What is Water on or in Real Property in California?

In the appeal in the recent case of Sandton Agriculture Investments, III, LLC, vs. 4-S Ranch Partners, LLC, a borrower that lost its 5,257-acre ranch in a nonjudicial foreclosure sale asked the appellate court to be the first California appellate court to recognize that water in an aquifer can be personal property.

The borrower contended approximately 500,000 acre-feet of captured floodwaters stored in the aquifer under the ranch is personal property that it still owns because the foreclosure sale transferred only real property to the lender.

The lender disagreed, contending it acquired the rights to the water because those rights were appurtenant to and ran with the land.

To resolve the dispute, the lender filed a declaratory relief action. 

The trial court granted the lender's motion for summary adjudication, concluding (1) the water was not personal property owned by borrower and (2) the rights to use of the water ran with the land and, thus, the lender acquired those rights at the foreclosure sale.

The appellate court agreed.

Under California water law, allowing water to seep into an aquifer changes its legal classification to percolating groundwater, regardless of whether it was previously classified as floodwater or personal property. Percolating groundwater is in a “natural state” and, as such, “is part of the land.”

Thus, summary adjudication of the lender's declaratory relief claim was proper.

In the unpublished part of its opinion, the appellate court concluded the trial court properly sustained the lender's demurrers to the seven causes of action alleged in the borrower's cross-complaint.

Plaintiffs and cross-defendants Sandton Credit Solution Master Fund IV, LP and Sandton Agricultural Investments III, LLC, a Delaware limited liability company, are referred to collectively as Sandton in the opinion.

Defendant and cross-complainant 4-S Ranch Partners, LLC (4-S) is a Delaware limited liability company, and it has been the sole managing member of 4-S since its formation in 2013.

In 2009, another company owned and operated by Sloan, Merced Falls Ranch, LLC, paid $11.5 million for land consisting of 17 assessed parcels and containing approximately 5,257.46 acres (Land) and related interests.

In 2013, 4-S acquired legal title to the Land and related interests.

In October 2019, the Land and attached improvements (described as a modest set of corrals) were appraised at $14,985,000. The appraisal was commissioned by Sandton and excluded any subsurface water or mineral rights.

In August 2017, Sandton loaned 4-S approximately $33 million. Sandton and 4-S executed a loan agreement defining their rights and obligations related to the loan. 4-S secured the loan by executing a “DEED OF TRUST, SECURITY AGREEMENT, AND FIXTURE FILING WITH ASSIGNMENT OF RENTS AND PROCEEDS, LEASES, AND AGREEMENTS” (Deed of Trust) granting Sandton the benefit of all of 4-S's right, title and interest in various property.

The collateral included the Land, improvements, leases, rents and proceeds, and “Water Rights” (Property).

The term “Water Rights” was defined as “all of [4-S's] right, title and interest in all water (including any water inventory in storage), water rights and entitlements, other rights to water and to receive water, and water rights of every other kind or nature, that serve the Land, including, without limitation, stored water, groundwater, surface water, riparian rights, drainage rights, and all rights to obtain water from governmental water district and non-governmental water companies including rights under groundwater sustainability or management plans and related judicial or administrative decisions.”

In August 2018, 4-S defaulted on its obligations under the loan agreement. The parties entered into a series of forbearance agreements, the last of which expired near the end of February 2020.

During the time of forbearance, Sandton obtained the October 2019 appraisal described earlier. In February 2020, 4-S failed to pay the sums due and Sandton proceeded with a nonjudicial foreclosure under the Deed of Trust. 

On March 2, 2020, 4-S stopped the foreclosure by filing a voluntary bankruptcy petition under title 11 of the United States Bankruptcy Code, which invoked an automatic stay. (See 11 U.S.C. § 362(a).)

Sandton filed a motion for relief from the automatic bankruptcy stay. 4-S's opposition stated the Deed of Trust “includes a security interest in the 4-S Property's water rights” and the value of those rights was a material part of the equity analysis for determining if relief from the automatic stay was appropriate.

The March 31, 2021 deadline established by the parties' stipulation expired without 4-S making the required payments. As a result, Sandton proceeded to enforce its rights under the Deed of Trust.

