Davis v. Agua Sierra Resources, L.L.C.

SUPREME COURT OF ARIZONA
En Banc

MERWYN C. DAVIS, Trustee under ) Arizona Supreme Court
the Merwyn C. Davis Trust dated ) No. CV-08-0163-PR
July 27, 1981, )
) Court of Appeals
Plaintiff/Counter-Defendant/ ) Division One
Appellee, ) No. 1 CA-CV 06-0806
)
and )
) Yavapai County
CHINO GRANDE, L.L.C., ) Superior Court
) No. CV 20040716
Plaintiff/Intervenor/Counter- )
Defendant/Appellee, )
)
v. ) O P I N I O N
)
AGUA SIERRA RESOURCES, L.L.C., a )
Texas limited liability company, )
)
Defendant/Counter-Claimant/ )
Appellant, )
)
and )
)
RED DEER CATTLE, INC., a Texas )
corporation; CJ PARTNERS, a )
Nevada limited partnership; and )
SEIBERT FAMILY LIMITED )
PARTNERSHIP, a Nevada limited )
partnership, )
)
Defendants/Appellants. )
__________________________________)

Appeal from the Superior Court in Yavapai County
The Honorable David L. Mackey, Judge
________________________________________________________________

Opinion of the Court of Appeals, Division One
217 Ariz. 386, 174 P.3d 298 (App. 2008)

VACATED AND REMANDED
________________________________________________________________
ROBERT S. LYNCH & ASSOCIATES Phoenix
By Robert S. Lynch

And

ANNA YOUNG PLLC Prescott
By Anna C. Young
Attorneys for Merwyn C. Davis

LEWIS AND ROCA LLP Phoenix
By Dale Danneman
Michael F. McNulty
Robert G. Schaffer
Attorneys for Chino Grande, L.L.C.

GALLAGHER & KENNEDY, P.A. Phoenix
By Michael R. Ross
Cober C. Plucker

And

TOM GALBRAITH ATTORNEY AT LAW Phoenix
By Tom Galbraith
Attorneys for Agua Sierra Resources, L.L.C, Red Deer
Cattle, Inc., CJ Partners, and Seibert Family Limited
Partnership

MAGUIRE & PEARCE, PLLC Phoenix
By Michael J. Pearce
Rita P. Maguire
Attorneys for Amicus Curiae Town of Prescott Valley

ARIZONA DEPARTMENT OF WATER RESOURCES Phoenix
By W. Patrick Schiffer, Chief Counsel
Kenneth C. Slowinski
Scott M. Deeny
Attorneys for Amicus Curiae Arizona Department of Water
Resources

RYLEY CARLOCK & APPLEWHITE Phoenix
By Cynthia M. Chandley
L. William Staudenmaier
Jenny J. Pelton
Attorneys for Amici Curiae Freeport-McMoRan Copper and
Gold, Inc., Roosevelt Water Conservation District, and
the Town of Chino Valley

2
SALMON, LEWIS & WELDON, P.L.C. Phoenix
By M. Byron Lewis
John B. Weldon, Jr.
Mark A. McGinnis
Attorneys for Amicus Curiae Salt River Project
Agricultural Improvement & Power District
________________________________________________________________

B A L E S, Justice

¶ 1 Arizona law allows landowners, outside of Active

Management Areas, to make reasonable and beneficial use of

groundwater underlying their land. This case involves deeds

that purported to reserve to the grantor, and to sever from the

surface estate, rights to the potential future use of

groundwater. Because a landowner has no real property interest

in the future use of groundwater, we hold that the attempted

reservation is invalid.

FACTS AND PROCEDURAL HISTORY

¶ 2 This case concerns land in the Chino Valley in Yavapai

County that is commonly referred to as the CF Ranch. In 1981,

Red Deer Cattle, Inc. (“Red Deer”) bought this land from Chino

Ranch, Inc. (“Chino Ranch”). In its 1981 deed to Red Deer,

Chino Ranch reserved all mineral rights and “commercial water

rights” but did not otherwise retain any ownership interest in

the land. In 1984, Red Deer conveyed the CF Ranch to Merwyn C.

