State Ex Rel. Utilities Commission v. Morgan , 277 N.C. 255 ( 1970 )

177 S.E.2d 405 (1970) 277 N.C. 255

STATE of North Carolina ex rel. UTILITIES COMMISSION, Lee Telephone Company (Applicant) and Commission Staff (Intervenor), Appellees,
v.
Robert MORGAN, Attorney General of North Carolina (Intervenor in behalf of the Using and Consuming Public of North Carolina), and Walkertown Telephone Exchange Committee (Protestant), Appellants.

No. 10.

Supreme Court of North Carolina.

November 18, 1970.

Atty. Gen. Robert Morgan, Deputy Atty. Gen. Jean A. Benoy and Maurice W. Horne, Sp. Asst. Atty. Gen., for appellant.

Edward B. Hipp, Raleigh, for appellee North Carolina Utilities Commission.

Burns, Long & Wood, by Richard G. Long, Roxboro, Ross, Hardies, O'Keefe, Babcock, McDugald & Parsons, by Melvin A. Hardies and Donald W. Glaves, Chicago, Ill., and Duane T. Swanson, Lincoln, Neb., for appellee Lee Tel. Co.

LAKE, Justice.

In February 1965, this Court remanded to the Utilities Commission a proceeding instituted by Lee Telephone Company in 1963 for an increase in its rates for service in North Carolina. The Commission was directed to hold a further hearing in accordance with G.S. § 62-133 and the opinion of this Court. State ex rel. Utilities Commission v. Lee Telephone Co., 263 N.C. 702, 140 S.E.2d 319. It is presumed that, pursuant to such direction, the Utilities Commission then fixed rates which were fair and reasonable in view of conditions then prevailing. Such rates would, necessarily, include adequate allowances for maintenance and for depreciation of the company's properties and would provide a return upon the fair value of those properties sufficient to enable the company to attract capital for necessary expansion of its plant.

The petition filed with the Commission in the present proceeding states that on 6 June 1968 the Commission granted a further rate increase to Lee. No appeal having been taken therefrom, it is presumed that the rates then fixed were, in the light of conditions then prevailing, fair and reasonable, yielding to the company a return upon the fair value of its properties sufficient to attract capital, under then prevailing conditions, after making adequate provision for maintenance and depreciation of its properties. G.S. § 62-132. Four months thereafter the company filed with the Commission its petition in the present matter.

In this proceeding the Commission has found that the company's service is "poor" and "substandard," and that this condition "reflects the failure of the company to take those steps necessary for the improvement of toll service, local central office service, proper maintenance and the reduction of unsatisfactory multiparty main station service as is economically feasible, as well as its failure to eliminate traffic overloads on toll trunks, extended area service trunks and central office equipment groups, and its failure to take sufficient action to improve transmission and reduce noise levels." (Emphasis added.)

A public utility, which has been allowed to charge rates sufficient to enable it to maintain its properties, in addition to the earning of a fair return thereon, and which nevertheless permits its properties to fall into such a poor state of maintenance as to impair the quality of its service, must accept the responsibility for its resulting inability to render adequate service to its patrons. Having been granted a monopoly in its franchise area, the utility is under a duty to render reasonably adequate service. G.S. § 62-131(b); G.S. § 62-42.

The identity of Lee Telephone Company was not changed by the transfer of its stock in 1965 from the former stockholders to Central Telephone & Utilities Corporation (erroneously designated by the Commission as Central Telephone Company, the name of another subsidiary of Central Telephone & Utilities Corporation). Lee's responsibility for its failure to maintain its plant, and for the resulting impairment of its ability to render adequate service, is not avoided by the change in stock ownership. The condition of the telephone plant and the resulting quality of service rendered is not, as the Commission called it, an "inherited problem" of the new stockholder. It is a condition acquired by purchase. Lee's brief states that when the new stockholder acquired control of Lee, "following four years of litigation, Lee's plant margins were virtually exhausted." It is not contended that the new stockholder was unaware of this circumstance when it purchased the controlling interest in Lee or when, as shown in its brief, it subsequently increased its ownership to 99.8% of the outstanding common stock.

