Agencies May Not “Bargain Away” Their Power to Tax

Category: Business & Facilities
Date: Oct 5, 2017 01:43 PM

In 2005, the City of Hayward entered into an agreement with Russell City Energy Company (“Russell”) to facilitate Russell’s construction and operation of a natural gas-fired electric generating facility.  The payments clause of the agreement required Russell to pay the City $10 million for ownership and operation of the power plant. The payments clause also prohibited the City from imposing any taxes on the “development, construction, ownership and operation” of the power plant, except taxes tethered to ownership of real property. 

In 2009, City voters approved a utility tax on the usage of electricity and gas on every person using electricity in the City.  In 2011, the City informed Russell it must pay this utility tax. 

Russell filed a lawsuit against the City for various contract-related claims. The crux of the lawsuit was that the City’s imposition of the utility tax violated the payments clause of the parties’ agreement.  The City denied Russell’s claims.  The City argued that applying the utility tax to the power plant’s operations did not breach the agreement because the payments clause did not preclude the City from imposing generally applicable taxes.  The City also argued that Russell’s interpretation of the payments clause as exempting Russell from future taxes violates Article XIII, Section 31 of the California Constitution (hereafter, “Section 31”).  Section 31 provides that “[t]he power to tax may not be surrendered or suspended by grant or contract.”  (Cal. Const., Art. VIII, § 31.)

The trial court agreed with the City and dismissed Russell’s lawsuit.  The trial court found the payments clause was unconstitutional if interpreted to mean the City contractually surrendered its power to tax Russell, as this would violate Section 31. 

Russell appealed and the Court of Appeal affirmed the trial court’s determination.  The Court of Appeal held that Russell’s interpretation of the payments clause cannot be reconciled with Section 31 which specifically prohibits local governments from surrendering or suspending their power to tax.  The Court held that under Russell’s interpretation, the payments clause would preclude the City from imposing any payroll, business license taxes, and occupancy taxes on the power plant, effectively insulating Russell from virtually all revenue-raising assessments.  “The Payments Clause unmistakably surrenders and suspended the City’s power to tax.  It prohibits the City from imposing any taxes on Russell except real-property related taxes.” 

Accordingly, the Court concluded that Russell’s interpretation of the payments clause violated Section 31 and was unenforceable.  

Russell City Energy Company, LLC v. City of Hayward (2017) __Cal.App.5th __.

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