1. Federal courts having jurisdiction of a cause through
questions raised under the federal Constitution may pass on all
questions of state law involved. P.
278 U. S.
307.
2. Parties who have procured action by a state commission under
a state statute may not assail that action in a federal court of
equity upon the ground that that statute, or the one creating the
commission, is void under the state constitution. P.
278 U. S.
307.
3. A state may compel a public service company to continue to
use its facilities to supply an existing need so long as it
continues to do business elsewhere in the state. P.
278 U. S.
308.
4. A public service company is bound by the common law, if not
by statute, to render its service at reasonable rates, and if the
rates fixed by a state commission are not shown to be confiscatory,
a suit in equity to enjoin their enforcement will not lie merely
because the order purporting to impose them was void for other
reasons under the state or federal constitution. P.
278 U. S.
309.
5. A public utility seeking to set aside as confiscatory a rate
fixed by state authority has the burden of proving by clear and
convincing evidence the value of property on which it is
constitutionally entitled to earn a fair return. P
278 U. S.
313.
Page 278 U. S. 301
6. In an attack on rates fixed for a company supplying gas to
consumers in Kentucky which was a subsidiary of a West Virginia
company owning, leasing and operating extensive natural gas fields
in the latter state, it was sought to prove the value of the West
Virginia gas rights in order that a portion of it might be
allocated to the subsidiary, and the method adopted depended on an
estimate of the quantity of available gas in the lands and a
computation of the profits that would accrue if, during the next
eighteen years, this were extracted, piped to a place in
Pennsylvania where there was a market for fuel gas free from public
regulation, and there sold at current prices.
Held that
the value, so computed, of property used in a business whose rates
are regulated could not be accepted, for not only was it made to
depend on an assumed earning capacity, but also the evidence of
this earning power was too speculative because, among other
possible objections, it rested on predictions that the prices would
remain unregulated for a long future period, and that gas, to the
amount estimated, would be available as required and could be sold
at those prices through that period in a market yet to be
established, despite future inventions and improved business and
manufacturing methods, and a prediction of what plant and equipment
must be constructed and maintained to effect delivery of gas for
that period, and of the cost of maintaining and operating it. P.
278 U. S.
317.
7. A public service corporation may not make a rate confiscatory
by reducing its net earnings through the device of a contract
unduly favoring a subsidiary or a corporation owned by its
shareholders. P.
278 U. S.
320.
13 F.2d 510
affirmed.
Appeal from a decree of the district court which dismissed a
bill for an injunction to restrain the Railroad Commission of
Kentucky from establishing an alleged confiscatory rate for the
sale of natural gas.
Page 278 U. S. 305
MR. JUSTICE STONE delivered the opinion of the Court.
This is an appeal from a final decree of the District Court for
Eastern Kentucky denying an injunction restraining the appellee,
the Railroad Commission of Kentucky, from establishing an alleged
confiscatory rate for the sale of natural gas in the Cities of
Ashland, Catlettsburg, and Louisa, Kentucky, or, in the
alternative, from preventing appellants from withdrawing their
service in the sale and distribution of natural gas to consumers in
those cities.
13 F.2d
510. The case comes here on direct appeal under § 238 of the
Judicial Code, the decree of the district court having been entered
before the effective date of the Jurisdictional Act of February 13,
1925.
The case was argued here with No. 4,
United Fuel Gas Co. v.
Pub. Serv. Comm'n of W.Va.,, decided this date,
post,
p.
278 U. S. 322,
which involves some questions considered in the opinion in this
case.
