Appendix — D. C. Transit System, Inc. v. Democratic Central Committee of the District of Columbia

Supreme Court brief1974

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APPENDIX A

Anited States Court of Appeals

FOR THE DISTRICT OF COLUMBIA CIRCUIT

No. 21,865

Democratic CentraL CoMMITTEE OF THE

District or Cotumsia, ef al., Peririoners

WasHinctron Merropouitan AREA TRANSIT ComMMISSION,

RESPONDENT

D.C. Transit System, Inc., IN TeERVENOR

Petition for Review of an Order of the

Washington Metropolitan Area Transit Commission

Decided June 28, 1973

Landon G. Dowdey, with whom S. David Levy, Neil J.

Cohen and William A. Grant were on the brief, for peti-

tioners.

Douglas N. Schneider, Jr., General Counsel, Washington

Metropolitan Area Transit Commission, for respondent.

Harvey M. Spear for intervenor.

LEARNER ETD LEI CEOS LE OE HEAL PEELE LANL LOL ELE LEIA

Before Rostnson and MacKinnon, Circuit Judges, and

Davis,* Judge, United States Court of Claims.

Opinion for the Court filed by Circuit Judge ROBINSON.

Opinion concurring in part and dissenting in part filed by

Circuit Judge MACKINNON, at p. 93.

Ropinson, Circuit Judge: This petition subjects to re-

view Order No. 773 of the Washington Metropolitan Area

Transit Commission’ in an aspect untouched hy today’s

Powell decision.? Petitioners assert, as their major con-

tention, that the Commission should have taken into ac-

count, in the fare-setting process leading to that order, the

amount hy which properties which Transit had transferred

from operating to nonoperating status had appreciated in

value while in service. We conclude, in the circumstances

peculiar to Transit as a public utility, that the Commission

erred in refusing to treat the excess of market value over

book value of the properties when transferred as an offset

to higher fares.* To that extent we hold Order No. 773

invalid and direct the remedial steps to be taken. In the

other respect in which the order is complained of, we affirm

the Commission.*

* Sitting by designation pursuant to 28 U.S.C. § 293(a)

(1970).

1 D.C. Transit Sys., Inc. (Order No. 773), 72 P.U.R.8d 113

(WMATC 1968).

2 Powell v. Washington Metropolitan Area Transit Comm’n,

No. 21,750 (D.C. Cir. June 28, 1973).

3 See also Bebchick v. Washington Metropolitan Area Tran-

sit Comm’n, No. 23,720 (D.C. Cir. June 28, 1973); Demo-

cratic Cent. Comm. v. Washington Metropolitan Area Transit

Comm’n, No. 24,398 (D.C. Cir. June 28, 1973).

4 See note 16, infra.

BACKGROUND

The evolution of Order No. 773 is summarized in our

Powell opinion.’ We need add only the events of record

which bear particularly on the transferred assets." All are

parcels of real estate which in times past were employed

by Transit in mass transportation operations, but which,

after later losing their usefulness for that purpose, were

withdrawn from service. These withdrawals are reflected

by entries on Transit’s books recording the removals—in

utility jargon, from “above the line” to “below the line”—

and denoting Transit's continuing interest in the properties

as investments. In some instances, Transit retains direct

ownership; in others, Transit has conveyed to a wholly-

owned subsidiary, and in still others it has made an out-

right sale. It appears without controversy that the market

value of the unsold properties at the time of transfer below

the line has invariably exceeded their value as tabulated on

Transit's books.’

During the course of the proceeding before the Com-

5 Powell v. Washington Metropolitan Area Transit Comm'n,

supra note 2, at 2-5.

® Many important facts pertaining to these properties are

in dispute. We need not, for present purposes, undertake to

resolve the disputes, and in any event we are not in position

to do so. Simply as a point of reference, we reproduce, as an

appendix to this opinion, the representation made in the

Commission’s brief, al to a3, in Democratic Cent. Comm. v.

Washington Metropolitan Area Transit Comm'n, supra note

3. Our disposition of this case includes prominently a direc-

tion to the Commission to identify the properties and the

material facts as to each. See Part V, infra, following note 387.

7 Witnesses before the Commission had so testified, and

Transit’s counsel conceded as much.

: ‘ Cahn ea bee ORANGE LE MIE TTAN sry POO LD Gr ea

aA AA al _ .

mission, petitioners endeavored to probe into Transit’s

helow-the-line real estate, Transit’s interrelationships with

its subsidiaries, and the market value of withdrawn realty

held by either. Transit resisted those efforts, maintaining

that the properties belonged exclusively to its investors,

and that information concerning them was irrelevant to the

fare investigation in which the Commission was engaged.”

The Commission, subscribing to Transit’s basic premise,

ruled that petitioners’ inquiries had but limited pertinence

to the proceeding.” It direeted that some of the sought-

after information he made available to petitioners, but

*In speaking of Transit’s “investors” we employ the lan-

guage of ratemaking litigation. We are fully aware of the

fact that Transit is a wholly-owned subsidiary of another

corporation.

® Transit’s counsel argued

that it is virtually axiomatic that non-depreciable prop-

erty upon which no return is allowed, upon which no

depreciation is allowable, and non-operating property

upon which no return is allowed in a rate base pro-

ceeding, and upon which no depreciation is allowed,

are both matters which are not properly within the

province of a rate proceeding.

Counsel had earlier assumed a broader position:

[T]he appraised market value of non-operating prop-

erty does not belong in a rate proceeding. It is not part

of what this Commission can consider as far as the rate

of return is concerned, and it is not part of what af-

fects the rate structure which any member of the pub-

lic pays. If there is a loss on the sale of that real estate

the stockholders bear it, and if there is a profit on the

sale it goes to the stockholders of the company... .

[N]one of these items requested here today as to non-

operating properties are relevant in this proceeding .. .

and the company will decline to furnish that informa-

tion at this time because we don’t think it is relevant.

1° See note 11, infra.

FRM INT NOE MEME PIMA NTE LIN IF RT REALS BOT I TO MRS I OP MR

—0a

refused to require disclosure of any market-value data on

the properties."

Not surprisingly, then, Order No. 773 reflects no con-

sideration whatever by the Commission of rises in the value

of the transferred assets during the course of structuring

the increased fares which that order awarded. Petitioners

filed a timely petition for reconsideration" containing,

inter alia, what may fairly be characterized as a request

that the Commission devise ways and means of giving Tran-

‘The Commission’s chairman declared “that the proceeds

from non-operating property belong to the stockholders of

the company and not to the rate-payer,” but felt that the in-

formation requested was not completely irrelevant. Since

some of the information had been supplied the Commission’s

staff by Transit, the chairman instructed the staff to make

certain of it available to petitioners’ counsel. The chairman

ruled, however, that neither the staff nor Transit would be

required to disclose information regarding the current mar-

ket value of the properties, and, addressing petitioners’ coun-

sel, that “[i]f that is information you think is pertinent or

you think should be in the record it will be up to you... to

adduce that evidence.”’ Petitioners, later undertaking some-

thing of a showing as to market value of the properties, in-

troduced the valuation of the properties for tax purposes and |

testimony assuming that the assessments approximated 55% |

of true market value.

'2See Washington Metropolitan Area Transit Regulation

Compact, tit. II, art. XII, §16 (Transit Regulation Com-

pact), incorporated into Pub.L. No. 86-794, 74 Stat. 1031

(1960), with amendments, appearing as a part of Pub.L. No.

87-767, 76 Stat. 764 (1962), set forth following D.C. Code

§ 1-1410a (1967). Title II of the Transit Regulation Com-

pact is the Washington Metropolitan Area Transit Authority

Compact (Transit Authority Compact), which is incorpo-

rated into Pub.L. No. 89-774, 80 Stat. 1824 (1966), and is

set forth following D.C. Code § 1-1431 (1967). In this opin-

ion, we refer to the Transit Regulation Compact and the

Transit Authority Compact together as the “Compact.”

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SRS mee Hs ARN wet EAR REE UATE RNA E SNES RT ARYAN LMG SIT BRS EY aaa EY, win AE NINE APH

sit’s farepayers appropriate credit for the appreciation in

value of the properties while in service. By Order No. 781,

the Commission denied the petition,” and by Order No.

78la stated its reasons for doing so."* The Commission's

statement, like Order No, 773 itself, is devoid of anything

which we can identify as a response to petitioners’ entreaty.

And so it is that the theory underlying their plea is pre-

sented here," now to support the charge that the Commis-

sion was grievously in error."

We have painstakingly examined this serious charge in

all of its many ramifications, and in this opinion we set

" D.C. Transit Sys., Inc. (Order No. 781) (WMATC Feb.

26, 1968) (unreported).

"D.C. Transit Sys., Inc. (Order No. 781a), 74 P.U.R.3d

178 (WMATC 1968).

'* See Compact, supra note 12, tit. II, art. XII, $ 17.

'® Petitioners also allude to several other complaints they

have against Order No. 773, and ask for remand of the case

to the Commission for reconsideration in light of Williams

v. Washington Metropolitan Area Transit Comm'n, 134 U.S.

App.D.C. 342, 415 F.2d 922 (en bane 1968), cert. denied,

393 U.S. 1081 (1969), and Payne v. Washington Metropoli-

tan Area Transit Comm'n, 134 U.S.App.D.C. 321, 415 F.2d

901 (1968). In their brief, however, petitioners offer no ar-

gument whatever in support of these points. We accordingly

decline to consider them. Fed.R.App.P. 20, 28(a) (4); D.C.

