Reported / Citable
Background
In 2022, the City of Los Angeles granted SoCalGas a new 21-year franchise authorizing it to install and operate its natural gas distribution system beneath City streets. Under the agreement, SoCalGas pays the City a franchise fee equal to 5.5% of its gross receipts from natural gas sales within the City. The City permitted SoCalGas to pass 3.5% of that fee through to customers as a “surcharge,” which the California Public Utilities Commission (CPUC) subsequently approved as just, reasonable, and nondiscriminatory.
Annie Nguyen, representing a putative class of SoCalGas customers, challenged the surcharge as an illegal tax under Proposition 26 — a 2010 voter initiative (Art. XIII C of the California Constitution) that expanded the definition of “tax” to require voter approval for a broader range of local government charges. Nguyen argued the franchise fee and its customer surcharge were not a legitimate fee for use of City property but a general revenue device that bypassed the voters. The Los Angeles Superior Court granted summary judgment for the City, and Nguyen appealed.
The Court’s Holding
The Second Appellate District affirmed. The franchise fee falls within Exemption 4 of Proposition 26, which carves out of the definition of “tax” any “charge imposed for entrance to or use of local government property, or the purchase, rental, or lease of local government property” (Art. XIII C, § 1, subd. (e)(4)). Because the City grants SoCalGas the right to use City-owned streets and right-of-way to install and operate gas infrastructure, the franchise fee is quintessentially compensation for use of public property — not a tax.
The court rejected Nguyen’s argument that Exemption 4 requires a separate showing that the fee bears a reasonable relationship to the value of the franchise. Following Howard Jarvis Taxpayers Assn. v. California, the court held that the absence of “reasonable cost” language in Exemption 4 — present in the first three Proposition 26 exemptions — means no substantive reasonableness requirement applies there. Even if it did, the undisputed evidence of bona fide, arms-length negotiations across 14 meetings and multiple written proposals satisfied the standard the California Supreme Court articulated in Jacks v. City of Santa Barbara. The CPUC’s approval of the surcharge as reasonable independently corroborated the fee’s legitimacy.
Key Takeaways
- A franchise fee charged for a utility’s right to install and operate infrastructure in public streets and rights-of-way is a “charge for use of local government property” under Proposition 26’s Exemption 4 — not a tax requiring voter approval.
- Proposition 26’s Exemption 4 does not impose a substantive reasonableness requirement on the government; the fee simply must be compensation for a defined property right.
- Even if reasonableness applies, a franchise fee negotiated at arms length across multiple sessions, with CPUC approval of the customer surcharge, easily satisfies that standard.
- A utility’s ability to pass a fee through to ratepayers does not undermine the legitimacy of the negotiation or transform the fee into a tax.
- California cities with utility franchise agreements can take guidance from this decision that properly structured, negotiated franchise fees remain insulated from Proposition 26 voter-approval requirements.
Why It Matters
Utility franchise fees are a significant and growing revenue source for California municipalities, and Proposition 26’s expanded definition of “tax” has spawned litigation challenging a wide range of local charges. This decision provides a clear roadmap: franchise fees paid by utilities for the privilege of using public streets and infrastructure rights are compensation for use of public property — squarely within Exemption 4 — and do not require a voter referendum. Cities that structure these fees through genuine, multi-session negotiations with independent CPUC oversight have additional protection against constitutional challenge.
For SoCalGas customers in Los Angeles, the ruling means the 3.5% surcharge appearing on their monthly bills is here to stay — it survived both judicial scrutiny and CPUC review. For California practitioners advising municipalities or utilities on franchise agreements, the decision confirms that the fee’s structure (compensation for property use, not general revenue), the negotiation process (arms length, multi-session, good faith), and CPUC oversight together form a durable defense against Proposition 26 tax challenges.