Appellant United Fuel Gas Company, a West Virginia corporation,
also appellant in No. 4, is engaged in the business of producing
natural gas from gas fields located principally in West Virginia,
which it sells to consumers in West Virginia, Kentucky, and Ohio. A
part of its business is the sale of gas wholesale to distributors
in West Virginia, and has not been subjected to regulation by any
public body. Its local business in Kentucky is subjected to
regulation by appellee. It formerly held franchises for the sale
and distribution of gas in the Kentucky cities named, all of which
had expired by July, 1918. Nevertheless, it continued its service
in those cities until June, 1923, when it organized appellant
Warfield Natural Gas
Page 278 U. S. 306
Company, a Kentucky corporation whose stock it owns and to which
it conveyed its property in Kentucky, and which has since carried
on its business of distributing gas in the cities named. The United
Company then purported to withdraw from all its business in
Kentucky by cancelling appointments of agents to receive service of
process within the state and by notifying the Secretary of its
action.
Before the organization of the Warfield Company, proceedings
were had before the commission which resulted in its order
directing a reduction of rates by the United Company to 80 percent
of the former rate of 40 cents per 1,000 cubic feet, less 5 cents
for prompt payment. Promptly on its organization, the Warfield
Company filed with the commission a new rate schedule for the
cities named of 45 cents per 1,000 cubic feet, with a reduction of
5 cents for punctual payment, and petitioned the commission to
establish this rate as fair and reasonable, or, in the alternative,
to permit it to withdraw its service from those cities. After an
extensive hearing, the commission denied the application and
construed its earlier order as requiring a rate of 28 cents (80
percent of 35 cents).
The present suit was then brought in the district court. That
court construed the order of the commission as fixing a 32-cent
rate, which it upheld and enjoined the commission from imposing any
lower rate. From the latter part of the decree, no appeal was
taken.
The present appeal challenges the constitutionality of the order
of the commission, as construed by the court, under the Fourteenth
Amendment of the Federal Constitution, both because the rate is
confiscatory and because the order which, under the Kentucky
Statutes, is not subject to judicial review, was not supported by
findings of the commission. The validity of the order is also
assailed on the further grounds that the part of it which required
appellants to continue to render service violates the Kentucky
Page 278 U. S. 307
Constitution, and that the commission itself was never
constitutionally created, and hence was without jurisdiction,
because the legislative act establishing the commission and giving
it its authority is in violation of § 51 of the Kentucky
Constitution, which provides that no legislative act shall relate
to more than one subject, which shall be expressed in its
title.
The district court and this Court, having jurisdiction of the
cause since questions are raised under the Constitution of the
United States, may pass on all questions of state law involved,
Risty v. Chicago, Rock Island & Pacific Ry. Co.,
270 U. S. 378,
270 U. S. 387,
and must do so so far as they are necessary to a decision.
Section 163 of the Kentucky Constitution provides that gas
companies may not procure franchises permitting them to lay pipes
in and under public streets without the consent of the appropriate
municipal governing bodies, and § 164 limits all franchises to
periods not exceeding 20 years. Section 23 of the Statutes of
Kentucky, c. 61 (Acts of 1920, p. 250), subjects any public service
company which has continued its service after the expiration of its
franchise to the jurisdiction and authority of the Railroad
Commission, and forbids it to withdraw such service without
permission of the commission so long as it remains in business in
any part of the state. It is said that the action of the commission
under this statute in effect operates as a renewal of the franchise
of appellants in the cities named in a manner not in conformity
with the provisions of the state constitution.
But this objection, and that as well to the constitutionality,
on state grounds, of the statute creating the commission and
defining its powers, are not available to appellants in the present
suit. It is the rule of this Court, consistently applied, that one
who has invoked action by state courts or authorities under state
statutes may not later, when dissatisfied with the result,
assail
Page 278 U. S. 308
their action on the theory that the statutes under which the
action was taken offend against the Constitution of the United
States.
Wall v. Parrot Silver & Copper Co.,
244 U. S. 407;
Electric Co. v. Dow, 166 U. S. 489;
Eustis v. Bolles, 150 U. S. 361;
Hurley v. Comm'n of Fisheries, 257 U.
S. 223;
St. Louis Malleable Casting Co. v. George C.
