Galveston Electric Co v. City of Galveston

• Decision Date: 10 April 1922
• Docket Number: No. 455,455
• Parties: GALVESTON ELECTRIC CO. v. CITY OF GALVESTON et al
• Court: U.S. Supreme Court

258 U.S. 388

42 S.Ct. 351

66 L.Ed. 678

GALVESTON ELECTRIC CO.

v CITY OF GALVESTON et al.

No. 455.

Argued December 15 and 16, 1921.

Decided April 10, 1922.

Mr. Wm. E. Tucker, of Boston, Mass., for appellant.

Messrs. Frank S. Anderson and James W. Wayman, both of Galveston, Tex., for appellees.

Mr. Justice BRANDEIS delivered the opinion of the Court.

The street railway system of Galveston was started as a horse car line in 1881. It was electrified about 1890, and after the hurricane of 1900 was largely rebuilt. Upon sale on foreclosure the railway passed in 1901 to a new company, and in 1905 it was purchased by the Galveston Electric Company, which supplies to the inhabitants of the city also electric light and power. At no time has the full fare on the railway been more than 5 cents— except during the period of 8 months, from October 1, 1918, to June 5, 1919, when 6 cents was charged. This higher fare was authorized by ordinance of the municipal board of commissioners, which possesses regulatory powers; and on June 5, 1919, the same board reduced the maximum fare to 5 cents. The latter ordinance was passed after a hearing and a finding by the board that with the reduced rate the company would continue to earn a fair return. Under the 1919 ordinance the company operated for 11 months. Then it brought this suit, in the federal court for Southern Texas, to enjoin its enforcement. The company contends that the fare prescribed is confiscatory, in violation of the Fourteenth Amendment; the city, that it is sufficient to yield a return of 8 per cent. on the value of the property used in the public service.

A temporary injunction having been denied, the court appointed a master to take the evidence and make advisory findings. There was substantially no dispute concerning the facts past or present. It was assumed, in view of then prevailing money rates, that 8 per cent. was a fair return upon money invested in the business. The experts agreed on what they called the estimated undepreciated cost of reproduction on the historical basis; that is, what the property ought to have cost on the basis of prices prevailing at the time the system and its various units were constructed. They agreed also on the amount of gross revenue, and on the expenditures made in operation and for taxes, except as hereinafter stated. The differences between the parties resulted mainly, either from differences in prophecy as to the future trend of prices or from differences in legal opinion as to the elements to be considered in determining whether a fair return would be earned. These differences affected both the base value and the amount to be deemed net revenues. The master, who heard the case in October, 1920, and filed his report in November, made findings in which he advised that the fare was confiscatory. The District Judge, who heard the case in January, 1921, found a much smaller base value and much larger net revenues; stated that he did not deem it necessary to determine whether the ordinance 'will produce exactly 8 per cent. or a little more or a little short of it'; declared that he was 'not satisfied that the ordinance produces a return so plainly inadequate as to justify this court in interfering with the action of the municipality in the exercise of its rate-making function'; and in March, 1921, entered a decree dismissing the bill without prejudice. In April he denied a petition for rehearing. 272 Fed. 147. The case comes here on appeal under section 238 of the Judicial Code (Comp. St. § 1215.)

The undepreciated reproduction cost on the historical basis¹ which seems to be substantially equivalent to what is often termed the prudent investment²—was agreed to be $1,715,825. The parties failed to agree in their estimates of the depreciation accrued up to 1921. The master estimated that, based on the 1913 price level, it was $390,000; and this estimate the court accepted. Thus measured, the value of the property, less depreciation, was $1,325,825. The court found that the net earnings under the five-cent fare for the year ending June 30, 1920 had been $90,159, and for the year ending December 31, 1920, $109,286, and estimated that for the year ending June 30, 1921, it would be at least $111,285. The return so found for the year ending June 30, 1920, is 6.8 per cent. of $1,325,825; for the calendar year 1920, 8.2 per cent., and for the year ending June 30, 1921, 8.4 per cent. The master made calculations only for the year ending June 30, 1920, and, mainly³ because he allowed an amount for maintenance and depreciation equal to nearly 18 per cent. of the prudent investment for the depreciable property (less accrued depreciation), found the net earnings to be only $50,249.60. This sum is 3.8 per cent. on the prudent investment value, less depreciation. But neither the District Judge nor the master reached his conclusion as to net return by a calculation as simple as that indicated above.

