# Appendix — Hansen v. City of San Buenaventura

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## Record

- **Collection:** Supreme Court brief
- **Document type:** Appendix
- **Published:** January 1, 1987
- **Citation:** 484 U.S. 804

## Text

IN THE
SUPREME COURT OF THE UNITED STATES

October Term, 1986

MAGDALINE M. HANSEN, individually and on
behalf of all those similarly situated,

Appellants,
Vv.
THE CITY OF SAN BUENAVENTURA,

Appellee.

ON APPEAL FROM
THE SUPREME COURT OF CALIFORNIA

APPENDIX TO JURISDICTIONAL STATEMENT

HELENE STONE

STONE AND STONE

A Professional Law
Corporation

Suite 208 D

674 County Square Dr.

Ventura, California

93003

(805) 654-1144

Counsel for
Appellants

APPENDIX Appendix

Page:
Opinion, California Supreme
Goure, FAiGe BOG. 32, 19SEC. ccccrcese 548i
Concurring and
Dissenting Opinion..............52=-73

Order Denying Rehearing,
California Supreme Court,
Pil@G Feb. 3S, 19ST ccccccccccccccccect’h

Opinion Filed April 8, 1985

Court of Appeal

of California, 2d Appellate

DASEELSS, DEVEGION Ga ccccccesceecIS°178
Appendix to Opinion...........179=-221

Opinion on Denial of

Rehearing and Modification

of Opinion Filed

May 7, 1985, Court of Appeal

of California, 2d Appellate

D2GCEISS, DAVABGSOR 6occcsccccessdaa 230

Findings of Fact and Conclusions

of Law, Ventura

County Superior Court, Filed

a eee 231-333

Judgment of Ventura
County Superior Court, Filed
Aug. AZ, OO) ee ee eee Fe

(see next page)

«

Notice of Appeal to the
United States Supreme Court,
Filed March 23, 1987......... 337-338

Ordinances of the City of

San Buenaventura:
NO. L7IAT ccccccccccesccceses 3397340
NO. TE—{aG acc cccccccccccccs cc 3417343
NO. TVI—ST ccccccccccccscessse sc dhawahd

SUPREME COURT
FILED
DEC. 31, 1986
Laurence P. Gill, Clerk

IN THE SUPREME COURT OF THE STATE OF
CALIFORNIA

L.A. 32091
2 Civ.67886
(Super.Ct. No. 55769)

MAGDALINE M. HANSEN et al.,
Plaintiffs and Respondents,

v. [OPINION]

CITY OF SAN BUENAVENTURA,
Defendant and Appellant.

Defendant City of San
Buenaventura (hereafter referred to as
Ventura) owns and operates a water
company which serves customers who
reside both in and outside the city
boundaries. In 1972, Ventura enacted an
ordinance imposing a 70 percent
surcharge on water supplied to customers
living outside the city limits. Those
nonresident customers brought this class

1

action to challenge the surcharge,
seeking declaratory relief and damages
on the ground that the rates imposed
were unreasonable, arbitrary, and
discriminatory and that the rate
structure denied them equal protection.
Following a nine-day trial, the superior
court held the 70 percent surcharge was
reasonable and entered judgment for
Ventura. , The Court of Appeal reversed
and remanded for a new trial; Ventura

sought review in this court.

SEE CONCURRING & DISSENTING OPINION

We granted review to resolve the
important question of whether a
municipal utility may recover a
reasonable rate of return on its
investments and to clarify what
circumstances may be considered by a

court in determining whether a rate is

reasonable. We conclude that a

municipal utility is entitled to a
reasonable rate of return and, for
reasons we shall explain, we agree with
the trial court that the 70 percent
surcharge on water supplied nonresidents
in this case was justified.
Accordingly, we reverse the judgment of
the Court of Appeal.
I

The city of Ventura has owned and
operated its own municipal water system
since 1923 when it bought the facilities
of the public utility corporation that
had previously supplied water to the
city and surrounding areas. Ventura
financed the sale through a $250,000
general obligation bond issue. Between
1925 and 1960, the citizens of Ventura
authorized four additional general bond
issues to improve and modernize the
system. Totalling over $3.6 million,

these bond issues subjected all private

property in the city to a lien: if
funds were unavailable to pay the bonds,
the bondholders had the right to require
Ventura to levy taxes on all private
property to meet the bond indebtedness.
Throughout the years, the
citizens of Ventura demonstrated their
commitment to the system by allowing the
city to use its general fund monies to
help maintain and improve the system.
Ventura used its general fund monies 1)
to provide office space for water system
employees as well as for city employees
who rendered services for the water
system and 2) to pay a portion of the
Salaries of city employees who performed
accounting, billing, administrative, and
legal services for the water systen.
Additionally, Ventura made a number of
transfers from its general fund to the
water system at little or no interest.

Ventura also used power taxes in the

amount of nearly $300,000 to support the
water system in the 1971-1972 and 1976-
1977 fiscal years. These funds
represented transfers to the system from
tax payments made by residents only.
Additionally, Ventura required new in-

city customers to pay upfront connection

and acreage fees to obtain water
service. These contributions, which
were used to benefit the entire water

system, totalled over $600,000 from 1964

until trial, in 1978. No water system
revenues have ever gone to Ventura's
general fund; all water revenues,
acreage and connection fees, power tax
revenues, and contributions from the
city's general fund have been used to
operate and maintain Ventura's water
systen.

In 1966, Ventura purchased the

Mound Water Company (Mound), a small

mutual water company! serving custo»ers
outside the city. At the time of the
sale, Mound represented to Ventura that
the Mound shareholders, that is the
Mound customers, had approved the
transaction. Thus, the sale was truly
consensual in that the very customers
who were to receive water from Ventura
ratified the purchase.

Pursuant to the terms of the
purchase agreement, Ventura agreed to
furnish water "to those customers
heretofore served by Mound who may
desire such service at the regularly
established rates for water service from
the Ventura Water System." However,

nothing in the sale agreement precluded

lpublic Utilities Code section 2725
defines a mutual water company as "any
private corporation or association
organized for the purposes of delivering
water to its stockholders and members at
cost, including use of works for
conserving, treating and reclaiming
water."

Ventura from continuing to apply
reasonable rate differentials between
residents and nonresidents as it had
done for years. 2 The purchase agreement
only assured that Ventura would continue
to provide service at regularly
established rates to customers served by
Mound at the time of the sale.

The water that Mound had supplied
its users prior to the sale came from
wells of poor quality which were below
public health standards. On
acquisition, Ventura abandoned the
polluted wells and commenced supplying

the former Mound customers with water of

2ventura has maintained a
differential in water rate schedules for
over 50 years, with out-of-city
customers required to pay higher rates
than in-city customers. Between 1935-
1952 the average surcharge was 48
percent, while between 1953 and 1972
that figure dropped to 32 percent.
Pursuant to the ordinance enacted in
July 1972 and continuing until the
present, the surcharge imposed on out-
of-city customers has been 70 percent.

7

substantially better quality. It is
undisputed that the sale of Mound to
Ventura immediately and significantly
improved the quality, availability, and
overall source of supply and service to
the customers previously served by
Mound, customers who all live outside
the city boundaries and are presently
subject to the disputed surcharge.

In 1969, Ventura acquired a second
water company, the Saticoy Water Company
(Saticoy). Saticoy was an investor-
owned public utility, 60 percent of
whose customers were residents of
Ventura, 40 percent nonresidents.
Because of the nature of the ownership
of the utility, the Saticoy customers
were not given an opportunity to approve
the sale. However, they were given the
chance to participate in an election to
approve or disapprove the purchase of

Saticoy by Ventura. Close to 90 percent

of those customers who voted registered
approval. In addition, customers also
had the opportunity to appear before the
Public Utilities Commission (hereafter
referred to as P.U.C.), but it appears
no protests were in fact received.

Under the terms of the agreement,
Ventura was bound for 60 days to
maintain the rates charged by Saticoy
prior to the sale; however, following
the 60-day period, Ventura had the right
to alter the preexisting rates. The
sale contract further provided:
"“(Ventura] agrees that from and after
the closing date it wit serve water
without unfair or unreasonable
discrimination to all customers in the
area wherein [it]} is certified to
provide service by the California Public
Utilities Commission whether such
customers are located within or without

the territorial boundaries of the city

and will continue to serve all of such
customers." Nothing in the sale
agreement, however, specifically
precluded Ventura from applying
reasonable rate differentials between
residents and nonresidents.

Saticoy customers benefited
immediately and substantially from the
sale. Instead of continuing to rely on
four small storage tanks, they suddenly
had available over fifty million gallons
of storage capacity from a vast network
of tanks and reservoirs tied into
Ventura's system. Further, the two wells
formerly owned by Saticoy fell short of
state health standards with respect to
water quality. Ventura abandoned one
well immediately and placed the other on
standby status, to be used only in event
of emergency.

The improvements to both the former

Mound and Saticoy customers were not

10

without cost. By 1969, Ventura was
serving approximately 2,800 out-of-city
water users, the vast majority of whom
were added in conjunction with the Mound
and Saticoy acquisitions. Because
Ventura did not have sufficient surplus
water of its own and because it did not
acquire any surplus water as a result of
these acquisitions, Ventura was obliged
to purchase additional water. The cost
of the additional water purchased from
the Casitas Municipal Water District
(Casitas) and others was substantially
greater than the cost of Ventura-owned

water sources. In addition to

2water purchased in 1970 by
Ventura from Casitas cost $44 an acre
foot and from Alta Mutual $35 an acre
foot. At the time of the 1978 trial
date, these prices had jumped to $61 and
$56 respectively, vis-a-vis, the $20-$25
price of well water for Ventura. The
cost of Ventura river water, obtained by
Ventura from its Foster Park facility,
is minimal. By virtue of having its own
water sources, Ventura saves
approximately $30-$40 per acre foot of
water that it does not have to purchase.

11

purchasing additional water to
accommodate the needs of its additional
customers, Ventura was forced to expand
and improve its facilities. Partly
because the facilities purchasec from
Mound and Saticoy were inadequate to
meet the needs of customers previously
served by these two water companies,
Ventura undertook major improvements to
improve and expand its own facilities.?
In 1970, Ventura acquired by
assignment a contract for 10,000 acre
feet of water annually from the State.

Water Project. Under the contract,

As the cost of alternative sources of
water has increased, the water rights of
Ventura have become more valuable.

These water rights were conservatively
set at $5 million in 1978.

3some of the major improvements
made during the 1970's to the Ventura
Water System which benefitted plaintiffs
include the construction of 6.5 million
gallons of additional storage, an 8-mile
transmission main, and a pump station.
In part, these and other improvements
were financed by revenue bond issues
totalling $6.5 million.

12

—— rt‘ ‘lt!

Ventura obliged itself to make payments
for the next 65 years estimated at $58
million. Althcugh Ventura had yet to
receive any state water at the time of
trial, it had made the required annual
payments for capital and fixed operating
and maintenance costs. Not only must
Ventura make payments irrespective of

whether it receives water, but the

contract provides that it must levy
taxes if revenues should be insufficient
to meet these payments. This tax lien
obviously falls only on property owners
in Ventura; as a class, nonresident
water users do not share the risk of
this obligation. Another burden not
shared by out-of-city users was
Ventura's obligation to construct the
necessary transmission facilities to
bring water from the state system, an
estimated cost at time of trial

exceeding $50 million.

13

‘een inne eer

Because of the impact caused by the
acquisition of the two water companies,
in 1970 Ventura retained the consulting
firm of Wilsey & Ham to analyze the
water rates. The firm initially
recommended and Ventura adopted a 20
percent overall rate increase. At some
later point, after obtaining updated
figures and doing further careful and
lengthy analysis, the firm
recommended: 1) another 10 percent
overall rate increase and 2) the _
imposition of the 70 percent surcharge
on outside customers. It also
recommended a rate scheme recognizing
three separate classes of customers:
1) residents using treated, potable
water; 2) nonresidents using treated,
potable water; and 3) industrial users
of untreated, nonpotable water. All

industrial users of untreated water also

happened to be nonresidents. Ventura

14

‘

subsequently enacted an ordinance
adopting these recommendations. That
ordinance, along with subsequent
ordinances enacted in 1975 and 1977,

constitute the subject of this

litigation.

After the action below was filed but
before trial, Ventura engaged a second
consulting firm to examine its rate
structure.* That firm, Brown &
Caldwell, concluded that the rates were
more than reasonable and, in fact, an
even greater differential covld have

been justified.

4at trial, plaintiffs' attorney
suggested that the study begun by Brown
& Caldwell in 1976 was irrelevant
because the 70 percent surcharge was
originally imposed in 1972. The lower
court overruled the objection, agreeing
with Ventura that if the study could
provide a reasonable basis for the
rates, there could be no complaint with
the city council's action in enacting
the ordinance. In other words, even if
Ventura arrived at reasonable rates
based on the wrong reasons, the rates
would nonetheless be lawful.

15

en a

The trial court concluded the rate
structure was reasonable. The Court of
Appeal reversed and remanded for a new
trial, holding that as a matter of law a
municipality is not entitled to a return
on investment and that Ventura erred in
calculating the amount of surcharge to

nonresidents.

