Searching over 5,500,000 cases.


searching
Buy This Entire Record For $7.95

Download the entire decision to receive the complete text, official citation,
docket number, dissents and concurrences, and footnotes for this case.

Learn more about what you receive with purchase of this case.

06/28/73 Democratic Central v. Washington Metropolitan

June 28, 1973

DEMOCRATIC CENTRAL COMMITTEE OF THE DISTRICT OF COLUMBIA, ET AL., PETITIONERS

v.

WASHINGTON METROPOLITAN AREA TRANSIT COMMISSION, RESPONDENT, D. C. TRANSIT SYSTEM, INC., INTERVENOR 1973.CDC.162 DATE DECIDED: JUNE 28, 1973



UNITED STATES COURT OF APPEALS FOR THE DISTRICT OF COLUMBIA CIRCUIT

Petition for Review of an Order of the Washington Metropolitan Area Transit Commission.

APPELLATE PANEL:

Robinson and MacKinnon, Circuit Judges, and Davis,* Judge, United States Court of Claims. MacKinnon, Circuit Judge, concurring in part and dissenting in part.

DECISION OF THE COURT DELIVERED BY THE HONORABLE JUDGE ROBINSON

This petition subjects to review Order No. 773 of the Washington Metropolitan Area Transit Commission *fn1 in an aspect untouched by today's Powell decision. *fn2 Petitioners assert, as their major contention, that the Commission should have taken into account, in the fare-setting process leading to that order, the amount by which properties which Transit had transferred from operating to nonoperating status had appreciated in value while in service. We conclude, in the circumstances peculiar to Transit as a public utility, that the Commission erred in refusing to treat the excess of market value over book value of the properties when transferred as an offset to higher fares. *fn3 To that extent we hold Order No. 773 invalid and direct the remedial steps to be taken. In the other respect in which the order is complained of, we affirm the Commission. *fn4 I BACKGROUND

The evolution of Order No. 773 is summarized in our Powell opinion. *fn5 We need add only the events of record which bear particularly on the transferred assets. *fn6 All are parcels of real estate which in times past were employed by Transit in mass transportation operations, but which, after later losing their usefulness for that purpose, were withdrawn from service. These withdrawals are reflected by entries on Transit's books recording the removals -- in utility jargon, from "above the line" to "below the line" -- and denoting Transit's continuing interest in the properties as investments. In some instances, Transit retains direct ownership; in others, Transit has conveyed to a wholly-owned subsidiary, and in still others it has made an outright sale. It appears without controversy that the market value of the unsold properties at the time of transfer below the line has invariably exceeded their value as tabulated on Transit's books. *fn7

During the course of the proceeding before the Commission, petitioners endeavored to probe into Transit's below-the-line real estate, Transit's interrelationships with its subsidiaries, and the market value of withdrawn realty held by either. Transit resisted those efforts, maintaining that the properties belonged exclusively to its investors, *fn8 and that information concerning them was irrelevant to the fare investigation in which the Commission was engaged. *fn9 The Commission, subscribing to Transit's basic premise, ruled that petitioners' inquiries had but limited pertinence to the proceeding. *fn10 It directed that some of the sought-after information be made available to petitioners, but refused to require disclosure of any market-value data on the properties. *fn11

Not surprisingly, then, Order No. 773 reflects no consideration whatever by the Commission of rises in the value of the transferred assets during the course of structuring the increased fares which that order awarded. Petitioners filed a timely petition for reconsideration *fn12 containing, inter alia, what may fairly be characterized as a request that the Commission devise ways and means of giving Transit's farepayers appropriate credit for the appreciation in value of the properties while in service. By Order No. 781, the Commission denied the petition, *fn13 and by Order No. 781a stated its reasons for doing so. *fn14 The Commission's statement, like Order No. 773 itself, is devoid of anything which we can identify as a response to petitioners' entreaty. And so it is that the theory underlying their plea is presented here, *fn15 now to support the charge that the Commission was grievously in error. *fn16

We have painstakingly examined this serious charge in all of its many ramifications, and in this opinion we set forth the results of our investigation. We begin in Part II with an exploration into the adjudicative history, administrative and judicial, of allocations of capital gains on operating utility assets. After that, in Part III, we scrutinize the interest of investors in value-appreciations on such assets, with reference to treatments of that interest in rate- and depreciation-base formulations and, more particularly, in Transit's ratemaking litigation. Next, in Part IV, we identify the doctrinal considerations guiding allocations of capital gains on in-service utility property and apply them to this case. Then concluding that Order No. 773 is invalid and must be set aside, we specify in Part V the basis for and mechanics of remediation. II

