Russell City Energy Co. v. City of Hayward

Filed 8/7/17
CERTIFIED FOR PUBLICATION

IN THE COURT OF APPEAL OF THE STATE OF CALIFORNIA

FIRST APPELLATE DISTRICT

DIVISION FIVE

RUSSELL CITY ENERGY COMPANY,
LLC,
Plaintiff and Appellant, A144749

v. (Alameda County
CITY OF HAYWARD, Super. Ct. No. RG14752278)
Defendant and Respondent.

The “Payments Clause” of an agreement between Russell City Energy Company,
LLC (Russell) and the City of Hayward (City) prohibited the City from imposing any
taxes on the “development, construction, ownership and operation” of Russell‟s power
plant except taxes tethered to ownership of real property. The question in this case is
whether Russell‟s interpretation of the Payments Clause violates article XIII, section 31
of the California Constitution (Section 31) which provides “[t]he power to tax may not be
surrendered or suspended by grant or contract.”
The answer is yes. We conclude Russell‟s interpretation of the Payments
Clause—that the City contractually promised not to impose any taxes other than real
property related taxes—violates Section 31 because it surrenders and suspends the City‟s
power to tax the power plant. Thus, the trial court properly determined the Payments
Clause was unenforceable and sustained the City‟s demurrer to Russell‟s complaint
alleging claims premised on a breach of the agreement.
We also conclude, however, that Russell must be permitted an opportunity to
amend its complaint to allege a quasi-contractual restitution claim.

1
 FACTUAL AND PROCEDURAL BACKGROUND
On appeal from an order sustaining a demurrer, we “accept as true the properly
pleaded material factual allegations of the complaint, together with facts that may
properly be judicially noticed.” (Crowley v. Katleman (1994) 8 Cal.4th 666, 672.)
The Agreement and the Utility Tax
In October 2005, Russell and the City entered into a Cooperation and Option
Agreement (agreement). The purpose of the agreement was to facilitate Russell‟s
construction and operation of the Energy Center, a natural gas-fired, combined cycle
electric generating facility in Hayward. In the agreement, the City granted Russell an
option to purchase 12.5 acres of City-owned land as the site for the Energy Center. The
City also promised to help Russell obtain permits, regulatory approval, and water
treatment services for the power plant. Pursuant to the agreement, Russell conveyed a
3.5-acre parcel to the City.
Section 6 of the agreement—the Payments Clause—required Russell to “pay to
the City $10,000,000 . . . for the City‟s design and construction of a new library.”1 The
Payments Clause also provides in relevant part: “In the interest of clarity, the Parties
acknowledge that payments to be made by [Russell] as contemplated in this Agreement
comprise all payments to be made to the City by [Russell], its parents or affiliates in
connection with the development, construction, ownership and operation of [the Energy
Center] and the City shall not impose any other levies, fees, taxes, contributions, or
charges on [Russell], its parents or affiliates other than such levies, fees, taxes,
contributions, or charges generally applicable to similarly situated owners of real
property located in the City.” Section 22 of the agreement contains a severability
provision providing: “If any provision, or any portion thereof contained in this agreement
is held to be unconstitutional, invalid, or unenforceable, the remainder of this agreement,

1
The original contracting party assigned its rights to Russell. The agreement was
amended in 2006. The amended agreement did not modify the Payments Clause.

2
or portion thereof, shall be deemed severable, shall not be affected, and shall remain in
full force and effect.”
When Russell entered into the agreement, it relied on the authority of the City and
its representatives to enter into the Payments Clause.2 Russell acquired real property,
entitlements, permits and other assets necessary to build the Energy Center, and incurred
“tens of millions of dollars in construction-related” and development costs. In June 2009,
Hayward voters approved a Utility Users Tax Ordinance (tax or utility tax) on the usage
of electricity and gas, which, as relevant here, imposes “a tax upon every person using
electricity in the City. The tax imposed . . . shall be at the rate of five and one-half
percent (5.5%) of the charges made for such electricity. . . . The tax shall be collected
from the service user.” The provision regarding gas usage is substantially similar.
Russell began building the Energy Center in October 2010. In April 2011, the
City informed Russell it must pay the utility tax. Russell claimed the Payments Clause
prohibited the City from imposing the tax, but it made payments to cover the utility tax
assessments. In October 2011, Russell paid the City $10 million as required by the
agreement. The Energy Center is complete and operational.
The Lawsuit
In 2014, Russell filed a verified complaint against the City alleging claims for:
(1) breach of contract; (2) promissory estoppel; (3) anticipatory repudiation; (4) violation
of the Contracts clauses of the federal and state constitutions; and (5) declaratory relief.3
The breach of contract claim and anticipatory repudiation causes of action alleged “the
City‟s promise not to impose levies, fees, taxes, contributions, or charges” on Russell

2
In Section 14 of the agreement, the City “represent[ed] and warrant[ed] to
[Russell] that the person who has executed this Agreement on behalf of the City has been
duly authorized to execute this Agreement on behalf of the City.” The City Manager and
City Attorney signed the agreement, and the City Council approved it.
3
After exhausting administrative remedies, Russell sued the City in federal court.
That lawsuit was dismissed for lack of subject matter jurisdiction. (Russell City Energy
Co., LLC. v. City of Hayward, (N.D.Cal., Feb. 17, 2015, No. C-14-03102) 2015 U.S.
Dist. LEXIS 26626.)

