Amicus Curiae Brief — Duquesne Light Co. v. Barasch

No. 87-1160

IN THE

Supreme Court of the United States

OCTOBER TERM, 1988

DUQUESNE LIGHT COMPANY

AND

PENNSYLVANIA POWER COMPANY,

. Appellants,

DAVID M. BARASCH,

CONSUMER ADVOCATE, et al.,

Appellees.

On Appeal from the Supreme Court of Pennsylvania

BRIEF OF THE

NATIONAL GOVERNORS’ ASSOCIATION,

U.S. CONFERENCE OF MAYORS,

INTERNATIONAL CITY MANAGEMENT ASSOCIATION,

NATIONAL. ASSOCIATION OF COUNTIES, AND

NATIONAL LEAGUE OF CITIES

AS AMICI CURIAE IN SUPPORT OF APPELLEES

ROBERT L. BEZEK, JR. BENNA RUTH SOLOMON *

ANDERSON, BYRD & RICHESON Chief Counsel

Second & Main, P.O. Box 7 JOYCE HOLMES BENJAMIN

Ottawa, KS 66067 BEATE BLOCH

(913) 242-1234 STATE AND LOCAL

BRIAN J. MOLINE LEGAL CENTER

712 S. Kansas Avenue 444 N. Capitol Street, N.W.

Suite 201 Suite 349

Topeka, KS 66603 Washington, D.C, 20001

(913) 354-8531 (202) 635-1445

Of Counsel * Counsel of Record for the

Amici Curiae

WILSON - EPES PRINTING Co., INC. - 789-0096 - WASHINGTO:, D.C. 20001

QUESTION PRESENTED

Whether the Takings Clause precludes a State, in set-

ting utility rates, from implementing its volicy of per-

mitting reimbursement only of investment that is used

and useful in the public service by denying recovery

of costs incurred in planning cancelled nuclear plants.

(i)

TABLE OF CONTENTS

Page

I i

a iv

INTEREST OF THE AMICI CURIAE .......................... 1

EES SAA 3

SUMMARY OF ARGUMENT .......000000..ee eee 8

ARGUMENT .......... II ieishcndsidebidsancisbetinsessinnedcstasncescccunes 10

I. DENIAL OF RECOVERY FOR PROPERTY

THAT IS NOT “USED AND USEFUL” DOES

NOT EFFECT A TAKING UNDER TRADI-

TIONAL RATE REGULATIGN CONCEPTS.. 12

Il. DENIAL OF RECOVERY OF PRE-

CONSTRUCTION COSTS IS NOT A TAKING

UNDER TRADITIONAL CONCEPTS OF

SIEM “ODUNNOOIOD cc cccccccceencseseceenceeeseeee- 24

Ee RipeneinaiiinNiL Atvenieassemenssiarssnsce 30

(iii)

ee

iv Vv

TABLE OF AUTHORITIES TABLE OF AUTHORITIES—Continued

CASES: Page Page

Andrus v. Allard, 444 U.S. 51 (1979) 0.0.0.0... 26, 27, 30 Mississippi Power & Light Co. v. Mississippi ex

Arkansas Electric Cooperative Corp. v. Arkansas rel. Moore, No. 86-1970 (June 24, 1988)... 29

Public Service Comm’n, 461 U.S. 375 (1983)... 1 Missouri ex rel. Southwestern Bell Telephone Co.

Baltimure & O.R.R. v. United States, 345 U.S. 146 v. Public Service Comm’n, 262 U.S. 276 (1923). 8, 11,

(1953) <i ancties paatalinasentsadannegiiianpumiienaaaatatnen 14 13, 16, 17

Cleveland Electric Illuminating Co. v. Public Util- Mobil Oil Corp. v. FPC, 417 U.S. 283 (1974)........ 14, 18

ity Comm’n, 4 Ohio St. 3d 107, 447 N.E. 2d 746, Mugler v. Kansas, 123 U.S. 623 (1887) ................. 26

appeal dismissed, 464 U.S. 802 (1983) ................. 6 Natural Gas Pipeline Co. v. FERC, 765 F.2d 1155

Cleveland Electric Illuminating Co. v. Public Util- (D.C. Cir. 1985) -............. eetteececcneceeeeseeeeereeeceeeeeeess: 23

ity Comm’n, No. 82-165 (Ohio, July 7, 1982), New England Power Co. 42 FERC (CCH)

appeal dismissed, 459 U.S. 1094 (1983) —........... 6 FR GI TI, FD picnic ccecrennrvonrtinsrciionee 20

Denver Union Stock Yard Co. v. United States, Nollan v. California Coastal Comm'n, 107 S.Ct.

Oi Ee I I i cecesorsnissesnenses 10, 11, 17 Se CD whether erecendeatorinnstiniasintntnsians 11, 25, 29

Euclid v. Ambler Realty Co., 272 U.S. 365 (1926).. 26 Office of Consumers’ Counsel v. Public Utility

FCC v. Florida Power Corp., 107 S.Ct. 1107 Comm’n, 67 Ohio St. 2d 153, 423 N.E. 2d 820

SAREE Re SER Bt AEE aR PRENE a: 10, 14, 24, 25 (1981), appeal dismissed, 455 U.S. 914 (1982). 6

FPC v. Hope Natural Gas Co., 320 U.S. 591 Penn Central Transportation Co. v. New York

(RSG es Rapaann nt rele Ha passim City, 438 U.S. 104 (1978) ...................... ities 12, 26, 27

FPC v. Natural Gas Pipeline Co., 815 U. Ss. B75 Pennell v. City of San Jose, 108 S.Ct. 849 (1988)... 10, 11,

(1942) ....... fins ow... passim 30)

FPC v. Texaco Ine., 417 US. 380 (1974) eatin 10, 14 Pennsylvania Coal Co. v. Mahon, 260 U.S. 393

Hadacheck v. Sebastian, 239 U.S. 394 (1915) .... 9, 26 OO) ae 11

Hodel v. Irving, 107 S.Ct. 2076 (1987) ..........<....... 29, 30 ) Permian Basin Area Rate Cases, 390 U.S. 747

Hodel v. Virginia Surface Mining & Reclamation | CUED entevenenscendiontentinsiniterivincrscnimiebesveneiennshansens passim

Ase’n, 452 U.S. 264 (1981) ........................--. 25 ) PruneYard Shopping Center v. Robins, 447 US.

Jersey Central Power & Light Co. v. FERC, 810 | 74 (1980) .. — seahceiatiecenaiariessieetn 25

F.2d 1168 (D.C. Cir. 1987) (en bane) —.............passim Ruckelshaus v. Monsanto Co., 467 US. 986

Kaiser Aetna v. United States, 444 U.S. 164 (1984) ........ ceenneeneecesnesseneeesenseseeeeeresesee sees seceseeeeneees 25, 27, 30

CID ns ncncrcesnsensnsnnaconssccnencninenincacenenanventnncnmversencumveted passim Smyth v. Ames, 169 U.S. 466 (1898) 8, 10, 11, 13, 17

Kentucky Utilities Co. v. FERC, 760 F.2d 1321 Washington Gas Light Co. v. Baker, 188 F.2d 11

(D.C. Cir. 1985)... ii. aie (D.C. Cir. 1950), cert. denied, 340 U.S. 952

Keystone Bituminors Coal Ass’ n v. DeBenedictis, CED — axccsnenscnemsnesesoonnrensreveverotntenscenosuneenesensestenness 22

107 S.Ct. 1232 (1987) 9, 25, 27 , Webb’s Fahulous Pharmacies, Inc. v. Beckwith,

Loretto v. Teleprompter Manhattan CATV Corp., SE TE I Cannes senso cne-nonenerommnnennnnianes 28, 30

158 U.S. 419 (1982). 3 24, 29 ‘

Market Street Railway Co. v. Railroad Comm'n, — CONSTITUTIONAL PROVISIONS:

994 U.S. 548 (1945) 18, 22, 23 U.S. Const. Amend. V, Takings Clause _....... passim

Miller v. Schoene. 276 U.S. 272 (1928) ik %6 U.S. Const. Amend. XTV, Due Process Clause 10-11

vi

TABLE OF AUTHORITIES—Continued

STATUTES: Page

Act 1982-335, 66 Pa. Cons. Stat. § 13815 ................. 6, 7,8

Act 1985-62, 66 Pa. Cons. Stat. § 520 -.................... 19, 26

BOOKS AND PERIODICALS:

Drobak, From Turnpike to Nuclear Power: The

Constitutional Limits on Utility Rate Regula-

tion, 65 B.U. L. Rev. 65 (1985) -...........-...--...-----. . 10, 19

Energy Information Administration, U.S. Dept. of

Energy, Nuclear Plant Cancellations: Causes,

Costs, and Consequences (April 1983) -............ 19, 28, 29

C. Phillips, Jr., The Regulation of Public Utilities

> ) oe 3, 4, 5, 29

Pierce, The Regulatory Treatment of Mistakes in

Retrospect: Canceled Plants and Excess Ca-

pacity, 132 U. Pa. L. Rev. 497 (1984) -.............. passim

¢

IN THE

Supreme Court of the United States

OCTOBER TERM, 1988

No. 87-1160

DUQUESNE LIGHT COMPANY

AND

PENNSYLVANIA POWER COMPANY,

e Appellants,

DAVID M. BARASCH,

CONSUMER ADVOCATE, et al.,

Appellees.

