Lincoln Gas & Elec. Light Co. v. Lincoln, 223 U.S. 349 (1912)

U.S. Supreme Court

Lincoln Gas & Elec. Light Co. v. Lincoln, 223 U.S. 349 (1912) Lincoln Gas & Electric Light Company v. City of Lincoln

No. 83

Argued December 6, 7, 1911

Decided February 19, 1912

223 U.S. 349

APPEAL FROM THE CIRCUIT COURT OF THE UNITED STATES

FOR THE DISTRICT OF NEBRASKA

Syllabus

Every legislative rate case presents three questions of prime importance: reasonable value of the plant; probable effect of the reduced rate upon future net income; deductions from gross receipts as a fund to preserve plant from depreciation.

A legislative rate for a public service corporation is presumed to be sufficient to produce a fair return on the plant, and the burden of showing that it is confiscatory rests upon those attacking it.

A public service corporation is entitled to a fair return upon the fair value of the plant at the time of the inquiry as to reasonableness of rates imposed, San Diego Land & Town Co. v. Jasper, 189 U. S. 439, but in this case, not decided what such a rate would be on a gas and electric plant in Nebraska.

Where a legislative rate contest involves ascertainment by testimony of experts and auditors of valuation of plant, capitalization, gross receipts, net earnings, depreciation, and other elements, the proper practice is to refer the case at the outset to a skilled master, upon whose report specific errors can be assigned and ruled upon. Chicago, Milwaukee & St. Paul Railway v. Tompkins, 176 U. S. 167.

What sum should be annually deducted from gross or net receipts of a public service corporation for depreciation and replacement and how it should be applied are novel and grave problems, and, in the absence of a full report as to every element involved, this Court is not justified in passing upon them.

The operation of an ordinance establishing a rate for gas will not be enjoined unless complainant enters into a bond to account to consumers for all overcharges in case the ordinance is eventually sustained.

The facts, which involve the validity of an ordinance of the City of Lincoln, Nebraska, regulating charges for gas furnished to consumers, are stated in the opinion.

Page 223 U. S. 356

MR. JUSTICE LURTON delivered the opinion of the Court.

This case involves the validity of an ordinance regulating the appellant's charges for gas furnished to consumers, and forbidding a charge in excess of one dollar per thousand feet. The bill assailed the rate as confiscatory, and therefore a taking of property without compensation. The ordinance rests upon legislative power to regulate the charges of such public service companies.

Page 223 U. S. 357

The sufficiency of the price prescribed to produce a fair profit upon the value of the property employed in the business is to be strongly presumed. The burden of showing its confiscatory character rests therefore upon the complaining company.

The court below, upon a final hearing, held that the appellant had not made out its case, and dismissed the bill, with leave to renew the litigation if, upon actual operation under the ordinance, the returns upon its business should not prove reasonably remunerative. The ordinance was never put in force. Within a few days after it went into effect, this bill was filed and an injunction pendente lite granted which was continued in force down to the final decree, and when this appeal was allowed, was, by order of the court allowing it, continued pending the appeal, under a bond conditioned to account for all overcharges if the ordinance should be sustained.

The case was not referred to a master, as is the usual course in such cases, although there was a great mass of conflicting evidence relating to the value of the plant, cost of operation, and gross and net income. Neither did the court make specific findings of fact to which specific objection could be made. Such facts as may be said to constitute "findings of fact" appear in the way of large conclusions in the course of the opinion found in the record.

In this as in every other legislative rate case, there are presented three questions of prime importance: first, the present reasonable value of the company's plant engaged in the regulated business, second, what will be the probable effect of the reduced rate upon the future net income from the property engaged in serving the public, and third, in ascertaining the probable net income under the reduced rates prescribed, what deduction, if any, should be made from the gross receipts as a fund to preserve the property from future depreciation.

Page 223 U. S. 358

The valuation fixed by the court is the main point of attack. That the company is entitled to a fair return upon the value of the property at the time of the inquiry is the rule. San Diego Land & Town Co. v. Jasper, 189 U. S. 442.

The court, as one means of finding the present value of the gas-making plant, found that the present cost of replacing it would be $566,073.59. The items which enter into this valuation, and the reason for reaching this result, as stated in the opinion, are shown by the paragraphs here set out:

"In determining for what amount the plant could be reconstructed, I have accepted in the main the testimony of complainant's witnesses as being the most satisfactory, and I find that the plant could be reconstructed for the following sums:"