3
“aside from those expressly authorized under the Agreement” was a “material aspect of
the bargain” between Russell and the City. According to the complaint, the City‟s “bad
faith” application of utility tax to Russell “was . . . an intentional breach and deliberate
anticipatory repudiation of its promises, covenants and obligations made under the
[a]greement.” Russell also alleged the City breached the agreement by claiming the City
“had no authority to enter into its promise that [Russell] not be subject to certain levies,
fees, taxes, contributions or charges.” According to the complaint, the City‟s bad faith
conduct “unfairly and unreasonably” deprived Russell of a “substantial portion of the
benefits it bargained for under the Agreement, and for which [Russell] . . . paid fair and
good consideration . . . .”
The promissory estoppel cause of action alleged the City promised not to impose
levies, fees, taxes, or charges “other than expressly allowed in the Agreement” and
“warranted its authority to make such promises.” Russell relied on those promises by
acquiring “real property, entitlements, permits and other assets necessary for
development . . . of the Energy Center,” beginning construction on the Energy Center,
incurring “tens of millions of dollars in construction-related costs,” and paying the City
$10 million pursuant to the agreement.
In its Contracts clause claim, Russell alleged the imposition of the utility tax in
contravention of the agreement violated Russell‟s contract rights under the United States
and California constitutions. According to the complaint, the imposition of the utility tax
“effectively nullifies the City‟s obligations under the [a]greement by imposing . . .
unexpected and new liabilities and limitations on the exercise of [Russell‟s] contractual
rights under the [a]greement, which related obligations and covenants [Russell] has
already substantially performed.” Russell‟s final claim, for declaratory relief, alleged the
parties disagreed regarding the interpretation of the agreement and “whether the City‟s
wrongful retention of fees and monies already paid to the City by [Russell] under the
[a]greement, including the $10,000,000 payment made by [Russell], . . . would unjustly
enrich the City.” Russell sought a judicial declaration the City breached the agreement,
and “damages in an amount according to proof.”

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The City’s Demurrer
The City demurred, arguing the complaint was based on “an erroneous and
unconstitutional interpretation of the Payments Clause” and, as a result, failed to state a
viable claim. It claimed Russell had no enforceable contractual right to avoid paying the
utility tax, explaining: (1) the Payments Clause authorized imposition of taxes
“ „generally applicable to similarly situated owners of real property located in the City‟ ”;
and (2) the utility tax was “ „generally applicable to similarly situated owners of real
property in the City.‟ ” In other words, applying the utility tax to the power plant‟s
operations did not breach the agreement because the Payments Clause did not preclude
the City from imposing “generally applicable taxes, [which] are simply the cost of doing
business in Hayward.” The City also argued a contractual provision exempting Russell
from future taxes would unconstitutionally surrender or suspend the City‟s power to tax
in violation of Section 31, which provides, “[t]he power to tax may not be surrendered or
suspended by grant or contract.” Finally, the City contended Russell‟s promissory
estoppel claim failed because Russell could not “use promissory estoppel to procure „the
indirect enforcement of an illegal contract.‟ ”
In opposition, Russell claimed the utility tax “turn[ed] on the usage of services”
not property ownership. Russell also argued the court must accept its interpretation of
the Payments Clause at the pleading stage, as long as the interpretation “ „does not place
a clearly erroneous construction‟ ” on the provisions of the contract. Next, Russell
claimed the Payments Clause did not violate Section 31 because it represented an
exercise—not a surrender—of the City‟s taxing power. According to Russell, the
Payments Clause was an upfront payment in lieu of future taxes, also known as a PILOT
agreement.4 The City‟s reply argued Russell was impermissibly trying to “secure

4
A payment in lieu of taxes—sometimes abbreviated “PILOT”—is “made to
compensate a local government for . . . tax revenue that it loses because of the nature of
the ownership or use of a particular piece of real property.” (14 McQuillin, The Law of
Municipal Corporations (3d ed. 2008) § 38:5, pp. 57-58.) At Russell‟s request, the court
judicially noticed several documents, including a tax settlement agreement between the
5
benefits . . . it never bargained for and that the City could never promise to provide in the
first place. . . . [¶] As a matter of law, the City did not, and could not, agree not to enact
future taxes applicable to [Russell].”
Hearing and Order Sustaining Demurrer
At a hearing, counsel for Russell characterized the Payments Clause as a PILOT
agreement and urged the court to uphold it. Russell‟s attorney also emphasized the
unfairness of declining to enforce the agreement, noting the City would be unjustly
enriched if permitted to accept the $10 million payment and impose the utility tax.
Counsel requested leave to amend the complaint to allege the Payments Clause is a
PILOT agreement. In response, the City‟s attorney argued Russell‟s interpretation of the
Payments Clause rendered the City unable to impose taxes—a clear “surrender of the
power to tax”—which violated Section 31.
The court questioned whether the Payments Clause represented an “illusory
promise” and asked counsel for the City: “[Y]ou have their $10 million. And to just let
you walk away from it now after you‟ve gotten the money . . . is that fair?” Ultimately,
however, the court sustained the City‟s demurrer without leave to amend and dismissed
the complaint. In a thorough written order, the court determined as a threshold issue it
was “not clearly erroneous” for Russell to interpret the Payments Clause as preventing
the City from imposing the utility tax because the tax “is assessed based on utility usage,
not property ownership.” But the court also concluded Russell‟s interpretation of the
Payments Clause violated the California Constitution. As the court explained, “none of
the cases cited by [Russell] show how the City‟s purported agreement not to impose any
taxes (other than real property-related taxes) can be reconciled with . . . section 31 of
California‟s Constitution.” The court rejected Russell‟s reliance on municipalities‟ tax
settlement agreements, concluding “[i]n the Payments Clause, the City did not exercise
its discretion to receive payments in lieu of taxes. The Court finds that the Payments

City of Richmond and Chevron USA, Inc. (Chevron), and a settlement agreement
between the County of Alameda and the City of Oakland.