On Appeal from the Supreme Court of Pennsylvania

BRIEF OF THE -

NATIONAL GOVERNORS’ ASSOCIATION,

U.S. CONFERENCE OF MAYORS,

INTERNATIONAL CITY MANAGEMENT ASSOCIATION,

NATIONAL ASSOCIATION OF COUNTIES, AND

NATIONAL LEAGUE OF CITIES

AS AMICI CURIAE IN SUPPORT OF APPELLEES

INTEREST OF THE AMICI CURIAE

The amici, organizations whose members include state,

county, and municipal governments and officials through-

out the United States, have a compelling interest in legal

issues that affect state and local governments. This case

concerns electric utility ratemaking, ‘“‘one of the most

important of the functions traditionally associated with

the police power of the States.” Arkansas Electric Co-

operative Corp. v. Arkansas Public Service Comm’n,

461 U.S. 375, 377 (1983). Indeed, the States are re-

sponsible for 90% of the utility regulation in this coun-

2

try... Moreover, many state and loca! governments and

agencies are captive customers of intrastate utility

monopolies.

The case arises from the cancellation of four proposed

nuclear plants. Appellants were denied recovery of pre-

construction planning expenses for the plants under a

Pennsylvania statute that prohibits electric utilities from

charging the cost of constructing or expanding their

facilities to the ratepayers until “such time as the facil-

ity is used and useful in service to the public.” Appel-

lants contend that this denial effected an uncompensated

taking of their property in violation of the Fifth and

Fourteenth Amendments. The statute codifies Pennsyl-

vania’s longstanding ratemaking policy, similar to that

in many other States, that an electric utility may not

include in its rates the cost of construction work in prog-

ress until the project has been placed in public service.

Amici fear that the invalidation of this policy would

strip the States of an important, time-tested reguiatory

tool. Such a decision could force the public to as-

sume the cost of virtually all utility expenditures, no

matter how superfluous, absolving investors of any risk

of loss from the consequences of mistakes by manage-

ment. Moreover, this Court would become the ultimate

arbiter of ratemaking disputes, indeed the ultimate rate-

maker, by sitting in review of every disallowance of

every utility expense.

An electric utility company is a natural monopoly sub-

ject to regulation, but it operates as a for-profit enter-

prise, receiving many state-conferred benefits in ex-

change for providing power to the public. The right of

the utility to a fair return is generally recognized to

avoid what would be tantamount to confiscation of prop-

erty that is used to serve the public. In this case, the

utilities have not been forced to operate any property

' See Jersey Central Power & Light Co. v. FERC, 810 F.2d 1168,

1207 (D.C. Cir. 1987) (en bane) (Mikva, J., dissenting).

3

in the public interest. Their expenditures for the pro-

posed plants produced no benefit for ratepayers or for

the Commonwealth because management cancelled the

plants at the initial stage of planning. This Court has

never suggested, much less held, that the Constitution

requires reimbursement of all utility expenditures unless

they are shown to be imprudent.

Amici are concerned that appellants’ claims would

significantly expand the takings doctrine as applied to

utility rate regulation. Their contentions are radical

departures from settled law and would hamstring the

States in their regulatory capacity by preempting their

judgment how best to balance the public interest with

that of investors in regulating rates for electricity and

other public services. Amici submit that the decision of

the Pennsylvania Supreme Court is correct. Because

this Court’s decision will have a direct effect on matters

of prime importance to amici and their members, amici

submit this brief to assist the Court in its resolution of

the case.”

STATEMENT

Amici believe that an understanding of the facts of

this case is aided by a review of the method nor-

mally employed by utility regulatory commissions. State

and federal regulators use a standard formula to deter-

mine the total revenues that a utility may raise through

rates.* The formula is designed to cover legitimate oper-

ating expenses and to allow a return on the utility’s rate

base. Operating expenses are the current costs associated

with furnishing utility service, and typically include

2 The parties’ letters of consent pursuant to Rule 36 of the Rules

of the Court have been filed with the Clerk.

*The revenue formula may be expressed as R=0+(V-—Dp)r.

R is the total revenue required; O 1s the operating costs; (V—D)

is the net value of or investment in the rate base, with V repre-

senting the gross value of the tangible and intangible property and

D the acerued depreciation of the tangible and reproducible prop-

erty; and r is the allowed rate of return. See C. Phillips, Jr.. The

Regulation of Public Utilities 157-58 (1984).

4

wages, salaries, fuel, maintenance, taxes, and annual

depreciation.*

The rate base is “the value of a utility’s property

used and useful in the public service minus accrued de-

preciation” (Phillips, supra n.3, at 281). It is helpful

to distinguish between “the elements of value” and “the

measures of value.” Jd. at 282. The elements of value

may be classified in four categories: tangibles, including

“used and useful’ land, buildings, and equipment

(plant)”; working capital, property held for future use,

and intangibles, including leaseholds and water rights;

customer contributions and tax deferrals; and construc-

tion work in progress. /bid; see also id. at 159. Not

all States allow all elements to be included.’ The meas-

ures of value, typically fair value or prudent investment,

also vary from State to State.®

The rate base is multiplied by the rate of return to

yield the net earnings, over and above operating ex-

*See id. at 158. A utility may charge other items, such as

advertising, research and development, charitable contributions,

and purchases from affiliated subsidiaries, to operating expenses,

but these may not be fully allowed for ratemaking purposes. See

ibid. ““When an expenditure is disallowed it, in effect, is charged

to a utility’s stockholders rather than to its customers.” IJbid.

5 Jd. at 159, 282. For example, in some jurisdictions (although

not in Pennsylvania), construction work in progress is included in

the rate base. See id. at 158-59. In jurisdictions where it is ex-

cluded, the allowance for funds used during construction is capital-

ized until the project is complete. See id. at 159. Other common

exclusions are customer contributions and tax deferrals (id. at

282) and certain intangibles, such as franchise value, going con-

cern value, and good will. Jd. at 159.

®A recent survey of practices among regulatory commissions

found that thirty-eight States and the District of Columbia use

original cost or prudent investment; eleven use fair value or current

value; and three consider all evidence submitted. See id. at 308,

citing National Association of Regulatory Utility Commissioners,

1981 Annual Report on Utility and Carrier Regulation 430-31

(1982). With one minor exception, the federal government uses

original cost. See id. at 308 & n.80.

5

penses (including taxes) and depreciation. The allowed

percentage is a weighted composite of the rates required

to pay the interest on bonded indebtedness, dividends to

preferred stockholders, and a return on the investment

of common stockholders.’

This case grew out of two ratemaking proceedings be-

fore the Pennsylvania Public Utility Commission (PUC).

In 1973, Duquesne Light Company (Duquesne) and

Pennsylvania Power Company (Penn Power), as part

of an interstate group of electric utility companies, de-

cided to construct seven nuclear plants to meet the an-

ticipated needs for electric power in Western Pennsyl-

vania and Ohio. J.S. App. 2a-3a, 7a. Pennsylvania did

not require the utilities to obtain prior PUC approval

of the proposed construction; and they neither sought

nor received approval of their decision to build.* Because

Pennsylvania does not recognize construction work in

progress as an operating expense, appellants planned to

capitalize their costs for inclusion in the rate base once

construction was complete.

7 Each of these components yields a different rate. See id. at 351-

32. The “equity” rate includes a “risk premium” in addition to the

cost of risk-free investment, both arrived at on the basis of mar-

ket factors. See, e.g., J.S. App. 91c-93c; 46e-48e.

8 In proceedings before the PUC to investigate the delays in the

construction of the plants at issue here, appellants resisted the

Commission’s jurisdiction “[als to the propriety of construction

and selection of fuel... .” J.S. App. Th. This argument was based

on findings of an administrative law judge that the Commission

lacked jurisdiction over the planning and siting of electric generat-

ing units, that a utility may plan and construct without the express

approval of the Commission, and that the first time that a utility

must seek approval was in a rate proceeding subsequent to placing

the unit in service. See ibid.

