Town of Hingham v. Dept. of Telecommunications

• Decision Date: 11 September 2000
• Docket Number: MASSACHUSETTS-AMERICAN,SJC-08201
• Citation: 740 N.E.2d 984,433 Mass. 198
• Court: United States State Supreme Judicial Court of Massachusetts Supreme Court
• Parties: (Mass. 2001) TOWN OF HINGHAM & another <A HREF="#fr1-1" name="fn1-1">1 vs. DEPARTMENT OF TELECOMMUNICATIONS AND ENERGY;WATER COMPANY, intervener. Docket No.:

740 N.E.2d 984 (Mass. 2001)

TOWN OF HINGHAM & another¹ vs. DEPARTMENT OF TELECOMMUNICATIONS AND ENERGY; MASSACHUSETTS-AMERICAN WATER COMPANY, intervener.

Docket No.: SJC-08201

Massachusetts Supreme Court

September 11, 2000

January 16, 2001

County: Suffolk

Present: Marshall, C.J., Greaney, Ireland, Spina, & Sosman, JJ.

Summary:

Water Company. Public Utilities, Judicial review, Rate structure, Rate of return, Findings. Administrative Law, Agency, Judicial review, Findings, Substantial evidence, Standard of proof, Regulations. Words, "Used and useful."

Civil action commenced in the Supreme Judicial Court for the county of Suffolk on July 12, 1996.

The case was reported by Spina, J.

James A. Toomey, Town Counsel (James B. Lampke, Town Counsel, with him) for town of Hingham & another.

Daniel J. Hammond, Assistant Attorney General, for the defendant.

Thomas G. Tumilty, for the intervener, was present but did not argue.

MARSHALL, C.J.

The towns of Hingham and Hull (towns) appealed to a single justice of this court, pursuant to G. L. c. 25, § 5, from a May 31, 1996, decision of the then Department of Public Utilities² (department). The decision allowed the Massachusetts-American Water Company³ (company) to increase base rates for all its customers, and to impose a surcharge on certain customers to recover costs associated with its new water treatment plant (plant) in Hingham. The single justice reserved and reported the case to the full court.

In November, 1995, the company petitioned the department to increase the rates in all the towns it served⁴ by a cumulative amount of $5,711,056, an over-all rate increase of 98.09%. Of this amount, $1,525,552 would be a general rate increase to all customers. The remaining $4,185,504, proposed to finance the new plant, would apply only to customers in Service Area A, the towns to be served by the plant. Following thirteen days of evidentiary hearings in March and April, 1996, the department issued a 198-page order allowing the company to file schedules of rates and charges designed to recover the lease and operation costs associated with the plant. The towns filed their petition for appeal, and the company filed its motion to intervene.

The towns assert that the department misapplied its own standard and precedent by finding the plant "used and useful" when it was not in service during the test year. The towns claim that the department committed an error of law by failing to apply the "affiliated transaction" standard in scrutinizing agreements between the company and Massachusetts Capital Resources Company (MassCap), a wholly owned subsidiary of American Water Works Company (American Water Works)⁵ that was established for the sole purpose of financing and completing construction of the plant. The towns further claim error in (1) allowing a fourteen per cent rate of return to MassCap because that rate of return rewarded "creativity," but was not evaluated for its fairness and reasonableness; (2) not determining whether the company's financing arrangements were in the public interest and whether the leasing arrangements were the least costly alternative where customers will pay for the total cost of a plant with a useful life of 60.5 years in 40.5 years; (3) allowing the company to recoup in rates the costs associated with certain construction expenses; and (4) shifting the burden of proof to the towns. Finally, the towns argue that the department's use of 220 Code Mass. Regs. § 31.03 (1997), to set the rate of return in the base rate is in excess of the department's authority and an illegal delegation of its responsibility. We affirm the department's order.

1. Background.

The company is a retail water utility that, at the time of the department's decision, provided water service to six towns in the Commonwealth. The company's quality of service had been, according to the department, "a long-standing issue." The company had entered into an administrative consent order with the department pursuant to which the company agreed to several conditions, including construction of a new water treatment plant by June 29, 1996. The plant was needed to bring the company's water supply into compliance with the Federal Safe Drinking Water Act, 42 U.S.C. 300j-12(g) (1994 & Supp. IV 1998), and related State laws and regulations governing the filtration, disinfection, and aesthetic qualities of drinking water.