6
Clause would be unconstitutional if interpreted to mean that the City contractually
surrendered or suspended its power to tax in violation of . . . section 31.”
For these reasons, the court concluded the complaint did not state a claim against
the City and sustained the demurrer without leave to amend. The court declined to permit
Russell to amend the complaint, noting Russell‟s interpretation of the Payments Clause
“renders it unconstitutional. The court fails to see how this defect can be cured by
amendment and [Russell] does not suggest any reasonable possibility that it can be.”
DISCUSSION
I.
General Principles
As stated above, “[i]n reviewing a judgment sustaining a demurrer without leave
to amend, we give the complaint a reasonable interpretation and treat the demurrer as
admitting all material facts properly pleaded.” (Coker v. JPMorgan Chase Bank, N.A.
(2016) 62 Cal.4th 667, 671.) “ „[W]e examine the complaint de novo to determine
whether it alleges facts sufficient to state a cause of action under any legal theory[.]‟
[Citation.] While our focus is on the pleadings, „[r]elevant matters that are properly the
subject of judicial notice may be treated as having been pled.‟ ” (Requa v. Regents of
University of California (2012) 213 Cal.App.4th 213, 223 (Requa).)
Russell‟s claims are based on contract. “When reviewing whether a plaintiff has
properly stated a cause of action for breach of contract, we must determine whether the
alleged agreement is „reasonably susceptible‟ to the meaning ascribed to it in the
complaint. [Citation.] „ “So long as the pleading does not place a clearly erroneous
construction upon the provisions of the contract, in passing upon the sufficiency of the
complaint, we must accept as correct plaintiff‟s allegations as to the meaning of the
agreement.” ‟ ” (Klein v. Chevron U.S.A., Inc. (2012) 202 Cal.App.4th 1342, 1384-1385
(Klein).) “Thus, to survive demurrer, [Russell] need[s] only set forth a reasonable
interpretation of [the agreement].” (Id. at p. 1385.) “ „As a reviewing court we are not
bound by the construction placed by the trial court on the pleadings but must make our
own independent judgment thereon, even as to matters not expressly ruled upon by the

7
trial court.‟ ” (Aragon-Haas v. Family Security Ins. Services, Inc. (1991) 231 Cal.App.3d
232, 239 (Aragon-Haas).)
II.
The Payments Clause Violates Section 31 of the California Constitution
The complaint alleges the Payments Clause prohibits the City from imposing the
utility tax. The Payments Clause provides in relevant part: (1) Russell‟s $10 million
payment “comprise[s] all payments to be made to the City” by Russell in connection with
the “development, construction, ownership and operation” of the Energy Center; and
(2) “the City shall not impose any other . . . taxes, . . . on [Russell], . . . other than such
. . . taxes . . . generally applicable to similarly situated owners of real property located in
the City.”
A. Russell‟s Interpretation of the Payments Clause is Not Clearly Erroneous
The tax applies to persons using gas and electricity in the City, and the tax is based
on a percentage of electricity and gas charges. A property owner who does not use
utilities does not pay the tax. Accordingly, the Payments Clause is “reasonably
susceptible of the meaning” alleged in the complaint—that the Payments Clause
precludes the City from imposing the utility tax because it is based on utility usage, not
property ownership. (Rutherford Holdings, LLC v. Plaza Del Rey (2014) 223
Cal.App.4th 221, 229 (Rutherford).) We must accept this interpretation at the pleading
stage. (Ibid.; Requa, supra, 213 Cal.App.4th at p. 231 [court must accept allegations as
to agreement‟s meaning unless the construction of the agreement is “ „clearly
erroneous‟ ”].)
As it did in the court below, the City contends the Payments Clause authorizes
imposition of the utility tax because it is generally applicable to similarly situated real
property owners. We reject this argument. The City‟s “competing” interpretation of the
Payments Clause does not demonstrate Russell‟s interpretation is clearly erroneous.
(Rutherford, supra, 223 Cal.App.4th at p. 229; Aragon-Haas, supra, 231 Cal.App.3d at
p. 239.)

8
 B. The Payments Clause Cannot Be Reconciled with Section 31, Which
Prohibits Local Governments from Surrendering or Suspending the Power
to Tax
Next, we consider whether the Payments Clause conflicts with Section 31. Article
VIII, section 6 of the 1879 California Constitution provided, “The power of taxation shall
never be surrendered or suspended by any grant or contract to which the State shall be a
party.” In 1974, section 6 was replaced with Section 31, which provides “[t]he power to
tax may not be surrendered or suspended by grant or contract.” (Cal. Const., art. VIII,
§ 31, added by Prop. 8 (Nov. 5, 1974).) Section 31 applies to local governments. It
expresses the principle that “governments cannot divest themselves by contract of the
right to exert their governmental authority „in matters which from their very nature so
concern that authority that to restrain its exercise by contract would be a renunciation of
power to legislate for the preservation of society or to secure the performance of essential
governmental duties.‟ ” (City of Glendale v. Superior Court (1993) 18 Cal.App.4th 1768,
1778-1779; Lin Sing v. Washburn (1862) 20 Cal. 534, 570 [the “power to tax is a
sovereign power, and wherever it exists may be exercised at the will and discretion of the
sovereign”].) Thus, California municipalities may not contract away their right to
regulate land use (Alameda County Land Use Assn. v. City of Hayward (1995) 38
Cal.App.4th 1716, 1724-1725), employ eminent domain (City of Glendale, at pp. 1777-
1781), or exercise other police powers (County Mobilehome Positive Action Com., Inc. v.
County of San Diego (1998) 62 Cal.App.4th 727, 735-741).
Section 31 does not define the terms “surrendered” or “suspended.”5 The absence
of a statutory provision defining these terms “leads us to presume the Legislature used

