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Alameda County Flood Control, Etc. et al v. Department of Water Resources

February 15, 2013


APPEAL from a judgment of the Superior Court of Sacramento County, Patricia C. Esgro, Judge. (Super. Ct. Nos. 05AS01775 & 07AS04901)

The opinion of the court was delivered by: Duarte , J.



Pillsbury Winthrop Shaw Pittman LLP, John S. Poulos, Amy L. Pierce, Darcy L. Muilenburg; Lewis Brisbois Bisgaard & Smith LLP, Greg L. Johnson; Kronick Moskovitz Tiedemann & Girard and Edward J. Tiedemann, for Plaintiffs and Appellants Alameda County Flood Control & Water Conservation District Zone 7, Alameda County Water District, City of Yuba City, County of Butte, County of Kings, Empire West Side Irrigation District, Kern County Water Agency, Napa County Flood Control & Water Conservation District, Oak Flat Water District, Plumas County Flood Control & Water Conservation District, Santa Clara Valley Water District, Solano County Water Agency, and Tulare Lake Basin Water Storage District.

Amelia T. Minaberrigarai, for Plaintiff and Appellant Kern County Water Agency.

Kamala D. Harris, Attorney General of California, Denise Ferkich Hoffman, Supervising Deputy Attorney General, Matthew J. Goldman and Vera Sandronsky, Deputy Attorneys General, for Defendant and Respondent, State of California, Department of Water Resources.

Bingham McCutchen LLP, James J. Dragna, Colin C. West and Thomas S. Hixson, for Defendants, Interveners and Appellants Antelope Valley-East Kern Water Agency, Castaic Lake Water Agency, Central Coast Water Authority, Coachella Valley Water District, Crestline-Lake Arrowhead Water Agency, Desert Water Agency, Littlerock Creek Irrigation District, Metropolitan Water District of Southern California, Mojave Water Agency, Palmdale Water District, San Bernardino Valley Municipal Water District, San Gabriel Valley Municipal Water District, San Gorgonio Pass Water Agency, and United Water Conservation District.

Best Best & Krieger LLP and Robert M. Sawyer, for Defendant, Intervenor and Appellant, Ventura County Watershed Protection District.

Marcia L. Scully, John Schlotterbeck, Heather C. Beatty and Karen L. Tachiki for Defendant, Intervenor and Appellant, The Metropolitan Water District of Southern California.

"As Mark Twain is said to have observed: 'Whiskey is for drinking; water is for fighting over.'" (County of Imperial v. Superior Court (2007) 152 Cal.App.4th 13, 18 (Imperial).) As lamented nearly 50 years ago, California's water is still maldistributed relative to supply and demand, and "California's North-South war still smoulders and is far from being resolved." (1 Rogers & Nichols, Water for California (Bancroft-Whitney 1967) California Water Plan, § 87, pp. 115-116 (Rogers & Nichols).)

The primary issue in this appeal after a court trial is whether the trial court properly interpreted the standard State Water Project (SWP) contract regarding how to credit water recipients (contractors) with the revenues from Oroville Dam hydropower ("Oroville" or "Hyatt-Thermalito" power). This power is now purchased by defendant Department of Water Resources (DWR) for use within the SWP, although some of it is then pooled with other SWP system power and traded or resold on the open market.

Generally speaking, plaintiffs are Northern California contractors who challenge DWR's methods, and interveners are Southern California contractors who defend the status quo.

The trial court found the contract was ambiguous as to whether the term "total revenues" as used in a key contract provision required valuing Oroville power at market rates as plaintiffs contend, but found the long course of dealings between the parties--a "practical construction" of the contract--refuted this construction. The trial court also found, as a matter of law, that the contract did not require DWR to treat profits from the so-called "resale" of system pool power towards that revenue. The trial court found these two interpretative conclusions resolved all issues. The judgment validates the status quo.

