Dedeaux Utility Co. v. City of Gulfport, No. 2005-CA-00102-SCT.

• Decision Date: 28 September 2006
• Docket Number: No. 2005-CA-00102-SCT.
• Citation: 938 So.2d 838
• Parties: DEDEAUX UTILITY COMPANY, INC. v. The CITY OF GULFPORT, Mississippi, A Municipal Corporation.
• Court: Mississippi Supreme Court

938 So.2d 838

DEDEAUX UTILITY COMPANY, INC. v. The CITY OF GULFPORT, Mississippi, A Municipal Corporation.

No. 2005-CA-00102-SCT.

Supreme Court of Mississippi.

September 28, 2006.

James H. Herring, J. Reilly Morse, attorneys for appellant.

Gary White, Gulfport, attorney for appellee.

Before SMITH, C.J., WALLER, P.J., and RANDOLPH, J.

WALLER, Presiding Justice, for the Court.

¶ 1. Dedeaux Utility Company, Inc., is the holder of certificates of public convenience and necessity for certain water and sewer services in Harrison County, Mississippi. Eight years after the City of Gulfport filed a petition for condemnation against Dedeaux, the matter went to trial in the Harrison County Special Court of Eminent Domain before a jury. Dedeaux's expert valued the utility plant at $9,025,500.00, and Gulfport's expert valued the utility plant at $2,140,000.00. The jury returned a verdict for $3,634,757.00, and a judgment was entered in accordance with that verdict. Dedeaux appeals, and Gulfport has filed a cross-appeal. Finding that the trial court erred, we reverse its judgment and remand this case for a new trial.

FACTS

¶ 2. In 1996, the City of Gulfport filed two separate petitions for condemnation: one against Orange Grove Utilities, Inc., and one against Dedeaux Utility Company, Inc. These two utility districts were privately owned and operated and were located on and served sites outside the Gulfport city limits, but annexations made by Gulfport in 1991 had made the utility plants and their customers a part of the city. Under Miss.Code Ann. § 77-3-17 (Rev. 2000),¹ Gulfport had the right to condemn such utility districts and incorporate them into its municipal system.

¶ 3. After Gulfport filed its petition against Orange Grove, the two parties agreed to acquire one appraisal—made by a mutually agreeable appraiser—to determine just compensation. As a result, Gulfport agreed to pay Orange Grove $33,800,000.

¶ 4. Dedeaux refused Gulfport's offer of $2,140,000, and the matter went to trial before a jury which awarded Dedeaux $3,634,757.00.

DISCUSSION

Dedeaux's Direct Appeal

I. CONTRIBUTIONS IN AID OF CONSTRUCTION.

¶ 5. Approximately 50% of Dedeaux's physical assets were contributed to Dedeaux by land developers, called "contributions in aid of construction." These assets include pipelines installed by and paid for by the developers under their projects. When the pipelines were connected to the Dedeaux plant, the title to the pipelines were transferred to Dedeaux. Therefore, Dedeaux never paid any consideration for the contributed assets. Other contributions in aid of construction included easements, rights-of-way, wells, lift stations and tank sites.

¶ 6. Gulfport's only expert witness who testified as to Dedeaux's value was James M. Stokes, a certified public accountant and a certified valuation analyst; however he had never before determined the value of a utility system. Stokes testified that he used the "discounted cash flow method," which is a method of calculating the value of an income stream. He used data from the Public Service Commission to determine Dedeaux's income. The Public Service Commission establishes rate bases for all public utilities in the state. In fixing the rate bases, the Public Service Commission considers the following data:

(a) the reasonable original costs of the property used and useful, or to be used and useful within a reasonable time after the test period; (b) the portion of the cost which has been consumed by previous use recovered by depreciation expense; (c) the allowance for funds used during construction, ... and, on the equity component thereof, a rate of return granted on common equity ...; (d) any other elements deemed by the commission to be material in determining the rate base for rate-making purposes.

Miss.Code Ann. § 77-3-43(1) (Rev.2000). "Rates prescribed by the [Public Service Commission] shall be such as to yield a fair rate of return to the utility furnishing service, upon the reasonable value of the property of the utility used or useful in furnishing service." Miss.Code Ann. § 77-3-33(1) (Rev.2000). Finally, "[t]he rate base shall not include property donated to such utility without any consideration nor shall operating expenses include depreciation of such donated property." Miss.Code Ann. § 77-3-43(2) (Rev.2000). Therefore, under our statutory scheme, a public utility's rate base is determined by calculating a fair rate of return on the reasonable value of the public utility's assets. However, contributed property is not counted as one of the public utility's assets; therefore, the rate of return fixed by the Public Service Commission excludes consideration of the value of contributed property.