5
“ „The principles of constitutional interpretation are similar to those governing
statutory construction. In interpreting a constitution‟s provision, our paramount task is to
ascertain the intent of those who enacted it. [Citation.] To determine that intent, we
“look first to the language of the constitutional text, giving the words their ordinary
meaning.” [Citation.] If the language is clear, there is no need for construction.
[Citation.] If the language is ambiguous, however, we consider extrinsic evidence of the
enacting body‟s intent.‟ ” (Professional Engineers in California Government v. Kempton
(2007) 40 Cal.4th 1016, 1037.) Russell traces the development of Section 31 in some
9
the[se] word[s] . . . in [their] ordinary sense and, consequently, we may refer to [those
words‟] dictionary definition[s] to ascertain [their] ordinary, usual meaning.” (County of
Kern v. T.C.E.F., Inc. (2016) 246 Cal.App.4th 301, 318.) The common meaning of
surrender is “to give up completely or agree to forgo especially in favor of another.”
(Merriam-Webster‟s Collegiate Dict. (11th ed. 2014) p. 1258.) Suspend or
“ „[s]uspended‟ is synonymous with temporarily debarred, inactive, inoperative and held
in abeyance.” (County of Kern, at p. 318. [defining “ „suspended‟ ” as “ „temporarily
inoperative‟ ”]; see Merriam-Webster‟s Collegiate Dict. (11th ed. 2014) p. 1259 [defining
suspend as “to debar temporarily,” or “to cause to stop temporarily,” or “to set aside or
make temporarily inoperative”].) In the Payments Clause, the City unquestionably
suspended its power to tax. The Payments Clause renders the City‟s power to tax
“ „temporarily inactive‟ ” for the life of the power plant. (County of Kern, at p. 318.)
A contract that surrenders or impairs a governmental power “is invalid . . . if the
contract amounts to a municipality‟s „surrender‟ or „abnegation‟ of its control of a
municipal function. . . . „the controlling consideration in this area appears to be whether a
disputed contract amounts to a local entity‟s “surrender,” “abnegation,” “divestment,”
“abridging,” or “bargaining away” of its control of a [taxing] power or municipal
function.‟ [Citations.] The inquiry thus turns on whether „this crucial control element
has been lost.‟ ” (108 Holdings, Ltd. v. City of Rohnert Park (2006) 136 Cal.App.4th
186, 194-195.) Here, the City has “surrendered” its power to tax in the Payments Clause:
it has relinquished the crucial element of control of its power to exercise municipal
functions by the imposition of “levies, fees, contributions, charges and taxes,” except by
raising revenue through imposition of taxes on real estate. Russell‟s interpretation of the

detail, and relies on Section 31‟s legislative history in an effort to demonstrate the
Payments Clause is constitutional. We need not examine Section 31‟s legislative history
because the words “surrender” and “suspend” are not ambiguous. “ „When the language
of the statute is clear, we need go no further‟ [citation]; that is, „[i]f the words themselves
are not ambiguous, we presume the Legislature meant what it said, and the statute‟s plain
meaning governs.‟ ” (Ramirez v. Tulare County Dist. Attorney’s Office (2017) 9
Cal.App.5th 911, 936.)

10
Payments Clause would preclude the City from imposing payroll, business license taxes,
and occupancy taxes on the power plant, insulating Russell from virtually all revenue-
raising assessments.
Russell‟s attempts to avoid the purview of Section 31 are unavailing. For
example, it claims Section 31 prohibits only “perpetual or irrevocable tax immunity.”
Russell reasons that the Payments Clause does not violate Section 31 because the City‟s
contractual promise not to impose taxes is “project-specific” (it applies only to the power
plant) and is “time-limited” (it applies only to the finite lifespan of the power plant).
Russell also contends Section 31 was intended to apply only to “tax immunity in
corporate charters, not contract provisions” such as the Payments Clause. These
arguments conflict with the plain language of Section 31, which broadly states “[t]he
power to tax may not be surrendered or suspended by grant or contract.” Nothing in
Section 31 authorizes surrenders or suspensions of the power to tax in “project-specific”
or “time-limited” situations.6 As the City points out, were Section 31 so limited, the

6
Two decisions involving the surrender or suspension of police power are
instructive. In Alameda County Land Use Assn. v. City of Hayward (1995) 38
Cal.App.4th 1716, a memorandum of understanding (MOU) impaired certain
municipalities‟ power to amend their respective general plans regarding 13,000 acres of
open space. We held a “local legislative body cannot surrender or impair its delegated
governmental power or that of successor legislative bodies either by ordinance or
contract. [Citations.] More particularly, a local government may not contract away its
right to exercise its police power in the future, and land use regulations involve the
exercise of police power.” (Id. at p. 1724.) We concluded the MOU constituted “an
impermissible divestment by respondents of their power and obligation to enact
legislation affecting the lands within their respective jurisdictions” notwithstanding the
discrete project—the 13,000-acre parcel—to which the MOU applied. (Id. at p. 1725.)
In County Mobilehome Positive Action Com., Inc. v. County of San Diego, supra, 62
Cal.App.4th at pp. 740-741, the Fourth District invalidated a lease agreement exempting
mobile home owners from rent control regulations for a 15-year period, concluding the
lease “represent[ed] an express effort by the County to „surrender,‟ „abnegate,‟ „divest,‟
„abridge,‟ or „bargain away‟ its control of a police power or municipal function.” By
analogy, these decisions support our conclusion that time-limited and project specific
surrenders or suspensions of a municipality‟s taxing power are impermissible.

