-city users were shared by

all members of that class.

Plaintiffs also make much of the

fact that a large portion of nonresident

users are technically ineligible to

receive Casitas water because they live

outside the Casitas water district.

This argument seems irrelevant.

Irrespective of whether nonresidents

actually received molecules of water

piped from Casitas or molecules of other

water, Ventura had to purchase the more

expensive Casitas water to provide

————————————EEEEEEEEEEEEEEEe

service to these new nonresident

customers.

We conclude it was proper for the

trial court to justify a surcharge based

on this theory. (See Beaumont Investors

v. Beaumont-Cherry Valley Water Dist.

(1985) 165 Cal.App.3d. 227, 232, fn.

4.)

Rate Base

Plaintiffs argue that Ventura should

have excluded from rate baselt any

facilities donated by developers or

financed through connection and acreage

fees. Ventura contends that such a

conclusion would leave it without

depreciation funds sufficient to replace

its entire system. According to

llpate base is the value of the

property on which the utility is

entitled to a return. "The rate base on

which a return may be earned is the

amount of property used and useful, at

the time of the rate inquiry, in

rendering a designated utility service."

(1 Priest, Principles of Public Utility

Regulation (1969) p. 139.)

plaintiffs, however, it would be

inequitable to allow Ventura to earn a

return on property provided by

customers themselves.

Contrary to plaintiffs' contention,

in this context we see nothing

inequitable in including in the rate

base assets that have been paid for by

past ratepayers. Unlike Pacific Tel. &

Tel. v. Public Util. Com. (1965) 62

Cal.2d 634, 663-665, relied on by the

dissent, in this case the inclusion of

such assets does not result in a double

payment by past ratepayers, but rather |

simply permits the past ratepayers to

be, in effect, credited for their past

contributions to capital. If the

municipal utility's proposed profit is

to be accurately evaluated pursuant to

the "utility method," such assets are

properly included in the rate base.

The Court of Appeal also disapproved

the inclusion of the increased value of

water rights. ln fact, Brown # Caldwell

did not employ this capitalization

figure, but used the_1940 book value of

$1,215,000. Accordingly, we do not have

to decide whether a higher figure would

have been appropriate.

The court mistakenly states that

Brown & Caldwell viewed the amounts owed

under the state contract as an asset

instead of a liability. On the

contrary, the project manager testified

the firm's study treated the item as

debt and did not allocate any of the

principal amounts due under the contract

to nonresident users.

Finally, the court noted that Ventura

could not impose an in lieu tax on

nonresidents. However, as the court

also noted, "(t)here—is nothing in the

record indicating that the city ever

attempted to officially impose such a

tax."

__The Three-Tier Classification Scheme

It is well established that "'a

utility may, without being guilty of

unlawful discrimination, classify its

customers or patrons upon any reasonable

basis .... '" (Durant, supra, 39

Cal.App.2d at p. 139; see Toward

Utility Rate Normalization v. Public

Utilities Commission (1978) 22 Cal.3d

529, 543-544; Kennedy v. City of Ukiah

(1977) 69 Cal.App.3d 545, 553-554.) The

trial court found Ventura's three-tier

classification scheme to be fair and

reasonable. Plaintiffs, however,

objected to Ventura's three-tier

classification scheme based on what it

perceived to be a feigned distinction in

treating users of nonpotable, untreated

water as a separate class.

Plaintiffs make much of the fact that

the first consulting firm Ventura hired

initially recommended a surcharge of

38.8 percent based on a two-tier

classification: out-of-city water users

(both industrial and domestic) and in-

city users. Later, after reanalyzing |

and updating the data, the firm

concluded a three-tier classification

scheme was more appropriate and

subsequently found a 70 percent

surcharge more accurate. It is

difficult to imagine a more

natural or obvious classification.

The cost of supplying treated water

is indisputably very different than the

cost of untreated water. The

classification seems patently

reasonable.

Plaintiffs argue that as a matter of

law the 70 percent surcharge violates

Government Code section 54514, which

requires the local agency to provide

water "at the lowest possible cost

consistent with sound economy, and

prudent management, and the security and

payment of the principal and interest of

the bonds." (Gov. Code, # 54514.)

Although section 54514 does require that

the agency furnish water "at the lowest

possible cost," such language is hedged

by references to "sound economy, "

"prudent management," and interest to

bondholders. These references clearly

give a local agency considerable

discretion in balancing its own

financial concerns against the

requirement of low rates. Moreover,

prudent management and sound business

judgment would seem to mandate some sort

of return on investment. First of all,

a municipal utility would be foolish to

increase its business risk by expanding

service to nonresidents without getting

some type of return commensurate with

the increased risk. Second, a city that

spends its funds to provide service to

nonresidents and only recovers the cost

of those funds is investing its money

poorly. Instead of getting zero return

by investing those funds in its own

water system for the benefit of

nonresidents, the city should invest

elsewhere and get even a minimum return.

‘Thus, "lowest possible cost" cannot be

read to mean "break-even cost"; rather,

it would seem only to bar unreasonable

or excess profits. It is not for the

court to determine what constitutes

sound economy and prudent management,

but only to determine the narrow issue

of whether the rates imposed are

reasonable. (See County of Inyo v.

Public Utilities Commission, supra, 26

Cal.3d 154; Durant v. City of Beverly

Hills, supra, 39 Cal.App.2d 133; see

also, American Microsystems, Inc. v.

City of Santa Clara (1982) 137

Cal.App.3d 1037.)12

Plaintiffs also argue Ventura

12tn American Microsystems, Inc. v.

City of Santa Clara, supra, 137

Cal.App.3d 1037, ratepayers of a

municipal power utility owned and

operated by Santa Clara sought to compel

that city to pass on to consumers

certain savings in the cost of

purchasing electrical power. The Court

of Appeal rejected this argument, in

spite of a provision in the utility's

contract with the federal supplier of

power that benefits be "made available

at fair and reasonable terms to all of

its consumers at the lowest possible

rates consistent with sound business

principles." (Id., at p. 1043, emphasis

in original.) The court noted that

unlike privately owned utilities which

are regulated by the P.U.C., publicly

owned municipal utilities are under no

mandate to pass on to ratepayers any

savings realized in the cost of service.

Rather, the public entity is entitled to

fix its utility rates pursuant to its

legislative power, and courts will

intrude only when rates are shown to be

unreasonable or unfair: "it is not the

function of the courts to evaluate the

wisdom of the City's rate-fixing

decisions. In that context, we cannot

determine what constituted 'sound

business practices,' but may only

consider that narrower leqal question

whether the rates- were unreasonable or

arbitrarily established. " (Id., at p.

1044.)

violated its obligations as a trustee.

When a city acquires the water system of

another community, as to the water

dedicated to the use of the outside

community, the acquiring city holds

"title as a mere trustee, bound to apply

it to the use of those beneficially

interested." (City of South Pasadena v.

Pasadena Land and Water Co. (1908) 152

Cal. 579, 594.) After the acquisition,

the city is "under the same obligation

as its grantor to continue the service

and supply the water to all persons who

may become entitled to it in the future

- - « -" (Id. at p. 593, emphasis

added.) 13

It is clear that the trustee city

13tt is because of the trust

relationship that consumers can "sue to

enjoin rates which are themselves

‘unreasonable, unfair, or fraudulently

or arbitrarily established' [citation],

or which discriminate without a

reasonable and proper basis [citation]."

(See Inyo, supra, 26 Cal.3d at p. 159.)

must continue to supply water, but there

is no support for the proposition’ that a

city must supply water at cost. In

fact, Durant made quite clear that an

acquiring city's trust obligation does

not require furnishing water at cost but

only at a reasonable rate: "When the

city purchased the private plant it

assumed a trust to perform the contract

and meet the obligations of the private

concern. . . . The obligation which the

city assumed through the purchase of the

system was an obligation to continue to

serve plaintiff water at a reasonable

rate." (Durant, 39 Cal.App.2d at p.

138, emphasis in original.)

Plaintiffs argue that it is a denial

of equal protection for nonresident

ratepayers to be separately classified

and required to pay a 70 percent

surcharge over rates paid by resident

taxpayers. They argue the surcharge is

based solely on the nonresident status

of the out-of-city customers, and that

the only distinguishing factor between

those who pay the surcharge and those

who do not is an artificial political

boundary line.

First, plaintiffs argue the

nonresidents are a suspect class and

therefore that we should apply the

strict scrutiny test. They reason that

the rationale behind the application of

the “suspect class" doctrine is the

political powerlessness of such groups.

Because out-of-city users have no right

to vote for or against city council

members who set the water rates, they

contend they are politically powerless

and accordingly that the rationale of

the suspect class doctrine militates

towards its application in this case.

We have categorized only a few

Classifications as suspect, namely

Classifications involving race,

alienate, or national origin. We

decline to extend the suspect class

analysis here. The plaintiffs are no

more powerless as customers of Ventura

than they were as Mound and Saticoy

customers. Although they cannot vote in

Ventura elections, they can exert

political influence in alternate ways:

through lolsbying, petitions, testimony

at hearings, for example. Asa

practical matter, most utility rate

decisions turn on rate hearings, and in

fact, plaintiffs were represented by a

member of the county board of

supervisors at the very hearing in

question. Moreover, despite plaintiffs’

contention that Ventura forced them into

its water system, this is not the case.

As members of a mutual water company,

former Mound customers were the same

shareholders who approved the sale to

Ventura. The Saticoy transaction was

approved by the P.U.C., and there is no

evidence that a single protest was

received.

Plaintiffs next argue that even if we

apply the traditional rational-

relationship test, they should prevail.

We agree that this is the correct

standard to use, but conclude that

plaintiffs' argument is without merit.

When social or economic regulations are

involved, the rational-basis test

applies. In such cases, "statutory

discrimination wiil not be set aside if

any state of facts reasonably may be

conceived to justify it." (Dandridge v.

Williams (1970) 397 U.S. 471, 485

(quoting McGowan v. Maryland (1961) 366

U.S. 420, 426).) The reasonableness

test applied to municipal utility rates

is somewhat more stringent than the bare

rational-basis test. Ventura has met

the reasonableness standard; a fortiori,

it passes the rational-relationship

test.

VI CONCLUSION

We agree with the trial court that

the rates imposed on nonresidents by

Ventura are reasonable despite the fact

that both nonresidents and residents

received water from the same source and

with the same quality of treatment.

Moreover, the factors used by the trial

court in resolving the issue of

reasonableness are permissible criteria.

ln administering a public utility, such

as a water system, a city acts in its

proprietary capacity. (South Pasadena,

supra, 152 Cal. at p. 593.) When a

municipal utility acquires the private

water system of another community, the

resident customers should not be forced

to bear any of the costs of providing

SSC

service to nonresidents. It is

appropriate to pass on to the

nonresident customers any extra cost the

city has had to incur by way of

expanding or modernizing facilities, in

purchasing additional water, in

increasing its business, or other

similar costs. Moreover, it does not

have to share the benefits for which it

has already paid if such sharing is at

the expense of residents. However, all

these costs must be passed on at a

proportional basis. For example, the

nonresidents cannot be made to bear the

cost of expansion or modernization

properly attributable to in-city users.

The court is not required to

determine all costs nor to balance them

precisely against rates. Rather, it is

the court's role to decide only whether

a reasonable basis exists for charging

different rates and whether the rates

themselves are reasonable. In the

present case, we conclude the Court of

Appeal erred in remanding the cause.

Accordingly, the judgment of the

appellate court is reversed.

GRODIN, J.

WE CONCUR:

MOSK, J

REYNOSO, J.

LUCAS, J.

PANELLI, J.

CONCURRING AND DISSENTING OPINION BY

BROUSSARO, Js

I agree with the majority, insofar as

they conclude that the City of San

Buenaventura is entitled to be

compensated for services, facilities or

capital which it contributes to the

municipal utility and the ratepayers and

that in lieu of such compensation the

city ratepayers may be charged a lower

rate than the noncity ratepayers.

However, I cannot agree that the city is

entitled to be compensated through

discriminatory rates for claimed capital

improvements and additions which were in

fact financed by the ratepayers both

within and without the city or obtained

by donations to the water systen.

In 1923 the city purchased a water

system from Southern California Edison

and commenced to provide water to the

city and out-of-city consumers. The

purchase was financed by general

obligation bonds. Although the

bondholders had the right to require the

city to levy taxes to pay for the bonds,

it was contemplated that the bonds and

the interest on them would be paid by

water revenues. Over the years the city

has issued similar bonds to purchase

additional water systems and to obtain

additional facilities. All payments of

principal and interest on the bonds have

been made from water revenues. An

advance made by the city to the water

company was repaid with interest, and so

far as appears, city capital

contributions have been negligible.

In 1935, the city established a

surcharge on out-of-city customers

requiring them to pay higher rates than

the in-city customers. From 1935 to

1952, the surcharge averaged 48 percent;

between 1953 and 1972 the surcharge was

32 percent. In 1972, the city imposed a

70 percent surcharge. The instant case

involves the validity of the latter

surcharge. ,

Over the years the water system has

been greatly expanded and improved, and

the value of the property devoted to the

system including water rights and

facilities has increased greatly. The

main issue presented is whether the

surcharge, or most of it, may be

justified on the theory that the city is

entitled to a rate of return based on

the value of the property in the system.

In County of Inyo v. Public Utilities

Com. (1980) 26 Cal.3d 154, we

considered the relationship between a

city water department and out-of-city

users. The Los Angeles Department of

Water and Power served consumers in the

County of Inyo, and the county

argued that the Public Utilities

Commission should regulate the rates

because it was established to protect

people from the consequences of monopoly

in the public services industry and

that, while city residents may exert

political power over the rates, outside

residents have no voice as voters or

taxpayers, leaving them at the mercy of

the city. (26 Cal.3d at pp. 158-159.)

The court held that, although the

Legislature could authorize the Public

Utilities Commission to regulate water

rates charged by a city to noncity

consumers, it had not done so.