ADJUDICATIVE HISTORY OF ALLOCATION OF CAPITAL GAINS ON OPERATING UTILITY ASSETS

Seldom have regulatory agencies or courts been called upon to allocate, as between investors and consumers, gains on utility assets while in operating status. *fn17 Nonetheless, for the assistance and indispensable background they may afford to resolution of the controversy at hand, we must pause to examine this group of cases. In the realization that problems of allocation may well differ according to whether the asset is depreciable *fn18 or nondepreciable, we look first to the decisions treating allocation issues in relation to depreciable properties.

A. Depreciable Assets Out-of-District Cases

Outside the District of Columbia, we find relatively little authority precisely in point. In 1959, the question was presented to the Appellate Division of the New Jersey Superior Court *fn19 after a utility providing water service made a profitable sale of a portion of its distribution system, consisting of cast-iron mains and fire hydrants. *fn20 In subsequent rate proceedings, the New Jersey Board of Public Utility Commissioners deducted the profit from the utility's earned surplus and credited it to its depreciation reserve, in conformity with the board-adopted uniform system of accounts for water companies. From 1931, when the sale was made, to 1958, when the rate case was instituted, the utility had not complained of this treatment. Ascribing controlling weight to the commissioners' long standing construction of their own regulation -- the accounting system prescribed -- the court found no error in the challenged adjustment. *fn21

In the same year, a similar question arose in a rate proceeding before the Minnesota Railroad and Warehouse Commission. *fn22 During its historical test period, a transit company sold obsolete buses and treated the proceeds as nonoperating income. This was held to be improper. *fn23 "The Uniform System of Accounts prescribed by this Commission," said the agency, "requires that such salvage *fn24 'shall be credited to the depreciation reserve account.'" *fn25 In its words, the agency accordingly "added this income from sale of obsolete buses to operating income in determining actual operating results. . . ." *fn26 "Any further income from sale of obsolete buses or equipment," the agency added, "will be treated . . . as a reduction in depreciation expense and thus, as an increase in operating income." *fn27

A few years later, the Wyoming Public Service Commission faced essentially the same problem in a variant context. *fn28 A utility engaged in selling natural gas purchased mineral interests in lands, including a gas-producing well. The utility thus became entitled to a depletion allowance on the purchased assets. *fn29 After taking some gas from the purchased properties for its southern division customers, the utility sold them at a profit. Regulatory approval of the sale had been accompanied by a direction to treat the profit as utility income. In a later rate proceeding, the Commission reiterated its position that the profit "must be treated as nonoperating utility income." *fn30 The theory underlying the order approving the sale, the Commission said, was that "the profit to be made by the company upon the sale thereof should be used to reduce its . . . natural gas rates, rather than increase them." *fn31 "As we view the transaction," the Commission explained, "the company will simply make the substantial profit from the sale of utility properties dedicated to its southern division operations, which, in our opinion, should inure to the benefit of the ratepayers in that division." *fn32

Such are the decisions outside this jurisdiction. In each, the entire gain from disposition of depreciable assets was passed on to the utility's consumers, to the exclusion of its investors. While it is true that two of the decisions were influenced by agency-adopted accounting practices, it must be remembered that such practices are but reflections in accounting technique of what is generally considered wholesome in substantive principle. And the principle to be gleaned, both from the practices and the decisions themselves, is that consumers have the superior claim on capital gains achieved when depreciable utility properties are removed from service. We do not suggest that so small a number of cases establish a rule of general and controlling applicability in the ratemaking field. But it can hardly be denied that these decisions are precedents of value in similar litigation.

-- District Cases

Within, much as without, the District of Columbia the problems of allocating value-appreciation of depreciable inservice utility property have but infrequently arisen before either regulatory agencies or courts. And the litigation locally, such as it has been, has invariably involved Transit and, by the same token, the peculiarities inherent in its situation. That is to say not only that the reasoning followed elsewhere obtains as to Transit, but also that additional reasons leading to similar results flow from Transit's uniqueness, in comparison with other utilities, with respect to properties transferred below the line. Not surprisingly, then, the claim of Transit's farepayers on capital gains accruing to such properties while above the line has achieved considerable fruition.

