The question of who should pay the cost of municipal services for new residential development is a vexing one. The answer is critically important to the developers and homebuilders who must finance and market their projects, the residents who will eventually foot the bills, and the communities seeking funds to ensure that new development pays for itself.
On October 13, 2016, the Court of Appeal for the First Appellate District addressed this issue in Building Industry Association of the Bay Area v. City of San Ramon, __ Cal.App.5th __ (2016) (Case No. A145575). The Court affirmed a trial court decision supporting the City of San Ramon’s formation of a community facilities district and a special tax levied on a 48-unit townhouse project under the Mello-Roos Community Facilities Act of 1982.
The California legislature adopted the Mello-Roos Act in 1982 to provide an alternative method of financing certain public capital facilities and services, especially in developing areas and areas undergoing rehabilitation. Alternative methods of financing were needed because in 1978 the voters approved Proposition 13, which added article XIII A to the state constitution and severely impaired local governments’ ability to raise money through property taxes.
Before Proposition 13, local governments could usually impose special taxes without any voter approval. In contrast, Proposition 13 required that special taxes be approved by a two-thirds vote of the local voters and prohibited local governments from levying special taxes in the absence of state enabling legislation. In passing the Mello-Roos Act, the legislature sought to address the limitations on the ability of local governments to raise money by passing the required enabling legislation to authorize the creation of community facilities districts empowered to impose special taxes to pay for specified services and facilities within the district.
Building Industry Association of the Bay Area v. City of San Ramon addressed two fundamental Mello-Roos Act requirements: (1) services funded by landowner-approved taxes must be “in addition to those provided in the territory of the district before the district was created” and (2) “[t]he additional services shall not supplant services already available within that territory when the district was created.”
In 2013, San Ramon approved the townhouse project. The approval process included a fiscal analysis showing that providing certain services to the project would exceed the project’s revenues by about $500 per year for each townhouse. The City thus conditioned the project’s approval on providing a funding mechanism to mitigate the negative fiscal impacts.
To satisfy the condition, the landowner-developer petitioned the City to initiate Mello-Roos Act proceedings. In response to the petition, the City formed a community facilities district to fund a variety of services including police, park, and recreation facilities, open space facilities, landscaping facilities, street and street lighting facilities, flood and storm protection facilities, and storm water treatment facilities. The sole landowner and qualified elector approved the levy of the tax.
The City sought to use the tax revenues to meet the increased demand for the enumerated services expected to result from the development of the project. Once the tax is imposed and the district is developed, property in the district will receive services that are qualitatively no better than the services received by property outside the district, even though district property owners are paying an additional tax.
The Association filed suit to invalidate and annul the district and the tax, arguing that they are illegal for three reasons. First, the tax violates the Mello-Roos Act’s authorization for community facilities district special taxes because the tax’s proceeds will not be used to pay for any new or enhanced service to the City residents who pay the tax. Second, the tax violates Proposition 218’s prohibition on special districts levying “general” taxes. And third, the tax’s implementing ordinance unconstitutionally retaliates against City residents by threatening them with financial liabilities if they repeal the tax.
The Association argued that the tax does not meet the requirements of the Mello-Roos Act because a tax that pays for increased quantities of existing services to meet increased demand does not pay for “additional services.” In other words, according to the Association, “a landowner-approved tax may finance services that supplement existing services, but only if the new services provide homeowner-taxpayers a real and meaningful benefit that is over and above what non-district property owners receive as part of a standard menu of municipal services.” The Court considered the text and structure of the Mello-Roos Act and disagreed with the Association. The Court held, instead, that the “additional services” requirement is met by services that meet increased demand for existing services within the district. Such services are “in addition to” the services provided in the area of the district before the district was created. Moreover, services that meet increased demand do not supplant the services available in the area of the district when the district was created, because they do not replace those services. To the contrary, they supplement those services.
The Association argued that the tax is an impermissible general tax because it will finance a wide range of services and facilities and its purpose is to raise revenue to supplement the City’s general fund. In other words, the Associated contended that because tax revenues can be used for “a widely disparate menu of services and facilities,” the tax is in effect a general tax. The Court first noted that the Mello-Roos Act itself provides that any tax imposed pursuant to its authority is a special tax. The Court also considered Proposition 218 and the cases interpreting it and concluded that they support the designation of this tax as a special tax. Proposition 218 explicitly recognizes that a special tax may have multiple purposes and does not limit the number of purposes allowed. The Court thus held that San Ramon’s tax is a special tax, not a general tax.
Finally, the Association argued that the tax is unconstitutional on its face because it contains a provision that “retaliates” against property owners by ceasing to provide the services funded by the tax if property owners in the district repeal the tax in the future. The City contended in response that the provision simply addresses the contingency that property owners of the district may repeal the special tax may in the future through the initiative or any other process.
The Court relied on several background principles for addressing facial challenges to ordinances, including that:
- “We start from the strong presumption that the ordinance is constitutionally valid.”
- “We resolve all doubts in favor of the validity of the ordinance.”
- “Unless conflict with a provision of the state or federal Constitution is clear and unmistakable we must uphold the ordinance.”
- “Plaintiffs bear the burden of demonstrating that the ordinance is unconstitutional in all or most cases.”
Following those established principles, the Court held it is not a violation of due process to recognize that if a tax has been imposed to provide additional services and facilities to a district, and if that tax is repealed and not collected, funds will no longer be available to provide the district with those additional services and facilities. Any obligations that have been incurred to provide those services and facilities will need to be met from other sources. The Court also held that there is no retaliation, injury, or penalty to property owners for exercising their rights. The Court reasoned that while there will be consequences if district property owners exercise their rights and that exercise results in the repeal of the tax, those consequences may be regarded as adverse by some, but they may well be precisely the consequences that are expected and desired by the property owners who take the actions. The consequences are not triggered by the filing of petitions, initiative proceedings, or lawsuits. The consequences follow instead from the absence of the tax revenue that was to be collected to pay for services and facilities.
Building Industry Association of the Bay Area v. City of San Ramon highlights the structural challenges to financing local government services and underscores what some refer to as the fiscalization of land use. While some believe that property tax limits and restrictions on raising other taxes are vital safeguards protecting Californians from excessive spending, others contend that the system starves important local services and incentivizes communities to approve more commercial and retail development and less housing. Regardless of one’s perspective on those issues, however, it seems safe to conclude that unless the California Supreme Court overturns this decision local governments are likely to increasingly rely on community facilities districts to address the potential negative fiscal impacts of new residential development.
Questions? Please contact Bryan W. Wenter, AICP of Miller Starr Regalia.
For more than 50 years, Miller Starr Regalia has served as one of California’s leading real estate law firms. Miller Starr Regalia has expertise in all types of real property matters, including full-service litigation and dispute resolution, transactions, acquisitions, dispositions, leasing, financing, common interest development, construction, management, eminent domain and inverse condemnation, exactions, title insurance, environmental law, and land use. Miller Starr Regalia attorneys also write Miller & Starr, California Real Estate 4th, a 12-volume treatise on California real estate law. “The Book” is the most widely used and judicially recognized real estate treatise in California and is cited by practicing attorneys and courts throughout the state. For more information, visitwww.msrlegal.com.