‘Franchise Fee’ Imposed By City And Utility Company An Illegal Tax On Residents
A utility company’s “franchise fee” was an “unauthorized tax” that violated the Michigan Constitution and, as a result, the utility company could not collect the fee from its customers and then remit the collected fees to the City of East Lansing, the Michigan Supreme Court has ruled.
In Heos v City of East Lansing (Docket No. 165763), the City of East Lansing (the City) and the Lansing Board of Water and Light (LBWL) entered into an agreement under which LBWL consumers who resided within the city were charged a “franchise fee.” In turn, LBWL was required to remit the collected franchise fees to the City.
The plaintiff, James Heos, is a City of East Lansing resident. He sued the City, claiming, among other things, that the franchise fee was a new local tax that violated the Headlee Amendment in Article 9, §31, of the Michigan Constitution. The Headlee Amendment limits the amount that property taxes may be increased and requires local governments to allow a public vote on any new taxes or tax increases.
The Ingham County Circuit Court granted the plaintiff’s motion for partial summary disposition, finding he was indeed a taxpayer because he was responsible for paying the franchise fee. The trial court also held the franchise fee violated the Headlee Amendment because it constituted a tax that had not been approved by a majority of the City’s voters. The trial court denied the City’s motion for summary disposition as to all the plaintiff’s claims, except his equal protection claim.
Both parties appealed and the cases were consolidated. The Michigan Court of Appeals, in a 2023 unpublished opinion (Docket Nos. 361105 and 361138), reversed the trial court and remanded the case for entry of an order granting the City’s motion for summary disposition on all counts. According to the Court of Appeals, its decision in Morgan v Grand Rapids, 267 Mich App 513 (2005), controlled and, regardless of whether the fee was a tax, the plaintiff was not a taxpayer but instead was member of the public, and therefore his claim was time-barred by the Headlee Amendment’s one-year limitations period in MCL 600.308a(3).
The plaintiff appealed. The Michigan Supreme Court heard oral arguments on whether to grant the plaintiff’s application for leave to appeal and, instead of granting leave, the justices issued a 31-page opinion reversing the Court of Appeals.
“[T]here is no question that the fee would be an illegal tax if the City imposed the charge directly on its residents,” the Michigan Supreme Court wrote. “The issue therefore is whether a municipality may circumvent the Headlee Amendment by enlisting a cooperative nongovernmental entity to accept the imposition of a franchise fee with the express understanding that the entity would, in turn, collect the franchise fee from would-be taxpayers and remit the revenue collected to the municipality. We hold that such an arrangement violates the Headlee Amendment because the purported ‘fee’ operates as a tax that has not been approved by the voters of the municipality.”
Justice Brian K. Zahra wrote the opinion, joined by Justice Megan K. Cavanagh, Justice Elizabeth M. Welch and Justice Kyra H. Bolden. Chief Justice Elizabeth T. Clement did not participate because of a potential conflict of interest. Justice Kimberly A. Thomas did not participate because the high court considered the case before she took office.
Justice Richard H. Bernstein concurred in part and dissented in part. “I join the majority opinion to the extent that it concludes that the franchise fee at issue is a tax,” he wrote. “However, I disagree with the majority’s conclusion that plaintiff James Heos is a taxpayer, and I dissent in this regard. I would hold that because plaintiff was not a taxpayer, his claims are time-barred under MCL 600.308a(3). I would therefore affirm the Court of Appeals’ holding granting summary disposition in favor of defendant, the city of East Lansing ….”
Background
Consumers Energy and LBWL are authorized to provide electrical services through franchise agreements with the City. When the City began experiencing budget shortfalls in its retirement system in 2016, the city manager indicated this problem could be resolved, in part, by imposing franchise fees on the LBWL.
Despite concerns by LBWL that the fee may violate the Headlee Amendment, the City negotiated a new franchise agreement with the LBWL that was finalized in 2017. In relevant part, the franchise agreement required that:
LBWL would collect the franchise fees, which were calculated at a rate of 5 percent of the revenue collected from the sale of energy, from its consumers and remit those fees to the City, but if LBWL was precluded from collecting the fees, remittance to the City would stop.
the franchise fee would appear on the consumers’ energy bills.
the City would at all times keep and save LBWL harmless from any loss associated with the franchise fee.
