Can an Arkansas city use city general funds to pay for water and sewer upgrades to a system that serves both residents and nonresidents?

Plain-English summary

State Representative John Baine asked the AG a question that comes up routinely in Arkansas towns that operate their own water and sewer systems: can the city pay for system upgrades out of general revenue (sales taxes, franchise fees, property taxes), or does the system have to fund itself out of user rates? The added wrinkle here was that the system served customers outside the city limits as well as residents.

AG Leslie Rutledge framed the answer in two pieces. The geographic part was easy: under A.C.A. § 14-234-110 and § 14-234-111, cities can extend water and sewer service beyond their corporate limits, and the same legal principles govern funding whether the customer is inside or outside the city. Inside-out is not its own legal category for these purposes. (A separate provision, § 14-234-110(a)(3), lets cities charge nonresidents at different rates than residents, but that goes to rate-setting, not the source of funds for capital improvements.)

The funding part was harder. The statutes governing municipal water systems (§ 14-234-214) and sewer systems (§ 14-235-223) tell cities to set rates "sufficient" or "adequate" to cover the cost of operating and maintaining the system. The water statute specifically directs that rates "[p]rovide an adequate depreciation fund and . . . the operating authority's estimated cost of operating and maintaining the waterworks system." The sewer statute requires rates "sufficient in each year for the payment of the proper and reasonable expense of operation, repair, replacements, and maintenance." A nonresident-extension statute, § 14-234-111(a), authorizes service extensions outside corporate limits "where the demand for services is sufficient to produce revenues that will retire the cost of such service lines."

The general drift of those provisions is that the system should pay for itself out of user rates. But, the AG concluded, none of them goes the next step and forbids a city from putting general revenue into the system on top of user rates. If the city has set its rates in good faith to recover the system's actual costs, layering in general revenue for additional improvements is not statutorily prohibited.

The opinion stops short of a flat yes. The AG noted that "the specific facts will ultimately be controlling," and that a different fact pattern (rates set artificially low to subsidize service from general revenue, in a way that effectively cross-subsidized one class of customers from another) might raise different legal questions. The opinion is therefore best read as "no general-law bar to using city general funds for water and sewer improvements, provided rates are set in good faith."

Currency note

This opinion was issued in 2015. Subsequent statutory amendments, court decisions, or later AG opinions may have changed the analysis. Treat this page as historical context, not current legal advice. Verify current law before relying on any specific rule, deadline, or remedy mentioned here.

Background and statutory framework

Arkansas cities that own water or sewer works operate them under Title 14 of the Arkansas Code. Three provisions framed the analysis here:

A.C.A. § 14-234-214 governs municipal waterworks rates. Subsection (a) requires the city's legislative body to set rates for resident and nonresident consumers. Subsection (b)(3) requires the rates to "[p]rovide an adequate depreciation fund and . . . the operating authority's estimated cost of operating and maintaining the waterworks system."

A.C.A. § 14-235-223 governs sewer rates. Subsection (a)(1) requires the city council to establish "just and equitable rates or charges for the use of and the service rendered by the works." Subsection (b) requires those rates to be sufficient annually "for the payment of the proper and reasonable expense of operation, repair, replacements, and maintenance of the works."

A.C.A. § 14-234-110 and § 14-234-111 govern extension of water and sewer service to areas beyond city limits. Section 14-234-110(a)(3) says nonresident rates "need not be the same as the rates charged residents of the municipality." Section 14-234-111(a) says extensions may be made "where the demand for services is sufficient to produce revenues that will retire the cost of such service lines."

The Arkansas Supreme Court's decision in City of Little Rock v. Chartwell Valley Limited Partnership, 299 Ark. 542 (1980), confirms that cities have authority to extend service beyond their corporate limits.

Op. Att'y Gen. 2002-230 (cited in this opinion) discusses guiding principles for the rate differential between resident and nonresident customers.

Common questions

Can a city use general fund money to pay for upgrades to its water plant?

According to this opinion, yes, as a matter of general state law. The statutes governing municipal water and sewer rates require rates to be sufficient to cover operation and maintenance, but they do not forbid a city from supplementing system revenues with general fund money for additional improvements. The opinion's caveat is that this analysis assumes rates have actually been set in good faith based on the estimated cost of operating the system. A city that artificially understates its operating costs to keep rates low and then makes up the difference from general revenue might face a different analysis.

Does it matter if the system serves customers outside the city limits?

No. The AG concluded the basic analysis is the same regardless of whether the upgrade benefits residents or nonresidents. Cities can extend service beyond their corporate limits under § 14-234-111, and the rate-setting framework already permits different rates for residents and nonresidents. Whether to use general revenue for improvements is a separate question from the geographic scope of service.

Can the city charge nonresidents higher rates than residents?

Yes. A.C.A. § 14-234-110(a)(3) explicitly authorizes that. Rates for nonresident water customers "may deem just and reasonable, and the rates need not be the same as the rates charged residents of the municipality." This is consistent with the city's contractual right to set the terms of voluntary service extensions to areas outside its jurisdiction. Op. Att'y Gen. 2002-230 discusses what amount of rate differential is defensible.

Does this opinion let a city raise general taxes to subsidize water service?