The leading case, and one which merits careful analysis, is D.C. Transit System, Inc. (Order No. 4577). *fn33 There the Commission's predecessor, the District of Columbia Public Utilities Commission ,34 addressed the question of allocating the profits on a sale of Transit's Fourth Street Shops and Southern Carhouse to the District of Columbia Redevelopment Land Agency. Of the total sale price of $3,320,000, Transit proposed to credit all of the net profit of $2,181,363.08 to earned surplus, and thereby to pass it on to its investors.35 This, PUC held, it could not be permitted to do.

As PUC determined, $1,039,657.72 of the sale price was attributable to land,36 $1,915,034.81 to depreciable improvements on the land,37 and the remainder to items not of present concern.38 PUC noted that strict adherence to the uniform system of accounts employed by it would require that the total amount received on disposition of depreciable assets -- here $1,915,034.81 -- be credited to the depreciation reserve as salvage.39 Since to have done that would, by PUC's calculations, have built the reserve to a point greatly in excess of the sum needed to retire all unrecovered original cost of the improvements,40 PUC felt that a departure from normal accounting procedures was warranted.41

In regard to the extent of the departure, PUC noted that Transit's operating franchise demanded of it a seven year program of gradual conversion from a streetcar-bus to an all-bus operation,42 and PUC was "unable to disassociate the instant transaction from the imminent retirement of all rail property under the mandate contained in the Franchise."43 Nor could PUC "ignore the probability that full provision for depreciation will not have been provided when the rail facilities are abandoned and retired by reason of conversion."44 Observing that Transit had consistently asserted, and PUC's staff had indicated agreement, that any retirement loss in this connection was recoverable by charges against the farepayers,45 PUC emphasized that "if the customers are to be required to bear the burden of extraordinary retirement losses incident to the whole conversion program, it appears equitable that they should share, at least to some extent, in extraordinary retirement gains of the nature here under consideration."46

PUC concluded, then, that of the total net profit of $1,450,872.03 realized on the sale of the improvements,47 $613,661.28 should inure to Transit's consumers and $837,210.75 to its investors.48 "This approach," it said, "takes into consideration the right of the company to recover from its customers through depreciation the loss of service value over the life of the property as measured by the original cost of the property less net salvage realized upon retirement."49 That treatment, in PUC's view, "provides an equitable solution to a difficult problem maintaining, as far as possible, what seems to be fair balance between the interests of the public and those of the company's investors."50

PUC's allocation of the profit on the improvements on the Fourth Street Shops and Southern Carhouse subsequently came under direct judicial review at Transit's instance, and we held that PUC's treatment was not arbitrary or unreasonable.51 That allocation also entered into this court's consideration of another problem several years later. In D.C. Transit System, Inc. v. Washington Metropolitan Area Transit Commission,52 an expense allowance to Transit for unrecovered costs of abandoned rail facilities was contested on grounds which included reference to that sale. The argument was that the sale was occasioned by the conversion program required by Transit's franchise,53 and that for that reason the profits made on the sale should be regarded as recoupment of obsolescence.54 In rejecting the argument, we noted that

PUC did not omit to give the riding public some considerable share in the benefits of this sale. . . . The profit on the depreciable property which went into surplus was $837,000. At the time of the sale, Transit carried this property on its books at an historical cost of $1,077,824, with an accrued depreciation reserve of $613,661. Thus only $464,163 was required from the proceeds of the sale to effect complete liquidation of this investment. The PUC, however, ordered a total of $1,077,824 be credited to the depreciation reserve, representing not only the $464,163 but an additional amount of $613,661 exactly duplicating the reserve already accrued. It was this action that we think was explained by the PUC's comment that equitable consideration suggested the riders should share in the profits from the sale. Under all these circumstances, therefore, we do not interfere with the Commission's discretion in deciding not to off-set the profits from the Fourth Street Shop sale against the [expense allowance for unrecouped investment in abandoned rail facilities].55

That, as PUC held in Order No. 4577,56 Transit's farepayers have a legitimate interest in capital gains on operating depreciable assets has never been doubted by its successor, the respondent Commission. In D.C. Transit System, Inc. (Order No. 245),57 the Commission recognized that "ratepayers may have a claim to depreciable property at least to the extent of the depreciation reserves."58 It added "that 'gains' may be experienced on disposal of depreciable items, and these are indeed used as offsets to depreciation, under the heading of 'salvage'".59 Later, in D.C. Transit System, Inc. (Order No. 563),60 the Commission, in finding no connection between Transit's track removal and repaving program and its sale of its Georgia and Eastern Terminal,61 concluded that "the ratepayer is not entitled to share in any portion of the proceeds of that sale, unless there was a profit on the depreciable portion of the asset sold,"62 and found that "there was none in this case."63 And even after issuance of the order under review, the Commission has declared that "there is no question that, when depreciable operating property is sold and a gain is realized, the gain should be used to reduce the depreciation expenses which ratepayers have paid but which the company, because of the gain, does not actually incur."64

