Transcanada Hydro Ne., Inc. v. Town of Rockingham

• Decision Date: 09 September 2016
• Docket Number: No. 15-356,15-356
• Citation: 154 A.3d 486
• Court: Vermont Supreme Court
• Parties: TRANSCANADA HYDRO NORTHEAST, INC. v. TOWN OF ROCKINGHAM

154 A.3d 486

TRANSCANADA HYDRO NORTHEAST, INC.

v.TOWN OF ROCKINGHAM

No. 15-356

Supreme Court of Vermont.

September 9, 2016

Motion for Reargument Denied October 5, 2016

Robert E. Woolmington of Witten, Woolmington, Campbell & Bernal, P.C., Manchester Center, for Plaintiff-Appellant.

William H. Sorrell, Attorney General, William E. Griffin, Chief Assistant Attorney General, and Mary L. Bachman, Assistant Attorney General, Montpelier, for Defendant-Appellee State.

Richard H. Saudek of Diamond & Robinson, P.C., Montpelier, for Defendant-Appellee Town of Rockingham.

PRESENT: Reiber, C.J., Dooley, Skoglund, Robinson and Eaton, JJ.

EATON, J.

¶ 1. Taxpayer TransCanada Hydro Northeast, Inc. appeals from a Windham County Superior Court order setting the value of its Bellows Falls hydroelectric facility (the facility) at $130,000,000, with $108,495,400 taxable by the Town of Rockingham (Town).¹ Taxpayer argues that the superior court erred when it relied on testimony of the Town's expert witness. We correct the trial court's valuation to read $127,412,212, and affirm.

¶ 2. The facility, which has been in continuous operation since 1928, is one of five hydropower dams owned by taxpayer situated along the Connecticut River and is located partly in Vermont and partly in New Hampshire. It has a nameplate capacity of 40.8 megawatts (mw) and a net peak capacity of 49.5 mw, and produces, on average, about 258,700 megawatt hours (mwh) of energy per year. It was first licensed by the Federal Energy and Regulatory Commission (FERC) in 1938. In 1979, the facility was relicensed for a period of forty years; that license is set to expire in 2018. Taxpayer acquired the facility and its surrounding property from USGen New England, Inc., in 2005.² Because taxpayer is an independent wholesale power producer, the electricity generated by the facility is sold at hourly market rates established by ISO New England, an independent system operator. This is in contrast to sales under power purchase agreements (PPA), where the sale price is contracted at a flat rate.

¶ 3. This dispute arose in 2012 when the Town listed the facility on its grand list at $108,110,000, the same value at which the facility had been listed the previous two years. Taxpayer did not challenge the 2010 or 2011 valuations, but appealed the 2012 listing to the board of civil authority, and then to the superior court pursuant to 32 V.S.A. § 4461(a). The State of Vermont intervened in the appeal on behalf of the Town.

¶ 4. At trial, both taxpayer and the Town presented expert testimony as to the value of the facility. The experts' opinions on value varied substantially, ranging from taxpayer's estimate of $84,000,000 to the Town's estimate of $130,000,000. Taxpayer offered testimony on value from Daniel Peaco, an engineer and consultant. Peaco employed an income-based approach to valuation of the facility using a discounted cash flow (DCF) analysis,³ and concluded that on April 1, 2012, the fair market value of the facility was $84,000,000, of which $67,000,000 was attributable to the Town.⁴ The Town offered expert testimony from George Sansoucy, a registered professional engineer in New Hampshire and a certified real estate appraiser in several states, including Vermont. Sansoucy prepared an appraisal of the facility using both the DCF analysis and a comparable sales analysis.⁵ He concluded that based on the DCF method, the facility had a value of $116,417,250, and that based on the comparable sales approach, it had a value of $142,287,750. After reconciling the income and sales values, Sansoucy concluded that the fair market value of the facility on April 1, 2012 was $130,000,000, of which $108,495,400 was attributable to the Town. The difference between the two appraisals amounts to $41,495,400. The experts' opinions were complex, and taxpayer has made several challenges to the court's acceptance of the Town's expert's opinion. Most of the issues taxpayer raises on appeal pertain to specific inputs or assumptions made by Sansoucy in each of the two methods of valuation he employed. Accordingly, to give context to the challenges raised on appeal, a detailed discussion of how the experts arrived at their opinions on value is necessary.

