Saturday, August 30, 2014

Southam v. South Despain Ditch Company

Yesterday the Utah Supreme Court issued its ruling in the case of Southam v. South Despain Ditch Company.  This case could have significant impact on how water companies are allowed to regulate and limit share transfers.

This case originates with a share transfer between Jordan School District and Southam's predecessor-in-interest.  South Despain's bylaws include restrictions on share transfers, including requirements that (1) South Despain's board of directors must approve all share transfers; (2) a person cannot acquire shares unless they can connect to South Despain's system; and (3) the shares must be sold for a fixed amount of $1,100 per share.  The school district had 23 shares that it no longer needed, and despite being reminded by South Despain of the share transfer restrictions, the school district held a sealed-bid auction for the 23 shares.  Two water brokers won the auction with a bid of $1,945 per share.  When the purchasers went to South Despain after the sale, South Despain refused to issue the new certificates to them or to recognize them as shareholders in the company. 

This lawsuit ensued.  During the course of the litigation, Mr. Southam acquired the water brokers' interest in the shares.  The district court ruled in favor of South Despain, and Mr. Southam appealed the decision to the Utah Supreme Court. 

in reaching its decision, the Supreme Court relied primarily on a statute contained in the Utah Revised Nonprofit Corporation Act, which provides that "[u]nless otherwise provided by the bylaws, a member of a nonprofit corporation may not transfer (a) a membership; or (b) any right arising from a membership."  Because this statute provides that shares in a nonprofit corporation are not generally transferrable unless the bylaws allow share transfers, the Court concluded that restrictions on transfers are not prohibited.  Based on this conclusion, the Court summarily dismissed Mr. Southam's arguments that prohibitions on share transfers contradict state policies of beneficial use of water and that prohibitions on share transfers violate the common law presumption against rules restricting the alienation of real property.  Ultimately, the Supreme Court upheld the district court and held that South Despain's restrictions on share transfers are enforceable.

The Court's decision raises issues of concern.  For example, the Court's decision seems to signal that water companies can place any restrictions on share transfers, regardless of whether they are legitimate and rational or arbitrary and irrational.  Additionally, as pointed out by Mr. Southam, restrictions on share transfers can conflict with principles of free alienation of property and beneficial use of water.  Finally, restrictions on share transfers could hamper efforts to put the limited resource of water to its highest and best use.  It will be interesting to see if this decision triggers any legislative action during the next session of the Utah Legislature.

To read the full text of the court opinion, click here.