Prendergast Co., 260 U. S. 469.
Upon like principle, we think that appellants who have procured
action by a state commission under a state statute may not assail
that action in a federal court of equity on the ground that that
statute, or the one creating the commission, is void under the
state constitution.
Cf. Shepard v. Barron, 194 U.
S. 553. The sound discretion which controls the exercise
of the extraordinary powers of a federal court of equity should not
permit them to be exerted to relieve suitors on such a ground from
the very action of state authorities which they have invoked.
Assuming, as we do for present purposes, the authority of the
commission under state law to refuse its permission to appellants
to withdraw, we perceive no objection under the federal
Constitution, or otherwise, to withholding it. Appellants do not
seriously deny that the Warfield Company is but an agency organized
by the United Company for the purpose of carrying on its public
service business in Kentucky, or that, through that agency, the
latter is doing business in the cities named and elsewhere in the
state. In these circumstances, its continuance in those cities is
neither forbidden nor illegal. It remained subject to state
regulation, and control of it is, by state statute, vested in the
commission with statewide authority. If a state may require a
public service company subject to its control to make reasonable
extensions of its service in order to satisfy a new or increased
demand, present or anticipated,
New York & Queens Gas Co.
v. McCall, 245 U. S. 345;
Woodhaven Gas Light Co. v.Pub. Serv. Comm'n, 269 U.
S. 244;
Missouri Pac.
Ry.
Page 278 U. S. 309
Co. v. Kansas, 216 U. S. 262;
Wisconsin, etc., R. Co. v. Jacobson, 179 U.
S. 287;
Atlantic Coast Line v. No. Car. Corp'n
Comm'n, 206 U. S. 1;
Chicago & Northwestern Ry. Co. v. Ochs, 249 U.
S. 416, obviously the latter may be compelled to
continue to use present facilities to supply an existing need so
long as it continues to do business in the state.
The primary duty of a public utility is to serve on reasonable
terms all those who desire the service it renders. This duty does
not permit it to pick and choose, and to serve only those portions
of the territory which it finds most profitable, leaving the
remainder to get along without the service which it alone is in a
position to give. An important purpose of state supervision is to
prevent such discriminations,
see New York & Queens Gas Co.
v. McCall, supra at
245 U. S. 351,
and, if a public service company may not refuse to serve a
territory where the return is reasonable, or even in some
circumstances where the return is inadequate, but that, on its
total related business is sufficient,
Atlantic Coast Line v.
No. Car. Corp'n Comm'n, supra at
206 U. S. 25;
Missouri Pac. Ry. Co. v. Kansas, supra, at
216 U. S. 277,
it goes without saying that it may not use its privileged position,
in conjunction with the demand which it has created, as a weapon to
control rates by threatening to discontinue that part of its
service if it does not receive the rate demanded. The powers of the
state, so far as the federal Constitution is concerned, were not
exceeded by the action of the commission in compelling appellants
to continue their service in the cities named so long as they
continued to do business in other parts of the state, and to there
avail of the extraordinary privileges extended to public
utilities.
The contentions also that the commission was not lawfully
created under provisions of the state constitution, and that its
order was void because not supported by findings, have the same,
and no greater, force than the
Page 278 U. S. 310
objection that the rate is confiscatory. Suitors may not resort
to a court of equity to restrain a threatened act merely because it
is illegal, or transcends constitutional powers. They must show
that the act complained of will inflict upon them some irreparable
injury. As the court below held, appellants, as public service
companies, are bound by the common law, if not by statute, to
render their service at reasonable rates. If the rates are not
shown to be confiscatory, they cannot complain that the order
purporting to impose them was void, for they have suffered no
injury even though the order was unauthorized.
Cf. Northern
Pacific R. Co. v. Dept. of Pub. Works, 268 U. S.
