Legal Alerts Apr 16, 2020

When is a Franchise Fee a Tax?

Franchise Fees Charged to Waste Hauler are Not a Tax if Reasonably Related to the Value of the Franchise

When is a Franchise Fee a Tax?

Franchise fees that exceed the reasonable value of the franchise conveyed may be considered taxes, according to a California court of appeal. In an opinion filed March 30, the California Court of Appeal reversed the trial court’s decision and held that contractual franchise fees negotiated between the City of Oakland and private solid waste providers must be reasonably related to the value of the franchise conveyed. 
In Zolly v. City of Oakland, properties in the City of Oakland received garbage, mixed materials and organics, and residential recycling services from two private companies providing solid waste services under franchise agreements with the City. The franchise agreements resulted from a public bidding and procurement process. In consideration for their rights under the agreements, the haulers were required to pay the City an initial franchise fee of more than $25 million for organics and materials and a residential recycling franchise fee of $3 million, both of which were subject to annual inflationary adjustments. The haulers established the rates to be charged to customers receiving solid waste services and passed the franchise fees on to customers in the solid waste bills. 
The plaintiffs, solid waste customers in the City, alleged that the City’s franchise fees were taxes subject to voter approval under Proposition 218. The trial court initially agreed with the City that the franchise fees were not subject to Proposition 218. In a subsequent round of pleadings, the plaintiffs asserted the franchise fees were an invalid tax because they did not bear a reasonable relationship to the value of the franchise rights conveyed. The plaintiffs relied on the California Supreme Court’s holding in Jacks v. City of Santa Barbara that a franchise fee is not a tax subject to voter approval, provided the franchise fee bears “a reasonable relationship to the value of the property interest.” The trial court ruled in favor of the City because “the lack of a direct pass-through of the franchise fees to the customer distinguished the franchise fee in Jacks from that charged by the City.”
The First District Court of Appeal’s review of the solid waste franchise fee was limited to whether the franchise fee was subject to Jacks’ holding that the fee must be reasonably related to the value of the franchise rights conveyed. The appellate court reversed the trial court and held that “a franchise fee, arguably subject to the fourth exemption in [Proposition 26] article XIII C, section 1, subdivision (e), must still be reasonably related to the value of the franchise.” In so holding, the court reasoned: “To qualify as a nontax ‘fee’ under [Proposition 26], a charge must satisfy both the requirement that it be fixed in an amount that is ‘no more than necessary to cover the reasonable costs of the governmental activity,’ and the requirement that ‘the manner in which those costs are allocated to a payor bear a fair or reasonable relationship to the payor’s burdens on, or benefits received from, the governmental activity.’” Thus, even assuming solid waste franchise fees are not a tax under Proposition 26, the holding in Jacks still applies when analyzing the validity of a non-voter approved franchise fee. These requirements apply whether or not the franchise fee is charged directly or indirectly to ratepayers. The court did not consider whether solid waste fees charged by private solid waste haulers are property-related fees or otherwise subject to the procedural or substantive issues of Proposition 218. 
The City filed a petition for rehearing this week. Unless the petition is granted, or unless the Zolly decision is appealed and overturned in the California Supreme Court, public agencies entering into solid waste franchise agreements should ensure that there is evidence showing that any franchise fee charged is reasonably related to the value of the franchise conveyed. Based on Jacks, this may include evidence of negotiations over the franchise fee, market surveys or other reasonable indications of value.
Note: BB&K represents the League of California Cities as amicus counsel in this matter.
If you have any questions about this opinion or how it may impact your agency, please contact the authors of this Legal Alert listed to the right in the firm’s Municipal or Special Districts practice groups, or your BB&K attorney.
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Disclaimer: BB&K Legal Alerts are not intended as legal advice. Additional facts or future developments may affect subjects contained herein. Seek the advice of an attorney before acting or relying upon any information in this communiqué.

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