New “Physical Capabilities” Test for 7 U.S.C. 1926(b) Debtors Applied to Dismiss CCN Decertification Complaint

by David Klein and Maris Chambers

As we have reported in a number of recent editions of The Lone Star Current, the legal and regulatory landscape governing the protection afforded under 7 U.S.C. § 1926(b) to holders of water and wastewater certificates of convenience and necessity (“CCNs”) in Texas that have loans from the United States Department of Agriculture (“USDA”) has been rapidly evolving over the past few years. Most recently, on November 23, 2020, the United States District Court for the Western District of Texas, Austin Division, applied a newly-adopted legal standard to dismiss the complaint of a Texas sewer CCN holder and debtor to the USDA who alleged that its wastewater CCN was protected from decertification under § 1926(b). There, on remand from the decision of the United States Court of Appeals for the Fifth Circuit in Green Valley Special Util. Dist. v. City of Schertz, Texas, 969 F.3d 460 (5th Cir. 2020), the federal district court rejected Green Valley Special Utility District’s (“GVSUD’s”) claim to protection under § 1926(b), finding that it could not satisfy the first prong of the new “physical capabilities” test adopted by the Fifth Circuit. Green Valley Special Util. Dist. v. Marquez, et. al, No. 1:17CV00819 (W.D. Tex. 2020).

In Texas, CCNs are granted by the Public Utility Commission of Texas (“PUC”) and provide their holders with the exclusive right and obligation to provide retail water and/or wastewater service within the specific geographic area designated by that CCN. Nevertheless, a CCN is not a vested right and a landowner or other retail public utility can file an application at the PUC to decertify another entity’s CCN, in whole or part. The ability to decertify CCN service area, however, is constrained by § 1926(b) because water and sewer utility service providers that have obtained federal loans under § 1926 are entitled to protection for “the service provided or made available” by the indebted utility.

As reported in the October 2020 edition of The Lone Star Current, the Fifth Circuit’s decision in Green Valley marked a sea change in the law governing water and wastewater CCN decertification and the protection afforded by § 1926(b). The issues addressed in that case stemmed from the PUC’s grant of the City of Schertz’s (“Schertz’s”) application to decertify approximately 405 acres of GVSUD’s sewer CCN area that overlapped with Schertz’s corporate limits. Aggrieved by the PUC’s decision, GVSUD filed a complaint in federal district court to challenge the decertification, arguing it was entitled to protection under § 1926(b) in light of its outstanding federal loan for water system improvements. Initially, Schertz filed a Motion to Dismiss GVSUD’s complaint, and the district court denied that Motion, based in part on the then-current precedent establishing that GVSUD’s mere possession of its CCN, imposing a state law duty to provide retail service, meant GVSUD had made service available for purposes of § 1926(b). Schertz then appealed that decision to the Fifth Circuit, which, before remanding the case to federal district court, adopted a new standard for determining whether a federally-indebted utility is entitled to § 1926(b) protection from CCN decertification.

The “physical capabilities” test adopted by the Fifth Circuit in Green Valley overruled longstanding precedent establishing the prerequisites for a federally-indebted utility to receive protection from decertification of all or a portion of its water or sewer CCN service area under § 1926(b). Previously, a CCN holder’s state law duty to provide service was seen as the legal equivalent of “making service available” under § 1926(b). Now, in order to have provided or made service available for purposes of § 1926(b), a utility must have (i) a legal right to provide service and (ii) adequate facilities to serve the area within a reasonable time after a request for service is made. The Fifth Circuit clarified, however, that although an indebted utility need not demonstrate that it has “pipes in the ground” in order to merit § 1926(b)’s protection, it must have some sort of infrastructure in place.

Having adopted this new “physical capabilities” test, the Fifth Circuit instructed the district court to apply it on remand. Thus, in reconsidering GVSUD’s claims under § 1926(b), the district court found that while GVSUD had a plan to provide sewer service to its entire CCN service area, the plan alone was not sufficient to entitle GVSUD to § 1926(b)’s protections under the new standard. Instead, citing the PUC’s determinations that GVSUD provided “no retail sewer service in the decertificated area” and had made “no physical improvements within the decertificated area, including any wastewater infrastructure,” the district court concluded that GVSUD could not satisfy the first prong of the “physical capabilities” test. The district court then indicated it need not address the second prong of the new test, held that GVSUD was not entitled to protection under § 1926(b), and dismissed GVSUD’s § 1926(b) claims related to the Schertz decertification.
As such, this decision provides an early example of the application of the “physical capabilities” test. Even so, we will continue to monitor the development of this case, and others like it, to maintain an up-to-date understanding of how Texas courts are likely to apply the recently-adopted standard.

David Klein is a Principal and Maris Chambers is an Associate in the Firm’s Water and Districts Practice Groups. If you would like additional information on CCNs or have questions related to this article, please contact David at 512.322.5818 or dklein@lglawfirm.com, or Maris at 512.322.5804 or mchambers@lglawfirm.com.