A Critical Evaluation of Water and Wastewater Entities for the Commercial and Residential Developer

by David Klein and Lauren Binger

When a developer desires to provide retail water and/or wastewater service to a new development, there are multiple entity types which a developer can consider. Much the same way that choosing a corporate entity type (e.g. limited liability company, corporation, limited partnership, etc.) is a critical strategic decision for a business, the same is true for a developer choosing the type of utility to create to provide retail water and/or wastewater service to a development. The outcome of this decision has many implications including, but not limited to, tax, rate-making, and financing options.

Although providing retail water and/or wastewater service to a development involves many other steps including, establishing a Public Water System with the Texas Commission on Environmental Quality (“TCEQ”), determining where to obtain water (obtaining water rights vs. purchasing wholesale water), determining what facilities need to be constructed, hiring operators and staff, setting rates, and obtaining a Certificate of Convenience and Necessity, this article will solely focus on the step in the process of evaluating the pros and cons of each distinct type of utility and is intended to provide a non-exhaustive evaluation.

The term “utility” is associated with the business and billing aspects of providing retail water (and sewer) service—including the investment of public funds in infrastructure and real property, including easements and water rights. The Public Utility Commission of Texas (“PUC”) generally has jurisdiction over utilities.

Retail Public Utilities

Municipal Utility Districts (“MUDs”)
MUDs are conservation and reclamation districts created under the “Conservation Amendment” of the Texas Constitution (Art 16, Sec. 59) and are governed by Chapters 49 and 54 of the Texas Water Code (“TWC”). MUDs are intended to address the problem of modernizing older irrigation-type districts when suburban sprawl ramped up mid-20th century and are focused on providing water, wastewater and drainage services. MUDs are typically used by developers to finance the construction of water, wastewater, and drainage infrastructure through issuance of tax-exempt bonds on the open market or for purchase by the Texas Water Development Board. Creation of MUDs requires approval of the TCEQ or the Texas legislature. A MUD can be created by either (1) adoption of a district creation bill by the Texas Legislature or (2) by the TCEQ following a petition and consent process described in the TWC. For property located in a City’s jurisdiction, to be included in a MUD, City consent is required prior to creation as part of the TCEQ process; however, there are certain limitations to the conditions a city may place on its consent. MUD powers include authority over water and sewer service, water and sewer rates, solid waste, irrigation, parks and recreation, drainage, street and security lighting, enforcement of deed restrictions, eminent domain, annexation, and authority to retain peace officers. Once a developer creates a MUD, the MUD would then be managed by an elected board. A MUD, as a governmental entity, is also subject to the Texas Open Meetings Act¹, Texas Public Information Act², and Texas Election Code³.

Special Utility Districts (“SUDs”)
SUDs are also conservation and reclamation districts created under the Conservation Amendment. A SUD is governed by a board of not less than five (5) and not more than eleven (11) directors. A SUD’s powers include: (water) own, operate, maintain and improve, or extend inside and outside its boundaries any infrastructure that are helpful to supply water for municipal, domestic, power and commercial, and other beneficial purposes; (waste) collect, transport, process, dispose of, store, and control domestic, industrial, or communal wastes whether in fluid, solid, or composite state; (drainage) gather, conduct, divert, and control local storm water or other local harmful excesses of water in the district; irrigate land located within the district; alter land elevation in the district where it is needed; and (fire) provide fire-fighting services for the inhabitants. A SUD has no taxing authority, but does have rate-making authority. Like a MUD, a SUD has rate-making authority, which means that a board can set rates independently and absent approval from the PUC.

A SUD can be created by either (1) adoption of a district creation bill by the Texas Legislature or (2) by the TCEQ following a petition and consent process described in the TWC. Additionally, a WSC (defined herein) can be converted to a SUD by either the TCEQ or the Texas Legislature. Once a WSC has approval to convert to a SUD, a confirmation election is held. If the votes are canvassed and the election is successful, the SUD must submit evidence of the successful election to the TCEQ and PUC and the SUD is created. The PUC will update the SUD’s records, Certificate of Convenience and Necessity certificate, database information, and mapping information to reflect the conversion of the WSC to the SUD. Once a developer creates a SUD, the SUD would then be managed by an elected board. A SUD, as a governmental entity, is also subject to the Texas Open Meetings Act⁴, Texas Public Information Act⁵, and Texas Election Code⁶.