We agree with the trial court's ultimate interpretive resolutions, but do not entirely accept the trial court's reasoning. We hold the contract is not ambiguous on the subject of market rates, because its language--when read in light of governing law--is not reasonably susceptible of a reading that requires application of current market rates. In 1967, DWR signed a 50-year "Power Sale Contract," agreeing to sell power--evidently at then-current market rates--to several utilities. Later, DWR took over that Power Sale Contract, in effect paying itself what the utilities had been paying to DWR. DWR was statutorily authorized to continue making to itself the payments that the utilities had previously made. The relevant statutes permitted DWR to do what it has been doing.

On the question of what plaintiffs generally refer to as "resales" of pooled system power, we conclude that DWR acted within its statutory authority in the manner in which it treated profits due to resales of Oroville power, and any arguable contractual ambiguity regarding this treatment is properly resolved against plaintiffs by the practical construction rule, given a 20-year period of performance without challenge to DWR's administration of the contract.

We agree with the trial court that reaching these two ultimate interpretive conclusions vitiates plaintiffs' bad faith claim.

Accordingly, we shall affirm the judgment, and dismiss as moot a protective cross-appeal filed by interveners.


California is the home of two huge, interrelated, water projects. The federal Central Valley Project (CVP, including notably Shasta Dam) was built during the 1930's, and the SWP (including the tallest dam in the United States, the Oroville Dam), was built during the 1960's. They exist for the following reason:

"California's critical water problem is not a lack of water but uneven distribution of water resources. The state is endowed with flowing rivers, countless lakes and streams and abundant winter rains and snowfall. But while over 70 percent of the stream flow lies north of Sacramento, nearly 80 percent of the demand for water supplies originates in the southern regions of the state. And because of the semiarid climate, rainfall is at a seasonal low during the summer and fall when the demand for water is greatest; conversely, rainfall and runoff from the northern snowpacks occur in late winter and early spring when user demand is lower. [Citation.] Largely to remedy such seasonal and geographic maldistribution, while simultaneously providing relief from devastating floods and droughts, the California water projects were ultimately conceived and formed." (United States v. State Water Resources Control Bd. (1986) 182 Cal.App.3d 82, 98-100; see In re Bay-Delta etc. (2008) 43 Cal.4th 1143, 1153-1155 (Bay-Delta).)

The SWP was initially authorized in 1951, and in 1960 the voters approved a then-massive $1.75 billion general obligation bond measure to build "a complex system of reservoirs, dams, power plants, pumping plants, canals, and aqueducts" operated by DWR, to deliver water to "contractors" who "received entitlements to an annual amount of water in return for which they repay a proportionate share of the financing and maintenance of the SWP facilities." (Planning & Conservation League v. Department of Water Resources (2000) 83 Cal.App.4th 892, 898-899 (PCL); see Wat. Code, §§ 12931, 12934, subd. (d), 12935.)*fn1

"The SWP serves the domestic water needs of approximately two-thirds of all Californians, with the [Metropolitan Water District of Southern California (MWD)] receiving about half of the SWP's water delivery. [Citations.] Due to environmental concerns, however, construction of the entire SWP project has never been completed, resulting in the annual delivery of only about half of the 4.2 million acre-feet of water projected." (Bay-Delta, supra, 43 Cal.4th at p. 1155.)

The parties on appeal--apart from DWR--are SWP contractors, assignees or successor entities.*fn2

Given the size of the SWP and the many conflicting economic, regional, and political interests, the contract details were hotly debated, and the trial court, in an understatement, found that the "respective positions and suggestions . . . were not harmonious."

On January 21, 1960, Governor Edmund G. "Pat" Brown issued "Contracting Principles for Water Service Contracts." Principle No. 4 partly stated most users would pay the actual cost of power to deliver water, large landholders would pay market value, and when power was "available for sale, it will be sold at its market value." "The difference between the actual cost and the market value" of power would yield a "power credit" to "reduce the cost of project water" except for large landholders.*fn3 The "cost of project water" was not defined.

