Texas Water Com'n v. Lakeshore Utility Co., Inc.

• Decision Date: 18 May 1994
• Docket Number: No. 3-93-432-CV,3-93-432-CV
• Citation: 877 S.W.2d 814
• Parties: TEXAS WATER COMMISSION, Appellant, v. LAKESHORE UTILITY COMPANY, INC., Appellee.
• Court: Texas Court of Appeals

Page 814

877 S.W.2d 814

TEXAS WATER COMMISSION, Appellant, v. LAKESHORE UTILITY COMPANY, INC., Appellee.

No. 3-93-432-CV.

Court of Appeals of Texas Austin.

May 18, 1994.

Rehearing Overruled June 22, 1994.

Dan Morales, Atty. Gen., Susan Bergen Schultz, Asst. Atty. Gen., Austin, for appellant.

J. Albert Kroemer, Smith & Moore, Dallas, for appellee.

Before POWERS, KIDD and B.A. SMITH, JJ.

KIDD, Justice.

This is an appeal from a suit for judicial review of an order of the Texas Water Commission (the "Commission"). ¹ Lakeshore Utility Company ("Lakeshore") filed an application with the Commission seeking a rate increase for its water and sewer services. The Commission in large part denied Lakeshore's application. The district court reversed the Commission's order and remanded the cause to the Commission with instructions. We will reverse the judgment of the district court and affirm the order of the Commission.

BACKGROUND

Lakeshore is a small, privately-owned utility that provides water and sewer services to residential customers in Henderson County. Lakeshore's stock is wholly owned by Sentry Title Company ("Sentry"), as are the physical plant and facilities Lakeshore uses in providing its utility services.

On January 23, 1989, Lakeshore filed an application for a rate and tap fee increase with the Commission. Lakeshore's application also sought a temporary surcharge of $4.58 per month per customer for five years to cover system improvements. The rate increase and surcharge sought by Lakeshore were to apply to approximately 111 residential customers in two subdivisions, Esquire Estates II and Point LaVista. Since Lakeshore's organization in 1978, the utility had received one rate increase, in 1987, which applied only to the Point LaVista subdivision. The Esquire Estates II subdivision was still subject to rates set in 1978. On March 1, 1989, Lakeshore put into effect on an interim basis the rates requested in its application.

After the subdivision homeowners' associations and the Office of Public Utility Counsel objected to the proposed rate increase, an evidentiary hearing was held before the Commission on August 1-2, 1989. After the hearing, the hearing examiner recommended, and the Commission approved, an order denying the majority of Lakeshore's requests. ²

Lakeshore brought a suit for judicial review of the Commission's order pursuant to the Administrative Procedure Act. See Tex. Gov't Code Ann. § 2001.171 (West Supp.1994). ³ Following a hearing on June 7, 1991, the district court rendered final judgment, reversing the Commission's order and remanding the cause to the Commission. In its judgment, the district court stated that it found "numerous errors in the treatment of this case by the Texas Water Commission."

The Commission appeals the district court's judgment, bringing seven points of error. We will reverse the judgment of the district court and affirm the Commission's order.

DISCUSSION

Ratemaking Authority of the Texas Water Commission

The Water Code invests the Commission with the authority to fix and regulate the rates charged by water and sewer utilities. Tex. Water Code Ann. § 13.181 (West Supp.1994). This appeal, in large part, represents a conflict between two Water Code provisions that govern the Commission's ratemaking authority. On the one hand, the Commission must fix a utility's "overall revenues at a level that will: (1) permit the utility a reasonable opportunity to earn a reasonable rate of return on its invested capital used and useful in rendering service to the public over and above its reasonable and necessary operating expenses; and (2) preserve the financial integrity of the utility." Tex. Water Code Ann. § 13.183(a) (West Supp.1994). On the other hand, "[i]n any proceeding involving any proposed change of rates, the burden of proof shall be on the utility to show that the proposed change, if proposed by the utility ... is just and reasonable." Tex. Water Code Ann. § 13.184(c) (West 1988).

The overall positions taken by the parties mirror these code provisions. Lakeshore argues that the Commission has acted arbitrarily and capriciously--even punitively--by approving a rate increase of only $1,265.40 per year. ⁴ Since Lakeshore has operated at an average loss of approximately $27,800 per year, Lakeshore contends that the Commission's decision threatens the utility's financial survival. The Commission responds that Lakeshore simply failed to shoulder its burden of proof. The Commission argues that the evidence in the record is wholly inadequate to justify the increase in rates and tap fees, as well as the surcharge, requested by Lakeshore.

