Mcle Self Study Article: State Constitutional Prohibitions on Promises Not to Tax

• Publication year: 2018
• Author: Michael G. Colantuono

MCLE Self Study Article: State Constitutional Prohibitions on Promises Not to Tax

Check the end of this article for information on how to access online MCLE self-study credit.

Michael G. Colantuono

Michael G. Colantuono is the Managing Shareholder of Colantuono, Highsmith & Whatley, PC, a municipal law firm with offices in Pasadena and Grass Valley. He is a leading expert on the law of local government revenues and has handled these issues in ten cases in the California Supreme Court since 2004.

I. INTRODUCTION

A recent decision of the California Court of Appeal highlights a somewhat obscure provision of the California Constitution which bars contracts to limit state and local governments' power to tax. Similar provisions appear in many other state constitutions, so the issue is of broader interest. The prohibition is related to the rule that a city or county cannot contract away its police power, as by agreeing not to amend its general plan,¹ not to exercise its power of eminent domain to terminate a lease,² or to exempt a mobile home park from rent control.³ There are ways to give those who contract with government protection against future taxes, but a flat promise not to tax is unenforceable. This article describes the case, explains its ruling, and identifies strategies to make enforceable agreements with private parties who require certainty as to future taxation.

II. THE RUSSELL CITY ENERGY CASE

A. The Facts and Procedural History of the Russell City Energy Dispute

Russell City Energy Co., LLC v. City of Haywar- arose on these facts: A power plant operator contracted with Hayward to develop a multi-million-dollar, natural-gas-fired power plant there.⁵ The parties agreed the developer would pay $10 million to build a new City library but would be exempt from "any other . . . taxes . . . other than . . . taxes . . . generally applicable to similarly situated owners of real property . . . in the City."⁶ Four years later, Hayward voters adopted a 5.5% utility users tax and the City informed Russell it must pay the tax on natural gas used to generate power, which would likely make the plant uneconomic.⁷ Russell sued, claiming breach of contract, promissory estoppel, anticipatory repudiation, and violations of the contract clauses of the California and federal constitutions.⁸

The City successfully demurred, citing article XIII, section 31 of the California Constitution which states, in its entirety: "The power to tax may not be surrendered or suspended by grant or contract."⁹ The provision dates from the Constitution of 1879 and was amended to apply to local government in 1974.¹⁰ Russell appealed, and the Court of Appeal affirmed, but the court remanded to allow Russell to amend its suit to argue for restitution of the $10 million library payment on a quasi-contract theory, rejecting the City's efforts to argue such claims do not lie against California governments.¹¹

The City argued the utility tax was a city-wide tax on "similarly situated owners" of property in the City that Russell was obligated to pay under the language of the contract quoted above.¹² Because the case arose on demurrer, the trial and appellate courts were required to accept the plaintiff's construction of the contract unless it was "clearly erroneous."¹³ Russell plausibly argued the utility user tax was not on property, but on those who use utility services without respect to property ownership, as is typically true of utility taxes.¹⁴ The trial and appellate courts did agree, however, that the promise not to tax Russell violated article XIII, section 31 and was therefore unenforceable.

B. Russell's Unsuccessful Efforts to Evade the Ban on Contractual Tax Immunity

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Russell raised several counterarguments, all of them unsuccessfully, and each illuminates the reach of the prohibition on contracting away the power to tax. It first argued that article XIII, section 31 was limited to perpetual tax exemptions and the contract exempted it from tax only while it operated a power plant.¹⁵ This argument relied on an Arizona Supreme Court decision construing that state's comparable constitutional prohibition¹⁶ as limited to perpetual tax exemptions, which noted that the provision responded to corporate charters conferring tax immunity.¹⁷ That decision provides this useful history of constitutions prohibiting grants or contracts for tax immunity:

Article IX, section 1 is best understood in the context of the problem it addresses. In the early nineteenth century, state legislatures frequently included tax exemptions in the charters of private corporations; litigation ensued over the power of subsequent legislatures to eliminate the exemptions. The United States Supreme Court held as early as 1812 that a state legislature's repeal of tax exemptions contracted by the state violate[s] the Contract Clause of article I, section 10 of the United States Constitution.
The Dartmouth College case subsequently established that the Contract Clause prevents a state from altering or amending terms in a private corporation's charter, unless the state's power to amend was reserved in the charter itself or in some general or special law to which it was originally subject. Trustees of Dartmouth College v. Woodward, 17 U.S. (4 Wheat.) 518, 4 L.Ed. 629 (1819). The Supreme Court applied this principle to protect perpetual tax exemptions granted in corporate charters. See Home of the Friendless, 75 U.S. (8 Wall.) 430, 19 L.Ed. 495 [(1869)] . . . . The Court later acknowledged, however, that grants in a corporate charter would not be protected by the Contract Clause if a state's constitution prohibited the state from granting permanent tax exemptions. Home of the Friendless, 75 U.S. (8 Wall.) at 438. Accordingly, many states adopted such prohibitions in their constitutions. See Stewart E. Sterk & Elizabeth E. Goldman, Controlling Legislative Shortsightedness: The Effectiveness of Constitutional Debt Limitations, 1991 Wis. L. Rev. 1301, 1319 (1991) ("Once the scope of Contract Clause doctrine became apparent, a number of states adopted constitutional provisions that prohibited legislatures from contracting away taxing power.").¹⁸

The California Court of Appeal was unpersuaded to follow the Arizona Supreme Court's decision limiting the prohibition on contracting away the tax power to permanent grants of immunity because it could find no language in the terse and direct article XIII, section 31 to support that distinction.¹⁹ Moreover, the Court noted, the 1974 amendment of the provision to extend it to local governments implied its reach beyond corporate charters because local governments do not issue such charters—the State does.²⁰

Russell next argued from cases allowing governments to settle tax disputes.²¹ The authority there was AB Cellular LA, LLC v. City of Los Angeles, which found that Los Angeles's expansion of the reach of its telephone users tax by administrative direction to the carriers which collect it was a tax "increase" requiring voter approval under Proposition 218, article XIII C, section 2 of the California Constitution.²² That decision noted its ruling did not prevent cities from settling tax disputes by direction to reduce tax collections as to a given taxpayer or a class of them and the Russell court accepted that the California...