Auction revenue is a key funding source for a high-speed rail project seeking to link Los Angeles and San Francisco by train. It also generates billions for transit construction and energy conservation efforts.
California and the Canadian province of Quebec, which have linked their cap-and-trade auctions, operate the world's only economy-wide limit on emissions, said Alex Jackson, an attorney for the Natural Resources Defense Council, which is defending the program.
"For a jurisdiction as large as California, that's not small potatoes," Jackson said. "This lawsuit strikes at the heart of how this program is operated."
Cap-and-trade programs in other parts of the world, including the European Union and a group of northeastern U.S. states, don't cover as many industries as California's, he said.
The California Chamber of Commerce and the Morning Star Packing Company, a tomato processing company required to buy carbon permits, filed separate lawsuits challenging the state's authority to levy the fee.
The lawyers argue that the 2006 law that underlies cap-and-trade never authorized the state to conduct an auction. Even if the legislation, AB32, did allow an auction, they argue, it amounts to a tax increase that would require approval of two-thirds of the House and Senate under the state constitution. AB32 did not reach that threshold.
In briefs filed with the court, lawyers challenging the auction say the state can give away pollution permits, known as allowances, but it can't sell them.
"The lawsuit does not affect the integrity of the cap and trade program," said Tony Francois, a lawyer from Pacific Legal Foundation, a conservative legal foundation that represents Morning Star. "This is just about the state's illegal add-on, this allowance auction."
The California Air Resources Board, which administers the program, says the auctions are similar to regulatory fees, which did not require a two-thirds supermajority in 2006, and are necessary to prevent polluters from getting windfall profits.
Sacramento County Superior Court judge Timothy Frawley upheld the program in in a 2013 ruling.
Judges from the 3rd District Court of Appeal have until late April to issue a decision. Lawyers for both sides said they will appeal to the California Supreme Court if they lose.
Demand for pollution permits has plummeted amid uncertainty about the court's thinking, along with questions about whether AB32 authorized cap-and-trade to continue beyond 2020 — a question not at issue in the current case.
Brown, who has urged leaders around the world to adopt carbon regulations, this month called for the Legislature to muster a two-thirds vote to explicitly authorize carbon auctions after 2020. The legislation, in its current form, would put the program on stronger legal footing in the future, but it would not resolve the uncertainty posed by the lawsuit.