A lawsuit challenging a Southern California water agency's purchase of a private water company has been reinstated by the Second District Court of Appeal. The unanimous three-judge appellate panel ruled that Los Angeles Superior Court Judge Dzintra Janavs did not consider all the questions before her when she ruled that the Castaic Lake Water Agency could acquire the Santa Clarita Water Company. If the water company became the alter ego of the public water agency, the transaction would violate state law, the court held. Because the lower court did not decide that question, the appellate panel returned the lawsuit for further proceedings. The Legislature created the Castaic Lake Water Agency to acquire water and water rights, and to provide that water at wholesale only. The agency sells water to four utilities in the Los Angeles County's fast-growing Santa Clarita Valley, including the sight of the proposed 21,000-home Newhall Ranch subdivision. The provision of water to Newhall Ranch is a central issue in ongoing litigation over the project. The Santa Clarita Water Company is the largest utility served by the Water Agency. The company has 21,000 customers, as well as rights to 15,000 acre feet of groundwater. On August 11, 1999, the Water Agency approved a retail service agreement with the company. Under Water Code § 12944.7, a wholesale water agency can sell water directly to consumers if the agency has a contract with a company that is subject to Public Utilities Commission (PUC) regulation. The Water Agency said it was following that law, which overrode the original act that created the Agency. The next day, the Water Agency filed a notice in court to condemn and acquire all outstanding stock in the Santa Clarita Water Company. On August 23, four residents from the Water Agency's territory filed suit on various grounds to halt the transaction. But the deal went forward anyway, and by September 3, the Water Agency had acquired all shares of the company for $63 million in cash. Afterward, the Water Agency wound up the company's business, dissolved the corporation, distributed the assets to the Agency, and accepted the resignation of three company directors and the secretary. When the residents who protested the transaction got a court hearing, they argued that the transaction merged the two entities into one, in violation of § 12944.7. They also contended that there was no longer a company subject to PUC regulation, so the retail service agreement approved in August no longer complied with § 12944.7. The Water Agency argued that the company is subject to PUC regulation, but denied that § 12944.7 requires the company to remain subject to PUC control during the life of the retail service contract. Judge Janavs ruled that § 12944.7 overrode the legislative act that created the Water Agency. The appellate panel concurred with Janavs regarding the applicability of § 12944.7. The appellate panel also said the Water Agency had the authority to take through eminent domain "any facility reasonably required for the importation and transmission of water." However, the appellate court ruled that the Water Code requires an arm's length contract between two separate entities. "[T]o comply with § 12944.7, whenever a wholesaler agency sells water directly to the consumer, it must be doing so pursuant to a contract with a water company that exists as an entity, be it a wholly owned subsidiary or otherwise, independent from the wholesaler agency," Justice Richard Aldrich wrote. "For these same reasons, we also conclude that a water company, with whom the wholesaler agency contracts, must remain subject to PUC regulation throughout the life of the contract. The Agency argued that there is no 'continuing obligation to be regulated by the PUC' once the transaction is closed. We reject this 'nanosecond' argument because it renders § 12944.7's requirement of PUC regulation pointless and surplusage." Because the trial court did not address whether the company continues to exist as a separate entity subject to PUC regulation, the appellate court did not rule on the question. Instead, it directed the Superior Court to consider the issue. But the appellate court clearly had concerns. "[I]f at any point the Agency actually merged with the Water Company or the Water Company became the alter ego of the Agency ... the Agency would no longer have a contract pursuant to § 12944.7 by which it could sell or deliver water at retail without violating its own enabling act, Aldrich wrote The Case: Jill Klajic v. Castaic Lake Water Agency, No. B137258, 01 C.D.O.S. 6194, 2001 DJDAR 7567. Filed July 20, 2001. The Lawyers: For Klajic: Jennifer Kilpatrick, (323) 852-1000. For the agency: Robert H. Clark, general counsel, (661) 297-9132.