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Application of Diamond State Telephone Co.

Superior Court of Delaware, New Castle County

February 19, 1954

Application of DIAMOND STATE TEL. CO.

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Telephone company filed a petition with the Public Service Commission to fix increased rates for telephone service. The Commission made a determination unfavorable to the company, and the company appealed. The Superior Court, Layton, J., held that it would, under the circumstances, adopt a rate base of 90 per cent of the company's reconstruction cost study.

Commission directed to recompute its findings in accordance with opinion.

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[48 Del. 308] On June 19, 1953, The Diamond State Telephone Company, hereafter referred to as the Company, petitioned the Public Service Commission, which I shall call Commission, to fix increased rates for telephone service in this State.[1] Schedules of the proposed new rates accompanied the petition. In accordance with Title 26 of the Delaware Code of 1953, Section 153, the Commission suspended the effective date of the proposed rates for 90 days or until further order. After several days of hearings, the Commission, on August 31, 1953, entered its findings, opinions and order determining that the increased rates proposed by the Company were unjust and unreasonable and directing the Company to submit to it for consideration schedules of rates designed to produce about one-third of the additional gross income requested by the Company. The Company, thereafter, without prejudice submitted new rate schedules as ordered which the Commission made effective as of September 10, 1953. On September 22, 1953, the Company instituted this appeal.

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Wm. S. Potter and Richard F. Corroon, Wilmington, for Diamond State Tel. Co. John B. King, Paul Maloney, Philadelphia, Pa., of counsel.

Max Terry, Dover, James J. Walsh, Wilmington, Richard W. Case, Baltimore, Md., for Public Service Commission.

LAYTON, Judge.

This appeal draws into question not only the action of the Commission in denying a substantial portion of the rate increase sought by the Company, but, also for the first time, a major interpretation of the [48 Del. 309] Public Service Commission Act, Title 26, Sections 101 et seq. of the Delaware Code of 1953. The decision of the Commission is very brief. It contains few findings of fact and is devoid of reasons in support of the conclusions arrived at. Inasmuch as the facts were all furnished by the Company and few, if any, are in dispute, in the interest of expediency, I shall make certain basic findings and, from time to time, others as the occasion may arise.

Findings of Fact

The Company is a wholly owned subsidiary of American Telephone and Telegraph Company and operates in Delaware exclusively except to the extent that calls originating in Delaware may be transmitted everywhere throughout the American Telephone & Telegraph system. The only increase in the level of its rates in Delaware since 1921 was one established in 1949 on a state-wide basis as the result of an increase for the City of Wilmington authorized by the old Board of Public Utility Commissioners of the City of Wilmington. On several occasions during the same period, rate reductions were voluntarily effected by the Company. Since the beginning of World War II, the demand for telephone service has increased at an unprecedented rate. The number of telephones in Delaware has just about doubled since 1945, and the number of telephone calls made has increased over 70%. On July 1, 1953, the Company had 2172 unfilled orders for telephone service and 6826 unfilled orders for higher grades of service. Because of the sustained demand for service, the Company plans to make net additions to its plant of $10,800,000 (1953 through 1955) in order to take care of unfilled orders.[2] Businesses other than utilities may choose the time

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for expansion but a telephone company must provide facilities where and when the demands for service arise.

Inflation has had a severe effect on all phases of the national economy but its impact has been particularly heavy on utilities which, being subject to regulation, are not free arbitrarily to increase their rates in order to keep abreast of rising costs. Thus, since the end of 1948, the level of the Company's expenses and taxes has risen at a faster rate than revenues. As of April 30, 1953, the level of intra-state operating expenses and taxes was 57% higher than at the end of 1948, while during this same period, intra-state revenues were only slightly in excess of 46% higher, with the result that, despite an increase of $8,500,000 in intra-state plant investment, there was no increase in net income. This has caused the Company's rate of return materially to decline.

