Thursday, December 26, 2013

2014 Legislative Preview: Shareholders' Rights Legislation

The following article was written by Craig Smith, one of my partners at Smith Hartvigsen, PLLC, for the Water & The Law newsletter that our firm publishes on a quarterly basis. If you would like to receive an email version of the newsletter, please click here to join our mailing list.

The very controversial water issue, the rights of shareholders of nonprofit water companies, will be back before the Utah Legislature in 2014. The 2013 legislation sparked a lively debate during the session which ended in a deadlock with the House approving the legislation and Senate not acting as the session ended. In legislative parlance, the 2013 shareholder rights legislation "died on the board." Rep. Kay McIff (R-Richfield) has now prepared a new version of his 2013 shareholder rights legislation and plans or introducing it during the 2014 legislation session.

Historically, nonprofit water companies came into being when individual farmers determined that they needed to band together to construct the water diversion and distribution facilities necessary to irrigate their farms. For decades, this commonality of interest (e.g., common facilities to deliver water for a common use) bound these companies together. After construction, these facilities needed to be operated and maintained. The water rights themselves were put in the name of the company and individual ownership of and right to use the water was represented by shares of stock in the nonprofit mutual water company.

As irrigated fields began to make way for subdivisions, this commonality of interest began to wane. Shareholders who sold their farms to developers sold their water shares as well. Cities began to either require dedication of or purchased shares and then filed change applications to move irrigation water to municipal sources and uses. In 1993, this practice led to the Utah Supreme Court ruling in East Jordan Irrigation Company v Morgan, commonly known as "the East Jordan Case."

The Utah Supreme Court ruled that shareholders of mutual irrigation companies could no longer file change applications based on their shares. The Supreme Court reversed the long standing practice of the State Engineer and held that only the company, as the holder of the water right, could file an application to change the point of diversion, place of use, nature of use or season of use of a water right.

Although the East Jordan Case stated that companies needed to reasonably consider requests from shareholders to file a change application, "reasonable" wasn't defined and some companies began to either refuse to consider change application requests or to impose conditions such as requiring approval of a super majority of all other shareholders.   In 2002, after a two year effort, then Senate President Leonard Blackham (R-Sanpete) obtained passage of what is now found in Utah Code section 73-3-3.5, the first legislation to define shareholder rights in the context of a shareholder initiated change application. While many argue that Section 73-3-3.5 works well, others disagree.
Rep. McIff's current legislation seeks to provide additional rights and protections for shareholders. According to Rep. McIff, who is a lawyer and former judge, his legislation has ten objectives:
1.  Retain the historical qualification that "a person entitled to use of water" may file a change application.
2.  Require a shareholder change application be submitted to the water company for its response before filing with the state engineer.
3.  Require a water company response within 60 days so that all the issues are on the table as early as possible.
4.  Eliminate stonewalling by the water company and the necessity of front end litigation by a shareholder just to obtain the right to file the change application.
5.  Maximize the opportunity for dispute resolution, including relying on mediation to resolve or refine the issues before administrative review of litigation.
6.  Allow either the water company or the shareholder to seek advance court resolution of legal issues (e.g., corporate issues) not within the purview of the state engineer.
7.  Foster the state engineer's gate-keeping role and facilitate getting the water issues before the state engineer as soon as practical.
8.  Provide more practical compensation options for water companies when water is removed from a delivery system, and equalize the remedies if either side is unreasonable.
9.  Allow a shareholder to elect whether or not to participate in the sale of water or an underlying water right proposed by the water company.
10.  Continue to allow denovo judicial review of the state engineer's final decision.

Whether or not Rep McIff's legislation or some derivation thereof passes in 2014 is anyone's guess, but with the continued conversion of farms to subdivisions, this issue will not soon fade away.

To read the full text of the proposed legislation (House Bill 49), click here.
Update: First Substitute House Bill 49 has been introduced. To see the differences between the original bill and the first substitute bill, click here.