In the District, then, the law on the topic immediately under discussion is already somewhat developed. Capital gains realized on disposition of depreciable assets while in service65 do not automatically flow to Transit's investors,66 although extraordinary circumstances may enable them to share.67 On the contrary, Transit's farepayers have a protectible interest in such gains which extends at the very least, to the amount of depreciation which has been charged to farepayers and may well extend far beyond.68

B. Nondepreciable Assets

The question whether a gain on disposition of nondepreciable assets inures to investors as capital surplus, or to consumers as a reduction in cost of service, has been litigated even less frequently than has the question in relation to depreciable assets. A survey of the few cases in point outside the District of Columbia reveals, somewhat paradoxically, a central strand of harmony amid diverse results. The decisions within the District -- all administrative -- have reached a uniform result, but without critical analysis either of the problem or the precedents.

-- Out-of-District Cases

In New York Water Service Corporation v. Public Service Commission,69 a utility sold, at a handsome profit, land which had outworn its usefulness as a storage reservoir. Its regulatory agency held that for ratemaking purposes the net profit reaped on the sale should be passed on to its customers.70 On judicial review, that adjudication was sustained.71 The court explained:

The uniform system of accounts approved by the Commission applicable to water companies in dealing with land used for utility purposes allows land sold at a loss to be debited to the depreciation reserve and thus increase the rate base. If land is sold at a profit, it is required that the profit be added to, i.e., "credited to", the depreciation reserve, so that there is a corresponding reduction of the rate base and resulting return. The utility is thus protected from a loss in the sale of the land in its operations; it seems reasonable it should pass on a profit to the consumer.72

As the opinion on review makes plain, the guiding principle was that the gain belonged to those -- investors or consumers -- who proviously bore the risk of loss from possible decline in market value.

In City of Lexington v. Lexington Water Company,73 the pertinent facts were similar. The utility had acquired land which for many years it used to collect water for reservoirs, but when the reservoirs became inadequate the land was retired from service and removed from the utility's rate base. Somewhat later, the land was sold,74 and the utility distributed the very considerable profit realized thereon to its investors as dividends.75 When the utility subsequently sought a rate increase, its regulatory agency ruled that its consumers were entitled to the gain.76 The agency, articulating essentially the same rationale espoused in New York Water Service Corporation, elucidated:

The question arises, should this gain, made on property devoted to the public service over the years, be used to reduce the cost of service to the customers or should it be treated as a capital surplus item, and be allowed to be paid out to the stockholders . . .? Having considered the evidence and arguments relating to this matter, we are of the opinion that it should be used to reduce the cost of service to the consumer.

The subject property was not purchased by the utility as a land speculation but it was acquired for providing utility service to the public over the years and was subject to acquisition by condemnation.77 Inasmuch as utility property necessary for rendering service to the public is not subject to sale at the option of the utility, but must be continued in service as long as needed to provide that service, any loss in service value of such property would properly be considered a cost of providing service and, in the case of depreciable property, is recovered through depreciation. . . . For nondepreciable property, where the change in service value cannot be determined until actual disposition of the property, amortization of an allowable loss or gain would be the proper procedure . . . . If it is proper to recover losses of nondepreciable property through amortization, then conversely it should be proper to amortize gains on such property.78

On review, however, it was held that the agency's ruling was erroneous. The court distinguished New York Water Service Corporation79 on the ground of a difference in the accounting methods respectively employed by New York and Kentucky regulatory authorities.80 The Kentucky agency had adopted a system of accounts providing for the charging of losses and for the crediting of profits on land sales, not to customers, but rather to the utility's surplus account.81 On that premise, the court apparently believed that the risk of capital gain or loss had actually been borne entirely by the utility's investors. On so much of the case, the court would seemingly have sustained the agency had the risk been on the utility's consumers.82