II

A city which acquires the water
system of another community incurs an
obligation to deal fairly with its
customers in that community and to
provide them with service at reasonable
rates. (County of Inyo v. Public
Utilities Commission (1980) 26 Cal.3d
154, 159.) Rates established
by the lawful rate-fixing body are
presumed reasonable, fair and lawful.
(Elliott v. City of Pacific Grove (1975)

54 Aal.App.3d 53, 59; Durant v. City of

16

Beverly Hills (1940) 39 Cal.App.2d 133,
139.) Thus, plaintiffs bear the burden
of showing that the rates fixed are
unreasonable or unfair. (Elliott,

supra, 54 Cal.App.3d at p. 60.)

A showing that rates lack uniformity
is by itself insufficient to establish
that they are unreasonable and hence
unlawful. To be objectionable,
discrimination must "draw an unfair line
or strike an unfair balance between
those in like circumstances having equal
rights and privileges. ... ‘It is
only unjust or unreasonable
discrimination which renders a rate or
charge unreasonable' ... ." (Durant,
supra, 39 Cal.App.2d at pp. 138-139.)
Unreasonableness will be shown where the
discrimination rests solely on the
nonresident status of the user. (Inyo,
supra, 26 Cal.3d at p. 159, fn. 4.)

Reasonableness,then, is the

17

beginning and end of the judicial
inquiry.> Clearly, the fact that
nonresident users of public utility
service are subject to a higher rate
than those customers residing within
city limits does not alone prove the
rate unreasonable and hence invalid.
Rather, nonresidents must show that the

discrimination is not based on "cost of

service or some other reasonable basis."
(Inyo, supra, 26 Cal.3d at p. 159, fn.

4, italics added; see Durant, supra, 39
Cal.App.2d at p. 139.)

To determine whether the rates
Ventura imposed on nonresident customers

were reasonable, Brown & Caldwell

°As the court stated in Kennedy v.
City of Ukiah (1977) 69 Cal.App.3d 545:
"Municipal corporations have the
authority and power to establish and
operate works for supplying their
inhabitants with water. They also have
the power to fix the rates to be charged
for the sale of the water. (Citations. )
The only requirement is that such rates
be reasonable. (Citations.)" (Id., at
p. 552.)

18

compared revenue requirements
(expenses,costs) properly allocable to
nonresident customers with the actual
revenues received from that group. To
ascertain the first element, it
conducted a cost-of-service analysis.

According to evidence, the cost-of-

service analysis calculates the share
each customer should pay for utility
service proportional to actual use of
the system. Revenue requirements are
allocated to various classes based on

each group's proportionate use of the

system, including use of physical plant
facilities and consumption of water,
among other elements. A preliminary
step in determining revenue requirements
is the establishment of appropriate
Classes among which costs will be
allocated. The next step is to
calculate the costs which properly

should be assessed each group. For this

19

analysis, two alternative methods exist:
the cash basis and the utility basis.
Very generally, the cash method sets
revenue requirements based on actual
operating and maintenance expenses plus
allowable charges for system
replacement, debt principal repayment,
and other capital costs. The utility
method also considers actual operating
and maintenance expenses, but instead of
looking to cash expenses such as system
replacement and debt principal
repayment, the method focuses on
depreciation attributable to outside use
and on rte of return on investment.

The utility-method is commonly used
to establish revenue requirements where
a class of customers owned the utility
and another class uses the facilities
owned by the others. It is nationally
recommended by the American Water Works

Association for determining water rates

20

of municipal customers located outside a

city. Brcwn & Caldwell used the utility

method to determine revenue
requirements. Significantly, the rate
of return it employed was much lower
than that granted a number of companies
regulated by the California P.U.C.
Based on its analysis, it found a
surcharge of 98.5 percent was justified.
Nonetheless, Ventura continued
to impose the 70 percent surcharge it
had established in 1972.

As noted, the utility method focuses
on depreciation and rate of return on

investment.© Depreciation is

6In its opening brief, Ventura
argued that a rate of return or return
on investment is not a profit. However,
in its subsequent answer to plaintiffs’
opening brief, Ventura apparently
retracted this argument and acknowledged
that "[sjome cases have referred to
[return on investment], acceptably, as
'‘prorit. '" ln any event, the trial
court found on rehearing that a return
on investment is a profit: "We are not
impressed by counsel's attempt to
distinguish between a rate of return and

21

‘

typically defined as a recovery of cost
over the life of the facility as it is
used; it does not provide for the
replacement of the facility.’ Partly
for this reason, a rate of return is
allowed.

In the context of the utility
method, return on investment allows a
municipal utility to raise necessary
replacement funds and to pay debt on the
system. It also allows the municipality
to be compensated for having invested
its money and incurred the risks
associated with building and maintaining
a water system. Moreover, it compensates

the municipal utility for foregoing the

a profit. The terms are synonymous.
(Citations.)"

’The project manager of Brown &
Caldwell testified that the consultants
considered depreciation on an original
cost basis, as is proper, rather than on
the projected replacement cost of new
facilities.

22

opportunity to use its money in some
other manner. Rate of return is, in
essence, payment for the use of property
of another.

Municipal utilities have
historically incorporated a return on
investment on rates charged customers. ®
Certainly, the existence of a practice
is not dispositive of its iegitimacy,
but while no case squarely establishes
the proposition that municipal utilities
may recover a return on investment

through rates charged to nonresidents,

Saccording to the August 1911 issue
of Pacific Municipalities, the official
monthly publication of the League of
California Municipalities, the return on
Pasadena's municipal light and power
plant was between 9 and 11 percent on
total investment; Sacramento's water
system yielded an annual net return of
approximately $100,000; and Los Angeles
derived sufficient revenue in its first
nine years of operation to rebuild the
inadequate system it had acquired, to
address the demands of growth, to meet
the interest and sinking fund
requirements of the water bonds, and
still "to leave the city a profit" of
about $125,000.

23

case law does suggest such a practice is
permissible. Moreover, common sense and
basic economic principles dictate the
necessity of such a rule.

California cases indicate that
utility rates need not be based purely
on costs. In Golden Gate Bridge &
Highway Dist. v. Luehring (1970) 4
Cal.App.3d 204, the court stated that
"the (California) Constitution does not
inhibit an entity of local government
from collecting fees for services it
performs and using the net proceeds of
enterprises such as municipal utility
systems for the benefit of its own
general fund." (Id., at p. 215, italics
added.) In Beard v. City and County of
San Francisco (1947) 79 Cal.App.2d 753,
the Court of Appeal noted "parks,
playgrounds, public utilities, and
other facilities in aid of health and

welfare of the community ... . may be

24

operated for profit." (Id., at p. 755,
italics added.) Finally, acccerding to

Dyke Water Co. (1963) 61 Cal. P.U.C.
315, “it is for the local governing body
to determine precise rates and whether
the system should be subsidized or
profitable." (Id., at p. 321, emphasis
added.) Plaintiffs' contention that
Ventura must provide service to
nonresident customers at "cost" without
an opportunity to recover a reasonable
rate of return is incorrect.

Plaintiffs urge that a rule
requiring municipal utilities to provide
service to nonresident customers at cost
is necessary to protect the interest of
out-of-city users. Whereas consumers of
services provided by private utilities
are protected by the P.U.C., plaintiffs
would have us believe nonresident users
of municipal utilities are left to the

mercy of the municipality. Although

25

judicial review of rates is not
comparable to regulation by the P.U.C.,
it does "protect consumers against
plainly unfair rates... ." (Inyo,
supra, 26 Cal.3d at pp. 159-160.)
Significantly, the present case appears
to be only the second municipal utility
rate case in California history. The
paucity of such litigation suggests that
existing law functions sufficiently.
wever, even if existing law is
inappropriate or inadequate, it would
seem to be the Legislature's role to
revise it. Despite our statement that
there is no constitutional barrier to
bringing municipal utilities within
P.U.C. jurisdiction (Inyo, supra, 26
Cal.3d at pp. 163-167) the Legislature
has to date declined to modify the
existing system.

The rule sought by plaintiffs would

have a negative impact on the expansion

26

of California municipal utilities.
Without the opportunity to obtain
revenue necessary for system replacement
and expansion, there would be little
incentive for municipal utilities to
expand in order to service nonresident
users. Moreover, without a chance to
recover a reasonable rate of return, a
municipal utility would be foolish to
increase its business risk by expanding
service to nonresidents without
demanding a commensurate increase in
“return.
S52

The trial court in the instant case
concluded an 8.67 percent rate of return
charged nonresidents was reasonable vis-
a-vis the 3.0 percent return charged
residents. We agree. A higher rate of
return for nonresidents is justified
because (1) the in-city customers (as

residents of Ventura) incurred

27

substantial risks and obligations not
shared by out-of-city users and (2) in-
city sources of revenue both directly
and indirectly financed the system in
ways that out-of-city revenues did not.
More specifically, only property of
residents was subject to the general
obligation and the State Water Project
liens, and only Ventura and its
taxpayers bore the responsibility for
management of the system, for repairs
and replacement in event of disaster,
and for construction of the transmission
system to bring state water to the city.
As for a difference in sources of
revenue, residents paid taxes that
contributed to the system, while
nonresidents did not, and only resident
customers had to pay connection fees.
Moreover, Ventura's city government
provided support and stability for the

water system over the years: general

28

monies of Ventura were used to provide
office space and to pay salaries of the
city employees who performed accounting,
billing, administrative, and legal
services for the water system; Ventura
made a number of transfers from its
general fund to the water fund at either
little or no interest; and only Ventura
and its taxpayers bore the
responsibility fo. (1) management of the
system, (2) repairs and replacement, and
(3) construction of the transmission
system to bring state water to the city.
Plaintiffs contend that any contribution
made from Ventura's general fund should
be disregarded because it was a source
of revenue from the city government and
not the city ratepayers. But, the use
of city funds cannot be disassociated
from its citizens. When a city uses its
funds to support the water system, out-

of-city customers can fairly be expected

29

to pay higher rates. (See Dyke. supra,
61 Cal. P.U.C. at p. 321.) Second,
evidence showed some of the general fund
originated from taxes, and all in-city
ratepayers are also taxpayers. Thirc,
the evidence is plain that the citizens
themselves bear certain significant
risks. Unlike those living outside the
city, residents are uniquely responsible
for the general obligation bonds that
built and improved the system, for the
reason that Ventura must levy taxes on
private property within the city
boundaries if revenue is insufficient to
meet that requirement. For the same
reason, residents bear the risk of
Ventura's long-term contractual
commitment with the state to pay an
estimated $58 million for water from the

State Water Project. ?

9Plaintiffs contend that the issue
of property tax liens arising from
‘Ventura's general obligation bonds and

30

In its 57 pages of findings of fact
and conclusions of law, the trial court
implicitly found thar a difference of
rate of return was justified. It also
specifically found that the rates
charged nonresident customers were fair
and reasonable and were commensurate
with the cost of service provided for
the following reasons: the costs of
providing services to nonresidents were
greater, in part because Ventura had to
purchase more expensive water to supply
the former Mound and Saticoy customers;
these same nonresident customers used up

surplus capacity, which had been

its State Water Project contract is an
obligation of city property owners, but
not on in-city residents. Obviously,
many in-city ratepayers are city
property owners and hence property
taxpayers. As for those in-city
ratepayers who do not own their homes,
it is reasonable to assume that they
will bear some of the burden of an extra
property tax in the form of higher
rents.

31

previously provided by Ventura, without
making any capital contributions;
Ventura substantially improved the water
service to the former Mound and Saticoy
customers and such service fully
justified the rates charged; the
nonresidents have not made and do not
make the same financial contributions to
the maintenance of the water system as
do residents; only residents are charged
acreage and connection fees, which raise
funds for the water system; nonresidents
do not have the same obligations and
responsibilities for the replacement and
repair of the system in the event of
disaster or to provide for the expansion
to meet population growth; Ventura
continues to use its general fund and
its credit to support its water system;
nonresidents, having foregone nothing
and shared in no risk in building up the

plant, cannot expect to share in the

32

a

benefits accruing from city ownership; a
municipality is entitled to recover the
cost of fire protection from
nonresidents, standby water demand being
greater by the addition of outside
areas; and a municipality is entitled to
earn a return on its plant and
facilities devoted to nonresident users.
Contrary to the Court of Appeal, we
agree that most of these justifications
are appropriate.

Miscellaneous Benefits

There is no question that after
acquisition the former Mound and Saticoy
customers immediately received
substantial benefits such as improved
water quality, increased water storage,
upgraded fire protection due to
Ventura's pumping stations, and major
transmission lines. These improvements
used up both reserve and growth capacity

in facilities previously provided at the

33

OO

expense of in-city customers.?° If
Ventura had not charged nonresident
users a higher rate of return than it
charged its own residents, then in-city
ratepayers would be subsidizing out-of-
city ratepayers for the latter group's
proportionate share of these expenses.

Plaintiffs argue that it was improper
to pass on the additional cost of
purchasing more expensive water directly
to nonresidents. They vehemently insist
that whatever new water supplies

benefited nonresidents who were former

l0plaintiffs argue that residents
alone did not pay for the facilities.
They argue that all operating expenses,
bond obligations, and State Water
Project contract payments have always
been paid solely from revenues of both
resident and nonresident ratepayers.
However, plaintiffs fail to realize that
the vast majority of nonresident
consumers did not spring into being
until 1966 and 1969 #hen Ventura
purchased the Mound and Saticoy
companies. For some 45 years prior,
only a handful of nonresidents had
contributed to the acquisition,
maintenance, and improvement of the
water systen.

