WSSC v. Utilities

• Citation: 775 A.2d 1178,365 Md. 1
• Decision Date: 21 June 2001
• Docket Number: No. 116,116
• Parties: WASHINGTON SUBURBAN SANITARY COMMISSION, v. UTILITIES, INC. OF MARYLAND.
• Court: Court of Appeals of Maryland

775 A.2d 1178

365 Md. 1

WASHINGTON SUBURBAN SANITARY COMMISSION, v. UTILITIES, INC. OF MARYLAND.

No. 116, September Term, 2000.

Court of Appeals of Maryland.

June 21, 2001.

Reconsideration Denied August 14, 2001.

Kurt J. Fischer (Paul A. Tiburzi and Marta D. Harting of Piper Marbury, Rudnick & Wolfe, LLP, Baltimore; Leonard L. McCants of McCants & Associates, LLC, Silver Springs; Ernest A. Crofoot and Robert H. Drummer of Washington Suburban Sanitary Commission, Laurel), all on brief, for petitioner/cross-respondent.

Steven P. Hollman (Jeffrey D. Pariser and Adam K. Levin of Hogan & Hartson L.L.P., Washington; William E. Sundstrom of Rose, Sundstrom & Bentley, LLP, Tallahassee), all on brief, for respondent/cross-petitioner.

J. Joseph Curran, Jr., Attorney General of Maryland, Robert A. Zarnoch, Assistant Attorney General of Maryland, as Amicus Curiae for appellant.

Margaret Scott Izzo, Morgan, Lewis & Bockius LLP, Washington, DC, Amicus Curiae, National Association of Water Companies for appellee.

Thomas P. Gadsden, Morgan, Lewis & Bockius LLP, of Counsel, Philadelphia, PA.

Argued before BELL, C.J. and RAKER, WILNER, CATHELL, HARRELL, BATTAGLIA and LAWRENCE F. RODOWSKY (retired, specially assigned), JJ. LAWRENCE F. RODOWSKY, Judge, Retired, Specially Assigned.

Appellant and cross-appellee, Washington Suburban Sanitary Commission (WSSC), petitioned for the conventional condemnation of water and sewerage systems (the Systems) owned and operated by the appellee and cross-appellant, Utilities, Inc. of Maryland (UIM), a public service utility. The jury valued the Systems at $9.7 million from which, per statute, the court deducted $3.2 million representing contributions in aid of construction (CIAC).¹ UIM contends, inter alia, that the statute requiring the deduction of CIAC effects an unconstitutional taking without just compensation.² WSSC contends, inter alia, that the trial court erred in admitting evidence relating to the value of the Systems based on capitalization of the regulated cash flow at rates of return appropriate to an unregulated, governmental owner. As explained below, we shall reverse on the appeal of UIM and affirm on the appeal of WSSC.

WSSC is a state agency, vested with broad authority to construct and operate water supply, sewerage, and storm water management systems in Prince George's and Montgomery Counties. See Maryland Code (1957, 1997 Repl.Vol., 2000 Cum. Supp.), Article 29, §§ 1-101 through 19-101; Katz v. WSSC, 284 Md. 503, 509, 397 A.2d 1027, 1031 (1979). UIM is a subsidiary of a nationwide holding company, Utilities Inc. (UI), that operates more than 350 utility systems in fifteen states. The Systems serve Marlboro Meadows, an unincorporated community of 1,200 residences in Prince George's County lying east of U.S. 301, approximately 1.6 miles northeast of Upper Marlboro. The Systems are capable of serving 1,800 residential units.

Major components of the condemned property include two wells collectively capable of producing three million gallons per day, a 500,000 gallon water tower, a 500,000 gallon ground source reservoir, auxiliary power sources, twenty-nine miles of pipe, seventy-five fire hydrants, 323 manholes, a waste water treatment plant, a waste water pumping station, a fresh water treatment plant, chemicals, inventory, spare parts, laboratory equipment, and office equipment. The utility also leases space on its water tower to three cellular telephone companies.

Marlboro Meadows was under development in 1965. The developer was Hylton Enterprises, Inc., a corporation owned by Cecil D. Hylton, Sr. (Hylton). Hylton also owned all of the stock of First Maryland Utilities, Inc. (First Maryland). In April 1965 the County Commissioners of Prince George's County granted First Maryland an exclusive franchise for the operation of water and sewerage treatment systems in Marlboro Meadows, and in July 1967 First Maryland received Public Service Commission of Maryland (PSC) authorization to exercise its franchise. It is undisputed that the PSC treated at least some substantial portion of the cost of construction by First Maryland of the initial water and sewerage treatment facilities at Marlboro Meadows as CIAC, made by the initial purchasers of homes in that community as part of their purchase prices, and that the PSC deducted the CIAC from First Maryland's rate base.

