| Road Manager
Are Trench-Cut Fees Constitutional?
If a city has granted a franchise under specific conditions, Federal
courts may say that they are.
by David A.
Battaglia, Randall R. Morrow, and Ben P. Pruett
 Citing studies demonstrating the adverse effects on public streets of
excavations and trench cuts, some municipalities in California and other
states have enacted or are considering laws which impose pre-excavation
fees on utility companies. Purportedly a means of compensating for street
deterioration, these trench-cut fees are one response to the rising number
of excavators, including telecommunication and cable companies, in city
streets throughout the country. They are often designed to serve the dual
purposes of raising additional municipal revenue while discouraging such
excavations.
As a number of cities in California recently discovered, however, there
are constitutional roadblocks to the imposition of these new and
additional charges upon utility companies and their customers. One
important — but often overlooked — provision is the Contract Clause of
the United States Constitution. This clause protects utilities with
existing franchise agreements from state and municipal action that impairs
the franchise. The experience of the Southern California Gas Company in
Santa Ana, California demonstrates the continued vitality of the Contract
Clause in federal court, and its usefulness to franchisees in resisting
new fees above and beyond the requisite annual franchise payments.
Unconstitutional in Federal Court
The City of Santa Ana enacted a trench-cut fee in October 2001. The
stated purpose of the fee was to offset the shortened life of city streets
caused by excavations and trench cuts and to encourage improved
coordination among excavators and the city. While the ordinance contained
several exceptions, the city refused to exempt the Southern California Gas
Company (The Gas Company).
 The Gas Company repeatedly requested an exemption from the law, given
the fact that its 1938 franchise with the city expressly authorized
excavations in exchange for the payment of a substantial franchise fee.
The franchise also contained an express obligation on The Gas Company to
repair damage to city streets caused by an excavation. The Gas Company
cited these two provisions to Santa Ana officials in an unsuccessful
attempt to demonstrate to them that excavation in city streets was part
and parcel of the benefits obtained by paying the existing franchise fee.
The Gas Company’s efforts at informal resolution were unsuccessful.
In January of 2002, the public utility filed a civil action against the
City of Santa Ana in the United States District Court for the Central
District of California, located in Los Angeles. The Gas Company alleged
violations of several provisions of the federal and state constitutions,
including the Contract Clause.
The federal court heard and considered the constitutional arguments in
the Southern California Gas Company vs City of Santa Ana case on April 22,
2002. Recently, the federal district court with the Honorable George H.
King presiding, ruled in favor of The Gas Company, finding that Santa Ana’s
attempt to apply its trench-cut fee ordinance to the public utility was
unconstitutional. This legal decision, which has been published in the
federal reporter at 202 F. Supp. 2d 1129, provides a road map to
franchisees facing similar trench-cut fees and a clear admonition to
municipalities to carefully consider the consequences of such fees and the
failure to grant exemptions to its franchisees.
Indeed, aside from its own costs in defending this action, a
municipality which fails to grant an exemption to a public utility may be
liable for the attorneys’ fees of its adversary pursuant to federal
statute. Because federal law authorizes an award of attorney’s fees to
prevailing parties in constitutional cases, the federal court ordered
Santa Ana to pay nearly $80,000 of The Gas Company’s attorneys’ fees
incurred in the action.
The Contract Clause
The Contract Clause is one of the oldest and most important provisions
of the Constitution. The Supreme Court has applied it from the earliest
days of the United States to protect private citizens in their commercial
interactions with state and local governments. It protects the obligations
of both parties to franchise agreements — municipalities and utility
companies. Despite its rich history, however, the Contract Clause often
has been overlooked in recent times.
 There are two elements that must be satisfied for a municipal action to
be considered an unconstitutional impairment of contract in violation of
the Clause. First, there must be a substantial impairment of the contract.
A legislative action impairs a contract if it reduces the value of a
contractual obligation or frustrates the ability of the beneficiary to sue
for breach of contract. The franchisee challenging the fee bears the
burden on this element. Second, the impairment must be determined to be
both legally reasonable and necessary to advance an important public
purpose. The municipality must establish both reasonableness and necessity
to defend the impairment.
The first element: substantial impairment. The question of whether a
particular impairment is substantial may not be reduced to a talismanic
formula, and it is not automatically satisfied by any particular dollar
amount. Though these fees may accumulate quickly, the amount of a
trench-cut fee may be relatively small when examined in the context of the
individual franchisee. As the federal district court found in The Gas
Company case, however, the precise monetary impact of the impairment is
not dispositive when evaluating the substantiality of the impairment.
Analyzing applicable precedent, the court found that an impairment may be
substantial if “it deprives a private party of an important right,”
“thwarts performance of an essential term,” “defeats the
expectations of the parties,” or “alters a financial term” of the
public contract. Thus, the new law need not totally destroy the rights of
the franchisee to be unconstitutional.
In applying this precedent to the facts before it, the federal court
found that the Santa Ana trench-cut fee substantially impaired The Gas
Company’s franchise in two respects. First, the franchise expressly
authorized the utility company to excavate in city streets in exchange for
the payment of an annual franchise fee. The franchise did not authorize
the payment of any additional fees as a condition of exercising these
excavation rights. The city could not rely on provisions in the franchise
requiring The Gas Company to pay for the costs of repairs to public
property because the city’s trench cut fee involved a pre-excavation
cost “for some harms that may not be realized for over a
quarter-century.” The parties’ 60-year course of conduct provided
additional support for the court’s finding of substantial impairment.
