In re Vermont Telephone Co.
Annotate this Case
In re Vermont Telephone Co. (98-332); 169 Vt. 476; 739 A.2d 671
[Filed 27-Aug-1999]
NOTICE: This opinion is subject to motions for reargument under
V.R.A.P. 40 as well as formal revision before publication in the Vermont
Reports. Readers are requested to notify the Reporter of Decisions,
Vermont Supreme Court, 109 State Street, Montpelier, Vermont 05609-0801 of
any errors in order that corrections may be made before this opinion goes
to press.
No. 98-332
In re Investigation Into the Existing Supreme Court
Rates of Vermont Telephone Company, Inc.
On Appeal from
Public Service Board
April Term, 1999
Richard H. Cowart, Chair
Michael Marks of Tarrant, Marks & Gillies, Montpelier, for Appellant.
Leslie A. Cadwell, Montpelier, for Appellee.
PRESENT: Amestoy, C.J., Dooley, Morse, Johnson and Skoglund, JJ.
AMESTOY, C.J. Appellant Vermont Telephone Company (VTel) appeals
from a Public Service Board order requiring VTel to eliminate over a
ten-year amortization period the value of what the Board characterized as
a goodwill cost in the purchase price to be borne by the shareholders and
not the ratepayers. We affirm.
This matter arises out of the sale of Contel of Vermont, Inc.'s
(Contel) assets to three separate operating companies, one of which was
VTel, and the impact of the structure of the acquisition on the rate base.
The three acquiring companies sought permission from the Board to acquire
Contel's assets and to provide local telephone service in Vermont. Both
the asset acquisition and the operation of local telephone service
required approval by the Board pursuant to 30 V.S.A. §§ 109 and 207
respectively. Under § 109, approval could only occur if the Board
concluded that the acquisition would "promote the general good of the
state." The Board conducted a detailed evaluation of the proposed
transaction and on June 14, 1994, granted the acquiring companies' request
to purchase the assets of Contel and issued VTel and the other two
companies Certificates of Public Good. The Board based its June 14, 1994,
order (settlement order) on a proposed settlement among the parties to the
acquisition proceeding, including VTel and the Department of Public
Service.
In approving the acquisitions and issuing the certificates, the Board
considered seven separate criteria for each of the three new operators.
Addressing the seventh criterion - the impact of the proposed acquisition
on established rates, terms and conditions of service - the Board stated
that for each of the three companies, local rates were expected to remain
at their existing levels for at least two years. The settlement order
contained additional provisions relevant to rates and the rate base,
beginning with the condition that the operating companies not seek an
increase in local rates for two years after the closing, unless "exogenous
changes" made such an increase necessary. At the end of the two years, a
service quality assessment of the companies was to occur to review, among
other things, appropriate rate levels and whether continuation of the
franchises granted by the settlement order would be in the public interest.
The settlement order also addressed the investment it would allow the
acquiring companies to recover in the future through rates. The Board
stated: "The Operating Companies shall not include in future rates
acquisition costs above regulatory book value for intrastate ratemaking,
except as may be specifically authorized by law." The Board explained that
its approval of the transactions did not imply inclusion in rates of all
the costs associated with the debt and equity financings, stating:
The proposed purchases include "goodwill," and/or a market
premium, approaching some forty million dollars ($40,000,000).
Expenditures to support such premiums will not be included in
rates. This Board's long standing policy has been to consider only
the book value, or historical cost, of tangible assets for rate-
making purposes.
