Garrett v. Swanton

This action was instituted in the court below by plaintiffs as taxpayers and residents of the city of Santa Cruz. Plaintiffs prayed for a decree directing the delivery into court, for the purpose of cancellation, of a certain contract between the city and Fairbanks, Morse & Co., a corporation; for an injunction preventing the city from making any further payments under the contract, and preventing the defendant city officials from auditing, allowing or approving any demand or claim based thereon; and for a decree requiring the defendants to repay to the city the sum of $30,000 already paid under the contract. Subsequently the plaintiffs filed an amendment to the complaint, which amendment merely set out with more . particularity the transaction which is the basis of this suit. Defendants demurred generally and specially, which

Appellants’ main contention is that the contract in question violates article XI, section 18, of the state Constitution. In this contention they are assisted by several amici curiae. So far as pertinent here, article XI, section 18, provides:

"No county, city, town, township, board of education, or school district, shall incur any indebtedness or liability in any manner, or for any purpose, exceeding in any year the income and revenue provided for such year, without the assent of two-thirds of the qualified electors thereof, voting at an election to be held for that purpose.”

It is alleged by the plaintiffs that the contract here involved creates an indebtedness or liability in excess of that allowed by the above provision, and that the incurring of such indebtedness or liability was not authorized by a vote of the electors of Santa Cruz. It is admitted by respondents that no such election was had.

The contract in question is pleaded as an exhibit to the complaint, and provides that the respondent Fairbanks, Morse & Co. agrees to install a pumping plant for the city at a total cost of $152,960. The complaint alleges that at the time this contract was entered into the city already owned and operated a water system plant supplying water to the inhabitants of the city; that this, water distributing system was acquired by the sale of bonds; that the amount of the bonded indebtedness of the city incurred for the purpose of acquiring and maintaining this water system now outstanding is $555,000; that said outstanding indebtedness constitutes a general obligation of the city. It appears from the complaint that in March, 1928, the city council of Santa Cruz by resolution indorsed a plan to acquire a pumping plant to be operated in connection with the existing distributing system. On April 30, 1928, pursuant to a resolution of the council, the city clerk advertised for bids for the pumping plant, said plant to be constructed in accordance with the plans and specifications furnished by

The contract also provides that the title and ownership of the machinery and materials installed shall remain in the company and shall retain their character as personal property, until all installments have been paid. It is then provided that “in the event of a breach of any of the terms and provisions herein contained on the part of said

The contract above outlined was accepted by the city council on May 14, 1928. On the same day the council determined by resolution that the installation of the pumping plant was an emergency measure for the reason that the existing plant was inadequate. Later the city desired to change the location of the pumping plant. Fairbanks, Morse & Co. agreed to the change providing that the city at its own cost would agree to bear certain expenses connected with the change. This the city agreed to do.

On May 21, 1928, Fairbanks, Morse & Co. presented its claim for $30,000 as and for the cash down payment provided for in the contract. This claim was approved and paid the same day. On May 28, 1928, plaintiffs demanded that the money be repaid, and demanded that the city immediately sue to recover the same. The defendants refused to comply with this request. The original complaint alleges that this sum of $30,000 was paid “out of the public funds of said city of Santa Cruz.”

Plaintiffs also plead the provisions of Ordinance No. 1287 of the city passed by the council and approved by popular vote in 1923. This ordinance provides that “the rents, income, and receipts from the water system of the said city shall be used solely and exclusively for the operation, maintenance, construction, improvement, extension, enlargement and upkeep thereof and for the payment and liquidation of the principal and interest of any bonded indebtedness now existing, or which may be hereafter created for the operation, maintenance, construction, improvement, extension, enlargement or upkeep of said water system”.

On information and belief plaintiffs allege that the necessary and requisite expenditures of the city for the fiscal year from July 1, 1927, to July 1, 1928, inclusive of the total obligation of this contract, exceed the income and

Essentially the transaction above outlined presents a situation where the city agrees to purchase certain machinery on the conditional sales plan, title to remain in the seller until paid for, and agrees to pay for the same, part in cash and the balance in installments over a period of years, out of a special fund, which fund is created not only by the profits from the property purchased, but contains also the profits earned by the entire water plant of the city. Can a city, when the total amount of such a purchase exceeds its income, enter into such a contract without submitting the same to a vote of the people ? Appellants urge that such a contract violates the constitutional provision above quoted.