34

Mound and Saticoy customers also
benefited residents who were former
Saticoy customers. This is true, but
plaintiffs fail to mention that the
cost allocated to nonresidents covered
only the cost required to supply then.
Nonresidents were not charged with the
cost of supplying new expensive water to
resident customers. These additional
costs of in-city users were shared by
all members of that class.

Plaintiffs also make much of the
fact that a large portion of nonresident
users are technically ineligible to
receive Casitas water because they live
outside the Casitas water district.

This argument seems irrelevant.
Irrespective of whether nonresidents
actually received molecules of water
piped from Casitas or molecules of other
water, Ventura had to purchase the more

expensive Casitas water to provide

35

————————————EEEEEEEEEEEEEEEe

service to these new nonresident
customers.

We conclude it was proper for the
trial court to justify a surcharge based
on this theory. (See Beaumont Investors
v. Beaumont-Cherry Valley Water Dist.
(1985) 165 Cal.App.3d. 227, 232, fn.
4.)

Rate Base

Plaintiffs argue that Ventura should
have excluded from rate baselt any
facilities donated by developers or
financed through connection and acreage
fees. Ventura contends that such a
conclusion would leave it without
depreciation funds sufficient to replace

its entire system. According to

llpate base is the value of the
property on which the utility is
entitled to a return. "The rate base on
which a return may be earned is the
amount of property used and useful, at
the time of the rate inquiry, in
rendering a designated utility service."
(1 Priest, Principles of Public Utility
Regulation (1969) p. 139.)

36

plaintiffs, however, it would be

inequitable to allow Ventura to earn a
return on property provided by
customers themselves.

Contrary to plaintiffs' contention,
in this context we see nothing
inequitable in including in the rate
base assets that have been paid for by
past ratepayers. Unlike Pacific Tel. &
Tel. v. Public Util. Com. (1965) 62
Cal.2d 634, 663-665, relied on by the
dissent, in this case the inclusion of
such assets does not result in a double
payment by past ratepayers, but rather |
simply permits the past ratepayers to
be, in effect, credited for their past
contributions to capital. If the
municipal utility's proposed profit is
to be accurately evaluated pursuant to
the "utility method," such assets are
properly included in the rate base.

The Court of Appeal also disapproved

37

the inclusion of the increased value of
water rights. ln fact, Brown # Caldwell
did not employ this capitalization

figure, but used the_1940 book value of

$1,215,000. Accordingly, we do not have
to decide whether a higher figure would
have been appropriate.

The court mistakenly states that
Brown & Caldwell viewed the amounts owed
under the state contract as an asset
instead of a liability. On the
contrary, the project manager testified
the firm's study treated the item as
debt and did not allocate any of the
principal amounts due under the contract
to nonresident users.

Finally, the court noted that Ventura
could not impose an in lieu tax on
nonresidents. However, as the court
also noted, "(t)here—is nothing in the
record indicating that the city ever

attempted to officially impose such a

38

tax."
__The Three-Tier Classification Scheme

It is well established that "'a
utility may, without being guilty of
unlawful discrimination, classify its
customers or patrons upon any reasonable
basis .... '" (Durant, supra, 39
Cal.App.2d at p. 139; see Toward
Utility Rate Normalization v. Public
Utilities Commission (1978) 22 Cal.3d
529, 543-544; Kennedy v. City of Ukiah
(1977) 69 Cal.App.3d 545, 553-554.) The
trial court found Ventura's three-tier
classification scheme to be fair and
reasonable. Plaintiffs, however,
objected to Ventura's three-tier
classification scheme based on what it
perceived to be a feigned distinction in
treating users of nonpotable, untreated
water as a separate class.

Plaintiffs make much of the fact that

the first consulting firm Ventura hired

39

initially recommended a surcharge of
38.8 percent based on a two-tier
classification: out-of-city water users
(both industrial and domestic) and in-
city users. Later, after reanalyzing |
and updating the data, the firm
concluded a three-tier classification
scheme was more appropriate and
subsequently found a 70 percent
surcharge more accurate. It is
difficult to imagine a more
natural or obvious classification.
The cost of supplying treated water
is indisputably very different than the
cost of untreated water. The
classification seems patently
reasonable.
IV

Plaintiffs argue that as a matter of
law the 70 percent surcharge violates
Government Code section 54514, which

requires the local agency to provide

40

water "at the lowest possible cost
consistent with sound economy, and
prudent management, and the security and
payment of the principal and interest of
the bonds." (Gov. Code, # 54514.)
Although section 54514 does require that
the agency furnish water "at the lowest
possible cost," such language is hedged
by references to "sound economy, "
"prudent management," and interest to
bondholders. These references clearly
give a local agency considerable
discretion in balancing its own
financial concerns against the
requirement of low rates. Moreover,
prudent management and sound business
judgment would seem to mandate some sort
of return on investment. First of all,
a municipal utility would be foolish to
increase its business risk by expanding
service to nonresidents without getting

some type of return commensurate with

41

the increased risk. Second, a city that
spends its funds to provide service to
nonresidents and only recovers the cost
of those funds is investing its money
poorly. Instead of getting zero return
by investing those funds in its own
water system for the benefit of
nonresidents, the city should invest
elsewhere and get even a minimum return.
‘Thus, "lowest possible cost" cannot be
read to mean "break-even cost"; rather,
it would seem only to bar unreasonable
or excess profits. It is not for the
court to determine what constitutes
sound economy and prudent management,
but only to determine the narrow issue
of whether the rates imposed are
reasonable. (See County of Inyo v.
Public Utilities Commission, supra, 26
Cal.3d 154; Durant v. City of Beverly
Hills, supra, 39 Cal.App.2d 133; see

also, American Microsystems, Inc. v.

42

City of Santa Clara (1982) 137
Cal.App.3d 1037.)12

Plaintiffs also argue Ventura

12tn American Microsystems, Inc. v.
City of Santa Clara, supra, 137
Cal.App.3d 1037, ratepayers of a
municipal power utility owned and
operated by Santa Clara sought to compel
that city to pass on to consumers
certain savings in the cost of
purchasing electrical power. The Court
of Appeal rejected this argument, in
spite of a provision in the utility's
contract with the federal supplier of
power that benefits be "made available
at fair and reasonable terms to all of
its consumers at the lowest possible
rates consistent with sound business

principles." (Id., at p. 1043, emphasis
in original.) The court noted that

unlike privately owned utilities which
are regulated by the P.U.C., publicly
owned municipal utilities are under no
mandate to pass on to ratepayers any
savings realized in the cost of service.
Rather, the public entity is entitled to
fix its utility rates pursuant to its
legislative power, and courts will
intrude only when rates are shown to be
unreasonable or unfair: "it is not the
function of the courts to evaluate the
wisdom of the City's rate-fixing
decisions. In that context, we cannot
determine what constituted 'sound
business practices,' but may only
consider that narrower leqal question
whether the rates- were unreasonable or
arbitrarily established. " (Id., at p.
1044.)

43

violated its obligations as a trustee.
When a city acquires the water system of
another community, as to the water
dedicated to the use of the outside
community, the acquiring city holds
"title as a mere trustee, bound to apply
it to the use of those beneficially
interested." (City of South Pasadena v.
Pasadena Land and Water Co. (1908) 152
Cal. 579, 594.) After the acquisition,
the city is "under the same obligation
as its grantor to continue the service
and supply the water to all persons who
may become entitled to it in the future
- - « -" (Id. at p. 593, emphasis
added.) 13

It is clear that the trustee city

13tt is because of the trust
relationship that consumers can "sue to
enjoin rates which are themselves
‘unreasonable, unfair, or fraudulently
or arbitrarily established' [citation],
or which discriminate without a
reasonable and proper basis [citation]."
(See Inyo, supra, 26 Cal.3d at p. 159.)

a4

must continue to supply water, but there
is no support for the proposition’ that a
city must supply water at cost. In
fact, Durant made quite clear that an
acquiring city's trust obligation does
not require furnishing water at cost but
only at a reasonable rate: "When the
city purchased the private plant it
assumed a trust to perform the contract
and meet the obligations of the private

concern. . . . The obligation which the

city assumed through the purchase of the
system was an obligation to continue to
serve plaintiff water at a reasonable
rate." (Durant, 39 Cal.App.2d at p.
138, emphasis in original.)
V

Plaintiffs argue that it is a denial
of equal protection for nonresident
ratepayers to be separately classified
and required to pay a 70 percent

surcharge over rates paid by resident

45

taxpayers. They argue the surcharge is
based solely on the nonresident status
of the out-of-city customers, and that
the only distinguishing factor between
those who pay the surcharge and those
who do not is an artificial political
boundary line.

First, plaintiffs argue the
nonresidents are a suspect class and
therefore that we should apply the
strict scrutiny test. They reason that
the rationale behind the application of
the “suspect class" doctrine is the
political powerlessness of such groups.
Because out-of-city users have no right
to vote for or against city council
members who set the water rates, they
contend they are politically powerless
and accordingly that the rationale of
the suspect class doctrine militates

towards its application in this case.

We have categorized only a few

46

Classifications as suspect, namely
Classifications involving race,
alienate, or national origin. We
decline to extend the suspect class
analysis here. The plaintiffs are no
more powerless as customers of Ventura
than they were as Mound and Saticoy
customers. Although they cannot vote in
Ventura elections, they can exert
political influence in alternate ways:
through lolsbying, petitions, testimony
at hearings, for example. Asa
practical matter, most utility rate
decisions turn on rate hearings, and in
fact, plaintiffs were represented by a
member of the county board of
supervisors at the very hearing in
question. Moreover, despite plaintiffs’
contention that Ventura forced them into
its water system, this is not the case.
As members of a mutual water company,

former Mound customers were the same

47

shareholders who approved the sale to
Ventura. The Saticoy transaction was
approved by the P.U.C., and there is no
evidence that a single protest was
received.

Plaintiffs next argue that even if we
apply the traditional rational-
relationship test, they should prevail.
We agree that this is the correct
standard to use, but conclude that
plaintiffs' argument is without merit.
When social or economic regulations are
involved, the rational-basis test
applies. In such cases, "statutory
discrimination wiil not be set aside if
any state of facts reasonably may be
conceived to justify it." (Dandridge v.
Williams (1970) 397 U.S. 471, 485
(quoting McGowan v. Maryland (1961) 366
U.S. 420, 426).) The reasonableness
test applied to municipal utility rates

is somewhat more stringent than the bare

48

rational-basis test. Ventura has met
the reasonableness standard; a fortiori,
it passes the rational-relationship
test.
VI CONCLUSION

We agree with the trial court that
the rates imposed on nonresidents by
Ventura are reasonable despite the fact
that both nonresidents and residents
received water from the same source and
with the same quality of treatment.
Moreover, the factors used by the trial
court in resolving the issue of
reasonableness are permissible criteria.
ln administering a public utility, such
as a water system, a city acts in its
proprietary capacity. (South Pasadena,
supra, 152 Cal. at p. 593.) When a
municipal utility acquires the private
water system of another community, the
resident customers should not be forced

to bear any of the costs of providing

49

SSC

service to nonresidents. It is
appropriate to pass on to the
nonresident customers any extra cost the
city has had to incur by way of
expanding or modernizing facilities, in
purchasing additional water, in
increasing its business, or other
similar costs. Moreover, it does not
have to share the benefits for which it
has already paid if such sharing is at
the expense of residents. However, all
these costs must be passed on at a
proportional basis. For example, the
nonresidents cannot be made to bear the
cost of expansion or modernization
properly attributable to in-city users.
The court is not required to
determine all costs nor to balance them
precisely against rates. Rather, it is
the court's role to decide only whether
a reasonable basis exists for charging

different rates and whether the rates

50

themselves are reasonable. In the

present case, we conclude the Court of
Appeal erred in remanding the cause.
Accordingly, the judgment of the

appellate court is reversed.

GRODIN, J.

WE CONCUR:

MOSK, J

REYNOSO, J.

LUCAS, J.

PANELLI, J.

51

CONCURRING AND DISSENTING OPINION BY
BROUSSARO, Js

I agree with the majority, insofar as
they conclude that the City of San
Buenaventura is entitled to be
compensated for services, facilities or
capital which it contributes to the
municipal utility and the ratepayers and
that in lieu of such compensation the
city ratepayers may be charged a lower
rate than the noncity ratepayers.
However, I cannot agree that the city is
entitled to be compensated through
discriminatory rates for claimed capital
improvements and additions which were in
fact financed by the ratepayers both
within and without the city or obtained
by donations to the water systen.

In 1923 the city purchased a water

52

system from Southern California Edison

and commenced to provide water to the
city and out-of-city consumers. The
purchase was financed by general
obligation bonds. Although the
bondholders had the right to require the
city to levy taxes to pay for the bonds,
it was contemplated that the bonds and
the interest on them would be paid by
water revenues. Over the years the city
has issued similar bonds to purchase
additional water systems and to obtain
additional facilities. All payments of
principal and interest on the bonds have
been made from water revenues. An
advance made by the city to the water
company was repaid with interest, and so
far as appears, city capital
contributions have been negligible.

