I have received many comments and questions on my earlier post about California Mutual Water Company Basics. In order to protect the privacy of questioners, I have responded to most individually rather than on this blog. In the belief that there may be value in providing answers to some of the most frequently asked questions here, this post elaborates on a few issues regarding mutual water companies.
On what matters of corporate management do mutual water company shareholders get to vote? Mutual water companies are governed like other corporations. In fact, mutuals are not formed according to special provisions of the California Corporations Code, but are normally formed as either general corporations or nonprofit mutual benefit corporations as may be appropriate under the circumstances. Corporate governance rules dictate that the shareholders or members of a corporation normally only vote in the election of directors, and the board of directors has the authority and obligation for all day-to-day management of the company. Day-to-day management includes water resources management, personnel decisions, capital improvements, financing and water rates. There are limited exceptions, such as the sale of substantially all assets and dissolution of the corporation, but these occur rarely in the life of a company. Instead of voting, a shareholder who wishes to change company management must seek to participate in the governance process, most notably through influencing the board of directors. In a well-run mutual, directors should always be available to discuss operations of the company with shareholders. If the directors are not responsive to the needs of shareholders, there is a process for removal of one or more directors. Note that the first place to look for internal governance rules is the articles and bylaws of each mutual.
Can a mutual lease shares to non-shareholders? Absent a contrary rule in its articles or bylaws, a mutual may deliver water to lessees of either shares or property to which shares are appurtenant. A mutual must be very careful about such deliveries, though, so that it is clear the mutual is not delivering or offering to deliver water to the public, with shares as a façade. A mutual is required to collect and maintain copies of all leases of shares or property in case a court or the California Public Utilities Commission (CPUC) asks to inspect the mutual’s records. If a mutual is going to deliver water to lessees, I recommend having the board of directors draft and diligently apply an official policy, with review by a knowledgeable attorney.
How does a developer turn over control for a mutual formed as part of a land subdivision? When a developer forms a mutual water company as part of a land subdivision, the developer may continue to control the mutual as long as lots remain unsold. This rule was established so that a developer does not become hostage to a poorly run mutual in the sale of final lots. However, if the sale of lots is taking an unreasonable amount of time, the developer should turn over control to the mutual shareholders on such reasonable terms and conditions as needed to protect the developer’s economic interests. This can be a difficult process, and the best solution will vary widely based on the number of lots, the relative experience and expertise of the developer and shareholders, and many other factors. In a well-planned mutual, there will be a control agreement between the developer and the mutual with terms related to the transition of control, including a time limit on developer control. While there is no hard and fast rule, generally speaking a developer should be able to cede control within five years, and in many cases much earlier.
What does “at cost” mean for operation of a mutual water company? The concept of operation “at cost” is part of the test for exemption of a mutual water company from CPUC jurisdiction. Nonprofit operation is part of the basic notion of a mutual being truly “mutual” in character, as opposed to a profit-seeking business. In practice, however, mutuals have great leeway regarding what constitutes “at cost” operation. For example, a mutual may determine its own revenue requirements and design its own rate structure, including stand-by, fixed service and commodity charges. A mutual may collect and build reserves, at levels determined in the discretion of the board of directors. A mutual may take actions to encourage water conservation, including the development of conservation pricing, with increasing block rates. A mutual may enter into an agreement to transfer water to non-shareholders at different rates than are charged to shareholders, although such transactions must be carefully structured. In order to determine whether a mutual is being operated at cost, all these revenues must be compared to company expenses (including taxes and depreciation, if any). As long as a mutual is actually delivering water to its shareholders on a regular basis and does not pay any dividends, it probably will not fun afoul of the requirement to operate at cost. As always, though, the outcome in any particular case will depend on the totality of the circumstances, which I cannot address here.
I hope the FAQs above are useful to some of my readers. If you have questions that are not answered here, or are specific to your mutual water company, please contact me.