The statutes authorizing the SWP, popularly referred to as the Burns-Porter Act, were submitted to and passed by the voters at the November 8, 1960, General Election, as Proposition 1.*fn4 "After the contracting principles were published, but before the Act was approved by the voters, [DWR] entered into its first local water supply contract pursuant to the Act with MWD. The contract was negotiated on the basis of the contracting principles, and was contingent on the Act's later approval. Negotiations were of statewide significance because it was generally recognized that the contract would be the prototype for all later Project contracts, for article 45 of the MWD contract required that the basic terms and conditions of all later contracts be substantially uniform." (Goodman v. County of Riverside (1983) 140 Cal.App.3d 900, 905 (Goodman).)

The parties agree the interpretation of the MWD contract applies to all the contracts.

Contractors must pay all SWP costs except recreation, fish and wildlife enhancement and flood control costs. Contractors pay both a "Delta Water Charge" and a "Transportation Charge." The Delta Water Charge is the water conservation facility capital, operation, maintenance, power and replacement (OMP&R) costs, and generally is paid whether or not a contractor takes water. The Transportation Charge is the transportation facility costs, including OMP&R costs, and is levied on delivered water. A major component of the Transportation Charge is the variable cost of power to pump and deliver water to each contractor.*fn5 Thus, credits to the Delta Water Charge benefit all contractors, but credits to the Transportation Charge benefit contractors as they receive water, and the farther their water travels, the more they benefit.

The Oroville Dam is the site of the Hyatt-Thermalito Power Complex, which annually produces 2.2 billion kilowatt hours of electricity. As characterized by our Supreme Court, "Power development is an essential part of the project, both to make it economically feasible and to provide the energy required for pumping in connection with the transportation of water." (Metropolitan Water Dist. v. Marquardt (1963) 59 Cal.2d 159, 173 (Marquardt).)*fn6

Annually, the SWP consumes more power than it generates. But its power plants can operate at all hours, allowing DWR to exploit the variable price of electricity: DWR can run water pumping plants at "off-peak" times (generally at night and on weekends), when the cost of electricity is lower, and sell or trade on the open market power it produces at "on-peak" times, when the value of electricity is higher, netting a profit to reduce SWP's costs.

As briefly discussed ante, the contracting principles contemplated that power would be sold at market rates. However, on this and many other points the Legislature was divided. The trial court found that, "As negotiations progressed, the concept of a market-based valuation of power was ultimately deleted from the contract." In May through July 1960, DWR and MWD exchanged proposed contract terms contemplating crediting power at market rates. But no such provision ultimately was adopted.

Instead, article 22(a) of the MWD contract as finally agreed by the parties reads in relevant part as follows:

"The payments to be made by each contractor for project water shall include an annual charge designated as the Delta Water Charge. This charge, together with the total revenues derived during the project repayment period from the sale or other disposal of electrical energy generated in connection with operation of project conservation facilities, shall return to the State during the project repayment period all costs of the project conservation facilities including capital, [OMP&R], which are allocated to the purpose of water conservation in, above, and below the Delta pursuant to subdivision (e) of this article."*fn7

The Legislature had the power to change the MWD contract during the 1961 Regular Session; if it chose to do so, MWD had the choice whether to accept the changes. But the Legislature did not make any changes, thereby indicating its approval of the contract. (See Marquardt, supra, 59 Cal.2d at pp. 181-182, 202.) The People also approved the contract. As correctly summarized by a relevant Attorney General opinion:

"When the people of the state approved the Burns-Porter Act, they enacted into law a unified system of financing the water system, including authorization for both initial financing (the bonds) and payment of long-term debt and operational costs (the water contracts). The bonds, the mandate to enter into contacts, and the pledge of proceeds are part of the single and indivisible scheme the voters accepted. The largest contract, the [MWD] contract, was signed four days prior to the voter approval of the Burns-Porter Act, and the California Supreme Court has held that the voters were aware of the contract when they approved the Burns-Porter Act. . . . In sum, the voters did not simply approve the $1.75 billion bond indebtedness; they also approved a contractual scheme to support the system and pay the indebtedness." (61 Ops.Cal.Atty.Gen. 373, 379 (1978), emphasis added.)

