Challenge to California's Cap-and-Trade Emission Allowances Auction Rejected on Appeal

In Short

The Situation: On appeal, the California Chamber of Commerce and other entities renewed their challenge to the lawfulness of the California Air Resources Board's auction sale of greenhouse gas emission allowances in California's cap-and-trade program.

The Result: The Court of Appeal upheld the trial court's judgment, affirming that the California Air Resources Board's auction sale of greenhouse gas emission allowances is lawful.

Looking Ahead: Covered entities may continue to purchase greenhouse gas emission allowances to comply with California's cap-and-trade program.

On April 6, 2017, the California Court of Appeal, in a 2–1 decision, upheld the sale of greenhouse gas ("GHG") emission allowances in California's cap-and-trade program. California Chamber of Commerce v. State Air Resources Board (2017) 10 Cal.App.5th 604. In affirming the trial court judgment, the Court of Appeal held that the California Legislature gave broad discretion to the California Air Resources Board ("Board") to sell GHG emission allowances by auction, and that the revenue generated by the auction sales did not amount to a tax in violation of Proposition 13. This decision preserves a key component of California's cap-and-trade program at a time when California and the Board are taking steps to extend the program beyond its current 2020 expiration date to 2030, in order to reduce statewide GHG emissions to 40 percent below 1990 levels by 2030. But, the decision leaves open the possibility of a legal challenge to the Legislature's use of auction revenue.

Background

The California Global Warming Solutions Act of 2006 (AB 32) designates the Board as the state agency charged with "monitoring and regulating sources of emissions of greenhouse gases that cause global warming in order to reduce emissions." Under AB 32, the Board implements the cap-and-trade program, which imposes a statewide, aggregate GHG emissions cap that covered entities—generally large emitters of GHGs—may emit during an annual compliance period. The Board enforces the cap, which lowers over time, by issuing a limited number of allowances, the total value of which is equal to the amount of the cap. Each allowance authorizes up to one metric ton of carbon dioxide equivalent GHG emissions. Covered entities comply with the program by reporting their emissions and surrendering allowances authorizing those emissions. The Board distributes a limited number of allowances for free to covered entities in certain industries. Part of the compliance obligation also may be satisfied by surrendering offset credits that the Board issues for projects, such as forest conservation and management projects, which reduce atmospheric GHGs. Otherwise, covered entities must purchase the allowances at Board auctions or in the secondary market.

In two cases consolidated at the trial level and on appeal, the California Chamber of Commerce and Morning Star Packing Company, along with other entities, challenged the Board's auction sale of GHG emission allowances. Petitioners asserted that the cap-and-trade program's auction sales exceed the Legislature's delegation of authority to the Board to design a market-based emissions reduction system, and that the revenue generated by the auction sales results from the imposition of a "tax" that was not authorized by a two-thirds supermajority vote of the California Legislature, as required by California's Proposition 13.

AB 32's Delegation to the State Board

The Court of Appeal first held that the California Legislature conferred on the Board's broad discretion to craft a distribution system that includes an auction sale of GHG emission allowances. Looking at the Act's mere 12 pages in length, the court noted that the Act's directives to the Board are "exceptionally broad and open-ended" and grant the Board authority to design regulations that include "distribution of emissions allowances."

Petitioners argued that the lack of discussion in the legislative record of an auction sale, the lack of legislative guidance for disposing of auction proceeds, and other cap-and-trade programs elsewhere with different allowance distribution schemes, precluded the Board's auction sale of emissions allowances. In response, the court maintained that AB 32 was passed as a "flexible" bill that was not required to detail the minutiae of California's cap-and-trade program.

The court also found that AB 32's administrative fees provision to pay for the costs of implementing AB 32 does not bar the Board from generating other revenue under the Act. None of the legislative materials in support of the administrative fees provision suggested that the Board lacked the authority to adopt an auction component in its cap-and-trade program. In support of its holding, the Court of Appeal declared that the Legislature affirmatively ratified the Board's auction system by passing four bills in 2012 that specified how the auction proceeds would be used to effectuate AB 32.

Emission Allowances Auction Is Not a Tax

The Court of Appeal next held that the GHG emission allowances auction sale is not the imposition of a tax subject to Proposition 13. As a threshold matter, the court rejected the petitioners' reliance on Sinclair Paint Co. v. State Bd. of Equalization, which set forth criteria to determine whether a revenue-generating measure is a tax under Proposition 13 requiring a two-thirds supermajority vote, or a regulatory fee that may be approved by a simple majority vote. Finding that Sinclair Paint did not create a "binary world" where every payment to the government must be either a fee or tax, the court noted that the auction of allowances is an entirely different system that does not impose a regulatory fee on GHG emitters.

The court then considered the two hallmarks of a tax: (i) it is compulsory, and (ii) it does not grant any special benefit to the payor. Participation in the Board's auction sales is not compulsory, according to the court, because a covered entity could avoid the need to purchase extra allowances at the auction by reducing emissions, purchasing allowances from third parties, or purchasing emission offsets. Moreover, the court maintained that covered entities lack a vested right to continue emitting GHGs without "paying for the privilege to do so." Emissions allowances, according to the court, grant a special benefit to the payor—the privilege to pollute the air. Because the auction system met neither of the twin hallmarks of a tax, the court concluded that it is not a tax.

Future Legal Challenges

Petitioners also argued that the state improperly used auction funds to support programs that lacked a connection to the emission of GHGs by covered entities, as required by law. The Court of Appeal held that this issue was not ripe for decision. None of the petitions sought to invalidate the Legislature's decisions on how to spend auction proceeds; rather, their object was to invalidate the auction sales. The court further stated that the Legislature's expenditure of allotted revenue does not speak to the legality of the collection of that revenue. The court left open the possibility, however, that "[t]o the extent the proceeds' expenditure may seem inappropriate to some, those who seek to challenge it may do so."

Key Takeaways

1. In an action resulting in defeat for the California Chamber of Commerce and other entities, the California Court of Appeal upheld a lower court’s decision deeming lawful the California Air Resources Board's auction sale of greenhouse gas emission allowances.
2. In its ruling, the Court of Appeal held that the state legislature had conferred on the State Resources Board broad discretion to craft a distribution system which could include an auction sale of GHG emission allowances. The court further held that the emission allowances auction sale is not the imposition of a tax.
3. Future legal challenges are possible, including with regard to the appropriateness of the expenditures of revenue resulting from the auction sales.

Lawyer Contacts

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Thomas M. Donnelly
San Francisco
+1.415.875.5880
tmdonnelly@jonesday.com

Daniel L. Corbett
San Francisco
+1.415.875.5885
dcorbett@jonesday.com

Benjamin C. Lee
San Francisco
+1.415.875.5848
blee@jonesday.com

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