¶ 7. Stokes testified that he based his valuation on the revenue being generated by the entire system, including contributed property and purchased property, but, since he also testified that he used data from the Public Service Commission as his sole source of information, his calculations did not take into consideration contributed property because, as set out above, the Public Service Commission does not consider contributed property. When Stokes testified that, in making his calculations, he only used data generated by the Public Service Commission, Dedeaux asked the trial court to exclude all of Stokes's testimony. It argued that, since, under § 77-3-43(2), contributed property is not taken into account by the Public Service Commission when establishing rates for various utilities, no data from the Public Service Commission would be reliable. Dedeaux argues that, since some of its valuable assets were excluded in the Public Service Commission rate decisions, any appraisal based on Public Service Commission data would be too low.

¶ 8. A leading treatise on eminent domain states, "`Contributed property' must be included in the plant value even though such items are disregarded for purposes of rate-regulation." Julius L. Sackman, Nichols on Eminent Domain § 15.07, at 15-48 (3d ed. rev.2000) (emphasis added). Sackman points out the distinction between valuation of a utility in rate-making cases and in condemnation cases: "when determining value in condemnation matters, greater weight seems to have been placed upon the fact of cost of reproduction, while in the rate-making cases, original cost is given predominant consideration." Id. § 15.06[2], at 15-46 (footnotes omitted). Further,

[e]ven though such physical additions [i.e., contributions in aid of construction] to the plant are typically deeded over to the utility, and add value to the plant, they are not added to the rate base and thus do not generate additional rate charges. the modern theory of rate setting requires not "market" or "fair" value, but rather, a "fair return to the investors." As such, contributions from customers are not direct investments of the utility owner, and are therefore excluded from rate base.

Note here that the property excluded from rate base (but which must be included in fair value) may be significant: fully depreciated machinery still functioning and useful; valuable assets, which have been depreciated on the books, but which may have appreciated in market value; and large amounts of contributed infrastructure owned and used by the utility owner, but not included in rate base. The importance of this point is that a utility valuation by whatever approach, premised on a regulatory rate base that excludes significant utility assets, almost without exception results in less than full or just compensation for all property taken.

Id. § 15.6[1], at 15-40 (footnotes omitted) (emphasis added).

¶ 9. Several courts have decided that data from state regulatory agencies are not reliable as proof of value of utility systems for eminent domain purposes. In Puget Sound Power & Light Co. v. City of Puyallup, 51 F.2d 688, 690 (9th Cir.1931), the Ninth Circuit stated that "the problem presented in a condemnation proceeding is essentially different from that presented to a rate-making body" because, in condemnation proceedings, the issue is "just compensation, which means `the market value' of the property taken." However, "the nature and character of the evidence to be considered by the ratemaking body ... ignores certain elements of value which go to make up a fair value of the property." In Onondaga County Water Authority v. New York Water Service Corp., 285 A.D. 655, 139 N.Y.S.2d 755, 768 (1955), the court stated, "The complete lack of similarity between the original cost used in rate-making and the `just compensation' for the purpose of taking needs no comment."

¶ 10. The Florida Supreme Court has held that, "[s]ince regulated earnings place no value on contributed property, it follows that capitalization of regulated earnings is unacceptable as a method of valuing appellees' property in this proceeding." Dade County v. Gen. Waterworks Corp., 267 So.2d 633, 641 (Fla.1972) (emphasis in original).

¶ 11. More recently, the Maine Supreme Judicial Court held, "The original source of the funds for construction of the Lakehause line [i.e., contributed funds in aid of construction] does not prevent the inclusion of the line in the valuation of the Water Company when the line was Water Company property under the law." Rangeley Water Co. v. Rangeley Water Dist., 691 A.2d 171, 178 (Maine 1997). And, finally, in Washington Suburban Sanitary Comm'n v. Utilities, Inc., of Maryland, 365 Md. 1, 775 A.2d 1178, 1194 (2001), the Maryland Court of Appeals found that a statute mandating that appraisals for eminent domain purposes would not include contributions in aid of construction was unconstitutional.

¶ 12. We find that the trial court erred when it denied Dedeaux's motion to strike Stokes's testimony because his entire appraisal was based on data based on rates fixed by the Public Service Commission. Rule 702 of the Mississippi Rules of Evidence provides that expert testimony is admissible...