In response to the county's argument

that the consumers had no control over

the rates charged, the court stated:

"(A] city which acquires the water

system of another community incurs an

obligation to deal fairly with its

customers in that community and to

provide them with reasonable service at

reasonable rates. (See South Pasadena

v. Pasadena Land, etc. Co. (1908) 152

Cal. 579, 587-588, 594 [93 P. 490].)

Such an acquiring city, as to the water

dedicated to the use of the outside

community, holds 'title as a mere

trustee, bound to apply it to the use of

those beneficially interested.' (ld.,

at p. 594; see Durant v. City of Beverly

Hills, supra, 39 Cal.App.2d 133, 138.)

Consequently, the county can sue to

enjoin rates which are themselves

‘unreasonable, unfair, or fraudulently

or arbitrarily established' (Durant v.

City of Beverly Hills, supra, 39

Cal.App.2d 133, 139), or which

discriminate without a reasonable and

proper basis (Elliott v. City of Pacific

Grove, supra, 54 Cal.App.3d 53, 59). 4"

Footnote 4 states: "A showing that

rates are discriminatory is in itself

insufficient to fulfill the

complainant's burden of proof (see

Durant v. City of Beverly Hills, supra,

39 Cal.App.2d 133, 138); a showing,

however, that such discrimination rests

solely on the nonresident status of the

customer, and not on the cost of service

or some other reasonable basis, will

prove the rate invalid (see Elliott v.

City of Pacific Grove, supra, 54

Cal.App.3d 53, 59)." (26 Cal.3d at p.

159.) |

When new users come into a municipal

utility system, the city may properly

charge connection fees or other charges

to defray the cost of the facilities

needed to serve the new sers. (E.g.,

Associated Homebuilders v. City of

Livermore (1961) 56 Cal.2d 847, 851 et

seq.; Beaumont Investors v. Beaumont-

Cherry Valley Water Dist. (1985) 165

Cal.App.3d 227, 233.) However, Coun of

Inyo, supra. 26 Cal.3d 154 makes clear

that once a municipality chooses to

dedicate its water service to consumers

outside the city, it becomes a trustee

bound to use the system for all of those

beneficially interested, and any

discrimination between consumers must be

based on the cost of service or other

reasonable basis. The lack of political

power of out-of-city residents may not

furnish a basis for discrimination but

requires the city to act reasonably in

setting their rates. They are not

second-class consumers but entitled to

the same rights as other ratepayers.

Accordingly, we must determine

whether the record shows that the

discriminatory rates are based solely on

the nonresident status of the consumers

and not on the cost of service or some

ees st — |

other reasonable basis. It is not

claimed that the surcharge can be

justified on the ground that it is more

expensive to deliver water to the out-

of-city consumers than the in-city

consumers. Most of the out-of-city

users live in islands of unincorporated

“erritory surrounded by the city or

areas adjacent to the city and the

facilities used to deliver the water are

the same for both types of users.

Rather, most of the surcharge is sought

to be Justified on the basis of extra

charges for the acquisition of water or

for facilities serving the systen.

As the majority recognize (ante, p.

_._. [typed opn., p. 12]) and as the

evidence established, there are two

alternative methods for determining the

revenue requirements of a utility, the

cash basis and the utility basis. Under

both methods. the water company is

entitled to recover all of its operating

and maintenance expense, including any

taxes. Under the cash basis, the

utility may add charges for system

replacement, debt service expenses

(principal and interest) and other

capital costs, including additions to

the facilities or reserves for

additions. The total of the charges

become the revenue requirement.

Under the utility basis, charges for

capital replacement, etditions, reserves

for additions and debt repayment are

not included; rather, the utility

recovers for depreciation of its plant

and a rate of return on its rate base or

investment. (See City of Los Angeles v.

Public Utilities Commission (1972) 7

Cal.3d 331, 336, 346-347.)

Under the utility basis, it should be

improper to include in the rate base

capital assets donated or paid for by

the ratepayers because such assets may

not be viewed as investment. The point

is illustrated by Pacific Tel. & Tel.

Co. v. Public Util. Com. (1965) 62

Cal.2d 634, 663-664. There the Public

Utilities Commission concluded that

Pacific could properly include in its

rate base its gross working cash

requirement but the commission

disallowed various additional cash sums

held by Pacific which had been collected

from customers in advance, from funds

collected to pay debenture interest, and

from taxes withheld from employees. The

disallowed sums exceeded the working

cash requirement. The court approved as

sound and fair the commission's view

that when the funds supplied by "'others

than investors are greater than the

amount required .. . for working cash,

and the excess amount is not deducted

from rate base, customers would be

unreasonably required to pay a return on

funds supplied by them to defray

reasonable expenses and taxes [and

debenture interest] and to provide a

reasonable return on invested funds.'”

The principle is clear. The utility

may not be permitted to include in its

rate base donations or assets: supplied

by the ratepayers because to allow

inclusion in rate base would permit "a

double return." (Id. at p. 664.)24 It

14The Court of Appeal in the

instant case in an opinion by McMahon,

J., assigned, reached the same conclu-

sion on the basis of other authorities.

The court stated: "The Donated Property

Should Have Been Excluded From the Rate

Base. Customer donations of plant are

normally excluded from the rate base on

the theory that it would be inequitable

to permit the utility to earn on >

property provided by the customers

themselves. (Conejo Valley Water Co.

(1965) 64 P.U.C. 212, 225; La Puente

Cooperative Water Co. (1966) 66

Cal.P.U.C. 614, 626; Sutter Butte Canal

Co. v. Railroad Com. (1927) 202 Cal.

179, 190-191 [259 P. 937] (affd. 279

#.S. 125 (73 L.Ed. 637, 49 S.Ct.

325]); Public Utilities Commission v.

Northwest Water Corp. (1969) 168 Colo.

154 (451 P.2d 266, 276-277]: Application

of Kaanapali Water Corp. (Hawaii #pp.

1984) 678 P.2d 584, 590-592; United Gas

Corp. v. Mississippi Public Service

Com'n. (1961. 240 Miss. 405 [127

So.2d 404, 412]; Cogent Public Service

v. Ariz. Corp. Com'n. (1984) 142

Ariz. 52 [688 P.2d 698, 701-703]}.)

"An lllinois court reasons that it is

proper to exclude contributions in aid

of construction made by customers; the

propriety of a reasonable depreciation

deduction is not dependent upon the

source of funds for the original

construction of the facility, as the

utility will have to replace obsolete

properties. (Du Page Utillty Co. v.

lllinois Commerce Comm. (1971) 47

111.2d 550 [267 N.E.2d 662, 668-669],

cert. den. 404 U.S. 852 130 L.Ed.2d

62, 92 S.Ct. 74).) However, most courts

reason that the purpose of depreciation

is not to replace property but to

recover the original investment over the

life of the property. 'Since the

company has invested no funds in

contributed property, it is not entitled

to recover the original investment

through depreciation. .. . We believe

it inequitable to allow a company to

recover depreciation accruals on plants

in which it has made no investment. '

(Mechanic Falls Water Co. v. Public

Utilities (Me. 1977) 381 A.2d 1080,

1104; accord State ex rel. Martigney

Creek Sewer Co. v. Public Service

Commission (Mo. 1976) 537 S.W.2d 388,

399; State ex rel. Utility Commission

v. Heater Utilities (1975) 288 N.C. 457

(219 S.E.2d 56, 62]; Sunbelt Utilities

v. Public Utility Commission (Tex.

1979) 589 S.W.2d 392, 395; Princess Anne

Utilities Corporation v. Commonwealth ex

rel. State Corporation Commission

(1971) 211 Va. 620 [179 S.E.2d 714].)

"What about federal grants and funds

derived from federal revenue sharing?

One court has reasoned that 'the city

has unqualified ownership of the portion

of the plant built with the money and

the fact that some infinitesimal portion

of the money might be considered to have

come from taxes paid by the out-of-city

consumers does not create equities in

their favor.' (City of Covington v.

Public Service Commission (Ky. 1958)

313 S.W.2d 391, 393.) On the other hand,

a Wisconsin court, in a valuation

proceeding, excluded federal

contributions on the theory that the

federal grant was made for the benefit

of both the town and the city and ".

. the city should not now be heard to

claim that they should receive

compensation for a portion of the water

utility which was never paid for by them

either directly or indirectly.' (City of

St. Francis v. Public Service

Commission (1955) 270 Wis. 91 [70

N.W.2d 221, 225=-226].)

"Most courts which have considered the

problem have excluded federal grants

from the rate base. (See, e.g.,

Pichotta v. City of Skagway (D.C.

Alaska 1948) 78 F.Supp. 999, 1006

($39,973 expended by army in

rehabilitating the system during World

War II was excluded from the rate base,

as the rule allowing additions was never

intended to embrace a gratuitous

contribution to capital made at the

taxpayers expense], In re Southern

California Edison Co. (1954) 53

is only the investment made by the

utility which may be included in the

rate base.

So far as appears in the instant

case there has been no substantial

investment of capital in the water

system by the city. Although the city

Cal.P.U.C. 385, 410; 6 P.U.C.3d 161,

185-186 [donations from governmental

entities were not ‘investment')]; City of

Detroit v. City of Highland Park (1949)

326 Mich. 78 [39 N.W.2da 325, 333]

{federal funded contributions were

excluded from rate base of municipally

owned utility]; City of

Hagerstown v. Public Service

Commission (1958) 217 Md. 101

[141 A.2da 699] [in setting rates to

utility serving outside customers, both

customer contributions and federal

grants were excluded from the rate

base].)

"We agree that both acreage fees,

connection fees, and other donations

should be excluded from the rate base,

in calculating any surcharge to

nonresidents. As to federal

contributions and grants, the same

result should obtain; it is unfair to

require those who have paid federal

income taxes to pay for the proverbial

‘pork barrel' a second time." (Fn.

omitted. )

initially advanced funds to the water

system, the advances were treated as a

loan by the city rather than a capital

investment and were repaid with

interest.

The majority suggest other bases for

concluding that the water facilities may

be viewed as investment by the city

warranting establishment of a rate base

and justifying the city receiving a rate

of return which can be used to reduce

rates paid by city customers.

First, it is urged that the city is

entitled to claim the assets of the

system as investment because payment of

the bonds used to acquire many of the

assets and the State Water Project

obligations was guaranteed by the

residents of the city whose property was

subJect to taxes if the water company

could not pay the bonds or obligations.

However, it is clear that it was always

contemplated that the principal and

interest on the bonds and the project

obligations would be paid from revenues

of the water system and in fact that is

what has occurred. In the absence of

any significant capital contribution by

the city, it is unreasonable to permit

the city to establish the assets

acquired by the bond funds or the

project obligation to be viewed as

investment by the city rather than the

ratepayers.

Second, the city points out that it

has provided services and facilities to

the water system. As pointed out at the

outset of this opinion, I agree that the

city is entitled to be compensated for

any services or facilities made

available to the water system and rather

than accept compensation the city may

properly discount the rates charged in-

city consumers. However, the discount

should be reasonably related to the

value of services and facilities. It is

not. The discount was more than 10

times the amount which the city claimed

as the value of its services and

facilities made available to the water

company.15 Because the discount, so far

as appears, greatly exceeded the value

of the services and facilities

contributed by the city, there is no

reasonable basis to conclude that the

city's contributions of services and

facilities furnished substantial

investment capital warranting a rate of

15The additional revenue due to the

70 percent surcharge during the fiscal

years 1972-1973 through 1976-1977

totalled approximately $1.4 million.

During the period the ratio of city

consumers to out-of-city consumers

ranged from approximately five to one to

six to one. Assuming, as the majority

conclude, that the out-of-city consumers

paid a reasonable rate, the discount

allowed city consumers from the

reasonable rate would be at least $7

million (5 x $1.4 million). During the

period the city claimed unreimbursed

expenses of $629,000.

return. The trial court found that over

the years the water system has

"generally proven to be self-

sustaining." To allow a rate of return

based on the city services and

facilities would permit the city a

double recovery.

It is also argued that. the water

system was built on the basis of

revenues spnaines from ratepayers and

that when the city added new ratepayers

the old ones who helped build the system

were entitled to a rate differential

based on the value of the existing

system. However, this is not the basis

of the discriminatory rates. Thus, when

in 1969 the city acquired the Saticoy

Water Company, 60 percent of the Saticoy

consumers were city residents and 40

percent nonresidents. Only the

nonresidents paid the surcharge; the 60

percent of the new users who were city

residents paid the discounted rate. The

converse is also true; “old" users

outside the city are required to pay the

surcharge. Prior to the Saticoy

acquisition, about 1,000 of the service

connections were outside city limits

with 12,600 within the city.1© The

1,000 noncity consumers, the "old" users

who helped to pay for the system, are

required to pay the surcharge unless

their property was annexed to the city.

It is also implied that the

discrimination may be justified because

after the purchase of the out-of-city

companies the consumers of those

companies received improved service and

water quality. Fixing utility rates on

the basis of the value of the service

provided would be a repudiation of our

long history of determining utility

l6after the acquisition, there were |

apparently 18,000 city customers and

2,800 customers outside the city.

rates on the basis of cost.

The record here is clear that the

system has been paid for and is being

paid for by the ratepayers, both within

and without the city, and the city has

not made a significant capital

contribution warranting the establish-

ment of a rate base composed of the

assets of the system and an allowance of

a rate of return on that rate base.

When the ratepayers have paid for the

system, requiring them to also pay a

rate of return to the city on the assets

of the system in the absence of a

Significant capital investment is to

charge them twice for the investment.

Although the rate of return may be used

for replacement, improvement and

additions to the system, it is improper

to discriminate against the out-of-city

consumers by requiring them to furnish

excessive amounts for those purposes.

Rather, when the city chose to dedicate

its system to serve out-of-city

consumers, they became entitled to the

same rights as to reasonable rates as

the city users. piscrinination in rates

can be justified on the basis of

differentials in cost in delivering

water or on the basis of city:

contributions but not on the basis of

fictitious capital contributions.

BROUSSARD, J.

I CONCUR.

BIRD, C.J.

