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Third District Court of Appeal Upholds California’s Cap-and-Trade Program in 2-1 Decision

Despite challenges from the California Chamber of Commerce, National Association of Manufacturers, and other entities subject to California’s carbon emissions regulations, the Third District Court of Appeal affirmed a trial court judgment in favor of the State Air Resources Board’s (Board) Cap-and-Trade Program (Program).  The decision was issued on April 6, 2017 in the consolidated action of California Chamber of Commerce, et al. v. State Air Resources Board, et al., Case Nos. C075930 and C075954.

The general purpose of the California Global Warming Solutions Act of 2006, otherwise known as “AB 32” (Act), is to reduce greenhouse gas (GHG) emissions.  With broad discretion from the Legislature, the Board created a regulatory system requiring covered entities (generally large emitters of GHGs) to either surrender sufficient compliance instruments (emissions allowances or offset credits amounting to one metric ton of carbon dioxide equivalent of GHGs) to cover the amount of pollutants they discharge, or pay monetary penalties.  For covered entities planning to emit GHGs in excess of their free emissions allowance, the Board sells additional emissions allowances – up to the cap – at quarterly auctions.  These capped allowances can also be traded on a secondary market, along with offsets resulting from voluntary reductions from a source that is not directly covered by the Program.  Put simply, the Program “caps” the aggregate amount of GHGs that can be emitted by covered entities, but permits the entities to “trade” the emissions allowances and offset credits amongst themselves.  Total GHG emissions are thereby reduced over time as the Board lowers the cap by issuing fewer free emissions allowances to covered entities.  By 2020, the Board plans to cap emissions allowances at an amount that will effectively lower GHG emissions to 1990 levels.

In this case, Plaintiffs argued that the Program’s auction sales are beyond the Legislature’s delegation of authority to the Board, and they sought a more “revenue-neutral” interpretation of the statute.  The Court reviewed the auction sales under Government Code section 11342.2, which requires regulations to be both “consistent and not in conflict with the statute” and “reasonably necessary to effectuate the purpose of the statute.”  Holding that an “agency is not limited to the exact provisions of a statute in adopting regulations to enforce its mandate,” and that the Legislature gave broad discretion to the Board to create a distribution system, the Court found that Plaintiffs could not meet their burden of proof on the issue.  The Court also noted that four bills passed in 2012 affirmatively ratified the Board’s auction system.

Plaintiffs also argued that because Proposition 13 requires taxes to be passed by a two-thirds supermajority, and because the Act was passed with only a simple majority, the auction sales are invalid because the revenue generated therefrom amounts to a tax.  Evaluating this issue, the Court noted that a tax has two hallmarks:  (1) it is compulsory, and (2) it does not grant any special benefit to the payor.  Finding that the purchase of emissions allowances is a business-driven decision and not a governmentally compelled one, and that it conveys a valuable property interest (i.e., “the privilege to pollute California’s air”), the Court held that the auction system does not equate to a tax in violation of Proposition 13.

Stating in a press release issued by the Board that the Court’s decision affirms the program’s purpose to “deliver carbon reductions in a cost-effective and flexible manner,” the Board’s Chair, Mary D. Nichols further states that California’s 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.”

For more information on this issue, please contact Jared Mueller at jmueller@somachlaw.com.

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