Most state commissions do not have the power to approve con-

struction in advance. See Pierce, The Regulatory Treatment of

Mistakes in Retrospect: Canceled Plants and Excess Capacity, 132

U. Pa. L. Rev. 497, 508, 532 (1984). “The decision to begin con-

struction of a new generating plant is the utility’s, at least in the

first instance.” Jd. at 508.

es mm

6

In 1980, before obtaining a construction permit from

the Nuclear Regulatory Commission, the utilities decided

to cancel construction of fovr of the proposed nuclear

plants. J.S. 4.°. The PUC did not order the cancellation,

and the utilities neither sought nor received approval of

their decision to cancel construction.” Duquesne’s share

of the “pre-construction” costs amounted to $34,697,389

(J.S. App. 3a); Penn Power’s equaled $9,569,665. Jd.

at 7a. In ratemaking proceedings before the PUC seek-

ing a general increase in rates, the two utilities sought

to amortize these pre-construction costs, as part of their

operating expenses. 7d. at 3a, 7a.

While the Duquesne rate case was before the PUC, the

Pennsylvania Legislature amended the Public Utility

Code by Act 1982-335, 66 Pa. Cons. Stat. § 1315, to pro-

vide that the “cost of construction or expansion of a

facility’ could not be “made a part of the rate base nor

otherwise included in the rates charged by the electric

utility” until the plant was “used and useful in service,”

which was defined as “presently providing actual utility

service to the customers.” Jd. at 4a-5a.

The Administrative Law Judge (ALJ) appointed by

the PUC to investigate the plant construction program,

found that the utilities had acted prudently at relevant

stages of the pre-construction period; he recommended

that Duquesne be allowed to recover the cost of the plan-

ning for the cancelled plants by amortization over a

period of ten years at the rate of $3,469,739 a vear. Id.

® The project was owned primarily by three Ohio utilities, which

were denied recovery of their share of the costs. See Office of Con-

sumers’ Counsel v. PUC, 67 Ohio St. 2d 153, 423 N.E.2d 820

(1981), appeal dismissed, 455 U.S. 914 (1982); Cleveland Elec.

Illum. Co. v. PUC, No. 82-165 (Ohio, July 7, 1982), appeal dis-

missed, 459 U.S. 1094 (1983): Cleveland Elec. Illum. Co. v. PUC,

4 Ohio St. 3d 107, 447 N.E.2d 746, appeal dismissed, 464 U.S.

802 (1983).

10“The decision to cancel a partially constructed plant .. . is

also the utility’s in the first instance.” Pierce, svpra n.&, at 510.

It appears that even fewer States can order cancellation than can

approve construction. See ibid.

%

7

at 4a. The PUC accepted the ALJ’s report: it also in-

terpreted Section 1315 to bar adding the costs of incom-

plete construction to the rate base, but not to preclude

passing through those costs to the ratepayers by amorti-

zation. Jd. at 5a-6a. The PUC granted Duquesne an

overall annual revenue allowance of $802,463,063, an in-

crease of $105,850,000 (id. at 126¢c), or 15.2%. The

amortization at issue in this case thus constitutes 3.28%

of the annual increase allowed by the PUC and less than

4, of 1% (.43%) of Duquesne’s total annual revenue

allowance. The increased revenue allowance reflected an

equity return of 16.14% and an overall return of

11.64%. Id. at 93c.

In a separate proceeding, the PUC, relying on the

ALJ’s report and its own decision in the Duquesne rate

case, allowed Penn Power to amortize its pre-construction

costs at the rate of $956,967 for ten years. /d. at Ta.

The PUC granted Penn Power overall revenues of

$184,186,000, an increase of $15,364,000 (id. at 3e-4e),

or 9.1%. The amortization contested here thus consti-

tutes 6.2% of the revenue increase approved by the PUC

and slightly more than % of 1% (.52%) of Penn

Power’s total annual revenue allowance. The increased

revenue allowance reflected an equity return of 15.72%

and an overall return of 12.02%. Id. at 48e.

The Office of Consumer Advocate filed petitions with

the Commonwealth Court for review of the orders in

both the Duquesne and Penn Power proceedings, which

were consolidated on appeal. Jd. at 8a. The Common-

wealth Court held, in a four-to-three decision, that the

PUC had correctly construed Section 1315. Jd. at 8a-

9a. On appeal, the Pennsylvania Supreme Court unani-

mously reversed on the ground that Section 1315 pre-

cluded recovery of the pre-construction expense of the

cancelled plants. Jd. at 15a. The court rejected appel-

lants’ federal constitutional challenges*' and remanded

11 The court rejected appellants’ argument that such an interpre-

tation would “wor[{k] a confiscation of utility property without

8

the case to the PUC for further proceedings. /d. at 30a-

3la.

SUMMARY OF ARGUMENT

I. Appellants’ assertions of per se taking reflect a

misunderstanding of this Court’s decisions in the field of

utility rate regulation. The criticisms voiced by Justice

Brandeis, concurring in Missouri ex rel. Southwestern

Bell Telephone Co. v. Public Service Comm’n, 262 U.S.

276, 289 (1923), persuaded the Court to repudiate the

requirement that a utility receive a fair return on the

“fair value” of its property devoted to the public service

(see Smyth v. Ames, 169 U.S. 466 (1898)). When it

did so, however, the Court shifted its focus from the

details of the ratemaking process to its end result. Thus,

in FPC v. Natural Gas Pipeline Co., 315 U.S. 575, 586

(1942), the Court approved a reduction in natural gas

rates, finding that the rate order, “viewed in its entirety,

produce(d] no arbitrary result.” In FPC v. Hope Nat-

ural Gas Co., 320 U.S. 591, 602 (1944), the Court clari-

fied that judicial review was confined to “the total effect

of the rate order,” regardless of “infirmities” in “the

method employed to reach that result.’ Since then, the

Court has repeatedly declined to mandate either a partic-

ular methodology or a particular rate, and has required

only that the end result avoid confiscation. ‘

Appellants’ reliance on Justice Brandeis’ Southwestern

Bell concurrence as replacing the used and useful test by

the prudent investment standard errs on two grounds.

First, that standard refers only to the measure of value

of property, and not to the inclusion of elements of value

in the rate base. For the latter purpose, Justice Brandeis

supported the used and useful test. Second, although the

Court agreed with Justice Brandeis that the “fair value”

just compensation.” J.S. App. at 2la. The court also rejected

Duquesne’s claim that Section 1315 violated the Due Process Clause

by operating retroactively, finding no contractual or vested right

to recover the cost of investments that do not provide utility serv-

ice. Id. at 26a. Finally, the court rejected an equal protection

claim (id. at 27a-30a) and claims under the state constitution.

9

standard must be rejected, it did not adopt his prudent

investment standard. The Court has wisely refused to

mandate any single standard for utility regulators.

Prudent investment, in particular, is seriously flawed as

an exclusive determinant of utility rates.

Appellants’ asserted rights to a balancing in their

favor of investor and consumer interests rests upon ref-

erences in Hope and the Permian Basin Area Rate Cases,

390 U.S. 747 (1968), to the investor interests that the

ratemaking process should consider. In neither Hope nor

Permian, however, did the Court engage in balancing; in

both cases, the Court concluded its inquiry when it deter-

mined that the investor interest had been met by the estab-

lishment of nonconfiscatory rates. Here, appellants have

not even alleged that their overall revenue allowance is

confiscatory. Moreover, investor interests are only part

of the equation; and on this record there is no reason

to elevate them over those of the ratepayers and the public.

II. Appellants’ per se arguments find even less sup-

port in regulatory takings cases outside the utility con-

text. There is no physical invasion of property, nor even

any physical property to invade. The facts do not meet

the criteria used by the Court to evaluate regulatory

takings. The overall economic impact on appellants of

denying recovery of their cancellation costs is minimal,

especially when compared with losses in other unsuccess-

ful takings claims. See, e.g., Hadacheck v. Sebastian, 239

U.S. 394 (1915). These costs may not be isolated for

takings law purposes as separate segments of property.

Keystone Bituminous Coal Ass’n v. DeBenedictis, 107

S.Ct. 1232, 1249 (1987). Nor have appellants, whose argu-

ments depend on a world in which utility investments are

risk-free, shown reasonable “investment-backed expecta-

tions” of recovery of the cost of the cancelled plants (see,

e.g., Kaiser Aetna v. United States, 444 U.S. 164, 175

(1979) ). Finally, appellants have not identified any gov-

ernmental action that took anything from them. It was

not the Commonwealth of Pennsylvania but economic

forces that rendered their investment worthless.