Appellants take the position that when the agreement with Fairbanks, Morse & Co. was entered into on May 14, 1928, an immediate liability for the full amount of the contract price—$152,960—came into existence, and that such liability was a general obligation of the city. There can be no doubt that immediately upon entering into the contract a liability arose for the full purchase price. The law is well settled in this state that installment contracts of any bind, where the installment payments are to be made over a period of years and are to be paid out of the ordinary revenue and income of a city, where each installment is not in payment of the consideration furnished that year, and the total amount of said installments when coupled with the other expenditures exceeds the yearly income, are violative of the constitutional provision in question unless approved by a popular vote. This is so whether the contract be denominated a mortgage, lease, or conditional sale. (Chester v. Carmichael, 187 Cal. 287 [ 201 Pac. 925 ]; In re City and County of San Francisco, 195 Cal. 426 [ 233 Pac. 965 ]; Mahoney v. San Francisco, 201 Cal. 248 [ 257 Pac. 49 ].) It is true that under the doctrine enunciated in McBean v. City of Fresno, 112 Cal. 159 [ 53 Am. St. Rep. 191 , 31 L. R. A. 794 , 44 Pac. 358 ], Smilie v. Fresno County, 112 Cal. 311 [ 44 Pac. 556 ], Poland v. Clark, 143 Cal. 176 [ 76 Pac. 958 ], California Pacific Title & Trust Co. v. Boyle, 209 Cal. 398 [ 287 Pac. 968 ], contracts for the furnishing of property in the future have been upheld, but only where

It is the contention of respondents that since by the terms of this contract the indebtedness or liability is made payable solely out of a specified fund created entirely from the income of the water system, and is not a general obligation of the city, the constitutional provision has not been violated. This so-called “special fund” doctrine finds ample support in the decisions of other jurisdictions where constitutional debt limit provisions similar to the one here involved, exist. It seems to be the majority rule in other jurisdictions that a limitation upon municipal indebtedness is not violated by an obligation which is payable out of a special fund, if the municipality is not liable to pay the same out of its general funds should the special fund prove to be insufficient, and the transaction by which the indebtedness is incurred cannot in any event deplete the resources of

The recent decisions of this court would seem to leave no room for doubt that the “special fund” doctrine has been adopted in this state. In Shelton v. City of Los Angeles, 206 Cal. 544 [ 275 Pac. 421 ], a taxpayer sought to enjoin the city of Los Angeles and the board of water and power commissioners from proceeding with the issuance of certain short-term notes on the ground that the issuance of the notes Avould violate the constitutional provision here involved. This court held that the constitutional provision was not violated because the notes were not a general obligation of the city, directly or indirectly, but were payable solely and entirely from a special fund. The position taken in the Shelton case has been recently affirmed in the case of In re California Toll Bridge Authority, 212 Cal. 298 [ 298 Pac. 485 ]. In that case not only was the Shelton case directly affirmed, but at page 302 the court stated: ‘ ‘ The overwhelming weight of judicial opinion in this country is to the effect that bonds, or other forms of obligation issued by states, cities, counties, political subdivisions, or public agencies by legislative sanction and authority, if such particular bonds or obligations are secured by and payable only from the revenues to be realized from a particular utility or property, acquired Avith the proceeds of the bonds or obligations, do not constitute debts of the particular state, political subdivision, or public agency issuing them, Avit.hin the definiton of ‘debts’ as used in the constitutional pro

It therefore follows that if the contract here involved comes within the limits of the “special fund” doctrine it does not violate the debt limit provision of the state Constitution. In order to determine this question it is necessary to determine the exact limits and extent of that doctrine. On this phase of the question the decisions of the courts of this state offer no assistance, but in other states this phase of the problem has been frequently considered. An examination of the cases from other jurisdictions establishes the fact that there are at least two well-settled limitations or exceptions to the “special fund” doctrine. Thus it is well established that an indebtedness or liability is incurred when by the terms of the transaction, a municipality is obligated directly or indirectly to feed the special fund from general or other revenues in addition to those arising solely from the specific improvement contemplated. It also seems to be well settled, as a second limitation to the doctrine, that a municipality incurs an indebtedness or liability when by the terms of the transaction the municipality may suffer a loss if the special fund is insufficient to pay the obligation incurred.