Cir. R. 4(b) (5); Cratty v. United States, 82 U.S.App.D.C.

236, 243, 163 F.2d 844, 851 (1947); Abrams v. American

Sec. & Trust Co., 72 App.D.C. 79, 80, 111 F.2d 520, 521, 129

A.L.R. 368 (1940) ; S. S. Kresge Co. v. Kenney, 66 App.D.C.

274, 275 n.1, 86 F.2d 651, 652 n.1 (1936) ; Smith v. Pickford,

66 App.D.C. 206, 209 n.6, 85 F.2d 705, 708 n.6 (1936);

Schwartzman v. Lloyd, 65 App.D.C. 216, 218, 82 F.2d 822,

824 (1936); Helvering v. Helmholz, 64 App.D.C. 114, 117,

75 F.2d 245, 248 (1934), aff'd, 296 U.S. 93 (1935); Ginder

v. Giuffrida, 61 App.D.C. 338, 340, 62 F.2d 877, 879 (1932);

Wardman-Justice Motors v. Petrie, 59 App.D.C. 262, 267, 39

F.2d 512, 517, 69 A.L.R. 648 (1930).

en Nr a ak ee ak ale Tle aa semaacceanns nay

forth the results of our investigation. We begin in Part IT

with an exploration into the adjudicative history, adminis-

trative and judicial, of allocations of capital gains on oper-

ating utility assets. After that, in Part III, we serutinize

the interest of investors in value-appreciations on such

assets, with reference to treatments of that interest in rate-

and depreciation-base formulations and, more particularly,

in Transit’s ratemaking litigation. Next, in Part IV, we

identify the doctrinal considerations guiding allocations of

capital gains on in-service utility property and apply them

to this case. Then concluding that Order No. 773 is invalid

and must be set aside, we specify in Part V the basis for

and mechanics of remediation.

ADJUDICATIVE HISTORY OF ALLOCATION OF

CAPITAL GAINS ON OPERATING UTILITY ASSETS

Seldom have regulatory agencies or courts been called

upon to allocate, as between investors and consumers,

gains on utility assets while in operating status.'7 None-

theless, for the assistance and indispensable background

they may afford to resolution of the controversy at hand,

we must pause to examine this group of cases. In the

realization that problems of allocation may well differ

according to whether the asset is depreciable * or nonde-

7 No issue as to allocation of capital gains and losses once

an asset is transferred below the line is tendered to us on

this review.

** We use the word “depreciation,” as it is commonly em-

ployed in District ratemaking, to refer not merely to physi-

cal wear and tear but also to other types of diminution of

serviceability. E.g., D.C. Transit Sys., Inc. (Order No. 245),

48 P.U.R.3d 385, 397 (WMATC 1968), remanded sub nom.

preciable, we look first to the decisions treating allocation

issues in relation to depreciable properties.

A. Depreciable Assets

—Out-of-District Cases

Outside the District of Columbia, we find relatively little

authority precisely in point. In 1959, the question was

presented to the Appellate Division of the New Jersey

Superior Court” after a utility providing water service

made a profitable sale of a portion of its distribution

system, consisting of cast-iron mains and fire hydrants.”

In subsequent rate proceedings, the New Jersey Board of

Publie Utility Commissioners deducted the profit from the

utility’s earned surplus and credited it to its depreciation

reserve, in conformity with the board-adopted uniform sys-

tem of accounts for water companies. From 1931, when

the sale was made, to 1958, when the rate case was insti-

tuted, the utility had not complained of this treatment.

Aseribing controlling weight to the commissioners’ long

D.C. Transit Sys., Inc. v. Washington Metropolitan Area

Transit Comm’n, 121 U.S.App.D.C. 375, 350 F.2d 753 (en

banc 1965), on remand sub nom. D.C. Transit Sys., Inc. (Or-

der No. 563), 63 P.U.R.3d 32 (WMATC 1966), rev'd sub

nom. Williams v. Washington Metropolitan Area Transit

Comm'n, supra note 16, where the Commission said:

Depreciation is the exhaustion of the service life of the

property in use. The accrued depreciation in the prop-

erty at a given time is the sum total of the exhausted

service life of the various units of the property at that

time. This exhaustion of service life is the combined re-

sult of the working of three factors, namely: (1) in-

adequacy, (2) obsolescence, and (3) physical deteriora-

tion.

19 Jn re Revision in Rates Filed by Plainfield-Union Water

Co., 57 N.J.Super. 158, 154 A.2d 201 (1959).

20 154 A.2d at 205, 211.

standing construction of their own regulation—the account-

ing system preseribed—the court found no error in the

challenged adjustment.”

In the same year, a similar question arose in a rate pro-

ceeding before the Minnesota Railroad and Warehouse

Commission.” During its historical test period, a transit

company sold obsolete buses and treated the proceeds as

nonoperating income. This was held to be improper.** “The

Uniform System of Accounts prescribed by this Commis-

sion,” said the agency, “requires that such salvage * ‘shall

be credited to the depreciation reserve account. “* In its

words, the agency accordingly “added this income from

sale of obsolete buses to operating income in determining

actual operating results... ."** “{A|ny further income

from sale of obsolete buses or equipment,” the agency

added, “will be treated . .. as a reduction in depreciation

expense and, thus, as an increase in operating income.” =

A few years later, the Wyoming Publie Service Com-

mission faced essentially the same problem in a variant

context." A utility engaged in selling natural gas pur-

21 154 A.2d at 211.

22 Minneapolis St. Ry. Co., 31 P.U.R.3d 141 (Minn. R.R.

and Warehouse Comm’n 1959).

= Id. at 152.

24 The agency’s reference to salvage, viewed in context, is

seemingly to the entire proceeds of sale, and not simply to the

amount of future recoupment originally estimated for depre-

ciation-computation purposes.

25 31 P.U.R.3d at 152.

26 Jd.

27 Id.

28 Wyoming Gas Co., 40 P.U.R.3d 509 (1961) (Wyo. Pub.

Serv. Comm'n 1961).

SR e ec oe paths - --

10a

chased mineral interests in lands, including a gas-producing

well. The utility thus became entitled to a depletion allow-

ance on the purchased assets.” After taking some gas

from the purchased properties for its southern division

customers, the utility sold them at a profit. Regulatory

approval of the sale had been accompanied by a direction

to treat the profit as utility income. In a later rate pro-

ceeding, the Commission reiterated its position that the

profit “must be treated as nonoperating utility income.” *

The theory underlying the order approving the sale, the

Commission said, was that “the profit to be made by the

company upon the sale thereof should be used to reduce

its . . . natural gas rates, rather than increase them.” **

“As we view the transaction,” the Commission explained,

“the company will simply make the substantial profit from

the sale of utility properties dedicated to its southern

division operations, which, in our opinion, should inure to

the benefit of the ratepayers in that division.” ”

Such are the decisions outside this jurisdiction. In each,

the entire gain from disposition of depreciable assets was

passed on to the utility's consumers, to the exclusion of

its investors. While it is true that two of the decisions were

influenced by agency-adopted accounting practices, it must

be remembered that such practices are but reflections in

accounting technique of what is generally considered whole-

some in substantive principle. And the principle to be

gleaned, both from the practices and the decisions them-

selves, is that consumers have the superior claim on capital

gains achieved when depreciable utility properties are re-

moved from service. We do not suggest that so small a

2° See Part V(A), infra, at note 222.

30 40 P.U.R.3d at 513.

31 Td.

32 Jd.

IIOP PAE IE NILE LS OD IG te RD yy pers

lla

number of cases establish a rule of general and controlling

applicability in the ratemaking field. But it can hardly be

denied that these decisions are precedents of value in simi-

lar litigation.

—District Cases

Within, much as without, the District of Columbia the

problems of allocating value-appreciation of depreciable

inservice utility property have but infrequently arisen be-

fore either regulatory agencies or courts. And the litigation

locally, such as it has been, has invariably involved Transit

and, by the same token, the peculiarities inherent in its

situation. That is to say not only that the reasoning fol-

lowed elsewhere obtains as to Transit, but also that addi-

tional reasons leading to similar results flow from Transit’s

uniqueness, in comparison with other utilities, with respect

to properties transferred below the line. Not surprisingly,

then, the claim of Transit’s farepayers on capital gains ac-

cruing to such properties while above the line has achieved

considerable fruition.

The leading case, and one which merits careful analysis,

is D.C. Transit System, Inc. (Order No. 4577).3* There the

Commission's predecessor, the District of Columbia Public

Utilities Commission (PUC),"* addressed the question of

allocating the profits on a sale of Transit’s Fourth Street

Shops and Southern Carhouse to the District of Columbia

Redevelopment Land Agency. Of the total sale price of

$3,320,000, Transit proposed to credit all of the net profit of

$2,181,363.08 to earned surplus, and thereby to pass it on

to its investors.* This, PUC held, it could not be permitted

to do.

33 30 P.U.R.3d 405 (D.C. Pub. Utils. Comm’n 1959).

34 Now the District of Columbia Public Service Commis-

sion.

35 30 P.U.R.3d at 406.

