The Department of Water Resources never looked at the ecological effects of running the Kern Water Bank when the state transferred the bank to private hands in 1997, Judge Timothy Frawley ruled.
A nearby water district sued in 2010, saying that the state did not study the bank's potential effects on its neighbors, including causing wells to run dry or groundwater levels to drop in drought years. California is currently experiencing a withering drought, with many reservoirs far below their normal levels.
Environmentalists sued as well, saying that running the bank was causing lasting damage to the Sacramento-San Joaquin Delta and would spur unsustainable urban growth by sending scarce water supplies to proposed cities that the ecosystem could not support.
Attorneys for the Rosedale-Rio Bravo Water Storage District and the San Francisco-based nonprofit Center for Biological Diversity said they were "thrilled" by Wednesday's ruling.
The Kern Water Bank Authority did not immediately return a message left Wednesday. Kern County Water Agency spokeswoman Jeanne Varga said the agency could not comment on pending litigation. The Department of Water Resources did not immediately respond to an email seeking comment.
The judge ordered all parties to meet with him soon to determine how his ruling will affect the operation of the bank.
Major water users in agricultural Kern County gained control of the Kern bank in the mid-1990s, after a round of negotiations with the state Department of Water Resources. Their position was that the state had shorted rural areas in allotting water in a previous drought.
To avoid potential litigation from unhappy water users, state officials ceded ownership of the Kern Water Bank developed with $74 million from the department and $23 million in taxpayer-approved bonds to a local water agency. In return, water users gave back 45,000 acre-feet from the amount they contracted to receive each year.
Ownership of the bank ultimately was transferred to a joint powers authority including the local water agency, and numerous powerful water districts.