F Gh s

HANSEN v. CITY OF BUENAVENTUHA

S.F.32091

COUNSEL FOR APPELLANT:Helene Stone

Stone and Stone

500 Esplanade drive, Ste. 1130 Oxnard,

CA 93030

805) 647-0120

COUNSEL FOR RESPONDENT:Arthur L.

Littleworth

Best, Best & Krieger

P. 0. Box 1028

Riverside, CA 92502

(714) 686-1450

TRIAL COURT & NO.:Ventura County

Superior

No. 55759

TRIAL JUDGE:Honorable Robert D. Carter

Supreme Court

FILED

FEB -5 1987

Laurence P. Gill, Clerk

ORDER DUE February 27, 1987 7

ORDER DENYING REHEARING

LA No. 32091

In the Supreme Court of the

State of California

IN BANK

HANSEN Et Al.

Vv.

CITY OF SAN BUENAVENTURA

Appellants’ petition for rehearing

DENIED.

/s/ Broussard

Acting Chief Justice

CERTIFIED FOR PUBLICATION

IN THE COURT OF APPEAL OF THE STATE OF

CALIFORNIA

SECOND APPELLATE DISTRICT

DIVISION SIX

COURT OF APPEAL-SECOND DIST.

FILED

APR 8 - 1985

CLAY ROBBINS, JR. Clerk

2d Civil No. 6788

(Super. Ct. No. 557)

(Ventura County)

[OPINION]

MAGDALINE M. HANSEN, et al.,

Plaintiffs and Appellants, _

Vv.

CITY OF SAN BUENAVENTURA,

Defendant and Respondent.

May a municipally owned water system

impose a 70 percent surcharge upon the

water bills of customers living outside

of the city limits when the cost of

providing water service has been funded

by water revenues, and not taxes?

We conclude that the answer to this

inquiry is found in venerable common law

rules and, accordingly, decline to

consider the constitutional arguments

advanced by the parties.

At common law, a privately owned

utility which had a monopoly in serving

a given area was required to serve all

consumers without unreasonable

discrimination in rates or manner of

service. Although such private

utilities are subject to regulation by

the Public Utilities Commission,

customers of municipally owned utilities

are just as protected from exorbitant

rates and unjust discrimination as the

consumers are under the Public Utility

Act. Indeed, when a municipality

proposes to acquire a water company

subject to the jurisdiction of the

Public Utilities Commission, the

commission will impose, as a condition

of its approval of the sale. a provision

that the city shall not unfairly

discriminate against customers who live

outside the city and who have no voice

in city government.

It is apparent that the trial judge

gave little weight to these settled

principles of California law, and relied

instead upon other rules of law

applicable in other states, but not

California. For the reasons stated, we

will remand the matter for a new trial

consistent with the principles

enunciated herein.

THE CASE

In 1972 the City of San Buenaventura

(hereinafter referred to as "Ventura" or

"the city") enacted an ordinance

imposing a 70 percent surcharge upon

water supplied to existing customers

living outside city limits. This

prompted a rebellion, and in 1973 a

Class action was filed seeking

declaratory relief and damages on the

ground that the rates imposed upon

customers outside the city limits, after

July 1. 1972, were exorbitant,

unreasonable, arbitrary and

discriminatory, and did not bear any

relationship to the actual cost of

furnishing water.

As is customary in water cases, the

matter languished for several years.

(See e.g., City of Los Angeles v. City

of San Fernando (1975) 14 Cal.3d 199.

207-208.) After a nine day trial in 1978

the trial judge then considered post-

trial briefs before filing his intended

decision in 1980. Prolix findings of

fact together with a judgment were filed

in 1981. This appeal followed.

The trial court concluded that the

rate structure was reasonable. While we

are, of course, obliged to uphold this

conclusion if it is supported by

substantial evidence, we are also guided

by what Justice Holmes said in K#dd v.

Alabama (1903) 188 U.S. 730. 733: "What

is reasonable is a question of practical

details into which fiction cannot

enter."

THE HISTORY OF THE SYSTEM

Prior to 1923 the City of Ventura

and adjacent territory was provided

water by the Southern California Edison

Company, a private company. That year

the city authorized the issuance of

general obligation bonds in the amount

of $250,000 to purchase the systen.

In 1925, 1927, 1948 and 1960

additional general obligation bonds

totalling over 3.5 million dollars were

issued and the proceeds were used to

improve and modernize the system.

Although all property within the city

was subject to a lien, and the city

would have had to raise taxes if the

funds generated from water revenues had

proved insufficient to pay the bonds, in

actuality, both operating costs and

payments of bond principal and interest

were always paid from available water

revenue, and not from ad valorem taxes.

Indeed, annual financial reports

issued by the city repeatedly stressed

that its water department was operated

on an “enterprise basis," and that the

department generated sufficient funds

through user fees to finance the

acquisition, operation and maintenance

of its facilities.

In 1966 the city purchased the Mound

Mutual Water Company for $62,500 from

water revenues. The water was of poor

quality, exceesing a thousand parts per

million of total dissolved solids.

Under water quality standards

promulgated in California, the

acceptable limits are 1500 parts per

million, and the health department will

only issue a temporary certificate if

the water contains 1000 parts per

million. After Mound was acquired, the

city abandoned wells which had served

the customers of the private water

company and began supplying them with

water of better quality.1’

In 1968, the city acquired the

l7tnterestingly, in calculating the

value of the system, Mr. Stetson, one of

the city's experts, opined that the city

had an entitlement to the "Mound Basin,"

or 40 percent of the indigenous water

rights. Because the "Mound Basin" and

the "Ventura river" provided a cheaper

source of water, as compared with the

supply obtained from Lake Casitas, it

these water rights were given a

capitalized value, they would be worth

$2,000,000, or 40 percent of the total

water rights. However. we are not told

whether the Mound Basin is coterminous

with the previous boundaries of the

Mound Mutual Water Company.

Saticoy Water Company ("Saticoy"). a

private water company regulated by the

Public Utilities Commission. Before

Saticoy was acquired, only 1,025 of the

13,681 service connections of the

municipal waterworks were outside city

limits. With the addition of Saticoy's

customers. although the number of

customers within city limits increased

slightly to 15,215. the number of

Customers living outside city limits

almost trebled, increasing to 2,711.18

A perusal of the map indicates that

the present boundaries of the city

resemble a partially completed jigsaw

puzzle; many of the county residents

provided with city water live in various

enclaves, surrounded by areas previously

annexed to the city.

18py 1976-1977, following

residential growth and annexations,

there apparently were 18,513 city

customers and 2911 customers living

outside city limits.

... ——

The acquisition of Saticoy was

financed by 2.5 million dollars in

revenue bonds which constitute a first

lien on the revenues of the water

department. The bond holders could not

make recourse either to the taxing power

of the city or to money derived from the

levy and collection of taxes.

Subsequently, an additional 4 million

dollars in revenue bonds were issued to

provide for the replacement of

deteriorated transmission and

distribution lines and to prepare the

system for waters expected to come from

the State Water Project.

Saticoy customers benefited from the

sale. Instead of relying on four small

storage tanks. they now could take

advantage of a city system which

provided over 50 million gallons of

storage capacity from tanks and a

reservoir tied into the Ventura water

system. Water obtained from Saticoy's

wells also was of poor quality. One

well was abandoned and one well was put

on a standby basis. Citizens now

complain when water is pumped from this

well during the summer. -

The 1968 contract of sale between

Saticoy and the city, which was approved

by the California Public Utilities

Commission, allowed the city to alter

the preexisting rates at any time after

60 days. The contract further provided:

"City agrees that from and after the

closing date it will serve water without

unfair or unreasonable discrimination to

all customers in the area wherein seller

is certificated to provide water service

by the California Public Utilities

Commission whether such customers are

located within or without the

territorial boundaries of the city and

will continue to serve all of such

customers."

Indeed, under the Revenue Bond Law

of 1941, the city shall prescribe,

revise, and collect such charges

that the services, facilities, or water

are furnished at the lowest cost

consistent with sound economy, and

prudent management, and the security and

payment of the principal and interest of

the bonds. (Gov. Code. # 54514.)

The city has taken the position that

the creation of separate pressure zones

for rate making purposes would be costly

to establish and politically divisive.

Nevertheless, since 1935, the city has

imposed a surcharge on nonresident water

users. Until December of 1952, the

surcharge was 48 percent. 19 Thereafter,

19tn 1943 the California Railroad

Commission, at the city's request,

issued an advisory opinion wherein it

concluded that the rate differential

produced a reasonable rate of return on

rate base, which apparently included

monies from donations and federal funds.

until July 1, 1972. the surcharge varied

between 31.4 percent and 32.7 percent.

Since July 1, 1972, the surcharge has

been 70 percent. In fiscal year 1976-

1977, this resulted in outsiders paying

an average of $97.13 more than their

neighbors living within city limits. If

they annexed, the surcharge would be

eliminated, but acreage and connection

fees would be paid by the developer.

Before considering the rate increase

of 1972, it is appropriate to consider

the sources of money used to improve the

system apart from the bonds. First,

there was an intra-city loan of $245,000

in 1958 to the water department which

was repaid, without interest in 1967 and

1971 (conversely, in 1946, $118.000 was

transferred from the water fund to the

sanitation fund. It was never repaid).

Second, there was a $322,000 loan

derived from revenue sharing funds in

1974 for improvements. It is to

be repaid with interest, over five

years, generating a return of $382,210.

Third, between 1972 and 1976 the

city received housing and urban

development water facility grants

totalling $1,774,889 for a transmission

pipeline, the Avenue treatment plant,

and other facilities. Fourth, the

general fund was to loan the

water department $1,380,245, for the

financing of the Bailey Reservoir in

1978-1979, which was to be repaid

with interest in five years in the

amount of $1,560,081.87.

Since 1972 or 1973, no nonresident

may connect to the system unless the

property is annexed to the city

and a correction fee is paid. By the

time of trial, these contributions

following annexation amounted to

$778,000. This sum was included in the

rate base, having been contributed by

those not within the city.

Turning now to the 1972 rate

increase. we first note that the

addition of the Saticoy customers

(together with the 31.4 percent

surcharge then imposed on nonresidents),

produced rather dramatic results. Gross

revenues for the fiscal year ending in

1970 increased 30.89 percent, while

expenses only increased 16.63 percent.

Net income jumped from $110,889.59 to

$303,787.75, an increase of 173.96

percent. Yet, further funds were

sought.

In the spring of 1970, the

consulting firm of Wilsey & Ham was

retained by the city to analyze the

water rates. Mr. Heidrick, who was in

charg: of the study, recommended an

overall rate increase of 20 percent,

which has never been challenged. When

it came to recommending a surcharge, Mr.

Heidrick initially concluded that those

outside contributed $340,000 in revenue,

and, after deducting a proportionate

share of operating expenses, interest

and depreciation, this would yield

$61,000 (a 17.9 percent yield). By

contrast, the city system would produce

$132,000 on revenues of $1,634,000 (a

8.1 percent yield). However, this

disparity was soon eliminated because

Mr. Heidrick thought that county

residents were being subsidized. For

instance, on the basis that persons who

made reservations for the city parks

were persons who lived somewhere in the

county, he believed that the relatively

few county residents supplied with

water by the city should be

charged $31,000 for the use of the city

parks and the swimming pool, and $1,000

for the fiesta de la Marina and

Poinsettia Festival. He also charged

nonresidents with $4,000 in indirect

administrative costs, and $135,000 for

foregone interest on investment in plant

serving the county.

Apparently, the city assumed that

the study would provide justification

for even a higher surcharge. However,

Mr. Heidrick initially concluded that

while the existing 32 percent surcharge

on outside customers could be justified,

any additional significant surcharge

would be hard to justify on the basis of

available data. He could only recommend

another 6.8 percent increase in the

surcharge, so that the total surcharge

would be 38.8 percent.

The director of public works then

came up with a novel approach; why not

exclide both th revenue and expenses

associated with the sale of untreated

water to the oil companies? The sale of

untreated water had generated

substantial revenue. Shell Oil paid

between $195,241 and $266,109 for

untreated water each year between 1972

and 1976. Yet, because the expenses

associated with the sale of untreated

water was less, this constituted a

profit center. By eliminating his

source of profit. the "loss" became

$111,000 rather than $23,000.29

Mr. Heidrick concurred, and in

light of the recalculated figures,

recommended that the surcharge be

increased to 70 percent. A grateful

city council then enacted an ordinance

imposing the recommended surcharge

effective July 1, 1972.

20appellants' expert, Mr. Knaggs,

believed that if the income and expenses

associated with the sale of untreated

water were added back in, only a 7.6

percent surcharge would be in order.

The difference between this figure and

the 6.8 percent figures chosen by Mr.

Heidrick, is not particularly

Significant.

After the 70 percent surcharge was

imposed, a funny thing happened. In

fiscal year 1971-1972, a new

administrative charge" of $71,744 was

imposed on the waterworks and those

revenues were transferred to the general

fund. This sum increased each year and

by fiscal year 1974-1975, $150,000 was

so transferred. The same amount was

transferred in the next two successive

years, plus $76,442 to repay a loan from

the general fund. This, of course, was

in addition to free water furnished to

city departments, which, if revenue had

been collected, would have resulted in

$31,199.79 in additional revenue in

fiscal year 1971-1972 and $56,353.22 in

fiscal year 1975-1976.

In the annual budget proposed by

the city manager in 1978-1979, water

revenues of $4,491,450 were anticipated,

including $300,000 for water

connections. Projected departmental

administration costs were $119,498.

Nondepartmental administrative charges

were $200,302, professional services

were $41,700 and taxes were $32,755.

The total expenses, including payments

to water purveyors, the state water

contract, and payments of bond,

principal and interest, amounted to

$3,314,681. After setting aside

$140,510 required by a bond covenant,

this would lead to a projected profit of

$1,036,259 which was to be used to

provide financing for a Reservoir.

THE CLAIMED JUSTIFICATION FOR THE

DISCRIMINATION

A consistent theme emerged from the

testimony of experts engaged by the

city, namely that the city owned the

System and was entitled to a reasonable

rate of return as if the city residents

were stockholders in a private utility.