Lee's brief states that the new stockholder immediately began "an extensive rehabilitation, expansion and service improvement program." (Emphasis added.) There is nothing to indicate that the new stockholder was not aware of the neglect of maintenance of the properties during the extended litigation related to its acquisition of the stock. The record is replete with testimony by subscribers to the service to the effect that, since 1965, the service has been grossly inadequate and characterized by marked indifference to complaints from subscribers. The Commission has found, in July 1969, that it is still "poor" and "substandard." Nevertheless, the Commission approved, over the vigorous dissent of two of its members, another substantial increase in the rates which the subscribers must pay for this service. The dissenting Commissioners state that the rates so approved for the "substandard" service are "the highest general telephone exchange rates in the State of North Carolina."

The Attorney General contends that if the "substandard" quality of the service is the result of inefficient management, as distinct from inability to attract capital, no rate increase should have been allowed by the Commission. Lee contends that the Commission may not lawfully refuse to approve rates which would yield to it a fair return on the fair value of its properties, regardless of the quality of its service. The Utilities Commission contends that the allowance of a rate increase, otherwise justifiable, is within its discretion, though the service be of substandard quality. To resolve this question, which has not previously been before this Court, we turn to the statutes governing the regulation of public utility rates. G.S. c. 62.

G.S. § 62-133 sets forth in detail the steps to be taken by the Commission in fixing rates to be charged by a public utility in this State. Paragraph (b) provides that in fixing such rates the Commission shall do the following things: (1) Ascertain the fair value of the property used and useful in providing the service; (2) estimate the revenue to be received under the present and the proposed rates; (3) ascertain the utility's reasonable operating expenses, including depreciation; (4) fix the rate of return on the fair value of the property such as will enable the utility, by sound management, to produce a fair profit for its stockholders, to maintain its facilities, and to compete in the market for capital on reasonable terms; and (5) fix rates to be charged for the utility's services such as will earn such return in addition to reasonable operating expenses. If this paragraph stood alone, there would seem to be merit in the contention of the company. It does not, however, stand alone.

Paragraph (a) of G.S. § 62-133 provides that in fixing rates "the Commission shall fix such rates as shall be fair both to the public utility and to the consumer." Paragraph (d) of this section provides, "The Commission shall consider all other material facts of record that will enable it to determine what are reasonable and just rates."

G.S. § 62-2 declares the policy of the State, which it is the purpose of the entire chapter to put into effect, as follows:

"Declaration of Policy.—Upon investigation, it has been determined that the rates, services and operations of public utilities * * * are affected with the public interest and it is hereby declared to be the policy of the State of North Carolina to provide fair regulation of public utilities in the interest of the public, to promote the inherent advantage of regulated public utilities, to promote adequate, economical and efficient utility services to all of the citizens and residents of the State, to provide just and reasonable rates and charges for public utility services without unjust discrimination * * * and to these ends, to vest authority in the Utilities Commission to regulate public utilities generally and their rates, services and operations, in the manner and in accordance with the policies set forth in this chapter." (Emphasis added.)

G.S. § 62-32 confers upon the Commission general supervision over the rates charged and services rendered by all public utilities in this State and vests in the Commission "all power necessary to require and compel any public utility to provide and furnish to the citizens of this State reasonable service of the kind it undertakes to furnish and fix and regulate the reasonable rates and charges to be made for such service."

G.S. § 62-42 provides that whenever the Commission, after notice and hearing, finds that the service of any public utility is inadequate, the Commission shall enter an order directing that "additions, extensions, repairs, improvements, or additional services or changes shall be made or affected [sic] within a reasonable time prescribed in the order."

G.S. § 62-131 reads as follows:

"Rates must be just and reasonable; service efficient.—(a) Every rate made, demanded or received by any public utility, or by any two or more public utilities jointly, shall be just and reasonable.

"(b) Every public utility shall furnish adequate, efficient and reasonable service."

The clear purpose of chapter 62 of the General Statutes is to confer upon the Utilities Commission the power and the duty to compel a public utility company to render adequate service and to fix therefor reasonable rates pursuant to the procedure prescribed in G.S. § 62-133.

It is not reasonable to construe G.S. § 62-133(b) to require the Commission to shut its eyes to "poor" and "substandard" service resulting from a company's wilful, or negligent, failure to maintain its properties or to heed complaints from its subscribers when the Commission is called upon by the company to permit it to increase its rates for its inadequate service. We reject the contention of the company upon this question.