In 1935, the city established a
surcharge on out-of-city customers

requiring them to pay higher rates than

53

the in-city customers. From 1935 to
1952, the surcharge averaged 48 percent;
between 1953 and 1972 the surcharge was
32 percent. In 1972, the city imposed a
70 percent surcharge. The instant case
involves the validity of the latter
surcharge. ,

Over the years the water system has
been greatly expanded and improved, and
the value of the property devoted to the
system including water rights and
facilities has increased greatly. The
main issue presented is whether the
surcharge, or most of it, may be
justified on the theory that the city is
entitled to a rate of return based on
the value of the property in the system.
In County of Inyo v. Public Utilities
Com. (1980) 26 Cal.3d 154, we
considered the relationship between a
city water department and out-of-city

users. The Los Angeles Department of

54

Water and Power served consumers in the
County of Inyo, and the county
argued that the Public Utilities
Commission should regulate the rates
because it was established to protect
people from the consequences of monopoly
in the public services industry and
that, while city residents may exert
political power over the rates, outside
residents have no voice as voters or
taxpayers, leaving them at the mercy of
the city. (26 Cal.3d at pp. 158-159.)
The court held that, although the
Legislature could authorize the Public
Utilities Commission to regulate water
rates charged by a city to noncity
consumers, it had not done so.

In response to the county's argument
that the consumers had no control over
the rates charged, the court stated:
"(A] city which acquires the water

system of another community incurs an

55

obligation to deal fairly with its
customers in that community and to
provide them with reasonable service at
reasonable rates. (See South Pasadena
v. Pasadena Land, etc. Co. (1908) 152
Cal. 579, 587-588, 594 [93 P. 490].)
Such an acquiring city, as to the water
dedicated to the use of the outside
community, holds 'title as a mere
trustee, bound to apply it to the use of
those beneficially interested.' (ld.,
at p. 594; see Durant v. City of Beverly
Hills, supra, 39 Cal.App.2d 133, 138.)
Consequently, the county can sue to
enjoin rates which are themselves
‘unreasonable, unfair, or fraudulently
or arbitrarily established' (Durant v.
City of Beverly Hills, supra, 39
Cal.App.2d 133, 139), or which
discriminate without a reasonable and
proper basis (Elliott v. City of Pacific

Grove, supra, 54 Cal.App.3d 53, 59). 4"

56

Footnote 4 states: "A showing that

rates are discriminatory is in itself
insufficient to fulfill the
complainant's burden of proof (see
Durant v. City of Beverly Hills, supra,
39 Cal.App.2d 133, 138); a showing,
however, that such discrimination rests
solely on the nonresident status of the
customer, and not on the cost of service
or some other reasonable basis, will
prove the rate invalid (see Elliott v.
City of Pacific Grove, supra, 54
Cal.App.3d 53, 59)." (26 Cal.3d at p.
159.) |

When new users come into a municipal
utility system, the city may properly
charge connection fees or other charges
to defray the cost of the facilities
needed to serve the new sers. (E.g.,
Associated Homebuilders v. City of
Livermore (1961) 56 Cal.2d 847, 851 et

seq.; Beaumont Investors v. Beaumont-

57

Cherry Valley Water Dist. (1985) 165
Cal.App.3d 227, 233.) However, Coun of
Inyo, supra. 26 Cal.3d 154 makes clear
that once a municipality chooses to
dedicate its water service to consumers
outside the city, it becomes a trustee
bound to use the system for all of those
beneficially interested, and any
discrimination between consumers must be
based on the cost of service or other
reasonable basis. The lack of political
power of out-of-city residents may not
furnish a basis for discrimination but
requires the city to act reasonably in
setting their rates. They are not
second-class consumers but entitled to
the same rights as other ratepayers.
Accordingly, we must determine
whether the record shows that the
discriminatory rates are based solely on
the nonresident status of the consumers

and not on the cost of service or some

58

ees st — |

other reasonable basis. It is not
claimed that the surcharge can be
justified on the ground that it is more
expensive to deliver water to the out-
of-city consumers than the in-city
consumers. Most of the out-of-city
users live in islands of unincorporated
“erritory surrounded by the city or
areas adjacent to the city and the
facilities used to deliver the water are
the same for both types of users.
Rather, most of the surcharge is sought
to be Justified on the basis of extra
charges for the acquisition of water or
for facilities serving the systen.

As the majority recognize (ante, p.
_._. [typed opn., p. 12]) and as the
evidence established, there are two
alternative methods for determining the
revenue requirements of a utility, the
cash basis and the utility basis. Under

both methods. the water company is

59

entitled to recover all of its operating
and maintenance expense, including any
taxes. Under the cash basis, the
utility may add charges for system
replacement, debt service expenses
(principal and interest) and other
capital costs, including additions to
the facilities or reserves for
additions. The total of the charges
become the revenue requirement.

Under the utility basis, charges for
capital replacement, etditions, reserves
for additions and debt repayment are
not included; rather, the utility
recovers for depreciation of its plant
and a rate of return on its rate base or
investment. (See City of Los Angeles v.
Public Utilities Commission (1972) 7
Cal.3d 331, 336, 346-347.)

Under the utility basis, it should be
improper to include in the rate base

capital assets donated or paid for by

60

the ratepayers because such assets may
not be viewed as investment. The point
is illustrated by Pacific Tel. & Tel.
Co. v. Public Util. Com. (1965) 62
Cal.2d 634, 663-664. There the Public
Utilities Commission concluded that
Pacific could properly include in its
rate base its gross working cash
requirement but the commission
disallowed various additional cash sums
held by Pacific which had been collected
from customers in advance, from funds
collected to pay debenture interest, and
from taxes withheld from employees. The
disallowed sums exceeded the working
cash requirement. The court approved as
sound and fair the commission's view
that when the funds supplied by "'others
than investors are greater than the
amount required .. . for working cash,
and the excess amount is not deducted

from rate base, customers would be

61

unreasonably required to pay a return on
funds supplied by them to defray
reasonable expenses and taxes [and
debenture interest] and to provide a
reasonable return on invested funds.'”
The principle is clear. The utility
may not be permitted to include in its
rate base donations or assets: supplied
by the ratepayers because to allow
inclusion in rate base would permit "a

double return." (Id. at p. 664.)24 It

14The Court of Appeal in the
instant case in an opinion by McMahon,
J., assigned, reached the same conclu-
sion on the basis of other authorities.

The court stated: "The Donated Property
Should Have Been Excluded From the Rate

Base. Customer donations of plant are
normally excluded from the rate base on
the theory that it would be inequitable
to permit the utility to earn on >
property provided by the customers
themselves. (Conejo Valley Water Co.
(1965) 64 P.U.C. 212, 225; La Puente
Cooperative Water Co. (1966) 66
Cal.P.U.C. 614, 626; Sutter Butte Canal
Co. v. Railroad Com. (1927) 202 Cal.
179, 190-191 [259 P. 937] (affd. 279
#.S. 125 (73 L.Ed. 637, 49 S.Ct.
325]); Public Utilities Commission v.
Northwest Water Corp. (1969) 168 Colo.
154 (451 P.2d 266, 276-277]: Application

62

of Kaanapali Water Corp. (Hawaii #pp.
1984) 678 P.2d 584, 590-592; United Gas
Corp. v. Mississippi Public Service
Com'n. (1961. 240 Miss. 405 [127
So.2d 404, 412]; Cogent Public Service
v. Ariz. Corp. Com'n. (1984) 142
Ariz. 52 [688 P.2d 698, 701-703]}.)

"An lllinois court reasons that it is
proper to exclude contributions in aid
of construction made by customers; the
propriety of a reasonable depreciation
deduction is not dependent upon the
source of funds for the original
construction of the facility, as the
utility will have to replace obsolete
properties. (Du Page Utillty Co. v.
lllinois Commerce Comm. (1971) 47
111.2d 550 [267 N.E.2d 662, 668-669],
cert. den. 404 U.S. 852 130 L.Ed.2d
62, 92 S.Ct. 74).) However, most courts
reason that the purpose of depreciation
is not to replace property but to
recover the original investment over the
life of the property. 'Since the
company has invested no funds in
contributed property, it is not entitled
to recover the original investment
through depreciation. .. . We believe
it inequitable to allow a company to
recover depreciation accruals on plants
in which it has made no investment. '
(Mechanic Falls Water Co. v. Public
Utilities (Me. 1977) 381 A.2d 1080,
1104; accord State ex rel. Martigney
Creek Sewer Co. v. Public Service
Commission (Mo. 1976) 537 S.W.2d 388,
399; State ex rel. Utility Commission
v. Heater Utilities (1975) 288 N.C. 457
(219 S.E.2d 56, 62]; Sunbelt Utilities
v. Public Utility Commission (Tex.

1979) 589 S.W.2d 392, 395; Princess Anne

63

Utilities Corporation v. Commonwealth ex
rel. State Corporation Commission
(1971) 211 Va. 620 [179 S.E.2d 714].)
"What about federal grants and funds
derived from federal revenue sharing?
One court has reasoned that 'the city
has unqualified ownership of the portion
of the plant built with the money and
the fact that some infinitesimal portion
of the money might be considered to have
come from taxes paid by the out-of-city
consumers does not create equities in
their favor.' (City of Covington v.
Public Service Commission (Ky. 1958)
313 S.W.2d 391, 393.) On the other hand,
a Wisconsin court, in a valuation
proceeding, excluded federal
contributions on the theory that the
federal grant was made for the benefit
of both the town and the city and ".

. the city should not now be heard to
claim that they should receive
compensation for a portion of the water
utility which was never paid for by them
either directly or indirectly.' (City of
St. Francis v. Public Service
Commission (1955) 270 Wis. 91 [70
N.W.2d 221, 225=-226].)

"Most courts which have considered the
problem have excluded federal grants
from the rate base. (See, e.g.,
Pichotta v. City of Skagway (D.C.

Alaska 1948) 78 F.Supp. 999, 1006
($39,973 expended by army in
rehabilitating the system during World
War II was excluded from the rate base,
as the rule allowing additions was never
intended to embrace a gratuitous
contribution to capital made at the
taxpayers expense], In re Southern
California Edison Co. (1954) 53

64

is only the investment made by the
utility which may be included in the
rate base.

So far as appears in the instant
case there has been no substantial
investment of capital in the water

system by the city. Although the city

Cal.P.U.C. 385, 410; 6 P.U.C.3d 161,
185-186 [donations from governmental
entities were not ‘investment')]; City of
Detroit v. City of Highland Park (1949)
326 Mich. 78 [39 N.W.2da 325, 333]
{federal funded contributions were
excluded from rate base of municipally
owned utility]; City of

Hagerstown v. Public Service
Commission (1958) 217 Md. 101
[141 A.2da 699] [in setting rates to
utility serving outside customers, both
customer contributions and federal
grants were excluded from the rate
base].)
"We agree that both acreage fees,
connection fees, and other donations
should be excluded from the rate base,
in calculating any surcharge to
nonresidents. As to federal
contributions and grants, the same
result should obtain; it is unfair to
require those who have paid federal
income taxes to pay for the proverbial
‘pork barrel' a second time." (Fn.
omitted. )

65

initially advanced funds to the water
system, the advances were treated as a
loan by the city rather than a capital
investment and were repaid with
interest.

The majority suggest other bases for
concluding that the water facilities may
be viewed as investment by the city
warranting establishment of a rate base
and justifying the city receiving a rate
of return which can be used to reduce
rates paid by city customers.

First, it is urged that the city is
entitled to claim the assets of the
system as investment because payment of
the bonds used to acquire many of the
assets and the State Water Project
obligations was guaranteed by the
residents of the city whose property was
subJect to taxes if the water company
could not pay the bonds or obligations.

However, it is clear that it was always

66

contemplated that the principal and
interest on the bonds and the project
obligations would be paid from revenues
of the water system and in fact that is
what has occurred. In the absence of
any significant capital contribution by
the city, it is unreasonable to permit
the city to establish the assets
acquired by the bond funds or the
project obligation to be viewed as
investment by the city rather than the
ratepayers.

Second, the city points out that it
has provided services and facilities to
the water system. As pointed out at the
outset of this opinion, I agree that the
city is entitled to be compensated for
any services or facilities made
available to the water system and rather
than accept compensation the city may
properly discount the rates charged in-

city consumers. However, the discount

67

should be reasonably related to the
value of services and facilities. It is
not. The discount was more than 10
times the amount which the city claimed
as the value of its services and
facilities made available to the water
company.15 Because the discount, so far
as appears, greatly exceeded the value
of the services and facilities
contributed by the city, there is no
reasonable basis to conclude that the
city's contributions of services and
facilities furnished substantial

investment capital warranting a rate of

15The additional revenue due to the
70 percent surcharge during the fiscal
years 1972-1973 through 1976-1977
totalled approximately $1.4 million.
During the period the ratio of city
consumers to out-of-city consumers
ranged from approximately five to one to
six to one. Assuming, as the majority
conclude, that the out-of-city consumers
paid a reasonable rate, the discount
allowed city consumers from the
reasonable rate would be at least $7
million (5 x $1.4 million). During the
period the city claimed unreimbursed
expenses of $629,000.