11
corporation and the municipality could circumvent Section 31 by the municipality‟s
piecemeal surrender of its power to tax.
Russell‟s reliance on Valencia Energy v. Arizona Dept. of Rev. (Ariz. 1998) 959
P.2d 1256 (Valencia) does not alter our conclusion. In that case, the Arizona Department
of Revenue (department) advised Valencia Energy Company (company) that certain
“transportation charges were not subject to tax” and, as a result, the company declined to
“charge or collect transaction privilege taxes.” (Id. at p. 1260.) Later, the department
changed course and assessed back taxes against the company. (Ibid.) Before the Arizona
Supreme Court, the company argued the department was estopped from collecting back
taxes because it had advised the company “the activity now levied on was not subject to
tax.” (Id. at p. 1259.) In response, the department argued Arizona‟s version of Section
31 “absolutely bars estopping the government from collecting taxes owed.” (Id. at
p. 1260.)
The Valencia court disagreed, concluding the constitutional provision “restrains all
branches of government, but only as to relinquishment of the Legislature‟s fundamental
power to tax. An estoppel from collecting revenue from a single taxpayer for a single
event is not the kind of permanent capitulation with which the framers were concerned.
We therefore hold that article IX, section 1 is not an absolute ban to estopping the
Department.” (Valenica, supra, 959 P.2d at pp. 1264-1265, fn. omitted.) Valencia does
not stand for the proposition that a municipality may contractually agree to surrender or
suspend future taxes. It simply held the constitutional provision at issue did not prevent
application of estoppel to the department. In context, the Valencia court‟s reference to
“collecting revenue from a single taxpayer for a single event” describes the payment of
back taxes, not a contractual promise not to impose future taxes. (Id. at pp. 1265, 1272.)
Nor does Section 31 limit its application to corporate charters, to prohibit
“perpetual tax exemptions for all of a corporation‟s activities” as embodied in a
corporation‟s charter. What Russell characterizes as a “modest textual change” embodied
in the 1974 amendment defeats this argument. The 1974 amendment deleted from former
section 6 the words “to which the State shall be a party,” thereby expanding Section 31‟s

12
reach to local governmental entities. The regulation of corporate formation and the filing
of articles of incorporation are a function of the State through the Secretary of State, not
of local municipalities. (See generally Corp. Code, §§ 200-213.) The trial court did not,
as Russell suggests, improperly broaden the narrow construction of Section 31 envisioned
by the 1878 framers.
We are mindful that the “ „ “taxing power of the state is never presumed to have
been relinquished unless the language in which the surrender is made is clear and
unmistakable.” ‟ ” (Coso Energy Developers v. County of Inyo (2004) 122 Cal.App.4th
1512, 1533.) Here, the Payments Clause unmistakably surrenders and suspends the
City‟s power to tax. It prohibits the City from imposing any taxes on Russell except real-
property related taxes. We cannot agree with Russell that in the Payments Clause, “the
City has surrendered nothing.”
For the reasons discussed above, we conclude Russell‟s interpretation of the
Payments Clause violates Section 31.
C. Characterizing the Payments Clause as a PILOT Agreement Does Not
Render It Constitutional
Russell contends the Payments Clause represents an exercise of the City‟s taxing
power, in the form of a PILOT agreement. According to Russell, interpreting the
Payments Clause as providing for “upfront payments in lieu of later taxes—i.e., as a
PILOT provision” is the “only sensible reading” of the agreement. We reject this
argument for two reasons.
First—and as counsel for Russell conceded at oral argument—the complaint does
not allege the Payments Clause is a PILOT agreement. The complaint does not contain
the acronym PILOT or the words “in lieu of taxes.” Nor is the interpretation of the
Payments Clause as a PILOT agreement “apparent from the complaint.” (Rutherford,
supra, 223 Cal.App.4th at p. 229.) Instead the complaint alleges the Payments Clause
constituted a “promise not to impose . . . taxes . . . on [Russell], aside from those
expressly authorized under the Agreement” and that the City breached the Payments
Clause by requiring Russell to pay the utility tax. At the demurrer stage, our focus is on

13
the pleadings. “ „ “[I]n passing upon the sufficiency of the complaint, we must accept as
correct plaintiff‟s allegations as to the meaning of the agreement.” ‟ ” (Klein, supra, 202
Cal.App.4th at pp. 1384-1385, 1387 [no error in sustaining demurrer without leave to
amend where complaint did not set forth a reasonable interpretation of alleged
agreement]; Rutherford, at p. 229 [demurer properly sustained where the plaintiff‟s
interpretation of the agreement was reasonable but was not alleged in the complaint].)
Second, Russell‟s argument fails even if we assume for the sake of argument the
complaint alleged the Payments Clause is a PILOT agreement. 7 To support its contention
that municipalities may enter PILOT agreements, Russell cites two cases, Cane v. City
and County of San Francisco (1978) 78 Cal.App.3d 654 (Cane) and AB Cellular LA, LLC
v. City of Los Angeles (2007) 150 Cal.App.4th 747 (AB Cellular). Cane concerned the
validity of leases between the City and County of San Francisco and corporations
operating three parking garages. In the leases, the city agreed to pay all taxes imposed on
the leased premises. (Cane, at pp. 655-656.) Plaintiff taxpayers challenged the tax
covenants in the leases, claiming they constituted “an unlawful grant of exemption from
taxation.” (Id. at p. 657.)
A division of this court rejected this argument, concluding a municipality may
agree to “pay a sum equal to the amount of taxes levied upon the private party‟s
property.” (Cane, supra, 78 Cal.App.3d at p. 659.) Cane noted, however, that “[i]f the
tax provisions in issue granted an exemption from taxation, those provisions would be
invalid.” (Id. at p. 658, italics added.) Cane does not support Russell‟s argument that the
Payments Clause is constitutional; instead, it suggests the Payments Clause is invalid

7
Russell characterizes the Payments Clause as requiring “up front” payments “in
lieu of” all future taxes, i.e., that in making the $10 million payment, Russell obtained a
broad exemption from all future local taxes. The Payments Clause uses neither “up
front” or “in lieu of” to describe Russell‟s payment. The Payments Clause does not
indicate the payment will be credited toward future tax liability, nor that the payment will
offset other tax liability owed by Russell. Instead, the Payments Clause exempts Russell
from all taxes except those tethered to real property. We assume without deciding the
Payments Clause is a PILOT agreement, and we express no opinion on whether PILOT
agreements are generally permissible.