It does not follow, however, that the Commission is forbidden to grant any rate increase to a company whose service is inadequate, even though the inadequacy be due to a wilful, or negligent, failure by the company to perform its duty. The statutes confer upon the Commission, not upon this Court, the duty and authority to determine adequacy of service and reasonable rates therefor. State ex rel. North Carolina Utilities Commission v. Westco Telephone Co., 266 N.C. 450, 146 S.E.2d 487; State ex rel. Utilities Commission v. Champion Papers, Inc., 259 N.C. 449, 130 S.E.2d 890; State ex rel. Utilities Commission v. State and State ex rel. Utilities Commission v. Southern Bell Telephone & Telegraph Co., 239 N.C. 333, 80 S.E.2d 133. The authority of the Court of Appeals and of this Court in reviewing an order of the Utilities Commission is limited to that conferred by G.S. § 62-94. Assuming adequate findings of fact, supported by competent, substantial evidence, we find nothing in the provisions of chapter 62 of the General Statutes which makes it unlawful for the Commission, in the exercise of its sound administrative discretion, to conclude that an increase in rates is warranted, notwithstanding existing service inadequacy due to the company's neglect of its properties, and that such increase is an appropriate step in the improvement of the service. This appears to be the prevailing view in other states. See: Baltimore Transit Co. v. Public Service Commission of Maryland, 206 Md. 533, 112 A.2d 687; City of Lexington v. Public Service Commission of Kentucky, 249 S.W.2d 760 (Ky.); Village of Apple River v. Illinois Commerce Commission, 18 Ill.2d 518, 165 N.E.2d 329.

There are infinite degrees of inadequate service and many differences in the causes of such deficiencies. The ultimate question for determination is, What is a reasonable rate to be charged by the particular utility company for the service it proposes to render in the immediate future? The determination of this question is for the Commission, in accordance with the direction of G.S. § 62-133. Serious inadequacy of such service, found by the Commission upon substantial evidence, is one of the facts which the Commission is required by that statute to take into account in making that determination. The Commission's determination reached pursuant to the mandate of G.S. § 62-133 and to the statutory procedural requirements, may not be reversed by the Court of Appeals or by us merely because we would have reached a different conclusion upon the evidence.

It is otherwise if it does not appear from the order of the Commission that these statutory mandates have been obeyed. In State ex rel. Utilities Commission v. Public Service Co., 257 N.C. 233, 125 S.E.2d 457, the Commission, in fixing the rate base of a public utility, said, "In so finding we have considered all factors required by G.S. 62-124 [the predecessor to the present G.S. § 62-133] and all other facts which we feel have bearing upon our conclusion—without reference to any specific formula." This Court, reversing the Commission, said:

"The statute gives the Commission the right to consider all other facts that will enable it to determine what are reasonable and just rates. The right to consider `all other facts' is not a grant to roam at large in an unfenced field. The Legislature properly understood that, at times, other facts may exist, bearing on value and rates, which the Commission should take into account in addition to those specifically detailed in G.S. § 62-124. However, it was contemplated that such facts be established by evidence, be found by the Commission, and be set forth in the record to the end the utility might have them reviewed by the courts."

In this respect it is, of course, immaterial whether the party seeking judicial review be the utility or its adversary. In the present case, the Commission has said in its order:

"The statutory rate-making formula is controlling in this matter. We have considered the substandard quality of service being rendered by Lee as one element bearing upon the value of its utility investment and the rate it should be permitted to earn * * *."

The Commission then stated that the company had made progress in improving its service and the Commission was taking the approach of procuring continued improvement by "fixing just and reasonable rates under our statutory formula." We are unable to determine from the record what specific effect the Commission gave to the poor quality of the existing service in reaching its conclusion that some but not all of the requested rate increase should be allowed. The order does not indicate what increase in rates would have been approved had the service been found adequate. The findings, conclusions and order of the Commission do not, therefore, disclose that in this respect the Commission acted arbitrarily or that its conclusion is in excess of its statutory authority or is affected by an error of law, nor do they disclose the contrary.