Appellants and amici curiae urge that the contract here involved comes within either or both of these exceptions or limitations. With this contention we are. inclined to agree. It is to be noted that the complaint alleges that before this contract was entered into the City of Santa Cruz owned its waterworks system, acquired with money raised from the sale of its own bonds. For a history of the method by which this waterworks system was acquired see City of Santa Cruz v. Wykes, 202 Fed. 357 ; Waite v. Santa Cruz, 184 U. S. 302 [ 46 L. Ed. 552 , 22 Sup. Ct. Rep. 327 ]. The complaint alleges that part of the bonds by which the waterworks system was acquired are still outstanding, and that such bonds constitute a general obligation of the city. All moneys collected from the operation of the waterworks system are placed in the water development fund. By the terms of Ordinance No. 1287, above quoted, such fund is to be used solely and exclusively for the “operation, maintenance, construction, improvement, extension, enlargement and upkeep” of the water system and for the pay

A case very similar to the instant case, likewise involving a Fairbanks, Morse & Go. contract, has been recently decided by the circuit court of appeals, eighth circuit,—City of Campbell, Mo., v. Arkansas-Missouri Power Co., 55 Fed. (2d) 560. In that ease the action was brought to enjoin the city and Fairbanks, Morse & Co. from carrying out the provisions of a contract for the purchase of certain machinery to be used by the city as a part of its municipal light plant. It appears that at the time the contract was entered into the city, by means of a bond issue approved by the people,

“The contract in question requires the use of the earnings of the entire property. In Bell v. City of Fayette, supra, the court said: ‘It will be noted that the distinction is whether any other property of the city is liable for the payments or whether the purchase price of such improvement is to be paid for wholly out of the earnings of the improvement. ’

“Notwithstanding the skillful attempt to evade the constitutional inhibition against the creation of indebtedness, we think it clear that the subterfuge resorted to does not have that effect, and that the lower court properly held that the contract was void.”

The reasoning of the Supreme Court of Illinois in the ease of Schnell v. City of Roch Island, 232 Ill. 89 [ 14 L. R. A. (N. S.) 874 , 83 N. E. 462 ], is also applicable here. In that case the court stated: “In this case the entire proceeds of the existing waterworks system were pledged to secure payment of the certificates, and they created an indebtedness against the city. The case is not like that of Village of East Moline v. Pope, 224 Ill. 386 [ 79 N. E. 587 ], where the scheme was to erect and establish a new system of waterworks. It was there said, in accordance with the principles of City of Joliet v. Alexander, 194 Ill. 457 [ 62 N. E. 861 ], that if nothing but the income from the waterworks had been pledged, or could be reached, the bonds would not create a debt, and in that case relief was granted because of the provision for a special tax. A city may acquire a system of waterworks by pledging the income until it shall pay for the system, and no indebtedness is created. The same rule might apply to some definite extension of waterworks where the income of the extension could be separated and applied to payment, but an obligation to pay with the income of the property already owned by a city is not different from an obligation to pay with any other funds, so far as the question whether the transaction amounts to a debt is concerned.”

The logic of these cases, and of the cases cited by the Federal Circuit Court, seems unescapable. The contract here involved is not payable solely from the income of the

The respondents attempt to distinguish the eases above cited on the ground that in the above cases it does not appear that there was a city ordinance similar to Ordinance No. 1287 of the City of Santa Cruz requiring that all the revenue of the water plant must go into the water development fund which can only be used for the maintenance, upkeep, construction and repair of the water plant. The argument proves too much. By the very terms of the ordinance relied upon, as above quoted, the revenue from the water plant is likewise to be used to pay the interest and principal on the bonds, which are general obligations of the city. If this fund is depleted the obligation to feed the fund will fall upon the taxpayer. Respondents state: “The money in the special fund cannot be placed in the general fund, nor used for charges to be met from tax-raised funds. ’ ’ Such a contention is directly in the face of the terms of the ordinance relied on by respondents, because that ordinance specifically states that the money in the water fund shall be used to pay a general obligation of the city, namely, the interest and principal on the bonds.

For still another reason we are of the opinion that the contract here involved must be held violative of the constitutional provision. It will be remembered that the contract provides for an immediate cash payment of $30,000, which was paid according to the allegations of the complaint, “out of the public funds of said city of Santa Cruz”. This positive allegation may have been weakened by the amendment to the complaint, although we do not think that this is so, but certainly there was nothing in the contract which required the city to make this payment from the water fund. The city also agreed to pay the taxes and insurance on the property, and to pay certain expenses caused by the change in the location of the pumping plant, all apparently out of the general funds. It is true that when these payments were made, and probably when the future payments are made for each item, such payments themselves will not constitute a violation of the constitutional provision.

Inasmuch as we are of the opinion that the contract involved violates the constitutional provision, we do not find it necessary to discuss the many other points raised and discussed by the litigants.

For the reasons heretofore stated the judgment appealed from is reversed.

Rehearing denied.