Wabash Valley Power Ass'n, Inc. v. Rural Electrification Admin., 89-2482

CourtUnited States Courts of Appeals. United States Court of Appeals (7th Circuit)
Writing for the CourtBefore WOOD, Jr., EASTERBROOK, and MANION; EASTERBROOK
Citation903 F.2d 445
PartiesWABASH VALLEY POWER ASSOCIATION, INC., Plaintiff-Appellee, and State of Michigan and Michigan Public Service Commission, Intervening Appellees, v. RURAL ELECTRIFICATION ADMINISTRATION, Defendant-Appellant.
Docket NumberNo. 89-2482,89-2482
Decision Date22 August 1990

Page 445

903 F.2d 445
State of Michigan and Michigan Public Service Commission,
Intervening Appellees,
No. 89-2482.
United States Court of Appeals,
Seventh Circuit.
Argued April 3, 1990.
Decided May 23, 1990.
As Modified Aug. 22, 1990.

Page 447

James T. Malysiak, Lee A. Freeman, Jr., John F. Kinney, Freeman, Freeman & Salzman, Chicago, Ill., Warren D. Krebs, Don F. Morton, Charles W. Ritz, III, Parr, Richey, Obremskey & Morton, David Kleiman, Dann, Pecar, Newman, Talesnick & Kleiman, Indianapolis, Ind., for Wabash Valley Power Ass'n, Inc.

Stuart A. Schiffer, Brenda Franklin Rodeheffer, Asst. Atty. Gen., Gerald A. Coraz, Asst. U.S. Atty., Deborah J. Daniels, U.S. Atty., Jeffrey L. Hunter, Asst. U.S. Atty., Indianapolis, Ind., J. Christopher Kohn, George Kielman, James G. Bruen, Jr., Andrea Larry, Letitia J. Mallin, Dept. of Justice, Civ. Div., Washington, D.C., Robert K. Johnson, Robert M. Glennon, Indianapolis, Ind., Frank J. Kelley, Atty. Gen., Louis J. Caruso, Sol. Gen., Don L. Keskey, Henry J. Boynton, Asst. Attys. Gen., Patricia S. Barone, Office of the Attorney General, State of Mich., Lansing, Mich., Deborah W. Hayes, Joseph E. Friend, Douglas S. Draper, Friend, Wilson & Draper, New Orleans, La., Frank Clover, Michael W. Kelly, Gen. Counsel, Dept. of Agriculture, Washington, D.C., for Rural Electrification Admin.

Louis J. Caruso, Sol. Gen., Don L. Keskey, Henry J. Boynton, Asst. Attys. Gen., Patricia S. Barone, Lansing, Mich., for State of Mich., Michigan Public Service Com'n.

Wallace F. Tillman, N. Beth Emery, Patrick W. Shea, Paul, Hastings, Janofsky & Walker, Washington, D.C., for Nat. Rural Elec. Co-op. Ass'n amicus curiae.

N. Beth Emery, Patrick W. Shea, Paul, Hastings, Janofsky & Walker, Washington, D.C., Charles T. Autry, E. Penny Gilbert, Tucker, Ga., for Oglethorpe Power Corp. amicus curiae.

Albert Ernst, Dykema & Gossett, Lansing, Mich., Steven H. Ancel, Sorelle J. Ancel, Ancel, Dunlap & Traylor, Indianapolis, Ind., John Coldren, Coldren & Frantz, Portland, Ind., for Official Members Committee of Wabash Valley Power Ass'n, Inc. amicus curiae.

Leo J. Clifford, Clifford, Claudon, Alexa & Koeppen, Valparaiso, Ind., for amicus curiae Kankakee Valley REMC.

Before WOOD, Jr., EASTERBROOK, and MANION, Circuit Judges.

EASTERBROOK, Circuit Judge.

Rate regulation for electricity rests on the theory that generating stations and transmission lines are natural monopolies. Unless constrained, suppliers charge monopoly prices in order to satisfy their investors. States hold electric utilities to the cost of service (including a competitive rate of return on invested capital); the Federal Energy Regulatory Commission does the same for wholesale electricity transmitted across state borders, preempting state regulation. 16 U.S.C. Sec. 824(b); FPC v. Southern California Edison Co., 376 U.S. 205, 84 S.Ct. 644, 11 L.Ed.2d 638 (1964). When the electric utility is owned by its customers, however, there is no reason to think that the seller will charge a monopoly price--or that if it does the customers will care. If the firm charges a monopoly price, the profits return to the customers as dividends, deferred rebates on the purchase price.