39,
268 U. S. 44;
Chicago, etc., Ry. v. Public Utilities Comm'n,
274 U. S. 344,
274 U. S. 351.
We are thus brought to the question, chiefly argued and decisive of
whole case, whether the rates complained of yield such a return
upon the property used and useful in the public service as avoids
confiscation.
Gas is sold by the United Company to the Warfield Company at the
state line at 30 cents per 1,000 cubic feet, but, in view of the
history and intercorporate relations of the appellants, it is not
contended that this contract rate is of any controlling
significance in determining the propriety of the rate fixed by the
commission. For this purpose, appellants do not deny that they,
with respect to their entire property and business, may be treated
as a unit, and we so treat them. They contend here, as in No. 4,
that all their property used and useful in producing the gas in
West Virginia and elsewhere and in transporting and distributing it
to consumers in the Kentucky cities should enter into the
calculation of the rate base.
Appellants, through ownership in fee and leases or contracts on
a rental or royalty basis, control the production of natural gas
from 814,910 acres of land. A part of this area, the so-termed
"proven" territory, is at present being used in production, the
remainder being
Page 278 U. S. 311
held in reserve as either "probable" or "unfavorable" sources of
future production. Their principal items of property consist of the
interest in this acreage, working capital, buildings, machinery,
mains, pipes, compressors, and other equipment used in the
production and distribution of gas.
The valuations of the entire business in the two states, made,
respectively, by the appellants and the court below as of December
31, 1923, are as follows:
Value claimed by appellants:
Physical property . . . . . . . . . . . . . . .
$22,274,274.00
Gas lands, leaseholds, and rights . . . . . . .
36,449,176.00
General overhead charges. . . . . . . . . . . . 6,357,046.00
Working capital . . . . . . . . . . . . . . . . 990,000.00
Going concern value . . . . . . . . . . . . . . 8,423,105.00
--------------
$74,493,601.00
Value as found or assumed by the court below:
Physical property . . . . . . . . . . . . . . .
$22,274,274.00
Gas lands, leases, and rights (book value). . . 6,732,920.00
Overheads . . . . . . . . . . . . . . . . . . . 4,009,370.00
Working capital . . . . . . . . . . . . . . . . 999,000.00
Going concern value . . . . . . . . . . . . . . 3,000,000.00
--------------
$37,015,564.00
As will be observed, the difference in these estimates of value
is due chiefly to the difference in value ascribed by each to the
gas rights and leaseholds. Appellants, as will more fully appear,
reached their claimed value by an estimate by experts of the
profits to be derived from the sale, in an unregulated market, of
the quantity of gas estimated to underlie the proven and probable
areas. The court below found that the value of appellants' gas
field did not exceed its "book cost," which it took to be
$6,732,920. This figure, however, included oil production acreage
amounting to $389,591 -- leaving $6,343,329 as the book value of
the entire gas field.
Page 278 U. S. 312
Appellants contend that, for the purpose of determining whether
the rate is confiscatory, the regulated business in Kentucky must
be separately considered, and it is immaterial whether or not a
fair return is being made on the entire business, a part of which
is unregulated. By taking the value of that property used
exclusively in this regulated business and allocating the gas
fields and other property used jointly in the two classes of
business, the former on the basis of the volume of gas supplied to
each type of business, appellants conclude that, if their valuation
of their gas rights be accepted, a composite percentage of 11
percent of the total value is to be allocated to the regulated
business. To establish that the rate is confiscatory, they accept
the conclusions of the court below as to the value of all items of
property except the gas lands and leases, and, substituting for
that item their own minimum valuation of $30,000,000, they arrive
at a hypothetical rate base for their entire property of
$60,282,644. The value of the 11 percent of this property properly
allocable to the regulated business in Kentucky is thus set at
$6,631,091. This valuation, on the basis of 14 percent return (1
1/2 percent depreciation, plus 4 1/2 percent amortization, which
items the court below deemed liberal, plus an 8 percent return),
would thus entitle appellants to earn $867,309, substantially more
than the actual earnings of the regulated business, shown to be
$749,839 in 1923 at the 32-cent rate. Appellants do not seriously
question the sufficiency of the allowance for depreciation or the 8
percent return. The 4 1/2 percent allowed for amortization,
calculated on the rate base, is more than sufficient to replace
appellants' entire property at the end of 18 years, the estimated
life of the gas field.