In the only other reported decision we have found, the problem was presented only obliquely. In Columbus Gas & Fuel Company v. Public Utilities Commission,83 the utility claimed that its annual depreciation allowance for depreciable property other than well-structures and equipment was inadequate because some items, consisting in land and rights of way, had been omitted from the computation.84 The Court denied the claim but in doing so indicated that under different conditions the claim might well have been valid.85 In relevant part the Court said:

Certainly lands and rights of way may not be characterized as wasting assets in the absence of explanation that would stamp that quality upon them. In saying this we do not forget that an abandonment of the business might bring about a sharp reduction in the value of the plant, aside from well-structures and equipment. There is nothing to show, however, that any such abandonment is planned or even reasonably probable. On the contrary, the course of business makes it clear that when the fields in use shall be exhausted, the business will extend to others, and this for an indefinite future, or certainly a future not susceptible of accurate estimation.86

As the Court indicated, a loss on the investment in nondepreciable elements of the utility's plant resulting from an unavoidable abandonment of its business would have been recognized if it had occurred, and that loss would then have been chargeable to its consumers.87 One might easily reason from this premise that an appreciation in value of the non depreciable elements would likewise become cognizable, and properly would redound to the benefit of the consumers.

In sum, the decisions outside the District have not viewed capital gains on in-service nondepreciable utility assets as inevitably belonging to investors to the exclusion of consumers. Rather, in each of the cases -- although they are few -- the allocation has depended upon location of the risk of loss. These holdings, then, may be accepted as applications of the broader principle that the benefit of a capital gain follows the risk of capital loss.88 So read, they have our approbation.

-- District Cases

The allocation properly to be made of in-service appreciations in value of Transit's nondepreciable assets is an open question in this jurisdiction. Although both the Commission and PUC, its predecessor in transit regulation, have occasionally spoken to the subject, this court has never before been called upon to face the issue. Our analysis of the administrative decisions -- which have uniformly viewed such gains as belonging to Transit's investors -- discloses that they leave a great deal to be desired.

In early 1959, as we have related, Transit received $3,320,000 from the sale of its Fourth Street Shops and Southern Carhouse to the District of Columbia Redevelopment Land Agency.89 Of a total net profit on the transaction of $2,181,363.08,90 $950,568.55 was attributable to land.91 In D.C. Transit System, Inc. (Order No. 4577),92 PUC resolved a dispute between Transit and PUC's staff as to the accounting treatment to be accorded the capital gain on the depreciable subject matter of the sale. At the outset, however, PUC declared that it could "dispose of one item not in controversy."93 It did, thusly:

The staff and the company are in agreement that under public utility accounting, the difference between the original cost of land and the selling price is recognized as profit. The net profit of $950,568.55 on the sale of the land (net proceeds of $1,039,657.72 less original cost of $89,089.17) is, therefore, a proper credit to earned surplus.94

We readily understand that the $950,568.55, as PUC held, was net profit traceable to sale of the land. We are not nearly so clear, however, as to why PUC was confident that it was "therefore a proper credit to earned surplus." In other words, PUC does not tell us why it felt that the profit automatically belonged to investors. It may be that since the treatment to be given it was "not in controversy,"95 PUC deemed it a simple, indubitable accounting problem. In any event, we are left with our doubts.

Order No. 4577 was later to come under judicial review by this court, but not in the aspect just discussed. By suit brought in the District Court for the District of Columbia, Transit attacked PUC's disposition of the profits allocable to the depreciable portion of the property sold.96 Losing in that effort, Transit applied to this court, which affirmed.97 Our action, of course, did not encompass PUC's ruling as to the gain realized on the land, for that ruling, favorable to Transit, was not brought before us. Still later, in D.C. Transit System, Inc. v. Washington Metropolitan Area Transit Commission,98 the sale of the same property was given attention by this court but, again, only in reference to the administrative disposition of the profits on the depreciable part.99

In D.C. Transit System, Inc. (Order No. 245),100 the only other relevant decision in this jurisdiction, it was argued to the respondent Commission, without avail, that Transit's losses on the premature retirement of rail facilities101 -- which the Commission has passed on to Transit's farepayers102 -- might be offset by gains which Transit realized upon the sale of certain real estate.103 The properties sold were, again Transit's Fourth Street Shops and Southern Carhouse104 and its Georgia and Eastern Terminal.105 From aught that appears, nothing more than allocation of the net profit attributable to the depreciable portion of these properties was placed in issue before the Commission, and surely the decision on our review was that narrowly limited.106 The Commission had, nevertheless, ventured a statement on the question as to which we are now analyzing the precedents. The Commission believed that "it is a cardinal principle of regulatory law that a utility is not entitled to recover through depreciation charges or other accounting devices its investment in land."107 "This principle," the Commission continued, "stems from the fact that in some instances the value of land appreciates and in other instances depreciates."108 So, the Commission said "while the ratepayers have a claim to depreciable property, at least to the extent of the depreciation reserves, no such claim can be directed to land."109