Davis, acting as a trustee for a trust bearing his name.

Similar to the 1981 deed, this deed purported to reserve to the

grantor “all commercial water rights and waters incident and
3
appurtenant to and within the real property,” but provided that

Davis could use water for “ranch, livestock and domestic and

agriculturally related purposes.”

¶ 3 Chino Ranch merged with Red Deer in 1989, thereby

consolidating their respective claims to the commercial water

rights associated with the CF Ranch. Following a series of

conveyances involving third parties, in May 1998, Red Deer and

CJ Partners each conveyed a one-half interest in the commercial

water rights for the CF Ranch to Agua Sierra Resources L.L.C.

(“Agua Sierra”).

¶ 4 In April 2003, Davis granted the City of Prescott an

option to purchase the CF Ranch and the adjacent CV Ranch, as

well as the water rights appurtenant to the two properties, for

$30 million. The option agreement included an addendum stating

that Davis was uncertain about the water rights on the

properties and that his interest “in said water rights may be

unclear, incomplete, inappropriately described, or subject to

challenge.” At the time of the option contract, the properties

appraised at $23 million, of which $18 to $21 million was

attributable to the associated water rights. Accordingly, the

City asked Davis to purchase the water rights so that the City

could acquire them. Because Davis was unable to purchase the

water rights from Agua Sierra, the City allowed the option to

expire.
4
¶ 5 Four months later, Davis filed a complaint against

Agua Sierra, Red Deer, CJ Partners, and the Seibert Family

Limited Partnership (collectively, the “Agua Sierra parties”),

seeking to invalidate the commercial water rights reservations

associated with the CF Ranch. The Agua Sierra parties filed an

answer raising several affirmative defenses. Agua Sierra

separately filed a counterclaim seeking a judgment declaring the

water rights reservation to be valid and quieting title to all

commercial water rights on the CF Ranch. In the alternative,

Agua Sierra sought to rescind the 1984 conveyance to Davis.

¶ 6 On cross-motions for summary judgment, the trial court

held the reservation invalid and entered judgment for Davis. In

doing so, the trial court relied on opinions of this Court

stating that “there is no right of ownership of groundwater in

Arizona prior to its capture and withdrawal,” Town of Chino

Valley v. City of Prescott (“Chino Valley II”), 131 Ariz. 78,

82, 638 P.2d 1324, 1328 (1981), and that “water rights cannot be

established or reserved for some potential future use,” In re

the Rights to the Use of the Gila River Sys. (“Gila River I”),

171 Ariz. 230, 239, 830 P.2d 442, 451 (1992). After entering

judgment, the trial court added Chino Grande, L.L.C. (“Chino

Grande”) as a party because it had bought the CF Ranch from

Davis. The Agua Sierra parties timely appealed.

¶ 7 The court of appeals vacated the trial court’s
5
judgment, holding that Arizona law allows a grantor to reserve

rights to the prospective commercial use of percolating

groundwater beneath the land conveyed. Davis v. Agua Sierra

Res., L.L.C., 217 Ariz. 386, 392-97 ¶¶ 21-42, 174 P.3d 298, 304-

09 (App. 2008). Without addressing other arguments by the Agua

Sierra parties challenging the judgment for Davis, the court of

appeals remanded for the trial court to determine whether the

commercial water rights at issue are limited to percolating

groundwater or also include surface-water rights. Id. at 397 ¶

45, 174 P.3d at 309.

¶ 8 We accepted review because this case presents an issue

of first impression and statewide importance. Our jurisdiction

is based on Article 6, Section 5(3) of the Arizona Constitution

and Arizona Revised Statutes (“A.R.S.”) section 12-120.24

(2003).