68

return. The trial court found that over
the years the water system has
"generally proven to be self-
sustaining." To allow a rate of return
based on the city services and
facilities would permit the city a
double recovery.

It is also argued that. the water
system was built on the basis of
revenues spnaines from ratepayers and
that when the city added new ratepayers
the old ones who helped build the system
were entitled to a rate differential
based on the value of the existing
system. However, this is not the basis
of the discriminatory rates. Thus, when
in 1969 the city acquired the Saticoy
Water Company, 60 percent of the Saticoy
consumers were city residents and 40
percent nonresidents. Only the
nonresidents paid the surcharge; the 60

percent of the new users who were city

69

residents paid the discounted rate. The
converse is also true; “old" users
outside the city are required to pay the
surcharge. Prior to the Saticoy
acquisition, about 1,000 of the service
connections were outside city limits
with 12,600 within the city.1© The
1,000 noncity consumers, the "old" users
who helped to pay for the system, are
required to pay the surcharge unless
their property was annexed to the city.
It is also implied that the
discrimination may be justified because
after the purchase of the out-of-city
companies the consumers of those
companies received improved service and
water quality. Fixing utility rates on
the basis of the value of the service
provided would be a repudiation of our

long history of determining utility

l6after the acquisition, there were |
apparently 18,000 city customers and
2,800 customers outside the city.

70

rates on the basis of cost.

The record here is clear that the
system has been paid for and is being
paid for by the ratepayers, both within
and without the city, and the city has
not made a significant capital
contribution warranting the establish-
ment of a rate base composed of the
assets of the system and an allowance of
a rate of return on that rate base.
When the ratepayers have paid for the
system, requiring them to also pay a
rate of return to the city on the assets
of the system in the absence of a
Significant capital investment is to
charge them twice for the investment.
Although the rate of return may be used
for replacement, improvement and
additions to the system, it is improper
to discriminate against the out-of-city
consumers by requiring them to furnish

excessive amounts for those purposes.

va

Rather, when the city chose to dedicate
its system to serve out-of-city
consumers, they became entitled to the
same rights as to reasonable rates as
the city users. piscrinination in rates
can be justified on the basis of
differentials in cost in delivering
water or on the basis of city:
contributions but not on the basis of

fictitious capital contributions.
BROUSSARD, J.

I CONCUR.

BIRD, C.J.

72

F Gh s
ee

HANSEN v. CITY OF BUENAVENTUHA
S.F.32091
COUNSEL FOR APPELLANT:Helene Stone
Stone and Stone
500 Esplanade drive, Ste. 1130 Oxnard,
CA 93030

805) 647-0120

COUNSEL FOR RESPONDENT:Arthur L.
Littleworth

Best, Best & Krieger

P. 0. Box 1028

Riverside, CA 92502

(714) 686-1450
TRIAL COURT & NO.:Ventura County
Superior

No. 55759

TRIAL JUDGE:Honorable Robert D. Carter

73

Supreme Court

FILED
FEB -5 1987
Laurence P. Gill, Clerk
ORDER DUE February 27, 1987 7
ORDER DENYING REHEARING
LA No. 32091
In the Supreme Court of the
State of California

IN BANK

HANSEN Et Al.
Vv.

CITY OF SAN BUENAVENTURA

Appellants’ petition for rehearing
DENIED.

/s/ Broussard

Acting Chief Justice

74

CERTIFIED FOR PUBLICATION
IN THE COURT OF APPEAL OF THE STATE OF
CALIFORNIA
SECOND APPELLATE DISTRICT
DIVISION SIX
COURT OF APPEAL-SECOND DIST.
FILED

APR 8 - 1985
CLAY ROBBINS, JR. Clerk

2d Civil No. 6788
(Super. Ct. No. 557)
(Ventura County)

[OPINION]

MAGDALINE M. HANSEN, et al.,
Plaintiffs and Appellants, _

Vv.

CITY OF SAN BUENAVENTURA,

Defendant and Respondent.

May a municipally owned water system
impose a 70 percent surcharge upon the
water bills of customers living outside

of the city limits when the cost of

75

providing water service has been funded
by water revenues, and not taxes?

We conclude that the answer to this
inquiry is found in venerable common law
rules and, accordingly, decline to
consider the constitutional arguments
advanced by the parties.

At common law, a privately owned
utility which had a monopoly in serving
a given area was required to serve all
consumers without unreasonable
discrimination in rates or manner of
service. Although such private
utilities are subject to regulation by
the Public Utilities Commission,
customers of municipally owned utilities
are just as protected from exorbitant
rates and unjust discrimination as the
consumers are under the Public Utility
Act. Indeed, when a municipality
proposes to acquire a water company

subject to the jurisdiction of the

76

Public Utilities Commission, the
commission will impose, as a condition
of its approval of the sale. a provision
that the city shall not unfairly
discriminate against customers who live
outside the city and who have no voice
in city government.

It is apparent that the trial judge
gave little weight to these settled
principles of California law, and relied
instead upon other rules of law
applicable in other states, but not
California. For the reasons stated, we
will remand the matter for a new trial
consistent with the principles
enunciated herein.

THE CASE
In 1972 the City of San Buenaventura
(hereinafter referred to as "Ventura" or
"the city") enacted an ordinance
imposing a 70 percent surcharge upon

water supplied to existing customers

77

living outside city limits. This
prompted a rebellion, and in 1973 a
Class action was filed seeking
declaratory relief and damages on the
ground that the rates imposed upon
customers outside the city limits, after
July 1. 1972, were exorbitant,
unreasonable, arbitrary and
discriminatory, and did not bear any
relationship to the actual cost of
furnishing water.

As is customary in water cases, the
matter languished for several years.
(See e.g., City of Los Angeles v. City
of San Fernando (1975) 14 Cal.3d 199.
207-208.) After a nine day trial in 1978
the trial judge then considered post-
trial briefs before filing his intended
decision in 1980. Prolix findings of
fact together with a judgment were filed
in 1981. This appeal followed.

The trial court concluded that the

78

rate structure was reasonable. While we

are, of course, obliged to uphold this
conclusion if it is supported by
substantial evidence, we are also guided
by what Justice Holmes said in K#dd v.
Alabama (1903) 188 U.S. 730. 733: "What
is reasonable is a question of practical
details into which fiction cannot

enter."

THE HISTORY OF THE SYSTEM

Prior to 1923 the City of Ventura
and adjacent territory was provided
water by the Southern California Edison
Company, a private company. That year
the city authorized the issuance of
general obligation bonds in the amount
of $250,000 to purchase the systen.

In 1925, 1927, 1948 and 1960
additional general obligation bonds
totalling over 3.5 million dollars were

issued and the proceeds were used to

79

improve and modernize the system.
Although all property within the city
was subject to a lien, and the city
would have had to raise taxes if the
funds generated from water revenues had
proved insufficient to pay the bonds, in
actuality, both operating costs and
payments of bond principal and interest
were always paid from available water
revenue, and not from ad valorem taxes.

Indeed, annual financial reports
issued by the city repeatedly stressed
that its water department was operated
on an “enterprise basis," and that the
department generated sufficient funds
through user fees to finance the
acquisition, operation and maintenance
of its facilities.

In 1966 the city purchased the Mound
Mutual Water Company for $62,500 from
water revenues. The water was of poor

quality, exceesing a thousand parts per

80

million of total dissolved solids.
Under water quality standards
promulgated in California, the
acceptable limits are 1500 parts per
million, and the health department will
only issue a temporary certificate if
the water contains 1000 parts per
million. After Mound was acquired, the
city abandoned wells which had served
the customers of the private water
company and began supplying them with
water of better quality.1’

In 1968, the city acquired the

l7tnterestingly, in calculating the
value of the system, Mr. Stetson, one of
the city's experts, opined that the city
had an entitlement to the "Mound Basin,"
or 40 percent of the indigenous water
rights. Because the "Mound Basin" and
the "Ventura river" provided a cheaper
source of water, as compared with the
supply obtained from Lake Casitas, it
these water rights were given a
capitalized value, they would be worth
$2,000,000, or 40 percent of the total
water rights. However. we are not told
whether the Mound Basin is coterminous
with the previous boundaries of the
Mound Mutual Water Company.

81

Saticoy Water Company ("Saticoy"). a
private water company regulated by the
Public Utilities Commission. Before
Saticoy was acquired, only 1,025 of the
13,681 service connections of the
municipal waterworks were outside city
limits. With the addition of Saticoy's
customers. although the number of
customers within city limits increased
slightly to 15,215. the number of
Customers living outside city limits
almost trebled, increasing to 2,711.18

A perusal of the map indicates that
the present boundaries of the city
resemble a partially completed jigsaw
puzzle; many of the county residents
provided with city water live in various
enclaves, surrounded by areas previously

annexed to the city.

18py 1976-1977, following
residential growth and annexations,
there apparently were 18,513 city
customers and 2911 customers living
outside city limits.

82

... ——

The acquisition of Saticoy was

financed by 2.5 million dollars in
revenue bonds which constitute a first
lien on the revenues of the water
department. The bond holders could not
make recourse either to the taxing power
of the city or to money derived from the
levy and collection of taxes.
Subsequently, an additional 4 million
dollars in revenue bonds were issued to
provide for the replacement of
deteriorated transmission and
distribution lines and to prepare the
system for waters expected to come from
the State Water Project.

Saticoy customers benefited from the
sale. Instead of relying on four small
storage tanks. they now could take
advantage of a city system which
provided over 50 million gallons of
storage capacity from tanks and a

reservoir tied into the Ventura water

83

system. Water obtained from Saticoy's
wells also was of poor quality. One
well was abandoned and one well was put
on a standby basis. Citizens now
complain when water is pumped from this
well during the summer. -

The 1968 contract of sale between
Saticoy and the city, which was approved
by the California Public Utilities
Commission, allowed the city to alter
the preexisting rates at any time after
60 days. The contract further provided:
"City agrees that from and after the
closing date it will serve water without
unfair or unreasonable discrimination to
all customers in the area wherein seller
is certificated to provide water service
by the California Public Utilities
Commission whether such customers are
located within or without the
territorial boundaries of the city and

will continue to serve all of such

84

customers."

Indeed, under the Revenue Bond Law
of 1941, the city shall prescribe,
revise, and collect such charges
that the services, facilities, or water
are furnished at the lowest cost
consistent with sound economy, and
prudent management, and the security and
payment of the principal and interest of
the bonds. (Gov. Code. # 54514.)

The city has taken the position that
the creation of separate pressure zones
for rate making purposes would be costly
to establish and politically divisive.
Nevertheless, since 1935, the city has
imposed a surcharge on nonresident water
users. Until December of 1952, the

surcharge was 48 percent. 19 Thereafter,

19tn 1943 the California Railroad
Commission, at the city's request,
issued an advisory opinion wherein it
concluded that the rate differential
produced a reasonable rate of return on
rate base, which apparently included
monies from donations and federal funds.

85

until July 1, 1972. the surcharge varied
between 31.4 percent and 32.7 percent.
Since July 1, 1972, the surcharge has
been 70 percent. In fiscal year 1976-
1977, this resulted in outsiders paying
an average of $97.13 more than their
neighbors living within city limits. If
they annexed, the surcharge would be
eliminated, but acreage and connection
fees would be paid by the developer.
Before considering the rate increase
of 1972, it is appropriate to consider
the sources of money used to improve the
system apart from the bonds. First,
there was an intra-city loan of $245,000
in 1958 to the water department which
was repaid, without interest in 1967 and
1971 (conversely, in 1946, $118.000 was
transferred from the water fund to the
sanitation fund. It was never repaid).
Second, there was a $322,000 loan

derived from revenue sharing funds in

86

1974 for improvements. It is to

be repaid with interest, over five
years, generating a return of $382,210.
Third, between 1972 and 1976 the

city received housing and urban
development water facility grants
totalling $1,774,889 for a transmission
pipeline, the Avenue treatment plant,
and other facilities. Fourth, the
general fund was to loan the

water department $1,380,245, for the
financing of the Bailey Reservoir in
1978-1979, which was to be repaid

with interest in five years in the
amount of $1,560,081.87.

Since 1972 or 1973, no nonresident
may connect to the system unless the
property is annexed to the city
and a correction fee is paid. By the
time of trial, these contributions
following annexation amounted to

$778,000. This sum was included in the

87

rate base, having been contributed by
those not within the city.

Turning now to the 1972 rate
increase. we first note that the
addition of the Saticoy customers
(together with the 31.4 percent
surcharge then imposed on nonresidents),
produced rather dramatic results. Gross
revenues for the fiscal year ending in
1970 increased 30.89 percent, while
expenses only increased 16.63 percent.
Net income jumped from $110,889.59 to
$303,787.75, an increase of 173.96
percent. Yet, further funds were
sought.