We are unable to follow this course of reasoning. With a paucity of holdings, administrative or judicial, on the point, we have not detected a hard-and-fast rule one way or the other.110 Nor can we understand how the economic fact that land values may trend upward or downward can support the position on appreciation which the Commission assumed. The value of depreciable property, including depreciable improvements on land, also rises and falls with changing market conditions, and yet it is clear that consumers may contend for any capital gain achieved while it was used in service to the public.111 What seeps through the Commission's discussion, however, is the conviction that the Commission has yet to consider factors which, at least in Transit's instance, bear importantly on the problem. III INTEREST OF INVESTORS IN VALUE-APPRECIATION IN OPERATING UTILITY ASSETS

We perceive no impediment, constitutional or otherwise, to recognition of a ratemaking principle enabling ratepayers to benefit from appreciations in value of utility properties accruing while in service. We believe the doctrinal consideration upon which pronouncements to the contrary112 have primarily rested has lost all present-day vitality. Underlying these pronouncements is a basic legal and economic thesis -- sometimes articulated, sometimes implicit -- that utility assets, though dedicated to the public service, remain exclusively the property of the utility's investors, and that growth in value is an inseparable and inviolate incident of that property interest.113 The precept of private ownership historically pervading our jurisprudence led naturally to such a thesis, and early decisions in the ratemaking field lent some support to it; if still viable, it strengthens the investor's claim. We think, however, after careful exploration, that the foundations for that approach, and the conclusion it seemed to indicate, have long since eroded away.

A. In Rate Base Formulation

Judicial indulgence in the concept that appreciation in value of utility property is an increment automatically attaching to its ownership reached its high water mark during the "fair value" era of rate-based formulations of returns to utilities.114 In its 1898 decision in Smyth v. Ames,115 the Supreme Court held "that the basis of all calculations as to the reasonableness of rates to be charged by a corporation maintaining a highway under legislative sanctions must be the fair value of the property being used by it for the convenience of the public."116 "In order to ascertain that value," the Court said, "the original cost of construction, the amount expended in permanent improvements, . . . the present as compared with the original cost of construction, . . . are all matters for consideration, and are to be given such weight as may be just and right in each case."117 And "what the company is entitled to ask," the Court continued, "is a fair return upon the value of land which it employs for the public convenience."118

Despite the Court's specification in Smyth v. Ames of original cost as well as reproduction cost as a factor to be considered in determining rate base value, the Court's decided preference during almost the next half-century was a reproduction cost formula.119 This meant, of course, that in times of rising prices, the use of reproduction cost to the exclusion of original cost advantaged the utility's investors and disadvantaged its consumers. In 1908, in Willcox v. Consolidated Gas Company,120 the Court remarked that "if the property which legally enters into consideration of the question of rates, has increased in value since it was acquired, the company is entitled to the benefit of such increase."121 Five years later, in the Minnesota Rate Cases,122 the Court observed that the utility's "property is held in private ownership, and it is that property, and not the original cost of it, of which the owner may not be deprived without due process of law."123 And as late as 1926, in Board of Public Utility Commissioners v. New York Telephone Company,124 the Court stated that "customers pay for service, not for the property used to render it . . . by paying bills for service they do not acquire any interest, legal or equitable, in the property used for the convenience or in the funds of the company."125 Expressions of this sort encourage the idea that investors were entitled to all the benefits of value-growth of utility assets, of which the base for their rate of return was only one.