LBWL would receive a 0.5 percent administrative fee from the City in exchange for collecting the fee.
The LBWL was to pay the 5 percent franchise fee to the City for the use of the City’s streets, public places and other facilities. The fee, however, did not correspond with any costs the City incurred as a result of LBWL providing electrical services. Rather, the amount was chosen to align with similar rates charged in other communities. The East Lansing City Council eventually approved and enacted by ordinance the franchise agreement between the City and LBWL. The ordinance was never approved by a majority of the City’s voters.
Thereafter, LBWL remitted the franchise fees to the City under the agreement at a rate of about $1.4 million per year. The City placed the fees in the “general fund,” which allowed the City to use the funds for any purpose.
‘Bolt’ Factors Applied
In reversing the Court of Appeals decision, the Michigan Supreme Court looked to the factors in Bolt v City of Lansing, 459 Mich 152 (1998). Those criteria are:
A user fee must serve a regulatory purpose rather than a revenue-raising purpose.
A user fee must be proportionate to the necessary costs of the service and correspond to any benefit conferred by the service.
A user fee must be for a commodity or service voluntarily used.
“Analyzing the present case through the Bolt framework, we conclude that the franchise fee is a tax because (1) the fee is used for a general revenue-raising purpose, (2) the fee is not proportionate to any costs incurred by the City for LBWL providing electrical services, and (3) the fee is not voluntary,” the high court said.
“First, it is clear that the franchise fee was used for a general revenue-raising purpose,” the justices noted. “LBWL has remitted this franchise fee to the City at a rate of about $1.4 million per year. This revenue does not correspond with consumer-specific benefits the City provides relating to LBWL’s supply of electrical services. In fact, the City provides no benefit, through electricity or otherwise, specific to plaintiff in exchange for payment of the franchise fee.”
Further, the franchise fee “was not proportional to the costs the City incurred for granting LBWL the right to provide electrical services to plaintiff,” the Michigan Supreme Court said. “In fact, the franchise fee imposed by the City did not fund and was not collected for the purpose of providing electrical services. Instead, the revenues generated pursuant to this franchise fee were put into the City’s general fund and spent for a variety of purposes unrelated to the provision of any benefit specific to plaintiff. The City has therefore ‘failed to differentiate any particularized benefits to [the payer] from the general benefits conferred on the public.’”
In addition, the franchise fee “was not voluntary,” the high court observed. “If the consumers did not pay the fee, their electricity, which is a basic human need, could have been shut off. Furthermore, plaintiff does not have the ability to contract for electricity with another utility provider. Consumers Energy and LBWL are the only two electric utility providers in the City, and Consumers Energy only services those parts of the City that LBWL does not. Therefore, if an electric utility consumer lives in an area serviced by LBWL and does not want to pay the franchise fee the City requires, the consumer will risk losing electricity. Consequently, plaintiff effectively has no option but to pay this compulsory ‘fee.’”
Therefore, under the Bolt factors, “we conclude that the franchise fee at issue is a tax,” the justices stated. “Because the City’s voters were never offered an opportunity to adopt the Ordinance approving the franchise fee by majority vote, it runs afoul of the Headlee Amendment.”
Taxpayer Or Member Of Public?
Next, the Michigan Supreme Court examined whether the plaintiff was “a taxpayer of the tax or mere member of the public, i.e., whether plaintiff bore the ‘legal incidence’ of the fees from the franchise agreement between the City and LBWL.” The justices noted this question was “significant” because “it determine[d] the point at which plaintiff’s claim accrued, which in turn is critical to whether plaintiff’s claim was brought within Headlee’s statute of limitations.”