Water Control and Improvement Districts (“WCIDs”)
A WCID is created under Article 3, Sec. 52, or the Conservation Amendment. A WCID is governed by a five (5) member board elected by voters of a district. A WCID may establish fees and charges, levy and collect ad valorem property taxes for maintenance and operating expenses, and for debt service costs. Powers of a WCID include: the improvement of rivers, streams, creeks to prevent overflows, or to permit navigation or irrigation, the reclamation and irrigation of its lands, the reclamation, conservation, drainage, and development of its water and hydroelectric power, sewer service, provision of water for beneficial uses, annexation, and eminent domain. Additionally, a WCID is a governmental entity, and as such, is also subject to the Texas Open Meetings Act⁷, Texas Public Information Act⁸, and Texas Election Code⁹.

Water Supply Corporations (“WSCs”)
WSCs are non-profit water supply corporations organized under Ch. 67 of the TWC and Ch. 22 of the Texas Business Organizations Code. WSCs are not political subdivisions of the State, but are still subject to the Texas Open Meetings Act¹⁰ and Texas Public Information Act¹¹ and are governed by a member-elected board. WSCs have the authority to construct, own, maintain, and expand infrastructure necessary or helpful to provide adequate water service, sewer service, flood control, or drainage for a political subdivision. WSCs also have authorities similar to public utilities including: granted rights of way along public roads and other rights of way without requirement for surety bond or security and WSC agents may enter land to inspect, survey, or perform tests to determine condition of property (locations of works, improvements, plants, facilities, etc.). Additionally, a WSC may contract with certain entities to issue bonds secured by a contract entered into under Local Gov’t Code 552.014 – but interest rates are higher. Additionally, like a SUD, WSCs cannot levy ad valorem taxes and can set their own rates.

Private Utilities

Investor-Owned Utilities (“IOUs”)
IOUs are created not by the Texas Legislature or the TCEQ, but through a corporate formation filing. An IOU then would apply to obtain a Certificate of Convenience and Necessity from the PUC and a Public Water System from the TCEQ. Prior to changing rates, an IOU must submit a rate application for review, approval, and/or modification by the PUC. The challenge for IOUs is to design rates that cover their regular expenses and that allow for the opportunity to earn a reasonable rate of return on their investment without undercharging or overcharging customers. The PUC has original jurisdiction over rates and service policies of IOUs outside the corporate limits of a city. Inside the corporate limits of a city, the city has original jurisdiction to set the IOU’s rates, unless the city has surrendered its jurisdiction to the PUC. Additionally, if an IOU applies to a city to increase its retail rates charged to customers located inside a city’s corporate limits, then the IOU can appeal the city’s decision to the PUC. There are four different rate filing packages for IOUs in Texas. The utility’s classification (Class A, B, C or D) determines which application form the utility must use to apply for a rate increase with the PUC. To determine the classification of an IOU, the number of retail water connections or taps is used. If the utility provides only retail sewer service, then the number of sewer connections or taps is used to determine the classification of the utility.

Additionally, an IOU is not a governmental entity, and as such, is not subject to the Texas Open Meetings Act, Texas Public Information Act, and Texas Election Code. An IOU also cannot levy ad valorem taxes.

Evaluating the type of water and wastewater utilities can be a difficult undertaking. When faced with this choice, a developer may look to specific priorities (independent rate-making, reimbursement, the power to levy taxes, etc.) in determining the appropriate utility system structure.

¹TEX. GOV’T CODE § 551(3)(H).
²TEX. GOV’T CODE § 552.003(1)(A)(viii).
³TEX. ELECTION CODE § 1.005(13).
⁴TEX. GOV’T CODE § 551(3)(H).
⁵TEX. GOV’T CODE § 552.003(1)(A)(viii).
⁶TEX. ELECTION CODE § 1.005(13).
⁷TEX. GOV’T CODE § 551(3)(H).
⁸TEX. GOV’T CODE § 552.003(1)(A)(viii).
⁹TEX. ELECTION CODE § 1.005(13).
¹⁰TEX. GOV’T CODE § 551(3)(H).
¹¹TEX. GOV’T CODE § 552.003(1)(A)(viii).

David Klein is a Principal in the Firm’s Districts and Water Practice Groups. Lauren Binger is an Associate in the Firm’s Districts and Water Practice Groups. If you have any questions regarding creating a water and/or wastewater utility or other matters, please contact David at 512.322.5818 or dklein@lglawfirm.com, or Lauren at 512.322.5807 or lbinger@lglawfirm.com.