Opinion
Argued February 7, 1991
Decided April 4, 1991
Appeal from the Appellate Division of the Supreme Court in the Third Judicial Department.
Kathryn C. Brown, William J. Cowan and Lawrence G. Malone for appellant.
Keith J. Roland, Usher Fogel and Emilio Petroccione for respondent.
The Public Service Commission (PSC or Commission) appeals, by leave of this Court, from an order of the Appellate Division, Third Department, which modified its determination as to revenue requirements and allocation for Crescent Estates Water Company (Crescent or Company) by annulling so much thereof as imputed to Crescent operating revenues from homeowners residing outside the Company's approved service area and remitted the matter to the Commission for further proceedings not inconsistent with the Court's decision. For the reasons that follow, we affirm the order of the Appellate Division.
I
Crescent Estates Water Company, Inc. is a privately owned water-works corporation which provides water service to some 1,650 residential customers in the Town of Clifton Park, Saratoga County. As a utility, Crescent is subject to the regulatory jurisdiction of PSC pursuant to which the agency is empowered to fix and determine the rates charged by Crescent for supplying water service to its customers (see generally, Public Service Law § 89-c). The rates and charges for water supplied to Crescent's customers within its approved service area are set forth in tariffs filed with the PSC. Unless an expansion of its service area is approved and a permit issued therefor by the Department of Environmental Conservation (DEC), Crescent may not supply water to customers outside its service area (see generally, ECL 15-1501 et seq.).
In 1988, Crescent filed with the PSC two joint petitions seeking approval of main extension agreements it had negotiated with certain real estate developers in Clifton Park. These agreements called for an expansion of Crescent's water service to approximately 110 residential dwellings built by these developers on properties located outside Crescent's approved service territory. Crescent undertook to secure PSC and DEC approval of the main extensions and the concomitant expansion of its service territory. In exchange, the developers agreed to construct the necessary mains and facilities at their own expense, and convey them to Crescent. In addition to certain other payments, the developers agreed to pay a hook-up fee of $2,000 for each residential unit connected.
Shortly thereafter, Crescent filed tariff revisions with the PSC designed to increase its operating revenues effective April 1, 1988. These revisions were suspended by order of the PSC through January 1989, pending investigation and review. Crescent also sought recovery of $28,471 in rate-case expense, a considerable portion of which reflected fees paid to a consultant in connection with the preparation of its rate case. Included in Crescent's calculation of its rate-year operating revenue projections was $11,124 in additional revenue expected to be derived from providing the service to new customers in its expanded service territory. This inclusion was predicated upon the anticipated approval of the main extension agreements and the expansion of Crescent's service territory. It appears that the Commission staff initially agreed with Crescent that in the event the petitions were denied, these anticipated additional revenues should be eliminated from the rate calculations.
The PSC disapproved the joint petitions because Crescent had not obtained the approval of DEC for its proposed service expansion and because the $2,000 per unit hook-up fees, which were to be paid to Crescent's principals and not the corporation, were deemed to be unjust, unreasonable and discriminatory and not in the best interests of the ratepayers. The PSC indicated however that it agreed with Crescent that the proposed expansion was prudent and that it would give its approval if after DEC authorization, the expansion was undertaken with reasonable and nondiscriminatory rates. The PSC indicated further that the Company's "prudent expansion of its revenue base or, conversely, the imprudent failure to so expand [would be] one factor" the Commission would consider in determining Crescent's rate case. Crescent challenged this determination disapproving the main extension agreements in an article 78 proceeding that was transferred to the Appellate Division, Third Department (CPLR 7804 [g]). The challenge was rejected by the Appellate Division and Crescent's petition dismissed ( 159 A.D.2d 765).
Crescent did not appeal the Appellate Division's affirmance.
In the meantime, in light of the PSC's disapproval of the main extension agreements, Crescent attempted to exclude the projected $11,124 anticipated new service revenues from its operating revenue forecast in the rate-case proceeding pending before the Administrative Law Judge (ALJ). It appears from the record that both the Company's expert and the Commission staff had initially agreed that these projections should be excluded if the agreements were disapproved since their inclusion in that circumstance would impact adversely upon the Company's rate of return. The Commission staff changed its position however after the main extension agreements were disapproved. In his recommended decision, the ALJ rejected Crescent's attempt to exclude these anticipated new service revenues and included them in the rate-year revenue projection. Additionally, he allowed recovery of only $11,891 of the requested $28,471 rate-case expense, to be amortized over four years.