In assigning to their total property a value of $74,493,601, and
in concluding that the prescribed rate is confiscatory because of
its effect on the regulated business alone, appellants make certain
assumptions, all of which are challenged. In the view which we
take, and for present
Page 278 U. S. 313
purposes only, we likewise make those assumptions without
determining their validity. They are (a) that, in the case as
presented, present reproduction value of property used and useful
in the business, if ascertainable, is to be taken as the rate base;
(b) that, under the circumstances of this case, it is not enough
that the return on appellants' business as a whole is remunerative,
but earnings of the property used in or properly allocated to the
Kentucky regulated business must be separately considered in
ascertaining whether the rate is confiscatory; (c) that both proven
and probable areas of appellants' gas acreage, whether shown to be
presently productive or not, if acquired in a prudent
administration of appellants' business, are to be included in the
valuation for ratemaking purposes; (d) that depreciation and
amortization are to be calculated on the basis of the present value
of the property, rather than upon the original cost or investment;
(e) that, although entitled to earn a fair return on the present
value of their gas leases, the "delay rentals" paid upon them
pending drilling and development are properly chargeable to
operating expense.
Making these assumptions, it is apparent that the disposition of
the present question must turn, as appellants argue, principally
upon the value to be assigned to the gas rights, although, in
certain aspects of the case, a minor consideration may be the
proportion of profits from the sale of gasoline extracted from the
gas which should properly be included in the net earnings of the
regulated business.
The burden of proving the value of property on which they are
constitutionally entitled to earn a fair return rests upon the
appellants, and, to justify judicial interference with the action
of state officers in fixing the rate assailed, must be supported by
clear and convincing evidence.
Knoxville v. Knoxville Water
Co., 212 U. S. 1,
212 U. S. 16. Of
the total of 814,910 acres embraced in the gas field, controlled by
appellants or subsidiaries, 41,969 acres are owned in
Page 278 U. S. 314
fee. The remainder is controlled by lease or contract. This
acreage, although concededly well selected for purposes of
economical development and avoiding loss of gas by drainage, is not
in a solid block; rather, it is in widely scattered areas; much of
it lies adjacent to or is interspersed with gas fields controlled
by others. Leases for fixed periods and so long after as gas is
found in paying quantities have been obtained by appellants by
payment of small bonus payments. The leases vary in their terms,
but a typical lease gives the lessee the right to drill for gas for
ten years, with the privilege of renewal at a fixed small annual
delay rental, varying from 25 cents to $2 per acre, materially
increased in the form either of a fixed rental or a royalty if and
when production is established. They are customarily renewed from
eighteen months to a year before expiration, and for renewal, an
additional bonus is paid.
The actual cost on this basis of appellants' gas field is not
shown, but it appears to have been substantially less than the book
value assigned to it. It was stated on the argument that these
leases, not only singly but in blocks, are sold in open market, but
their market price appears not to have been established.
Appellants do not accept either cost or market value as the
basis of value of their gas rights. Instead, they urge that their
assembled holdings of gas rights are unique, in that they cannot be
reproduced, and that their value depends largely upon their
peculiar nature and situation. They rest their claim to a largely
enhanced value over book value upon alternative theories supported
by two classes of expert testimony. Appellants' experts, on the
basis of geological and mining engineering data, and especially by
ascertaining the existing rock pressure of the gas in various pools
and by comparing the rate of decrease of rock pressure with the
amount of gas produced from these
Page 278 U. S. 315
pools in the same period of time, arrived at an estimate of the
total volume of gas underlying the proven and probable territory.