At the center of this appeal is the impact on ratepayers of the
treatment of a Contel account called the accumulated deferred income tax
account (ADITs or ADIT account). ADIT accounts allow a utility to finance
investments with money owed to the federal government for taxes, thereby
relieving the utility of having to finance that portion of the investment
with its own equity or debt. Ratepayers pay the taxes reflected in the
ADIT account in advance, providing the utility with a cost-free source of
capital until it must pay the taxes. (FN1) The Board, in setting just
and reasonable rates pursuant to 30 V.S.A. § 218, recognizes these
prepayments and makes adjustments to reflect the cost-free capital. In
the case of Contel and VTel, the ADIT has been treated as an offset to the
rate base. The value of the ADIT to ratepayers is that, over time, as the
offsets are made, the reduced rate base translates into lower rates than
would be paid if the ADIT offset was eliminated. In essence, the utility
is gaining a cost-free "loan" from ratepayers between the time in which it
collects the taxes and the eventual payment of the taxes to the IRS. The
ratepayers benefit when and if the utility's use of the money is reflected
by an ADIT offset
to the rate base.
In the instant case, prior to VTel's acquisition, Contel's books
included approximately $5.1 million in ADITs. The account reduced
Contel's rate base until the money became payable to the federal
government. (FN2) When VTel purchased a portion of Contel's assets,
however, the tax repayment schedule changed. The structure of Contel's
sale of its assets to the three acquiring companies triggered an Internal
Revenue Service rule which required Contel to pay the taxes to the federal
government before the acquisition was completed. Therefore, no portion of
the ADIT account transferred to VTel.
In their proposed order, VTel and the settling parties asked the Board
to include in the settlement order a condition related to Contel's $5.1
million ADIT account. The condition, as proposed by the parties and
included in the Board's final order, provided:
Within 90 days after Closing, the Operating Companies shall
provide to the Board and the Department the methodology which
was used to allocate among the three Operating Companies the
depreciation reserve and deferred income taxes accrued by Contel
of Vermont, Inc., as well as the results of such allocation
methodology.
After the closing, VTel and the other acquiring companies filed a letter
with the Board asking for an extension of time to file the explanation on
the allocation methodology relating to the ADITs. The letter, dated
October 28, 1994, stated that the three companies had reached a tentative
agreement as to the appropriate methodology to allocate among them the
ADITs accrued by Contel, and the results of the methodology. The letter
did not state that the ADIT account had
been eliminated as a result of the transaction. In their follow-up letter
dated January 3, 1995, the operating companies explained that in order to
meet IRS requirements, "all pre-acquisition deferred taxes must be
eliminated from the company's ratemaking books." The letter stated that
based on the companies' interpretation of the tax laws, "the successor
corporations report that there were no deferred income taxes on the books
of Contel of Vermont to allocate among themselves."
On July 31, 1996, in accordance with the settlement order, the Board
opened a rate investigation of VTel pursuant to its authority under 30
V.S.A. § 227(b). During the investigation, the Department recommended
that the Board exclude from VTel's rate base approximately $1.8 million
dollars relating to the ADIT account. VTel moved for dismissal of all
issues relating to the ADIT account, and for summary judgment on the
grounds that the settlement order precluded the Department's proposed
elimination of the $1.8 million from the rate base and compelled the
treatment of the ADITs elected by VTel. The Board's hearing officer
denied the motions, ruling that the Board had not analyzed the effect of
Contel's ADIT account in the settlement order except to require - as
proposed by the companies themselves - that the three operating companies
provide to the Board and the Department at a later date the methodology
used to allocate the ADIT account and the results of such allocation
methodology.
According to the Department's critique of the acquisition structure,
when VTel acquired its portion of Contel, the ratepayer-generated ADIT
account, which allowed for a rate base offset, did not transfer to VTel,
but was nonetheless included in the rate base upon which VTel shareholders
were entitled to a rate of return. Evidentiary hearings followed before a
hearing officer of the Board, who concurred with the Department's proposal
that VTel's rates be adjusted
due to the non-transference of the ADIT account. The Board agreed that an
adjustment was necessary, reiterating that when the sales transaction
occurred, VTel paid cash to acquire its assets and, "[p]art of the assets
it acquired was cost-free capital, provided by ratepayers and held by
Contel as deferred taxes." The structure of the transaction, however,
caused an acceleration of the income tax payments for which the ADIT
account was reserved. Thus, "ratepayers lost the time-value benefit of
the money they had provided, cost-free, to Contel in advance of the taxes
being due." Rather than ordering a reduction in rate base that would
mirror the ratemaking treatment that would have occurred had the ADIT been
transferred to VTel, the Board ordered that VTel amortize "the total value
of the additional goodwill" over a ten-year period as an adjustment to its
cost of service. (FN3) VTel requested reconsideration of this order, and
the Board denied any relief. VTel appeals.
