Alternative Water Supply Options for Some Development

With the ongoing drought in California, multifamily and residential subdivision developers who encounter difficulties in obtaining water service commitments for their projects from existing water suppliers may consider establishing a privately held mutual water company to service the development. Such a course of action would require the existence of an adequate water supply either through existing groundwater rights, contract or otherwise but presents an alternative to securing water service for a project where no water suppliers currently exist or if existing suppliers are unwilling or unable to provide the necessary water services.

CalBRE Approval Required

In California, mutual water companies are typically organized as nonprofit mutual benefit corporations. However, mutual water companies are not required to take any specific corporate form as long as they are formed for the purpose of delivering water and providing water services to shareholders at cost. Under the California Corporations Code, specific language as to the purpose of the corporation and issuance of its shares must be set forth in the articles of incorporation or the bylaws. Corp. Code Section 14300.

Mutual water companies that are intended to serve subdivisions of five or more lots, condominiums or apartment units generally fall within the jurisdiction of the California Bureau of Real Estate (CalBRE) and must make an application to that agency in order to serve the subdivision. As part of CalBRE's approval process, mutual water companies must comply with specific requirements applicable to mutual water companies, some of which pertain to the mutual water company's formation and governance documents. Corps. Code Section 14300 et seq.

The process to seek CalBRE approval for a mutual water company begins with the preparation and submission of an application to the CalBRE for issuance of the subdivision's public report. Through that application, the applicant must submit Form RE 699B which, although short, sets forth a series of specific representations and assurances regarding the mutual water company. Among other things, these representations and assurances must include a verification that the applicant has obtained a certificate from the Department of Public Health to operate a public water system and an engineer's report indicating compliance with specified design standards. The application also requires the applicant to represent that it has previously contacted the California Public Utilities Commission (CPUC) and the county's Local Agency Formation Commission to determine if the intended development area overlaps an existing water service area or if an existing water service provider could more appropriately serve the subdivision.

Avoiding CPUC Regulation

One key issue is whether mutual water companies are subject to CPUC regulation. The CPUC comprehensively regulates companies that fall within its jurisdiction, including most aspects of provision of water service, water rates and capital structure. Such regulations can significantly increase costs of compliance and diminish operational flexibility for unwary mutual water companies that unknowingly operate in a manner that triggers the CPUC's jurisdiction.

To avoid falling within the CPUC's jurisdiction, a mutual water company must be wary of two potential pitfalls while delivering water and providing water services. First, the company must maintain strict adherence to the water delivery limitations set forth in the safe-harbor provision under Public Utilities Code Section 2705. This section generally provides that a company is exempt from CPUC regulation only if it delivers water exclusively to its stockholders or members at cost. Section 2705 also provides limited exceptions allowing mutual water companies to deliver water at cost to certain third-parties (including state and federal agencies providing fire protection or operating park facilities and other mutual water companies) or during emergencies without becoming subject to CPUC jurisdiction. Application of these exceptions must be carefully analyzed and applied on a case-by-case basis to prevent inadvertently triggering CPUC regulation.

The second pitfall is where the company is deemed to have "held itself out as willing to supply water to the public or any portion thereof." Â Yucaipa Water Co. v. Public Utilities Com., 54 Cal. 2d 823, 82728 (1960). Specifically, the Yucaipa court said a mutual water company's water supplies may be deemed to have been devoted to public use by implication, "without regard to statutory provisions." In making such a determination, the court explained, "[t]he test to be applied ... is whether or not those offering the service have expressly or impliedly held themselves out as engaging in the business of supplying the water to the public as a class, 'not necessarily to all of the public, but to any limited portions of it, such portion, for example, as could be served from its system."

Thus, mutual water companies must carefully determine to whom they will provide services lest they be deemed to have acted as a public water supplier, triggering CPUC regulation by implication.

A Key Consideration

Ultimately, in deciding whether to establish a mutual water company to provide water service for a subdivision, developers and owners must first consider whether an adequate water supply is available that can be relied on in lieu of water service from an existing supplier. But assuming such supplies may be secured, the focus then shifts to obtaining approval from CalBRE and maintaining the mutual water company's operations in an appropriate manner in order to avoid CPUC regulation. Developers who are considering establishing or are currently operating mutual water companies need to have a complete understanding of the application process and regulatory framework to avoid incurring unnecessary costs and burdens associated with added regulation and related compliance.