The fair value theory, however, was not to survive as the inexorable standard for setting rate base. Perhaps the turning point in conceptualization of the rights of investors viz-a-viz consumers in utility property occurred in 1923. In that year, Justice Brandeis, in his celebrated separate opinion in Southwestern Bell Telephone Company,126 rejected the fair value approach to ratemaking and advanced a new basic concept:

The thing devoted by the investor to the public use is not specific property, tangible or intangible, but capital embarked in the enterprise. Upon the capital so invested the Federal Constitution guarantees to the utility the opportunity to earn a fair return.127

Justice Brandeis' formula for ascertaining rate base -- the amount of capital prudently invested -- was not to become the prevailing rule.128 But what has since prevailed is the central idea that the investor's legally protected interest resides in the capital he invests in the utility rather than in the items of property which that capital purchases for provision of utility service. In 1933, the Court sustained a rate base valuation from which reproduction cost had been excluded,129 and five years later the Court upheld another valuation founded upon historical cost alone.130 In 1942, in Federal Power Commission v. Natural Gas Pipeline Company,131 the Court more formally abandoned reproduction cost when it ruled that "the Constitution does not bind rate-making bodies to the service of any single formula or combination of formulas."132 Finally, in 1944, in Federal Power Commission v. Hope Natural Gas Company,133 the Court rejected the Fourth Circuit's conclusion that the utility's rate base should reflect the "present fair value" of its property.134 "'Fair value,'" it said, "is the end product of the process of ratemaking not the starting point as the Circuit Court of Appeals held."135 "Under [a] statutory standard of 'just and reasonable,'"136 it added, "it is the result reached not the method employed which is controlling. . . . It is not the theory but the impact of the rate order that counts."137 This approach to rate base formulation is the prevailing doctrine today.138

The teaching of the modern cases in this area is plain. If investors in a public utility possessed an indefeasible right to the appreciation in value of the utility's operating assets, the base on which their rate of return is computed -- the aggregate of the assets themselves -- could be set only at the true value of the assets at the moment of setting. Fairness would suggest that result and due process would seem to compel it.139 But it is now clear that the utility is not entitled of right to have its rate base established at the value which the assets would command on the current market, although that market value exceeds original cost. This can mean only that the investors' legally protected interest in such assets does not inexorably extend to the increment in value.

B. In Depreciation Base Formulation

The rise and fall of fair value as the exclusive method of measuring utility rate base has been paralleled by judicial treatment of the interrelated problem of basis for depreciation of utility assets. An integral part of the process of establishing a rate base for purposes of rate of return is ascertainment of the amount to be deducted from rate base -- and, of course, allowed as an operating expense -- for depreciation140 of the utility's in-service property.141 And if appreciation in the value of utility property is to invariably inure to the benefit of investors, it would logically follow that allowances for depreciation must be computed on present value rather than acquisition cost or some other basis.

That was the view to which the Supreme Court originally subscribed. In 1909, in Knoxville v. Knoxville Water Company,142 the Court decided that the utility "is entitled to see that from earnings the value of the property invested is kept unimpaired, so that at the end of any given term of years the original investment remains as it was at the beginning."143 "It is," the Court said, "not only the right of a company to make such a provision but it is its duty to its bond and stockholders, and, in the case of a public service corporation at least, its plain duty to the public."144 Two decades later, the Court, in United Railways and Electric Company v. West,145 upheld a ruling that annual depreciation allowances were to be calculated on the basis of present value rather than cost.146 Repeating the theme of Knoxville Water Company, a majority of the Court147 referred to its then "settled rule" that rate base was to be established at present value,148 and argued that "it would be wholly illogical to adopt a different rule for depreciation."149

Fair value, as the basis for depreciation, however, was later to go the way of fair value as the measure of rate base.150 By 1934, in Lindheimer v. Illinois Bell Telephone Company,151 the Court upheld the propriety of computing annual depreciation on original cost.152 The Court pointed out that "if the amounts charged to operating expenses and credited to the account for depreciation reserve are excessive, to that extent subscribers for the telephone service are required to provide, in effect, capital contributions, not to make good losses incurred by the utility in the service rendered and thus to keep its investment unimpaired, but to secure additional plant and equipment upon which the utility expects a return."153 And by 1942, in Federal Power Commission v. Natural Gas Pipeline Company,154 the Court had sustained an amortization basis for depletable utility property calculated on capital investment rather than reproduction cost.155 There the Court stated:

When the property is devoted to a business which can exist only for a limited term, any scheme of amortization which will restore the capital investment at the end of the term involves no deprivation of property. Even though the reproduction cost of the property during the period may be more than its actual cost, this theoretical accretion to value represents no profit to the owner, since the property dedicated to the business, save for its salvage, is destined for the scrapheap when the business ends. The Constitution does not require that the owner who embarks in a wasting-asset business of limited life shall receive at the end more than he has put into it.156

