The Court of Appeal Deals Another Blow to Conservation Pricing by Municipally-Owned Water Systems

By Viral Mehta and David Moran. Editor, Thomas McMorrow

Court Strikes Down San Diego’s Imposition of Tiered Water Rates to Encourage Conservation

In San Diego, the City owns and operates the local water utility system, which provides potable water to its 1.4 million residents. As with many utilities, the water system is designed to be self-supporting and its revenues and expenses are segregated from other City operations. In 2014, the City imposed a tiered rate structure, arguing that it encourages conservation by single-family residential customers (SFR). Specifically, the City charged higher rates for each hundred cubic feet (HCF) of water a SFR consumes, while it charged other customer classes (multi-family residential, commercial, construction, irrigation) uniform rates for each HCF of water they consume. 

Proposition 218, which was enacted by the California voters in 1996, added article XIII D to the California Constitution. Section 6(b)(3) of article XIII D states: “a governmental fee or charge imposed on a parcel of property or as an incident of property ownership, ‘shall not exceed the proportional cost of the service attributable to the parcel.’” Patz v. City of San Diego, 2025 WL 2158329, *2 (Jul. 30, 2025) (Patz). Fees or charges for water service are fees imposed as an incident of property ownership and fall within Section 6(b)(3)’s purview. 

In July 2015, Daniel Patz and Joan Mann Chester, as representatives of a class of SFR customers of the City (the Class), sued the City to challenge the tiered rate system, alleging that it violated Proposition 218. Patz, 2025 WL 2158329 at *3. According to the Class, the City’s tiered rate system for SFR customers imposed higher rates on those customers than the cost incurred to provide them with water service—effectively requiring SFR customers to subsidize non-SFR customers’ water service. Id.

To defend its rate structure, the City argued that the higher rates for high SFR water users were justified, at least in part, by the differential between local and non-local water supply costs. According to the City, the units of water supplied in the lowest tier come from local supply, which is the City’s least expensive source of water. Patz, 2025 WL 2158329 at *63. The higher tiers “were priced higher because consumption in those tiers required the City to acquire more expensive sources of water.” The City also argued that it incurs greater costs “to size its water system to meet customers’ demand at peak times—on the day and hour of highest use—than it would if all customers who always received water at a uniform rate of use.” Patz, 2025 WL 2158329 at *65. Therefore, according to the City, “customers who cause that peak demand should be made to bear the cost of sizing the system to meet it.” Id. The City submitted a cost-of-service study, developed by a third-party consulting firm, to substantiate the differential costs and support its rate structure.

The trial court rejected the City’s arguments and entered judgment in favor of the Class, finding the “City failed to demonstrate by substantial evidence that the tiered rates imposed on the Class did not exceed the City’s proportional cost of providing water service to each class member’s parcel.” Patz, 2025 WL 2158329 at *16. The Class was awarded a refund of $79,541,880. 

The Court of Appeal Affirms and Holds the Burden Is on the City to Present Substantial Evidence to Establish Its Rates Comply with Proposition 218

The City appealed and argued that the trial court held it to an incorrect burden of proof to demonstrate that its tiered rates satisfy Section 6(b)(3). The City contended it should only be required to show that “its rates reasonably reflect its costs of service.” Patz, 2025 WL 2158329 at *19. The Court of Appeal disagreed and held that reasonableness is not the standard. To justify fees or charges imposed under Proposition 218, a public agency must show “with substantial evidence withstanding independent review, that the agency’s water rates are proportional to the ascertainable costs of service that can be attributed to specific parcels.” Thus, it is not enough that the agency show it used a reasonable cost allocation method and relied on reasonably accurate data with respect to SFR customers. A more direct showing that the charge is proportional to the costs of service is required. Patz, 2025 WL 2158329 at *48-49. 

Even if the City established that its local water supply was less expensive than water supplied from non-local sources, that would not satisfy its burden. The City was also required to establish that the units of water consumed by SFR customers in the lowest tier came from the City’s lower cost, local water supplies. Patz, 2025 WL 2158329 at *63-64. Similarly, the City could not rely solely on evidence establishing the added expense to size a water system to accommodate SFR customer demand at peak times. The City had to present evidence to demonstrate when higher tier SFR customers used water to establish that SFR customers using water in the higher tiers actually used more water at peak times than SFR customers in the lower tiers. Patz, 2025 WL 2158329 at *66-67. The City could not meet this burden. 

Municipally-Owned Water Systems Will Be Hard Pressed to Justify Conservation Rates

Similar challenges to municipal rate structures across the state are likely to follow. We are closely monitoring these disputes as the fight over water and other natural resources will only increase as these resources become scarcer and more impacted by the climate and existing infrastructure.