14
because it grants an exemption from taxation. Russell‟s attempt to distinguish Cane is
unconvincing.
Nor are we persuaded by Russell‟s reliance on AB Cellular. There, the issue was
whether a municipality‟s enactment of a cell phone tax required voter approval pursuant
to Proposition 218. (AB Cellular, supra, 150 Cal.App.4th at pp. 757, 758.) The appellate
court determined the methodology of calculating the cell phone tax had changed,
requiring a Proposition 218 election. (Id. at pp. 758, 760-761.) It explained: “a local
taxing entity can enforce less of a local tax than is due under a voter-approved
methodology, . . . and later enforce the full amount of the local tax due under that
methodology without transgressing Proposition 218. While the settlement of local tax
disputes and enforcement of local taxes may be taxpayer specific, the methodology for
the maximum recovery of local taxes will remain constant. A local taxing entity could
even revise its methodology to decrease local taxes and then . . . return to the previously
approved methodology. Proposition 218 allows it. The evil to be counteracted is the
increase of local taxes beyond what was formerly approved.” (Id. at pp. 763-764, fn.
omitted.)
According to Russell, AB Cellular authorizes the use of “ „taxpayer specific‟ ”
agreements such as the Payments Clause. We disagree. The AB Cellular court did not
consider whether an agreement not to impose certain taxes violates the California
Constitution. Rather the court interpreted Proposition 218 and Proposition 218‟s
Omnibus Implementation Act, and “the rights of citizens to circumvent lawmakers and
pass initiatives.” (AB Cellular, supra, 150 Cal.App.4th at p. 758.) The court merely
noted “[s]ettling local tax disputes or deciding not to enforce local taxes does not trigger
Proposition 218 concerns, but it could transgress other legal principles. That issue is
beyond the purview of this opinion.” (Id. at p. 764, fn. 11.) AB Cellular does not assist
Russell.
Russell claims the Payments Clause was a legitimate way for the City to “provide
tax relief” by contract, and that municipalities commonly enter such contractual
agreements to its corporate citizens. Russell also claims a municipality may “bargain for

15
up front tax payments based on its best estimate of the other party‟s future [tax]
liabilities.” Again, Russell urges “municipalities are exercising—not giving up—the
power to tax.” But that is not what happened here.
People v. Board of Supervisors (1932) 126 Cal.App. 670, is instructive. There, the
petitioner owned real property to which a lien had attached. (Id. at p. 672.) The State of
California acquired the land and the petitioner sought cancellation of the lien pursuant to
a section of the Political Code. The Calaveras court determined the petitioner was
entitled to have the liens cancelled. It rejected the argument that the cancellation
constituted an impermissible surrender of the power of taxation, explaining: “The facts
before us show that the power of taxation was exercised, and that by operation of law, it
has ceased to be a charge upon the land for the reason that the land is now the property of
the state.” (Id. at p. 674.) In Calaveras, the cancellation of quantifiable tax liability, as
required by a provision of the Political Code, represented an exercise of the public
entity‟s taxation power. The same cannot be said here. The Payments Clause does not
correlate the payment of $10 million to any quantifiable tax liability.
Russell‟s reliance on two documents judicially noticed by the trial court is
unhelpful. In one document—a tax settlement agreement with the City of Richmond—
Chevron agreed to make lump sum payments in exchange for Richmond‟s withdrawal of
a proposed ballot measure amending a utility users tax. Under the agreement, if
Richmond imposes new taxes on Chevron‟s refinery during a specified time period,
Chevron will receive a credit for the qualifying portion of the settlement payment. The
second document is an agreement between the City of Oakland and Alameda County
regarding distribution of parking taxes collected at the Oakland Coliseum. These
documents do not assist Russell because they do not involve municipality‟s promise not
to impose taxes.
Russell‟s interpretation of the Payments Clause violates Section 31 and, as a
result, Russell cannot state a claim for contractual relief. The court properly sustained the
City‟s demurrer to the complaint.
III.

16
 Russell Must Be Permitted Leave to Amend the Complaint to Allege
a Quasi-Contractual Restitution Claim
Russell claims the court erred by denying leave to amend, reasoning it may allege
a quasi-contractual claim even if the Payments Clause is unconstitutional. While the
decision to sustain a demurrer “ „is a legal ruling subject to de novo review on appeal, the
granting of leave to amend involves an exercise of the trial court‟s discretion. [Citations.]
When the trial court sustains a demurrer without leave to amend, we must also consider
whether the complaint might state a cause of action if a defect could reasonably be cured
by amendment. If the defect can be cured, then the judgment of dismissal must be
reversed to allow the plaintiff an opportunity to do so. The plaintiff bears the burden of
demonstrating a reasonable possibility to cure any defect by amendment.‟ ” (Bock v.
Hansen (2014) 225 Cal.App.4th 215, 235.)
Russell contends it can state a claim for “money paid under the [a]greement.”8 In
response, the City contends an award of restitution would violate the agreement‟s
severability provision, which provides, “If any provision, or portion thereof contained in
this agreement is held to be unconstitutional, invalid, or unenforceable, the remainder of
this agreement or portion thereof, shall be deemed severable, shall not be affected, and
shall remain in full force and effect. (See MKB Management, Inc. v. Melikian (2010) 184
Cal.App.4th 796, 803, fn. omitted.) Here, the trial court implicitly concluded the
agreement was severable, and this conclusion is consistent with the City‟s contention on
appeal that “one unenforceable provision would not unravel the entire contract.” We do
not read the severability provision as precluding the City from bearing “any liability