The natural-monopoly explanation for regulation of investor-owned utilities has been challenged. E.g., George J. Stigler & Claire Friedland, What Can Regulators Regulate?: The Case of Electricity, 5 J.L. & Econ. 1 (1962), reprinted in Stigler, The Citizen and the State 61 (1975); see also Paul L. Joskow & Richard Schmalensee, Markets for Power: An Analysis of Electrical Utility Deregulation (1983). For customer-owned utilities there is no equivalent debate: either way, the customers win. Most states accordingly do not regulate the

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prices charged by these firms. When the federal Rural Electrification Administration lends money to a utility--which it does at bargain rates for customer-owned firms--the Federal Energy Regulatory Commission drops its own system of price control, believing that customers of such firms don't need "protection" from their own managers' decisions. Dairyland Power Cooperative, 37 F.P.C. 12 (1967). See also Salt River Project Agricultural Improvement & Power District v. FPC, 391 F.2d 470 (D.C.Cir.1968).

Yet 11 states do regulate the prices charged by cooperative electric utilities. Arkansas Electric Cooperative Corp. v. Arkansas Public Service Commission, 461 U.S. 375, 103 S.Ct. 1905, 76 L.Ed.2d 1 (1983), holds that neither the hands-off attitude of the FERC nor any generally-applicable rule established by the REA preempts state regulation. Why might states choose to regulate the prices charged by customer-owned utilities? We can think of two answers, both of which start from the premise that the equity investors (shareholders, members) of a corporation are not its sole "owners". Other persons also invest: creditors invest money in exchange for a promise of interest plus repayment; employees invest specialized skills that may not be so useful at other firms. These investors obtain contractual rights. The equity investors "own" only the rights to control and profit not assigned by contract to other investors. Electric utilities commonly depend more on debt financing than on equity financing. So perhaps the "real" owners--at least the effective controllers--of an electric co-op are the debt investors, who would be tempted to raise prices past the competitive level in order to make their loans more safe or hike up the rate of interest. When creditors control the firm, they may be inclined to set a monopoly price and not rebate the profits to the equity-investor-customers. Regulation then would play the same role it does in traditional theories.

If one possibility is that regulation prevents the debt investors from exploiting the equity investors, the other possibility is that regulation enables the equity investors to exploit the debt investors. Customer-investors--residents of the state who wield political influence there--may seek regulation of "their own" utility's prices in order to depress revenues so greatly that they no longer can pay off the debt investors. They hope to emerge from bankruptcy with control of the firm and entitled to keep all future revenues for themselves. Without regulation, the debt investors may have contractual rights to force price increases sufficient to pay the debt in full; regulation plus bankruptcy law may provide a one-two punch allowing the customer-cum-equity-investor to escape these contractual provisions yet remain in control of the utility.

Neither the customer-exploits-creditor hypothesis nor the creditor-exploits-customer hypothesis is troubling if the firm depends on a flow of fresh capital under new contracts; the need to return to capital markets frequently ensures that contractual terms are competitive, and anyone who violates commitments made then cannot be expected to be invited back. When, however, an event sufficiently large in the life of the firm or the industry occurs, it may be worth accepting the injury to one's reputation for square dealing. In this "last period", the gains from breach exceed any loss from fetters on future bargains.


According to the Rural Electrification Administration, the Wabash Valley Power Association has entered that last period and is doing its best to extract the value of loans the REA made. Wabash is a non-profit generation-and-transmission utility whose customers operate in Indiana, Michigan, and Ohio. Indiana and Michigan regulate the rate customer-owned electric utilities may charge for power. Over the years the REA loaned Wabash a sum that, with unpaid interest and further advances to prevent other lenders from foreclosing, comes to about a billion dollars. Wabash promised the REA to set rates high enough to ensure that the principal and interest would be repaid. To make doubly sure, before lending money the REA required

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Wabash to obtain state agencies' approval for its projects. On top of that, the REA takes a security interest in a co-op's assets, including its contracts with customers--contracts that require customers to take their requirements of electricity from the co-op at rates high enough to repay the loans. The REA thought that this combination of contractual devices would protect it. It has been proved wrong.

During the 1970s one of Wabash's neighbors, the for-profit Public Service Company of Indiana, decided to construct the Marble Hill nuclear generating station. Wabash purchased a 17% interest in the project. To finance its share it borrowed $480 million on the strength of the REA's guarantees. In January 1984 Public Service of Indiana abandoned construction of the Marble Hill station because costs had risen so high that further work would throw good money after bad. Wabash was out the money, and unless it raised its rates could not repay the lenders. It did not raise its rates and defaulted; the lenders exercised their rights under the REA's guarantees, compelling it to pay in Wabash's stead. The REA, pointing to its contract, instructed Wabash to file for rate increases sufficient to assure repayment. Wabash complied with transparent insincerity, making it clear to the state regulators that it would be delighted if they said no. (So the REA contends, and given the posture of this case we must take facts and inferences in the REA's favor. Because as a practical matter Wabash serves the interests of its owner-customers, this interpretation of its behavior before the state agencies is plausible.)

Public Service of Indiana applied for its own rate increase and emerged empty-handed. Until 1984 the Indiana Utility Regulatory Commission believed that an investment prudent when made may be included in the rate base even though things turn out poorly. When Northern Indiana Public Service Co....

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