They pointed out that other cities

imposed surcharges and that the City of

Pasadena took 16 percent of gross

revenues from water and electric sales

and put it in the general fund.

For instance, Mr. Heidrick believed

that the city was entitled to a

reasonable rate of return on its

investment in plant serving customers

residing outside city limits. Thus, he

explained that the $135,000 which

represented the surplus revenues .

generated by the surcharge upon water

sales to nonresidents could be

classified as foregone interest on

investment. The foregone interest

theory was based on the assumption that

although the assets of the enterprise

were created from water revenues

contributed by both nonresidents and

residents, the municipality which owned

the plant should be entitled to a return

on the investment devoted to persons

outside city limits, namely those who

did not own the system. In fact, the

$135,000 represented a 5 percent return

on that part of the waterworks whose

value was allocated to nonresident

customers. He did not find fault with

the rate of return, as a good part of

the waterworks was based on historic

cost, namely the cost of acquisition

years before, and not the replacement

cost.

Mr. Heidrick also felt that the

$135,000 profit could be classified as

an in lieu tax, based upon the theory

that the city managed the enterprise,

that city property was theoretically at

risk if revenues proved insufficient to

pay any outstanding general obligation

bonds, and that only the city would be

in a position to obtain short term

financing if an emergency arose.

When Mr. Heidrick recommended a 70

percent surcharge when he studied the

system between 1970 and 1972, he

admitted that he thought that a court

reviewing another rate surcharge imposed

by another city had actually upheld the

validity of such a surcharge. By the

time of trial. he became awa~e that the

other 70 percent surcharge had resulted

from a negotiated settlement of that

lawsuit. Although Mr. Heidrick

acknowledged that he had been laboring

under a misapprehension, he was still

of the opinion that a 70 percent

surcharge was appropriate. He believed

that the data would have justified a

surcharge of 75.7 percent. If he

eliminated the mistaken allowance for

parks and the fiesta, it would only

result in a lowering of the surcharge by

2.9 percent, and that the data still

justified a surcharge in excess of 70

percent.

Mr. Ferry testified that the city's

water rate base was $21,006,505, and

included $10,706,000 in long term debt

(50.97%). The Public Utility Commission

in 1976 had allowed a median return of

12.30 percent on the equity of privately

owned water companies. The embedded

annual cost of debt averaged 5.18

percent in fiscal year 1976-1976. Ifa

rate of 12.30 percent was applied

against the 49.03 percent of the rate

base representing the city's equity, and

if the 5.18 percent embedded annual cost

of debt was applied against the 50.97

percent of the rate base financed by

long term debt, the equitable composite

rate of return for the city's total rate

base would be 8.67 percent.

Nonresident users accounted for

14.41 percent of the total potable water

usage in fiscal year 1975-1976.

Although only 10.43 percent of the

hydrants were in the county, 83 percent

of the property subject to county taxes

were in areas where nonresident users

were found, and Mr. Ferry allocated

$21.164 to nonresidents for county

taxes. The total revenues from

nonresident potable water in fiscal year

1975-1976 was $615,778. The recorded

expenses associated with service to

nonresidents was $328,762, yielding a

significant profit.

On the other hand by applying an

8.67 percent rate of return to the

nonresident portion of the rate base,

which amounted to $3,067,170 of the

total of $21,006,505, an additional

$265,924 would be added to the "revenue

requirements," which would then total

$594,686. The disparity then only

amounted to $20,000, which Mr. Ferry

ve |

{

believed was within the "zone of

reasonableness."

Under Mr. Ferry's computation.

grant monies were included in the total

rate base.*1 He also included $4,639,656

in the rate base. representing the

capitalized value to the future payments

that the city is obligated to pay under

its contract with the State Water

Project, even though the system is not

connected to the nearest state water

conduit. Note also that nonpotable

water supplied to industrial users, such

as Shell Oil Company and Getty Oil

Company, who use 95 percent of the

untreated water, was excluded from this

computation. If the revenues ($374,301)

and expenses ($271,972) were allocated

to outside users, then revenue would

21mr. Ferry acknowledged that the

California Public Utilities Commission

does not allow donations to be included

in the rate base of an investor-owned

utility.

amount to $1,001,075, expenses would be

$866,658, and there would be a surplus

of $134,417. Under that analysis, only

a 33.9 percent surcharge could be

justified by Mr. Ferry. He also treated

the $56,353 in free water as revenue

foregone, and that the outside users

should be charged $8,064 to make up

for this lost revenue.

Mr. Jones, who served as the city's

public works director, explained that

the Casitas Mutual Water District

provides half the water used by the

system at a cost of $61.00 per acre

foot. The water from Casitas lake can

only be used within the boundaries of

the district, which only includes the

westerly portion of the city's water

system. Because the city's water system

is integrated, the city uses no more

water from Casitas than is pumped from

other sources, such as from the

100

ee Sei ei ey OT

submerged dam and wells on the Ventura

)/ river, which supply 25 percent of the

' water, certain golf course wells, which

provide 20 percent of the supply, and

‘cost $20 to $25 per acre feet. Certain

| other wells are used and water is also

| purchased from Alta Mutual Water

Company, at $56 per acre feet.

Mr. Stetson, another engineer

calculated that the value of the city's

water rights on the basis that

6,000 acre feet would be extracted

annually from the Ventura river and

_4,000 per year from the Mound basin.

| ‘The city could save in excess of $30 per

acre feet if it used the water.

‘Capitalizing this sum, he came to the

conclusion that the value of each acre

foot was $500, and the water rights

would be worth $5,000,000. If that

figure were used in place of the

$1,221,838 used by Mr. Ferry as the

101

value of water rights. an 83 percent

surcharge could be justified.

Overlooking the fact that a large

proportion, if not a majority of those

living outside city limits also are not

Se ee eee

within the boundaries of the Casitas

Mutual Water District, and technically

therefore could not use

unblended Casitas water, Mr. Stetson

assumed that when the Saticoy wells were

abandoned, or put on a standby

basis, the city had to purchase

additional more costly water to serve

these customers from the Casitas Mutual

Water District. Based upon the costs

associated with purchased water, in

1976-1977, the annual cost to

nonresidents was $127.17 while the

annual cost to residents was $71.89,

thereby justifying a 76.9 percent

differential in rates.

We turn now to the State Water

102

EEE ——e

ee ee ye

Ve’ ae ALOT Sid

Project. After the voters of California

approved the project, the Ventura Flood

Control District reserved 20,000 acre

feet of water. Because the city did not

acquire its right to 10,000 feet of the

20,000 acre feet until 1970 or 1971, it

must pay back the charges that accrued

since 1960, and make ongoing annual

payments as well. $1,785,681 has been

contributed as of June 30, 1977 and, of

course, each nonresident consumer

contributed $1.70 for every $1.00

contributed by a city resident. Future

contributions on the arrearages include

$313,199 in principal and $94,550 in

projected interest. Between 1977 and

December 31, 2035, $3,704,757 in

principal and $5,699,761 in interest

will be paid in annual installments to

the state. In addition, there will be

operating and maintenance charges of

$34,091,193 and Delta water charges of

103

—

$14,346,755. Yet even then, not a drop

of state water will be delivered to the

adits

city or the customers until a 40 to 50

mile conduit is built between Castaic

and existing Ventura mains, at a cost of

Pa ee Le eee ee ey

countless millions.

Although all monies necessary to

26 Pa A ASS

reserve the right to ultimately acquire

state water were contributed by all rate

payers, Mr. Ferry included a figure of

$4,517,361, as the capitalized value of

future payments, and then has 14.41

percent of that figure included in the

rate base allocated to nonresidents, so

that they must pay a return on monies

previously paid. Mr. McMillan, the

city's Director of Management Services,

treated the fixed obligation of

$4,017,955 as a liability. Yet that

figure is also somehow treated as a

future asset, and it, together with

previous payments of $1,785,681, amounts

104

to an asset of $5,803,636.

DISCUSSION

I. INTRODUCTION

To persuade the trial court that it

could exact a profit from nonresident

customers, the city submitted briefs

containing numerous out-of-state

authorities. We find significant

differences between the rules governing

water rates in other states and the

rules operative in California.

For the reader's convenience, we

have canvassed and criticized these

authorities in Appendix A to this

Opinion. Briefly stated, we find

several recurrent themes. First, some

municipalities charge "what the traffic

will bear," unless of course the

nonresident consumer is protected by a

contract. Second, municipalities can

exact profits from service to

nonresidents, and place the profits in

105

a a a

the general fund.

While it is understandable that

Ventura might prefer the rate making

freedom enjoyed by municipalities in

other jurisdictions we see no reason to

adopt the reasoning of those out-of-

state cases which sanction egregious

forms of discrimination in municipal

rate making. Certainly a politically

powerless class of consumers are not

going to tamely surrender their right

under California law to obtain essential

services at a fair price. In

considering these expectations, it would

seem that California public utility law

would be a logical point of departure.

II. UNDER CALIFORNIA PUBLIC UTILITY

LAW, POLITICAL BOUNDARIES ARE NOT

RELEVANT CONSIDERATIONS IN RATE SETTING.

We acknowledge that although the

Legislature could confer upon the State

106

Public Utilities Commission the power to

regulate municipally owned utility

rates, including the rates charged

nonresidents, it has not chosen to do

so. (County of Inyo v. Public

Utilities Com. (1980) 26 Cal.3d 154.

166-167.) Nevertheless, a brief survey

of our public utility law will prove to

be useful.

First, a regulated public utility

shall not raise any rate or alter any

Classification as to result in any

increase in that rate except upon a

showing that such a rate increase is

justified. (Cal. P.U.C.. # 454(a);

e.g., Dyke Water Co. (1964) 63 Cal.

P.U.C. 507, 509-510 (where exhibits

essential for calculation of a rate base

or operating results were uncertain,

unsubstantiated or improperly accounted

for, the application would be

dismissed) .)

107

A public service water company

appropriating water for purposes of

rental, distribution or sale cannot

confer upon a customer any preferential

right to the use of any part of its

water. (Leavitt v. Lassen Irrigation

Co. (1909) 157 Cal. 82, 89; Cal. P.U.C.

sec. 453(a).) Thus, stockholders

obviously are not entitled to free

service or preferential rates.

{Application of Foothill Ditch Company

(1929) 33 C.R.C. 237, 240; Narbonne

Ranch Water Company No. 2 (1928) 31

C.R.C. 548. 550 (company must

discontinue the practice of charging

stockholders $1.25 and nonstockholders

$1.50 for the same amount of

water); Franscioni v. Soledad Land &

Water Company (1914) 4 C.R.C. 184. 187.)

No public utility shall establish

or maintain any unreasonable differences

as to rates, charges, services,

108

facilities, or in any other respect,

either as between localities or as

petween classes of service. (P.U.C.

sec. 453(c).) Thus, each district should

provide a reasonable return on the

investment in that district. It would

not be fair to require customers in

other districts to provide more than

their fair share of total earnings

requirement, so that a particular

district could have lower rates. (Cal.

Water service Co. (1969) 69 Cal.P.U.Cc.

423, 429.)

At one time, the commission would

suggest that political boundaries were

proper criteria for different rate

zones. In s s of Kentwood v.

Pacific Gas & Electric Co. (1936) 39

C.R.C. 577 (13 P.U.R. (N.S.) 400),

residents of Kentwood believed they

should be entitled to rates operative

in incorporated towns of Ross, Larkspur

109

and San Anselmo in Marin County.

However, the evidence established that

there were only 38.5 electric customers

per mile in Kentfield, as compared with

68.1 per mile in the incorporated

municipalities. and pevenes per mile was _

$2,209 in Kentfield while the revenue

per mile was $4,430 in the cities. A

similar, but less striking, disparity

existed with respect to gas service.

The commission said: ". . . Taken as a

whole, the density of customers and

revenue per mile of line is greater, and

the cost of installation and operation

per customer is less in incorporated

cities and towns than in unincorporated

areas, for both gas and electricity. It

is equally true that the incorporated

limits of cities and towns form a rather

definite diviaineg line between areas of

low cost and high cost service, which

justified a differential in rates. . ."

110

(39 C.R.C. 577, 582.)

The commission suggested that

Kentfield could procure more favorable

rates through the simple process of

incorporation. Until it did so, it

would share the advantages and handicaps

characteristic of rural districts. (39

C.8.C. $77. $862.)

On the other hand, where the

proposed rates would favor customers

inside city limits, and there was no

difference in the method of providing

water service to customers, or the

expense involved simply by reason of the

limits of the City of Vallejo, such a

rate differential was an unfair

discrimination. Hence a uniform rate

was set by the commission. (Vallejo

Water Company (1931) 36 C.R.C. 321,

323.)

Some 30 years ago, the Public

Utilities Commission announced that it

pee I

was doing away with incorporation of a

city as a reason for being placed in a

lewer electric or gas rate zone. In the

future, for a city to improve its

position as to rates, certain density

and other pertinent factors were to be

considered. (Pacific Gas & Electric

Company (1952) 52 Cal.P.U.C. 111, 142;

Pacific Gas & Electric Co. (1954) 53 |

Cal.P.U.C. 616, 622.) Also, territory |

contiguous to cities must now be

reviewed periodically to determine if

any newly developed territory has urban

characteristics warranting consideration

for either more favorable rate

treatment, or for rates comparable to

the adjoining cities. (Southern

California Edison (1957) 55 Cal. P.U.C.

743, 761.)

In California Water Service Co.

(1955) 54 Cal. P.U.C. 266 (9 P.U.R.3d

128) the City of Chico urged that its

112

——eSEsECmC CC

city limits should be adopted as a zone

boundary. The commission disagreed,

saying: "This commission has long

adhered to the premise that no

distinction, without other controlling

reasons, should be recognized either in

rates charges customers or in rules

governing service to them by reason of

the fact that a political bhowndary,

such as that determined by the limits of

a city, separated one customer from

another. If such a distinction were to

be made, political rates, rather than

service rates, might soon follow -- a

condition abhorrent to the general

public interest and to the clear mandate

of the law that no unreasonable

distinction shall exist." (54

Cal.P.U.C. 266, 269.)