The PSC issued its final order in which it approved the inclusion of these anticipated new service revenues in Crescent's rate-year projection but reduced the allowed rate-case expense recovery to $9,513, to be amortized over a two-year period. As to the imputation of the anticipated new service revenues, the Commission observed that it had strongly urged the Company to expand its territory, that in view of the Company's excess capacity such an expansion would be prudent and a failure to expand would be imprudent. It concluded that the revenue imputation was clearly reasonable and "provides the company's managers an incentive to undertake a desirable project and protect ratepayers from the consequences of a failure to do so." The Commission found that because the Company itself initially set the figure of $11,124 as its anticipated revenue growth, the imputation of that amount represented an "accurate assessment of the revenues to be earned from new customers."
This portion of the Commission's determination was confirmed by the Appellate Division and Crescent's cross motion for leave to appeal was denied ( 76 N.Y.2d 708).
Crescent challenged this determination in an article 78 proceeding which was transferred to the Appellate Division, Third Department (see, CPLR 7804 [g]). As indicated that court modified the determination insofar as it imputed the anticipated revenues from the additional customers residing outside Crescent's service area into Crescent's operating revenue forecast, concluding that such imputation "amount[s] to an indirect order to [Crescent] to expand its service territory and, thus, [PSC] exceeded its authority" ( 161 A.D.2d 882, 885).
The PSC argues on its appeal to this Court that its ratemaking authority is necessarily broad and encompasses the authority to impute to Crescent's operating revenue forecast the available additional income, since it would have been prudent for Crescent's management to undertake this expansion for the benefit of its ratepayers. Thus, the Commission argues, Crescent's failure to do so for reasons wholly unrelated to the Company's best interest and the interest of its ratepayers, was an imprudent management decision which the Commission could consider in setting new rates pursuant to its rate-making authority. The Commission concludes therefore, that the Appellate Division erred in determining that the contested imputation was beyond the PSC's authority and that the imputation of the projected revenues constituted an indirect order to Crescent to expand its services. The Commission argues that the imputation of these additional, available revenues merely recognizes the "cost of [Crescent's] imprudence" to the Company's customers.
II
The Public Service Commission is empowered by the Legislature to assure that "[a]ll charges made or demanded by any * * * water-works corporation for water * * * shall be just and reasonable and not more than allowed by law or by order of the commission" (Public Service Law § 89-b). To this end the Commission has broad discretion to review and determine the reasonableness of any rates or charges sought to be imposed by any water-works corporation (Public Service Law § 89-c), and "unless it is shown that the judgment of the PSC [in the exercise of this discretion] was * * * 'without any rational basis or without any reasonable support in the record', its determination will not be set aside" (Matter of Abrams v Public Serv. Commn., 67 N.Y.2d 205, 212, citing Matter of New York State Council of Retail Merchants v Public Serv. Commn., 45 N.Y.2d 661, 672).
However, the Commission only "possesses those powers expressly delegated to it by the Legislature, or those incidental to its expressed powers, together with those required by necessary implication to enable the Commission to fulfill its statutory mandate" (Matter of Niagara Mohawk Power Corp. v Public Serv. Commn., 69 N.Y.2d 365, 368-369). Concededly, the Commission has no power to compel a water-works corporation to expand and provide service to customers beyond its approved service area (see, Matter of Utica Tr. Corp. v Feinberg, 277 App. Div. 464; see also, Rochester Gas Elec. Corp. v Public Serv. Commn., 71 N.Y.2d 313; Interstate Commerce Commn. v Oregon-Washington R.R. Co., 288 U.S. 14). The issue here, then is whether the imputation of these revenues is a proper exercise of PSC's rate-making power or an improperly imposed compelled expansion of Crescent's service area.
In Rochester Gas Elec. Corp. v Public Serv. Commn. ( 71 N.Y.2d 313, 326, supra) we noted that the Feinberg court "recognized the general rule that governmental regulation forcing a carrier to extend its operation into previously unserviced area, beyond its commitment, is a taking." In both Feinberg and Rochester Gas Elec., however, the courts concluded that the challenged regulatory determinations did not compel the provision of services beyond the company's original commitment, they did no more than require the companies to extend their services within the areas they had already committed to serve.