Thirty water supply contracts were signed between 1960 and 1963, and each contained similar terms, consistent with the MWD contract's uniformity provision.

Under article 1(w), the "project repayment period" extends "until all bonds secured by the pledge of revenues provided for by the Bond Act have been repaid." Proposition 1 authorized $1.75 billion in Burns-Porter Act general obligation bonds, to fund construction of the Oroville Dam and other facilities. (§ 12934; see PCL, supra, 83 Cal.App.4th at pp. 898-899.) Article 5 provides that the contract was entered into "for the direct benefit" of holders of those bonds, "and the income and revenues derived from this contract" were pledged according to a statutory hierarchy. (§ 12937, subd. (b).) The Hyatt-Thermalito power plants were built with CVP revenue bonds. (See 15 McQuillin, Law of Municipal Corporations (3d ed. 2005) Municipal Bonds, § 43:10, pp. 654-655 [distinguishing the two kinds of bonds].)

Under a 1966 Suppliers Contract, utilities sold power to the SWP at a fixed price, paid for by way of the "variable" component of the Transportation Charge paid by the contractors, which is essentially the net cost of SWP's power.*fn8

Under a November 29, 1967, Power Sale Contract, the utilities (other than LADWP) agreed to buy all Oroville power from the SWP for 50 years, or until the Hyatt-Thermalito construction revenue bonds were repaid, whichever was later. The utilities paid $16.15 million annually, based on an estimated annual generation of 2.1 billion kilowatt hours.*fn9 Of that annual payment, $14.65 million was applied to principal and interest on the construction revenue bonds, and the remaining $1.5 million was a fixed amount applied to OMP&R costs. However, those costs eventually exceeded $1.5 million. The trial court found DWR "treated the $16.15 million a year received under the Power Sale Contract as the 'total revenues' generated by Hyatt-Thermalito under Article 22 in calculating the Delta Water Charge thereunder. There was no evidence of any objection to this interpretation . . . ."

The parties stipulated that, "The energy crisis of 1973 caused power prices to increase to unanticipated levels." As anticipated, the utilities gave five years of notice that they were canceling the 1966 Suppliers Contract, effective April 1, 1983. This meant, as the trial court put it, that if DWR "did nothing, after 1983 it would be selling Hyatt-Thermalito power to the utilities at a relatively low price, and likely buying power from them at significantly higher prices." However, as the trial court found, the Power Sale Contract allowed DWR to terminate it with five years of notice and "in essence step[] into the shoes of the utilities[,]" by buying the same SWP power it had been selling to the utilities. (See §§ 11670, 11671.) DWR's outside bond counsel (now known as Orrick, Herrington & Sutcliffe) opined DWR would act "on both sides of the transaction," or "in effect contract with itself for the sale and use of Oroville Power[.]"

But there was disagreement about what DWR should do. An "Ad Hoc Energy Committee" was created in 1976; it conducted many meetings with contractors and received many letters from them. The trial court summarized the discussions as follows:

"Whether to withdraw Hyatt-Thermalito power had substantial implications for the contractors, since DWR passed on all power costs incurred for pumping water to them. [Citation.] Withdrawal of that power also raised the issue central to the current dispute regarding how to value the power for purposes of crediting the Delta Water Charge. DWR convened the Ad Hoc Energy Committee for the purposes of addressing these issues, and sent a notice to the contractors inviting them to participate in the Committee's meetings. [Citations.] The Ad Hoc Energy Committee met many times over the next few years.

"A key issue addressed in the committee meetings and related correspondence was how to value Hyatt-Thermalito power for purposes of crediting the Delta Water Charge. . . . As to the value of Hyatt-Thermalito power, DWR enumerated four potential alternatives:

"Alternative A - The status quo, meaning that DWR would not cancel the Power Sale Contract and would continue to sell power at a fixed amount to the utilities, yet buy power at what was reasonably anticipated to be a significantly increased market rate.

