On April 20, 2015, in Capistrano Taxpayers Association Inc. v. City of San Juan Capistrano, the California Court of Appeal released a highly anticipated decision, holding that:

( (Cal. Ct. App. Apr. 20, 2015).)

In February 2011, the City of San Juan Capistrano, California adopted a new water rate structure. As part of this structure, the City divided water users into four distinct classes based on their water usage and allocated the City's total water costs among these four tiers, with users paying progressively higher fees for increased usage. The City did not try to calculate the incremental cost of providing water at each class. In fact, the City admitted it used revenues from the top tiers to subsidize below-cost rates for the bottom tier. Regardless of whether the user received recycled water, the City also imposed a fee on all users for recycled water services and capital costs attributed to these services (such as costs to build a recycling plant).

In August 2012, the Capistrano Taxpayers Association filed an action against the City citing a violation of Proposition 218. Proposition 218 was enacted in 1996 by California voters to curtail discretionary fees by local agencies. The Taxpayers Association alleged that the City's water rate structure violated the Proposition 218 section that limits fees to the cost of service attributable to usage. The Taxpayers Association also alleged that the fee for recycled water and related improvement projects violated the Proposition 218 requirement that fees only be charged for water that was used by or "immediately available" to the property owner because residential users did not receive recycled water.

The trial court found that the City had violated both requirements of Proposition 218 and the City appealed.

The court held that the trial court erred in finding that the fee for recycled water services and related improvement projects violated Proposition 218. The court looked to Article XIII D, Section 6(b)(4) which provides that no fee may be imposed for a service unless that service is "used by, or immediately available to, the owner of the property in question" (Cal. Const. art. XIIID, § 6). The court found that when a single local agency provides different kinds of water to different users, providing both kinds of water is fundamentally providing the same service. While private residences' plumbing can only use traditional potable water, other customers' use of recycled non-potable water frees up potable water for the residential customers. Because water, potable and non-potable, was already immediately available to all customers, the court found that there was no violation of this section of Proposition 218.

The court noted that Proposition 218 would prevent these capital costs from being imposed on lower-than-average users to the extent that those fees exceeded the actual cost of service to those users, because those customers' levels of consumption are not what make the investments in recycling necessary.

The court held that the trial court was correct in finding that the tiered rate structure implemented by the City violated Article XIII D, Section 6(b)(1) and (b)(3) of Proposition 218. That section provides that fees cannot exceed the funds required to provide the property-related service nor the proportional cost of the service attributable to the parcel. The court held that under Proposition 218, a public water agency can only set tiered rates if the increased rates correspond to the actual cost of providing the water at each usage tier. Since the City had not shown any correlation between the costs of service and the rates charged, the court found that the City's rate structure violated Proposition 218.

This decision will likely have a substantial impact on water suppliers throughout California, particularly those with tiered rate structures in place. While the court does not say that these rate structures are necessarily in violation of California law, water suppliers have the burden of showing that their tiered rates correlate with the actual cost of supplying greater amounts of water. Counsel to these suppliers should be sure their clients have carefully calculated the breakdown of costs of providing water at each usage level and have set rates accordingly.