VTel presents three points of contention with the Board's order.
First, it argues that the adjustment is unlawful because it reduces VTel's
revenues below the level of legitimate expenses and return on investment.
Second, VTel disagrees with the Board's characterization of the
amortization as an adjustment to eliminate goodwill; instead, VTel argues,
the amortization disallows the return on investment in real assets.
Third, VTel contends that the amortization collaterally attacks the
Board's settlement order in which it approved VTel's acquisition of a
portion of Contel. We address these arguments, presuming, as we must, that
the Board's decision was valid. See In re Green Mountain Power Co., 162
Vt. 378, 380, 648 A.2d 374, 376 (1994).
We will not set aside the Board's findings or conclusions unless VTel
demonstrates that they are clearly erroneous. See id.
We address together VTel's first and second points on appeal, as the
second point is essentially an elaboration and explanation of the first.
VTel contests the legality of the proposed amortization because it: (1)
reduces VTel's revenues below the level of legitimate expenses and return
on investment VTel should be permitted to recover, and (2) does not
represent any portion of the goodwill which was conclusively eliminated
from the rate base in the settlement order approving the acquisition. It
argues that public utility regulation should allow a utility to recover
its expenses and investments but that here the Board made no finding that
any of VTel's expenses or investments were imprudent, or were not used to
provide service. Instead, the ordered reduction was based on the Board's
conclusion that VTel's net investment would have been different if the
acquisition transaction had been structured differently. VTel argues that
the Board has relied on speculation as to what effect a different
transaction structure would have had on rates in order to justify setting
a rate below the level necessary to cover expenses and return on net
investment.
We begin with the presumption of great deference to the Board's rate
orders, so long as those orders are directed at proper regulatory
objectives. See id. at 380, 648 A.2d at 376. When setting rates for a
utility subject to its jurisdiction, the Board is guided by the statutory
requirement that ratepayers pay just and reasonable rates only. See 30
V.S.A. §§ 218(a), 227(b); In re Central Vt. Pub. Serv. Corp., 141 Vt. 284,
288, 449 A.2d 904, 906-07 (1982) ("The Board's duty to set just and
reasonable rates is well settled both by statute and our case law.")
(citations omitted). Because the "complexities of utility regulation place
an added premium upon
the expertise of the Board in ratemaking," we assume a limited role in the
ratemaking process. Central Vt. Pub. Serv. Corp., 141 Vt. at 288, 499 A.2d at 907.
Based on the testimony of the Department's expert witness Randy Allen,
VTel purchased 50.32 percent of Contel's assets for approximately $40.3
million. Of this amount, only $21.6 million represented the cost to VTel
to purchase VTel's share of the physical plant -- the remaining amount
attributable to goodwill and other items excluded from the rate base.
VTel's 50.32 percent of Contel's preexisting ADIT account was $2.6
million. (FN4) According to Allen, this meant that only $19 million of the
cost of the physical plant was funded by VTel investors. The remaining
$2.6 million cost of purchasing the physical plant represents funds
generated by Contel's ratepayers and used for plant investment. Allen
concluded that Contel used investor-supplied funds "to pay the government
and that $2.6 million of the purchased plant still represents
customer-supplied funds." The Board agreed with the Department expert that
the recognition of cost-free capital as contributions in aid of
construction was consistent with treating the $2.6 million as additional
goodwill.