To make this determinations, the high court examined Taxpayers for Constitutional Taxation v Wayne County, 450 Mich. 119 (1995), where it was held that taxpayers could bring a Headlee Amendment claim to sue for a refund within one year after the wrongfully imposed tax was due. The decision “clarified that, if a plaintiff is a taxpayer, they may bring a Headlee Amendment claim to recover tax payments within one year after the wrongfully imposed tax is due; however, if a plaintiff is a member of the public, they cannot recover any tax payments that others may have made and Headlee’s one-year limitations period runs from the date the ordinance authorizing the wrongful tax was enacted.”
The Michigan Supreme Court also “compar[ed] and contrast[ed]” the decision in Morgan v Grand Rapids to determine whether a plaintiff is a taxpayer or “mere member of the public.” The Morgan panel held that, because the plaintiff in that case failed to bring her Headlee Amendment claim within one year, her claim was time-barred. Therefore, if the plaintiff in the present case is deemed to be a taxpayer, “his claims are timely” and he “may seek to recover fees assessed and due within one year of the filing of this lawsuit and any subsequent fees,” the high court observed. “However, if plaintiff is only a member of the public, his Headlee Amendment claim is time-barred because he did not commence this action until 2020, three years after the fee was authorized by the Ordinance.”
The Michigan Supreme Court continued by stating the Court of Appeals wrongly found that Morgan controls the present case and by holding the plaintiff is not a taxpayer. “Unlike Morgan, where a federal statute allowed the city to charge a franchise fee on the cable provider and the provider chose to pass the fee on to its customers, the City’s arrangement here is of a different kind. In this case, the City has attempted to enlist LBWL in collecting a disguised tax, and it has done so in violation of the Headlee Amendment. Moreover, the cable provider in Morgan had a legal responsibility to pay the franchise fee. Here, LBWL has no legal responsibility whatsoever to pay the franchise fee to the City.”
But although Morgan is distinguishable, “it provides helpful considerations in determining whether a party is a taxpayer when a pass-through charge is imposed by a local government and collected by a nongovernmental entity (such as the utility),” the justices pointed out. “In Morgan, the Court of Appeals discussed the following considerations: (1) whether the charge obligation falls primarily on the consumer or retailer (i.e., whether the consumer or the utility bears the legal incidence of the charge); (2) whether the local government has any recourse against the consumer for failing to pay the franchise fee; (3) whether the consumer has a contract with the utility or local government; (4) whether the consumer pays the challenged charge to the utility or local government; and (5) whether the local government or utility places the challenged charge on the consumer’s bill. These considerations are also relevant to determining which party is the taxpayer because they examine who is legally responsible to pay the tax as well as the circumstances concerning the payment of the tax.”
Accordingly, “we conclude that plaintiff bears the legal incidence and obligation to pay the franchise fee, and LBWL does not,” the Michigan Supreme Court stated. “Although the City cannot sue plaintiff for failing to pay the franchise fee, plaintiff is responsible for paying this charge in other ways. … It is also clear that plaintiff bears the legal incidence of paying the challenged charge because it is clear that LBWL does not have the obligation of paying the tax. … While noteworthy that plaintiff has a contract that provides for electrical service from LBWL and, per that contract, plaintiff pays the fee to LBWL, it is not material that plaintiff does not pay the fee directly to the City. … To condone a structure whereby a city can outsource taxing power to a third-party contractor as a nongovernmental fee would create a massive loophole in the Headlee Amendment and its constitutional protections. If such a practice were allowed under Headlee, cities could simply contract with nongovernmental agencies such as LBWL, which may be deeply connected to City government, to collect revenue the cities could not otherwise collect themselves.”
Moreover, “the City requires that the challenged fee be placed on the consumer’s bill,” the justices pointed out. “A holistic review of these considerations reveals that plaintiff is the taxpayer of the franchise fee that is collected and remitted to the City. … This is clearly a tax imposed by the City on taxpayers, who are also consumers of LBWL.”
“[W]e hold that the franchise fee is a tax,” the high court concluded. “We further hold that plaintiff is a taxpayer and not a mere member of the public. Accordingly, … plaintiff may bring a Headlee Amendment claim for taxes wrongfully imposed within one year of the filing of this lawsuit.”
Therefore, the justices reversed the Court of Appeals as to whether the plaintiff was a taxpayer and remanded the case to the trial court for further proceedings.