;

diene a eT Ee READ aeccecmgee 2

NONE

12a

As PUC determined, $1,039,657.72 of the sale price was

attributable to land,** $1,915,034.81 to depreciable improve-

ments on the land,* and the remainder to items not of

present concern** PUC noted that strict adherence to the

uniform system of accounts employed by it would require

that the total amount received on disposition of depreciable

assets—here $1,915,034.81—be credited to the depreciation

reserve as salvage.*” Since to have done that would, by

PUC’s caleulations, have built the reserve to a point greatly

in excess of the sum needed to retire all unrecovered origi-

nal cost of the improvements,” PUC felt that a departure

from normal accounting procedures was warranted."

36 Jd. at 407, 409. So, after subtracting $89,089.17, repre-

senting the original cost of the land, a net profit of $950,-

568.55 was realized on this aspect of the sale. Jd. at 407, 409,

411.

37 Jd. at 409. Original cost of this portion of the sold prop-

erty was determined to be $1,077,824.06. Id. The depreciation

reserve on the improvements was then $613,661.28, leaving

$464,162.78 as the unrecovered original cost. Id. at 411. Thus

net profit on the sale of the depreciable portion of the prop-

erty was $1,450,872.03—the sale price of $1,915,034.81 less

unrecovered original cost of $464,162.78.

38 See id. at 407-09. A part of the remainder was $36,-

550.92, net, representing so much of the sale price as was re-

lated to certain equipment and machinery. Because of uncer-

tainty as to the items of equipment and machinery included

in the sale, PUC placed that amount in a suspense account

pending ascertainment, “at which time determination will be

made as to what portion thereof should be credited to the

depreciation reserve and what portion, if any, should be

credited to earned surplus.” Jd. at 409.

39 Jd. at 410.

4° The unrecovered portion of original cost was $464,162.78,

that is, original cost of $1,077,824.06 less depreciation re-

serve of $613,661.28. See note 37, supra.

4130 P.U.R.3d at 410.

EA TPR ae ar CE Se

RI HES ERASE BONES Y

13a

In regard to the extent of the departure, PUC noted

that Transit’s operating franchise demanded of it a seven-

year program of gradual conversion from a streetcar-bus

to an all-bus operation,*? and PUC was “unable to disasso-

ciate the instant transaction from the imminent retirement

of all rail property under the mandate contained in the

Franchise.” ** Nor could PUC “ignore the probability that

full provision for depreciation will not have been provided

when the rail facilities are abandoned and retired by reason

of conversion.” “4 Observing that Transit had consistently

asserted, and PUC’s staff had indicated agreement, that

any retirement loss in this connection was recoverable by

charges against the farepayers,“” PUC emphasized that “if

the customers are to be required to bear the burden of

extraordinary retirement losses incident to the whole con-

version program, it appears equitable that they should

share, at least to some extent, in extraordinary retirement

gains of the nature here under consideration.” **

PUC concluded, then, that of the total net profit of

$1,450,872.03 realized on the sale of the improvements,”

42 Transit had purchased the assets of Capital Transit

Company, its predecessor, which for many years had oper-

ated a system of transportation by streetcars and buses in

the Washington metropolitan area. The obvious purpose of

the franchise provision mentioned in text was to eliminate

the streetcars. This matter is discussed more fully in Part

IV(B), infra.

43 30 P.U.R.3d at 412.

4 Td.

45 Jd. That such losses did fall on Transit’s farepayers sub-

sequently became the fact. See Part IV(B), infra, at notes

243-46.

46 30 P.U.R.3d at 412.

47 See note 37, supra.

‘

2%:

i PRESS —™ aS SS ey ~ ow ~

l4a

$613,661.28 should inure to Transit’s consumers and $837,-

210.75 to its investors.* “This approach,” it said, “takes

into consideration the right of the company to recover

from its customers through depreciation the loss of service

value over the life of the property as measured by the

original cost of the property less net salvage realized upon

retirement.” That treatment, in PUC’s view, “provides

an equitable solution to a difficult problem maintaining, as

| far as possible, what seems to be fair balance between

the interests of the public and those of the company’s

investors.” °°

PUC’s allocation of the profit on the improvements on

the Fourth Street Shops and Southern Carhouse subse-

quently came under direct judicial review at Transit’s

instance, and we held that PUC’s treatment was not arbi-

trary or unreasonable. That allocation also entered into

this court’s consideration of another problem several years

later. In D.C. Transit System, Inc. v. Washington Metro-

politan Area Transit Commission;? an expense allowance

to Transit for unrecovered costs of abandoned rail facilities

was contested on grounds which included reference to that

sale. The argument was that the sale was occasioned by the

conversion program required by Transit’s franchise,*> and

that for that reason the profits made on the sale should be

regarded as recoupment of obsolescence.** In rejecting the

48 30 P.U.R.3d at 411.

49 Td.

50 Td. at 412.

51 D.C. Transit Sys., Inc. v. Public Utils Comm’n, 110 U.S.

App.D.C. 241, 292 F.2d 734 (1961). See also Part III(B),

infra, at notes 89-99.

52 Supra note 18.

53 See note 42, supra, and accompanying text.

54 121 U.S.App.D.C. at 397, 350 F.2d at 775. The same argu-

ment was made with reference to a capital gain achieved

ERAS LPP LILLE LLY OE POE EINE LIE LIEN ELT LE AHA RAT

lda

argument, we noted that

PUC did not omit to give the riding public some con-

siderable share in the benefits of this sale... . [T]he

profit on the depreciable property which went into

surplus was $837,000. At the time of the sale, Transit

carried this property on its books at an historical cost

of $1,077,824, with an accrued depreciation reserve of

$613,661. Thus only $464,163 was required from the

proceeds of the sale to effect complete liquidation of

this investment. The PUC, however, ordered a total

of $1,077,824 he credited to the depreciation reserve,

representing not only the $464,163 but an additional

amount of $613,661 exactly duplicating the reserve

already accrued. Tt was this action that we think was

explained by the PUC’s comment that equitable con-

sideration suggested the riders should share in the

profits from the sale. Under all these circumstances,

therefore, we do not interefer with the Commission’s

discretion in deciding not to off-set the profits from the

Fourth Street Shop sale against the [expense allow-

ance for unrecouped investment in abandoned rail

facilities }.%

That, as PUC held in Order No. 4577,°° Transit’s fare-

payers have a legitimate interest in capital gains on op-

erating depreciable assets has never been doubted by its

successor, the respondent Commission. In D.C. Transit

System, Inc. (Order No. 245),°" the Commission recog-

nized that “ratepayers may have a claim to depreciable

property at least to the extent of the depreciation re-

serves.” °* It added “that ‘gains’ may be experienced on

on the depreciable portion of Transit’s Georgia and Eastern

Terminal. We discuss the disposition of that facet of the ar-

gument in Part IV(B), infra, at notes 292-300.

55 Id. (footnote omitted).

56 See text supra at notes 34-50.

57 Supra note 18.

58 48 P.U.R.3d at 399.

Sa ee a a a icc RNCR INS

l6a

disposal of depreciable items, and these are indeed used

as offsets to depreciation, under the heading of ‘sal-

vage’”.*® Later, in D.C. Transit System, Inc. (Order No.

563), the Commission, in finding no connection between

Transit’s track removal and repaving program and its

sale of its Georgia and Eastern Terminal," concluded

that “the ratepayer is not entitled to share in any portion

of the proceeds of that sale, unless there was a profit on

the depreciable portion of the asset sold,” * and found

that “[t]here was none in this case.” ® And even after

issuance of the order under review, the Commission has

declared that “[t]here is no question that, when depre-

ciable operating property is sold and a gain is realized,

the gain should be used to reduce the depreciation ex-

penses which ratepayers have paid but which the com-

pany, because of the gain, does not actually incur.” “

In the District, then, the law on the topic immediately

under discussion is already somewhat developed. Capital

gains realized on disposition of depreciable assets while

in service® do not automatically flow to Transit’s in-

vestors,” although extraordinary cireumstances may en-

59 Td. at 404.

69 Supra note 18.

8! See note 287, infra, and accompanying text.

6°63 P.U.R.3d at 34.

63 Td.

** D.C. Transit Sys., Inc. (Order No. 1090), 85 P.U.R.3d

508, 513 (WMATC 1970).

*> It may, of course, be that in given situations no gain is

realized. That was so in D.C. Transit Sys., Inc. (Order No.

563), supra note 18, discussed in text supra at notes 60-63.

66 This is clear from all of the decisions in the District.

eA H LIONS OT eT

a ial

17a

able them to share.®? On the contrary, Transit’s farepay-

ers have a protectible interest in such gains which extends

at the very least, to the amount of depreciation which has

been charged to farepayers and may well extend far be-

yond.®

B. Nondepreciable Assets

The question whether a gain on disposition of nonde-

preciable assets inures to investors as capital surplus, or

to consumers as a reduction in cost of service, has been

litigated even less frequently than has the question in re-

lation to depreciable assets. A survey of the few eases in

point outside the District of Columbia reveals, somewhat

paradoxically, a central strand of harmony amid diverse

results. The decisions within the District—all administra-

tive—have reached a uniform result, but without critical

analysis either of the problem or the precedents.