Noting that there had been 26

boundary changes in Chico in 3 years,

the commission found no just cause

113

Se Be Pe Je

for establishing a rate differential

based upon whether the water service was

rendered within or without the

political boundaries of the city. (54

Cal.P.U.C. 266, 270.)

Similarly in San Diego Gas &

Electric Co. (1972) 74 Cal.P.U.C. 93,

the commission noted that counsel's

arguments that preferential treatment

should be accorded San Diego over the

contiguous cities such as El Cajon,

National City. La Mesa and others, were

not convincing. "The use of city

boundaries is frequently advocated by

cities and has just as frequently been

cast aside by the commission as

inappropriate. .. . "™ (74 Cal.P.U.C.

93, 124.) The commission reminded the

city that the purpose in establishing

differential rate zones on a geographic

basis is to reflect differences in costs

of service in the most equitable manner

114

as practical. (74 Cal. P.U.C. 93, 124.)

The commission does not assert

jurisdiction over rates charged by a

city for service inside and outside

its boundaries. However, it is most

signiflicant that the ommission, when it

approves the acquisition of a privately

owned, regulated public utility by a

municipality, dces afford protection to

nonresident consumers. (Dyke Water Co.

(1963) 61 Cal.P.U.C. 313. 321.) In that

case the commission observed ". . . the

transfer would not be in the public

interest if discriminatory treatment by

the city were to result. It is for that

reason that the commission has at all

times imposed, as a condition of its

approval, a provision that a city

purchasing a utility system shall not

unfairly discriminate against customers

who live outside the city and have no

voice in city government. " (61

115

Cal.P.U.C. 315, 321.) 2?

Thus, the Public Utilities

Commission, foreseeing the risk of

discrimination against nonresidents, has

guaranteed that they may not be treated

like the "Outcasts of Poker Flat.??

IIr. IN

CALIFORNIA A MUNICIPALITY MAY NOT

ESTABLISH RATES WHICH UNFAIRLY

DISCRIMINATE AGAINST NONRESIDENT WATER

CONSUMERS, ESPECIALLY WHEN THE

NONRESIDENTS ARE PROTECTED BY THE TERMS

OF A CONTRACT BETWEEN THE CITY AND THE

PRIVATE WATER COMPANY WHICH PREVIOUSLY

22tn Dyke. the evidence indicated

that the City of Anaheim had used other

city funds to support the syster. Hence

the customers living outside the city

could fairly be expected to pay for the

water at higher rates. (61 Cal.P.U.c.

3345, 321.)

23see, I, The Writings of Bret

Harte, Houghlin & Mifflin, 1896, p. 14

et seq.

116

SERVED THEM.

If we were confronted with

discriminatory water rates established

by a municipal water district governed

by the Municipal Water District Law of

1911, this opinion would have been

mercifully brief. Although a district

may establish different rates for

different classes or conditions of

service, “rates shall be uniform

throughout the district for like classes

and conditions of service." (Wat. Code.

sec. 71614.) Although a city may be

included within the boundaries of such a

district (Wat. Code. sec. 71611), once

the city is made part of this district,

the district may sell such water

“without preference" to a city. (Wat.

Code, sec. 71611.24 Nevertheless, it

24The similarity between this

language in these

sections and those found in section

453(a) and (b) of the

Public Utilities Code is not surprising.

117

appears that no specific statute

regulates the rates set by

municipalities operating their own

waterworks. We turn then to common law

as both measures

were first enacted two years apart

during the trust busting era of the

first part of this century.

Nevertheless, under the Municipal Water

District Law of 1911, special rates have

been set for property annexed to the |

district (Wat. Code. sec. 71615), and it

has also been held that section 71614 of

the Water Code is discretionary, and

that the district had the statutory

authority to enter into long term

contracts governing rates so as to

induce pulp mills to locate within

the district. (Louisiana-Pacific Corp.

v. Humboldt Bay Mun. Water Dist. (1982)

137 Cal.App.3d 152.) In Louisiana-

Pacific it appears that the pulp

companies did bear all of the cost of |

the initial costs for the additional

facilities, paid $105,000 toward the

district's fixed expenses for existing |

facilities, and agreed to pay a |

percentage of the operating expenses, |

which was subject to changes in a

building cost index. (Id. at pp.154-

155.) Nevertheless, Justice Grodin,

concurring, suggested that in setting

rates by contract, the district must

still guarantee that the district

substantially complies with Water Code

section 71616, which requires revenues

sufficient to pay operating expenses,

depreciation, etc. (Id. at p. 163.)

118

rules upon that subject as they have

evolved in California.

she rates charged by a municipally

owned utility must be fair, reasonable,

just and nondiscriminatory. (American

Microsystems, Inc. v. City of Santa

Clara (1982) 137 Cal.App.3d 1037, 1041;

Boynton v. City of Lakeport Mun. Sewer

Dist. (1972) 28 Cal.App.3d 91. 94.)

However, the lack of uniformity in

rates charged to users of public utility

service who reside outside city limits

and those charged users within city

limits is not necessarily evidence of

unlawful discrimination and is not prima

facie unreasonable. (Elliott v. City of

Pacific Grove (1975) 54 Cal.App.3d 53,

57; Durant v. City of Beverly Hills

(1940) 39 Cal.App.2d 133, 138-1391

County of Inyo v. Public Utilities Com.,

supra, 26 Cal.3d 154, 159, fn. 4.)

It is presumed that the rates fixed

119

are reasonable, fair and lawful. Thus

the challengers must establish that the

rates fixed are unreasonable, unfair or

unlawful. (Elliott v. City of Pacific

Grove. supra. 54 Cal.App.3d 53, 60;

Durant v. City of Beverly Hills. supra,

39 Cal.App.2d 133, 139.) If, however, it

is shown that a city set sewer charges

four tines the rate set for users inside

city limits, based upon the nonresident

status of the consumer, not on cost of

service, and it appears that the system

is financed by revenue, and no part

will be financed through taxation,

the rate will be deemed invalid.

(Elliott v. City of Pacific Grove.

supra. 54 Cal.App.3d at pp. 57, 59;

Cou QO Vv. blic Ut ties

Com., su , 26 Cal.3d at p.159, fn.

4.)

In the area of economic regulation,

such as rate regulation, it need only be

120

shown that the distinction between

customers bears a rational relationship

to other reasonable considerations.

(Toward Utility Rate Normalization v.

Pu ties - (1978) 22 Cal.3d

529, 544; Wood v. Public Utilities

Commission (1971) 4 Cal.3d 288, 294;

Swanson v. u Wa s ’

supra, 56 Cal.App.3d at pp. 523-524.)

Nevertheless, ". . . a city which

acquires the water system of another

community incurs an obligation to deal

fairly with its customers in that

community and to provide them with

reasonable service at reasonable rates.

(See South Pasadena v. Pasadena Land.

etc. Co. (1908) 152 Cal. 579. 587-588,

594 (93 P. 490]}.) Such an acquiring

city, as to the water dedicated to the

use of the outside community, holds

‘title as a mere trustee, bound to apply

it to the use of those beneficially

121

interested. ' (Id.. at p. 594; see

Durant v. City of Beverly Hills, supra.

39 Cal.App.2d 133, 138.) .. ." (County

of Inyo v. Public Utilities Com., supra.

26 Cal.3d 154, 159. Emphasis added.) 2°

See also People ex rel City of Downey v.

Downey County Water Dist. (1962) 202

Cal.App.2d 786, 797.)

These common law rules are

illustrated in Austin View Civic

Association v. City of Palos Heights

(1980) 811 Ill.App.3d 89. (405 N.E.2d

1256). In that case, defendant purchased

two private water companies that were

supplying water to residents in the

unincorporated area. It also entered

into a contract with the City of Alsip

to obtain water which originated in the

25conversely, the relationship

between a private utility company and

its customers is not that of trustee and

beneficiary. (Board of Commrs. v. New

York Telephone Co. (1926) 271 U.S. 23,

31 (60 L.Ed. 808.)

122

City of Chicago. Under this contract,

defendant was required to pay to the

City of Alsip, who in turn must pay to

the City of Chicago, a 50 percent

surcharge over the normal price for

water delivered to nonresidents.

Defendant then elected to require

nonresidents to pay 25 percent more for

all water from whatever source,

delivered to nonresidents. In reversing

the order dismissing the class action.

the Illinos court said:

", . . The business of supplying

water belong to that class of

enterprises upon which the public

interest is impressed. [Citations.] At

common law, such an enterprise, because

it had a monopoly on the service

provided in the area, was prohibited

from charging exorbitant rates and was

required to serve all of its consumers

without reasonable discrimination in

123

SST

rates or manner of service. [Citations.]

Today, private utility companies are

prevented from charging exorbitant rates

or from engaging in unreasonable

discrimination in rates or manner of

service by statute, and are no longer

subject to the common law [citation].

Though there is no statute that prevents

municipal corporations that operate

public utilities from acting in an

unreasonably discriminatory manner,

there is still the common law duty that

prevents them from doing so." (405

N.E.2d 1256, 1262.)

The court noted that consumers of

municipally owned utilities are just as

completely protected from exorbitant

rates and unjust discrimination as the

consumers are under the Public Utilities

Act. Hence, the test to be applied in

determining whether there has been a

violation of the common law right is the

124

same test used to determine whether a

privately owned utility company is

acting in an unreasonably discriminatory

manner. The court said:

"When a privately owned utility is

charged with unreasonable discrimination

in rates, the test used for deciding

the validity of the difference in rates

is to determine whether the difference

is reasonable, and not arbitrary, based

on a consideration of such factors as

differences in the amount of the product

used, the time when used, the purpose

for which used, or any other relevant

factors reflecting a difference in costs

[citations]. If the difference in rates

is reasonably related to a difference in

the costs of providing the service,

there is no unreasonable

discrimination." [405 N.E.2d 1256.

1265.)

Because the complaint alleged that

125

the rate structure was arbitrary and

discriminatory, because it bore no

reasonable relationship to a difference

in the costs of providing water to

nonresidents, then evidence had to be

presented to refute that contention.

While defendant may have had the power

to enter into a contract with another

municipal corporation for the purpose of

procuring a supply of water, it did not

have the power to enter into a contract

which would discriminate against

nonresidents. (405 N.E.2d 1256, 1266-

1267.)

Finally, it should be remembered

that nonresidents are protected by the

earlier contract between the city and

the private water companies. While the

city is not under the jurisdiction of

the Public Utilities Commission, if,

after the commission has fixed the

conditions of sale, the city purchases ;

126

the private water companies. the city

may not disregard those conditions.

Thus in Henderson v. Ov -W dott

Irr. Dist. (1931) 213 Cal. 514, 526-534,

where the contract guaranteed that the

consumers outside the district pay the

same total costs for water, the district

could not impose a 50 percent surcharge

for nonresident use, to substantially

extend se=vice within the district.

In Rutherford v. Oroville-Wyandotte

Irr. Dist. (1932) 215 Cal. 124. cert.

den. 287 U.S. 609, the Supreme Court

issued a writ of mandate requiring the

district to grant water service to a

nonresident at the same rate charged to

residents.

The district persisted in attempting

to obtain additional funds for

nonresidents and chose to impose a

standby charge of $2.00 in addition to a

standard 46.00 rate. The standby charge

127

was imposed whether water was used or

not. Coincidentally, the district

reduced the tax on lands belonging to

residents from $3.00 per acre to $ .10

per acre.

The Supreme Court recognized that

the standby charge imposed upon |

nonresidents was designed to defray

additional expenses to seCure additional

rights for the exclusive benefit of

those within the district. The court

ruled that the amount chargeable against

inside users in extending the works of

the district could not be included in

the charge made against outside users.

It held that inside and outside

users must be charged the same rate.

(Rutherford v. Oroville-Wyandotte I.

Dist. (1933) 218 Cal. 242, 250.)

With these principles in mind, we

now examine the proffered justification

for the surcharge.

128

4. ALTHOUGH A MUNICIPALITY MAY

PROVIDE ITSELF WITH FREE SERVICE AND MAY

ESTABLISH KZESERVES, THE UTILITY MAY NOT

EXCLUDE OTHER WATER REVENUES OR IMPOSE

AN IN LIEU TAX OR MAKE ANY OTHER

UNREASONABLE DISCRIMINATION, IN SETTING

DISCRIMINATORY RATES TO NONRESIDENTS

PREVIOUSLY SERVED BY A PRIVATE WATER

COMPANY.

A. Free Service

There is no legal reason why a city

which owns and operates its water or

sewer system should take money from its

own taxpayers to pay itself for the use

of its own waterworks or sewers. This

is simply not equivalent to the public

utilities doctrine which prohibits the

rendition of free public service to

preferred customers. (See Gericke v.

City of Philadelphia (1945) 353 Pa. 60

(44 A.2ad 233, 237)? Camden County v.

Pennsauken Sewage Authority (1953) 28

129

N.J. Super. 586 (101 A.2d 361, 362);

Twitchell v. City of Spokane (1909) 55

Wash. 86 (104 P. 150, 151).)

For the guidance of the trial court,

the revenue associated with what appears

to be a reasonable allowance

for free city use should be totally

excluded from the calculations.

Otherwise, if, as the trial court

suggested, revenue imputed to this free

service was included in the overall

calculation, then there is a real risk

that the nonresidents would be charged

with a proportion of nonexistent

revenue.

B. Reserves

Municipally owned utilities may charge

rates to finance needed replacement, or

expansion of the facilities. (Pub.

Util. Code. sec. 10003 (to complete,

reconstruct, extend, enlarge and repair

water facilities).) American

130

Microsystems. Inc. v. City of

Santa Clara. supra. 137 Cal.App.3d 1037.

1040. (to create funds for new

construction) Cramer v. City of San

Diego (1958) 164 Cal.App.2d 168,

169,173, (funds used to pay for

extending or improving the sewer system)

Western Heights Land Corp. v. City of

Ft. Collins (1961) 146 Colo. 464 (362

P.2d 155, 158) (rates can be established

to extend the service and replace

facilities outmoded by depreciation and

obsolescence) City of Mt. Vernon v.

