Energy Law Alert: California Cap and Trade Auctions Upheld as Constitutional

by Stoel Rives LLP
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The Sacramento Superior Court has upheld the constitutionality of California Air Resources Board's ("ARB") cap and trade auctions in the related cases California Chamber of Commerce v. ARB and Morning Star Packing Company v. ARB. The petitioners in these cases challenged the cap and trade auctions on two fronts. First, petitioners argued that ARB's regulation providing for the auction of cap and trade allowances exceeds the scope of authority granted to ARB in the California Global Warming Solutions Act of 2006, or AB 32. Second, petitioners claimed that the sale of allowances at auction constitutes an illegal tax adopted without the requisite supermajority vote of the California State Legislature. The court rejected both arguments, finding the cap and trade auctions constitutional and within the scope of AB 32.

AB 32 requires the reduction of California's greenhouse gas ("GHG") emissions to 1990 levels by 2020. To achieve this task, AB 32 gave ARB authority to design and implement emissions reduction measures, including the use of a market-based compliance mechanism. Pursuant to this authority, ARB developed a cap and trade program, which establishes a firm cap on GHG emissions state-wide. As the cap on emissions declines year over year, a regulated source that exceeds its share of free allowances must either reduce its GHG emissions or purchase emission allowances in state-run auctions. Starting November 2012, ARB began holding quarterly auctions to sell emission allowances to regulated sources.

Since its inception, AB 32 and its programs have been beset by legal challenges. In the California Chamber of Commerce and Morning Star Packing cases, two groups of petitioners separately filed actions challenging the cap and trade auctions on similar grounds. The National Association of Manufacturers intervened in the California Chamber of Commerce case on behalf of petitioners. The Environmental Defense Fund and the Natural Resources Defense Council intervened in both cases on behalf of ARB. The Sacramento Superior Court ordered the cases related for briefing and argument. Petitioners contended that the cap and trade regulations providing for the sale of allowances are void because they exceed the scope of authority conferred to ARB under AB 32, and that the allowances constitute an illegal tax adopted in violation of California Constitution, Article XIIIA, established by Proposition 13, requiring a supermajority vote of the legislature for any new tax.

Sacramento Superior Court issued a joint ruling on the cases on November 12, 2013, denying the petitions. The court found petitioners' first argument unpersuasive, holding that the sale of allowances is within the broad scope of authority delegated to ARB in AB 32. The court found that it was "reasonable to assume that the legislature understood the phrase 'distribution of emissions allowances' to potentially encompass both giving away allowances and selling them via an auction or direct sale."

The court also rejected petitioners' second argument, that the auction provisions constituted an illegal tax because AB 32 was not passed by a two-thirds vote of the legislature, as required by Proposition 13. The court viewed the argument that the cap and trade auctions provided for under AB 32 constitute a revenue-generating tax as a closer question than the delegation issue. It was undisputed that the cap and trade auctions will result in a cumulative net increase in state revenues. To resolve the question of whether the sale of allowances constitutes a tax, the court focused on the distinction between taxes and fees. The court distinguished "taxes" from "fees" and reviewed the various categories of fees not subject to Proposition 13's supermajority requirement, including special assessments and related business charges, development fees, user fees, and regulatory fees. While the specific facts of this case did not fit squarely within any recognized fee classification, the court agreed with ARB and found on balance "the charges to be more like a regulatory fee/charge than a traditional tax." As a result, the court found that the provisions of AB 32 creating the market-based compliance mechanism did not need to be approved by a supermajority of both houses of the California legislature.

Petitioners in each case have 60 days from entry of judgment to appeal the decision to the Third District Court of Appeal. ARB still faces a challenge to another aspect of the cap and trade program, in Citizens Climate Lobby v. ARB, currently before the First District Court of Appeal. Petitioners in Citizens Climate Lobby attack the offset credit provisions of the cap and trade regulation.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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