"Alternative B - DWR would sell Hyatt-Thermalito power at market to the utilities under a renegotiated Power Sale Contract and buy power back from the utilities at the increasing market rate.

"Alternative C - DWR would cancel the Power Sale Contract, buy Hyatt-Thermalito power for the benefit of the SWP, and, for purposes of the credit to the Delta Water Charge, value that power at DWR's assigned amount ($14.65 million plus actual [OMP&R] costs).

"Alternative D - DWR would cancel the Power Sale Contract, buy Hyatt-Thermalito power for the benefit of the SWP, and, for purposes of the credit to the Delta Water Charge, value that power at market (then estimated at $50 million)."

Alternatives A and B were quickly rejected. Then, the Tehachapi Mountains reared up into the discussions. Although some water is sent to the South Bay Aqueduct, and then west to the Santa Clara Valley, most of it is "lifted into the California Aqueduct . . . and eventually again lifted by a series of pumping stations over the Tehachapi Mountains for delivery and use in the Southern California region." (United States v. State Water Resources Control Bd., supra, 182 Cal.App.3d at p. 100.) The difference in transportation cost is huge. It takes more electrical power to pump water to the west, to service the Central Coast contractors, or to the south, to cross the Tehachapi Mountains and service Southern California contractors, than it takes to pump water to contractors closer to the Oroville Dam. Some interveners are west of the California Aqueduct, but most are south of the Tehachapis; plaintiffs are further north and therefore have lower power costs for the water delivered to them.*fn10

As the trial court found:

"Thus Alternative D would benefit contractors with relatively low pumping costs, since it would substantially lower the Delta Water Charge which would receive a credit based upon the full market value of the power generated and consumed in the SWP. Alternative D would at the same time disadvantage contractors with high pumping costs, since a market value credit to the Delta Water Charge would mean that those contractors would pay market value for Hyatt-Thermalito power through the Transportation Charge thereby dramatically increasing the cost of water to them.

"Alternative C would have the opposite effect; it would benefit contractors with high pumping costs, to the detriment of those with low pumping costs."

The trial court found DWR favored Alternative C for two perceived reasons, both of which concerned potential downsides to implementation of Alternative D. First, Alternative D could create a power credit so large that "contractors would pay nothing, or would be paid, to take water." Second, Alternative D could cause cash flow problems, because Oroville power revenue first went towards paying off construction bonds, and although Alternative D would pay off those bonds more quickly, DWR would have less available money in the meantime.

On September 30, 1977, DWR cancelled the Power Sale Contract, effective April 1, 1983. It was replaced by the "Fourth Supplemental Resolution," which became the "State Power Contract." In October 1978, DWR adopted a power valuation formula, set forth in its "Bulletin 132-78," incorporating Alternative C. DWR has consistently applied that formula since it terminated the Power Sale Contract. The Hyatt-Thermalito CVP revenue bonds were retired in 1994; since then, the State Power Contract has been set forth in "Project Order No. 36."

Under Project Order No. 36, DWR credits the Delta Water Charge with the same $14.65 million the utilities paid under the 50-year 1967 Power Sale Contract, but pays actual OMP&R costs--which plaintiffs concede are more than fixed amount the utilities paid. Project Order No. 36 expires November 29, 2017, when the Power Sale Contract would have expired, had it not been cancelled.

In December 2003--20 years after Alternative C was implemented--plaintiff Kern County Water Agency (KCWA, referred to as the "lead" and "largest" plaintiff)--claimed all revenue from sales or "allocable" transfers of Oroville power must be credited to the Delta Water Charge at current market rates.

Plaintiffs filed their initial complaint on April 25, 2005. After pretrial skirmishes, two cases were consolidated for court trial. Over plaintiffs' objection, the trial court bifurcated liability and damages.

After a lengthy court trial and extensive briefing, the trial court issued a statement of decision finding against plaintiffs on the issue of contract interpretation. The trial court concluded the phrase "total revenues" in article 22(a) was ambiguous as to whether it meant market rates whether the power was used by DWR or resold for a profit, but concluded that the long course of dealings ...

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