Banks (Ky 1964) 380 S.W.2d 268, 271 (65

percent increase in water rates was

justified to finance a sewer systen.

Prudent management contemplates

contingencies and conserves assets

needed for normal growth, maintenance

and improvements) Rankin v. Chester

Municipal Authority (1949) 165 Pa.

Super. 438 (68 A.2d 458. 462. 464) (the

131

authority was committed to provide a new

source of water, including a dam 40

miles away, and a pumping station. An

increase in rates to provide a new

source of water is not a tax) Pabst

Corp. v. Railroad Commission (1929) 199

Wisc. 536 (227 N.W. 18, 20) (funds

should be available to facilitate

continued development, so that the

quality and abundance of the supply will

be well in advance of actual needs of

the community) Laramie Citizens for Good

Government v. City of Laramie (Wyo.

1980) 617 P.2d 474, 484 (rates should

take into account the cost of

construction and operation, necessary

expansion, reserve for depreciation and

debt retirement).

Unlike the situation in Rutherford

v. Oroville-Wyandotte Irrigation Dist.

supra, 218 Cal. 242, 250, the connection

to the state water project will not

132

be merely for the benefit of city

residents. If and when the actual

connection is made, all consumers will

equally derive whatever benefit is

obtained from the additional water

supply. While a private utility could

not include such a contingent water

supply in its rate base, there

was no evidence before the trial court

that the decision to reserve rights to

state water was an imprudent

investment, or that other less costly

alternatives existed for future

expansion. (See generally. Pub. Util.

Code. sec. 10153.)

We part company with the city on the

subject as to whether such a protected

enormous experse should, by some process

of alchemy, ve treated as an asset for

rate making purposes sufficient to

justify a discrimination against

nonresidents. The city had not even

133

begun the task of physically connecting

its system to the state water project,

so it cannot be categorized as work in

progress. Remember too, that the Mound

and Saticoy customers became city

customers before the city ever began

paying on its state water obligation.

The nonresidents are not specially

benefited by this expenditure. Yet,

under the city's reasoning, they should

continue to pay $1.70 for each $1.00

contributed by their neighbors who

possibly live across the street, but

within city limits. We do not agree.

The obvious solution, of course, is

to treat this as a liability to be paid

by nonresidents and residents alike. It

should not be employed to discriminate

among similarly situated customers.

Cc. W wed Se es a

Rent

When the city lends its employees to

134

the utility, and acts as landlord, the

city is entitled to compensation.

Unless the utility pays the city that

which it would have to pay to private

individuais for rent, management, fiscal

and legal services, the utility

rate payers are getting a "free ride" at

the expense of city taxpayers who are

furnishing the service. (State ex _

rel. Lloyd v. Hurd (Ohio App. 1964) 1

Ohio App.2d 447 (205 N.E.2d 116, 118),

(35 percent of municipal salaries,

including the auditor, solicitors,

mayor, and city council salaries, were a

charge against the municipal light

plant) Borough of Ambridge v.

Pennsylvania Public Service Utility

Commission (1939) 137 Pa.Super. 50 (8

A.2d 429, 432) (salaries of all persons

directiy employed.and a just portion of

executive officers whose time is partly

devoted to the business should be

135

included) Hastings v. Village of Stowe,

Electric Department (Vt. 1965) 214 A.2d

56. 60 (municipal utility allowed

expenses for renting a warehouse).

However, the utility must prove that it

incurred labor expenses. (See e.g.,

Garden Water Co. (1968) 68 Cal.P.U.C.

751, 755.) (The record did not persuade

the Commission that the salary

allocation percentages were in fact

based upon a study of employees' time

actually engaged in construction and

operations).

The city did not attempt to prepare

documents reallocating the proportions

of city salaries attributable to water

service until shortly before trial

began. Its new allocation is somewhat

inconsistent with its earlier statement

to the effect that the water department

was entirely self-supporting. While we

might question the admissibility of

136

these documents prepared long after the

services were rendered (Evid. Code. sec.

1280 (b) and (c)); see Elsworth v. Beech

Aircraft Corp. (1984) 37 Cal.3d 540,

554) this evidence ultimately was

received without objection.

D. Exclusion of Income and Expenses

From Nonpotable Water.

While under public utility law

different types of service may be

separately classified, we know of no

decision which allows a utility to

exclude income and expenses from one

particular class of customers, so as to

create a feigned distinction for rate-

making purposes between customers

receiving the same service and who are

Similarly situated. Several cases

demonstrate that this practice is

unfair, if not pernicious.

In Marshall Durbin & Co. v. Jasoer

Utilities Bd. (Alabama 1983) 437 So.2d

137

1014, the court acknowledged that it was

not per se improper to combine a water,

sewer and gas system for the purpose of

rate making. However, it appeared that

the gas rates were excessive and

arbitrary. While the system as a whole

earned 2.18 percent to 6.51 percent

during the period in question, and a

proper rate of return for gas services

ranged from 7.79 percent to a maximum of

10.38 percent, the actual rate of return

on gas service was 42.12 percent one

year, 60.86 percent a second year, and

73.20 percent a third year. The court

said: "A consolidated utility may

establish rates which in effect, allow

one component of the system to subsidize

another component, where the overall

rate structure is reasonable.

Nevertheless, the profit on any one

system may not unduly burden the

customers with rates which are

138

unreasonable in order to lower rates for

other services. (437 So.2d 1014, 1020.)

The Alabama court ruled that the

gas rate was unlawful and that a

customer might recover damages at common

law resulting from discrimination by a

utility as to rates or services. The

customer was entitled to a refund. To

hold otherwise would create a situation

where a utility could set a clearly

unreasonable, even exorbitant rate,

collect it during prolonged litigation,

and then be relieved of the duty to make

a refund. (437 So.2d 1014, 1026.)

In Pennsylvania Public Utility

Co ss v. Johnstown Water Co. (1957)

19 P.U.C.3d 433, 450, the proposed rates

for a company operating a gravity system

for customers in areas of lower

elevation and a pumping system in areas

of higher elevation were discriminatory

in that the proposed rates would impose

139

a large segment of the pumping system

expense upon the customers served by the

gravity systen.

ln Jager v. State (Alaska 1975) 537

P.2d 1100, the rate of $1.49 per MCF for

residential service produced 53 percent

of the total revenues and 63.8 percent

of pretax profits on only 25 percent of

the volume of gas sold. Conversely,

the rate for service subject to

interruption to cities, electric

companies, and military customers was

between .34 cents to .55 cents per MCF.

It produced 36.2 percent of the pretax

profits. Because each class of

customers was responsible for roughly

equal operating costs, the court

directed the Public Utilities Commission

to entertain the issue of discrimination

in the rate structure.

The exclusion of the nonpotable

revenues and expenses appears to have

140

resulted in a surcharge approaching 30

percent upon nonresident potable water

users. This alone justifies the

reversal of the judgment. "Profits of

the past cannot be used to sustain

confiscatory rates for the future."

{Board of Commissioners v. New York

Telephone Co., su » 271 U.S. 23, 32.)

tio e

Justified Because Casitas Water is More

Costly.

Although one of the city's experts

believed that

a 76.9 percent surcharge could be

justified on the theory that the

nonresidents created the need to

purchase additional and more costly

water from Casitas, we already know that

the assumption is erroneous because a

large proportion of nonresidents are not

technically eligible for unblended

Casitas water because they live to the

141

east of the area where the Casitas

boundaries bisect the city. Yet, the

theory itself is alien to public utility

law.

In Butte County Water Users Assn.

v. Railroad Commission (1921) 185 Cal.

218, it was claimed that a consumer of

public water company had a vested right

to service in preference to later

customers, so that their rights were

ranked, in the order of the time that

each became a customer. The court said:

"This is a rather novel doctrine and one

whose statement alone is well-nigh

sufficient for its rejection. .. [A]

public utility must hold itself out as

ready to serve and must serve the public

or its portion of the public without

discrimination or preference other than

such as corresponds to difference in the

value or cost of the service rendered.

[I]t would be most unjust and very

142

injurious to the state to hold that, in

times of shortage the older consumers

could have a full supply and the later

none." (185 Cal. 218, 224-225.)

In In re Trunkline Gas Co.. 29

P.U.C.3d 1 (F.Power Comm. 1959) the

utility proposed to impose an

incremental charge. The commission

ruled: "The commission has consistently

rejected allocation methods which would,

in effect, assign costs of particular

main line facilities to a specific

customer. Likewise, the commission has

rejected methods which treat, for rate

purposes, particular gas purchase

contracts as being dedicated to a

specific customer. Trunkline's

proposed rates, based as they are upon

all of the incremental costs of

Trunkline's expansion project, are

inherently unequitable and would tax

the consumers for benefits to

143

be enjoyed by all of the customers of

the integrated system. " (29 P.U.R.3d l,

ll.)

McGinley v. Wheat Belt Power Dist.

(1983) 214 Neb. 178 (332 N.W.2d 915,),

involved a situation where the district,

because of increased seasonal irrigation

and increased peak loads, built a new

facility and created two consumer

Classes based on the date the customer

requested the service on the theory that

new customers were creating the sudden

demand. In 1976 old customers paid 39

cents per unit while the new customers

paid $5.02 per unit. Although the older

customers used 75 percent of the power,

by 1981 they paid only $5.75 while the

newer customers paid $17.17. The court

found no justification for the practice.

While discrimination can be based on

classes, the class may not be subdivided

solely upon the date the service was

144

provided. Otherwise, a utility could

impose on a new building, the entire

cost of obtaining a new source of energy

required by reason of the addition of

the building to the service, even though

the nature of the service is in all

respects identical to all other

commercial customers in the community.

"Such a rate formula is beyond

comprehension." (332 N.W.2d 915, 919.)

The court said: "This is a question

of Wheat Belt determining that the least

expensive block of power it purchases

belongs to the first customers and the

most expensive block belongs to the

later customers, though Wheat Belt

cannot show where any particular block

of power is transmitted." (332 N.W.2d

915, 920.)

The court found the rate to be

invalid and directed Wheat Belt to

refund or credit the 1976 class the

145

proper amount, and absorb the loss in

future rates. 2°

Likewise, a Washington court

concluded that it would be inequitable

to assess all costs to the new consumer

block when benefits were received

system-wide, even when the water

consumption within the district did

not increase. However, when it appeared

that 40 percent of the water distributed

through the new facilities went to the

city, and 60 percent went to purveyors,

it was reasonable to allocate costs on

that basis. (King County Water District

No. 75 v. City of Seattle (1978) 89

26, related problem may exist in

the context of a development. For

instance, when developers contribute

water facilities with excess storage

capacity, and in fact use one-half of

the capacity, a rate which would require

them to be repaid in full by subsequent

developers, would mean subsequent

developers would have to bear all of the

costs. (See Huntington Inc. v. Penn.

Public Utility Commission (1983) 76

Pa.C. 387 (464 A.2d 601, 605).)

146

Wash.2d 890 (577 P.2d 567. 574‘.)

This is not a situation described

by the Washington court, especially

because the number of consumers both in

and outside of the city have increased,

and, if Casitas is now providing 50

percent of the water, all customers are

being benefited by this particular

supply. Hence, to charge existing

nonresident consumers on the basis of

incremental costs is patently

ridiculous.

_F. The Donated Property Should Have

Been Excluded From The Rate Base.

Customer donations of plant are

normally excluded from the rate base on

the theory that it would be inequitable

to permit the utility to earn on

property provided by the customers

themselves. (Conejo Valley water Co.

(1965) 64 P.U.C. 212, 225; La Puente

Cooperative Water Co. (1966) 66

147

Cal.P.U.C. 614, 626; Sutter Butte Canal

Co. v. Railroad Com. (1927) 202 Cal.179,

190-191 (aff'd. 279 U.S. 125); Public

Utilities Commission v. Northwest Water

Corp. (1969) 168 Colo. 154 (451 P.2d

266, 276-277); Application of Kaanapali

Water Coro, (Hawaii App. 1984) 678 P.2d

584, 590-592; United Gas Corp. v.

Mississippi Public Service Commission

(1961) 240 Miss. 405 (127 So.2d 404,

412); Cogent Public Service v. Ariz.

Corp. Com'n. (Ariz.App. 1984) 688 P.2d

698, 701-703.)

An Illinois court reasons that it is

proper to exclude contributions in aid

of construction made by customers, the

propriety of a reasonable depreciation

deduction is not dependent upon the

source of funds for the original

construction of the facility. as the

utility will have to replace obsolete

properties. (Dupage Utility Co. v.

148

Illinois Commerce Comm. (1971) 47 Ill.2d

550 (267 N.E.2d 662, 668-669, cert. den.

404 U.S. 85&2).) However, most courts

reason that the purpose of depreciation

is not to replace property but to

recover the criginal investment over the

life of the property. "Since the

company invested no funds in contributed

property, it is not entitled to recover

the original investment through

depreciation... . We believe it

inequitable to allow a company to

recover depreciation accruals on plants

in which it has made no investment."

{Mechanic Falls Water Co. v. Public

Utilities Commission (Me. 1977) 381 A.2d

1080, 1104; accord State ex rel

Martioney Creek Sewer Co. v. Public

Service Commission (Mo. 1976) 537 S.W.2d

388, 399; State ex rel Utility

Commission v. Heater Utilities (1975)

288 N.C. 457 (219 S.E.2a 56, 62; Sunbelt

149

Utilities v. Public Utility Commission

(Tex. 1979) 589 S.W.2d 392, 395;

Princess Anne Utilities Corporation v.

Commonwealth ex rel State Corporation

Commission (1971) 211 Va. 620 (179

S.E.2da 714).)?2?

27The propriety of "connection

fees" for water and sewer charges in

general is undisputed. (Associated

Homebuilders v. City of Livermore (1961)

56 Cal.2d 847; Carlton Santee Corp. v.

(1981) 120

Cal.App.3d 14, 24.) A water district may

use such revenues not only for

operational and maintenance purposes but

also to provide a reasonable surplus for

improvements, extensions, and

enlargements. (Carlton Santee Corp. v.