In the spring of 1970, the
consulting firm of Wilsey & Ham was
retained by the city to analyze the
water rates. Mr. Heidrick, who was in
charg: of the study, recommended an
overall rate increase of 20 percent,

which has never been challenged. When

88

it came to recommending a surcharge, Mr.
Heidrick initially concluded that those
outside contributed $340,000 in revenue,
and, after deducting a proportionate
share of operating expenses, interest
and depreciation, this would yield
$61,000 (a 17.9 percent yield). By
contrast, the city system would produce
$132,000 on revenues of $1,634,000 (a
8.1 percent yield). However, this
disparity was soon eliminated because
Mr. Heidrick thought that county
residents were being subsidized. For
instance, on the basis that persons who
made reservations for the city parks
were persons who lived somewhere in the
county, he believed that the relatively
few county residents supplied with
water by the city should be
charged $31,000 for the use of the city
parks and the swimming pool, and $1,000

for the fiesta de la Marina and

89

Poinsettia Festival. He also charged
nonresidents with $4,000 in indirect
administrative costs, and $135,000 for
foregone interest on investment in plant
serving the county.

Apparently, the city assumed that
the study would provide justification
for even a higher surcharge. However,
Mr. Heidrick initially concluded that
while the existing 32 percent surcharge
on outside customers could be justified,
any additional significant surcharge
would be hard to justify on the basis of
available data. He could only recommend
another 6.8 percent increase in the
surcharge, so that the total surcharge
would be 38.8 percent.

The director of public works then
came up with a novel approach; why not
exclide both th revenue and expenses
associated with the sale of untreated

water to the oil companies? The sale of

90

untreated water had generated
substantial revenue. Shell Oil paid
between $195,241 and $266,109 for
untreated water each year between 1972
and 1976. Yet, because the expenses
associated with the sale of untreated
water was less, this constituted a
profit center. By eliminating his
source of profit. the "loss" became
$111,000 rather than $23,000.29

Mr. Heidrick concurred, and in
light of the recalculated figures,
recommended that the surcharge be
increased to 70 percent. A grateful
city council then enacted an ordinance
imposing the recommended surcharge

effective July 1, 1972.

20appellants' expert, Mr. Knaggs,
believed that if the income and expenses
associated with the sale of untreated
water were added back in, only a 7.6
percent surcharge would be in order.
The difference between this figure and
the 6.8 percent figures chosen by Mr.
Heidrick, is not particularly
Significant.

91

After the 70 percent surcharge was
imposed, a funny thing happened. In
fiscal year 1971-1972, a new
administrative charge" of $71,744 was
imposed on the waterworks and those
revenues were transferred to the general
fund. This sum increased each year and
by fiscal year 1974-1975, $150,000 was
so transferred. The same amount was
transferred in the next two successive
years, plus $76,442 to repay a loan from
the general fund. This, of course, was
in addition to free water furnished to
city departments, which, if revenue had
been collected, would have resulted in
$31,199.79 in additional revenue in
fiscal year 1971-1972 and $56,353.22 in
fiscal year 1975-1976.

In the annual budget proposed by
the city manager in 1978-1979, water
revenues of $4,491,450 were anticipated,

including $300,000 for water

92

connections. Projected departmental
administration costs were $119,498.
Nondepartmental administrative charges
were $200,302, professional services
were $41,700 and taxes were $32,755.
The total expenses, including payments
to water purveyors, the state water
contract, and payments of bond,
principal and interest, amounted to
$3,314,681. After setting aside
$140,510 required by a bond covenant,
this would lead to a projected profit of
$1,036,259 which was to be used to

provide financing for a Reservoir.

THE CLAIMED JUSTIFICATION FOR THE
DISCRIMINATION

A consistent theme emerged from the
testimony of experts engaged by the
city, namely that the city owned the
System and was entitled to a reasonable

rate of return as if the city residents

93

were stockholders in a private utility.
They pointed out that other cities
imposed surcharges and that the City of
Pasadena took 16 percent of gross
revenues from water and electric sales
and put it in the general fund.

For instance, Mr. Heidrick believed
that the city was entitled to a
reasonable rate of return on its
investment in plant serving customers
residing outside city limits. Thus, he
explained that the $135,000 which
represented the surplus revenues .
generated by the surcharge upon water
sales to nonresidents could be
classified as foregone interest on
investment. The foregone interest
theory was based on the assumption that
although the assets of the enterprise
were created from water revenues
contributed by both nonresidents and

residents, the municipality which owned

94

the plant should be entitled to a return
on the investment devoted to persons
outside city limits, namely those who
did not own the system. In fact, the
$135,000 represented a 5 percent return
on that part of the waterworks whose
value was allocated to nonresident
customers. He did not find fault with
the rate of return, as a good part of
the waterworks was based on historic
cost, namely the cost of acquisition
years before, and not the replacement
cost.

Mr. Heidrick also felt that the
$135,000 profit could be classified as
an in lieu tax, based upon the theory
that the city managed the enterprise,
that city property was theoretically at
risk if revenues proved insufficient to
pay any outstanding general obligation
bonds, and that only the city would be

in a position to obtain short term

95

financing if an emergency arose.

When Mr. Heidrick recommended a 70
percent surcharge when he studied the
system between 1970 and 1972, he
admitted that he thought that a court
reviewing another rate surcharge imposed
by another city had actually upheld the
validity of such a surcharge. By the
time of trial. he became awa~e that the
other 70 percent surcharge had resulted
from a negotiated settlement of that
lawsuit. Although Mr. Heidrick
acknowledged that he had been laboring
under a misapprehension, he was still
of the opinion that a 70 percent
surcharge was appropriate. He believed
that the data would have justified a
surcharge of 75.7 percent. If he
eliminated the mistaken allowance for
parks and the fiesta, it would only
result in a lowering of the surcharge by

2.9 percent, and that the data still

96

justified a surcharge in excess of 70
percent.

Mr. Ferry testified that the city's
water rate base was $21,006,505, and
included $10,706,000 in long term debt
(50.97%). The Public Utility Commission
in 1976 had allowed a median return of
12.30 percent on the equity of privately
owned water companies. The embedded
annual cost of debt averaged 5.18
percent in fiscal year 1976-1976. Ifa
rate of 12.30 percent was applied
against the 49.03 percent of the rate
base representing the city's equity, and
if the 5.18 percent embedded annual cost
of debt was applied against the 50.97
percent of the rate base financed by
long term debt, the equitable composite
rate of return for the city's total rate
base would be 8.67 percent.

Nonresident users accounted for

14.41 percent of the total potable water

97

usage in fiscal year 1975-1976.
Although only 10.43 percent of the
hydrants were in the county, 83 percent
of the property subject to county taxes
were in areas where nonresident users
were found, and Mr. Ferry allocated
$21.164 to nonresidents for county
taxes. The total revenues from
nonresident potable water in fiscal year
1975-1976 was $615,778. The recorded
expenses associated with service to
nonresidents was $328,762, yielding a
significant profit.

On the other hand by applying an
8.67 percent rate of return to the
nonresident portion of the rate base,
which amounted to $3,067,170 of the
total of $21,006,505, an additional
$265,924 would be added to the "revenue
requirements," which would then total
$594,686. The disparity then only

amounted to $20,000, which Mr. Ferry

98

ve |

é
4
1
3
|
{

believed was within the "zone of
reasonableness."

Under Mr. Ferry's computation.
grant monies were included in the total
rate base.*1 He also included $4,639,656
in the rate base. representing the
capitalized value to the future payments
that the city is obligated to pay under
its contract with the State Water
Project, even though the system is not
connected to the nearest state water
conduit. Note also that nonpotable
water supplied to industrial users, such
as Shell Oil Company and Getty Oil
Company, who use 95 percent of the
untreated water, was excluded from this
computation. If the revenues ($374,301)
and expenses ($271,972) were allocated

to outside users, then revenue would

21mr. Ferry acknowledged that the
California Public Utilities Commission
does not allow donations to be included
in the rate base of an investor-owned
utility.

99

amount to $1,001,075, expenses would be
$866,658, and there would be a surplus
of $134,417. Under that analysis, only
a 33.9 percent surcharge could be
justified by Mr. Ferry. He also treated
the $56,353 in free water as revenue
foregone, and that the outside users
should be charged $8,064 to make up
for this lost revenue.

Mr. Jones, who served as the city's
public works director, explained that
the Casitas Mutual Water District
provides half the water used by the
system at a cost of $61.00 per acre
foot. The water from Casitas lake can
only be used within the boundaries of
the district, which only includes the
westerly portion of the city's water
system. Because the city's water system
is integrated, the city uses no more
water from Casitas than is pumped from

other sources, such as from the

100

ee Sei ei ey OT

submerged dam and wells on the Ventura

)/ river, which supply 25 percent of the

' water, certain golf course wells, which

provide 20 percent of the supply, and

‘cost $20 to $25 per acre feet. Certain
| other wells are used and water is also

| purchased from Alta Mutual Water

Company, at $56 per acre feet.

Mr. Stetson, another engineer
calculated that the value of the city's
water rights on the basis that
6,000 acre feet would be extracted

annually from the Ventura river and

_4,000 per year from the Mound basin.

| ‘The city could save in excess of $30 per

acre feet if it used the water.

‘Capitalizing this sum, he came to the

conclusion that the value of each acre

foot was $500, and the water rights

would be worth $5,000,000. If that
figure were used in place of the

$1,221,838 used by Mr. Ferry as the

101

value of water rights. an 83 percent

surcharge could be justified.
Overlooking the fact that a large

proportion, if not a majority of those

living outside city limits also are not

Se ee eee

within the boundaries of the Casitas
Mutual Water District, and technically
therefore could not use

unblended Casitas water, Mr. Stetson
assumed that when the Saticoy wells were
abandoned, or put on a standby

basis, the city had to purchase
additional more costly water to serve
these customers from the Casitas Mutual
Water District. Based upon the costs
associated with purchased water, in
1976-1977, the annual cost to
nonresidents was $127.17 while the
annual cost to residents was $71.89,
thereby justifying a 76.9 percent
differential in rates.

We turn now to the State Water

102

EEE ——e

ee ee ye

Ve’ ae ALOT Sid

Project. After the voters of California
approved the project, the Ventura Flood
Control District reserved 20,000 acre
feet of water. Because the city did not
acquire its right to 10,000 feet of the
20,000 acre feet until 1970 or 1971, it
must pay back the charges that accrued
since 1960, and make ongoing annual
payments as well. $1,785,681 has been
contributed as of June 30, 1977 and, of
course, each nonresident consumer
contributed $1.70 for every $1.00
contributed by a city resident. Future
contributions on the arrearages include
$313,199 in principal and $94,550 in
projected interest. Between 1977 and
December 31, 2035, $3,704,757 in
principal and $5,699,761 in interest
will be paid in annual installments to
the state. In addition, there will be
operating and maintenance charges of

$34,091,193 and Delta water charges of

103

—

$14,346,755. Yet even then, not a drop

of state water will be delivered to the

adits

city or the customers until a 40 to 50
mile conduit is built between Castaic

and existing Ventura mains, at a cost of

Pa ee Le eee ee ey

countless millions.

Although all monies necessary to

26 Pa A ASS

reserve the right to ultimately acquire
state water were contributed by all rate
payers, Mr. Ferry included a figure of
$4,517,361, as the capitalized value of
future payments, and then has 14.41
percent of that figure included in the
rate base allocated to nonresidents, so
that they must pay a return on monies
previously paid. Mr. McMillan, the
city's Director of Management Services,
treated the fixed obligation of
$4,017,955 as a liability. Yet that
figure is also somehow treated as a
future asset, and it, together with

previous payments of $1,785,681, amounts

104

a

to an asset of $5,803,636.
DISCUSSION

I. INTRODUCTION

To persuade the trial court that it
could exact a profit from nonresident
customers, the city submitted briefs
containing numerous out-of-state
authorities. We find significant
differences between the rules governing
water rates in other states and the
rules operative in California.

For the reader's convenience, we
have canvassed and criticized these
authorities in Appendix A to this
Opinion. Briefly stated, we find
several recurrent themes. First, some
municipalities charge "what the traffic
will bear," unless of course the
nonresident consumer is protected by a
contract. Second, municipalities can
exact profits from service to

nonresidents, and place the profits in

105

a a a

the general fund.

While it is understandable that
Ventura might prefer the rate making
freedom enjoyed by municipalities in
other jurisdictions we see no reason to
adopt the reasoning of those out-of-
state cases which sanction egregious
forms of discrimination in municipal
rate making. Certainly a politically
powerless class of consumers are not
going to tamely surrender their right
under California law to obtain essential
services at a fair price. In
considering these expectations, it would
seem that California public utility law

would be a logical point of departure.

II. UNDER CALIFORNIA PUBLIC UTILITY
LAW, POLITICAL BOUNDARIES ARE NOT
RELEVANT CONSIDERATIONS IN RATE SETTING.

We acknowledge that although the

Legislature could confer upon the State

106

Public Utilities Commission the power to
regulate municipally owned utility
rates, including the rates charged
nonresidents, it has not chosen to do
so. (County of Inyo v. Public
Utilities Com. (1980) 26 Cal.3d 154.
166-167.) Nevertheless, a brief survey
of our public utility law will prove to
be useful.

First, a regulated public utility
shall not raise any rate or alter any
Classification as to result in any
increase in that rate except upon a
showing that such a rate increase is
justified. (Cal. P.U.C.. # 454(a);
e.g., Dyke Water Co. (1964) 63 Cal.
P.U.C. 507, 509-510 (where exhibits
essential for calculation of a rate base
or operating results were uncertain,
unsubstantiated or improperly accounted
for, the application would be
dismissed) .)