The results reached by this method were checked by comparison with
the actual experience in gas production from selected pools and
wells. As a final outcome of these calculations, it was estimated
that there was underlying the 136,384 acres of proven territory and
available for use 249,100,000,000 cubic feet of gas, and, in the
126,208 acres of probable territory, 414,600,000,000 cubic feet.
With respect to the probable territory, there were no production or
pressure records to aid the experts in the preparation of their
estimate. In calculation the volume of gas in this area, they had
recourse to comparison with the nearest pools in the same
geological structure. This method was characterized by the witness
using it as "difficult and uncertain," and as "much less
trustworthy" than that applied to the proven territory.
These calculations are supplemented by testimony that, in
Pittsburgh, there is an unregulated market for natural gas used for
industrial purposes at 35 cents per 1,000 cubic feet which would,
on an estimated changing schedule of annual production, absorb in
eighteen years the total estimated reserve of gas in appellant's
gas field. At this price, natural gas, it was said, could compete
successfully in Pittsburgh, for industrial purposes, with gas
produced from soft coal at the prevailing price of $2.75 a ton at
the mine. After calculating the cost of getting this gas to the
market, distant 130 miles from the nearest point on appellants'
mains, providing for all construction costs, including the cost of
plant and transmission line, the gas, when marketed, it was
estimated, would pay a fair return upon investment, repay taxes and
investment, and leave a balance, when discounted so as to give
present value, of $32,458,129. A second witness, taking 30 cents as
the market price of gas in Pittsburgh and deducting
transportation
Page 278 U. S. 316
costs, concluded that the gas in the ground is worth 5 cents per
1,000 cubic feet, and arrived at a higher value, $33,155,421. To
this latter estimate he added the present estimated cost of
acquiring the 552,319 acres of improbable or unfavorable territory
at $5.96 per acre, or $3,293,754, making a total estimated present
value of appellants' gas field of $36,449,176. In this connection,
there is evidence, which appears to be unchallenged, that the
average cost of acquiring unoperated acreage during 1921 to 1923
was 83 cents per acre, and that, in 1923, appellants acquired
15,184 acres at a cost of 66 cents per acre.
Appellants' second class of expert testimony is that of men
experienced and interested in the production and marketing of
natural gas, who purported to assign to appellants' gas field what
was described on the argument as its present exchange value or the
price which the property would bring if sold by a willing seller to
a willing buyer. Three such witnesses testified to a present value
of appellants' gas field in amounts varying from $30,000,000 to
$35,000,000, and a fourth fixed the value at $45,000,000.
Examination of their testimony discloses that these estimates were
not based on prevailing prices for gas leases or on actual sales,
but, as in the case of the geological and engineering experts, upon
an estimated or assumed exhaustible supply of gas available to
appellants until exhausted, and upon a predictable price for
natural gas in unregulated markets through a future period of about
eighteen years. Common characteristics of both methods of valuation
therefore are the estimation on uncertain bases of the volume of
gas available and of the price at which it may be sold through a
long future period.
A point considered below and argued here is that gas in the
earth is not capable of ownership, but we assume that appellants'
leases and contracts give them complete legal power of control over
the gas available beneath the surface of the area embraced in the
gas field, so far as it may
Page 278 U. S. 317
be brought under physical control. We assume also that the gas
is now present in substantially the volume indicated, and we lay to
one side the speculative character of the assumption that the gas
in that volume, despite its fugitive character and its possible
drainage into other fields not under appellants' control, will
remain available for appropriation through the eighteen or more
years required to exhaust the field.
Waiving these not inconsiderable difficulties in the way of
establishing value, we pass to another and more serious difficulty.
In both methods of valuation, the value of property used in a
business whose rates are regulated is made to depend on an assumed
earning capacity, and the data relied on to establish assumed
earning capacity are themselves essentially speculative -- so much
so as to form no trustworthy basis for the computation of
value.