DISCUSSION

A. Arizona Groundwater Law

¶ 9 The 1981 and 1984 deeds for the CF Ranch purport to

reserve to the grantor, and thus to sever from the surface

estate, all “commercial water rights.” The parties agree that

there has not been any historical use of such water rights on

the CF Ranch and that there is no issue before the Court

regarding appropriable waters. This case instead involves the

potential future use of groundwater that has never been captured
6
and put to reasonable use.

¶ 10 Arizona law distinguishes groundwater from surface

water, even though such waters may be hydrologically connected.

John D. Leshy & James Belanger, Arizona Law Where Ground and

Surface Water Meet, 20 Ariz. St. L.J. 657, 659 (1988). Surface

water is subject to the doctrine of prior appropriation. In re

the Gen. Adjudication of All Rights to Use Water in the Gila

River Sys. & Source (“Gila River IV”), 198 Ariz. 330, 334 ¶ 3, 9

P.3d 1069, 1073 (2000). In contrast, under Arizona’s common

law, groundwater “is not appropriable and may be pumped by the

overlying landowner, subject to the doctrine of reasonable use.”

Id.

¶ 11 Because others have detailed the history of Arizona

groundwater law, see Cherry v. Steiner, 543 F. Supp. 1270, 1273-

76 (D. Ariz. 1982), aff’d, 716 F.2d 687 (9th Cir. 1983); Leshy &

Belanger, supra, at 666-700, we present only a brief overview

here. Arizona’s common law evolved from the territorial-day

view that a landowner has a property interest in groundwater

underlying the surface estate. E.g., Howard v. Perrin, 8 Ariz.

347, 353, 76 P. 460, 462 (1904) (“Throughout the Pacific Coast,

where the doctrine of appropriation obtains, the decisions are

uniform to the effect that waters percolating generally through

the soil beneath the surface are the property of the owner of

the soil . . . .”). Later decisions clarified that land
7
ownership does not include ownership of the groundwater itself,

but instead may afford a qualified right to extract and use the

groundwater for the benefit of the land. Chino Valley II, 131

Ariz. at 82, 638 P.2d at 1328.

¶ 12 Recognizing that groundwater is vital to our state,

Arizona’s legislature in 1980 established a comprehensive

regulatory framework by enacting the Groundwater Management Act

(the “GMA”). 1980 Ariz. Sess. Laws, ch. 1, § 86 (4th Spec.

Sess.) (codified as amended at A.R.S. §§ 45-401 to -704 (2003 &

Supp. 2008)). With the goal of reducing the state’s overdraft

of groundwater, the GMA created a system of groundwater rights

and conservation requirements. Id. § 45-401.

¶ 13 The GMA divided the state into three categories:

Active Management Areas (“AMAs”), id. § 45-411, Irrigation Non-

Expansion Areas (“INAs”), id. § 45-431, and areas outside a

designated AMA, id. § 45-453. AMAs are “geographical areas

where groundwater supplies are imperiled.” Chino Valley II, 131

Ariz. at 79 n.*, 638 P.2d at 1325 n.*. In such areas, a person

may withdraw and use groundwater only in accordance with the

GMA’s detailed regulations. A.R.S. § 45-451(A)(1).

¶ 14 The CF Ranch, located within the Big Chino sub-basin,

is not within an AMA and thus is not subject to the extraction

and use limits applicable to AMAs. The GMA, however, does

govern the withdrawal of groundwater on land outside an AMA if
8
the water is to be transported to an established AMA. Id. § 45-

551.

¶ 15 The Prescott Active Management Area includes the City

of Prescott. Id. § 45-411(A)(3). The GMA thus regulates any

withdrawal and transportation of groundwater from the CF Ranch

to the City of Prescott. In general, the GMA provides that

“[i]n areas outside of active management areas, a person may:

1. Withdraw and use groundwater for reasonable and beneficial

use, except as provided in article 8.1 of this chapter. 2.