Since 1940, the Consumer Price Index[3] indicates that the cost of living has increased 89% but, actually, most of the things with which the average man is familiar and uses constantly have increased at least 100%. Thus, labor costs have more than doubled, Federal income taxes have increased 117%, and the price of automobiles has increased 150% or more depending on make. During this same period, intrastate telephone rates in Delaware have increased but 18% and if the full increase requested in this proceeding had been granted, the total increase in such telephone rates since 1940 would have amounted to 38%. The increase in rates actually granted by this Commission together with that allowed in May, 1949, amount to a total rate increase since 1940 of about 24 1/2%. The proposed rates, if granted in full, would increase monthly telephone charges by about 85 cents per average resident customer, and by about $4.54 per average business customer. Even if the proposed rates had been granted in full as of August 1953, the Company would have had to reduce its surplus by $27,000 to pay its long established $2 annual common stock dividend for

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1953; and in 1954-1955, it would have been able merely to maintain its dividend and add to surplus a sum less than the amount required for one quarterly dividend payment. A number of years ago, the Company sold $3,000,000 of debentures to a group of insurance companies. Except for [48 Del. 310] these debentures, all external financing of the Company has been effected through the parent, American Telephone & Telegraph Company.

Basic Contentions of the Company and of the Commission

The proposed rates here in dispute were designed to produce for the Company additional annual gross revenues of about $1,514,000, which, after taxes, would amount to $717,600 of additional net income. The Commission directed reduction in the proposed rates so that the Company would receive an increase in gross income of only $517,000 before taxes. The Company contended that the rate base [4] should be approximately $28,700,000, while the Commission found that the rate base was $22,000,000. The Company based its case for a rate base primarily on reproduction cost less depreciation. The Commission in its determination of the Company's rate base apparently added 12% weight to original book cost depreciated to allow for reproduction cost of plant.[5] It accepted a version of the Company's probable earnings based upon former rates as sharply revised by its own expert witness.

Basically then, the bones of contention are these:

(1) The Commission disallowed over $380,000 of cash working capital as a part of the Company's rate base.

(2) The Commission erred in accepting its own expert's estimate of allowable net earnings which contained the following errors, all of which exceeded the bounds of reasonable discretion and resulted in overstating the Company's net earnings by:

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(a) Using the year ended April 30, 1953 as a test period.

(b) Failing to reflect the full annual amount of expense due to wage increases incurred during the test period.

(c) Crediting earnings with a non-recurring income tax credit applicable to a prior year.

(d) Refusing to include charitable contributions made by the Company during the test period.

(e) Fictitiously increasing the Company's debt ratio and thereby reducing fictitiously, the Company's Federal tax liability.

(3) In any event, because of the 90% increase in the cost of living since 1940, the Commission erred as a matter of law in not giving substantially greater weight to the fair value of the Company's plant as depicted by its study of reproduction cost less depreciation.

History of Fair Value

It is a legal maxim extending far back into the common law of England that he who devotes his property to the public use does so charged with full notice that it may be subject to governmental regulation[6] both as to the manner in which it is used and the compensation which is obtained from it. 73 C.J.S., Public Utilities, § 10. The form of regulation which has taken place in this country is by State or Federal Public Utility Commissions, which, in general, have been authorized to determine just and reasonable rates based upon either the original cost of, or the fair value of the utility property.[7]

Inasmuch as one of the important questions for decision here is whether or not Title 26 of the 1953 Code is a fair

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value statute, some understanding of the term [48 Del. 311] must be had. Fair value began with Smyth v. Ames, 1899, 169 U.S. 466, 18 S.Ct. 418, 42 L.Ed. 819. Prior to 1899, a few states had Public Service Commission Statutes which, in essence, authorized the Commissions to fix just and reasonable rates. But the concept of constitutional law prohibiting as confiscatory the fixing of rates which would yield less than a fair return on the fair value of the utility property was as yet unknown. The argument was advanced before the Supreme Court in Munn v. Illinois, 94 U.S. 113, and other decisions but was rejected upon the theory that the Fourteenth Amendment prohibited only confiscation of physical assets or title to property itself.[8] Gradually, the Court shifted its position, at first intimating that rates might be violative of the Fourteenth Amendment if outrageously low and then, finally, in Smyth v. Ames, taking its stand squarely upon the proposition that the due process provisions of the Constitution required that rates be fixed at levels which would insure the yielding of a fair return on the fair value of the utility property. Oddly enough, this pronouncement was purely dictum, which I quote [ 169 U.S. 466, 18 S.Ct. 434]:

‘ We hold, however, that the basis of all calculations as to the reasonableness of rates to be charged by a corporation maintaining a highway under legislative sanction must be the fair value of the property being used by it for the convenience of the public. And, in order to ascertain that value, the original cost of construction, the amount expended in permanent improvements, the amount and market value of its bonds and stock, the present as compared with the original cost of construction, the probable earning capacity of the property under particular rates prescribed by statute, and the sum ...

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