Standard of Review

We must view the arguments of Lakeshore and the Commission through the prism of substantial evidence review. Tex. Water Code Ann. § 13.381 (West 1988); Texas Water Comm'n v. Customers of Combined Water Sys., 843 S.W.2d 678, 680-81 (Tex.App.--Austin 1992, no writ). The test under substantial evidence review is whether the evidence as a whole is such that reasonable minds could have reached the conclusion that the agency must have reached in order to justify its action. APA § 2001.174(2)(E); Texas State Bd. of Dental Examiners v. Sizemore, 759 S.W.2d 114, 116 (Tex.1988). We must review the record to determine whether there was a reasonable basis for the Commission's action. Customers of Combined Water Sys., 843 S.W.2d at 681; United Resource Recovery, Inc. v. Texas Water Comm'n, 815 S.W.2d 797, 801 (Tex.App.--Austin 1991, writ denied). In doing so, we may not substitute our own judgment as to the weight of the evidence. APA § 2001.174; Customers of Combined Water Sys., 843 S.W.2d at 680-81. We must reverse the Commission's order if it is not supported by substantial evidence or if the order was arbitrary, capricious, or an abuse of discretion. APA § 2001.174(2)(F); Customers of Combined Water Sys., 843 S.W.2d at 680. We must uphold the Commission's order if (1) the findings of underlying fact in the order fairly support the Commission's findings of ultimate fact and conclusions of law, and (2) the evidence presented at the hearing reasonably supports the findings of underlying fact. Customers of Combined Water Sys., 843 S.W.2d at 680.

Interest Expense on Loan from Sentry

In its first point of error, the Commission contends that the district court erred in finding that the Commission should have allowed $11,410 in claimed interest expense. The $11,410 interest charge was incurred on a loan from Sentry, Lakeshore's parent company, paid incrementally to Lakeshore over an eight-year period. In its application, Lakeshore requested that the interest expense be treated as an operating expense. Lakeshore presented uncontroverted evidence that the payments were made by Sentry to help Lakeshore meet shortfalls in its operating revenues. However, while the payments from Sentry were recorded as deposits to Lakeshore's account, Lakeshore's records did not specify how the loan proceeds were used. Further, there was testimony at the hearing that Lakeshore had operated several utility systems over the eight-year period, and Lakeshore was unable to produce evidence that the loan proceeds had been used only on Esquire Estates II and Point LaVista, the subdivisions from which Lakeshore was seeking the rate increase.

The Commission disallowed the interest payments for three reasons. First, because Lakeshore offered no evidence detailing how the loan proceeds were expended other than that the proceeds were used for the daily operating expenses of the utility, the Commission found that "the accompanying request for interest expense was not established as reasonable and necessary." Second, the Commission found that the interest payments from Lakeshore to Sentry were inappropriate "in light of the artificial separation of ownership and operation of the utility." Third, the Commission found that the "cash flow problems experienced by the utility should have been resolved by properly prepared and presented rate increase requests."

Lakeshore argues that it met its burden of presenting evidence that the interest expense was reasonable and necessary. During the hearing, Lakeshore's general manager, Alan Whatley, testified that the loan proceeds were used to cover the shortfall between Lakeshore's revenue and expenses; that the funds were used solely for operating expenses; and, that the interest rate charged by Sentry was below the market rate. Lakeshore contends that this evidence established that it was entitled to have the interest expense included in its rate base. Tex. Water Code Ann. § 13.185(e) (West 1988). The district court agreed with Lakeshore, finding that the Commission erred in disallowing the interest expense.

Lakeshore is correct that interest payments made by a utility to its parent company may be treated as operating expenses for ratemaking purposes. However, section 13.185(e) of the Water Code permits the Commission to treat interest payments to affiliated interests ⁵ as operating expenses only under certain circumstances:

Payment to affiliated interests for costs of any services, or any property, right or thing, or for interest expense may not be allowed either as capital cost or as expense except to the extent that the regulatory authority finds that payment to be reasonable and necessary. A finding of reasonableness and necessity must include specific statements setting forth the cost to the affiliate of each item or class of items in question and a finding that the price to the utility is no higher than prices charged by the supplying affiliate to its other affiliates or divisions for the same item or items, or to unaffiliated persons or corporations.

Tex. Water Code Ann. § 13.185(e) (West 1988) (emphasis added). ⁶ Thus, section 13.185(e) only permits inclusion of interest payments to an affiliated interest if the Commission finds the payments were "reasonable and necessary." The Commission is given...