The trustee sent 4-S a “Notice of Trustee's Sale” dated April 1, 2021, stating 4-S was in default under the Deed of Trust, the unpaid amount was slightly over $70 million, and the trustee's sale would be held at 12:30 p.m. on April 29, 2021, at the west entrance of the Merced County Courts Building.

At the April 29, 2021 nonjudicial foreclosure sale, Sandton submitted a successful credit bid of $20 million. On May 5, 2021, a trustee's deed upon sale listing Sandton as the grantee was recorded by the Merced County Recorder.

The trustee's deed stated the amount of unpaid debt was $60,856,264.58; the purchase amount paid by Sandton (the foreclosing beneficiary and grantee) was $20 million; all right, title and interest held by the trustee under the Deed of Trust in the property described thereafter was granted and conveyed to Sandton; and the conveyance was made in compliance with the terms of the Deed of Trust.

In August 2021, Sandton filed a complaint for declaratory relief seeking an order stating 4-S had no ongoing interest in the Property, including any associated water rights (regardless of how characterized), and Sandton was the rightful owner of all rights, title and interest in all water, including any water inventory in storage, relating to the Property.

In July 2022, Sandton filed a motion for summary adjudication of its declaratory relief claim.

Sandton's moving papers asserted 4-S conveyed all water rights as part of the Property included in the Deed of Trust, the water rights constituted real property that ran with the land, and the nonjudicial foreclosure passed the water rights to Sandton.

The court granted Sandton's motion for summary adjudication of the declaratory relief cause of action.

The court concluded “that, absent evidence of a physical severance of water from land, any interest or right to water that has percolated into the soil beneath a given parcel of land, is real property” and 4-S had failed to establish a triable issue of material fact as to whether the water in question had been physically severed from the Property.

It is laid down by our law writers, that the right of property in water is usufructuary, and consists not so much of the fluid itself as the advantage of its use. Hence, the cases do not speak of the ownership of water, but only of the right to its use.

The right to use water is limited by the California Constitution “to reasonable and beneficial use[s].” (Cal. Const., art. X, § 2)

Accordingly, holders of water rights may take and use water, but they do not own the water and cannot waste it.

A water right itself has been considered an interest in real property. It is also sometimes described as a right appurtenant to or part and parcel of’ an interest in real property.

Notwithstanding the foregoing principles, there is a sense in which discrete quantities of water can be owned.

For example, one who purchases a container of Arrowhead Puritas water then owns five gallons of California water because water severed from the land becomes personal property which may be bought and sold like any other commodity.

But in its natural state, water is certainly not subject to ownership by an individual.

The constant circulation of water molecules on this planet is referred to as the hydrologic cycle. 

As part of this cycle, water molecules in the atmosphere condense into precipitation that falls as rain or snow and then evaporates, runs off the earth's surface into watercourses, or seeps into the ground.

The hydrologic cycle is continuous so all sources of water are interrelated.

Water law divides the continuous hydrologic cycle into discrete segments and categorizes water by its source. The categories are artificial because the water within a category is in a temporary phase that is part of a perpetual cycle.

This brief description of the hydrologic cycle is background for the point that water law's characterization of particular water molecules changes as those molecules move through the cycle. A nonexclusive list of the categories of water recognized by the law include (1) diffused surface water, (2) stream water, (3) floodwater, (4) percolating groundwater and (5) personal property.

Diffused surface waters are defined by the California Supreme Court as waters that “fall on the land by precipitation from the skies or arise in springs and spread over the surface of the ground without being collected into a definite body.”

More recently, the court stated: “Water diffused over the surface of land, or contained in depressions therein, and resulting from rain, snow, or which rises to the surface in springs, is known as ‘surface water.’ It is thus distinguishable from water flowing in a fixed channel, so as to constitute a watercourse, or water collected in an identifiable body, such as a river or lake.”

Essential characteristics of diffused surface waters are short-lived flows that are not concentrated or confined in what the law recognizes as a watercourse or body of water, such as a pond or lake.

Diffused surface waters retain that classification “until, in obedience to the laws of gravity, they [1] percolate through the ground or [2] flow vagrantly over the surface of the land into well defined watercourses or streams.”