VTel claims that this characterization of the amortization amount as
the total value of additional goodwill is wrong as a matter of law and
fact. VTel acknowledges that a utility's rate base can include only its
net book investment and cannot include any allowance for intangibles,
including goodwill. See In re Towne Hill Water Co., 139 Vt. 72, 74, 422 A.2d 927, 928 (1980) (explaining that "it is well established that the
target of a rate base determination is the net value of the property upon
which a return should be earned. The net value in issue is not fair market
value, but net investment."). It argues, however, that the Board's
description of the ADIT account as goodwill does not comport with the
United States Supreme Court's definition which describes the concept as:
the advantage or benefit, which is acquired by an establishment,
beyond the mere value of the capital, stock, funds, or property
employed therein, in consequence of the general public patronage
and encouragement which it receives from constant or habitual
customers, on account of its local position, or common celebrity,
or reputation for skill or affluence, or punctuality, or from other
accidental circumstances or necessity . . . .
Newark Morning Ledger Co. v. United States, 507 U.S. 546, 555 (1993)
(quoting Metropolitan Bank v. St. Louis Dispatch Co., 149 U.S. 436, 446
(1893)). Assuming this definition, derived from a treatise on
Partnerships from 1841, is the standard by which Vermont's Public Service
Board should determine what portion of an investment represents goodwill,
we are not convinced that Contel's ADIT account fails to satisfy the
definition. Contel's position as provider to Vermont residents of
telephone services placed it in the unique position to generate its ADIT
account from every one of its ratepayers. That cost-free capital was made
possible due to Contel's local position as telephone service provider and
the requirement that, in order to establish and maintain telephone
service, ratepayers subscribe to and make payments to Contel.
VTel emphasizes that in approving the acquisition, the Board already
disallowed almost $40 million in goodwill from the rate base and that
ADITs were never included in the tally that yielded the $40 million
figure. It asserts that it is undisputed that its net book investment
never included an account associated with ADITs, that this account was
paid over to the federal government and did not transfer to VTel, and that
the amortization does not eliminate any of VTel's intangible assets or
goodwill, but instead requires the offset of real cash against legitimate
expenses and rate base under the guise of an offset to goodwill. To a
great extent, we are dealing with a matter of semantics. The Board
generally characterized assets that would not be reflected in allowed
rates as "goodwill." The issue for the Board, and us, is one of proper
ratemaking, not labeling. Even if the Board erroneously labeled the rate
base in issue as "goodwill," we will not reverse its decision if it
comports with its statutory responsibility and is supported by its
findings and conclusions.
The Board is guided by the statutory requirement that ratepayers only
pay just and reasonable rates. See 30 V.S.A. §§ 218(a), 227(b) Here, the
Board's decision to make a cost of service adjustment by way of a ten year
amortization resulted from the Board's review of VTel's rates and its
objective of establishing a rate base that reflected the net value of the
property upon which shareholders should rightfully earn a return. See In
re Towne Hill Water Co., Inc., 139 Vt. at 74, 422 A.2d at 928 . The
parties agree that under Contel's ownership and operation, ratepayers
generated the ADIT account, providing Contel with a cost-free source of
capital to invest in its physical plant. The Board found that in
acquiring its portion of Contel, VTel paid a premium - a portion of the
cost-free source of capital - to allow Contel to pay off its ADIT account
to the federal government consistent with the structure of the acquisition.
The Board then concluded that this account was generated by ratepayers
who, due to VTel's acquisition of Contel, lost the time value benefit of
the money they had provided to Contel.