I. Methods of Valuation

A. Income-Based Approach

¶ 5. Both experts relied, at least in part, on a DCF analysis, an income-based approach to valuation. This approach converts the future benefits of property ownership—that is, the income the property will generate—into an expression of the property's present worth by discounting each future benefit at a rate that reflects the investment's income pattern, value change, and yield rate. In Beach Properties, Inc. v. Town of Ferrisburg, we explained this approach as follows:

The income approach is based on the proposition that a rational investor would pay the fair market value for a piece of property, which is the price (P) that, when multiplied by the rate of return available from alternative investments of comparable risk (the capitalization rate or R), is equal to the property's expected net income (I). In other words, if the known factors are capitalization rate and net income, the price of the property may be calculated by dividing the net income by the capitalization rate: P = I/R.

161 Vt. 368, 372, 640 A.2d 50, 52 (1994) (footnote omitted).

¶ 6. Converting periodic income and reversion into present value is called discounting, and the rate of return is called the discount rate. In a DCF analysis, a yield rate is applied to a set of projected income streams and a reversion to determine whether the investment property will produce a required yield given a known price of acquisition. The critical elements in the DCF approach are net income or revenue (I), which can be discounted back to present value using the predetermined discount rate (R), to arrive at price (P). Net income is dependent on projected revenues, including capacity revenue and energy prices, less expenses. It is then discounted by a discount rate, or rate of return, which represents the cost of borrowing money to pay for the purchase of an asset. A lower projected cost of capital generally results in a higher estimated fair market value. Although both experts' DCF analyses employed the same general methods, differences in the inputs and treatment of certain variables resulted in vastly different opinions on value.

¶ 7. Each expert's revenue projection was derived from annual generation figures multiplied by the predicted price of electricity for the particular future year. Both experts made certain assumptions about the facility's generating capacity, using historic data regarding stream flows and facility operation. The primary difference in the experts' calculations stems from differences in the number of years used to determine the average generation in megawatt hours. Sansoucy relied on a ten-year average of generation, for the years 2000 through 2011, a time period he determined would capture the evolving trends of increased rainfall on the Connecticut River and increased efficiency and capacity at the facility during that time. He predicted that future generation would be 258,700 mwh per year. Peaco relied on a twenty-year average of generation, for the years 1991 through 2011, a time period he determined would account for fluctuations in short term hydrologic phenomena. He predicted that future generation would be 242,000 mwh per year, 16,700 mwh less than Sansoucy's estimated generation.

¶ 8. The experts also differed in their projected expenses, which accounted for a difference in fair market value of approximately $8,400,000. Both parties considered two main categories of expenses in their DCF analyses: (1) maintenance costs and capital expenses; and (2) protection, mitigation, and enhancement expenses (PM&E).⁶

¶ 9. The primary differences in the experts' calculations were with regard to their treatment of capital expenses and the treatment of the projected costs of relicensing. Among maintenance costs and capital expenses, Sansoucy considered the costs of operation and maintenance (O&M), administrative and general costs, and capital expenditures. He allocated about $55 per kilowatt (kw) of capacity, or $2,200,000 per year in the first year, to O&M, which he considered to include maintenance with a life of one year or less. He then assigned 1% of the value of the facility per year to capital improvements with a life longer than one year—amounting to approximately $1,300,000 in the first year—which he explained was comparable to what similar companies were spending on capital projects. He also included $1,500,000 in expenses associated with the expected costs associated with FERC relicensing in 2018 and amortized the expenses over the life of the forty-year license at $38,000 per year.

¶ 10. Inherent in Sansoucy's DCF analysis is the facility's remaining value at the end of the term of the DCF, or terminal value. The inclusion of terminal value in Sansoucy's DCF has a significant impact on the present value of the facility and is intended to reflect the reasonable expectation that after twenty years, the length of the DCF term, the facility will continue to operate and produce revenue. Sansoucy estimated that in 2031 the facility will generate a net operating cash flow of $22,725,000. He capitalized the after-tax net operating cash flow at a rate of 9% and concluded that a reasonable estimate of the facility's value in the year 2031 would be about $176,000,000. Discounted back to 2012, the terminal value represented $33,900,000 in 2012 dollars.

¶ 11. Rather than assigning a percentage of the facility's value to capital improvements over the period of the FERC license, Peaco identified two categories of capital expenses: baseline capital expenditures, which taxpayer would incur yearly, and large capital expenses, which taxpayer would incur on a one-time basis. He arrived at the baseline capital expenses by reference to taxpayer's...