—Out-of-District Cases

In New York Water Service Corporation v. Public

Service Commission,” a utility sold, at a handsome profit,

land which had outworn its usefulness as a storage reser-

voir. Its regulatory agency held that for ratemaking pur-

poses the net profit reaped on the sale should be passed

on to its customers.” On judicial review, that adjudica-

®7 As in D.C. Transit Sys., Inc. (Order No. 4577), supra

note 33. See text supra at notes 39-41.

® As in D.C. Transit Sys., Inc. (Order No. 4577), supra

note 33. See text supra at notes 47-50.

12 App.Div. 122, 208 N.Y.S.2d 857 (1960).

™ New York Water Serv. Corp., 7 P.U.R.3d 32 (N.Y. Pub.

Serv. Comm’n 1955). The commission felt that amortization

of the profit from the sale over a seventeen-year period was

“the most equitable method of meeting the problem.” Jd. It

directed the utility to transfer the amount of the profit from

Re . — . B

18a

tion was sustained.” The court explained:

The uniform system of accounts approved by the

Commission applicable to water companies in dealing

with land used for utility purposes allows land sold

at a loss to be debited to the depreciation reserve and

thus increase the rate base. If land is sold at a profit,

it is required that the profit be added to, i.e., “credited

to”, the depreciation reserve, so that there is a cor-

responding reduction of the rate base and resulting

return. The utility is thus protected from a loss in the

sale of the land in its operations; it seems reasonable

it should pass on a profit to the consumer.”

As the opinion on review makes plain, the guiding prin-

ciple was that the gain belonged to those—investors or con-

sumers—who previously bore the risk of loss from pos-

sible decline in market value.

In City of Lexington v. Lexington Water Company,”

the pertinent facts were similar. The utility had acquired

land which for many years it used to collect water for

reservoirs, but when the reservoirs hecame inadequate

the land was retired from service and removed from the

utility’s rate base. Somewhat later, the land was sold,™

surplus to a reserve account and in each future year to

amortize one-seventeenth against the depreciation accruals

charged to operations. /d.

71 New York Water Serv. Corp. v. Public Serv. Comm'n,

supra note 69, 208 N.Y.S.2d at 863-64.

72 Id. at 864

73 458 S.W.2d 778 (Ky. 1970).

74 Neither of the two published opinions in the case informs

as to the time interval between the retirement of the prop-

erty from service and its sale. Assuming, without deciding,

that any appreciation in its value after retirement belonged

to the utility investors, there would remain the question

whether appreciation prior thereto would inure to the bene-

fit of its customers.

19a

and the utility distributed the very considerable profit

realized thereon to its investors as dividends. When the

utility subsequently sought a rate increase, its regulatory

agency ruled that its consumers were entitled to the gain.”

The agency, articulating essentially the same rationale

espoused in New York Water Service Corporation, eluci-

dated:

The question arises, should this gain, made on prop-

erty devoted to the public service over the years, be

used to reduce the cost of service to the customers or

should it be treated as a capital surplus item, and be

allowed to be paid out to the stockholders. . . ? Hav-

ing considered the evidence and arguments relating to

this matter, we are of the opinion that it should be

used to reduce the cost of service to the consumer.

The subject property was not purchased by the

utility as a land speculation but it was acquired for

providing utility service to the public over the years

and was subject to acquisition by condemnation.” In-

asmuch as utility property necessary for rendering

service to the public is not subject to sale at the op-

tion of the utility, but must be continued in service

as long as needed to provide that service, any loss

75 By the agency’s computation, the total net profit was

$2,415,846, of which $138,791 was attributable to miscel-

laneous improvements on the land. The latter portion of the

profit invites the problem of allocation of capital gains on

depreciable property. See Part II(A), supra. On judicial

review of the agency’s decision, City of Lexington v. Lex-

ington Water Co., supra note 73, the court did not distin-

guish between the two portions of the $2,415,846.

76 Lexington Water Co., 72 P.U.R.3d 253 (Ky. Pub Serv.

Comm’n 1968).

77 On review of the decision, the court stated that there

was a dispute as to whether the land had been acquired by

condemnation or the threat thereof. 458 S.W.2d at 778. The

court was of the opinion, however, that “whether the prop-

erty was acquired by threats of use of the power of eminent

domain [is] irrelevant.” Jd. at 779.

in service value of such property would properly be

considered a cost of providing service and, in the case

of depreciable property, is recovered through depre-

ciation. . . . For nondepreciable property, where the

change in service value cannot be determined until

actual disposition of the property, amortization of an

allowable loss or gain would be the proper procedure.

... If it is proper to recover losses of nondepreciable

property through amortization, then conversely it

should be proper to amortize gains on such prop-

erty.”

On review, however, it was held that the agency’s ruling

was erroneous. The court distinguished New York Water

Serrice Corporation ™® on the ground of a difference in the

accounting methods respectively employed by New York

and Kentucky regulatory authorities.*°° The Kentucky

agency had adopted a system of accounts providing for the

charging of losses and for the crediting of profits on land

sales, not to customers, but rather to the util'ty’s surplus

account.” On that premise, the court apparently believed

that the risk of capital gain or loss had actually been

borne entirely by the utility’s investors. On so much of

the case, the court would seemingly have sustained the

agency had the risk been on the utility’s consumers.”

™ Lexington Water Co., supra note 76, 72 P.U.R.3d at

259-60.

7 Supra note 69.

” For the New York practice, see text supra at note 72.

*! 458 S.W.2d at 779.

* The court, however, also relied upon a passage in Board

of Pub. Util. Comm'rs v. New York Tel. Co., 271 U.S. 23,

32 (1926):

Customers pay for service, not for the property used

to render it. Their payments are not contributions to de-

preciation or other operating expenses or to capital of

the company. By paying bills for service they do not

2la

In the only other reported decision we have found, the

problem was presented only obliquely. In Columbus Gas

€ Fuel Company v. Public Utilities Commission the

utility claimed that its annual depreciation allowance for

depreciable property other than well-structures and equip-

ment was inadequate because some items, consisting in

land and rights of way, had been omitted from the com-

putation.“ The Court denied the claim but in doing so in-

dicated that under different conditions the claim might

well have been valid.“ In relevant part the Court said:

Certainly lands and rights of way may not be char-

acterized as wasting assets in the absence of explana-

acquire any interest, legal or equitable, in the property

used for their convenience or in the funds of the com-

pany.

And from that the Court further concluded that “ [p] rofit

made from the sale of non-depreciable land no longer used

in serving customers is not an ingredient to be considered

in fixing rates. The customers had no interest in the profit

realized on the sale—it belonged to the stockholder” 458

S.W.2d at 780. In our view, New York Telephone Company

hardly sustains that proposition. There the Supreme Court

addressed the question whether consumers could benefit from

excessive depreciation, taken by a utility in prior years,

through an offset that would produce lower future rates. 271

U.S. at 26-31. The Court held that the assets representing

the excess in the reserve for depreciation could not be used

to make up a deficiency in current rates which rendered them

confiscatory. Jd. at 32. As the Court said, consumers do not

acquire an interest in utility assets merely by paying their

bills for service. Jd. at 32. That is not to say that the utility’s

investors have an indefeasibly vested right to gains arising

from the appreciated market value of capital assets. See dis-

cussion in Part III, infra.

*§ 292 U.S. 398 (1934).

Id. at 410-11.

8 Id. at 411.

Oo — <en en . ———_ .

22a

tion that would stamp that quality upon them. In say-

ing this we do not forget that an abandonment of the

business might bring about a sharp reduction in the

value of the plant, aside from well-structures and

equipment. There is nothing to show, however, that

any such abandonment is planned or even reasonably

probable. On the contrary, the course of business

makes it clear that when the fields in use shall be ex-

hausted, the business will extend to others, and this

for an indefinite future, or certainly a future not

susceptible of accurate estimation.

As the Court indicated, a loss on the investment in non-

depreciable elements of the utility’s plant resulting from

an unavoidable abandonment of its business would have

heen recognized if it had occurred, and that loss would

then have been chargeable to its consumers.’ One might

easily reason from this premise that an appreciation in

value of the nondepreciable elements would likewise be-

come cognizable, and properly would redound to the bene-

fit of the consumers.

In sum, the decisions outside the District have not

viewed capital gains on in-service nondepreciable utility

assets as inevitably belonging to investors to the exclu-

sion of consumers. Rather, in each of the cases—although

they are few—the allocation has depended upon location

of the risk of loss. These holdings, then, may be accepted

as applications of the broader principle that the benefit

of a capital gain follows the risk of capital loss.** So read,

they have our approbation.

—District Cases

The allocation properly to be made of in-service appre-

ciations in value of Transit’s nondepreciable assets is an

86 Jd.

57 See Part IV (A), infra, at notes 211-18.

88 See Part IV (A), infra, at notes 181-90.

23a

open question in this jurisdiction. Although both the Com-

mission and PUC, its predecessor in transit regulation,

have occasionally spoken to the subject, this court has

never before been called upon to face the issue. Our analy-

sis of the administrative decisions—which have uniformly

viewed such gains as belonging to Transit’s investors—

discloses that they leave a great deal to be desired.

In early 1959, as we have related, Transit received

$3,320,000 from the sale of its Fourth Street Shops and

Southern Carhouse to the District of Columbia Redevelop-

ment Land Agency.” Of a total net profit on the transac-

tion of $2,181,363.08,° $950,568.55 was attributable to

land.” In D.C. Transit System, Inc. (Order No. 4577) ,*?