10

ARGUMENT

Constitutional protection for utilities in rate regula-

tion is based on the right to a fair return on property

put to publie use, namely to provide utility service.’* The

theories used by this Court in reviewing the constitu-

tionalitv of rate regulation have varied over time, but

today there can be no doubt that the appropriate stand-

ard is whether the rate arrived at can be termed con-

fiscatory, without regard to the methodology employed.”

12 See Jersey Central Power & Light Co. v. FERC, 810 F.2d 1168,

1175 (D.C. Cir. 1987) (en banc); see also FPC v. Natural Gas

Pipeline Co., 315 U.S. 575, 602-03 (1942) (Black, J., concurring) ;

see generally Drobak, From Turnpike to Nuclear Power: The Con-

stitutional Limits on Utility Rate Regulation, 65 B.U.L. Rev. 65,

72-79 (1985).

13 Over time, the Court has identified both the Takings Clause

(see, e.g., Smyth v. Ames, 169 U.S. 466, 546 (1898) (“just com-

pensation” for the use of property beneficial to the public re-

quired), and the Due Process Clause (see, e.g., Denver Union Stock

Yard Co. v. United States, 304 U.S. 470, 475 (1938); Natural Gas

Pipeline, 315 U.S. at 586; see also id. at 599 (Black, J., concur-

ring) ), as the source of the constitutional limits on rate regulation.

More recently, the Court has not explicitly named the source of

the constitutional protection. See, e.g., FPC v. Texaco Inc., 417

U.S. 380, 391-92 (1974) (referring only to “constitutional” limita-

tions on ratemaking); Permian Basin Area Rate Cases, 390 U.S.

747, 768-70 (1968) (same). In FCC v. Florida Power Corp., 107

S. Ct. 1107, 1113 (1987), the Court cited “traditional Fifth Amend-

ment standards,” but discussed only a taking of “private property

devoted to public uses.” See also id. at 1114 (Powell, J., con-

curring).

In Pennell v. City of San Jose, 108 S. Ct. 849 (1988), involving

the related issue of rent control, the Court considered both takings

and due process challenges to a requirement that tenant hardship

be considered in reviewing a substantial rent increase. The ma-

jority held that the takings claim was premature (id. at 856), but

two Justices dissented, finding that a taking had occurred (id. at

859). The Court, however, did reach, and rejected without dissent,

the due process claim. Jd. at 858, 859.

In this case, the questions presented are phrased in terms of

takings, and appellants do no more than hint at a violation of sub-

stantive due process (Brief at 24 n.20). Although this case there-

11

Given the formula by which a revenue allowance is de-

termined (see pp. 3-5, supra), in a particular case chal-

lenges may be leveled at exclusions from the rate base,

undervaluation of property in the rate base, a low rate

of return, or—as in this case—the exclusion of operating

costs or other annual expenses. This Court’s cases have

reflected considerable controversy over what property

should be included in the rate base,‘ how it should be

valued,’® and the appropriate rate of return on that

value."®

The present case, however, raises only the question

whether appellants’ pre-construction expenses incurred in

the initial planning stages of their ill-fated nuclear venture

must be included in their revenue allowances as operating

fore does not require the Court to decide what difference there may

be between due process and takings standards in the context of

utility rate regulation, amici suggest that the modern view of the

constitutional restrictions on rate regulation is probably better

grounded in takings law. By setting rates, the government intends

to allow compensation. Even if, in a particular case, the overall

revenue provides insufficient compensation, the intention to pay for

the public’s use of utility property is still present. The Court has

relied on notions of substantive due process to determine when

regulation that the government does not intend to pay for “goes

too far.” See Nollan v. California Coastal Comm'n, 107 8S. Ct. 3141,

3150 (1987); Pennsylvania Coal Co. v. Mahon, 260 U.S. 393, 415

(1922). Moreover, in its modern application, substantive due process

has little force to invalidate rate regulation. “The standard for

determining whether a state price-control regulation is constitu-

tional under the Due Process Clause is well established: ‘Price con-

trol is “unconstitutional ... if arbitrary, discriminatory, or demon-

strably irrelevant to the policy the legislature is free to adopt.

...”’” Pennell, 108 S. Ct. at 857 (quoting Permian, 390 U.S. at

769-70, quoting Nebbia v. New York, 291 U.S. 502, 539 (1934) ).

14 See, e.g., FPC v. Hope Natural Gas Co., 320 U.S. 591, 605-06

(1944) ; Denver Union Stock Yard, 304 U.S. at 475-77.

15 Compare Missouri ex rel. Southwestern Bell Tel. Co. v. Public

Serv. Comm'n, 262 U.S. 276, 290 (1923) (Brandeis, J., concurring),

with Smyth v. Ames, 169 U.S. at 546-47.

16 See, e.g., Permian, 390 U.S. at 768-70; Hope, 320 U.S. at 604-

05; Natural Gas Pipeline, 315 U.S. at 584-86.

12

expenses.'’ This Court has resolved comparatively few

disputes between utilities and their regulatory commis-

sions over the legitimacy of operating expenses, and ap-

pellants cite none in the modern era since FPC v. Hope

Natural Gas Co., 320 U.S. 591 (1944).

Instead, appellants and their amici assert in a variety

of ways that Pennsylvania’s refusal to permit recovery

of these expenses constitutes a per se taking. These

claims stand in sharp contrast to this Court’s decisions,

which make clear that per se takings are extremely rare.

In the utility context, the modern cases exemplify a

highly deferential standard based on the overall revenue

allowance, which, if reasonable, will be sustained without

descending into the particulars. See Hope, 320 U.S. at

602; FPC v. Natural Gas Pipeline Co., 315 U.S. 575, 586

(1942). In other contexts, the Court has repeatedly em-

phasized that the takings analysis rests on an ad hoc,

factual inquiry. See, e.g., Kaiser Aetna v. United States,

444 U.S. 164, 175 (1979); Penn Central Transportation

Co. v. New York City, 438 U.S. 104, 124 (1978). Under

either approach, no taking, per se or otherwise, has been

shown on this record.

I. DENIAL OF RECOVERY FOR PROPERTY THAT

IS NOT “USED AND USEFUL” DOES ‘NOT EF-

FECT A TAKING UNDER TRADITIONAL RATE

REGULATION CONCEPTS.

Appellants rely on this Court’s seminal cases on utility

rate regulation to attack the decision below. Because ap-

pellants’ discussion of these cases seriously misconstrues

their teachings, we review them briefly before turning to

appellants’ specific contentions.

17 Appellants argued in the Pennsylvania Supreme Court (Brief

of Duquesne below at 13, 18, 56; Brief of Penn Power below at 11,

88, 46, 47) and they still argue (Brief at 30 n.23) that they are

entitled to recover these expenditures as operating expenses. We

use this term even though the expenses are not those typically

classified as operating expenses, i.e., expenses of operating the

utility to produce electricity. See n.4, supra.

13

An historical review. For many years, the controlling

authority on questions of rate base and rate of return

was Smyth v. Ames, 169 U.S. 466 (1898), which held

that a utility was entitled to a “fair return” on the “fair

value of the property being used by it for the convenience

of the public.” Jd. at 546-47. The Court’s later abandon-

ment of the “fair value” standard is generally traced to

Justice Brandeis’s concurring opinion in Missouri ex rel.

Southwestern Bell Telephone Co. v. Public Service

Comm'n, 262 U.S. 276, 289 (1923). In its move away

from the “fair value” standard, the Court did not, how-

ever, adopt the “prudent investment” standard advocated

by Justice Brandeis in Southwestern Bell. Instead, the

Court shifted its focus in reviewing utility rate regula-

tion from the ingredients of the ratemaking process to

the bottom line.

The shift began with Natural Gas Pipeline, a challenge

to the constitutionality of the Natural Gas Act of 1938,

52 Stat. 821, 15 U.S.C. § 717 et seg. The Court upheld

the Act’s standard of “just and reasonable rates” as iden-

tical with the constitutional standard; thus the FPC could

order a decrease where existing rates were not the “low-

est reasonable rates.” 315 U.S. at 586. In approying a

rate reduction ordered by the FPC, the Court held (ibid.;

emphasis added) :

The Constitution does not bind rate-making bodies

to the service of any single formula or combination

of formulas. Agencies to whom this legislative

power has been delegated are free, within the ambit

of their statutory authority, to make the pragmatic

adjustments which may be called for by particular

circumstances. . . . If the Commission’s order, as

applied to the facts before it and viewed in its en-

tirety, produces no arbitrary result, our inquiry is

at an end.