During argument, Santa Ana admitted that The Gas Company made thousands of
trench cuts since the inception of the franchise in 1938 and had
adequately patched these cuts without any demands for costs.
Second, the court cited The Gas Company’s franchise right to repair
excavated streets in advance of any penalty for substandard repairs. The
court found that Santa Ana’s failure to allow the utility to exercise
these rights represented a separate impairment: “the trench cut
ordinance imposes, in advance, an estimated fee regardless of the actual
quality of repairs, without proof of actual harm, and without affording an
opportunity to perform repair work.” While this right was not as
essential to the utility’s right to excavate, “the impairment is
nevertheless substantial.”
To rebut the argument that the impairment was substantial, Santa Ana
relied on a reservation-of-rights clause in the franchise agreement. The
clause reserved to the city the right to exercise its police powers by
future ordinance. The city contended that because its trench-cut fee
measures were a proper exercise of its police powers, it was insulated
from being held liable for an impairment. The court summarily rejected
this argument, which it found to be “absurd”, because municipalities
may not rely on a reservation of their police powers to compromise the
material terms of a negotiated written franchise agreement. To adopt the
city’s argument would render the terms of the contract entirely
meaningless.
The second element: public purpose justification. Establishing that the
impairment was legally “substantial” is only the first step in the
process. If the state or municipality establishes a public purpose
justification for the impairment, a contract impairment may be
constitutionally valid. To do so, the impairment must be “reasonable and
necessary” to justify an important public purpose.
Because trench-cut fees involve public contracts, the Supreme Court has
applied a heightened scrutiny to a municipality’s actions. While a court
may typically defer to a legislature’s judgment about the reasonableness
or need for a particular measure, there will be no such deference when a
state or municipality attempts to impair a contract to which it is a
party. This is because the government’s own self-interest — as a party
to the contract alleged to have been impaired — is at stake. The
municipality bears the burden of establishing both the reasonableness and
necessity of its impairment.
As to the first prong, an impairment is not reasonable if the nature of
the problem existed at the time the contractual obligation was incurred.
By requiring The Gas Company to pay a franchise fee in order to excavate
and subsequently to repair its excavations, the City of Santa Ana knew
there would be inherent damage from cutting into the street when it
granted the franchise in 1938. Any changed circumstances, including recent
purported studies, were “of degree and not kind.” In other words, the
frequency of excavations may have increased between 1938 and the present,
but the fact that street excavations cause damage to the streets was as
evident in 1938 as today.
When the impairment involves a change in the financial terms of a
public contract, the impairment is rarely considered reasonable because a
municipality may always find a use for extra money. One exception is if a
private party receives unexpected windfalls, as was the case during many
depression-era regulations.
Although the Santa Ana ordinance contained several exceptions, this was
insufficient to save the trench-cut fee. The city waived the application
of the trench-cut fee if the street was scheduled for repaving within one
year of the excavation, or if the city affirmatively required relocation
of utility pipes or lines. “In short,” the court explained, “Santa
Ana only exempts trench cuts when it is cheap for it to do so.” There
was no exemption taking into account The Gas Company’s franchise rights,
so the measure was not reasonable for purposes of the Contract Clause.
Second, even if the ordinance is reasonable, a municipality would have
to establish that it is necessary to satisfy the Contract Clause. The
ordinance is not necessary if more moderate alternatives would accomplish
the city’s valid purposes without impairing the contract. The federal
court in The Gas Company case observed that this is a “heavy burden”
for a municipality, because one obvious — but politically unpopular —
revenue alternative exists: raising taxes. Perhaps for this reason, in the
last 35 years there has been no Supreme Court or Ninth Circuit Court of
Appeals case upholding a state or local law as necessary when the
challenged law modified a financial term of a public contract. The court
rejected Santa Ana’s argument that the higher repaving costs made a
trench cut fee necessary, because “[if] Santa Ana’s recognition of
higher costs alone sufficed, few if any contracts with government entities
would be safe from impairment.” Further, aside from its taxing power,
Santa Ana could have accomplished its goal of improving coordination among
utilities through other means short of imposing a pre-excavation fee.
Another example
Shortly after the decision in The Gas Company/Santa Ana case, another
United States District Court in Northern California found that the actions
of San Francisco, Union City, and Stockton in passing similar trench-cut
fees violated the constitutional rights of Pacific Gas & Electric
Company, following much of the analysis applied by the federal court in
Los Angeles.
The Contract Clause in the United States Constitution presents a
formidable barrier to municipal attempts to impose new fees on
franchisees. As illustrated by The Gas Company litigation with the City of
Santa Ana, this clause is alive and well, and courts are not afraid to use
it to protect franchise agreements against impairment by municipalities.
Before enacting a trench-cut fee or applying one to a franchisee,
cities should carefully determine whether such action would violate the
Constitution. The experience of The Gas Company and Santa Ana reveals that
a failure to consider the Contract Clause before adopting such a measure
may be quite costly for a municipality in the long-run.
David A. Battaglia
is a litigation partner with the law firm of Gibson,
Dunn & Crutcher LLP in Los Angeles. He represented the Southern
California Gas Company (The Gas Company) in the case with the City of
Santa Ana. Randall R. Morrow is associate general counsel and Ben P.
Pruett is the franchise and fees manager, both for The Gas Company.
Reprinted from Better Roads Magazine
December 2002 |