PSC argues here that its imputation of the contested revenues does not compel Crescent to extend its water service beyond its approved area, rather the order is merely an appropriate exercise of its rate-making authority pursuant to which it may protect the ratepayers within the approved area (and apparently outside that area, according to the PSC) from the Company's imprudent failure to take advantage of the opportunity to expand its service.
There is of course, no gainsaying the PSC's broad ratemaking powers, which are sufficient to allow it generally to assess the prudence of a utility's actions as those actions impact upon the ratepayers. Indeed, a specific function of the rate-making power is to protect the utility's ratepayers (Matter of Niagara Mohawk Power Corp. v Public Serv. Commn., 69 N.Y.2d 365, 369, supra; Matter of General Tel. Co. v Lundy, 17 N.Y.2d 373, 382). Thus in its review of the utility's operating expenses, the Commission may act to "prevent unreasonable costs for materials and services from being passed on to ratepayers." (Matter of General Tel. Co. v Lundy, supra, at 378.)
The Commission acknowledges that no New York case has specifically addressed the issue we now consider. The reported New York cases have dealt primarily with instances where there has been a disallowance of a utility's costs or the exercise of the Commission's authority in respect to matters involving affiliates of the regulated utility (see, e.g., Matter of National Fuel Gas Distrib. Corp. v Public Serv. Commn., 66 N.Y.2d 956, affg for reasons stated at 107 A.D.2d 357; Matter of General Tel. Co. v Lundy, 17 N.Y.2d 373, supra; Matter of Port Chester Water Works v Public Serv. Commn., 84 A.D.2d 898, lv denied 56 N.Y.2d 504; Matter of New York Water Serv. Corp. v Public Serv. Commn., 72 A.D.2d 841, lv denied 49 N.Y.2d 706, appeal dismissed 49 N.Y.2d 799, cert denied 449 U.S. 844; Matter of Spring Val. Water Co. v Public Serv. Commn., 71 A.D.2d 55, lv denied 49 N.Y.2d 706; Matter of Long Is. Water Corp. v Public Serv. Commn., 49 A.D.2d 392). The Commission argues however, that its power to set reasonable rates necessarily includes the ability to adjust the Company's claimed revenue forecast through revenue imputations. In support, the Commission points to one of its prior determinations (apparently not challenged by the utility there involved) in which it imputed to the utility revenues that could be derived from its excess capacity. The Commission concluded in that case, that inasmuch as the excess capacity had been built by the utility, the burden of carrying the costs of that excess plant should be shared between the shareholders and the ratepayers (see, Matter of Central Hudson Gas Elec. Corp., Case 27032, 17 N.Y. PSC 401 [July 8, 1977]). The Commission also relies upon a decision of the Second Circuit in Rochester Gas Elec. Corp. v Public Serv. Commn. ( 754 F.2d 99), which upheld the imputation of revenues from the company's incidental sale of electricity for resale in interstate commerce, in computing the rate adjustment necessary to permit the utility to earn its authorized rate of return. However, neither of these cases, nor any of the other cases cited by PSC support its position here. None of the determinations in those cases involved the imputation of revenues deriving from sources outside the utility's authorized service area.
In the Central Hudson Gas Elec. case relied upon by the Commission, the imputed revenue was that which the utility would have received had it utilized its excess capacity to make sales within its approved territory. In Rochester Gas Elec. Corp. v Public Serv. Commn. ( 754 F.2d 99, supra), the issue was whether, in computing the company's authorized rate of return, it was permissible for the PSC to include estimated revenues from incidental sales actually being made by the company, in light of the fact that these sales are interstate sales regulated by the Federal Energy Regulatory Commission (FERC) and thus beyond PSC's jurisdiction. The court rejected Rochester Gas Electric's claim that the imputation of an estimated level of sales "compelled" those sales or constituted an attempt to "regulate" in a preempted field. The court observed that the imputation was not an attempt to regulate those sales and that the reasonableness of the level of imputation was not questioned. The court concluded that "[w]hile [the imputation] may provide some incentive to operate efficiently, * * * PSC's recognition that [the company] will make incidental sales and its inclusion of a reasonable estimate of those sales in [its] revenue base [would not] materially affect [the company's] incidental sales decisions." (Id., at 102 [emphasis added].) The court noted further that "[i]ndeed * * * [the company does not argue] that but for the imputation policy it would engage in a lesser level of incidental sales." (Id.) Because incidental sales in that case were in fact being made by the company it could not be said that the imputation of a reasonable level of revenue from those sales "compelled" such sales.