Within two years, the Court would clarify that the

“entirety” of the order was to be measured by the “end

result”; and the fair value standard would become just

one of the methodologies available to reach that end re-

14

sult. In Hope, the Court reaffirmed the conclusions

reached in Natural Gas Pipeline, holding (320 U.S. at

602) :

It is not the theory but the impact of the rate order

which counts. If the total effect of the rate order

cannot be said to be unjust and unreasonable, judi-

cial inquiry ... is at an end The fact that the

method employed to reach that result may contain

infirmities is not then important.

Parallel reasoning led the Court to reject the conten-

tion that there is but one constitutional rate. Rather,

rate regulation reflects a “broad zone of reasonableness,”

and any rate falling within that zone “cannot properly

be attacked as confiscatory.” Permian Basin Area Rate

Cases, 390 U.S. 747, 770 (1968). When the Court dis-

missed for the second time the argument that there is

only one just and reasonable rate, it specifically rejected

a rate “based entirely on some concept of cost plus a rea-

sonable rate of return.” Mobil Oil Corp. v. FPC, 417

U.S. 283, 316 (1974). In the Court’s most recent case

deciding a takings challenge to rate regulation, the Court

held simply that “[{s]o long as the rates set are not con-

fiscatory, the Fifth Amendment does not bar their im-

position.” FCC v. Florida Power Corp., 107-8. Ct. 1107,

1113 (1987).

Although Hope and Permian did not deal with operat-

ing expenses, they did prescribe the constitutional stand-

ard fer judging the sufficiency of all revenue allow-

ances, whether the shortfall is attributed to elements

18 See also FPC v. Texaco Inc., 417 U.S. 380, 391-92 (1974)

(“All that is protected against, in a constitutional sense, is that

the rates fixed ... be higher than a confiscatory level.”); id. at

392 (“whether any rate is confiscatory ...can only be judged by

‘the result reached, not the method employed’”’, citing Hope, 320

U.S. at 602); Baltimore & O.R.R. v. United States, 345 U.S. 146,

148 (1953) (“So long as a railroad is not caused by such regula-

tions to lose money on its over-all business, it is hard to think

that it could successfully charge that its property was being taken

for public use ‘without just compensation.’ ”).

15

or measures of value in the rate base, to the rate of re-

turn, or to operating expenses.'® That constitutional

standard does not, however, as appellants insist (Brief at

19, 26-33), reject the used and useful test or mandate

recovery of all prudent investment.

Given Hope’s holding that the Constitution does not

require regulators to use any particular methodology,

nothing is inconsistent with Hope except an insistence on

a single methodology. Similarly, given Permian’s holding

that the Constitution does not require any single rate,

nothing is inconsistent with Permian except an insistence

on a particular rate. Hope and Permian embrace a

choice of methodology, and a zone of reasonable rates;

they preclude nothing except a confiscatory bottom line.?°

In this case, of course, appellants have not even alleged

that their overall revenue allowances are confiscatory.*!

‘9 Thus, if the exclusion of an item of operating expenses were

significant enough to render the overall revenue allowance con-

fiscatory, Hope and Permian suggest that the bottom line might

have to be adjusted to a constitutionally sufficient level. Consistent

with Hope and Permian, however, a reviewing court should not

mandate any particular remedial approach. Operating costs or ele-

ments of the rate base that have been properly excluded by ap-

plication of general principles should not be ordered back in; nor

should a rate base properly valued according to standard practices

be ordered revalued. See, e.g., Jersey Central, 810 F.2d at 1188

(authorizing FERC to choose either option or to adjust the rate

of return).

*0The D.C. Circuit has expressly rejected the contention that

the used and useful test may not constitutionally be applied. See

Jersey Central, 810 F.2d at 1187 (“The Commission is not pre-

cluded from employing ‘used and useful,’ or any other specific

rate-setting formula’); id. at 1188 (“Jersey Central has mounted

an ill-conceived and overly broad attack on the ‘used and useful’

principle”) (Starr, J., concurring).

“1 Such a claim would border on the frivolous. The exclusions

amounted to approximately |. of 1% of appellants’ annual revenue

allowances, and their annual increases, even after the exclusions,

were 14.75% for Duquesne, and 8.5% for Penn Power. In its Form

10-K filing with the Securities and Exchange Commission, for the

fiscal year ending December 31, 1986, Duquesne concluded (at 15)

16

Rather than meet the requirements of Hope and Per-

mian by demonstrating deficiencies of constitutional pro-

portion in their revenue allowances, appellants urge upon

this Court the startling propositions that the used and

useful standard cannot be employed, that the prudent in-

vestment standard must be employed, and that any ex-

clusion of operating expenses fails to take proper account

of investors’ interests.

The used and useful standard. Appellants trace their

condemnation of the used and useful standard to Justice

Brandeis’ concurring opinion in Southwestern Bell. In

this attempt, they fail to distinguish between what Jus-

tice Brandeis advocated and what he achieved. He clearly

advocated abandoning the fair value standard; and the

Court ultimately agreed. See Hope, 320 U.S. at 601, 605.

He also advocated replacing the fair value standard with

a standard of prudent investment; but in this he was not

successful. See id. at 605-06; see also Natural Gas Pipe-

line, 315 U.S. at 606 (Black, J., concurring) .*

Moreover, appellants’ argument confuses the elements

of value in the rate base and the measures of value of

those elements. As a result, appellants attribute to Justice

Brandeis a view that he did not advocate. The prudent

investment standard is used as a measure“of value of

that the case before the Pennsylvania Supreme Court “will not

have a material adverse effect on its financial position or results

of operations.”

22 Even Justice Jackson, dissenting in Hope, agreed that the

Court had not adopted the prudent investment standard.

The Commission appears to have understood the effect of

the two opinions in the Pipeline case to be at least authority

and perhaps direction to fix natural gas rates by exclusive

application of the “prudent investment” rate base theory.

This has no warrant in the opinion of the Chief Justice for

the Court, however, which released the Commission from sub-

servience to “any single formula or combination of formulas”

provided its order, “viewed in its entirety, produces no arbi-

trary result.”

320 U.S. at 628, quoting Natural Gas Pipeline, 315 U.S. at 586.

17

elements in the rate base; it is not used to identify the

elements that should be included in the rate base (see p.

4, supra). Justice Brandeis preferred prudent invest-

ment to fair value as the measure of value; he did not

advocate any change in the used and useful standard,

which identifies the elements of value to be included in

the rate base.** Thus, the prudent investment standard,

even if the Court had adopted it, would apply only to

used and useful property.”

Justice Brandeis confirmed that he had no quarrel with

the used and useful standard when he joined the Court’s

opinion in Denver Union Stock Yard Co, v. United States,

304 U.S. 470, 475 (1938). That case expressly held that

the Constitution required “a reasonable rate of return

upon the value of the property used, at the time it is

being used, to render the services,” “|b]ut [the company]

is not entitled to have included any property not used

and useful for that purpose.” »

3 Justice Brandeis criticized, among other things, what he

regarded as the unsound basis of Smyth v. Ames’ fair value

standard (262 U.S. at 290), the difficulty of setting present value

(id. at 292), the difficulty of judicial review of present value (id.

at 297-98), and the unfairness of the present value standard (id.

at 306-07). None of these difficulties inhere in the used and use-

ful standard.

*4 As to this latter point, Justice Brandeis explained: “Historical

cost . . . is the amount which normally should have been paid for

all the property which is usefully devoted to the public service.

It is, in effect, what is termed the prudent investment.” 262 U.S.

at 294 n.6. See also id. at 290 (“so long as the specific items of

property are employed by the utility, their exchange value is not

of legal significance”); id. at 308-09 (“What is now termed the

prudent investment is, in essence, the same thing as that which

the court has always sought to protect in using the term present

value.”). Southwestern Bell did not involve the question what

property should be included in the rate base, but only how that

property should be valued (see id. at 282, 287).