Transport groundwater pursuant to articles 8 and 8.1 of this

chapter.” Id. § 45-453. Article 8.1 further provides that in

the case of the Big Chino sub-basin,

[a] city or town that owns land consisting
of historically irrigated acres in the Big
Chino sub-basin of the Verde River
groundwater basin, as designated by order of
the director dated June 21, 1984, or a city
or town with the consent of the landowner,
may withdraw from the land for
transportation to an adjacent initial active
management area an amount of groundwater
determined pursuant to this section.
Id. § 45-555(A). The GMA limits the annual transportation

allotment based on the historically irrigated acres retired from

irrigation. Id. § 45-555(B).

¶ 16 Although the Agua Sierra parties claim they own the

“commercial water rights” reserved by the prior owners of the CF

Ranch, the GMA does not recognize the existence of anything

9
called a “commercial water right” to groundwater.

B. Future Rights to Groundwater

¶ 17 The court of appeals held that a grantor may reserve

rights to the commercial use of percolating groundwater beneath

land that the grantor no longer owns. Davis, 217 Ariz. at 396

¶ 43, 174 P.3d at 308. In so holding, the court reasoned that a

landowner has a property right to the “usufruct” of underlying

groundwater and that this right is subject to the general common

law rule that “[a] grantor has the right to make a reservation

of an interest in real property.” Id. at 393 ¶ 23, 174 P.3d at

305 (quoting Phoenix Title & Trust Co. v. Smith, 101 Ariz. 101,

106-07, 416 P.2d 425, 430-31 (1966)). Supporting this

conclusion, the Agua Sierra parties argue that the right to

prospectively use groundwater is one of the “sticks” in the

bundle of a landowner’s property rights, and the landowner can

reserve this stick when conveying the surface estate to another.

¶ 18 For a deed reservation of commercial groundwater

rights to be valid, however, the grantor must in fact have a

real property interest in such rights. Thus, we first consider

whether Arizona law recognizes a real property right to the

potential future use of groundwater.

¶ 19 This Court has noted that “Arizona law recognized no

right to reserve water for some potential future use.” Gila

River I, 171 Ariz. at 239, 830 P.2d at 451. The court of
10
appeals dismissed this language as irrelevant to the validity of

Agua Sierra’s reservation of commercial water rights, stating

that Gila River I concerned only appropriable surface waters

(which include surface-stream subflows) and not percolating

groundwater. Davis, 217 Ariz. at 395 ¶ 37, 174 P.3d at 307.

Gila River I, however, cannot be read so narrowly.

¶ 20 Gila River I concerned both real property owners who

claimed rights to appropriable subflows and other land owners

who claimed that their interests would be impacted by any legal

determination of “when underground water is appropriable.” 171

Ariz. at 239, 830 P.2d at 451. The second group, who were not

then using groundwater, claimed that they had a property right

to use groundwater in the future, and thus were entitled to

constitutionally adequate notice in the Gila adjudication. Id.

The Court squarely rejected this argument: “Having no legally

recognized property right in potential, future groundwater use,

they have no due process rights of which they could be

deprived.” Id.

¶ 21 The Court in Gila River I also cited its earlier

decision Chino Valley II, which addressed groundwater rights

under the GMA, not appropriable water rights. Gila River I, 171

Ariz. at 239, 830 P.2d at 452 (citing Chino Valley II, 131 Ariz.

at 82, 638 P.2d at 1328). In Chino Valley II, we stated that

“[i]n the absolute sense, there can be no ownership in seeping
11
and percolating waters until they are reduced to actual

possession and control by the person claiming them because of

their migratory character. Like wild animals free to roam as

they please, they are the property of no one.” 171 Ariz. at 82,

638 P.3d at 1328. Thus, we held that “there is no right of

ownership of groundwater in Arizona prior to its capture and

withdrawal from the common supply and that the right of the

owner of the overlying land is simply to the usufruct of the

water.” Id.