This principle illustrates how water can change legal categories, and it shows diffused surface waters lose their characterization as such when they percolate through the ground.

Once diffused surface waters have become part of a stream in a watercourse, they are no longer recognized as [diffused] surface waters.

A natural watercourse is a channel with defined bed and banks made and habitually used by water passing down as a collected body or stream in those seasons of the year and at those times when the streams in region are accustomed to flow. It is wholly different from a swale, hollow, or depression through which may pass surface waters in time of storm not collected into a defined stream.

Floodwater refers to the extraordinary overflow of rivers and streams. Flood waters are distinguished from diffused surface waters by the fact that the former have broken away from a stream, while the latter have not yet become part of a watercourse.

The general classifications of underground waters in California are (1) the underflow of surface streams, (2) definite underground streams, and (3) percolating waters.

Percolating waters move through the soil, do not move in an underground stream, and generally are found in a basin under the ground.

A subsurface stream only avoids classification as percolating water if the course of the stream is known and definite.

In the appeal, the appellate court was only concerned only with the water classified as percolating groundwater. No one contended the water claimed by 4-S as personal property should be classified as either the underflow of a surface stream or part of a definite underground stream.

Courts typically classify water rights in an underground basin as overlying, appropriative, or prescriptive. Sandton contended it is the overlying landowner and, in that capacity, holds rights to the disputed water. The overlying right, like the riparian right, is associated with the ownership of land.

The trial court interpreted California water law to mean a former landowner does not have an ongoing personal property interest in water that has not been severed from the land.

Applying this and other legal principles, the court concluded the rights to the water associated with the Property were appurtenant to the real property (not personal property) because 4-S (1) never exercised dominion and control over the water and (2) never physically severed the water from the real property.

Based on this rationale and the alternate ground of judicial estoppel barring 4-S's personal property arguments, the trial court determined Sandton was entitled to judgment as a matter of law on its declaratory relief cause of action.

4-S contended the floodwater it captured and stored before the foreclosure is personal property and, as such, the lien created by the Deed of Trust never attached to 4-S's rights or interests in the water. Stated another way, 4-S argued the controlled flood flows over which 4-S exerted dominion and control are a personal property commodity owned by 4-S.

4-S also argued the trial court erred in concluding the water could not be personal property unless it was severed from the land, asserting: “It is unnecessary that the water be ‘severed’ from the real property, as it was never part of the real property.”

Based on these arguments, 4-S concluded the trial court mischaracterized 4-S's rights or interests in the floodwater.

The broad issue is whether the water claimed by 4-S is properly classified as personal property or, alternatively, 4-S's rights and interests in the water were appurtenant to the Property and ran with the land.

To resolve this broad issue, the appellate court considered three specific questions of law.

First, does the person capturing floodwater own the captured water as personal property.

Second, assuming the captured floodwater was personal property, did the water retain the personal property classification after it was allowed to seep into the ground?

Third, under California water law, can the water in question be classified as personal property when it is not severed from the real property?

The appellate court answered these questions “no”.

In summary, the trial court properly rejected 4-S's argument that the water in question was personal property water and concluded the rights to the water were “appurtenant to or part and parcel of an interest in real property.”

Consequently, the court did not err when it granted Sandton's motion for summary adjudication of its declaratory relief cause of action.

LESSONS 

1.         Under California water law, allowing water to seep into an aquifer changes its legal classification to percolating groundwater, regardless of whether it was previously classified as floodwater or personal property. Percolating groundwater is in a “natural state” and, as such, “is part of the land.”

2.         The right to use water is limited by the California Constitution “to reasonable and beneficial use[s].” (Cal. Const., art. X, § 2)

3.         In its natural state, water is certainly not subject to ownership by an individual.

4.         Water law divides the continuous hydrologic cycle into discrete segments and categorizes water by its source. The categories are artificial because the water within a category is in a temporary phase that is part of a perpetual cycle.

5.         Courts typically classify water rights in an underground basin as overlying, appropriative, or prescriptive. Sandton contended it is the overlying landowner and, in that capacity, holds rights to the disputed water. The overlying right, like the riparian right, is associated with the ownership of land.