PUC resolved a dispute between Transit and PUC’s staff

as to the accounting treatment to be accorded the capital

gain on the depreciable subject matter of the sale. At the

outset, however, PUC declared that it could “dispose of

one item not in controversy.” ™ It did, thusly:

The staff and the company are in agreement that un-

der public utility accounting. the difference between

the original cost of land and the selling price is recog-

nized as profit. The net profit of $950,568.55 on the

sale of the land (net proceeds of $1,039,657.72 less

original cost of $89,089.17) is, therefore, a proper

credit to earned surplus.”

We readily understand that the $950,568.55, as PUC

held, was net profit traceable to sale of the land. We are

*® See Part II(A), supra at notes 33-55.

* See Part II(A), supra at note 35.

*! See note 36, supra.

*2 Supra note 33.

* 30 P.U.R.3d at 409.

* Td.

24a

not nearly so clear, however, as to why PUC was confi-

dent that it was “therefore a proper credit to earned sur-

plus.” Tn other words, PUC does not tell us why it felt

that the profit automatically belonged to investors. It may

be that since the treatment to be given it was “not in con-

troversy,”* PUC deemed it a simple, indubitable ac-

counting problem. In any event, we are left with our

doubts.

Order No. 4577 was later to come under judicial review

by this court, but not in the aspect just discussed. By suit

brought in the District Court for the District of Colum-

bia, Transit attacked PUC’s disposition of the profits al-

locable to the depreciable portion of the property sold.”

Losing in that effort, Transit applied to this court, which

affirmed.” Our action, of course, did not encompass PUC’s

ruling as to the gain realized on the land, for that ruling,

favorable to Transit, was not brought before us. Still

later, in D.C. Transit System, Inc. v. Washington Metro-

politan Area Transit Commission,™ the sale of the same

property ®as given attention by this court but, again,

only in reference to the administrative disposition of the

profits on the depreciable part.”

In D.C. Transit System, Inc. (Order No. 245),' the

only other relevant decision in this jurisidetion, it was ar-

*5 Since the only party to the proceeding was Transit, no

such “controversy” was likely unless generated by the Com-

mission itself.

*6 See Part II(A), supra, at note 55.

*"* D.C. Transit System, Inc. v. Public Utils. Comm’n, supra

note 51.

* Supra note 18.

* See 134 U.S.App.D.C. at 396-97, 350 F.2d at 774-75. See

also the discussion in Part II(A), supra, at notes 52-55.

1” Supra note 18.

gued to the respondent Commission, without avail, that

Transit’s losses on the premature retirement of rail facili-

ties *"—which the Commission has passed on to Tran-

sit’s farepayers *°*—might be offset by gains which Tran-

sit realized upon the sale of certain real estate. The

properties sold were, again Transit’s Fourth Street Shops

and Southern Carhouse'™ and its Georgia and Eastern

Terminal.’® From aught that appears, nothing more than

allocation of the net profit attributable to the depreciable

portion of these properties was placed in issue before

the Commission, and surely the decision on our review

was that narrowly limited.” The Commission had, never-

theless, ventured a statement on the question as to which

we are now analyzing the precedents. The Commission he-

lieved that “[i]t is a cardinal principle of regulatory law

that a utility is not entitled to recover through deprecia-

tion charges or other accounting devices its investment

in land.”?” “This principle,” the Commission continued,

“stems from the fact that in some instances the value of

101 These were facilities acquired by Transit from its prede-

cessor, Capital Transit Company. Transit’s franchise required

that it convert to an all-bus operation, see notes 42, supra,

and 237, infra, and accompanying text, and in the process the

facilities in question became obsolete. See the discussion in

Part IV(B), infra, at notes 277-300.

102 See Part IV(B), infra, at notes 243-44.

103 48 P.U.R.3d at 403-04.

14 See Part II(A), supra, at notes 33-35, and this Part,

supra, at notes 89-99.

10 See Part II(A), supra, at notes 61-63.

196 See D.C. Transit Sys., Inc.. v. Washington Metropolitan

Area Transit Comm’n, supra note 18, 121 U.S.App.D.C. at

396-98, 350 F.2d at 774-76.

17 48 P.U.R.3d at 399.

26a

land appreciates and in other instances depreciates.”

So, the Commission said “[w]hile the ratepayers have a

claim to depreciable property, at least to the extent of the

depreciation reserves, no such claim can be directed to

land.” 1°

We are unable to follow this course of reasoning. With

a paucity of holdings, administrative or judicial, on the

point, we have not detected a hard-and-fast rule one way

or the other." Nor can we understand how the economic

fact that land values may trend upward or downward can

support the position on appreciation which the Commis-

sion assumed. The value of depreciable property, includ-

ing depreciable improvements on land, also rises and falls

with changing market conditions, and yet it is clear that

consumers may contend for any capital gain achieved while

it was used in service to the public.“ What seeps through

the Commission’s discussion, however, is the conviction

that the Commission has yet to consider factors which, at

least in Transit’s instance, bear importantly on the prob-

lem.

Ill

INTEREST OF INVESTORS IN VALUE-

APPRECIATION IN OPERATING UTILITY ASSETS

We perceive no impediment, constitutional or otherwise,

to recognition of a ratemaking principle enabling rate-

108 Jd.

109 Jd.

11 The Commission, like the Court in Lexington Water

Company, see note 76, supra, felt that Board of Pub. Util.

Comm’rs v. New York Tel. Co., supra note 82, “clearly resolves

the issue raised in this case concerning the proceeds from

nondepreciable property.” 48 P.U.R.3d at 400. We think other-

wise. See note 82, supra, and Part III, infra.

111 See Part II(A), supra.

27a

payers to benefit from appreciations in value of utility

properties accruing while in service. We believe the doc-

trinal consideration upon which pronouncements to the

contrary '* have primarily rested has lost all present-day

vitality. Underlying these pronouncements is a basic legal

and economic thesis—sometimes articulated, sometimes

implicit—that utility assets, though dedicated to the pub-

lie service, remain exclusively the property of the utility’s

investors, and that growth in value is an inseparable and

inviolate incident of that property interest."* The pre-

cept of private ownership historically pervading our juris-

prudence led naturally to such a thesis, and early deci-

sions in the ratemaking field lent some support to it; if

still viable, it strengthens the investor’s claim. We think,

however, after careful exploration, that the foundations

for that approach, and the conclusion it seemed to indi-

cate, have long since eroded away.

A. In Rate Base Formulation

Judicial indulgence in the concept that appreciation in

value of utility property is an increment automatically

attaching to its ownership reached its high water mark

during the “fair value” era of rate-based formulations of

returns to utilities." In its 1898 decision in Smyth v.

"2 See D.C. Transit Sys., Inc. (Order No. 563), supra note

18, discussed in Part II(A), supra, at notes 60-64; D.C. Tran-

sit Sys., Inc. (Order No. 245), supra note 18, discussed in Part

II(B), supra, at notes 100-11; D.C. Transit Sys., Inc. (Order

No. 4577), supra note 33, discussed in Part II (A), supra, at

notes 33-50; City of Lexington v. Lexington Water Co., supra

note 73, discussed in Part II(B), supra, at notes 73-82.

13 See cases cited supra note 112.

4 See generally, 1 A. Priest, Principles of Public Utility

Regulation 139 et seg. (1969); J. Bonbright, Principles of

Public Utility Rates 159 et seg. (1961). To be distinguished

is the operating ratio method of computing return. See note

266, infra, and accompanying text.

28a

Ames,'* the Supreme Court held “that the basis of all

calculations as to the reasonableness of rates to be

charged by a corporation maintaining a highway under

legislative sanctions must be the fair value of the prop-

erty being used by it for the convenience of the public.” !"°

“[{I]n order to ascertain that value,” the Court said, “the

original cost of construction, the amount expended in per-

manent improvements, . . . the present as compared with

the original cost of construction, . .. are all matters for

consideration, and are to be given such weight as may be

just and right in each case.” "7 And “[w]hat the company

is entitled to ask,” the Court continued, “is a fair return

upon the value of land which it employs for the public

convenience.” "48

Despite the Court’s specification in Smyth v. Ames of

original cost as well as reproduction cost as a factor to be

considered in determining rate base value, the Court’s de-

cided preference during almost the next half-century was

a reproduction cost formula.'’® This meant, of course, that

in times of rising prices, the use of reproduction cost to

the exclusion of original cost advantaged the utility’s in-

vestors and disadvantaged its consumers. In 1908, in Will-

5 169 U.S. 466 (1898).

16 Td. at 546.

"7 Id. at 546-47.

"8 Id. at 547,

1° For application of the formula in various contexts, see

West v. Chesapeake & Potomac Tel. Co., 295 U.S. 662, 671

(1935) ; St. Louis & O’F Ry. v. United States, 279 U.S. 461,

487 (1929); McCardle v. Indianapolis Water Co., 272 U.S.

400, 408-09 (1926); Missouri ex rel. Southwestern Bell Tel.