Finally, in Federal Power Commission v. Hope Natural Gas Company,157 in 1944, the Court upheld depreciation and depletion allowances based on cost,158 overruling United Railways and Electric Company v. West in the process.159 "By such a procedure," said the Court, "the utility is made whole and the integrity of its investment maintained. No more is required."160

Here again we draw a lesson from the jural history of ratemaking. Investors are entitled to recover the utility's outlay in the assets employed in provision of the utility's public service.161 If the investors' protected interest in those assets encompassed increases in their market value, it would necessarily follow that the recoupment must embrace the increases as well as the amount laid out for their acquisition. But it is now clear that the amount of eventual recovery -- the depreciation base -- may permissibly be limited to the amount of the original outlay. This is but another way of saying that the investors do not possess a vested right in value-appreciations accruing to in-service utility assets.

C. In Transit's Ratemaking Litigation

The considerations just explored take on added weight in Transit's case, for fair value has never been assigned a role in determinations as to its rate or depreciation bases. That it was not an ingredient of either was settled rather early in Transit's regulatory history. In the days prior to utilization of the operating ratio method in computations of its margins of return,162 the Commission's predecessor, PUC, established and maintained Transit's rate base without consideration of the then present value of its in-service properties.163 In those days, PUC also employed original cost as the formula for setting Transit's depreciation base,164 and the Commission in its turn, has done the same.165 Neither for purposes of its rate base nor its basis for depreciation, then, has appreciation in the market value of its assets been deemed a benefit to which Transit's investors might justly lay claim.

But that was not because the effort was not made. In a fare-increase proceeding inaugurated in 1960, Transit sought to persuade PUC to adopt a depreciation base combining replacement cost for some properties with market value for others.166 PUC, however, declined to do so.167 Instead, PUC pointed out that it has "long held that original cost is the only sound basis for measuring depreciation as it is in accord with the fundamental purpose of depreciation accounting, namely, to recover the cost of investment rather than to provide for the cost of replacement."168 "The use of replacement cost as a base for the calculation of depreciation allowances," in PUC's view, "has many serious faults,"169 not the least of which is the distinct possibility that Transit's farepayers would thereby be made involuntary contributors to its capital. PUC explained:

If prices are rising the use of the replacement cost base would compel consumers to provide additional capital for the utility, at least to the extent that replacement costs were greater than the costs of the depreciating equipment. [Transit's witness] admitted that under his theory consumers would be in the position of involuntary investors though with no right to a return on their investment; and what is even worse, they would thereafter be required to provide a fair return and depreciation allowance on capital which they themselves had contributed. Obviously, consumers' obligations end when they have paid the cost of service including the cost of the depreciable assets used and exhausted in rendering that service. The original cost base is just and equitable for both investors and consumers. Consumers pay the cost of service including the cost of capital. To ask the consumers to pay more than the cost is to make them contribute to the capital of the enterprise.170

We cannot, then, accept the thesis that appreciations in value of Transit's properties while in operating status automatically flow to Transit's investors as inseparable incidents of ownership. To be sure, investors are entitled to have rates fixed with a view to a fair return on their investment,171 and to have depreciation allowances set in contemplation of eventual recoupment of their investment in toto.172 But modern ratemaking doctrine militates against the proposition that value-appreciation alone can legitimately increase either the return173 or the recoupment.174 Indeed in Transit's case it never has,175 and that would have been legally impossible if the investors' protected interest in Transit's assets extended to advances in market value as well as to the original investment in them. The fact is that Transit's investors have been so limited in both respects, and that serves adequately to refute any notion that they necessarily possess a claim on such advances.176 IV BASIS FOR ALLOCATION OF CAPITAL GAINS ON OPERATING UTILITY ASSETS

Investors, we have concluded, are not automatically entitled to gains in value of operating utility properties simply as an incident of the ownership conferred by their investments. And it goes without saying that consumers do not succeed to such gains simply because they are users of the service furnished by the utility. Neither capital investment nor service consumption contributes in any special way to value-growth in utility assets. Rather, the values with which we are concerned have grown simply because of a rising market.

Investors and consumers thus start off on an equal footing, and the disposition of the growth must depend on other factors. We thus reach the dual critical inquiry: identification of the principles which must guide the allocation, as between investor and consumer groups, of appreciation in value of utility assets ...


Buy This Entire Record For $7.95

Download the entire decision to receive the complete text, official citation,
docket number, dissents and concurrences, and footnotes for this case.

Learn more about what you receive with purchase of this case.