Municipalities charge fees for the use of utilities, including water, sewer, and electricity. Generally the purpose of the fees is to provide funds for the municipality to use to operate, maintain, and eventually improve the utility system. Challenges to utility fees or rates are becoming more common. In particular, class actions challenging utility rates have increased, especially in Eastern Michigan. Generally, the goal of these challenges is for the municipality to refund all or a majority of the fees it charged to the system users. If the challenge is a class action, this could involve hundreds of thousands or even millions of dollars.
Utility Fees and the Headlee Amendment
A common challenge to utility fees is that the fees are actually disguised taxes that are designed to avoid the requirements of the Headlee Amendment, Const 1963, art 9, § 31. Under that constitutional provision, a local unit of government may not levy a new tax, or increase the rate of an existing tax, without the approval of the majority of the electors in that unit of local government, unless such tax or rate was authorized by law at the time of the Headlee Amendment’s ratification in 1978. Cities and villages are generally prohibited by statute from levying taxes, other than ad valorem property taxes, unless the tax was being imposed by the city or village on January 1, 1964. MCL 141.91. If utility fees are actually taxes, they may violate the Headlee Amendment or MCL 141.91.
The Michigan Supreme Court addressed this issue in Bolt v City of Lansing, 459 Mich 152; 587 NW2d 264 (1998). In Bolt, the Court considered whether Lansing’s storm water service charge was a valid user fee or a tax that violated the Headlee Amendment. The Bolt Court outlined three criteria to determine whether a charge was a user fee or a tax: 1) a user fee must serve a regulatory purpose and not a revenue-raising purpose; 2) user fees must be proportionate to the necessary cost of the service; and 3) a user fee is voluntary.
It is important that municipal officials understand the Bolt factors and are able to determine which charges are permissible user fees and which charges are taxes that must be approved by the voters.
Regulatory Purpose and Proportionality Under Bolt
The first two factors in Bolt are often considered together. A charge will be upheld as a fee if it is intended to be a police regulation and is not primarily for raising revenue. Any revenue that the charge raises must be proportionate with the cost of the service that is provided.
If an ordinance does not have a “significant element of regulation” it is more likely that a court would conclude it is a tax. Ordinances with user fees should include regulations relevant to the utility, and should not only include charges.
The revenue must be proportional because user fees are intended to benefit the people and entities paying the charge, and not for the general benefit of the public. If the charge is not proportional to the cost of the service, that is evidence that the municipality does not intend for the charge to benefit a particular class that uses the service, but intends to benefit the general public. The stated goal of the ordinance matters as well. In Bolt, the goal of the ordinance was to address environmental concerns over the water quality in the area. The Court stated that was evidence that the storm water service charge was intended by the city to benefit the general public instead of just the property owners who had to pay the charge.
Sometimes it is clear that a charge is not proportionate to the actual cost of the service. For example, the Michigan Court of Appeals concluded that a $7,500 water connection charge was not proportionate when the actual cost to connect the properties to the water system was approximately $800. Grunow v Frankenmuth Twp, unpublished opinion of the Michigan Court of Appeals, issued October 22, 2002 (Docket No 226094).
Voluntariness Under Bolt
Although a user fee must be “voluntary,” this does not mean that a user must have the option to refuse to pay for using the municipal water system. Under Bolt, a user fee is voluntary when the payments of user fees are only required for those who use the service and if the users can choose how much of the service they want to use or whether they want to use it at all.
In contrast, taxes are compulsory and users cannot decide whether or not they will pay the tax. For example, in Bolt an annual storm water service charge was not voluntary because it was charged on any real property in Lansing that had storm water runoff (including all properties with buildings). Landowners cannot control whether or not they have storm water runoff, and therefore the Bolt Court concluded that the charge was not voluntary.
Bolt is a Totality of the Circumstances Test
A charge does not have to meet all three requirements in Bolt to be a user fee. The Bolt test is a balancing test, with the factors considered together, and as one court noted, “a weakness in one area would not necessarily mandate a finding that the charge at issue is not a fee.” Graham v Kochville Twp, 236 Mich App 141, 151; 599 NW2d 793 (1999). Courts can also consider other factors. In Bolt, the Court noted that the fact that the water service charge was secured by a lien was relevant, and that the storm water service charge was billed through the city assessor’s office with the property tax statements.
Equitable Challenges to Utility Fees
Challengers do not only raise Bolt claims. They may also raise equitable challenges to utility fees, such as arguing that the fees amount to unjust enrichment. The basic elements of a claim of unjust enrichment are: 1) the receipt of a benefit by the defendant from the plaintiff(s) and 2) inequitable retention of the benefit by the defendant. Morris Pumps v Centerline Piping Inc, 273 Mich App 187, 195; 729 NW2d 898 (2006).
In the public utility context, a municipality obtains a benefit from the users because the users pay various charges. The issue is whether the municipality is unjustly or inequitably retaining the funds. Whether a municipality received an unjust benefit from retaining charges depends on whether the rates, “viewed as a whole, were unreasonable insamuch as they were excessive, not on whether some aspect of the [municipality’s] ratemaking ideology was improper.” Youmans v Charter Twp of Bloomfield, 336 Mich App 161, 219; 969 NW2d 570 (2021). If the municipality’s rates are excessive, then they may be required to refund utility fees to users under the theory of unjust enrichment. This is another reason why municipalities must make sure that utility fees are proportional to the actual cost of the service.
It is also important to remember that the municipality collects utility fees to provide for the operation and maintenance of that utility. Municipalities should keep utility fees separate and not transfer them to the general fund or to any other funds. Utility fees should not be used for other purposes. Other practices, such as lending utility funds for another use, have not been addressed by the courts, but are risky.
Challenges Based on the Municipalities’ Ordinance and Policies
Municipal officials should be familiar with the provisions in their own ordinances regarding public utility fees. Users may also challenge fees if they feel that the municipality is not following its own ordinances or policies. If a municipality is not imposing or administering fees in accordance with its established policies, then a challenge is more likely to be upheld. Municipalities should be careful to make sure that the employees that are administering utility fees are familiar with the relevant ordinance and policies.
Municipal government officials are encouraged to contact Mika Meyers for any assistance, legal advice, or additional information regarding challenges to public utility rates.