Here, of course, Crescent has not made any of the imputed sales and cannot make them and realize the revenue therefrom, unless it expands its approved area of service. These cases then, do not support PSC's contention that its ratemaking authority authorizes it to impute revenue from sales outside a utility's territory into that utility's revenue projections.
We find no express or implied legislative authority empowering the PSC to impute income derived from sources outside the utility's authorized service area in computing its rate-year projections. Such authority may not be implied as necessarily incidental to the rate-making power since the ineluctable effect of such an imputation here, is to compel the utility to expand its services in order to actually receive that projected income or suffer a deprivation of a fair return on its investments through the rate set.
Indeed, Crescent contends, and the PSC does not dispute that the 15% rate of return which the Commission has approved as being a just and reasonable return can only be achieved if the disputed $11,124 of imputed revenue is actually received. Should these revenues not be actually realized, according to Crescent, its actual rate of return would be only 10.76%. While the specific function of the PSC's rate-making power is to protect the utility's ratepayers (see, Matter of Niagara Mohawk Power Corp. v Public Serv. Commn., 69 N.Y.2d 365, 369, supra; Matter of General Tel. Co. v Lundy, 17 N.Y.2d 373, 380, supra) the PSC may not deny a utility a reasonable rate of return on its investment (see, Matter of New Rochelle Water Co. v Public Serv. Commn., 31 N.Y.2d 397, 407). Under the facts of this case, the only way in which Crescent can realize these revenues and thus enjoy the 15% just and reasonable return, would be to expand its service to the additional customers.
Thus we conclude that the imputation of these projected revenues in Crescent's rate-year projections was unauthorized, was beyond PSC's rate-making power and therefore was arbitrary and capricious.
Accordingly the order of the Appellate Division should be affirmed, with costs.
Chief Judge WACHTLER and Judges SIMONS, TITONE and HANCOCK, JR., concur with Judge ALEXANDER; Judge KAYE dissents and votes to reverse in a separate opinion in which Judge BELLACOSA concurs.
Order affirmed, with costs.
A prime function of the Commission, as a regulatory body, is to separate costs which should be borne by a utility's ratepayers from costs properly chargeable to its owners (see, Matter of Consolidated Edison Co. v Public Serv. Commn., 66 N.Y.2d 369, 372, appeal dismissed 475 U.S. 1114, reh denied 476 U.S. 1179; Rochester Gas Elec. Corp. v Public Serv. Commn., 51 N.Y.2d 823, 825, appeal dismissed 450 U.S. 961). In that the Commission properly determined that the economic effects of Crescent's decision to forego the revenue from its planned expansion should be absorbed by the company's two principals, not the residential consumers it serves, I would reverse the Appellate Division order and reinstate the Commission's determination imputing $11,124 of lost revenues to the utility.
As the majority acknowledges, review of Commission determinations begins with several fundamental propositions. First, although not without limit, the authority of the Commission is very broad, in that it must protect the public interest in what is essentially a government-licensed monopoly (see, Matter of Niagara Mohawk Power Corp. v Public Serv. Commn., 69 N.Y.2d 365, 368-369, rearg denied 69 N.Y.2d 1038). Second, the scope of judicial review is very narrow: unless it is shown that the Commission's determination lacked any rational basis or had no reasonable support in the record, that determination must be sustained (majority opn, at 616). Third, the combination of broad Commission authority and limited judicial authority has particular significance in the area of rate setting by the Commission, which generally involves analysis of technical data within the Commission's expertise (see, Abrams v Public Serv. Commn., 67 N.Y.2d 205, 211-212).
Applying these propositions to the facts before us, the Commission's determination should be sustained.
This dispute centers on Crescent's request for tariff revisions designed to increase its annual operating revenues by 59.9%. In arriving at this figure, Crescent excluded from its pro forma revenues the sum of $11,124, representing projected revenues of its planned but unrealized expansion of service to 110 new residential customers. Crescent argues that the Commission cannot impute these revenues because to do so would be tantamount to coercing expansion outside its service area.
Taking up Crescent's argument, the majority opinion from start to finish sounds just one note: that the Commission's imputation of the projected revenues to the utility was unlawful because it in effect compelled Crescent to expand services beyond its territory. No one disputes that the Commission is without authority to force a utility to expand its business operations outside its authorized territory (see, Rochester Gas Elec. Corp. v Public Serv. Commn., 71 N.Y.2d 313, 325-326). But that principle does not resolve this case.