Co. v. Public Serv. Comm'n, 262 U.S. 276, 288 (1923) ; Minne-

sota Rate Cases (Simpson v. Shepard), 230 U.S. 352, 354

(1913) ; Willcox v. Consolidated Gas Co., 212 U.S. 19, 41, 52

(1909).

| _ ‘ ; |

29a

cox v. Consolidated Gas Company,’” the Court remarked

that “[i]f the property which legally enters into considera-

tion of the question of rates, has increased in value since

it was acquired, the company is entitled to the benefit of

such increase.” '*' Five years later, in the Minnesota Rate

Cases,’ the Court observed that the utility’s “property

is held in private ownership and it is that property, and

not the original cost of it, of which the owner may not be

deprived without due process of law.” ?%* And as late as

1926, in Board of Public Utility Commissioners v. New

York Telephone Company, the Court stated that “[e]us-

tomers pay for service, not for the property used to render

it... [b]y paying bills for service they do not acquire

any interest, legal or equitable, in the property used for

the convenience or in the funds of the company.” !* Ex-

pressions of this sort encourage the idea that investors

were entitled to all the benefits of value-growth of utility

assets, of which the base for their rate of return was only

one.

The fair value theory, however, was not to survive as

the inexorable standard for setting rate base. Perhaps

the turning point in conceptualization of the rights of inves-

tors viz-a-viz consumers in utility property occurred in 1923.

In that year, Justice Brandeis, in his celebrated separate

opinion in Southwestern Bell Telephone Company, '** re-

jected the fair value approach to ratemaking and ad-

120 Supra note 119.

121 212 U.S. at 52.

122 Supra note 119.

123 230 U.S. at 454.

124 Supra note 82.

125 271 U.S. at 32.

126 Supra note 119, 262 U.S. at 289. Justice Holmes joined

in the opinion.

5 RI nor

30a

vanced a new basic concept:

The thing devoted by the investor to the public use

is not specific property, tangible or intangible, but

capital embarked in the enterprise. Upon the capital

so invested the Federal Constitution guarantees to

the utility the opportunity to earn a fair return.’

Justice Brandeis’ formula for ascertaining rate base—

the amount of capital prudently invested—was not to be-

come the prevailing rule.'** But what has since prevailed

is the central idea that the investor’s legally protected in-

terest resides in the capital he invests in the utility rather

than in the items of property which that capital pur-

chases for provision of utility service. In 1933, the Court

sustained a rate base valuation from which reproduction

cost had heen excluded,’ and five years later the Court

upheld another valuation founded upon historical cost

alone.**° In 1942, in Federal Power Commission v. Natural

Gas Pipeline Company,™ the Court more formally aban-

doned reproduction cost when it ruled that “[t]he Con-

stitution does not bind rate-making bodies to the service

127 Id. at 290 (footnote omitted) .

28 The prudent investment theory has, however, seen serv-

ice in the District of Columbia. In Washington Gas Light Co.

v. Baker, 88 U.S.App.D.C. 115, 188 F.2d 11 (1950), cert. de-

nied, 340 U.S. 952 (1951), where PUC had applied that theory

in lieu of reproduction costs, id. at 123, 188 F.2d at 19, we

pointed out that “[p]rimary emphasis is now being placed

not on ‘specific property, tangible and intangible,’ but on capi-

tal prudently invested and embarked on an enterprise in the

public service.” Jd. (footnote omitted).

129 Los Angeles Gas Co. v. Railroad Comm’n, 289 U.S. 287,

295-97 (1933).

1% Railroad Comm’n v. Pacific Gas Co., 302 U.S. 388, 399,

405 (1938).

131 315 U.S. 575 (1942).

3la

of any single formula or combination of formulas.” "2 Fin-

ally, in 1944, in Federal Power Commission v. Hope

Natural Gas Company," the Court rejected the Fourth

Circuit’s conclusion that the utility’s rate base should re-

flect the “present fair value” of its property.’* “‘[F Jair

value,’” it said, “is the end product of the process of rate-

making not the starting point as the Circuit Court of Ap-

peals held.” ?** “Under [a] statutory standard of ‘just

and reasonable,’ ” ™* it added, “it is the result reached not

the method employed which is controlling. . . . It is not

the theory but the impact of the rate order that counts.” 137

This approach to rate base formulation is the prevailing

doctrine today.'**

The teaching of the modern cases in this area is plain.

If investors in a public utility possessed an indefeasible

182 Id. at 586.

188 320 U.S. 591 (1944).

134 See Id. at 599-600.

135 Id. at 601. It seems clear that Hope Natural Gas thus

adopted the investment concept which Justice Brandeis had

espoused in Southwestern Bell. See text supra at note 127.

See also 2 A. Priest, Principles of Public Utility Regulation

503-04 (1969).

6 The quoted language is from the Natural Gas Act

of 1938, 52 Stat. 821 (1938), §§ 4(a), 5(a), 15 U.S.C.

8§ 717c(a), 717d (a) (1970). The Commission is required to

apply exactly the same standard in promulgating Transit’s

fares. Compact, supra note 12, tit. II, art. XII, § 6(a) (3).

187 320 U.S. at 602.

1388 See, in addition to cases cited supra, FPC vy. Natural

Gas Pipeline Co., supra note 133, 315 U.S. at 586; Permian

Basin Area Rate Cases (Continental Oil Co. v. FPC), 390 U.S.

747, 800 (1968), As to the District of Columbia, see note 128,

supra, and, as to the states, I A. Priest, Principles of Public

Utility Regulation 142-66 (1969).

32a

right to the appreciation in value of the utility’s operating

assets, the base on which their rate of return is com-

puted—the aggregate of the assets themselves—could be

set only at the true value of the assets at the moment of

setting. Fairness would suggest that result and due process

would seem to compel it.“ But it is now clear that

the utility is not entitled of right to have its rate base

established at the value which the assets would command

on the current market, although that market value ex-

ceeds original cost. This can mean only that the investors’

legally protected interest in such assets does not inexor-

ably extend to the increment in value.

B. In Depreciation Base Formulation

The rise and fall of fair value as the exclusive method

of measuring utility rate base has been paralleled by judi-

cial treatment of the interrelated problem of basis for

depreciation of utility assets. An integral part of the process

of establishing a rate base for purposes of rate of re-

turn is ascertainment of the amount to be deducted from

rate base—and, of course, allowed as an operating ex-

pense—for depreciation '° of the utility’s in-service prop-

erty. '*' And if appreciation in the value of utility prop-

erty is to invariably inure to the benefit of investors, it

would logically follow that allowances for depreciation

139 See, e.g., Minnesota Rate Cases (Simpson v. Shepard),

supra note 119, 230 U.S. at 454, quoted in text supra at note

123.

140 See note 18, supra.

141 “Annual depreciation is the loss which takes place in a

year. In determining reasonable rates for supplying public

service, it is proper to include in the operating expenses, that

is, in the cost of producing the service, an allowance for con-

sumption of capital in order to maintain the integrity of the

investment in the service rendered.” Lindheimer V. Illinois

Bell Tel. Co., 292 U.S. 151, 167 (1934) (footnote omitted).

33a

must be computed on present value rather than acquisi-

tion cost or some other basis.

That was the view to which the Supreme Court origi-

nally subscribed. In 1909, in Knoxville v. Knorville Water

Company,'* the Court decided that the utility “is entitled

to see that from earnings the value of the property in-

vested is kept unimpaired, so that at the end of any given

term cf years the original investment remains as it was

at the beginning.” '* “It is,” the Court said, “not only the

right of a company to make such a provision but it is its

duty to its bond and stockholders, and, in the case of a

public service corporation at least, its plain duty to the

public.” ** Two decades later, the Court, in United Rail-

way and Electric Company v. West, upheld a ruling

that annual depreciation allowances were to be calculated

on the basis of present value rather than cost.* Repeat-

ing the theme of Knoxville Water Company, a majority of

the Court '* referred to its then “settled rule” that rate

base was to be established at present value,* and argued

that “it would be wholly illogical to adopt a different rule

for depreciation.” !*°

Fair value, as the basis for depreciation, however, was

later to go the way of fair value as the measure of rate

42212 U.S. 1 (1909).

43 Id. at 13-14.

144 Td. at 14,

5 280 U.S. 234 (1930).

46 Td. at 253-54.

47 Justice Brandeis, with whom Justice Holmes concurred,

dissented. 280 U.S. at 254.

48 See Part III (A), supra.

149 280 U.S. at 254.

base." By 1934, in Lindeheimer v. Illinois Bell Telephone

Company," the Court upheld the propriety of computing

annual depreciation on original cost."** The Court pointed

out that “if the amounts charged to operating expenses

and credited to the account for depreciation reserve are

excessive, to that extent subscribers for the telephone

service are required to provide, in effect, capital contri-

butions, not to make good losses incurred by the utility in

the service rendered and thus to keep its investment un-

impaired, but to secure additional plant and equipment

upon which the utility expects a return.” ** And by 1942,

in Federal Power Commission v. Natural Gas Pipeline

Company, the Court had sustained an amortization basis

for depletable utility property calculated on capital in-

vestment rather than reproduction cost."* There the Court

stated:

When the property is devoted to a business which can

exist only for a limited term, any scheme of amorti-

zation which will restore the capital investment at the

end of the term involves no deprivation of property.

Even though the reproduction cost of the property

during the period may be more than its actual cost,

this theoretical accretion to value represents no profit

to the owner, since the property dedicated to the busi-

ness, save for its salvage, is destined for the scrap-

heap when the business ends. The Constitution does not

require that the owner who embarks in a wasting-asset

business of limited life shall receive at the end more

than he has put into it."

