Iowa Supreme Court requires Des Moines to refund roughly $35 million in franchise fees

by Gary Taylor

Kragnes, et al., v. City of Des Moines
(Iowa Supreme Court, March 2, 2012)

In 2004, the City of Des Moines considered raising property taxes to hire more police and firefighters, maintain the library’s hours, and rehabilitate deteriorating neighborhoods. The City realized the state was phasing out sales and use taxes on residential gas and electric services and determined that it would be possible to increase the franchise fees on these services to raise revenue. After deciding this source of revenue was preferable to an increase in property taxes, the City renegotiated the franchise agreements with MidAmerican Energy and increased the franchise fee beginning June 2005. Lisa Kragnes promptly filed a lawsuit on behalf of herself and all others similarly situated challenging the franchise fees as illegal taxes. She sought reimbursement for all illegal taxes paid through the allowable statute of limitations and sought an injunction prohibiting the City from charging such franchise fees in the future. In the first suit that came before the Supreme Court the Court determined that a city has the authority to assess a franchise fee expressed as a percentage of the gross receipts derived from the utility’s sale of its services to the public, so long as the charge is “reasonably related to the reasonable costs of inspecting, licensing, supervising, or otherwise regulating the activity that is being franchised.”  The case was sent back to district court to determine whether all or part of the franchise fees were reasonably related to the City’s administrative expenses in exercising its police power.  It was also up to the district court to determine whether a class should be certified (which would allow all  City of Des Moines utilities customers who paid the electricity or gas franchise fee from July 27, 1999, forward to be represented in a single action).  The district court did, in fact, certify the class and determined that a portion of the franchise fee collected was excessive. The court held the City must refund to the class, with interest, the amount by which the franchise fees exceeded $1,575,194 per year for the electric utility and $1,574,046 for the gas utility (an amount that would cost the city roughly $40 million). The court retained jurisdiction to determine the details of how the refund would be calculated and refunded to class members. Both the City and Kragnes appealed.

Certifying class.  The City first contended the district court should have granted its motion to decertify the class because a conflict of interest exists between Kragnes, as the class representative, and Des Moines property owners who will suffer economically as a result of a judgment in favor of the class. Specifically, the City contended that if the City is required to refund the roughly $40 million in excess tax that was collected from 2004 until 2009, it will need to raise the revenue for this payment from property taxes. This puts Kragnes and class members in a fundamental conflict over the litigation because property owners would tend to oppose Kragnes’s refund objective because they benefitted from the collection of the excessive franchise fees from payors who were not property owners.  The Court sided with Kragnes, stating that the City’s position was “rife with speculation” —beginning with speculation about what City leaders would have done in the past and ending with predictions about what City might do to raise revenue to pay the refund.  In light of this the district court did not abuse its discretion in certifying the class.  The Supreme Court further observed:

The litigation of this case has resulted in two Supreme Court opinions, a forty-nine page district court decision after a fourteen-day bench trial involving the testimony of twenty-eight witnesses, including eight experts—three for the City and five for Kragnes. The record fills five bankers’ boxes. However, Kragnes’s claim standing alone would likely fall within the jurisdictional limit of the small claims court. We think this case demonstrates the very necessity and importance of class action litigation both for the plaintiffs and for the City. The likelihood of a plaintiff bringing such a complex suit requiring substantial resources to litigate in small claims is highly unlikely. And if she, and scores of thousands of others like her, did bring their claims individually, it could easily overwhelm the legal department of the City and the resources of the Polk County district court….

It also determined that sufficient procedural safeguards exist to protect individuals when members are not given the option of excluding themselves from the class.

Proper amount of expenses.  Both parties disagreed with the categories and amounts of expenses that the district court counted as “reasonably related” to the administration of electric and gas franchises during the relevant time period, an amount which totaled nearly $1.574 million annually for the gas utility and $1.575 million annually for the electric utility.  After a lengthy review of the various costs claimed by the City (lost value of trees, indirect operating costs, construction costs paid by other governments, others) the Supreme Court concluded that the amounts the City were entitled to collect in franchise fees were $1.47 million annually for the gas utility and $2.1 million annually for the electric utility (still resulting in an overcollection by the city of roughly $35 million).

Refund to customers.  Finally, the City contended the district court erred in concluding the plaintiff class is entitled to a refund.  Citing with approval a 1990 U.S. Supreme Court case, the Iowa Supreme court reasoned that there must be financial consequences from the illegal taxation of the City’s residents notwithstanding that the funds received from the illegal taxation of the City’s residents were used wisely, legally, and with the best intentions for the residents. “Because exaction of a tax constitutes a deprivation of property, procedural safeguards are generally required to protect against “unlawful exactions in order to satisfy the commands of the Due Process Clause.” The Court further noted that Kragnes filed the case soon after the City decided to commence collecting the franchise fees. On notice of Kragnes’s claim that the franchise fees were illegal, the City nonetheless collected them and even increased the amount of the fees collected. “The failure of the City to respond differently after it was on notice of Kragnes’s claim does not mitigate in favor of depriving Kragnes and the class of a remedy for the unlawful taxation.”

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