25 The Court’s later opinions have had little or no occasion to

address the question directly, but they reflect an assumption that

the used and useful test may constitutionally be employed to deter-

18

The prudent investment standard. Appellants’ insis-

tence that the constitutional standard encompasses recov-

ery of all prudent investment is plainly incorrect. The

Court has disclaimed any particular formula or any par-

ticular rate and has specifically declined to mandate the

prudent investment standard. See, e.y., Market Street

Railway Co. v. Railroad Comm’n, 324 U.S. 548, 567

(1945) (Commission is not required “to fix rates... on

an investment after it has vanished, even if once pru-

dently made”). The point is that not every disallowance

of an expense rises to constitutional dimensions. Rather,

there is a zone of reasonableness within which the overall

rate, unchallenged here, may be set. Permian, 390 U.S.

at 767; Natural Gas Pipeline, 315 U.S. at 585.*°

Important reasons of comity and practicality argue

against this Court’s mandating any single standard for

all state utility rate regulation. Such a_ requirement

would further constitutionalize ratemaking, reducing

flexibility for the States and creating docket problems

for the Court.** States as a matter of policy use a va-

riety of approaches in rate regulation and have devised

mine the elements of value in the rate base. For instance, in Nat-

ural Gas Pipeline, the Court remarked (315 U.S. at 590): “It is

only on the assumption that excess capacity is a part of the utility’s

equpiment used and useful in the regulated business, that it can be

included as a part of the rate base on which a return may be

earned.” See also Hope, 320 U.S. at 606 n.12 (noting the statutory

limitation of depreciation and amortization to property that is

used and useful in service).

26 See, e.g., Mobil Oil Corp., 417 U.S. at 315 (noting the “com-

mon error .. . that certain provisions of the [rate] order can be

isolated and viewed without regard to the total effect the order

is designed to achieve”).

27 The era before Hope bears witness to the problems of a con-

stitutional standard that requires this Court to scrutinize every

ratemaking proceeding. By comparison, since Hope (at least un-

til the last few vears), the Court had nearlv gotten out of the rate

regulation business. Of course, this case concerns only operating

expenses. Even prior to Hope, the Court had not been deeply in-

volved in setting that component of the overall revenue allowance.

19

different ways to deal with the financial disaster resulting

from cancellation of nuclear power generating units

across the country.”

As the sole determinant of recovery, the prudent in-

vestment standard is particularly flawed. It may be the

least economically defensible of all the regulatory ap-

proaches. It would “increase consumers’ bills dramatic-

ally without producing any tangible benefit for the con-

sumers” and would produce “results strikingly different

from the results of erroneous investment decisions made

by firms in unregulated markets.” *° It provides an in-

centive to overinvest in capital assets.*° A regulatory

process based solely on prudence would be expensive, in-

trusive, unpredictable, and probably futile, in part be-

cause a finding of prudent investment may reflect no more

than the extraordinary difficulty of proving imprudence.”'

Nor is recovery of prudent investment in assets that are

not used and useful necessary to enable the utility to at-

tract new capital or to protect the long-term interests of

existing stockholders.

28 See, e.g., Energy Information Administration, U.S. Dept. of

Energy, Nuclear Plant Cancellations: Causes, Costs, and Con-

sequences 33-57 (April 1983); Drobak, supra n.12, at 112-19;

Pierce, supra n.8, at 517-20. Thus, it makes no difference whether

“‘the overwhelming weight of authority’ support[s] the recovery

through amortization of prudently incurred investment in can-

celled electric generating projects.” Brief for Appellants at 6,

quoting the ALJ’s report. This choice is a matter of policy, not

constitutional imperative. Pennsylvania itself uses a number of

different approaches. Since the enactment of Act 1985-62, 66 Pa.

Cons. Stat. $520, the PUC is authorized to permit recovery by

amortization of prudently incurred investment in cancelled gen-

erating units.

29 See Pierce, supra n.8, at 506.

30 See Jerseu Central, 810 F.2d at 1190 n.1, 1191 (Starr, J.,

concurring) ; Pierce, supra n.8, at 506-07, 559.

31 See id. at 512 & n.80, 517, 538.

32 The market in utility stocks and bonds is self-correcting.

If application of the used and useful standard operates to increase

20

Appellants invoke “the utility’s statutory duty to

serve” (Brief at 29) as the basis for a constitutional

requirement of recovery of prudent investment.” Con-

trary to their implication, utilities are managed not only

to serve the public, but to earn profits for their investors.

The utility’s right to a reasonable rate of return and pro-

tected monopoly position are provided in exchange for

service in a least-cost manner.** The so-called “regulatory

compact” is plainly more complex than “we spend it, you

pay for it.” *

the risk of disallowance, “{t|heoretically, in subsequent rate cases,

this higher risk will manifest itself in a higher rate of return allow-

ance being granced to the utility to ‘compensate’ for the additional

risk.” New England Power Co., 42 FERC (CCH) £ 61,016, at 61,080

(Jan. 15, 1988). Cf. Jersey Central, 810 F.2d at 1172 (higher rate

of return requested in view of disallowance of costs from the rate

base).

33 Appellants suggest (Brief at 3) that they were required to

undertake the abortive construction, but the record supports at

most a finding that they were encouraged to do so. The record

also contains appellants’ view that the PUC was powerless even to

investigate their construction activities, much less to compel them.

See n.8, supra.

34 For example, the duty to serve can be fulfilled by purchase of

electric power as well as building generating units. In recent

years, the electric industry has had substantial excess capacity. See

Pierce, supra n.8, at 525, 526, 527 n.177 (citing General Accounting

Office Report).

35 Moreover, if cancellation of the units at issue in this case

was prudent, going ahead with the construction would likely have

been either imprudent or unnecessary, or both. Regulatory com-

missions, in setting rates, generally disallow all costs associated

with imprudent investment decisions; and return on costs resulting

from investments that create excess capacity has also been pre-

cluded. See Pierce, supra n.&, at 511, 514-17. The effect of a

rule prohibiting recovery of the costs of cancelled units is simply

to impose a heightened incentive for management to cancel early.

The magnitude of the incentive that States provide for prudent

decisions by utility management, and the allocation of risk between

the utility and the ratepayers, are clearly for legislative determina-

tion, and they do not raise constitutional questions.

21

Balancing ef investor and consumer interests. At the

outset, appellants’ argument that the statutory mandate

enforeed by the Pennsylvania Supreme Court interfered

with the PUC’s exercise of its discretion in balancing

investor and consumer interests can be put to one side.

The PUC is a state agency, which must act within the

scope of its legislative authorization. Pennsylvania’s

highest court has determined the correct interpretation

of the applicable state law and concluded that the PUC’s

order rested on an incorrect interpretation.** The consti-

tutionality of the state law itself plainly is not to be

measured by the agency’s mistaken application of it.

In any event, Hope and Permian do not support ap-

pellants’ contention that the Pennsylvania Supreme Court

cid not properly balance investor and consumer interests.

Hope and Permian do not mandate balancing any more

than they require any particular ratemaking methodology

or any particular rate; and this Court did not engage in

any balancing in either case.

Hope indicated that “the fixing of ‘just and reasonable’

rates . . . involves a balancing of the investor and the

consumer interests” and identified the factors relevant

“from the investor or company point of view.” 320 U.S.

at 603. But the Court approved a reduction of rates

ordered by the FPC without any balancing because “the

end result in this case cannot be condemned under the

Act as unjust or unreasonable from the investor or com-

pany viewpoint.” Jbid. In Permian, the Court, echoing

Hope, explained, “the [reviewing] court must determine

whether the order may reasonably be expected to main-

tain financial integrity, attract necessary capital, and

fairly compensate investors for the risks they have as-

sumed, and yet provide appropriate protection to the

relevant public interests, both existing and foreseeable.”

390 U.S. at 792 (emphasis added) .*”

36 Thus, the second question presented raises no more than a

question of state law.

57 Although it is not entirely clear whether the references to

balancing in Hope and Permian pertained to the essentially legisla-

22

Appellants argue for a balancing of investor interests

as though it would elevate those interests over the rate-

payers’. In fact, because the ratemaking process itself

is designed to produce an allowance that will afford a

reasonable return to investors after payment of expenses

(see Hope, 320 U.S. at 603; see also Permian, 390 U.S.

at 792), the effect of balancing will generally be to

reduce rates in order to reflect consumer interests.*

Although the Court has said that investors’ interests

are an important part of the calculus of setting rates,

they are only a part. “‘[Rjegulation does not insure

that the business shall produce net revenues’” (Hope,

320 U.S. at 603, quoting Natural Gas Pipeline, 315 U.S.

at 590), for “the obvious reason that the hazard that

the property will not earn a profit remains on the com-

pany in the case of a regulated, as well as an unvegu-

lated business.” Natural Gas Pipeline, 315 U.S. at 590.

See Market Street Railway, 324 U.S. at 566.