When the sale of Contel took place, the "return" to ratepayers on
their cost-free "loan" to the utility stopped because, as a result of the
acquisition structure, VTel paid the amount owed to the IRS rather than
continuing to pay "interest" to the ratepayers. As a result of this
acquisition structure, ratepayers were denied the time value benefit of
the bargain. In order to correct this
inequity, the Board simply adjusted the rates as if the ADIT account was
not repaid to the IRS and the sale never occurred. The Board's findings
were sufficient to support its conclusion that $1.8 million of the amount
paid by VTel represented cost-free capital that ratepayers had provided to
Contel and that this was a cost of acquisition that ratepayers should not
rightfully bear. See id. ("Assuming use for utility purposes, appropriate
costs of acquisition, not shown to be excessive, unwarranted or incurred
in bad faith, are to be included in rate base after depreciation."). The
Board did not attempt to deny shareholders appropriate costs of
acquisition, but rather ordered the amortization as a way to achieve its
objective of establishing a just and reasonable rate base. The
determination that this objective would be satisfied by eliminating the
cost to VTel of Contel's payment of ADITs to the federal government was not
clearly erroneous.
VTel's remaining argument criticizes the amortization as a collateral
attack on the Board's order approving VTel's acquisition of a portion of
Contel. VTel argues that the Board, not the parties, chose the structure
of the transaction and that it is undisputed that the Board understood
that the ADITs would be paid to the federal government, that they would not
pass on to VTel, and that such an acquisition structure would have an
impact on rates. According to VTel, because the Board was equipped with
all the necessary information and power to reject the proposed structure
of the transaction or impose on it any other conditions that it chose, the
doctrines of res judicata and collateral estoppel prohibit the amortization
ordered by the Board. VTel claims that central to the Board's analysis
and consideration in approving the acquisition was the amount of the
investment by the shareholders and what portion of that investment would
be recognized in the future rates of the parties. Specifically, VTel
stresses that the Board conclusively determined that VTel was permitted a
return on its "net investment," excluding from that figure approximately
$40 million in what the Board deemed "goodwill."
VTel contends that res judicata prohibits the Board's amortization
order because the amount of investment that would be recognized in the
future rates of the parties was conclusively determined in the acquisition
docket, the Department was a party to the docket, the Board issued binding
orders on rates which detailed what would and would not be included in
rates, and the parties had a full and fair opportunity to litigate what
portion of the investment would be included. See Agway, Inc. v. Gray, 167
Vt. 313, 316-18, 706 A.2d 440, 442 (1997) (res judicata bars litigation of
claims which were or might properly have been litigated in previous
action). VTel makes a similar argument using a collateral estoppel
analysis. It argues that: the Department was a party to the acquisition
docket; the ADIT account and its disposition was raised in the evidence
presented during the acquisition process; the portion of the acquisition
investment that would be recognized in rates was litigated and was made
part of the final judgment; there was a full and fair opportunity to
litigate the issue; and, preclusion is fair because VTel relied on the
settlement order in closing on its purchase. See Trepanier v. Getting
Organized, Inc., 155 Vt. 259, 265, 583 A.2d 583, 587 (1990) (listing
elements of collateral estoppel).
We disagree with VTel that either collateral estoppel or res judicata
prevents the Board from issuing its amortization order. The core inquiry
in either case is whether there was a "full and fair opportunity to
litigate" the matter in the earlier action. Cold Springs Farm Dev., Inc. v.
Ball, 163 Vt. 466, 468, 661 A.2d 89, 91 (1995). This matter originated from
a proposed sale by Contel of its assets to three companies. The
acquisition docket involved a determination by the Board of whether the
transaction would serve the public good, taking into account a variety of
factors. Although the Board considered potential rates, including a
determination that an amount
"approaching some forty million dollars" in goodwill would be excluded from
the rate base, the Board stated, and the findings support that:
At no point did the parties to the transaction state that the structure
of the arrangement would have an effect upon rates. Nor did the
parties request that we approve any particular ratemaking treatment
for the ADIT or any other component of the transaction, including
the rather significant "goodwill" included in the purchase price. In
fact, none of the material submitted by VTel demonstrated that any
component of the transaction would affect rates.