Padre Dam Mun. Water Dist., supra. 120

Cal.App.3d at p. 30.) But see Beaumont

Investors v. Beaumont Cherry Valley

Water District (March 5, 1985, 4th Dist.

No. E-00534) ____ Cal.App.3d ___, holding

that to sustain a facilities fee, a

district must prove that it was

necessary by evidence establishing, (1)

the estimated construction costs of the

improvement, and (2) the basis

for determining the amount of the fee

allocated to the

plaintiff. However, these payments are

made by developers and other individual

applicants for new service connections

in order to defray the costs of

obtaining service. By no stretch of the

imagination could such payments be

labeled prepaid expenses by every city

1590

What about federal grants and funds

derived from federal revenue sharing?

One court has reasoned that "the city

has unqualified ownership of the portion

of the plant built with the money and

the fact that some infinitesimal portion

of the money might be considered to have

come from taxes paid by the out-of-city

consumers does not create equities in

their favor." (City of Covington v.

Public Service Commission (Ky. 1958) 313

S.W.2d 391, 393.) On the other hand, a

Wisconsin court, in a valuation

proceeding, excluded federal

contributions on the theory that the

federal grant was made for the benefit

of both the town and the city and ".

resident. Therefore, it is not logical

to employ such payments as a method of

perpetuating rate discrimination against

existing nonresident customers, most of

whom also paid connection charges when

they first obtained service from the

private water company or the public

entity itself.

151

. the city should not now be heard to

claim that they should receive

compensation for a portion of the water

utility which was never paid for by them

either directly or indirectly." (City of

St. Francis v. Public Service Commission

(1955) 270 Wisc. 91 (70 N.W.2d 221, 225-

226) .)

Most courts which have considered

the problem have excluded federal grants

from the rate base. (See, e.g.,

Pichotta v. City of Skagqwav (Alaska

1948) 78 F.Supp. 999, 1006 ($39,973

expended by army in rehabilitating the

system during World War II was excluded

from the rate base, as the rule allowing

additions was never intended to embrace

a gratuitous contribution to capital

made at the taxpayers expense); In re

Southern California Edison Co. (1954) 53

Cal.P.U.C. 385, 410; 6 P.U.R.3d 161,

185-186; (donations from governmental

152

entities were not "investment") City of

Detroit v. City of Highland Park (1949)

326 Mich. 78 (39 N.W. 2d 325, 333;

(federal funded contributions were

excluded from rate base of municipally

owned utility) City of Hagerstown v.

Public Service Commission (1958) 217 Md.

101 (141 A.2d 699); (in setting rates to

utility serving outside customers, both

customer contributions and federal

grants were excluded from the rate

base).

We agree that both acreage fees,

connection fees and other donations

should be excluded from the rate base,

in calculating any surcharge to

nonresidents. As to federal

contributions and grants, the same

result should obtain; it is unfair to

require those who have paid federal

income taxes to pay for the proverbial

"pork barrel" a second time.

153

Although donations per se should not

be depreciated, and we recognize that

there is only a gossamer thin line

separating federal donations from other

types of private donations, cities might

be deterred from applying for federal

grants for improved water works or from

applying revenue sharing funds to aid

one of its utilities serving

nonresidents if the city elders

discovered that none of the investment _

could ever be recouped, as depreciation,

and made available for reinvestment in

utility projects in subsequent years.

After all, facilities built with federal

funds do become obsolescent, and it is

incumbent upon the city to repair and

rebuild the system with funds created by

the concept of depreciation. (See city

of Detroit v. City of Highland Park,

supra, 326 Mich. 78 (39 N.W. 2d 325,

333.) Therefore, for policy reasons, we

154

will allow the city to depreciate that

part of the plant which was financed by

federal funds.

Value o ts

One expert added $5,000,000 to the

rate base on the theory that water

rights within the area served by

the system could generate water at a

lower cost than the

amount which was obtained from Lake

Casitas.

Although we acknowledge that the

value of water rights owned by a

privately owned and regulated utility

must be taken into account in setting

rates (San Joaquin Co. v. Stanislaus

County (1914) 233 U.S. 454 ; San Joaquin

Land & Power Co. v. Railroad Commission

(1917) 175 Cal. 74, 77), we are puzzled

by the suggestion that this increased

value suddenly springs into being when

nonresidents challenge a discriminatory

155

rate.28 This is not a valuation case,

or a situation where the water rights in

question were paid for with tax

revenues. Therefore, the inclusion of

this sum would be wholly inconsistent

with the rights to nondiscriminatory

service found in the Mound and Saticoy

contracts.

H. In Lieu Taxes

In lieu taxes have not fared too

well in the history of this country.

At one time, the colonists

evaded the tea duty by smuggling Dutch

tea, reducing the sale of the tea of

the East lndia company by almost two-

thirds. To rescue the company, Lord

North devised a majestic scheme by which

the surplus tea piling up in company

warehouses could be sold directly to

America, skipping England and the

English customs duty. If the duty was

28see footnote 1, supra.

156

reduced to 3d, a pound, the tea could be

sold at 10s, instead of 20s a pound.

Considering the Americans known fondness

for tea, the lowered price was expected

to overcome their patriotic resistance

to paying duty, and the duty would then

generate funds to pay for the defense of

the colonies.

This resulted in the Boston Tea

Party. Disgruntled patriots boarded

ships, slashed open the tea chests, and

dumped the contents into the waters of

Boston Harbor, voicing seditious

thoughts, such as "no taxation without

representation." And you know how the

story ended. 29

When private utilities are regulated

by a public utility commission, the

commission will not allow the utility to.

charge customers living outside

29For a modern account, see B.

Tuchman, The March of Folly: From Troy

to Vietnam, pp. 193-196, (A.Knopf 1984).

157

municipal boundaries with business and

occupation, or gross receipts taxes, and

will instead require such taxes to be

paid exclusively by the inhabitants of

the city which impose the tax. (State

ex rel. West Plains v. Public Service

Comm. (Mo. 1958) 310 S.W.2d 925; City of

Spartanburg v. Public Service Comm.

(1985) ____S.C. ____.s-« (314 S.E.2da 599) 3

City of Houston v. Public Utilities

Commission of Texas (Tex.Civ.App. 1983)

656 53.W.2d 107; Ogden City v. Public

Service Commission (1953) 123 Utah 437

(260 P.2a 751)? King County Water

District No. 75 v. City of Seattle

(1978) 89 Wash.2d 890 (577 P.2d 567,

571-573.)

In most jurisdictions, the burden

of paying franchise payments is imposed

upon the inhabitants of the communities

which exact the franchise payment, and

not upon those consumers residing

158

elsewhere. (City of Petersberg v.

Hawkins (Fla. 1978) 366 So.2d 429;

Village of Maywood v. Illinois Commerce

Commission (1961) 23 I11.2da 447 (1978

N.E.2d 345. cert.den. 369 U.S. 851);

City of Des Moines v. Iowa State

Commerce Commission (Iowa 1979) 285

N.W.2d; City of Norfolk v. Chesapeake

and Potomac Telephone Company of

Virginia (1975) 216 Va. 317 (218 S.E.2da

531); Contra State v. Department of

Public Service (1943) 19 Wash.2d 200

(142 P.2d 498, 535-537); and City of

Montrose v. Public Utilities Commission

(1978) 197 Colo. 119 (590 P.2d 502.)

In California, private utilities

do pay franchise fees regulated by the

Legislature. (P.U.C., sec. 6231(c).)

When San Diego, a charter city, imposed

a 3 percent franchise fee, which was

higher than the rate which could be

charged by other municipalities, the

159

Public Utilities Commission required the

customers within the City of San Diego

to bear the increased cost in their

utility bills, and would not permit the

increased fee to become a general

operating expense which could be levied

upon customers living outside the

charter city. (San Diego Gas and

Electric Company (1972) 73 Cal.P.U.C.

623, 627-628.)

Thus, California utility law

appears to be consistent with the rules

operative in other states. -

Before examining cases from other

jurisdictions, allowing the imposition

of so-called “in lieu” taxes, we should

note that "in lieu” taxes are usually

found in statutes allowing one

governmental entity to collect funds

from another public entity. Thus, the

Federal payment in Lieu of Taxes Act (31

U.S.C., sec. 6901, et seq.) is designed

160

to compensate local governments from the

loss of revenue from tax immune federal

lands. See generally, Lawrence County

v. Lead Deadwood School Dist. (1985) ___

—_ = 2 (105 S.Ct. 695). In lieu

taxes are also collected by the

Metropolitan Water District from public

entities within its own boundaries.

(See Wat. Code Aspen., sec. 109-306 and

109-331 et seq.; see generally City of

Burbank v. ° Wa

(1960) 180 Cal.App.2d 451. Yet courts

tend to mistakenly view extraterritorial

taxes of the type proposed by Lord

North, as being simply in lieu taxes.

In some states, tax equivalent

charges are permitted by statute, see

e.g., Village of Fox Point v.

Public Service Commission (1943) 247

Wisc. 97 (7 N.W.2d 571. £74) (sec.

66.069(c) of the Wisconsin statutes

permitted a $550,000 tax equivalent

161

charge).

In H.P. Biggs Inc. v. Borough of

Madison (1983) 188 N.J. Super 212 (457

A.2d 43), the utility only provided

service within its municipal boundaries.

Although it acquired its electricity

from a private company at wholesale

rates, it charged the same rates as the

private company, instead of

recalculating the cost of service. It

had thereby created a surplus of

$536,232 and paid in lieu taxes of

$425,000 to the municipality.

The New Jersey court held that

the rate was proper. A municipality

could set rates within its own

boundaries, and if the resident consumer

voter did not like the rates, he could

vote the governing body out of office.

(457 A.2d 43, 48.) The court

acknowledged that because the statute

allowed the utility to create a surplus,

162

there was no reason to invalidate the

tax. In reaching its conclusion, the

court opined that electric utility

charges should not be a substitute for

general taxation. However, charges,

otherwise reasonable would not be

invalidated merely because they resulted

in the creation of surpluses to be

transferred to the budget. (457 A.2d 43.

51.)

In Rosalind Holding Co. v. Orlando

Utilities Commission (Fla.App. 1981) 402

So.2d 1209, the court noted that the

municipal owned utility imposed a charge

of 1 percent of retail sales of

electricity to customers outside the

city of Orlando but within Orange

County. Over several years, $1,114,000

was given to Orange County. Although no

statute authorized the practice, the

court noted that this was less than ad

valorem taxes paid by a public utility

163

————__~

and that the experts had said that it

was not an uncommon practice for tax

exempt utilities to make tax equivalent

payments.

The utility also charged a franchise

equivalent fee based on six percent of

the revenues earned. This yielded a

payment of $1,442,561 in addition to

profits of $5,542,000. Although the

Florida Public Service Commission would

have limited the charge to customers in

cities charging the fees, the court

concluded that it was not really a

franchise fee. However, as no witness

testified that the rates or profits were

unreasonably high, the Florida court

found that it was immaterial whether a

franchise equivalent was charged.

In Hastings v. Village of Stowe,

Electric Department (1965) 125 Vt. 227

(214 A.2d 56), the court allowed a small

sum as a tax equivalent. However, it

164

disallowed a claim of $15,106 for

federal income and state franchise taxes

which, of course, were never paid,

saying: "To proliferate a utilities true

operating expense by the introduction of

illusory charges never actually

experienced would impair the regulatory

process." (214 A.2d 56, 59.)3°9

In Petition of Burlington Electric

Light Department (1977) 135 vt. 114 (373

A.2da 514); a challenge was made to a

$452,783 contribution in lieu of taxes,

on the ground that it was a guise to

redistribute taxes upon tax exempt

private organizations, and various

governmental agencies, including the

University of Vermont, by requiring them

to pay a contribution through increased

3°although in lieu taxes were

approved, because the total contribution

from other earnings constituted 60

percent of the village budget, the

Public Utility Commission could lower

the rates. (214 A.2d 56, 62.)

165

utility bills. The court rejected the

challenge, reasoning that a Vermont

statute allowed municipalities a return

commensurate with that allowed private

utilities. Property taxes were a

recognized operating expense for private

utilities. Therefore, as a contribution

in lieu of taxes is analogous to a

proper operating expense of a private

utility, it could be expected to make up

for taxes lost where the municipality,

instead of a private company, owned the

facility. (373 A.2d 514, 516.)

Nevertheless, it should be recognized

that an in lieu tax is a fiction. We

are aware of no California statute which

authorized a municipality to impose an

in lieu tax upon nonresidents. There is

nothing in the record indicating that

the city ever attempted to officially

impose such a tax. To the extent to

which the judgment is based upon the

166

assumption that an in lieu tax could be

imposed on nonresidents protected by

their contract between the city and

Saticoy, it is clearly erroneous.

{Rutherford v. Oroville-Wyandotte _

Irrigation District. supra, 218 Cal.

242, 247.)32

Conversely, to the extent to which

the county taxes service extensions used

to furnish service exclusively

to nonresidents, that burden would be

borne by the outsiders. If the tax was

imposed on land and facilities serving

all customers, then there is no reason

for any discrimination.

I. ofits

Of course, a charge for water services

31lsee also Guy S. Atkinson Co. v.

(1958) 158

Cal.App.2d 718, 723, where the court

found it was unfair to increase the

connection fee from $5.00 to $175, where

the district had earlier agreed to give

a refund to the developer at the rate of

$184.42 per house.

167

is not a tax (Arcade County Water Dist.

v. Arcade Fire Dist. (1970) 6

Cal.App.3d 232, 240 (charge for

hydrants); Trumbo v. C e e

Arrowhead Water Agency (1967) 250

Cal.App.2d 320, 322; (charge for standby

water service). However, where a given

rate is imposed in order to provide a

fund for the general benefit of the

city, and thereby enable the city to fix

a lower rate for general purposes, this

could constitute an unjust

discrimination, rendering the charges

excessive and unreasonable. (City of

Madera v. Black (1919) 181 Cal.