This is not a case where the Commission has decided that expansion into a new territory would be in the best interests of ratepayers and is penalizing the utility for failing to implement the Commission's business judgment. Rather, Crescent itself, having excess capacity, filed petitions seeking main extensions into new territories, and Crescent itself included $11,124 of projected revenues from such service. Moreover, Crescent has never argued that it would not make $11,124 if it expanded according to its original plan; at no time has it advanced any reason related to its cost of services, or business operations, for its decision not to pursue the planned expansion.
Also included in Crescent's petitions was a $2,000 "connection capacity" fee for each new residential unit, which was to go not to the utility but directly into the pockets of Crescent's two principals.
The petitions were denied by the Commission on the procedural ground that Crescent had failed to obtain the prior approval of the Department of Environmental Conservation, but it noted that the petitions would in any event have been rejected because the $2,000 per-unit connection fee was "unjust and unreasonable." In rejecting the petitions, the Commission stated:
"Here, the company is attempting to circumvent the statutory scheme by seeking Commission approval of its 'special agreements' as a condition precedent to seeking DEC approval of the extension in order to secure a fee that would otherwise be unauthorized. It understands that once it obtains DEC approval, it is obligated to serve pursuant to the tariff, but it has indicated that it will not seek approval unless its terms are met." (Commission Order Denying Petitions, Case 21656, Sept. 28, 1988, at 4.)
In these circumstances, the Commission's determination that Crescent should not imprudently abandon its decision to expand has both reasonable support in the record and a rational basis.
Unlike a private company, a public utility enjoys a municipally awarded franchise, and therefore is "'clothed with a public interest.'" (Rochester Gas Elec. Corp. v Public Serv. Commn., supra, at 322, quoting Munn v Illinois, 94 U.S. 113, 126.) The public interest requires that the Commission, by exercising its broad powers under the Public Service Law, guard against abuses in what is essentially a marketplace of monopolies — acting in effect as a "surrogate for competition" (see, Comment, Utility Rates, Consumers and the New York State Public Service Commission, 39 Alb L Rev 707, 709 [1975]; see also, Public Service Law § 89-c).
As the majority notes, the Commission's rate-setting powers necessarily include assessment of "the prudence of a utility's actions as those actions impact upon the ratepayers." (Majority opn, at 617; see also, Matter of Abrams v Public Serv. Commn., supra, at 216-217 [upholding application of the "prudent investment" test for determining if utility could pass along cost of abandoned facility]; Matter of Long Is. Light. Co. v Public Serv. Commn., 134 A.D.2d 135, 143 [upholding decision to charge utility with costs associated with Shoreham nuclear power plant based on "imprudent management" analysis].) In effect, the Commission, in looking to the consequence of management decisions, is acting to replace absent market forces that would ordinarily guide those decisions.
Nor has the Commission's rate-setting authority been so stringently restricted to consideration of forces that operate inside a utility's territory (see, e.g., Matter of General Tel. Co. v Lundy, 17 N.Y.2d 373 [adjustment of operating expenses to reflect excessive payments to affiliates]; see also, Rochester Gas Elec. Corp. v Public Serv. Commn., 754 F.2d 99 [2d Cir] [Commission's decision to impute revenues from incidental sales upheld, although deemed interstate transactions and therefore subject to Federal regulation]). In concluding that there is "no express or implied legislative authority empowering the PSC to impute income derived from sources outside the utility's authorized service area" (majority opn, at 619) the majority neglects the Commission's authority to take such extraterritorial factors into account when fixing a fair rate of return.
The majority's mechanical rule — strictly limiting the Commission's rate-setting jurisdiction by the boundaries of the utility's service area, whatever the circumstances — impairs the ability of the Commission to act in the public interest, and allows a utility to manipulate the regulatory system at the expense of the ratepayers. Without a guarantee that it will be paid the $2,000 per-unit fee — which the Commission has concluded is improper — Crescent has no incentive to make the proper filing with the DEC. Instead, it can simply continue to pass off the cost of its unused capacity to the ratepayers.
Under these circumstances, the Commission acted within its authority in allocating the lost revenues to Crescent's two shareholders, rather than its 1,650 ratepayers.