It is true that a part of appellants' business is not regulated
at present, but it does not appear that the ultimate distribution
of their product to consumers in other states will be immune from
regulation either because of the interstate commerce clause,
Pennsylvania Gas Co. v. Public Service Comm'n,
252 U. S. 23;
Public Utilities Comm'n v. Landon, 249 U.
S. 236, or for other reasons, and there can be no
reasonable assumption that it will be. The unique character of
appellants' control over a natural product, limited in amount,
asserted here as a basis of value, the obvious necessity of
securing franchises or special privileges to enable them to
distribute their product to consumers under the conditions assumed,
and other circumstances which subject them to regulation in
Kentucky and West Virginia, make inadmissible the assumption that
the price to consumers would remain unregulated elsewhere.
And in other respects, the assumed earning capacity is so
wanting in probative force as to require its rejection in the
circumstances here disclosed. It rests on a prediction,
Page 278 U. S. 318
feebly made, that the estimated amount of gas will be available
as required through a period of eighteen years; that natural gas so
transported and used as a fuel will command a price of from 30 to
35 cents per 1,000 cubic feet through that period in a market yet
to be established despite the changes wrought by invention and
improved business and manufacturing methods, and a further
prediction not only of what plant and equipment must be constructed
and maintained to effect delivery of the gas for this period to
consumers in the city of Pittsburgh, but also of the cost, through
a like period, of the construction, maintenance, and operation of
that plant and equipment. Such predictions can only be made on the
basis of data which are not and cannot be known, and most of which
are in the highest degree speculative. Such a process of estimating
value is without any known sanction.
On the record as made, appellants have failed to present any
convincing evidence of value of their gas field which would enable
us to assign to it any greater value than that which they appear to
have assigned to it on their books. This book value therefore may
be accepted not as evidence of the real value of the gas field, but
as an assumed value named by the appellants, which, on the evidence
presented, cannot reasonably be fixed at any higher figure.
We likewise find no persuasive ground for not accepting as
substantially correct the amount of $30,282,644 fixed by the court
below as the maximum value to be assigned to those items of
appellants' property other than the gas reserve, rather than
$38,044,425, appellants' outside figure for those items. But, to
avoid unnecessary discussion of them in detail and for present
purposes, appellants' valuation of all these items may be conceded
to be correct. If we restate appellants' claimed valuation of their
property by substituting for their estimate of the
Page 278 U. S. 319
value of the gas rights their book value (after deduction for
oil acreage) of $6,343,329, we arrive at a total assumed maximum
valuation of appellants' entire property of $44,387,754. Taking 12
percent
* of this total,
or $5,326.530, as the largest amount which could be allocated to
the Kentucky business, a return upon it of 14 percent (8 percent
plus 1 1/2 percent depreciation, plus 4 1/2 percent amortization)
would amount to $745,714, an amount less than the actual
return.
Appellants also contend that the court below erroneously
included in the earnings of the regulated business the sum of
$65,166, or 50 percent of the net proceeds of the sale of gasoline
extracted, before sale, from the gas sold in the regulated
business, on the ground that this amount exceeded the profits from
this branch of appellants' business as reflected on their
books.
In the process of extracting gasoline from natural gas, the gas
flows from the field to the extraction plant, where the gasoline is
taken out; the residual gas being returned to the transmission
system for distribution to consumers. In the production of this
gasoline, therefore, joint use is made of the gas, gas field, and
certain facilities of the gas company. This joint use requires a
prorating of joint investment and expenses and of the return from
the joint
Page 278 U. S. 320
enterprise. Formerly, appellant United Company maintained and
operated its own gasoline extracting plant. The West Virginia
Public Service Commission having held that 50 percent of the net
return from the sale of gasoline should be credited to the gas
business, the United Company organized a corporation, the Virginia
Gasoline & Oil Company, and conveyed to it its gasoline
extraction plant, receiving the stock of the new corporation in
exchange. Later it turned over this stock to its own stockholders
of which there are but two, both corporations, in the same
proportions in which they held stock in the United Company. It
entered into a contract with this subsidiary by which it receives
one-eighth of the gross profit from the gasoline extracted. The
commission and the Supreme Court of West Virginia, in
City of
Charleston v. Public Service Commission of West Virginia, 95
W.Va. 91, 120 S.E. 398, in which the United Company was a party,
held that 50 percent was a fair share of the net return of the
subsidiary's business attributable to appellant United Company, and
this was the conclusion adopted by the court below.