We turn now to see how the Commission proceeded in "fixing just and reasonable rates under our statutory formula." It determined what it designates as "the original cost rate base applicable," which it fixed at $4,158,121 as of the end of the test period. It then found the "trended original cost rate base" to be $5,009,100. It then found the fair value of the company's property to be $4,500,000.

We note, in passing, the error of terminology. It is incorrect to speak of "the original cost rate base" and the "trended original cost rate base." See State ex rel. Utilities Commission v. State and State ex rel. Utilities Commission v. Southern Bell Telephone & Telegraph Co., supra. There is but one rate base—the fair value of the public utility's property used and useful in providing the service rendered to the public within this State, which value the Commission must determine as of the end of the test period. G.S. § 62-133. The original cost of the properties is simply evidence to be considered in making this determination. The replacement cost, whether determined by use of trended cost indices or otherwise, is also but evidence of the fair value of the properties.

A public utility is not entitled to rates which will enable it to earn a fair return on either the original cost or the replacement cost, per se. "Although the sense in which the courts use the phrase `fair value' is less definite than it should be, it seems clear that the term does not cover money stupidly, extravagantly, or corruptly spent. If a utility has been seriously overbuilt, or its promoters have been seriously overpaid, the law does not intend that its customers shall be saddled with the payment of interest on the money thrown away." Edgerton, Value of Service as a Factor in Rate Making, 32 Harvard L.Rev. 516.

In the present case, the Commission has found as facts that the properties owned by Lee prior to the acquisition of its stock by the present stockholder "were engineered in such a way as to engender [the inadequate] service," that "the plant was inadequate and inefficient" and the company had failed to maintain it properly. The brief filed by Lee in this Court states that following such stock acquisition the company embarked upon a program for "extensive rehabilitation." Neither the original cost nor the reproduction cost may properly be taken as the present fair value of telephone properties which were improperly engineered, have not been properly maintained and, consequently, are in need of extensive rehabilitation.

The testimony of Lee's vice president shows that, from the date of acquisition of control of Lee by Central Telephone & Utilities Corporation to the end of the test period used by the Commission, Lee made "gross additions" to its plant in the amount of $1,859,000. Of this amount, $709,000 was added during the last five months of the test period. Obviously, the replacement cost at the end of the test period of these "gross additions" to plant, less normal depreciation, would be little, if any, more than the original cost thereof.

The Commission found that at the end of the test period the company's "gross plant and plant under construction" (actual investment, with no deduction for depreciation and exclusive of working capital) was $5,312,766. Subtracting the "gross additions" made from the stock transfer to the end of the test period, it is apparent that the undepreciated original investment in the poorly engineered, poorly maintained properties owned prior to the stock transfer and still in service at the end of the test period was $3,453,766. The Commission found that the "applicable depreciation reserve," virtually all of which would, in the nature of things, be attributed to the older properties, was $1,245,088. The depreciation reserve is, of course, accumulated on the basis of the normal life of properties, assuming normal maintenance and with no allowance for inadequate engineering. Attributing only $1,000,000 of this depreciation reserve to the older properties, the company's net investment therein at the end of the test period would not have exceeded $2,453,766.

The Commission's finding of $5,009,100 as the "trended original cost" of the entire properties obviously includes an allowance of $90,443 for working capital, leaving $4,918,657 as its computation of the "trended original cost" of the entire plant, less depreciation. Subtracting from this figure, the entire "gross additions" made from the time of the stock transfer to the end of the test period, it is clear that the Commission must have estimated the "trended original cost" (less depreciation) of the poorly engineered, poorly maintained property to have been at least $3,059,657 at the end of the test period. Of course, neither the actual depreciation reserve on the company's books nor the "trended depreciation reserve" used by the Commission in these computations reflects any of the abnormal depreciation due to the poor engineering or the poor maintenance. Thus the Commission's computation of the "trended original cost," depreciated, of these poorly engineered, poorly maintained properties was at least $605,891 in excess of their actual original cost less the reserve for normal depreciation.