By 1983 First Maryland had been sued by the Maryland Department of Health and Mental Hygiene for violations in sewerage treatment operations, and First Maryland had agreed to pay $200,000 in fines and plant improvements to settle that action. Re First Maryland Utilities, Inc., 76 Md. P.S.C. 175, 177 (1985). The drinking water frequently contained "sand, iron and other particulate matter" and there were "instances of raw sewage backing up into ... homes." Id. at 176-77. In March 1985 the PSC approved the transfer of the assets, rights, and franchises of First Maryland to UIM. Id. at 179. For purposes of the PSC's calculation of the rate base, UIM's purchase price was $200,000.³ UIM promised the PSC that it would make substantial improvements to the Systems. At the time of trial of the instant matter UIM had made approximately $2 million of improvements to the Systems.

Despite the improvements made by UIM, homeowners in Marlboro Meadows continued to complain about the quality of the tap water. As a result the Prince George's County Council organized the Marlboro Meadows Policy Review Group. It consisted of representatives of the County Executive of Prince George's County, certain members of the Maryland Senate, House of Delegates, and Prince George's County Council, and representatives of WSSC and Marlboro Meadows. At times meetings of the group were attended by representatives of the Maryland Environmental Service (MES).⁴ WSSC received funding in its capital improvement programs for fiscal years 1994 and 1996 to study acquisition of the Systems. In September 1996 consultants engaged by WSSC reported that the tap water met current federal and state primary and secondary drinking water standards but that customer dissatisfaction with discoloration caused by the high iron content of the water continued. In November 1996 the review group recommended that WSSC acquire the Systems. By resolutions of July 30, 1997, and October 29, 1997, the Commissioners of WSSC authorized condemnation. The instant action was filed in the Circuit Court for Prince George's County on September 8, 1997.

At trial, the sole witness called by WSSC was John J. Boland, Ph.D. (Boland), a professor of applied economics at Johns Hopkins University. Boland opined that the fair market value of the Systems is $2,083,693, a figure which included valuing the leases to the cellular telephone companies at $461,180. Of the three basic approaches to value, comparable sales, capitalization of income, and reconstruction cost new less depreciation (RCNLD), Boland rested his ultimate opinion on his analysis of comparable sales.⁵ Boland calculated the value under the RCNLD method to be $7.2 million. In his income approach Boland capitalized the regulated income of UIM at rates which he considered appropriate for an investor owned buyer. He excluded rates appropriate to a willing acquisition by a governmental entity because he did not believe that there was a reasonable probability of a willing acquisition by a governmental entity, other than WSSC.⁶ Comparing his valuation by the income approach with his valuation by the RCNLD method, Boland concluded that the disparity was due to "external obsolescence," namely, the regulation of the rates charged by UIM. Because of his view that the income approach placed a ceiling on what a buyer would pay, Boland excluded his $7.2 million calculation of RCNLD. Based on sales of privately owned utilities in Maryland which Boland considered to be comparable, he computed the value of the Systems under the comparable sales method at $1,622,513, to which he added the value of the tower leases, arriving at his ultimate opinion of value at $2,083,693.

Unlike WSSC's trial strategy, which sought to minimize or negate the weight of evidence of RCNLD value, UIM focused its case on attempting to persuade the jury to give maximum weight to a RCNLD value. UIM's first witness described the facilities and processes of the Systems. He testified that UIM invested between $1,750,000 and $2 million on capital improvements. UIM next called James Camaren, the CEO and board chairman of UI. He explained UI's business strategy of acquiring water and sewerage utilities from developers, making capital improvements to the utilities, and ultimately selling the utilities to municipal purchasers. He estimated the value of UIM, excluding the water tower leases, to be $3,000 for water service and $3,000 for sewerage service per actual and potential customer for a total of $10.78 million. UIM's third witness appraised the land without any improvements at $2,062,400.

A consultant who had been retained by WSSC to perform a RCNLD analysis which was rejected by WSSC testified that the value of the improvements under that method was $7.2 million. An expert, Gerald Hartman (Hartman), who had been retained by UIM to perform a RCNLD valuation of the Systems opined that the value was $9,233,036, exclusive of the land.

Next, UIM called John F. Guastella (Guastella), a consultant specializing in water and sewerage utility issues. In his opinion, based upon the RCNLD approach, the value of the tangible property as a going concern was $9,233,000 so that the fair market value of the Systems, including the land, was $11,295,000. Guastella's testimony included a discussion about a hypothetical government purchaser as part of the relevant market.

UIM's final witness was Robert F. Reilly (Reilly), an appraiser and author of works on appraisal whose experience is nationwide. Reilly expressed no opinion on value. He was retained by UIM to review and critique...