¶ 22 Chino Valley II used the term “usufruct” to describe

the rights of landowners with respect to underlying groundwater.

But Chino Valley II’s use of that term does not mean that

landowners have some vested real property right in the potential

use of groundwater. See Gila River IV, 198 Ariz. at 344, 9 P.3d

at 1083 (citing Chino Valley II and Gila River I to reject

landowners’ claim that an expansive definition of “subflow”

resulted in a taking of private property rights to future

groundwater use). Rather, as Chino Valley II makes clear, the

landowner’s right is perhaps better described as an unvested

expectancy insofar as it concerns the potential future use of

groundwater that has never been captured or applied. This is

why this Court concluded in Chino Valley II, and the federal

courts concluded in Cherry, that the restrictions on groundwater

use under the GMA did not unconstitutionally infringe the rights
12
of landowners.

¶ 23 Recognizing that Arizona’s groundwater is a critical

public resource, the legislature has granted landowners outside

of AMAs a limited right, essentially an opportunity, to pump

groundwater for reasonable and beneficial uses as permitted by

the GMA. See A.R.S. §§ 45-453, -541 to -554; see also Leshy &

Belanger, supra, at 715-16 (discussing GMA’s impact on

reasonable use doctrine). The legislature is free to choose

between competing uses of groundwater and to modify such rights

in the public interest as an exercise of its police power.

Chino Valley II, 131 Ariz. at 83-84, 639 P.2d at 1329-30; Sw.

Eng’g Co. v. Ernst, 79 Ariz. 403, 409-10, 291 P.2d 764, 768-69

(1955).

¶ 24 Agua Sierra and its predecessors have not identified

any pre-existing or current use of the groundwater underlying

the CF Ranch that is embraced by the reservation of commercial

water rights. Arizona law does not recognize a real property

interest in the potential future use of groundwater that has

never been captured and applied to reasonable use.1

C. Severability of Right to Potential Use of Groundwater

¶ 25 The Agua Sierra parties also argue that the deed

1
      We do not here address the circumstances in which the owner of
the surface estate may, consistent with the GMA, grant others
contractual rights to withdraw, use, or transport groundwater
from beneath the owner’s land.
13
reservations were at least effective to sever and reserve to the

grantor whatever “rights” a surface owner would otherwise have

to the future use of groundwater. We therefore consider whether

a landowner’s qualified “right” or expectancy to the potential

use of groundwater is an interest that can be severed from the

surface estate.

¶ 26 The court of appeals observed that “Arizona law

generally permits the severance and transfer of water rights

from the associated real property.” Davis, 217 Ariz. at 392

¶ 21, 174 P.3d at 304 (citing W. Maricopa Combine, Inc. v. Ariz.

Dep’t of Water Res., 200 Ariz. 400, 407 ¶ 35, 26 P.3d 1171, 1178

(App. 2001)). The court further noted that the right to use

groundwater is a property right, id. at ¶ 22 (citing Paloma Inv.

Ltd. P’ship v. Jenkins, 194 Ariz. 133, 138 ¶ 22, 978 P.2d 110,

115 (App. 1998)), and that because this right is a hereditament,

it must be conveyed by deed, id. (citing Neal v. Hunt, 112 Ariz.

307, 310-11, 541 P.2d 559, 562-63 (1975)).

¶ 27 The cases cited by the court of appeals, however, do

not establish a severable right to the potential future use of

groundwater. West Maricopa Combine involved the transfer of

Central Arizona Project water via the Hassayampa riverbed. 200

Ariz. at 402 ¶ 1, 26 P.3d at 1173. In rejecting arguments by

landowners that they could prohibit such transfers through their

property, the court of appeals discussed how Arizona law
14
distinguishes water rights from real property rights. Id. at

407-08 ¶¶ 35-40, 26 P.3d at 1178-79. In this context, the court

cited its earlier decision in Paloma for the proposition that

water rights can be bought and sold distinct from land. W.