Indeed, the Board accepted verbatim the provision in the acquiring parties'
proposed settlement which gave the acquiring companies ninety days from
the date of closing to provide to the Board and Department the methodology
which was used to allocate the ADIT account accrued by Contel, as well as
the results of the allocation methodology. We are unconvinced that rate
base generally, or the effect of ADITs on the rate base specifically, was
in any way an issue in the acquisition proceeding. In fact, it was as a
result of the acquiring companies' proposed settlement that consideration
of the impact of ADITs on rate base was deferred until a later date.
VTel argues, however, that in the settlement order, the Board defined
exactly what net investment the companies could carry on their books for
rates. According to VTel, the Board knew that the acquisition would
create a new company with a net investment which excluded all ADITs. It
stresses that the Board considered an exhibit submitted by the three
companies during the acquisition process which revealed to the Board that
the ADIT account on Contel's books would not be on VTel's post-acquisition
balance sheet. The Board could have disapproved this aspect of the
transaction, or approved it with conditions.
We disagree with this argument as well as VTel's assertion that,
because the Board's settlement order prohibited the recovery of certain
expenditures to support the cost of goodwill, it should be precluded or
collaterally estopped from issuing the amortization order eliminating
additional goodwill. VTel characterizes this aspect of the order as the
Board having "explicitly addressed the investment that the Board would
allow the acquiring companies to recover." The assertion that the Board's
assessment of rate impact due to the acquisition was conclusive and final
is unpersuasive given the provisions in the settlement order requiring a
two-year stay on rate changes and scheduling of a review of rates two
years from the acquisition date consistent with its explicit statutory
endorsement. See 30 V.S.A. § 227(b) (Board may order an investigation and
hearing on the justness and reasonableness of existing rates). VTel
minimizes the fact that if the Board's ruling was explicit on any aspect
of the rate base, it was that the allocation methodology for the ADIT
account was to be provided to the Board and the Department three months
after the deal closed, and that rates would be reassessed two years after
the date of closing. At no point during the acquisition process did VTel
or the other two acquiring companies provide testimony or any other
information in the record addressing the impact on rate base of the
non-transference of the ADIT account, and in fact, ultimately elected an
adjustment to the cost of service, rather than an elimination from rate
base. The Board did not clearly err in delaying consideration of the
impact upon rates of the ADIT account, but rather accepted VTel's proposal
to refrain from such consideration until the acquiring companies were
prepared to present all material information to the Board.
Affirmed.
FOR THE COURT:
____________________________________
Chief Justice
------------------------------------------------------------------------------
Footnotes
FN1. Like the regulatory commissions of every other jurisdiction, the
Board has normalized tax allowances in compliance with IRS regulations so
that Vermont utilities can take advantage of accelerated depreciation. The
process of tax normalization allows public utilities to keep the tax
effect of an accelerated depreciation for investment into new physical
plant. As the years pass, plant investment, paid for with cost-free
capital collected from ratepayers, is returned through the depreciation
expense. The ADIT reserve reverses as the utility pays the tax to the
IRS. At the time of the sale to Contel, approximately $5.1 million of
ADIT's had been collected from ratepayers and invested into the physical
plant. These funds are therefore also referred to as CIAC - capital in
aid of construction.
FN2. As VTel explains in its brief, the income taxes are only deferred and
are repaid on a schedule that mirrors when taxes would have been due had
normal depreciation rates applied. Accordingly, the ADIT account
diminishes as taxes become due and increases as new qualifying investments
allow accelerated depreciation for tax purposes.
FN3. It is undisputed that the overall economic impact of the Board's
adjustment to cost of service is the same as the hearing officer's
continuation of the rate base offset although the year-by-year impact may
be somewhat different. The Board apparently modified the method of
recognizing the ADIT account to ensure there was no adverse consequence to
VTel's ability to use accelerated depreciation for tax purposes in the
future.
FN4. Rather than removing the entire $2.6 million amount as goodwill, the
Department recommended a $1.8 million deduction from rate base as
temporary amortizable cost-free capital in aid of construction.
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