Long Beach’s financial future has been thrust into uncertainty by the COVID-19 pandemic, but existing litigation over its practice of charging city-run utilities to access rights of ways could blow a nearly $20 million hole in future budgets if the city loses a court appeal.

The city has been in a legal battle to maintain the right to spend money it transfers out of the water department’s water and sewer funds and into the general fund, something it had done since 2003.

It settled one lawsuit in 2017, where it agreed to transfer $12 million back into the city’s sewer and water funds. California law prohibits utilities charging more than the cost of providing the service, something the city has acknowledged was the reason it settled in 2017.

However the 2018 passage of Measure M, which codified the city’s practice of charging its own utility companies for access to rights of way, seemed to settle the dispute over the transfers, something that generates about $14 million annually for the city’s general fund. 

But the vote was almost immediately taken to the courts as opponents challenged the election results on the grounds that it violated the California Constitution in regard to taxes on utilities. Losing the water and sewer transfer fee revenues would cut the general fund by just over 2%.

In January, a Los Angeles Superior Court judge ruled that the practice was unconstitutional and the city filed its only appeal shortly after. The ruling largely rests on language in the state constitution that requires a two-thirds vote of the people to levy taxes on utilities.

Measure M passed with just over 50% of voter approval, something the city thought at the time was adequate and legal.

The ramifications of the city losing the appeal could be dire. The city is currently trying to close a budget deficit as large as $41 million with more economic uncertainty on the horizon.

In the meantime, Deputy City Attorney Rich Anthony explained that the two sides have reached an agreement that will allow the city to spend some of the funds that would have been transferred under Measure M, but placing a portion of those funds into an escrow account until the case is decided.

Under an agreement until the case is heard, the city will be allowed to transfer and spend around $20 million over the next two fiscal cycles but if the ruling is upheld the city would have to transfer back whatever money it spent to the water and sewer funds within 180 days.

For this fiscal year, which ends at the end of September, the city would have to place $3 million in escrow. For the next fiscal year it would be required to place $6 million in escrow. After the 2021 fiscal year the city would be required to place all fee revenue into the escrow account and request a waiver to potentially spend any of it.

The escrowed money would have to be transferred back to the water and sewer funds and collection of the fees would also have to stop within 30 days.

Anthony said that normally during an appeal process the status quo—the city continuing to transfer the full amount into the general fund—would continue, but in this case some questions arose and both parties agreed to the escrow fund.

“We understand we may lose this appeal so the city doesn’t want to spend all the money if we can help it,” Anthony said. “Because if we lose, that’s more money we have to pay back in the future and that’s a big burden on the city financially.”

The agreement was struck in part because prohibiting the city from spending any of the money until the appeal was heard likely would have led to layoffs and reductions of services, something neither party wanted, Anthony said. 
He added that the agreement was negotiated before the pandemic forced much of the city to shut down, leading to a projected budget deficit for the current fiscal year as well as those in the immediate future.

Diana Lejins, one of the plaintiffs that challenged Measure M, said that while the appeal has been delayed by the pandemic, she remains confident that the appeals court will uphold the original ruling.

“They [City Hall] are just trying to delay the inevitable, continuing to raise our taxes again and again, and spending like drunken sailors,” Lejins said.

The city’s appeal has yet to be scheduled but could be heard sometime in the fall, with a potential ruling coming in the spring. While this is the city’s lone appeal at the local court level, it could appeal to the California Supreme Court if the January ruling is upheld.

A Supreme Court appeal could add on another 12-18 months, Anthony said.

If Measure M heads to the state’s top court it could mean that the city’s finances could be in limbo for multiple budget cycles. The city’s budget must be passed before October every year and not being able to depend on millions of dollars it normally would have spent could lead to cut backs.

“From our viewpoint it’s money that we had at one point counted on and now it’s not available,” said John Gross, the city’s Director of Financial Management.

The funds that will be locked away in escrow would be helpful in addressing one-time infrastructure investments, of which there are many, Gross said. However, because the agreement doesn’t allow the city to spend some of the money, the budget is being crafted as if it doesn’t exist.

If the appeal were to be decided in favor of the city, the escrowed money would be like a bonus, he said. But if the city loses it could have to come up with a lot of money, fast.

Gross said that if there’s available cash reserves the city could transfer the money back to the water and sewer funds.

Another option is use of a judgement bond, which are a growing trend for cities nationwide who lose court cases and need cash to pay out those judgements. The City of Los Angeles issued judgement bonds in the wake of the Rampart police scandal and over the past few years municipalities across the country have taken on billions of dollars of debt in the form of judgement bonds.

If the city did take on debt it would likely mean that the city’s taxpayers would be on the hook for more than whatever the sum required to be transferred back to the water and sewer funds due to underwriting costs and interest on the debt.

“We’re not there yet,” Gross said “We haven’t lost and we’re hoping that isn’t the situation.”

The cost to defend Measure M continues to grow. On Tuesday the City Council is expected to approve another extension of the contract with the law firm representing the city in the case with that sum possibly reaching $400,000. The city had previously approved a $300,000 contract with the firm in April.