Construction of the plant commenced in September, 1994. On July 1, 1995, the company sold its interest in the partially constructed plant to MassCap. The company and MassCap entered into a ground lease and a facility lease, with the company agreeing to lease the plant from MassCap for 40.5 years, beginning on June 1, 1996. The expected useful life of the plant is 60.5 years, and the facility lease permits the company to renew the lease after its expiration. According to the department, this arrangement, involving project financing and a sale-leaseback, was the first among the nation's public water utilities.⁶

The total cost of the plant was estimated, at the time of the hearings, to be $39,530,000. The company sought the department's authorization to recover payments under the facility lease by adding a surcharge to the customers' water rate in Service Area A. The company's request was approved by the department's order, with certain modifications. Further facts will be presented as relevant.

2. Standard of Review. Our standard of review of petitions under G. L. c. 25, § 5, is well settled: a petition that raises no constitutional questions requires us to review the department's findings to determine only whether there is an error of law. See Costello v. Department of Pub. Utils., 391 Mass. 527, 532 (1984), and cases cited. Appellants bear the burden of proving error, and we have observed that this burden is a heavy one. Id. at 533. Wolf v. Department of Pub. Utils., 407 Mass. 363, 367 (1990). We give great deference to the department's expertise and experience in areas where the Legislature has delegated decision-making authority to the agency. See G. L. c. 30A, § 14. The department has broad authority to determine ratemaking matters in the public interest. See id. at 369; Commonwealth Elec. Co. v. Department of Pub. Utils., 397 Mass. 361, 369 (1986), cert. denied, 481 U.S. 1036 (1987); Lowell Gas Light Co. v. Department of Pub. Utils. 319 Mass. 46, 52 (1946).

3. Used and Useful Standard. The department evaluated the costs associated with the plant by its "prudent used and useful" standard. For costs to be included in rate base,⁷ expenditures must be prudently incurred, and the resulting plant must be used and useful to customers. The prudence test determines whether cost recovery is allowed at all, based on how a reasonable company would have responded to the particular circumstances and whether the company's actions were prudent in light of all circumstances known or reasonably known at the time. See Boston Gas Co., D.P.U. 93-60, at 24-25 (1993). The "used and useful" analysis determines the portion of prudently incurred costs on which the utility is entitled to earn a return. The "used and useful" standard generally requires that a utility plant must be in commercial operation and providing net benefits to customers in order for expenses associated with it to be included in rate base.

The towns claim that the department committed an error of law when applying its "used and useful" standard because the plant, not in service until after the test year,⁸ was not a "used and useful" capital expenditure such that its costs could be included in rate base.⁹ According to the towns, the department only provides for a "post-test year adjustment" when such costs are known and measurable at the time of the order, citing Boston Edison Co. v. Department of Pub. Utils., 375 Mass. 1, 22, cert. denied, 439 U.S. 921 (1978), for this proposition.¹⁰ Under the "used and useful" standard, a utility expenditure generally can be included in rate base if (1) it was prudently incurred and (2) the result of the expenditure is "used and useful" by providing service to customers during the test year. Id. at 18-21. Accordingly, a public utility's rate base is its total prudent investment in property that is "used and useful" to the public in providing utility service during the test year. Cf. Commissioner of Revenue v. New England Power Co., 411 Mass. 418, 423 (1991). See Boston Edison Co. v. Department of Pub. Utils., supra at 18-21. Once the department decides which expenses can be included in the rates, it determines a fair rate of return on the utility's investment. It is a long-standing principle that a public utility is entitled to charge rates that allow it to meet its costs of service, including a fair and reasonable return on honestly and prudently invested capital. Lowell Gas Co. v. Department of Pub. Utils., 324 Mass. 80, 94-95 (1949).

The towns misconstrue how the department analyzed the costs associated with the plant, as these costs relate to rate base. The department indicated in its final order that, for a posttest- year addition to be considered part of a utility company's rate base, the company must have an ownership interest in the addition. Because the plant was not owned by the company, but instead had been sold to, and leased back from, MassCap, the department did not analyze the plant construction costs as a capital investment to be reflected in the company's rate base. Rather, the department analyzed the lease payments to MassCap as an annual expense to the company, and inquired into the prudence of that expense as a prerequisite to allowing the company to pass the lease expenses on to the customers.

As noted in its order, the department had to "examine the overall costs of the [construction] project to determine the level of lease payments to MassCap which should be included in the . . . cost of service." The department evaluated the costs by an objective...