Public Land, Canceled Shares: First District Court Upholds Mutual Water Company Stock Rule

The First District California Court of Appeal has upheld a statutory rule that requires mutual water companies to cancel “appurtenant” shares held by public entities. The court rejected a constitutional challenge by City of Clearlake (City). This decision clarifies that public ownership of land served by a mutual water company does not necessarily carry continued shareholder rights, even where the public entity may continue receiving water at shareholder rates.

Background

In City of Clearlake v. Highlands Mutual Water Company, the California Court of Appeal, First Appellate District, Division One, issued its decision on July 7, 2026. The court reversed a Lake County Superior Court order granting the City of Clearlake (City) a preliminary injunction that required Highlands Mutual Water Company to reissue shares canceled under Corporations Code section 14300, subdivision (a). The Court of Appeal held that the statute, which requires cancellation of appurtenant mutual water company shares held by public entities, does not violate article XVI, section 17 of the California Constitution.

The City initially sued over an allegedly invalid board election and Highlands’s refusal to permit inspection of corporate records. After the trial court invalidated the election, Highlands canceled shares appurtenant to property owned by governmental agencies, including the City’s shares. Highlands cited section 14300 and stated that it would continue selling water to the City at shareholder rates. The City sought interim relief, contending that cancellation impaired its shareholder rights and conflicted with the Constitution.

Mutual Water Companies and Section 14300

A mutual water company distributes water only to shareholders, whose shares represent proportional rights to available water. Appurtenant shares are attached to specific land, pass automatically with the land, and may be used only for that land’s benefit. Non-appurtenant shares are personal property comparable to ordinary corporate stock.

Section 14300 continues a statutory framework dating to 1935. It requires the secretary of a qualifying mutual water company to cancel appurtenant shares held by the state, school districts, and other public agencies. The company may nevertheless sell water to those entities at the same rates charged to shareholders. The court treated the cancellation duty as mandatory and self-executing.

At the Trial Court

Article XVI, section 17 generally prohibits public entities from holding private corporate stock, but permits them to acquire and hold stock in a mutual water company when held for the purpose of furnishing water for public, municipal, or governmental purposes. The City argued that using water on municipal property, including a community splash pad, brought its shares within that exception.

The trial court agreed and found section 14300 unconstitutional as applied. It ordered Highlands to reissue the shares, reasoning that the City was likely to prevail on the constitutional question. On appeal, the constitutional ruling was reviewed de novo. The appellate court also examined whether the trial court had properly applied the two preliminary injunction factors: likelihood of success and relative interim harm.

Interpreting the Constitutional Exception

The Court of Appeal held that section 17 can reasonably be read to protect stock ownership when a public entity acts as a water purveyor, rather than when it merely consumes water on its own land. The phrase “furnishing a supply of water,” the court reasoned, ordinarily implies affirmative action to provide, distribute, or deliver water. Under that construction, the exception applies when a public agency secures water and distributes it throughout the territory it serves for public purposes.

Appurtenant shares operate differently. A public entity acquires them automatically with the land, and the associated water may be used only for the parcel’s benefit. In that setting, the public entity is a consumer, while the mutual water company furnishes the water. Even when a parcel contains a public facility, the public entity furnishes the facility or municipal service, not the water itself.

The court also relied on constitutional history and rules favoring harmonization. Earlier constitutional provisions expressly protected stock ownership incident to land ownership when the electorate intended to include appurtenant shares. Comparable language was omitted from the provision that became section 17. The statutory cancellation rule also predates the current constitutional language. Because voters are presumed aware of existing law, the court found it reasonable to conclude that section 17 and section 14300 were intended to operate together.

The court acknowledged that the City’s interpretation was linguistically possible. That was insufficient to invalidate the statute. Legislation is presumed constitutional and may be struck down only when a conflict is clear and unquestionable. Because Highlands’s interpretation was possible, practical, and consistent with the historical framework, the City did not carry its burden.

Delegation Challenge and Disposition

The City separately argued that section 14300 violated article XI, section 11 by delegating to a private company authority to interfere with municipal property. The court rejected that claim. Public ownership of private stock implicates a statewide constitutional policy, not a purely local concern. Further, the company secretary exercises no policy discretion because the statute requires cancellation of all qualifying shares.

The court reversed the preliminary injunction and remanded for further proceedings. It did not direct judgment for Highlands on the remaining action. The trial court must reconsider preliminary relief under the correct constitutional analysis and evaluate both likelihood of success and the parties’ relative interim harms.

Conclusions and Implications

The decision provides significant guidance for public agencies and mutual water companies involved in land transactions. A public entity acquiring land with appurtenant shares should not assume it will retain voting, inspection, governance, or other shareholder rights. Section 14300 requires cancellation, although the public entity may continue purchasing water at shareholder rates.

Transaction counsel should determine whether shares are appurtenant, whether the company’s governing documents and recorded instruments satisfy section 14300, and whether the agency’s water need is parcel-specific or part of a broader public water-supply function. The distinction is material because section 17 may still allow a public entity acting as a water purveyor to hold non-appurtenant shares.

This article was originally published in the September 2026 edition of the California Water Law & Policy Reporter. It is posted here on our website with the permission of California Water Law & Policy Reporter, Argent Communications Group, Argent & Schuster, Inc., and the author, Darien Key. All rights remain with the original publisher.

Darien Key is a Land Use and Natural Resources Attorney based in Oakland. Darien’s practice focuses on Land Use entitlement (such as the Subdivision Map Act, Housing Accountability Act, and Builder’s Remedy), CEQA (California Environmental Quality Act), municipal law (such as the Brown Act, Public Records Act, Conflicts of Interest, etc.), water (SGMA compliance and groundwater adjudications), and related environmental laws both on the transactional side but also in litigation. He can be reached at dkey@fennemorelaw.com.