8
Russell variously refers to this quasi-contractual claim as for “money paid under
the [a]greement” and for restitution based on an unjust enrichment theory. “The right to
restitution or quasi-contractual recovery is based upon unjust enrichment.” (1 Witkin,
Summary of Cal. Law (10th ed. 2005) Contracts, § 1013, p. 1102 (Witkin).) A “party to
an express contract can assert a claim for restitution based on unjust enrichment by
„alleg[ing in that cause of action] that the express contract is void or was rescinded.‟
[Citation.] A claim for restitution is permitted even if the party inconsistently pleads a
breach of contract claim that alleges the existence of an enforceable agreement.”
(Rutherford, supra, 223 Cal.App.4th at p. 231.)

17
under the circumstances presented here.” Nor are we persuaded by the City‟s claim that
restitution is somehow unavailable because “untangling” this complex deal would be
difficult because the agreement has largely been “executed, and the power plant built.”
We disagree with the City‟s contention that the Payments Clause is “malum in se,
such that restitution is prohibited.”9 “There is a marked distinction between contracts
which are malum in se, and those which are merely malum prohibitum.” (Martin v. Wade
(1869) 37 Cal. 168, 174.) Malum in se means “against good morals”—malum in se
contracts are “in violation of the general law of public policy, immoral.” (Witkin, supra,
§ 431, p. 473; Martin, at p. 174; see, e.g., Vick v. Patterson (1958) 158 Cal.App.2d 414,
417 [examples of contracts involving moral turpitude].) Traditionally, “parties to a
contract malum in se, whether it be executory or executed, whether the action be brought
on the contract or to recover the consideration, are denied all remedy by the Courts.”
(Martin, at p. 174.)
Malum prohibitum means “prohibited by statute”—malum prohibitum contracts
are illegal as contrary to a statute. (See Witkin, supra, § 431, p. 473; Mills, supra, 121
Cal.App.4th at p. 344, fn. 10 [“illegality set by statute”].) Parties to malum prohibitum
contracts may “recover back money paid on [the] contract as the circumstances of the
case may require.” (Smith v. Bach (1920) 183 Cal. 259, 263-264; Witkin, supra, § 438,

9
“ „The illegality of contracts constitutes a vast, confusing and rather mysterious
area of the law.‟ ” (McIntosh v. Mills (2004) 121 Cal.App.4th 333, 344 (Mills).) As
relevant here, there are two categories of illegal contracts: (1) those “[c]ontrary to an
express provision of law”; and (2) those “[o]therwise contrary to good morals.” (Civ.
Code, § 1667.) The distinction between contracts malum in se and those which are
malum prohibitum is “ „ somewhat artificial‟ ” (Mills, at p. 344, fn. 10) and of “little
significance save where the parties are not in pari delicto.” (Witkin, supra, § 431,
p. 473.) “ „The rule denying recovery to a party to an illegal contract is subject to a wide
range of exceptions. . . . In each case, the extent of enforceability and the kind of remedy
granted depend upon a variety of factors, including the policy of the transgressed law, the
kind of illegality and the particular facts. [Citations.]‟ [Citation.] Among the factors
noted [are] that the party claiming illegality would be unjustly enriched if the other party
were denied recovery, and that the forfeiture from refusal to permit recovery would be
harsh in proportion to the character and extent of illegality.” (South Tahoe Gas Co. v.
Hofmann Land Improvement Co. (1972) 25 Cal.App.3d 750, 759.)

18
pp. 478-479.) “There is no question that the [Payments Clause] is . . . malum prohibitum,
as its illegality derives from violation of statute, and is not grounded in common
standards of morality.” (Mills, at p. 344, fn. 10.) While the Payments Clause violates the
California Constitution, it is not “immoral,” and the City‟s reliance on a single sentence
from Berka v. Woodward (1899) 125 Cal. 119 does not demonstrate otherwise.
In one sentence on the last page of its brief, the City argues Russell should not be
granted leave to amend because a private party may not sue a public entity on a quasi-
contract theory. To support this argument, the City relies on a single case: Janis v.
California State Lottery Com. (1998) 68 Cal.App.4th 824 (Janis).10 In Janis, plaintiffs
sued the California State Lottery Commission (CSL), seeking to recover money lost
playing Keno before the lottery game was declared illegal. (Id. at p. 827.) As relevant
here, plaintiffs asserted a claim for “ „restitution and unjust enrichment,‟ ” alleging CSL
misrepresented the legality of the game and that they “were entitled to rescind their
contracts with CSL to obtain restitution of moneys wagered on the game.” (Id. at p. 830.)
The trial court sustained CSL‟s demurrer without leave to amend and the appellate
court affirmed. (Janis, supra, 68 Cal.App.4th at pp. 828, 834.) First, the Janis court
determined plaintiffs‟ claim was “a fraud claim, not a breach of contract claim” because
it centered on misrepresentations concerning the legality of the game and plaintiffs‟
reliance on those representations. (Id. at p. 830) The court determined CSL was immune
from liability because the claim was “based on tort rather than contract.” (Id. at p. 831.)
Second, Janis held plaintiffs did not have a contract with CSL because, “as a matter of
law, playing Keno does not create an express contract between CSL and the player.” The
court then stated, “[l]ikewise, generally a private party cannot sue a public entity on an
implied-in-law or quasi-contract theory, because such a theory is based on quantum
meruit or restitution considerations which are outweighed by the need to protect and limit

10
We disapprove of the cursory manner in which the City raised this contention,
without any discussion or analysis. We exercise our discretion to address it,
notwithstanding “the lack of any cogent argument.” (Imagistics Internat., Inc. v.
Department of General Services (2007) 150 Cal.App.4th 581, 591, fn. 8.)