Coal gas apparatus . . . . . . . . . . $ 80,605.00

Water gas apparatus. . . . . . . . . . 29,278.00

Mains in dirt streets. . . . . . . . . 90,578.00

Mains in paved streets . . . . . . . . 130,027.00

Gas services, etc. . . . . . . . . . . 107,106.82

Gas meters in use. . . . . . . . . . . 36,282.90

Meter connections. . . . . . . . . . . 6,304.00

Piping for gas ranges. . . . . . . . . 16,500.00

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$496,681.72

Engineering expenses (2 1/2%). . . . . 12,417.04

Real estate. . . . . . . . . . . . . . 4,000.00

Present value of buildings . . . . . . 24,643.00

Contingent expenses in construction. . 25,000.00

Cost of organizing company . . . . . . 3,000.00

-----------

$565,741.76

"While the evidence as to the depreciation is somewhat vague and indefinite, I think, upon the items aggregating

Page 223 U. S. 359

said $496,681.72, there should be deducted for depreciation 10 percent, amounting to the sum of $49,688.17, making the total present valuation of the plant $516,073.59; but it is apparent that, for the successful and economical operation of the plant, a certain amount of working capital is required. This amount I find to be $50,000, making the total value of complainant's investment, upon which it is entitled to a reasonable return, $566,073.59."

"While it is true that the testimony shows that the complainant has not such working capital, but has purchased upon credit the supplies necessary to operate, yet I think that, in determining what is a reasonable compensation, a working capital should be considered."

But the appellant does not accept the valuation thus fixed. It contends that there should be added to that the following:

Steam boiler for water gas . . . . . . $ 2,225.00

Underestimate of present value

of buildings . . . . . . . . . . . . 10,000.00

Underestimate of working capita. . . . 10,000.00

Underestimate of meter connections . . 6,102.00

Underestimate contingent expenses

of construction. . . . . . . . . . . 37,500.00

Interest on idle capital during

construction . . . . . . . . . . . . 40,000.00

Promotion of business, or going

value and franchise, as elements

in replacing value . . . . . . . . . 100,000.00

------------

205,852.00

Add court's valuation. . . . . . . . . 566,073.59

------------

$771,825.59

The appellee, on the other hand, in support of the general

Page 223 U. S. 360

decree dismissing the bill, joins issue upon each of these items, and insists that, if the court shall see fit to go into the evidence, it will find that the plant has been greatly overvalued. It particularly objects to the large item of $107,000 for gas service, and to the item of $50,000 added to the value of the property as "working capital," and says that the incorrectness of this is seen in the admission that the appellant has in fact no such working capital engaged in the business. Appellee further contends that the "expense of operation" in 1907 includes reconstruction or replacement work, and that such items enlarge the operating expenses of that year unduly, and correspondingly reduce the net income. If the expense of operating the plant for that year is to be accepted as the standard by which the operating expenses of future years are to be estimated, the objection is serious if the facts are as claimed.

The appellant further claims that the sum of $8,000 deducted from the net income, as a permanent protection against future depreciation in the value of the plant, is too small, and should be much larger. Upon this there was conflicting expert testimony. Upon all of these questions of valuation and of operating expense there is much evidence, and much of it conflicting. The findings of the court, as before stated, are of too comprehensive a character to be of much help in dealing with the details which are embraced.

But it is urged that even upon the valuation fixed by the court, the estimated future net income will be little over five percent, and, in consideration of the character of the property and the high average interest rate prevailing in Nebraska, this is not a reasonable or fair return, and demonstrates the confiscatory character of the ordinance. But if the $8,000 first deducted from the receipts, and laid aside as a permanent fund to meet future depreciation be taken into account, the estimated future

Page 223 U. S. 361

net income with the rate in force will exceed six percent

Nor did the circuit court hold that a net profit of five and two-tenths percent would be a fair and reasonable return upon the value of the property employed. What the court found was, in substance, that at least an income of that amount was certain, aside from the amount reserved for a permanent preservation fund. What the court said was this:

"While complainant, I think, is entitled to at least six percent upon the money invested, it does not appear that the reduced rate would not yield that sum. It is quite probable that the reduced rate would considerably increase the consumption of gas, and thus increase the complainant's net profits."

"The record shows that, in June, 1904, complainant voluntarily reduced its rates from approximately $1.50 per thousand to $1.20, and the amount of gas consumed, and net profits resulting, considerably increased. The inquiry in cases of this character is not alone what has complainant theretofore earned, but it is what will be the effect of the ordinance reducing the rate upon the future net earnings of the company, and it devolves upon complainant to show not that the past rates have not produced a reasonable return, but that the rate prescribed by the ordinance will not in the future produce a reasonable return."

This case is full of difficult and grave questions. Such conclusions as to facts as are found in the court's opinion are not helpful when, as here, errors are assigned which open up substantially the whole case. The cause should have gone at the beginning to a skilled master, upon whose report specific errors could have been assigned and a ruling from the court obtained.

In the case of Chicago, M. &c. Ry. Co. v. Tompkins, 176 U. S. 167, 176 U. S. 179,, this Court was called upon to review

Page 223 U. S. 362

a decree upholding a state-made railroad rate which had been unsuccessfully attacked as confiscatory. In that case, as in this, the matter had not been referred to a master, but had been decided by the circuit court upon the whole of the evidence. It came to this Court upon such a variety of questions of fact and law as to practically open up the whole case. Impressed with the seriousness of the questions involved, this Court remanded the case for a reference and report by a skilled master. As to this practice, this Court said:

"The question then arises, what disposition of the case shall this Court make? Ought we to examine the testimony, find the facts, and from those facts deduce the proper conclusion?"