We need not labor the point that a public service corporation
may not make a rate confiscatory by reducing its net earnings
through the device of a contract unduly favoring a subsidiary or a
corporation owned by its own stockholders.
Cf. Chicago &
Grand Trunk Ry. Co. v. Wellman, 143 U.
S. 339,
143 U. S. 345.
We recognize that a public service commission, under the guise of
establishing a fair rate, may not usurp the functions of the
company's directors and in every case substitute its judgment for
theirs as to the propriety of contracts entered into by the
utility, and common ownership is not of itself sufficient ground
for disregarding such intercorporate agreements when it appears
that, although an affiliated corporation may be receiving the
larger share of the profits, the regulated company is still
receiving substantial benefits from
Page 278 U. S. 321
the contract and probably could not have secured better terms
elsewhere.
Southwestern Bell Telephone Co. v. Public Service
Comm'n, 262 U. S. 276,
262 U. S. 288;
Houston v. Southwestern Telephone Co., 259 U.
S. 318.
But this case is not of that class. It is not without
significance that the West Virginia court in considering this
question had before it previous findings of its commission, based
upon actual contracts for gasoline extraction where the parties,
dealing at arm's length, had agreed upon a 50 percent division.
Credible evidence was introduce below tending to show that expenses
on property used jointly by the two companies and properly
allocable to the gasoline company had been borne by the gas
companies to an amount in excess of the return received by them
from the gasoline extraction. It likewise was shown, the evidence
not being challenged by appellants, that the extracting company
during the years 1917 to 1922, inclusive, after allowing appellants
50 percent of the net earnings for the extraction privilege, would
have earned not less than 102 percent of its capital investment in
each year. The average yearly profit during this period was 119.75
percent. In 1923, its net return on this basis was 80.40 percent.
Making allowance for fluctuation in market prices and other common
business hazards, we do not think it would be difficult to induce
capital to seek investment on the basis of this division of net
earnings. In such circumstances, we think no adequate reason is
shown for not including in the appellants' earnings 50 percent of
the net proceeds from the gasoline extraction.
Appellants' computation of value and of earnings is assailed at
many other points, but fully conceding, for present purposes only,
every contention made by them except those which we have discussed,
namely, the value of appellants' gas rights and the division of
return from gasoline extraction, the appellants have failed to
show
Page 278 U. S. 322
that the rate imposed is confiscatory or otherwise such as to
call for the interference of a court of equity.
Affirmed.
MR. JUSTICE McREYNOLDS concurs in the result.
* Various witnesses allocated to the Kentucky regulated business
an amount of property used for "production" (including the gas
field) varying from 7.1 percent to 10.49 percent, and a percentage
of property other than "production" ranging from 9 percent to 12.07
percent-or for the entire property as a unit, from 8.4 percent to
11 percent No witness testified that there was a composite
percentage which could be taken generally to represent the part of
appellants' entire property used in the regulated business,
regardless of the varying values assigned to different items of
property. Appellants have used this last figure, 11 percent, in
their calculations, and do not contest its validity. This
percentage appears to include some property located in Kentucky but
not actually used in the local regulated business. In our own
computation, we have, for convenience, taken 12 percent as the
highest possible percentage applicable and as the figure most
favorable to appellants.