19
a public entity‟s contractual obligations. [Citation.] Here, then, Janis cannot point to a
contractual promise to support this claim.” (Janis, supra, 68 Cal.App.4th at p. 830.)11
Katsura v. City of San Buenaventura (2007) 155 Cal.App.4th 104 (Katsura)
extended the principle articulated in Janis to a public works contract. In Katsura, an
engineer and a city entered into a contract for consultant services for a maximum price of
$18,485. (Id. at p. 106.) “The contract required that any modifications were only to be
made by mutual written consent of the parties.” (Ibid.) The city paid the engineer‟s first
two invoices, which totaled $15,565; after completion of the project, the engineer
submitted a final invoice for an additional $23,743.75, which the city refused to pay
“because it was beyond the maximum contract price and included work that was not
authorized by the contract.” (Id. at p. 107.) The engineer sued the city for breach of
contract and common counts. He admitted he did not comply with the contract‟s written
modification requirement, but argued the contract was orally modified to include extra
work based on requests by the city‟s associate engineer and an outside consultant that he
perform the work. (Id. at pp. 107-108.)
Katsura determined the engineer could not orally modify the contract, explaining:
“There is no provision in the City charter for execution of oral contracts by employees of
the City who do not have requisite authority. The alleged oral statements by the associate
city engineer and project manager are insufficient to bind the City. „ “No government,
whether state or local, is bound to any extent by an officer‟s acts in excess of his . . .
authority.” ‟ ” (Katsura, supra, 155 Cal.App.4th at p. 109.) Katsura then held “ „a
private party cannot sue a public entity on an implied-in-law or quasi-contract theory,
because such a theory is based on quantum meruit or restitution considerations which are
outweighed by the need to protect and limit a public entity‟s contractual obligations.‟
[Citations.] [¶] . . . The reason is simple: „ “The law never implies an agreement against
its own restrictions and prohibitions, or [expressed differently], „the law never implies an

11
The Janis court‟s statement that a private party may not sue a public entity on an
implied in law or quasi-contract theory is arguably dicta. At the very least, the principle
is more broadly stated than necessary to cover the facts in Janis.

20
obligation to do that which it forbids the party to agree to do.‟ ” ‟ [Citation.] In other
words, contracts that disregard applicable code provisions are beyond the power of the
city to make.” (Id. at pp. 109-110.)
As summarized by a division of this court, the rule from Katsura is “all implied
contracts against public entities are barred because, by definition, they have not formally
been approved by the entity.” (Green Valley Landowners Assn. v. City of Vallejo (2015)
241 Cal.App.4th 425, 438.) The rationale for this rule is that “[l]imitations on a
municipality‟s power to contract should be strictly construed because such restrictions are
designed to protect the public, not those who contract with the municipality.” (Ibid.) The
principle articulated in Katsura has been applied in cases where there was no contract or
when there was an attempt to orally modify a written contract. (See Fairview Valley
Fire, Inc. v. Department of Forestry & Fire Protection (2015) 233 Cal.App.4th 1262,
1271 [no contract]; Green Valley, at p. 432 [implied promise]; Orthopedic Specialists of
Southern California v. Public Employees’ Retirement System (2014) 228 Cal.App.4th
644, 649 [implied oral promise]; P&D Consultants, Inc. v. City of Carlsbad (2010) 190
Cal.App.4th 1332, 1341 [oral modification to written contract].)
This situation is unlike Janis, where there was no contract. Here, Russell can
point to a “contractual promise”—albeit one we have held violates Section 31 of the
California Constitution. (Janis, supra, 68 Cal.App.4th at p. 830.) Nor is this situation
like Katsura, where the plaintiff attempted to enforce an alleged oral promise that had not
been formally approved by the public entity. The issue here is not whether the City
formally approved the agreement or had the power to contract: the parties had a written
agreement, executed by the City Manager and City Attorney, and approved by the City
Council, and no one disputes the City‟s power to enter a contract to facilitate the
construction of a power plant. Finally, this case is distinguishable from subsequent cases
applying Janis and Katsura. In seeking quasi-contractual relief, Russell is not attempting
to imply the existence of an extra-contractual agreement, nor is Russell attempting to
enforce the invalid provision of the agreement. Rather, Russell is seeking recovery of at
least some of the consideration it provided because the City was unable to deliver its

21
promised performance. Under the unique set of circumstances here, we conclude Russell
“should be given an opportunity to amend its complaint to allege” a quasi-contractual
restitution claim. (First Nationwide Savings v. Perry (1992) 11 Cal.App.4th 1657, 1669-
1670.)
DISPOSITION
The order sustaining the City‟s demurrer without leave to amend and dismissing
the complaint is reversed to the extent it denies Russell leave to amend. The matter is
remanded with directions to grant Russell leave to amend the complaint consistent with
the views expressed in this opinion. In all other respects, the order is affirmed. Russell is
entitled to costs on appeal. (Cal. Rules of Court, rule 8.278.)

22
 _________________________
Jones, P. J.

We concur:

_________________________
Simons, J.

_________________________
Bruiniers, J.

A144749

23
Russell City Energy Company, LLC v. City of Hayward (A144749)

Trial Court: Alameda County Superior Court

Trial Judge: Hon. Brenda Fay Harbin-Forte

Counsel:

Winston & Strawn, Robb C. Adkins, Charles J. Moll III, Krista M. Enns and Benjamin J.
Kimberley for Plaintiff and Appellant.

Office of City Attorney, Michael S. Lawson; Jarvis, Fay, Doporto & Gibson, Benjamin P.
Fay and Gabriel J. McWhirter, for Defendant and Respondent.

24