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Calif. Cap-And-Trade Program Upheld By Split Appeals Court

Originally reported by by Melissa Daniels, Legal360 Staff Witter

Added comments from ARB Chair Mary Nichols and NAVF Managing Partner, John Cataldi.


The auction program at issue was created by the California Air Resources Board after the Legislature passed a broad measure to reduce greenhouse gas emissions, formerly dubbed the California Global Warming Solutions Act. The legislation, Assembly Bill 32, passed with a simple majority vote by both legislative houses in 2006.


In 2013, The California Chamber of Commerce, as well as Morning Star Packing Co. and other businesses, sued the state over its cap-and-trade program in a pair of similar lawsuits, which they alleged the regulations exceed the scope of the California Air Resources Board’s authority, and that the revenue generated by the sales of the allowances constituted an unauthorized “tax” that wasn’t passed with a requisite two-thirds vote in the state Legislature. In a split California appellate panel on Thursday, April 6, 2017, the Court upheld the state’s cap-and-trade program against a closely watched challenge from businesses and advocacy groups, finding the state’s auction revenues from greenhouse gas emission allowances do not equate to a tax.

Judges Elena J. Duarte and M. Kathleen Butz said they agreed with the state and stated that “its environmentalist supporters that the auction sales don’t equate to a tax” as elaborated within a 53-page opinion. Both judges agreed that a tax is compulsory, and a payor doesn’t receive anything in return for the tax itself — conditions the state’s auction system doesn’t meet.

“Contrary to plaintiffs’ view, the purchase of allowances is a voluntary decision driven by business judgments as to whether it is more beneficial to the company to make the purchase than to reduce emissions,” the panel said. “Further, once purchased, either from the board or the secondary market, the allowances are valuable, tradable commodities, conferring on the holder the privilege to pollute.”

But Judge Harry E. Hull wrote in a 25-page partial dissent that he would reverse the lower court decision in favor of the state because the cap-and-trade program is a tax, as businesses must bear the cost if they wish to do business in California.

The chamber and a cohort of California businesses challenged the act in separate cases, arguing how the ability to run the allowance auctions unlawfully extends the Air Resources Board’s authority. They also argued the program was unlawfully created, as the revenue generated by the auctions constitutes a “tax” and AB 32 wasn’t passed with the two-thirds supermajority vote required to pass a tax under Proposition 13. Both challenges were unsuccessful in the trial court.

But the majority panel said Thursday the auction system is not subject to Proposition 13, as it doesn’t constitute a tax. The allowances are not compulsory, and they have their own value once someone decides to make a purchase, the panel said.

“Indeed, speculators have bought allowances seeking to profit from their sale, and as one party puts it, taxes do not attract volunteers,” the majority said.

Morning Star had argued the cap-and-trade program will increase its costs, as it would have to participate in the auctions in order to stay in business in California. The panel said Thursday while that may be true, “making the business decision to pay is not the same as being compelled to do so by the state.”

The majority also said the Legislature, in passing AB 32, intentionally allowed the Air Resources Board to decide whether to create a cap-and-trade program or other type of system. And though the plaintiffs argued there was no legislative record showing discussion about the establishment of an auction capable of generating billions of dollars in revenue,  the panel said “the Legislature chose to pass a flexible bill, with the understanding that the board, as the agency with expertise in air quality matters, was better equipped to study the problem and design a program to effectuate those goals.”

In his dissent, Judge Hull looked at the use of the auction revenues and said the state seeks to “end-run the provisions of Proposition 13.” Revenues are not used to specifically fund the cap-and-trade program but instead are used for state programs including a high-speed rail fund, Judge Hull said.

“Although not alone determinative, the use of the money must be factored into the analytical equation,” Judge Hull said. “If the state treats the revenue as general revenue to be used to pay for public services, that strongly suggests the exaction is a tax.”

Responding to the decision Thursday, John Cataldi, Managing Partner of the NAVF’s ESG Climate Change / Carbon Fund, stated that he has already seen a surge in both investment inquiries and corporate clients seeking to purchase carbon offsets.


In a separate statement by California Air Resources Board Mary Nichols, in response to the decision in the Court of Appeal of the State of California, Third Appellate District, upholding the lower court’s decision relating to CARB’s cap-and-trade program: “The court’s decision affirms the basic purpose and structure of the program–to deliver carbon reductions in a cost-effective and flexible manner. The decision provides additional certainty for this keystone program, which supports all the other approaches California has underway to fight climate change. Together, our climate policies will continue to drive innovation and clean energy, deliver good clean tech jobs, and make it possible to continue to invest in programs, especially in disadvantaged communities, to reduce greenhouse gases and improve the quality of life.”





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