First. As the base value of the property, master and court took—instead of the prudent investment value—the estimated cost of reproduction at a later time less depreciation; and in estimating reproduction cost both refused to use as a basis the prices actually prevailing at the time of the hearings. There had risen to 110 per cent. above those of 1913. The basis for calculating reproduction cost adopted by all was prophecy as to the future general price level of commodities, labor, and money. This predicted level, which they assumed would be stable for an indefinite period, they called the new plateau of prices. As to the height of this prophesied plateau there was naturally wide differgence of opinion. The company's expert prophesied that the level would be 60 to 70 per cent. about 1913 prices; the master that an increase of 33 1/3 per cent. would prove fair; and the court accepted the master's prophecy of 33 1/3 per cent.⁴ Thus both master and court assumed a reproduction cost, after deducting accrued depreciation, of about $1,625,000. On this sum the net earnings found by the court yielded—after deducting a 4 per cent. depreciation annuity on property subject to depreciation, a maintenance charge, and a charge for taxes, other than the federal income tax—a net return of 5 1/2 per cent. for the fiscal year ending June 30, 1920, of 6.7 per cent. for the calendar year 1920, and the promise of more for the fiscal year ending June 30, 1921. But to fix base value the master added, and the court disallowed, items aggregating nearly $600,000, which must now be considered.

The most important of these items is $520,000 for 'development cost.' The item is called by the master also 'going concern value or values of plant in successful operation.' He could not have meant by this to cover the cost of establishing the system as a physically going concern, for the cost of converting the inert railway plant into an operating system is covered in the agreed historical value by items aggregating $202,000. These included, besides engineering, supervision, interest, taxes, law expenses, injuries and damages during construction, the sum of $73,281 for the expenses of organization and business management. The going concern value for which the master makes allowance is the cost of developing the operating railway system into a financially successful concern. The only evidence offered, or relied upon, to support his finding is a capitalization of the net balance of alleged past deficits in accordance with what was said to be the Wisconsin rule.⁵ The experts calculated this sum in various ways. One estimate placed the development cost at $2,000,000; a more moderate estimate by the company's expert was $575,300; and the city's expert made a calculation by which he estimated this so-called cost at $212,452.

If the rule were that a prescribed rate is to be held confiscatory in case net earnings are not sufficient to yield 8 per cent, on the amount prudently invested in the business, there might be propriety in counting as part of the investment such amount, if any, as was necessarily expended at the start in overcoming initial difficulties incident to operation and in securing patronage. But no evidence of any such expenditure was introduced; and the claim of the company does not proceed upon that basis. What was presented by the witnesses are studies, on various theories, of what past deficiencies in net income would aggregate, if 4 per cent. were allowed as a depreciation annuity and 8 per cent. compound interest were charged annually on the value of the property used. These calculations covered, on one basis, the period of 39 years since the original horse car line was built; on another, the period of 15 years since the appellant purchased the property as a going concern. If net deficits so estimated were made a factor in the rate base, recognition of 8 per cent. as a fair return on the continuing investment would imply substantially a guarantee by the community that the investor will net on his investment ultimately a return of 8 per cent. yearly, with interest compounded on deferred payments; provided only that the traffic will in course of time bear a rate high enough to produce that amount.⁶

The fact that a utility may reach financial success only in time or not at all, is a reason for allowing a liberal return on the money invested in the interprise; but it does not make past losses an element to be considered in deciding what the base value is and whether the rate is confiscatory. A company which has failed to secure from year to year sufficient earnings to keep the investment unimpaired and to pay a fair return, whether its failure was the result of imprudence in engaging in the enterprise or of errors in management, or of omission to exact proper prices for its output, cannot erect out of past deficits a legal basis for holding confiscatory for the future, rates which would, on the basis of present reproduction value, otherwise be compensatory....