SUD Conversion: A Hail Mary for WSCs

by Danielle Lam

While the population in Texas hit 30 million in 2022, the State’s water supplies are struggling to keep up with the growth.¹ The Texas Water Development Board’s (“TWDB”) 2022 State Water Plan predicts that in the next five decades, the State’s water needs will exceed existing supplies as the demands for water for municipal use continue to grow.² Many wholesale and retail water providers are working on regional water supply projects to meet these growing demands, and these projects are often funded by low-interest state or local bonds.

However, non-profit water supply corporations have limited access to these projects due to federal law limiting the tax-exempt financing of “private activities.” Under 26 U.S.C. § 141, a bond is considered a private activity bond if more than ten percent of its proceeds are used for private business purposes, and if either the principal or interest on more than ten percent of the bond’s proceeds is directly or indirectly secured by, or payments are derived from, a private business use. Therefore, water supply projects funded by tax-exempt bonds often cap the participation of non-profit water supply corporations (“WSC”) at ten percent to avoid jeopardizing the tax-exempt status of the bonds. If there are multiple WSCs participating, then those WSCs must split that ten percent.

There are over 750 active WSCs in Texas, many of which are located in the fast-growing counties surrounding Austin, Dallas, Fort Worth, Houston, and San Antonio. Some of these WSCs may be feeling the pressure of the exponential demand in service, but may be unable to increase their water supplies due to limited access to regional water projects and/or limited financing options. This is where special utility districts (“SUD”) play a role. Under Chapter 65 of the Texas Water Code (“TWC”), a WSC may apply to the Texas Commission on Environmental Quality (“TCEQ”) or submit a bill to the State Legislature to convert into a SUD.

WSCs and SUDs share many similarities. They are both subject to the Texas Open Meetings Act and Public Information Act, may have eminent domain authority, cannot levy ad valorem taxes, may be exempt from sales and property taxes, and may set their own rates.

But as a government entity, SUDs are not limited to only ten percent of regional water supply projects financed by tax-exempt bonds. Further, SUDs can issue their own tax-exempt revenue bonds or apply for a loan from the TWDB at tax-exempt rates. Other perks include eligibility for the Texas Municipal League Intergovernmental Risk Pool, Texas Counties and Districts Retirement System, and TexPool, as well as governmental immunity. SUDs may also serve customers inside or outside of the SUD’s jurisdictional boundaries as long as the customer is not in another certificate of convenience and necessity. Lastly, only out-of-district customers can appeal a SUD’s rates or fees at the Public Utility Commission of Texas. On the other hand, SUDs are subject to federal and state election laws, public procurement and contract laws, the Public Funds Investment Act, and Chapter 395 of the Local Government Code regarding impact fees.

Interested WSCs can file a conversion application at TCEQ, which first requires a two-thirds vote of the WSC’s membership. Also, if the boundaries of the proposed SUD overlap with a municipality, then the WSC needs to submit proof of the municipality’s written consent. TCEQ will review the application to ensure it meets the criteria in TWC Chapter 65 and it may even conduct a hearing on the application. Alternatively, WSCs can work with a State Legislator to sponsor and carry a bill during a Legislative Session. The 2025 Legislative Session begins on January 14, 2025, and state legislators may begin filing bills on November 11, 2024, so WSCs interested in the legislative route should start taking action now.

However, SUD conversion is a multi-phase process, and obtaining a final TCEQ Order or enabling legislation is only the first part. Once a SUD is created it still needs to hold a confirmation election, subject to the Election Code, to confirm the district’s creation and the permanent board of directors. Then, if the SUD was created by a bill from the Texas Legislature, the WSC must hold a meeting of its membership to vote on the dissolution of the WSC and conveyance of assets and debts. The SUD also needs to organize itself and submit regulatory compliance filings and create service and personnel policies in order to begin operations. Lastly, the WSC must wind up its business and convey all of its assets and debts to the SUD, which may be complicated if the WSC has loans, real property, and/or contracts to assign. Ultimately, although SUD conversion may sound like a daunting process, the benefits—especially access to regional water supply projects and better financing options—may be worth the effort for many WSCs.

¹U.S. Census Bureau, Texas Population Passes the 30 Million Mark in 2022 (Mar. 30, 2023), https://www.census.gov/library/stories/2023/03/texas-population-passes-the-30-million-mark-in-2022.html.

²Texas Water Development Board, Texas State Water Plan, https://texasstatewaterplan.org/statewide (last visited Oct. 13, 2024). Texas Public Utility Commission, Water Utility Search, https://www.puc.texas.gov/watersearch (last visited Oct. 13, 2024).

Danielle Lam is an Associate in the Firm’s Districts, Water, and Energy and Utility Practice Groups. If you have questions or would like additional information related to this article or other matters, contact Danielle at 512.322.5810 or dlam@lglawfirm.com.