Appellants have shown no constitutional reason why a

balance must be struck so as to permit recoupment of

their expenditures for the cancelled plants. Appellants

may not have been at fault when they risked a substan-

tive task of setting the appropriate revenue allowance, or to the

judicial task of determining the constitutionality of that allowance,

the Court obviously did not envision a constitutional balancing

requirement with respect to every ingredient of the ratemaking

process. The opinions demonstrate that the Court was concerned

to avoid review of the details of that process, perhaps in recollec-

tion of the complexities in which it became enmeshed in attempting

to determine the fair value of property under Smyth v. Ames.

38 See Market Street Railway, 324 U.S. at 556, 568 (financial

plight of company does not entitle it to charge exploitative rates) :

Natural Gas Pipeline, 315 U.S. at 607-08 (Black, J., concurring) ;

Washington Gas Light Co. v. Baker, 188 F.2d 11, 15 (D.C. Cir.

1950), cert. denied, 340 U.S. 952 (1951); see also Pierce, supra n.8,

at 506 (because the result would be a dramatic increase in electric

bills without any tangible benefit, “full recovery of investment costs

has no chance of emerging from the regulatory process as a solu-

tion’”’).

23

tial sum on an investment that turned out to be worth-

less; but clearly, neither the public nor the ratepayers

were at fault.*’ They were not consulted about appel-

lants’ plans, and the cancelled plants—which never pro-

ceeded beyond the planning stage—cannot conceivably

benefit them. Under these circumstances, it was hardly

unreasonable for Pennsylvania to decide that the balance

should be struck in favor of the ratepayers, by preclud-

ing recovery of appellants’ fruitless expenditures.*

In sum, Hope and Permian could sunport appellants’

takings claim only if the exclusion of their costs in con-

nection with the cancelled nuclear plants rendered their

overall revenue allowance confiscatory. Although com-

plaining that the Pennsylvania Supreme Court did not

even cite Hope and Permian," appellants have not alleged

39 In Natural Gas Pipeline Co. v. FERC, 765 F.2d 1155, 1163

(D.C. Cir. 1985), the court upheld the denial of recovery of pru-

dent expenditures on abandoned projects, noting: “At bottom,

Natural’s claim is that because it acted prudently, it cannot fairly

be punished by nonrecovery of its expenses. But the problem of

risk allocation in this case is not a problem of fault.” See also

Jersey Central, 810 F.2d at 1181 n.3; Kentucky Utilities Co. v.

FERC, 760 F.2d 1221 (D.C. Cir. 1985).

40 See Permian, 390 U.S. at 771, approving the FPC’s determina-

tion that a “producer’s inability to recover either its unsuccessful

exploration costs or the full 12% return on its production invest-

ment would not, without more, warrant relief’; Market Street

Railway, 324 U.S. at 527 (due process clause “has not and cannot

be applied to insure values or to restore values that have been lost

by the operation of economic forces”).

41 Brief for Appellants at 11. This complaint is surprising be-

cause in the Pennsylvania Supreme Court, appellants between them

cited Permian but once (Duquesne brief below at 32), and that

was only in passing. They cited Hope only in passing (Penn Power

brief below at 49), incorrectly (Duquesne brief below at 34-35,

36, 62), or for the noncontroversial proposition that it protects

against a confiscatory rate of return (id. at 37, 38). Appellants

did not argue that the used and useful standard was inconsistent

with those cases; their argument was that the used and useful

concept did not apply to operating expenses. See Brief of Duquesne

below at 13, 18, 56; Brief of Penn Power below at 11, 38, 46, 47.

24

that the disallowance would make their revenue allow-

ances confiscatory. Without an allegation of constitu-

tional shortfall, appellants are not even entitled to a

hearing, much less to prevail, on their takings claim.

Il. DENIAL OF RECOVERY OF PRE-CONSTRUCTION

COSTS IS NOT A TAKING UNDER TRADITIONAL

CONCEPTS OF REGULATORY TAKINGS.

Appellants seek support in land use and other regula-

tory takings cases outside the utility context for their

claim that the “reasonable expectations” of utility in-

vestors to be “made whole on their investment” “re-

quir|e| recovery, per se, of a utility’s prudent investment

in cancelled electric generating units” (Brief at 26).

The precedent in these areas, however, affords even less

basis for appellants’ contentions than the decisions in

the special subspecies of takings law devised for rate

regulation.

Appellants argue, first, that “|r]ecovery of prudently

incurred costs . .. is deserving of protection per se”

(Brief at 32 n.25) because to deny it is analogous to a

physical invasion of their property. The denial of re-

covery of costs “takes from a person something that was

once physically in his possession” (ibid.) and therefore

must be “treated under a higher standard than regula-

tions that merely diminish the expected value of an in-

dividual’s property” (id. at 31-32 n.25, citing, e.g., Lor-

etto v. Teleprompter Manhattan CATV Corp., 458 U.S.

419, 435-38 (1982)). This argument merits no serious

consideration because there is no physical property to be

invaded. Cf. FCC v. Florida Power Corp., 107 S. Ct.

1107, 1112 (1987) (distinguishing Loretto on ground

that statute gave no right to physical occupation of

42 Appellants’ efforts never proceeded beyond the planning stage.

The plans themselves, of course, remain in appellants’ possession,

and, should they ever come to fruition, may then, in conjunction

with the resulting facilities, be includable in the rate base.

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25

another’s property). Invasion of a mere pocketbook in-

terest has never been per se prohibited.**© No govern-

ment action physically took anything from appellants

or their investors. Whether viewed from the standpoint

of the stockholders or of the utilities themselves, the

investment in the cancelled plants in this case was volun-

tary, as was the decision to terminate the projects.

Second, appellants note (Brief at 27) that this Court

has considered “whether governmental conduct interferes

with ‘reasonable, investment-backed expectations’ in de-

terming whether a taking has occurred,” citing Kaiser

Aetna v. United States, 444 U.S. 164, 175 (1979). Ap-

pellants argue, in effect, that they are constitutionally

absolved from any risk of loss if an investment, prudent

when made, proves to be worthless. Because appellants

cite only part of the test set out in Kaiser Aetna, and

fail to satisfy even that, their argument is insufficient.

In the regulatory takings area, the Court has repeat-

edly disclaimed a one-factor test or “any ‘set formula’

for determining when ‘justice and fairness’ require that

economie injuries caused by public action be compen-

sated by the government, rather than remain dispropor-

tionately concentrated on a few persons.” Kaiser Aetna,

444 U.S. at 175 (citations and footnotes omitted). In-

stead, the Court has decided takings claims “by engaging

*8 The heightened protection against physical invasion is pro-

vided because “the right to exclude [others is] ‘one of the most

essential sticks in the bundle of rights that are commonly char-

acterized as property.’” Nollan v. California Coastal Comm’n,

107 S.Ct. 3141, 3145 (1987) (citations omitted). Appellants’ dis-

appointed hopes of gain are not the kind of intangible property

entailing “legal ownership” that is entitled to protection. See

Ruckelshaus v. Monsanto Co., 467 U.S. 986, 1002 (1984). Of

course, not even all regulation affecting real property interests

constitutes a taking (see, ¢.g., Keystone Bituminous Coal Ass'n v.

DeBenedictis, 107 S.Ct. 1232, 1244 n.18, 1249-50, 1250 n.27 (1987) ;

Hodel v. Virginia Surf. Min. & Recl. Ass'n, 452 U.S. 264 (1981)),

not even all physical invasions. See Florida Power, 107 S.Ct. at 1111-

13; PruneYard Shopping Center v. Robins, 447 U.S. 74 (1980).

26

in essentially ad hoc, factual inquiries that have identi-

fied several factors—such as the economic impact of the

regulation, its interference with reasonable investment

backed expectations, and the character of the govern-

mental action—that have particular significance.” Jbid.

Economic Impact. The economic impact of the denial

of recovery in this case of appellants’ cancellation costs

fails to rise to the level of a constitutionally significant loss

under this Court’s cases. The Court has rejected takings

claims even where the regulation has been alleged to

render the property nearly worthless (see Andrus v. Al-

lard, 444 U.S. 51, 64-66 (1979)), or has resulted in a

measurable loss as high as 8714% of the value. See

Hadacheck v. Sebastian, 239 U.S. 394 (1915); see also

Euclid v. Ambler Realty Co., 272 U.S. 365 (1926) (75%

diminution).** In this case, the excluded costs amounted

to approximately |; of 1% of annual revenues.** Appel-

lants were allowed substantial annual revenue increases

(by our calculation, 14.75% for Duquesne and 8.5% for

Penn Power) even after excluding the disputed expendi-

tures, and there is no suggestion that they were com-

pelled to operate at a loss. Cf. Penn Central Transporta-

tion Co. v. New York City, 438 U.S. 104, 129, 136

(1978). It is well settled that appellants have no right

to the most profitable use of their property (see Andrus

v. Allard, 444 U.S. at 66; Penn Central, 438 U.S. at

125-27).

