Rick Jarvis is a partner with Jarvis, Fay & Gibson, LLP; he can be reached at rjarvis@jarvisfay.com.

Each new development project in a city results in new residents, employees, and visitors, placing increasing demands on existing public infrastructure. To accommodate this growth, cities and counties typically construct public improvements that expand the capacity of their roadways, police, fire stations, parks, recreation facilities, and other public services.

To build these improvements, local officials typically impose “development impact fees” to ensure that development pays its “fair share” of the associated costs. But it can take many years for a local agency to accumulate enough funds to actually construct such improvements; during this time the agency must properly maintain and account for these fees.

Governing this process is California’s Mitigation Fee Act which imposes several requirements on the way cities and counties calculate, impose, and account for development impact fees. One of the stipulations (Government Code section 66001, subdivision (d)), requires local agencies to adopt “five-year findings” justifying the continued retention of any unspent fee proceeds held for more than five years. A local agency that fails to adopt adequate findings may be required to refund the fees.

However, the statute is vaguely written. Furthermore, recent court decisions such as Walker v. City of San Clemente have interpreted it in a strict manner, suggesting that a local agency must automatically refund its development impact fee proceeds if the court finds any defect in the local agency’s findings, and without any chance for the agency to fix the defect. As a result, some developers and other property owners have filed lawsuits against local agencies attempting to force a refund of these development impact fees.

Courts have long recognized local agencies’ authority to impose fees

Since Proposition 13 was adopted in the late 1970s, local agencies’ ability to raise taxes has been constrained. As such, they have increasingly relied on development impact fees to fund infrastructure expansion. Courts have long recognized local agencies have inherent police power to impose such fees and require developers to pay their fair share of the costs brought on by their developments.

When the Legislature adopted the Mitigation Fee Act in 1987, local agencies had to start accounting for and justifying the amounts of development impact fees they imposed. To comply with the law, local agencies typically prepare detailed nexus studies that identify what public improvements are needed to accommodate future growth and the methodology used to calculate development impact fees.

“Five-year findings” requirements

The Mitigation Fee Act also requires local agencies to comply with certain procedures once development impact fees have been collected. Among other requirements, these fees must be deposited in separate capital facilities accounts and local agencies must provide detailed annual reports accounting for each development impact fee fund.

Additionally, Section 66001(d) requires local agencies to adopt special findings every five years for any unexpended funds in each development impact fee account. These findings must:

1. Identify the purpose to which the fee is to be put.
2. Demonstrate a reasonable relationship between the fee and the purpose for which it is charged.
3. Identify all sources and amounts of funding anticipated to complete financing in incomplete improvements.
4. Designate the approximate dates on which the funding … is expected to be deposited into the appropriate account or fund.

Section 66001(d) further requires that, if such findings “are not made as required by this subdivision, the local agency shall refund the moneys” to the current property owners of the development projects upon which the fees were imposed. Recognizing that calculating and distributing these refunds can be a complicated undertaking, the Mitigation Fee Act allows agencies to reallocate such funds to an alternative purpose consistent with their overall purpose, but only if the administrative costs of the refunds exceed the amount to be refunded.

How courts are interpreting the Mitigation Fee Act

Several years ago, the court in Walker v. City of San Clemente ordered a city to refund over $10 million in development impact fees that it had collected over two decades to fund the construction of future beach parking facilities. The facts in that case appeared extreme in terms of the city’s failure to adopt five-year findings justifying its continued retention of development fees.

Years after the city originally started imposing this particular fee, it conducted two studies, both of which concluded the city already had adequate beach parking and did not need to construct more. However, the city continued to collect the fee. The court had no difficulty concluding that the city failed to adequately justify its continued retention of the fee. It also rejected the city’s request that it be allowed to administratively fix its findings, concluding the “plain language” of Section 66001(d) mandated automatic refunds with no opportunity to cure any defect.

Some litigants are now relying on the Walker decision to argue that any legal defect in a local agency’s five-year findings — or even a short delay or other administrative oversight in their adoption — requires an automatic refund of all development impact fee proceeds held in the affected account, without any opportunity for the agency to remedy the defect.

While it is hoped that courts will ultimately reject these theories, there is significant uncertainty in the law. Local agencies’ development impact fee funds are, and could remain, vulnerable to potentially huge refund claims.

Other issues being litigated

The growing number of litigants are making various arguments, some of which are “creative” in challenging local agency compliance with Section 66001(d). These arguments expose some of the uncertainties created by the vague statutory language. They include:

• Arguments that a local agency must adopt five-year findings even for fund accounts that have not had unexpended amounts for more than five years. Most agencies do not adopt five-year findings if the balance that existed five years before has been fully expended, even if the account still has a current balance due to more recent development fee collections. They typically apply a “first-in/first-out” accounting approach that assumes older amounts are expended first. However, the vagueness of the statutory language is giving litigants room to argue that five-year findings are required to justify amounts held for less than five years.
• Arguments that, if the agency does fail to adopt adequate five-year findings, it must refund the entire amount of the current fund — even amounts collected and held for less than five years. Some are even arguing that the failure to adopt adequate five-year findings also prohibits an agency from collecting any additional development impact fees until it resolves the defect. In support of such arguments, litigants rely upon unclear language in another recent court decision suggesting that each collection of a development fee opens the door to a lawsuit challenging the five-year findings under what is called the “continuous accrual doctrine.”
• Arguments that any delay in the adoption of the five-year findings, or any other clerical error in the findings, automatically requires a refund of the entire fund balance, even if the agency later resolves the defect.
• Arguments that agencies must prepare new, updated nexus studies in support of the five-year findings. These arguments are undercut by a new law (Gov. Code § 66016.5, subd. (a)(8)) that specifies that nexus studies only need to be updated every eight years. This law explicitly applies prospectively, so that the first updated nexus studies will not be required until eight years after Jan. 1, 2022.

There is also active litigation and additional uncertainty over the extent to which the five-year findings requirement applies to other types of development fees, such as in-lieu fees and habitat mitigation fees.

What local agencies can do

Cities and counties should be vigilant and adopt adequate five-year findings for their development impact fee accounts to preserve these important public funds from lawsuits asserting refund claims.

Staff may not always have the capacity to devote adequate time and attention needed to prepare thorough, “bullet-proof” five-year findings. Indeed, many combine their efforts with their adoption of annual findings without sufficient thought as to what Section 66001(d) requires. Although this may initially save staff time, it could result in stressful, lengthy litigation. Municipalities should plan ahead for the next time their five-year findings come due.

One efficient proactive step staff can take is to incorporate the necessary analysis for the five-year findings every time the agency updates its nexus studies. Much of the relevant data and analysis for the nexus studies themselves can support solid five-year findings for previously collected funds. As updated nexus studies are now statutorily required every eight years, the five-year findings should be routinely included as part of the scope of work for such studies.

At the state level, legislation that clarifies the ambiguity in the current statute would help resolve many of the existing issues. The creation of an administrative procedure for litigants to first raise any alleged defects to the local agency before going to court could provide a reasonable vehicle for minimizing litigation costs and would establish that agencies are entitled to the opportunity to cure any defects, whether technical or substantive.