Maricopa Combine, 200 Ariz. at 407 ¶ 35, 26 P.3d at 1178.

¶ 28 Paloma, however, did not involve the severance of a

right to the potential future use of groundwater. Instead,

Paloma concerned a water rights agreement giving one party a

share of the proceeds from future sales of water from the land

by the fee owner. See 194 Ariz. at 138 ¶ 24, 978 P.2d at 115

(“We recognize that [the] interest is not to use the water

itself, the ordinary form of water rights.”). The court of

appeals characterized this right as a “royalty interest” that,

as a real property interest, bound successor landowners. Id. at

¶ 25-26. Thus, even if we assume arguendo that it was correctly

decided, Paloma does not establish the right of a grantor to

sell groundwater from land that it no longer owns.

¶ 29 Nor did this Court in Neal decide whether the

potential use of groundwater is a property right severable from

the overlying land. In that case, the grantor reserved certain

water rights to a ranch he had sold. 112 Ariz. at 309, 541 P.2d

at 561. Citing George v. Gist, 33 Ariz. 93, 263 P. 10 (1928),

the Court stated that water rights in land must be conveyed by

deed and that conveyances of groundwater, a hereditament, are
15
subject to the recording statute. Neal, 112 Ariz. at 310-11,

541 P.2d at 562-63. We did not address the validity of such a

reservation in Neal, but rather held only that if not recorded,

a reservation cannot be effective against a subsequent bona fide

purchaser who lacks notice. 112 Ariz. at 311, 542 P.2d at 563.

¶ 30 Neal preceded this Court’s decision in Chino Valley

II, which rejected as dicta language in prior decisions,

including Howard, suggesting that a landowner may have a

property interest in groundwater. See Chino Valley II, 131

Ariz. at 81, 638 P.2d at 1327. Given Chino Valley II, our

holding in Neal cannot be understood as holding that rights to

the potential future use of such water may be severed from the

overlying land by a deed reservation.

¶ 31 On the issue of severability, more pertinent is the

language of the GMA itself, which provides that the landowner

must consent to the transportation of water off the property:

A city or town that owns land consisting of
historically irrigated acres in the Big
Chino sub-basin of the Verde River
groundwater basin . . . or a city or town
with the consent of the landowner, may
withdraw from the land for transportation to
an adjacent initial active management area
an amount of groundwater determined pursuant
to this section.

A.R.S. § 45-555(A)(emphasis added).

¶ 32 Section 45-555(A) presumes that a landowner has

authority to consent to a city or town’s withdrawing water from
16
the land for transportation. But a landowner would not be able

to grant such consent if a prior owner could reserve and sever

from the land the rights to the potential future use of

groundwater. If the legislature had contemplated that such

rights exist and are transferable apart from the land, we do not

believe the legislature would have required the consent of the

landowner for the withdrawals contemplated by § 45-555(A).

¶ 33 We recognize that there are many policy arguments for

or against allowing the transfer, outside of AMAs, of rights to

prospectively use groundwater, but those arguments should be

weighed by the legislature if it thinks it desirable to amend

this aspect of the GMA. See Chino Valley II, 131 Ariz. at 81,

83, 638 P.2d at 1327, 1329 (”[I]f any change in the law is

necessary, it should be made by the Legislature.”).

CONCLUSION

¶ 34 For the reasons stated, we hold that landowners

outside of AMAs do not have a real property interest in the

potential future use of groundwater that may be severed from the

overlying land. Accordingly, we vacate the opinion of the court

of appeals and remand so that court may consider other properly

preserved arguments by the Agua Sierra parties challenging the

trial court’s judgment for Davis.

_______________________________________
W. Scott Bales, Justice
17
CONCURRING:

_______________________________________
Ruth V. McGregor, Chief Justice

_______________________________________
Rebecca White Berch, Vice Chief Justice

_______________________________________
Michael D. Ryan, Justice

_______________________________________
Andrew D. Hurwitz, Justice

18