I have written several posts about mutual water companies in California and continue to see a lot of interest in the topic from readers. This post describes a recent court decision regarding the method of allocating water supplies within a mutual water company in Ventura County, in the case of De Boni Corporation v. Del Norte Water Company, 200 Cal.App.4th 1163 (2011).
Del Norte Water Company (DNWC) was founded in 1910 as a mutual water company with a service area located in the Somis area of Ventura County. It provides water to its shareholders for both domestic and irrigation uses, although unlike some mutual water companies serving both purposes, there is a single class of shares. Shares of the company are not appurtenant to specific lands, but are freely transferable to support water use within the company’s service area. The DNWC articles and bylaws provide that the primary purpose of the company is to supply domestic water, and a shareholder may only request irrigation water if he or she owns more than a threshold number of shares, which is set at 1 share for every 3 acres north of a defined grant line, or 1 share for every 5 acres south of the grant line. In the event of a water shortage, irrigation water is allocated in proportion to the number of shares that each shareholder holds above the threshold requirement. Thus, if a shareholder desires more water, he or she may purchase additional shares above the domestic threshold.
Plaintiff De Boni Corporation is a shareholder in DNWC, and the De Boni family have been shareholders since 1913. During the recent dry period from 2007 through 2009, De Boni filed a complaint for declaratory relief, claiming that the DNWC water allocation scheme violated California Corporations Code § 400, which provides that a corporation may not discriminate between shares of the same class. De Boni argued that the allocation scheme creates a de facto classification of shares as either domestic or irrigation in a manner not authorized in the articles of incorporation.
The trial court held, and the appellate court affirmed, that the plaintiff’s argument failed for two reasons. First, the DNWC was formed prior to the adoption of § 400, so that provision does not apply to the company. Former California Civil Code § 290, the statute that was in effect at the time of incorporation, allowed for the classification of capital stock, consistent with a company’s articles of incorporation. The DNWC articles provide the basis for the company’s water allocation scheme and include the critical element of dividing water supplies proportionally based on the number of shares held by each shareholder in excess of those required for domestic water service. Second, the court noted that the water allocation scheme treats every share and every shareholder equally, in that all are subject to the same threshold system. That conclusion would seem to apply to a mutual water company formed after the effective date of § 400 (January 1, 1977), as well as one formed under former § 290. (The plaintiff did not argue, and the court did not address, the differential treatment of properties north and south of the grant line.)
This case is interesting as an example of how one mutual water company allocates its water supplies in times of shortage, and how that allocation scheme fared in response to challenge by a shareholder. Of course, another mutual does not need to use the DNWC water allocation scheme, and may establish its own allocation method through its articles, bylaws and rules and regulations. Mutuals are generally free to determine the rules by which they will operate internally, and the courts will not interfere. As the court pointed out in this case, mutual water company articles and bylaws may be characterized as a contract between and among the corporation and its shareholders. A court cannot change a water allocation scheme to benefit one shareholder without adversely affecting other shareholders. Courts are generally reticent to interfere in the internal operations of a company, as long as the company exercises its discretion in a fair and reasonable manner. A well-run mutual need not be overly concerned about judicial modification of its water allocation scheme.