18° See Part III(A), supra.

151 Supra note 141.

52 292 U.S. at 168-69.

153 Jd. at 169.

154 Supra note 131.

155 315 U.S. at 592-93.

138 Jd. at 593.

35a

Finally, in Federal Power Commission v. Hope Natural

Gas Company, in 1944, the Court upheld depreciation

and depletion allowances based on cost," overruling

United Railway and Electric Company v. West in the

process." “By such a procedure,” said the Court, “the

utility is made whole and the integrity of its investment

maintained. No more is required.” *®

Here again we draw a lesson from the jural history of

ratemaking. Investors are entitled to recover the utility’s

outlay in the assets employed in provision of the utility’s

public service." If the investors’ protected interest in

those assets encompassed increases in their market value,

it would necessarily follow that the recoupment must em-

brace the increases as well as the amount laid out for their

acquisition. But it is now clear that the amount of even-

tual recovery—the depreciation base—may permissibly be

limited to the amount of the original outlay. This is but

another way of saying that the investors do not possess &

vested right in value-appreciations accruing to in-service

utility assets.

C. In Transit’s Ratemaking Litigation

The considerations just explored take on added weight

in Transit’s case, for fair value has never heen assigned a

role in determinations as to its rate or depreciation bases.

That it was not an ingredient of either was settled rather

early in Transit’s regulatory history. In the days prior

to utilization of the operating ratio method in computa-

157 Supra note 133.

188 320 U.S. at 606.

189 Jd. at 606-07.

180 Jd. at 606.

161 See text supra at notes 142-44.

a eee oe ee

36a

tions of its margins of return,’ the Commission’s prede-

cessor, PUC, established and maintained Transit’s rate

base without consideration of the then present value of its

in-service properties.’* In those days, PUC also employed

original cost as the formula for setting Transit’s deprecia-

tion base,’ and the Commission in its turn, has done the

same.’® Neither for purposes of its rate base nor its basis

for depreciation, then, has appreciation in the market value

of its assets heen deemed a benefit to which Transit’s in-

vestors might justly lay claim.

But that was not because the effort was not made. In a

fare-increase proceeding inaugurated in 1960, Transit

sought to persuade PUC to adopt a depreciation base com-

bining replacement cost for some properties with market

value for others.’ PUC, however, declined to do so.’*

Instead, PUC pointed out that it has “long held that origi-

nal cost is the only sound basis for measuring depreciation

as it is in accord with the fundamental purpose of de-

preciation accounting, namely, to recover the.cost of invest-

oe ee) ee)

SA aa ed al han ;

[Pee ane Tae eh ee

CWO Pee ee ee eT me yee mete Py

abe si

162 See note 266, infra.

163 See note 266, infra.

14 See D.C. Transit Sys., Inc. (Order No. 4631), 33 P.U.R.

3d 137, 155 (D.C. Pub. Utils. Comm’n 1960), wherein PUC

established Transit’s acquisition adjustment account, dis-

cussed in text infra at notes 251-56, a device which incorpo-

rated original cost rather than present value as the basis

for depreciation. See also D.C. Transit Sys., Inc. (Order No.

4735), 38 P.U.R.3d 19, 34-35 (D.C. Pub. Utils. Comm’n 1961)

(rejecting replacement cost), discussed in text infra at notes

167-70.

185 See, ¢.g., D.C. Transit Sys., Inc. (Order No. 984), 81 |

P.U.R.3d 417, 427 (WMATC 1969). 4

166 D.C. Transit Sus., Inc. (Order No. 4735), supra note :

164, 38 P.U.R.3d at 34.

16t Td. at 34-35.

ET ee ee Rey Vary eee

37a

ment rather than to provide for the cost of replacement.” **

“The use of replacement cost as a base for the calculation

of depreciation allowances,” in PUC’s view, “has many

serious faults,” ' not the least of which is the distinct pos-

sibility that Transit’s farepayers would thereby be made

involuntary contributors to its capital. PUC explained:

[I]f prices are rising the use of the replacement cost

base would compel consumers to provide additional

capital for the utility, at least to the extent that re-

placement costs were greater than the costs of the

depreciating equipment. [Transit’s witness] admitted

that under his theory consumers would be in the posi-

tion of involuntary investors though with no right to a

return on their investment; and what is even worse,

they would thereafter be required to provide a fair

return and depreciation allowance on capital which

they themselves had contributed. Obviously, consum-

ers’ obligations end when they have paid the cost of

service including the cost of the depreciable assets used

and exhausted in rendering that service. The original

cost base is just and equitable for both investors and

consumers. Consumers pay the cost of service includ-

ing the cost of capital. To ask the consumers to pay

more than the cost is to make them contribute to the

capital of the enterprise.”

We cannot, then, accept the thesis that appreciations in

value of Transit’s properties while in operating status auto-

matically flow to Transit’s investors as inseparable inci-

dents of ownership. To be sure, investors are entitled to

have rates fixed with a view to a fair return on their

investment,” and to have depreciation allowances set in

sad, Sel ey se

Sa Ba, aed sealed ibe

4a bash Itt te ances, Pas Cae RL eee a Nene

PWT Py Re eee ey

Pa Ree Re Vr eke

168 Td. at 34.

169 Jd.

170 Td. at 34-35.

111 D.C. Transit Sys., Inc. v. Washington Metropolitan Area

Transit Comm’n, —— U.S.App.D.C. ——, ——, 466 F.2d

394, 418-19, cert. denied, 409 U.S. 1086 (1972).

- <n A aes I es — ale

38a

contemplation of eventual recoupment of their investment

in toto.’ But modern ratemaking doctrine militates

against the proposition that value-appreciation alone can

legitimately increase either the return’ or the recoup-

ment.'* Indeed in Transit’s case it never has,’ and that

would have been legally impossible if the investors’ pro-

tected interest in Transit’s assets extended to advances in

market value as well as to the original investment in them.

The fact is that Transit’s investors have been so limited in

both respects, and that serves adequately to refute any

notion that they necessarily possess a claim on such ad-

vances.'”®

BASIS FOR ALLOCATION OF CAPITAL GAINS

ON OPERATING UTILITY ASSETS

Investors, we have concluded, are not automatically en-

titled to gains in value of operating utility properties

simply as an incident'of the ownership conferred by their

investments. And it goes without saying that consumers do

not succeed to such gains simply because they are users of

the service furnished by the utility. Neither capital invest-

112 See Part III(A), supra.

173 See Part III(B), supra.

174 See Part III(B), supra.

175 See text supra at notes 162-70.

176 Indeed, claims of utility investors, including Transit’s,

on appreciations in value of depreciable utility assets have

generally been subordinated to the claims of the utility’s con-

sumers. See Part II(A), supra. That, we believe, is a conse-

quence, rather than a cause, of the investors’ lack of an in-

defeasible right to the appreciations. But it is evident that

consumers could never have enjoyed priority, or even a meas-

ure of equality, if the investors’ right were absolute.

BR AA eee ee pe te ee ee ee re | “

—

ea AT ee ON

TT eb be aa ae

sip aki

39a

ment nor service consumption contributes in any special

way to value-growth in utility assets. Rather, the values

with which we are concerned have grown simply because of

a rising market.

Investors and consumers thus start off on an equal foot-

ing, and the disposition of the growth must depend on other |

factors. We thus reach the dual critical inquiry: identi-

fication of the principles which must guide the allocation,

as between investor and consumer groups, of appreciation

in value of utility assets while in operating status; and

application of those principles to Transit’s situation.

A. Doctrinal Considerations

The ratemaking process involves fundamentally “a bal-

ancing of the investor and the consumer interests.” 77 The

investor’s interest lies in the integrity of his investment

and a fair opportunity for a reasonable return thereon.’”

The consumer’s interest lies in governmental protection

against unreasonable charges for the monopolistic service

to which he subscribes.’ In terms of property value ap-

preciations, the balance is best struck at the point at which

the interests of both groups receive maximum accommo-

dation. We think two accepted principles which have served

comparably to effect satisfactory adjustments in other as-

pects of ratemaking can do equal service here.

One is the principle that the right to capital gains on

utility assets is tied to the risk of capital losses. The other

117 FPC v. Hope Natural Gas Co., supra note 133, 320 U.S.

at 603.

178 F.g., id.

179“TF]rom the earliest cases, the end of public utility

regulation has been recognized to be protection of con-

sumers from exhorbitant rates.” Washington Gas Light Co.

v. Baker, supra note 128, 88 U.S.App.D.C. at 119, 188 F.2d

at 15 (footnote omitted).

is the principle that he who bears the financial burden of

particular utility activity should also reap the benefit re-

sulting therefrom. The justice inherent in these principles

is self-evident, and each already occupies a niche in the law

of ratemaking;'* and their application, sometimes over-

lapping, to the problem at hand weighs the scale heavily in

favor of consumers. For practice in the utility field has

long imposed upon consumers substantial risks of loss and

financial burden associated with the assets employed in the

utility’s business. We will pause to examine the practices,

and then their effect in conjunction with the principles

mentioned.