306, 314.)

This principle is now incorporated in

the California Constitution. "Under

article Xlll B, with the exception of

state subventions, the items that make

up the scope of ‘proceeds of taxes'

concern charges levied to raise general

168

revenues for the local entity."

"Proceeds of taxes" in addition to "all

tax revenues" includes "proceeds...

from .. . regulatory licenses, user

charges, and user fees [only] to the

extent that such proceeds exceed the

costs reasonably borne by such entity in

Vv tio

service. ... .." (sec. 8, subd. (c),

italics added.) Such “excess regulatory

or user fees are but taxes for the

raising of general revenue for the

entity. (City of Madera v. Black (1919)

181 Cal. 306. 313-314. .. ." (County of

Placer v. Corin (1980) 113 Cal.App.3d

443, 451.) 32

32See also Beaumont Investors v.

Vv Wate strict

supra, (filed March 5, 1985, 4th Dist.

No. E-00534) Cal.App.3d °

Conversely, where a public entity has

incurred obligations to the state water

project before the enactment of article

XIIIA of the California Constitution,

taxes levied to meet those obligations

are not subject to the tax limitation

provisions found in article XIIIA.

169

Remember too, that having acquired a

water works, as to the water dedicated

to the use of the outside community, the

city holds title as "a mere trustee,

bound to apply it to the use of those

beneficially interested. County of Inyo

v. Public Services Commission. supra. 26

Cal.3d 154. 159.) Obviously, a trustee

may not use or deal with trust property

for his own profit. (Civ. Code. sec.

2229.)

Thus, unlike the many states which

have sanctioned the practice of allowing

a municipality to make a profit on

~~ service to customers outside city limits

previously served by a private water

company, California law would prohibit

such a practice. Furthermore, as a

general proposition, a rate which

produces an excessive return is a tax,

(Goodman v. County of Riverside (1983)

140 Cal.App.3d 900.)

170

and there is no California statute

allowing a municipality to tax

nonresidents by way of an in lieu tax,

or otherwise.

Note too that under the Revenue Bond

Law, the services, facilities, or waters

of the enterprise must be furnished

at the lowest possible cost consistent

with sound economy, and prudent

management, and the security and payment

of principal and interest on the bonds.

(Gov. Code. sec. 54514.) A rate which

creates an artificial discrimination

against nonresident customers would be

inconsistent with this requirement. 33

In short, where the city has agreed

to serve all customers of a private

33In Michigan, by way of contrast,

the revenue bond statute contains no

limitations as to what methods of

developing rates may be used, and under

other provisions of Michigan law, a

municipality may include a fair rate of

return. (County of Oakland v. City of

Detroit (1978) 81 Mich.A. 308 (265

N.W.2d 130, 133.)

171

water company, including those customers

located outside city boundaries, without

unfair or unreasonable discrimination,

it cannot establish a discriminatory

rate for outsiders which is not based on

true differential in cost of service.

Therefore, it was not proper to allow a

rate of return on outside service to

justify a discriminatory rate which

favored city residents. (Henderson v.

Oroville-Wyandotte Irr. Dist., supra,

213 Cal. 514, 529; Rutherford v.

Vv -W .

supra. 218 Cal. 242, 247; Dyke Water

Co., supra, 61 Cal.P.U.C. 315, 321.) The

foregone investment theory is flawed for

the same reason. Thus, where, as here,

the nonresidents were existing customers

of a private water company acquired by

the city, and the cost of service was

defrayed through revenue, rather than

taxes, a surcharge would only be

172

justified if the costs of serving them

were higher. 24

J. Fire Protection

Because water is furnished both for

general use and fire protection, the

task of dividing the cost of service

between the two services has always been

a perplexing one. (City of Bangor v.

Public Utilities Commission (1960) 156

Me. 455 (167 A.3d 6, 10)? Chicopee Mfg.

Corp. v. ste a Wat

Commissioners (1951) 97 N.H. 109 (81

A.2da 837, 839.) It is of course

unavoidable that the determination of

34In light of this conclusion, we

will not consider the interesting

question as to whether a public entity

holding water subject to a "public

trust" (National Audubon Society v.

Superior Court (1983) 33 Cal.3d 419,

433-434; People v. Weaver (1983) 147

Cal.App.3d Supp. 23, 28-29) might be

precluded from discriminating between

residents and nonresidents as to user

fees. (See Neptune City v. Avon By The

Sea (1972) 61 N.J. 296 (294 A.3d 47, 55;

57 A.L.R.3d 983.) (Higher fees charged

to nonresidents using a beach within a

municipality were invalid.)

173

fire protection charges often involve

sharp conflicts of interests between

city officials, taxpayers and water

users. City of Bangor v._ Public

Utilities Commission, supra, 167 A.2d 6,

12.)

The problem is magnified when fire

protectionservices are rendered to

nonresident. If the residents live in

another municipality, district or

simply within a county, part of their

tax bill may include a provisionfor fire

protection. Insofar as appellants are

concerned, after 1978, the other

governmental entity is not obliged to

pay for the service, unless it consents

to do so. (Gov. Code sec. 53069.9;

Public Water Agencies Group v.

Consolidated Fire Protection Dist.

(1983) 145 Cal.App.3d 695.)

Because appellant did not

specifically advert to this issue in the

174

briefs filed with this court, we will

not address the point (In re Marriage of

Sheldon (1981) 124 Cal.App.3d 371, 381),

except to alert the trial judge who

hears the retrial of this matter that it

will prove to be a difficult one to

resolve.

SUMMARY

Although we acknowledge our obligation

to uphold rates which are within the

proverbial "zone of reasonablen»:s"

(Permian Basin Area Rate Cases (1968)

390 U.S. 747, 767, citing FPC v. Natural

Gas Pipeline Co. (1942) 315 U.S. 575,

585, we have concluded that in the case

before us, reason was replaced by

several fictions. Although the experts

chosen by the city may have been

among the "best and brightest",°> they

were beguiled by legal principles

35see generally, D. Halberstam. The

Best & Brightest, Random House (1972).

175

applicable in other jurisdictions, but

not in California. The expert who

espoused the view that the existing

nonresident customers should pay the

incremental costs of Casitas water not

only was unaware of the facts, but he

also relied upon a discredited

theory. Apparently no one considered

the Rutherford and Henderson cases

decided by the Supreme Court more than

40 years earlier.

It appears to us that the collection

of errors made by the city's experts led

in turn to a flawed analysis by the

trial court. For instance, even if

nonresidents should contribute to defray

the expenses incurred by employees whose

salaries are paid by taxes, the 70

percent surcharge was also predicated

upon a host of other errors, such as the

exclusion of the operating results

arising from the sale of nonpotable

176

water, or the theory that the city was

entitled to a return on investment, etc.

We think that a miscarriage of justice

occurred requiring us to reverse the

judgment and remand the case for a new

trial (Cal. Cont., art. VI, sec. 13;

Kuffell v. Seaside Oi] Co. (1977) 69

Cal.App.3d 555, 567) and a result

consistent with the principles

enunciated herein (Puritan Leasing co.

v. Superior Court (1977) 76 Cal.App.3d

140).

DISPOSITION

The judgment is reversed, and the

cause is remanded for a new trial.

CERTIFIED FOR PUBLICATION.

McMahon. J.*

We concur:

GILBERT. Acting P.J.

ABBE. J.

*Assigned by the Chairperson of the

Judicial Council

177

Robert D. Carter. Judge*

Superior Court County of Ventura

Stone and Stone, a Professional

Corporation, and Richard C. Gilman, for

Plaintiffs and Appellants.

Donald S. Greenberg, City Attorney;

Michael R. Dougherty, Assistant City

Attorney, Arthur L. Littleworth, Best,

Best & Krieger, Special Ccunsel, for

Defendant and Respondent.

*Retired judge of the superior court

sitting under assignment by the

Chairperson of the Judicial Council.

178

APPENDIX A

1. IN MOST JURISDICTIONS,

MUNICIPALITIES ARE ALLOWED TO GENERATE A

PROFIT FROM THEIR UTILITY OPERATIONS AND

MAY IMPOSE A SURCHARGE UPON THE RATES

PAID BY NONRESIDENTS.

Invariably, it is the rule that it is

presumed that the municipal rates are

reasonable, and the party assailing the

rates has the burden of persuasion.

(See e.g.. om ach v.

Oltman (Fla.App. 1980) 389 So.2d 283,

286; County of Oakland v. City of

Detroit. supra. 81 Mich.App. 308. (265

N.W.2d 130, 132); Laramie Citizens for

Good Government v. City of Laramie (Wyo.

1980) 617 P.2d 474, 484; Village of

Niles v. City of Chicago (1980) 81

I11.App.3d 60 (401 N.E.2d 1235, 1242);

Shawnee Hills Mobile Homes Inc. v. Rural

Water Dist. No.6 (1975) 217 Kan. 421

(537 p.2d 210. 217).)

179

Several states take the sensible

position that a municipal water system

should be operated to serve its

residents and that nonresidents may be

served if that commitment does not

endanger local service. However,

such incidental service to nonresidents

may not fairly be converted to an

obligation to render additional

nonresident service tending to

jeopardize service within the

municipality. ello v. Borough of

Hightstown (1955) 17 N.J. 611 (112 A.2d

241, 245; 48 A.L.R.2d 1216); see e.g.,

Richards v. City of Portland (1927) 121

Ore. 340 (255 p. 326, 329) (service

could be discontinued to customers of

private water company which refused to

provide storage facilities, despite a

water shortage, where the water contract

was for a fixed period of time and

contained the reservation that the water

180

was supplied subject to the superior

rights of the city when no surplus

existed.) 36

Other states have gone a step

further, reasoning that since a

governmental unit has the power to

withhold service to nonresidents, it has

no duty at all to them, and can

establish whatever rates the traffic

will bear. The following passage from a

South Carolina case evidences uncommon

solicitude for a local city - state and

36In California a water district,

empowered to declare a water shortage

emergency condition, may deny new

connections to preserve the supply when

there would be insufficient water for

human consumption, sanitation, and fire

protection. (Wat. Code. sections 350,

353, 354, 356; Butte Co. W.U. Assn. v.

Railroad Com. (1921) 185 Cal. 218, 230;

Swanson v. Marin County Mut. Water Dist.

(1976) 56 Cal.App.3d 512, 522-523.)

Similarly, a sanitary district may not

grant a preference in limited disposal

capacity to those outside the district

over its inhabitants who had a current

need for such service.

(Trimont Land Co. v. an

Dist. (1983) 145Cal.App.3d 330, 351-354.)

181

brings to mind medieval walled cities,

where the only entrance was a fortified

gate protected by guard towers, a moat,

and portcullis.

Assuming the city had an obligation to

sell surplus water. ". . . it did not

import an obligation to make a contract

with any particular person at a

reasonable price; but on the contrary,

it did import an obligation to sell its

surplus water for the sole benefit of

the city at the highest price

obtainable. It was a duty not owed to

outsiders, but exclusively to

inhabitants and taxpayers of the city.

It follows that the plaintiff, as a mere

nonresident, had no rights whatever

against the city, except such as he may

have acquired by contract. In other -

words, the city was under no public duty

to furnish water to the appellant at

reasonable rates, or to furnish it at

182

all. .. ." (Childs v. City of Columbia

(1911) 87 S.C. 566 (70 S.E. 296, 298).)

This doctrine finds acceptance in

many jurisdictions. (See e.g.. City of

Phoenix v. Kasun (1939) 54 Ariz. 470 (97

P.2d 210).) (The relationship is purely

contractual and courts do not have the

power to determine the reasonableness of

rates charged nonresidents) ; (City of

Englewood v. City and County of Denver

(1951) 123 Colo. 290 (229 P.2d 667,

672.) (Defendant was under no

obligation to serve another city at any

particular rate, or at all); (Lee v.

City of Colorado Springs (1957) 136

Colo. 248 (315 P.2d 822, cert. den. 355 -

U.S. 955; Barr v. City Council of

Augusta (1950) 206 Ga. 753 (58 S.E.2d

823); Davisworth v. City of Lexington

(1949) 311 Ky. 606 (224 S.W.2d 649,

651.) (Nonresidents have no lawful claim

upon any city service and any use of

183

city facilities is wholly permissive,

and the outside customers are mere

licensees); (Forest City v. City of

Oreoon (Mo.App. 1978) 569 S.W.2d 330,

334.) (Missouri statutes which allow

water to be provided to nonresidents or

to other cities on such terms as may be

agreed upon by the contracting parties,

have left the sale of water free of

regulation).

In those types of jurisdictions the

nonresident may secure protection by

contracting with the municipality. 37

(See e.g.. City of Daytona Beach v.

Stansfield (Fla. 1972) 258 So.2d 809.

810 (under a 1954 agreement, when the

city bought a water company, the parties

agreed that the rate to nonresidents

3710s Angeles was held bound by a

contract with the Veterans

Administration providing for water at

the resident rate to facilities located

cutside city limits. (Department of

Water & Power v. United St s (1945)

105 Ct. Claims 72 (62 F.Supp. 938).)

184

would not exceed 133 percent of resident

“Fe

184a

rates. In upholding an order enjoining

a 200 percent increase, the court

reasoned that the charge to outsiders

could never be less than cost unless the

city elected to charge rates to its own

residents which were less than cost) ;

Copper County Mobile Home Park v. City

of Globe (Ariz. App. 1981) 131 Ariz. 329

(641 P.2d 243) (when city contracted to

provide sewer service at a rate equal

that charged within city limits, it

could not charge nonresidents a monthly

service fee of $10.00 when $1.00 per

month was charged residents) .)

However, a fixed contractual rate such

as $10.00 per annum set in 1946, may

become unreasonable in the face of

unforeseen inflation, and when such a

low rate compromises health services, it

.9n be replaced with just and equitable

sewer charges. (Landau v. City of

eaw (1974) 214 Kan. 104 (519 P.2d

185

676.) Conversely, when a developer

entered into a contract calling for a

rate of not less than 70 cents per 1,000

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