The Commission's final conclusion was that the fair value of the total properties used and useful in providing the service was $4,500,000. This includes its allowance of $90,443 for working capital, leaving $4,409,557 as the "fair value" of the telephone plant. Again, subtracting from this figure the entire $1,859,000 of "gross additions" from the stock acquisition to the end of the test period, we have a remainder of $2,550,557 allowed by the Commission in the rate base as the fair value of the poorly engineered, poorly maintained properties said by the company itself to be in need of extensive rehabilitation. The full actual cost of these properties, less only normal depreciation was, as above shown, not in excess of $2,453,766. In view of the evidence and the Commission's findings as to the condition of these properties, the Commission's finding as to the fair value of the company's properties at the end of the test period must be deemed unsupported by substantial evidence in the record.

The Commission found that during the calendar year 1968 Lee Telephone Company purchased materials, supplies and equipment from Centel Service Company. Centel is a wholly owned subsidiary of Central Telephone Company. Central Telephone Company is, in turn, a subsidiary of Central Telephone & Utilities Corporation, the owner of 99.8% of the common stock of Lee Telephone Company. The Commission found that upon Lee's purchases, for its North Carolina operations, from Centel in the calendar year 1968 Centel derived a profit of $39,621. The test period used by the Commission in this proceeding, however, was the twelve months ending May 31, 1968. There is no finding by the Commission concerning sales by Centel to Lee during the test period, and no evidence from which such finding could be made. The Commission's finding with reference to the transactions between Lee and Centel is, therefore, meaningless so far as the reasonableness of the rates established by the Commission's order is concerned.

The Commission found that Centel was incorporated in June 1967. Thus it was in existence throughout all or substantially all of the test period. Centel manufactures nothing. Its sole function is to purchase materials, supplies and equipment for resale to operating companies within the Central Telephone system. According to Lee's brief, Centel's pricing policy is to sell to the operating companies at prices comparable to those which would be paid if the same materials were purchased through other distributors. The record shows Centel's total paid in capital is $1,000. In 1968, the first full calendar year of its existence, Centel paid to its single stockholder dividends of $971,964 and at the end of 1968 had a surplus of $112,958.

The Attorney General contends that the profits made by Centel on its sales in 1968 to Lee Telephone Company for its North Carolina operations, $39,621, should have been credited by the Commission to Lee's net operating income, from its North Carolina operations in the test period, for rate making purposes. If this were done, a smaller rate increase than that allowed would be required to produce the net operating income necessary to constitute a fair return upon the fair value of the company's properties as found by the Commission. The theory of the Attorney General's argument is that the prices paid by Lee for the materials, supplies and equipment purchased are reflected in its statement of its operating expenses for the test period and, therefore, the operating expenses are overstated by the amount of $39,621, with the result that the net operating income is understated by that amount.

In the instant case, the contention of the Attorney General must fail for two reasons. First, only those purchases for operating materials and supplies, including current maintenance, are chargeable to operating expense. The purchases for plant construction go into the account for investment in plant, not to operating expense, an overcharge, if any, to investment in plant does not affect the net operating income. While such overcharge would improperly add to the account for original cost of the plant, which is an item to be considered in computing the rate base, it actually would not affect the rate base directly, since the rate base is the fair value of the plant, not the cost of it. There is in this record no evidence whatever to support a finding as to how much of the profit derived by Centel from its sales to Lee, for North Carolina operations, was made on purchases for use as operating supplies, including current maintenance, and how much was made on purchases for additions to plant. Second, the evidence in the record relates to profits made by Centel on Lee's purchases from it in the calendar year 1968. There is no finding, and no evidence in the record which would support a finding, as to Centel's profits on sales to Lee during the test period.

It is well established that the doctrine of the corporate entity may not be used as a means for defeating the public interest and circumventing public policy. Henderson v. Security Mortgage & Finance Co., 273 N.C. 253, 260, 160 S.E.2d 39; Estridge v. Denson, 270 N.C. 556, 565, 155 S.E.2d 190; Terrace, Inc. v. Phoenix Indemnity Co., 243 N.C. 595, 598, 91 S.E.2d 584. In order to prevent such a result, a parent corporation and its wholly owned subsidiaries may be treated as one. Obviously, an operating telephone company may not justify its application for a rate increase by showing on its books expenditures for materials and supplies in excess of the amount actually paid therefor. For example, Lee Telephone Company, when operating independently, might have purchased certain items in large quantity because of its combined operations in North Carolina and Virginia. Having done so, it could not charge its North Carolina operations with a higher price for such materials than it actually paid therefor, irrespective of the fact that the price so charged might be no higher than would have been paid if the small volume, purchased for use in North Carolina alone, had been purchased separately. In the present case, we refrain from expressing an opinion as to whether a parent company, operating numerous wholly owned subsidiary telephone companies, may establish an additional wholly owned subsidiary to purchase materials in large quantities at favorable prices, due to volume, and then resell to its operating subsidiaries at a higher price and thus enhance the operating expenses of the subsidiary companies for their respective rate making purposes. Upon the present record, that question is not presented and it was not determined by the Commission or by the Court of Appeals.