107

A public service water company
appropriating water for purposes of
rental, distribution or sale cannot
confer upon a customer any preferential
right to the use of any part of its
water. (Leavitt v. Lassen Irrigation
Co. (1909) 157 Cal. 82, 89; Cal. P.U.C.
sec. 453(a).) Thus, stockholders
obviously are not entitled to free
service or preferential rates.
{Application of Foothill Ditch Company
(1929) 33 C.R.C. 237, 240; Narbonne
Ranch Water Company No. 2 (1928) 31
C.R.C. 548. 550 (company must
discontinue the practice of charging
stockholders $1.25 and nonstockholders

$1.50 for the same amount of

water); Franscioni v. Soledad Land &

Water Company (1914) 4 C.R.C. 184. 187.)
No public utility shall establish

or maintain any unreasonable differences

as to rates, charges, services,

108

facilities, or in any other respect,
either as between localities or as
petween classes of service. (P.U.C.
sec. 453(c).) Thus, each district should
provide a reasonable return on the
investment in that district. It would
not be fair to require customers in
other districts to provide more than
their fair share of total earnings
requirement, so that a particular

district could have lower rates. (Cal.

Water service Co. (1969) 69 Cal.P.U.Cc.
423, 429.)

At one time, the commission would
suggest that political boundaries were
proper criteria for different rate
zones. In s s of Kentwood v.
Pacific Gas & Electric Co. (1936) 39
C.R.C. 577 (13 P.U.R. (N.S.) 400),
residents of Kentwood believed they
should be entitled to rates operative

in incorporated towns of Ross, Larkspur

109

and San Anselmo in Marin County.
However, the evidence established that
there were only 38.5 electric customers
per mile in Kentfield, as compared with
68.1 per mile in the incorporated
municipalities. and pevenes per mile was _
$2,209 in Kentfield while the revenue
per mile was $4,430 in the cities. A
similar, but less striking, disparity
existed with respect to gas service.

The commission said: ". . . Taken as a
whole, the density of customers and
revenue per mile of line is greater, and
the cost of installation and operation
per customer is less in incorporated
cities and towns than in unincorporated
areas, for both gas and electricity. It
is equally true that the incorporated
limits of cities and towns form a rather
definite diviaineg line between areas of
low cost and high cost service, which

justified a differential in rates. . ."

110

(39 C.R.C. 577, 582.)

The commission suggested that
Kentfield could procure more favorable
rates through the simple process of
incorporation. Until it did so, it
would share the advantages and handicaps
characteristic of rural districts. (39
C.8.C. $77. $862.)

On the other hand, where the
proposed rates would favor customers
inside city limits, and there was no
difference in the method of providing
water service to customers, or the
expense involved simply by reason of the
limits of the City of Vallejo, such a
rate differential was an unfair
discrimination. Hence a uniform rate
was set by the commission. (Vallejo
Water Company (1931) 36 C.R.C. 321,
323.)

Some 30 years ago, the Public

Utilities Commission announced that it

pee I

was doing away with incorporation of a
city as a reason for being placed in a
lewer electric or gas rate zone. In the
future, for a city to improve its
position as to rates, certain density
and other pertinent factors were to be
considered. (Pacific Gas & Electric
Company (1952) 52 Cal.P.U.C. 111, 142;
Pacific Gas & Electric Co. (1954) 53 |
Cal.P.U.C. 616, 622.) Also, territory |

contiguous to cities must now be
reviewed periodically to determine if

any newly developed territory has urban

characteristics warranting consideration
for either more favorable rate

treatment, or for rates comparable to

the adjoining cities. (Southern

California Edison (1957) 55 Cal. P.U.C.
743, 761.)

In California Water Service Co.
(1955) 54 Cal. P.U.C. 266 (9 P.U.R.3d

128) the City of Chico urged that its

112

——eSEsECmC CC

city limits should be adopted as a zone
boundary. The commission disagreed,
saying: "This commission has long
adhered to the premise that no
distinction, without other controlling
reasons, should be recognized either in
rates charges customers or in rules
governing service to them by reason of
the fact that a political bhowndary,
such as that determined by the limits of
a city, separated one customer from
another. If such a distinction were to
be made, political rates, rather than
service rates, might soon follow -- a
condition abhorrent to the general
public interest and to the clear mandate
of the law that no unreasonable
distinction shall exist." (54
Cal.P.U.C. 266, 269.)

Noting that there had been 26
boundary changes in Chico in 3 years,

the commission found no just cause

113

Se Be Pe Je

for establishing a rate differential
based upon whether the water service was
rendered within or without the
political boundaries of the city. (54
Cal.P.U.C. 266, 270.)

Similarly in San Diego Gas &
Electric Co. (1972) 74 Cal.P.U.C. 93,

the commission noted that counsel's
arguments that preferential treatment
should be accorded San Diego over the
contiguous cities such as El Cajon,
National City. La Mesa and others, were
not convincing. "The use of city
boundaries is frequently advocated by
cities and has just as frequently been
cast aside by the commission as
inappropriate. .. . "™ (74 Cal.P.U.C.
93, 124.) The commission reminded the
city that the purpose in establishing
differential rate zones on a geographic
basis is to reflect differences in costs

of service in the most equitable manner

114

as practical. (74 Cal. P.U.C. 93, 124.)
The commission does not assert
jurisdiction over rates charged by a
city for service inside and outside
its boundaries. However, it is most
signiflicant that the ommission, when it
approves the acquisition of a privately
owned, regulated public utility by a
municipality, dces afford protection to
nonresident consumers. (Dyke Water Co.
(1963) 61 Cal.P.U.C. 313. 321.) In that
case the commission observed ". . . the
transfer would not be in the public
interest if discriminatory treatment by
the city were to result. It is for that
reason that the commission has at all
times imposed, as a condition of its
approval, a provision that a city
purchasing a utility system shall not
unfairly discriminate against customers
who live outside the city and have no

voice in city government. " (61

\

115

Cal.P.U.C. 315, 321.) 2?

Thus, the Public Utilities
Commission, foreseeing the risk of
discrimination against nonresidents, has
guaranteed that they may not be treated

like the "Outcasts of Poker Flat.??

IIr. IN
CALIFORNIA A MUNICIPALITY MAY NOT
ESTABLISH RATES WHICH UNFAIRLY
DISCRIMINATE AGAINST NONRESIDENT WATER
CONSUMERS, ESPECIALLY WHEN THE
NONRESIDENTS ARE PROTECTED BY THE TERMS
OF A CONTRACT BETWEEN THE CITY AND THE

PRIVATE WATER COMPANY WHICH PREVIOUSLY

22tn Dyke. the evidence indicated
that the City of Anaheim had used other
city funds to support the syster. Hence
the customers living outside the city
could fairly be expected to pay for the
water at higher rates. (61 Cal.P.U.c.
3345, 321.)

23see, I, The Writings of Bret
Harte, Houghlin & Mifflin, 1896, p. 14
et seq.

116

|

SERVED THEM.

If we were confronted with
discriminatory water rates established
by a municipal water district governed
by the Municipal Water District Law of
1911, this opinion would have been
mercifully brief. Although a district
may establish different rates for
different classes or conditions of
service, “rates shall be uniform
throughout the district for like classes
and conditions of service." (Wat. Code.
sec. 71614.) Although a city may be
included within the boundaries of such a
district (Wat. Code. sec. 71611), once
the city is made part of this district,
the district may sell such water
“without preference" to a city. (Wat.

Code, sec. 71611.24 Nevertheless, it

24The similarity between this
language in these
sections and those found in section
453(a) and (b) of the
Public Utilities Code is not surprising.

117

appears that no specific statute
regulates the rates set by
municipalities operating their own

waterworks. We turn then to common law

as both measures

were first enacted two years apart
during the trust busting era of the
first part of this century.
Nevertheless, under the Municipal Water
District Law of 1911, special rates have
been set for property annexed to the |
district (Wat. Code. sec. 71615), and it
has also been held that section 71614 of
the Water Code is discretionary, and

that the district had the statutory
authority to enter into long term
contracts governing rates so as to
induce pulp mills to locate within

the district. (Louisiana-Pacific Corp.
v. Humboldt Bay Mun. Water Dist. (1982)
137 Cal.App.3d 152.) In Louisiana-

Pacific it appears that the pulp
companies did bear all of the cost of |

the initial costs for the additional
facilities, paid $105,000 toward the
district's fixed expenses for existing |
facilities, and agreed to pay a |
percentage of the operating expenses, |
which was subject to changes in a

building cost index. (Id. at pp.154-

155.) Nevertheless, Justice Grodin,
concurring, suggested that in setting
rates by contract, the district must

still guarantee that the district
substantially complies with Water Code
section 71616, which requires revenues
sufficient to pay operating expenses,
depreciation, etc. (Id. at p. 163.)

118

rules upon that subject as they have
evolved in California.

she rates charged by a municipally
owned utility must be fair, reasonable,
just and nondiscriminatory. (American
Microsystems, Inc. v. City of Santa
Clara (1982) 137 Cal.App.3d 1037, 1041;
Boynton v. City of Lakeport Mun. Sewer
Dist. (1972) 28 Cal.App.3d 91. 94.)

However, the lack of uniformity in

rates charged to users of public utility
service who reside outside city limits
and those charged users within city
limits is not necessarily evidence of
unlawful discrimination and is not prima
facie unreasonable. (Elliott v. City of
Pacific Grove (1975) 54 Cal.App.3d 53,
57; Durant v. City of Beverly Hills
(1940) 39 Cal.App.2d 133, 138-1391
County of Inyo v. Public Utilities Com.,
supra, 26 Cal.3d 154, 159, fn. 4.)

It is presumed that the rates fixed

119

are reasonable, fair and lawful. Thus
the challengers must establish that the

rates fixed are unreasonable, unfair or

unlawful. (Elliott v. City of Pacific

Grove. supra. 54 Cal.App.3d 53, 60;
Durant v. City of Beverly Hills. supra,

39 Cal.App.2d 133, 139.) If, however, it
is shown that a city set sewer charges
four tines the rate set for users inside
city limits, based upon the nonresident
status of the consumer, not on cost of
service, and it appears that the system
is financed by revenue, and no part

will be financed through taxation,
the rate will be deemed invalid.

(Elliott v. City of Pacific Grove.
supra. 54 Cal.App.3d at pp. 57, 59;

Cou QO Vv. blic Ut ties
Com., su , 26 Cal.3d at p.159, fn.
4.)

In the area of economic regulation,

such as rate regulation, it need only be

120

|

shown that the distinction between
customers bears a rational relationship

to other reasonable considerations.

(Toward Utility Rate Normalization v.
Pu ties - (1978) 22 Cal.3d
529, 544; Wood v. Public Utilities
Commission (1971) 4 Cal.3d 288, 294;
Swanson v. u Wa s ’
supra, 56 Cal.App.3d at pp. 523-524.)
Nevertheless, ". . . a city which

acquires the water system of another
community incurs an obligation to deal
fairly with its customers in that
community and to provide them with
reasonable service at reasonable rates.

(See South Pasadena v. Pasadena Land.
etc. Co. (1908) 152 Cal. 579. 587-588,

594 (93 P. 490]}.) Such an acquiring
city, as to the water dedicated to the
use of the outside community, holds
‘title as a mere trustee, bound to apply

it to the use of those beneficially

121

~~

interested. ' (Id.. at p. 594; see
Durant v. City of Beverly Hills, supra.
39 Cal.App.2d 133, 138.) .. ." (County
of Inyo v. Public Utilities Com., supra.
26 Cal.3d 154, 159. Emphasis added.) 2°
See also People ex rel City of Downey v.

Downey County Water Dist. (1962) 202
Cal.App.2d 786, 797.)

These common law rules are

illustrated in Austin View Civic

Association v. City of Palos Heights
(1980) 811 Ill.App.3d 89. (405 N.E.2d

1256). In that case, defendant purchased
two private water companies that were
supplying water to residents in the
unincorporated area. It also entered
into a contract with the City of Alsip

to obtain water which originated in the

25conversely, the relationship
between a private utility company and
its customers is not that of trustee and
beneficiary. (Board of Commrs. v. New

York Telephone Co. (1926) 271 U.S. 23,
31 (60 L.Ed. 808.)

122

City of Chicago. Under this contract,
defendant was required to pay to the
City of Alsip, who in turn must pay to
the City of Chicago, a 50 percent
surcharge over the normal price for
water delivered to nonresidents.
Defendant then elected to require
nonresidents to pay 25 percent more for
all water from whatever source,
delivered to nonresidents. In reversing
the order dismissing the class action.
the Illinos court said:

", . . The business of supplying
water belong to that class of
enterprises upon which the public
interest is impressed. [Citations.] At
common law, such an enterprise, because
it had a monopoly on the service
provided in the area, was prohibited
from charging exorbitant rates and was
required to serve all of its consumers

without reasonable discrimination in

123

SST

rates or manner of service. [Citations.]
Today, private utility companies are
prevented from charging exorbitant rates
or from engaging in unreasonable
discrimination in rates or manner of
service by statute, and are no longer
subject to the common law [citation].
Though there is no statute that prevents
municipal corporations that operate
public utilities from acting in an
unreasonably discriminatory manner,
there is still the common law duty that
prevents them from doing so." (405
N.E.2d 1256, 1262.)