The opinion does not directly address that question. It allows general fund money to be used for water and sewer improvements where rates have already been set to cover operating and maintenance. Raising new general taxes to subsidize water service would raise separate questions about the tax authorization, the city's general taxing powers, and any applicable election requirements.

What kind of "upgrades" did the AG have in mind?

The opinion uses the term "upgrades" interchangeably with "improvements," which the AG understood to mean capital improvements to the system rather than ordinary operation and maintenance. The statutory rate-setting provisions cover operation, maintenance, and depreciation; the AG's analysis was that additional capital improvements above and beyond those baseline costs can be supported with general revenue without violating the statutes.

What facts could change the analysis?

The AG's deliberate framing ("the specific facts will ultimately be controlling") points to several fact patterns that could change the result. Rates set well below operating cost (forcing chronic reliance on general revenue and effectively cross-subsidizing); use of general revenue in a way that gives some users a benefit not given to others; statutory limits on the city's general fund spending that the proposed transfer would breach. Any city contemplating this kind of funding should check its rate-setting record, the city's general fund authority, and any bond covenants or grant conditions on the underlying system.

Citations

Core water statutes: A.C.A. § 14-234-110 (extension to nonresident customers); § 14-234-110(a)(3) (different rates for nonresidents); § 14-234-111 (extension of service lines); § 14-234-111(a) (extension where revenues will retire cost); § 14-234-214 (rate setting); § 14-234-214(b)(3) (rates to cover estimated cost of operation and maintenance).

Sewer statutes: A.C.A. § 14-235-223 (rate setting); § 14-235-223(b) (rates to cover reasonable expense of operation, repair, replacements, and maintenance).

Case: City of Little Rock v. Chartwell Valley Limited Partnership, 299 Ark. 542 (1980).

Prior AG opinions: Op. Att'y Gen. 2002-230 (resident/nonresident rate differential).

Source

• Landing page: https://arkansasag.gov/divisions/opinions-foia/attorney-general-opinions-search/

Original opinion text

Opinion No. 2015-006
March 13, 2015
The Honorable John Baine
State Representative
Post Office Box 10056
STATE OF ARKANSAS
THE ATTORNEY GENERAL
LESLIE RUTLEDGE
El Dorado, Arkansas 71730-0022
Dear Representative Baine:

This is in response to your request for my opinion on the following question:

May a city use city general funds to pay for water and
sewer upgrades to the city system that includes
customers inside and outside the city limits?

RESPONSE

This question does not lend itself to a simple "yes" or "no" because the answer
will depend upon an analysis of the particular surrounding facts. While I
consequently cannot offer a definitive response to your inquiry, I will review some
of the generally applicable law in an effort to assist in framing the relevant legal
and factual issues.

As an initial matter, according to my review of the various statutes that may bear
on this question, the analysis is essentially the same regardless of whether the
city's water or sewer system includes both resident and nonresident customers.
Accordingly, if the concern is that the city may be foreclosed from using general
funds for "upgrades" based upon the fact that the system services nonresidents, I
believe that concern is unfounded. The same basic principles come into play when
addressing the matter of funding the cost of serving those inside and outside city
limits.

The law generally contemplates that the rates for resident and nonresident
consumers of a municipal waterworks or sewer system will be sufficient to pay for
installing and maintaining the system. The statutes governing municipal
waterworks systems provide in relevant part:

(a) Rates for resident and nonresident consumers of a municipal
waterworks system shall be fixed by the legislative body of the
municipality.
(b) The rates to be charged by the municipality must be adequate to:

(3) Provide an adequate depreciation fund and to
provide the operating authority's estimated cost of
operating and maintaining the waterworks system.

The statutes applicable to municipal sewage systems similarly provide:

(a)(1) The council of the municipality shall have the power, and it
shall be its duty, by ordinance to establish and maintain just and
equitable rates or charges for the use of and the service rendered by
the works, to be paid by each user of the sewerage system of the
municipality. . . .
(b) The rates or charges shall be sufficient in each year for the
payment of the proper and reasonable expense of operation, repair,
replacements, and maintenance of the works. . . .

A statute addressed specifically to servicing areas outside corporate limits also
similarly contemplates rates being sufficient to cover the cost of the extension:

Any municipality in the State of Arkansas owning and operating a
municipal waterworks system or a municipal sewer system or both
may extend its service lines beyond its corporate limits for the
purpose of giving water service, sewer service, or both, to adjacent
areas where the demand for services is sufficient to produce
revenues that will retire the cost of such service lines. . . .

As a general rule, based on these statutes, a city is expected to fund its water and
sewer systems through system revenues. However, these statutes do not, in my
opinion, impliedly proscribe devoting general revenues to those systems.
Assuming that rates have been set in good faith, based on the "estimated cost" of
the water system and "reasonable expense" of the sewer system, I see no reason
to think a city is generally foreclosed from using its general funds for
improvements. As indicated above, I believe this conclusion pertains regardless of
whether the improvements will benefit customers inside or outside city limits.

I cannot opine further because the specific facts will ultimately be controlling of
any issues surrounding the funding of a city's water or sewer system. While I am
unable to definitively answer your question, the foregoing will hopefully be of
assistance in identifying what I believe are the most relevant general guiding
principles in this area of the law.

Deputy Attorney General Elisabeth A. Walker prepared the foregoing opinion,
which I hereby approve.

Sincerely,

Attorney General
LR/EAW:cyh