44 In some cases, the denial of any compensation for total loss

of investment has been sustained. See, e.g., Miller v. Schoene,

276 U.S. 272 (1928); Mugler v. Kansas, 123 U.S. 628 (1887).

** There is no claim based on the effect of the exclusion of the

costs on the value of the stock in appellants’ companies. Of course,

even if stock prices were adversely affected, the value of the stock

would not be destroyed. The stock would retain value because of

the expectation of future earnings. Moreover, as appellants them-

selves acknowledge (Brief at 24 n.20), the exclusion of costs in

this case is a one-time occurrence. Under current Pennsylvania

law, similar future costs can be recovered. 66 Pa. Cons. Stat. § 520.

27

Appellants describe the economic impact of the non-

recovered costs as though it could be viewed in isolation

from their profitable utility business. The Court, how-

ever, has repeatedly held that the economic impact of

government action is to be evaluated on the basis of the

property as a whole. See Keystone Bituminous Coal

Ass’n v. DeBenedictis, 107 S.Ct. 1232, 1248 (1987);

Andrus v. Allard, 444 U.S. at 65-66; Penn Central, 438

U.S. at 130-31.*°

Appellants’ claims that the denial of recovery of costs

would penalize their investors (Brief at 19) and leave

them uncompensated for a risk that they did not assume

(id. at 26-30, 33) are not supported in the record. The

state supreme court explained that the used and useful

standard has been the law in Pennsylvania at least since

1921 (J.S. App. 19a-20a). Thus, it is reasonable to as-

sume, absent any evidence to the contrary, that in Penn-

sylvania utility revenue allowances reflect the fact that

recovery of expenditures is not guaranteed. In fact, ap-

pellants’ equity rates of return included risk premiums.

Reasonable investment-backed expectations. Appel-

lants’ repeated references to their investors’ expectations

and to the prudence of the expenditures at issue in this

case ignore a crucial factor in the determination whether

property interests and expectations are constitutionally

protected. Not all investment-backed expectations are

protected; they must be “reasonable.” Kaiser Aetna, 444

U.S. at 175 (emphasis added); see Ruckelshaus v. Mon-

santo Co., 467 U.S. 986, 1005-10 (1984).

46 In Keystone, for example, the coal companies contended that

Pennsylvania’s Mine Subsidence Act, by preventing them from

mining 27 million tons of coal that they owned, had appropriated

that coal for public purposes. 107 S.Ct. at 1249. The Court refused

to treat this coal as “a separate segment of property for takings

law purposes.” Jbhid. Rather, it viewed these 27 million tons in

the context of the companies’ overall operations and _financial-

backed expectations. /bid.

28

This Court has made clear that

“Tfp]roperty interests . . . are not created by the

Constitution. Rather, they are created and their

dimensions are defined by existing rules or under-

standings that stem from an independent source

such as state law... .” Board of Regents v. Roth,

408 U.S. 564, 577 (1972). But a mere unilateral

expectation or an abstract need is not a property

interest entitled to protection.

Webb’s Fabulous Pharmacies, Inc. v. Beckwith, 449 US.

155, 161 (1980). The Pennsylvania Supreme Court’s

authoritative construction of state law defeats appellants’

claim to a reasonable expectation of compensation for all

prudently incurred expenses. “Used and useful” has long

been the law in Pennsylvania; it was applied to operat-

ing costs as early as 1944 (J.S App. 24a). As appellants

recognize (Brief at 8 n.10), the effect of this rule is to

“prevent a utility from ever receiving a return of or on

its investment in. . . costs” of cancelled plants.

No more could the upheaval in the nuclear industry

have been a secret to appellants. These units were

planned in 1973 and cancelled in January 1980. During

that time, 60 nuclear plants were cancelled, the first

in 1972; 1974 was the last year that more units were

planned than cancelled.*7 When appellants cancelled their

plants, they had not yet received an NRC permit, with-

out which construction would not have been possible.

Against this backdrop, no reasonable expectation of com-

pleting the projects, much less of recovering all the costs,

could have matured.

Appellants’ expectations are grounded in a constitu-

tional right that this Court has never recognized. The

Constitution simply does not guarantee recovery of ex-

penses, no matter how prudently incurred. In fact, rate

regulation may reduce the value of investments or limit

the rate of return to accommodate the public interest.

See Hope Natural Gas, 320 U.S. at 601, 603; Natural

47 See Nuclear Plant Cancellations, supra n.28, at 4-5.

<——*

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29

Gas Pipeline, 315 U.S. at 590. Appellants’ only consti-

tutionally cognizable expectation was a nonconfiscatory

revenue allowance; and they make no claim that their

overall revenues are constitutionally insufficient. Their

vision that utility investments are risk-free is not pro-

tected because it is not reasonable.

Character of the governmental action. Perhaps the

most elusive aspect of appellants’ takings claim is what,

if anything, Pennsyivania took from them, indeed,

whether Pennsylvania did anything at all to affect their

property interests.** Appellants decided to build nuclear

plants. They then decided to cancel those plants. The

former decision was likely motivated by the advantages

perceived, in 1973, of nuclear power; the latter decision

by the loss of those advantages. But the Commonwealth

mandated neither decision and was not responsible for

the loss of advantage.*”

Nevertheless, appellants insist that the Commonwealth

has “taken” something from them. It appears to be noth-

ing other than the ability to charge consumers the costs

of ill-fated, unproductive studies and planning for their

failed venture. The finding of a taking absent physical

invasion of real property is rare, and the Court has re-

sisted extending the protection of the “right to exclude

48 It may be argued that this third factor is the most important,

or that it is most likely to be determinative. See. +.g., Nollan,

107 S.Ct. at 3145; Hodel v. Irving, 107 S.Ct. 2076, 2083 (1987);

Kaiser Aetna, 444 U.S. at 179-80; Loretto, 458 U.S. at 442 (Black-

mun, J., dissenting). It is here that the Court considers whether

the government has authorized a physical invasion or only imposed

regulation.

49 The causes of the reversal in fortune of the nuclear industry

have been well documented. They include the OPEC oil embargoes

and the ensuing conservation efforts, inflation, and the nuclear

disaster at Three Mile Island. See Brief for Appellants at 17;

Mississippi Power & Light Co. v. Mississippi ex rel. Moore, No.

86-1970 (June 24, 1988), slip op. 4 n.5; Jersey Central, 810 F.2d

at 1206 (Mikva, J., dissenting); Nuclear Plant Cancellations,

supra n.28, at 19-21, 26; Phillips, supra n.3, at 18; Pierce, supra

n.8, at 502-05.

30

others” beyond that context. Where the Court has found

a taking, it has been because of the destruction of a pro-

tected ownership interest (see, e.g., Hodel v. Irving, 107

S.Ct. 2076, 2083-84 (1987); Monsanto, 467 U.S. at 1010-

14), not justified by the police power. See Webb’s Fabu-

lous Pharmacies, 449 U.S. at 163-64. Here, appellants

have identified no protected property right; and the pub-

lie interest in price regulation is well settled. See, e.g.,

Pennell v. City of San Jose, 108 S.Ct. 849, 857-59 &

nn. 6,8 (1988).

Because appellants’ nuclear investment has been ren-

dered worthless, and the profitability of their business

diminished, they seek to recover for their mistake from

the government. But Pennsylvania did not destroy the

value of their investment, and the “loss of future

profits—unaccompanied by any physical property restric-

tion—provides a slender reed upon which to rest a tak-

ings claim.” Andrus v. Alleid, 444 U.S. at 66.

CONCLUSION

For the foregoing reasons, the judgment of the Su-

preme Court of Pennsylvania should be affirmed.

Respectfully submitted,

ROBERT L. BEZEK, JR. BENNA RUTH SOLOMON *

ANDERSON, BYRD & RICHESON Chief Counsel

Second & Main, P.O. Box 7 JOYCE HOLMES BENJAMIN

Ottawa, KS 66067 BEATE BLOCH

(9313) 242-1234 STATE AND LOCAL

BRIAN J, MOLINE LEGAL CENTER

712 S. Kansas Avenue 444 N. Capitol Street, N.W.

Suite 201 Suite 349

Topeka, KS 66603 Washington, D.C. 20001

(913) 354-8531 (202) 638-1445

Of Counsei * Counsel of Record for the

Amici Curiae

June 30, 1988