The Commission included in the rate base property under construction at the end of the test period in the amount of $318,052. Obviously, such property did not produce any operating income during the test period. As an offsetting adjustment, the Commission added to the company's operating revenue for the test period interest charged to construction during the test period. This is a practice which the Commission has followed for many years. It is commonly accepted in utility rate making. See: Petition of New England Telephone & Telegraph Co., 115 Vt. 494, 66 A.2d 135; City of Lynchburg v. Chesapeake & Potomac Telephone Company, 200 Va. 706, 107 S.E.2d 462. While not the exact equivalent, the addition to the company's operating income during the test period of interest charged to construction is an approximation of the income reasonably to be expected from the properties under construction when placed in service. Nevertheless, this practice cannot be followed in view of G.S. § 62-133(c) which reads as follows:

"(c) The public utility's property and its fair value shall be determined as of the end of the test period used in the hearing and the probable future revenues and expenses shall be based on the plant and equipment in operation at that time." (Emphasis added.)

Thus the plant under construction at the end of the test period should not have been included in the rate base and the item of interest during construction should not have been added to the company's operating income during the test period. The result of correcting these offsetting errors will be minimal and would not, alone, justify a remand of the matter to the Commission for further consideration. G.S. § 62-94(c) provides that upon appeal from an order of the Commission due account shall be taken of the rule of prejudicial error.

We find no merit in the Attorney General's contention that the Commission erred in its computation of the addition to the rate base for working capital. The basis of the contention is that the company bills its customers for local services for one month in advance. It is true that where the customers of a public utility, in the payment of their bills, provide the company with funds in order to enable it to meet expenses, which it will not have to pay until some time in the future, these funds, being available to the company for working capital, are to be credited to its need therefor. The rate base should include working capital supplied by the company but not funds supplied by its customers. State ex rel. Utilities Commission v. State and State ex rel. Utilities Commission v. Southern Bell Telephone & Telegraph Co., supra. This principle is not, however, applicable to the present case. While the company bills its customers for local service one month in advance, the record does not show when these bills are actually paid so as to place the money in the hands of the company for use. The Attorney General estimates that they are paid not later than the middle of the month. If so, by the time of payment, half of the month's service has been rendered. Thus the effect is the same as if payment for the service were made as it is rendered and there is no substantial accumulation of funds in the hands of the company for the payment of expenses at some future time.

The Commission said in its order that it had considered the substandard quality of the service being rendered by Lee as an element bearing upon the value of its property and upon the rate of return it should be permitted to earn thereon. Nothing in its order indicates the effect given thereto by the Commission. The order does not show wherein, or the extent to which, the determination of the fair value of the properties or of the rates for service are different from what they would have been had the service been excellent and had the properties been in a high state of efficiency and maintenance.

Under the unusual circumstances of this case, the Commission should make specific findings showing the effect upon its decision of the inadequacy it found in the service and the deficiencies it found in the engineering and maintenance of the properties. The Commission may not lawfully "ignore the duty imposed upon it by statute," as suggested in its order, by reason of the company's poor service, nor does it discharge that duty by a mere statement that it has considered the matter, without showing the effect given to it. Such finding or conclusion is necessary to enable a reviewing court to determine whether the duty imposed by statute has been performed.

The judgment of the Court of Appeals which affirmed the order of the Commission is reversed, and the matter is remanded to that Court with direction that it enter a judgment reversing the order of the Utilities Commission and remanding the matter to it for further consideration in accordance with this opinion upon the present record or after such further hearing as the Commission shall deem proper.

Reversed and remanded.