United States: Developer’s Lease Agreement With City Not Protected By Vested Rights Doctrine

In a decision underscoring the importance of development agreements and vested rights, a California Court of Appeal has held that an oil developer’s oil and gas lease with a city was not protected under the vested rights doctrine from a subsequent voter initiative banning oil drilling.

In Hermosa Beach Stop Oil Coalition v. City of Hermosa Beach, an oil exploration company had entered into an oil and gas lease with the City of Hermosa Beach to allow the company to develop an oil drilling and production site on a parcel owned by and located in the City. The lease required the developer to comply with all applicable laws and expressly stated that the developer was required to obtain all necessary permits and approvals prior to construction and drilling. At the time of lease execution, applicable City ordinances allowed oil and gas operations on the leased parcel under a City permit system. The developer proceeded to secure entitlements for its project, completing an environmental impact report and several land use approvals.

Despite the investment of time and "soft costs" on these entitlements, and after weathering two separate lawsuits in connection with these approvals, the developer faced an additional hurdle that proved insurmountable. The voters of the City passed Proposition E, an initiative that banned oil and gas operations on the leased parcel. At the time Proposition E passed, the developer had not obtained necessary building and drilling permits from the City. Litigation ensued.

The Court held that the developer had not acquired any vested rights to drill, and, accordingly, the project was subject to the initiative. Relying on well-established law, the Court found that the developer had not obtained all final permits and had not expended significant "hard costs" in reliance on those permits. Furthermore, Proposition E was a legitimate exercise of the City’s police powers and was not an unconstitutional impairment of the lease agreement. The Court pointedly emphasized that the developer could have protected itself by either entering into a development agreement with the City or by bargaining for a lease provision allocating the risk of a change in law.

For all developers, this case serves as an important reminder of the significance of contractual provisions and separate development agreements as means of handling the risks of subsequently enacted laws affecting a project.