The court noted that consumers of
municipally owned utilities are just as
completely protected from exorbitant
rates and unjust discrimination as the
consumers are under the Public Utilities
Act. Hence, the test to be applied in
determining whether there has been a

violation of the common law right is the

124

same test used to determine whether a

privately owned utility company is
acting in an unreasonably discriminatory
manner. The court said:

"When a privately owned utility is
charged with unreasonable discrimination
in rates, the test used for deciding
the validity of the difference in rates
is to determine whether the difference
is reasonable, and not arbitrary, based
on a consideration of such factors as
differences in the amount of the product
used, the time when used, the purpose
for which used, or any other relevant
factors reflecting a difference in costs
[citations]. If the difference in rates
is reasonably related to a difference in
the costs of providing the service,
there is no unreasonable

discrimination." [405 N.E.2d 1256.

1265.)

Because the complaint alleged that

125

the rate structure was arbitrary and
discriminatory, because it bore no
reasonable relationship to a difference
in the costs of providing water to
nonresidents, then evidence had to be
presented to refute that contention.
While defendant may have had the power
to enter into a contract with another
municipal corporation for the purpose of
procuring a supply of water, it did not
have the power to enter into a contract
which would discriminate against
nonresidents. (405 N.E.2d 1256, 1266-
1267.)

Finally, it should be remembered
that nonresidents are protected by the
earlier contract between the city and
the private water companies. While the
city is not under the jurisdiction of
the Public Utilities Commission, if,
after the commission has fixed the

conditions of sale, the city purchases ;

126

the private water companies. the city
may not disregard those conditions.
Thus in Henderson v. Ov -W dott
Irr. Dist. (1931) 213 Cal. 514, 526-534,
where the contract guaranteed that the
consumers outside the district pay the
same total costs for water, the district
could not impose a 50 percent surcharge
for nonresident use, to substantially
extend se=vice within the district.

In Rutherford v. Oroville-Wyandotte

Irr. Dist. (1932) 215 Cal. 124. cert.
den. 287 U.S. 609, the Supreme Court

issued a writ of mandate requiring the
district to grant water service to a
nonresident at the same rate charged to
residents.

The district persisted in attempting
to obtain additional funds for
nonresidents and chose to impose a
standby charge of $2.00 in addition to a

standard 46.00 rate. The standby charge

127

was imposed whether water was used or
not. Coincidentally, the district
reduced the tax on lands belonging to
residents from $3.00 per acre to $ .10
per acre.

The Supreme Court recognized that
the standby charge imposed upon |
nonresidents was designed to defray
additional expenses to seCure additional
rights for the exclusive benefit of
those within the district. The court
ruled that the amount chargeable against
inside users in extending the works of
the district could not be included in
the charge made against outside users.
It held that inside and outside
users must be charged the same rate.
(Rutherford v. Oroville-Wyandotte I.
Dist. (1933) 218 Cal. 242, 250.)

With these principles in mind, we
now examine the proffered justification

for the surcharge.

128

4. ALTHOUGH A MUNICIPALITY MAY
PROVIDE ITSELF WITH FREE SERVICE AND MAY
ESTABLISH KZESERVES, THE UTILITY MAY NOT
EXCLUDE OTHER WATER REVENUES OR IMPOSE
AN IN LIEU TAX OR MAKE ANY OTHER
UNREASONABLE DISCRIMINATION, IN SETTING
DISCRIMINATORY RATES TO NONRESIDENTS
PREVIOUSLY SERVED BY A PRIVATE WATER
COMPANY.

A. Free Service

There is no legal reason why a city
which owns and operates its water or
sewer system should take money from its
own taxpayers to pay itself for the use
of its own waterworks or sewers. This
is simply not equivalent to the public
utilities doctrine which prohibits the

rendition of free public service to
preferred customers. (See Gericke v.

City of Philadelphia (1945) 353 Pa. 60
(44 A.2ad 233, 237)? Camden County v.

Pennsauken Sewage Authority (1953) 28

129

N.J. Super. 586 (101 A.2d 361, 362);
Twitchell v. City of Spokane (1909) 55
Wash. 86 (104 P. 150, 151).)

For the guidance of the trial court,
the revenue associated with what appears
to be a reasonable allowance
for free city use should be totally
excluded from the calculations.
Otherwise, if, as the trial court
suggested, revenue imputed to this free
service was included in the overall
calculation, then there is a real risk
that the nonresidents would be charged
with a proportion of nonexistent
revenue.

B. Reserves

Municipally owned utilities may charge
rates to finance needed replacement, or
expansion of the facilities. (Pub.
Util. Code. sec. 10003 (to complete,
reconstruct, extend, enlarge and repair

water facilities).) American

130

Microsystems. Inc. v. City of

Santa Clara. supra. 137 Cal.App.3d 1037.
1040. (to create funds for new
construction) Cramer v. City of San
Diego (1958) 164 Cal.App.2d 168,
169,173, (funds used to pay for
extending or improving the sewer system)
Western Heights Land Corp. v. City of
Ft. Collins (1961) 146 Colo. 464 (362
P.2d 155, 158) (rates can be established

to extend the service and replace
facilities outmoded by depreciation and
obsolescence) City of Mt. Vernon v.
Banks (Ky 1964) 380 S.W.2d 268, 271 (65
percent increase in water rates was
justified to finance a sewer systen.
Prudent management contemplates
contingencies and conserves assets

needed for normal growth, maintenance

and improvements) Rankin v. Chester

Municipal Authority (1949) 165 Pa.
Super. 438 (68 A.2d 458. 462. 464) (the

131

authority was committed to provide a new
source of water, including a dam 40
miles away, and a pumping station. An
increase in rates to provide a new
source of water is not a tax) Pabst
Corp. v. Railroad Commission (1929) 199
Wisc. 536 (227 N.W. 18, 20) (funds
should be available to facilitate
continued development, so that the
quality and abundance of the supply will

be well in advance of actual needs of

the community) Laramie Citizens for Good
Government v. City of Laramie (Wyo.
1980) 617 P.2d 474, 484 (rates should
take into account the cost of
construction and operation, necessary
expansion, reserve for depreciation and
debt retirement).

Unlike the situation in Rutherford
v. Oroville-Wyandotte Irrigation Dist.
supra, 218 Cal. 242, 250, the connection

to the state water project will not

132

be merely for the benefit of city
residents. If and when the actual
connection is made, all consumers will
equally derive whatever benefit is
obtained from the additional water
supply. While a private utility could
not include such a contingent water
supply in its rate base, there

was no evidence before the trial court
that the decision to reserve rights to
state water was an imprudent
investment, or that other less costly
alternatives existed for future
expansion. (See generally. Pub. Util.
Code. sec. 10153.)

We part company with the city on the
subject as to whether such a protected
enormous experse should, by some process
of alchemy, ve treated as an asset for
rate making purposes sufficient to
justify a discrimination against

nonresidents. The city had not even

133

begun the task of physically connecting
its system to the state water project,
so it cannot be categorized as work in
progress. Remember too, that the Mound
and Saticoy customers became city
customers before the city ever began
paying on its state water obligation.
The nonresidents are not specially
benefited by this expenditure. Yet,
under the city's reasoning, they should
continue to pay $1.70 for each $1.00
contributed by their neighbors who
possibly live across the street, but
within city limits. We do not agree.
The obvious solution, of course, is

to treat this as a liability to be paid
by nonresidents and residents alike. It
should not be employed to discriminate
among similarly situated customers.

Cc. W wed Se es a

Rent
When the city lends its employees to

134

the utility, and acts as landlord, the
city is entitled to compensation.

Unless the utility pays the city that
which it would have to pay to private
individuais for rent, management, fiscal
and legal services, the utility

rate payers are getting a "free ride" at
the expense of city taxpayers who are
furnishing the service. (State ex _
rel. Lloyd v. Hurd (Ohio App. 1964) 1
Ohio App.2d 447 (205 N.E.2d 116, 118),
(35 percent of municipal salaries,
including the auditor, solicitors,
mayor, and city council salaries, were a
charge against the municipal light
plant) Borough of Ambridge v.
Pennsylvania Public Service Utility
Commission (1939) 137 Pa.Super. 50 (8
A.2d 429, 432) (salaries of all persons
directiy employed.and a just portion of
executive officers whose time is partly

devoted to the business should be

135

included) Hastings v. Village of Stowe,

Electric Department (Vt. 1965) 214 A.2d
56. 60 (municipal utility allowed

expenses for renting a warehouse).
However, the utility must prove that it
incurred labor expenses. (See e.g.,
Garden Water Co. (1968) 68 Cal.P.U.C.
751, 755.) (The record did not persuade
the Commission that the salary
allocation percentages were in fact
based upon a study of employees' time
actually engaged in construction and
operations).

The city did not attempt to prepare
documents reallocating the proportions
of city salaries attributable to water
service until shortly before trial
began. Its new allocation is somewhat
inconsistent with its earlier statement
to the effect that the water department
was entirely self-supporting. While we
might question the admissibility of

136

these documents prepared long after the

services were rendered (Evid. Code. sec.
1280 (b) and (c)); see Elsworth v. Beech
Aircraft Corp. (1984) 37 Cal.3d 540,
554) this evidence ultimately was
received without objection.

D. Exclusion of Income and Expenses

From Nonpotable Water.
While under public utility law

different types of service may be
separately classified, we know of no
decision which allows a utility to
exclude income and expenses from one
particular class of customers, so as to
create a feigned distinction for rate-
making purposes between customers
receiving the same service and who are
Similarly situated. Several cases
demonstrate that this practice is

unfair, if not pernicious.

In Marshall Durbin & Co. v. Jasoer
Utilities Bd. (Alabama 1983) 437 So.2d

137

1014, the court acknowledged that it was

not per se improper to combine a water,
sewer and gas system for the purpose of
rate making. However, it appeared that
the gas rates were excessive and
arbitrary. While the system as a whole
earned 2.18 percent to 6.51 percent
during the period in question, and a
proper rate of return for gas services
ranged from 7.79 percent to a maximum of
10.38 percent, the actual rate of return
on gas service was 42.12 percent one
year, 60.86 percent a second year, and
73.20 percent a third year. The court
said: "A consolidated utility may
establish rates which in effect, allow
one component of the system to subsidize
another component, where the overall
rate structure is reasonable.
Nevertheless, the profit on any one
system may not unduly burden the

customers with rates which are

138

unreasonable in order to lower rates for

other services. (437 So.2d 1014, 1020.)
The Alabama court ruled that the
gas rate was unlawful and that a
customer might recover damages at common
law resulting from discrimination by a
utility as to rates or services. The
customer was entitled to a refund. To
hold otherwise would create a situation
where a utility could set a clearly
unreasonable, even exorbitant rate,
collect it during prolonged litigation,
and then be relieved of the duty to make

a refund. (437 So.2d 1014, 1026.)

In Pennsylvania Public Utility

Co ss v. Johnstown Water Co. (1957)
19 P.U.C.3d 433, 450, the proposed rates

for a company operating a gravity system
for customers in areas of lower
elevation and a pumping system in areas
of higher elevation were discriminatory

in that the proposed rates would impose

139

a large segment of the pumping system
expense upon the customers served by the
gravity systen.

ln Jager v. State (Alaska 1975) 537
P.2d 1100, the rate of $1.49 per MCF for
residential service produced 53 percent
of the total revenues and 63.8 percent
of pretax profits on only 25 percent of
the volume of gas sold. Conversely,
the rate for service subject to
interruption to cities, electric
companies, and military customers was
between .34 cents to .55 cents per MCF.
It produced 36.2 percent of the pretax
profits. Because each class of
customers was responsible for roughly
equal operating costs, the court
directed the Public Utilities Commission
to entertain the issue of discrimination
in the rate structure.

The exclusion of the nonpotable

revenues and expenses appears to have

140

resulted in a surcharge approaching 30
percent upon nonresident potable water
users. This alone justifies the
reversal of the judgment. "Profits of
the past cannot be used to sustain
confiscatory rates for the future."
{Board of Commissioners v. New York
Telephone Co., su » 271 U.S. 23, 32.)
tio e
Justified Because Casitas Water is More

Costly.
Although one of the city's experts

believed that

a 76.9 percent surcharge could be
justified on the theory that the
nonresidents created the need to
purchase additional and more costly
water from Casitas, we already know that
the assumption is erroneous because a
large proportion of nonresidents are not
technically eligible for unblended

Casitas water because they live to the

141

east of the area where the Casitas

boundaries bisect the city. Yet, the
theory itself is alien to public utility
law.

In Butte County Water Users Assn.
v. Railroad Commission (1921) 185 Cal.

218, it was claimed that a consumer of
public water company had a vested right
to service in preference to later
customers, so that their rights were
ranked, in the order of the time that
each became a customer. The court said:
"This is a rather novel doctrine and one
whose statement alone is well-nigh
sufficient for its rejection. .. [A]
public utility must hold itself out as
ready to serve and must serve the public
or its portion of the public without
discrimination or p

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385017_0594%3A2. Public record. Not legal advice.