"It would doubtless be within the competency of this Court on an appeal in equity to do this, but we are constrained to think that it would not (particularly in a case like the present) be the proper course to pursue. This is an appellate court, and parties have a right to a determination of the facts in the first instance by the trial court. Doubtless, if such determination is challenged on appeal, it becomes our duty to examine the testimony and see if it sustains the findings; but if the facts found are not challenged by either party, then this Court need not go beyond its ordinary appellate duty of considering whether such facts justified the decree. We think this is one of those cases in which it is especially important that there should be a full and clear finding of the facts by the trial court. The questions are difficult, the interests are vast, and therefore the aid of the trial court should be had. . . . We are all of opinion that a better practice is to refer the testimony to some competent master, to make all needed computations, and find fully the facts. It is hardly necessary to observe that, in view of the difficulties and importance of such a case, it is imperative that the most competent and reliable master, general

Page 223 U. S. 363

or special, should be selected, for it is not a light matter to interfere with the legislation of a state in respect to the prescribing of rates, nor a light matter to permit such legislation to wreck large property interests."

The question as to what sum, if any, upon the facts of this case should be annually deducted from the net income as a permanent maintenance or replacement fund is novel ,and presents a grave problem.

Conflicting expert evidence has been introduced presenting radically different theories as to the necessity, character, and amount of such a fund, and as to how it should be created, preserved, and expended. Some of this evidence puts the sum to be annually deducted and set aside as a permanent fund at five percent upon the value of the plant at the time of deduction. It is obvious that, if this view is sound, there will be little or nothing of the net income left for distribution among shareholders, and no basis for legislative rate reduction now, and none likely until such time as the income from the permanent fund will keep up the plant. The work of reconstructing and replacing old parts by new in a plant of this kind must, in the very nature of things, be going on constantly. Heretofore it seems to have been so well and continuously done that the value of the plant as a whole has suffered less than one percent per annum if the total depreciation be distributed through the more than thirty years of operation. So far as can be now seen, reconstruction and replacement charges have, up to the present time, been borne by current revenue, with the result that the revenue remaining in the single year of 1907 showed a net surplus of $73,851.83 -- a sum large enough, if distributed to shareholders upon the basis of the value of property engaged in the business as claimed by appellant, to have paid a dividend of ten percent, and about fifteen percent upon the valuation settled by the circuit court.

There is no finding as to the extent of the application

Page 223 U. S. 364

of the revenue of 1907 to reconstruction or replacement, as distinguished from current repairs and operating expenses. It is, however, plainly inferable that the revenue of that year was used to the extent necessary. If, in the past, reconstruction and replacement charges have been met out of current expenses, the fact must be taken into consideration both when we come to estimating future net income and in determining what sum shall be annually set aside to guard against future depreciation. This doubtless influenced the court below in settling upon the amount of $8,000 as a sufficient annual appropriation of income as insurance against future depreciation. But if the constantly recurring necessity to do reconstruction or replacement work was in 1907 met out of the current income of that year, thereby diminishing the net income, the fact should be given weight in estimating future net income -- otherwise there will be a double deduction on that account, first by paying such charges as they occur and thereafter by a contribution out of the remaining income for the same object.

The facts found are not full enough to at all justify this Court in dealing with this problem of a replacement fund.

There should be a full report upon past depreciation, past expense for reconstruction or replacement, and past operating expenses, including current repairs. We should be advised as to the gross receipts for recent years and just how these receipts have been expended. Then the amount to be set aside for future depreciation will depend upon the character and probable life of the property and the method adopted in the past to preserve the property. It can be readily seen that the amount to be annually set aside may be such as to forbid rate reductions because of the requirement of such a fund. The matter is one first for a skilled master, who should make a full report upon the value of the property, the receipts and the expenses of operation, and the sums paid out on reconstruction

Page 223 U. S. 365

and replacements, and in dividends in recent years.

For the reasons indicated, we direct that the decree be

Reversed, and the cause remanded to the district court to refer the case to a competent and skilled master, to report fully his findings upon all of the questions raised by either party, separately, and with leave to both parties to take any additional evidence they may wish within a time to be fixed by the court, and that that court, upon such report, proceed as equity shall require.

It is further ordered for the protection of all parties that the injunction granted in the court below continue in force until final decree there, upon condition that the appellant enter into a new bond, with sureties satisfactory to the court below, to account for all overcharges to consumers since the original restraining order, in the event the ordinance shall be sustained, and that, if such bond be not made within twenty days after the filing of the mandate, that the injunction stand dissolved.