—Right to Gain Follows Risk of Loss

A factor strongly influencing the rate of return to which

the utility investor becomes entitled is the magnitude of

the risk which his investment encounters.’*' High risks

justify larger returns,’ while low risks more nearly guar-

antee the investment, and so may warrant smaller re-

turns.'** Similarly, an investor can hardly muster any

180 See discussion in Part IV(A), infra.

181 See, ¢.g., FPC v. Hope Natural Gas Co., supra note 133,

320 U.S. at 605; Smith v. Illinois Bell Tel. Co., 282 U.S. 133,

160-62 (1930); United Ry. & Elec. Co. v. West, supra note

145, 280 U.S. at 249, 250; Bluefield Water Works & Im-

provement Co. v. Public Serv. Comm’n, 262 U.S. 679, 692-93

(1923) ; Williams v. Washington Metropolitan Area Transit

Comm'n, supra note 16, 134 U.S.App.D.C. at 355 nn. 64, 65,

415 F.2d at 935 nn. 64, 65.

182 See Atlantic Ref. Co. v. FPC, 115 U.S.App.D.C. 26, 28,

316 F.2d 677, 679 (1963) ; New Haven Water Co., 2 P.U.R.3d

452, 456-60 (Conn. Pub. Utils. Comm’n 1954). See also cases

cited supra note 181.

183 FPC y. Hope Natural Gas Co., supra note 133, 320 US.

at 604-05; State ex rel. Pacific Tel. & Tel. Co. v. Department

POAC aim or Ae ne eae

iA De Oi te TSC AS bay eg Bh Ne AN il BS i PP

4la

equitable support for a claim to appreciation in asset value

where he has been shielded against the risk of loss on his

investment, or has already been rewarded for taking on

that risk.

The proposition that capital gain rightly inures to the

benefit of him who bore the risk of capital loss has been

accepted in ratemaking law. Thus, as we have seen, invest-

ors have been denied capital gains realized on disposition

of utility assets where they have not borne the risk of loss

associated with the holding of such assets." And we have

consistently held that investors cannot recover for under-

depreciated assets where they have in some form been

compensated either for the deficiency or for assuming the

risk that a deficieney might occur." On the other hand,

grave risks associated with utility assets are commonly

thrust upon consumers. Many are susceptible to loss or

damage from acts of nature and man, and risks of such

casualties are usually passed on to consumers.’ The risk

of Pub. Serv., 19 Wash.2d 200, 142 P.2d 498, 528 (en banc

1943) ; Michigan Bell Tel. Co. v. Public Serv. Comm’n, 332

Mich. 7, 50 N.W.2d 826, 840-41 (1952); El Paso Natural

Gas Co., 28 F.P.C. 688, 694-95, 45 P.U.R.3d 262, 270-71

(1962).

184 See cases discussed supra in Part II(A).

185 Bebchick v. Washington Metropolitan Area Transit

Comm’n, 115 U.S.App.D.C. 216, 224, 318 F.2d 187, 195,

cert. denied, 373 U.S. 913 (1963); Williams v. Washington

Metropolitan Area Transit Comm’n, supra note 16, 134 U.S.

App.D.C. at 374-76, 415 F.2d at 954-56; Washington Gas

Light Co. v. Baker, supra note 128, 88 U.S.App.D.C. at 123-

25, 188 F.2d at 19-21. See also Minneapolis St. Ry. Co. v.

pont of Minneapolis, 251 Minn. 48, 86 N.W.2d 657, 665-68

(1957).

186 See, Northwestern Bell Tel. Co., 78 S.D. 15, 98 N.W.2d

170, 179 (1959) ; Diamond State Tel. Co., 28 P.U.R.3d 121,

137-89 (Del. Pub. Serv. Comm’n 1959); Baltimore Gas &

42a

of loss from premature retirement of assets because of

obsolescence, as a general rule, also falls on consumers.'*

Moreover, in at least one jurisdiction, the possibility that

a utility asset will diminish in market value while in service

is a hazard which the consumer rather than the investor

must face.’** And, unlike casualty losses, those resulting

from obsolescence and declining markets may occur with

respect to nondepreciable as well as depreciable assets.’

Some cases have already awarded value appreciations to

consumers in such situations.'”

In our view, the doctrine that capital gain accompanies

the risk of capital loss is sound. The following example

illustrates how this principle applies to land, which, while

it may have lost its usefulness in a utility's operations, has

nonetheless appreciated in value while in operating status.

Let us suppose that fifteen years ago the company pur- x

chased a piece of property on which to construct a building ~~

to be used as its central offices. Under established principles

of regulatory law, the loss from normal wear and tear on ~

the building—a depreciable asset—would be recouped from”

its ratepayers hy the investors, who are entitled to have

their investment in an operating asset protected.’ What

Elec. Co., 25 P.U.R.3d 91 (Md. Pub. Serv. Comm’n 1959) ;

Florida Power & Light Co., 19 P.U.R.3d 417, 429 (Fla. R.R. i

& Pub. Util. Comm’n 1957); Long Island Lighting Co., 7 Fy

P.U.R.3d 140, 141-42 (N.Y. Pub. Serv. Comm’n 1955).

187 See text infra at note 201.

188 See New York Water Serv. Corp. v. Public Serv.

Comm’n, supra note 69, discussed in Part II(B), supra, at oe

notes 69-72. 3

189 See id.; Columbus Gas & Fuel Co. v. Public Serv.

Comm’n, supra note 83, 292 U.S. at 411.

190 See cases discussed in Part II(B), supra.

191 See Part IV(A), infra, at note 199.

43a

would happen if, because of a change in the character of the

neighborhod or because of a need for increased office space,

the building were no longer suitable for the utility’s opera-

tions? If the building had to be sold at a loss, clearly the

ratepayers, under the precepts articulated above, would

bear the burden of covering that loss.’ On the other hand,

if a profit were made on the sale of the building, the gain

would go to the ratepayers, at least to the extent necessary

to recoup their payments for depreciation.”

As for the land on which the building is located, it is

true that land does not depreciate from ordinary wear

and tear the way a building does. But it is also true that

the land in our example has become unsuitable—in business

parlance, obsolete—for continued use in the company’s op-

erations. If it, like the building, must be retired from

service and sold at a loss, who bears the onus of making

up that loss? Since the investors may insist upon preser-

vation of any investment they make in an asset to be used

in the utility’s operations, it is the ratepayers’ burden to

compensate them for the loss on their investment in the

land. Accordingly, if the land no longer useful in utility

operations is sold at a profit, those who shouldered the risk

of loss are entitled to benefit from the gain.’

The principle that capital gain follows risk of loss, useful

as it may be, is not without its limitations. There may be

situations where the assignment of risk of loss on a par-

ticular asset is not readily ascertainable, or where for some

192 See Part IV(A), infra, at notes 211-18.

193 See Part II(A), supra; Part IV(A), infra, at notes

225-27.

194 See Part IV(A), infra, at notes 211-18.

195 See Part II(B), supra.

44a

other reason the terminology “capital gains and losses” is }

inappropriate or inapposite.'* In such a case the second ¢

doctrinal consideration we have mentioned—the precept

that those who bear the financial burden of particular utility

activity should also reap the benefit resulting therefrom

--comes into play.

—Economic Benefit Follows Economic Burden

Ratepayers bear the expense of depreciation, including

obsolescence and depletion,’ on operating utility assets

through expense allowances to the utilities they patronize.’

It is well settled that utility investors are entitled to recoup

from consumers the full amount of their investment in

depreciable assets devoted to public service.'” This entitle-

196 See Part IV(B), infra, at notes 228-29.

187 For definitions, see note 18, supra.

198 St. Joseph Stock Yards Co. v. United States, 298 U.S.

38, 65-67 (1936) ; Lindheimer v. Illinois Bell Tel. Co., supra

note 141, 292 U.S. at 165-75; Pacific Gas & Elec. Co. v. City

& County of San Francisco, 265 U.S. 408, 415-16 (1924) ;

Kansas City S. Ry. v. United States, 231 U.S. 423, 449-52

(1913) ; Minnesota Rate Cases (Simpson v. Shepard), supra

note 119, 230 U.S. at 456-58; Knoxville v. Knoxville Water

Co., supra note 142, 212 U.S. at 9-11; D.C. Transit Sys., Inc.

v. Washington Metropolitan Area Transit Comm’n, supra

note 18, 121 U.S.App.D.C. at 394-95, 350 F.2d at 772-73;

Washington Gas Light Co. v. Baker, supra note 128, 88 U.S.

App.D.C. at 123, 188 F.2d at 19; FPC v. Hope Natural Gas

Co., supra note 133, 320 U.S. at 605. See also the cases cited |

infra notes 201-02. s

1% FPC v. Hope Natural Gas Co., supra note 183, 320 U.S.

at 596-607; United Rys. & Elec. Co. v. West, supra note 145,

280 U.S. at 253-54; Illinois Cent. R.R. v. ICC, 206 U.S. 441, ;

461-68 (1907) ; Smyth v. Ames, supra note 115, 169 U.S. at ©

547; D.C. Transit Sys., Inc. v. Washington Metropolitan Area

Transit Comm'n, supra note 18, 121 U.S.App.D.C. at 394-95, |

350 F.2d at 772-73; Panhandle Eastern Pipe Line Co. v.

SAGE BS aA OSs SSSA BS TR SBE

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rose

=. OF REM

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ptosis ee BAe Pee ee eS te” ee se “ee

45a

ment extends, not only to reductions in investment attribu-

table to physical wear and tear (ordinary depreciation)*”

but also to those occasioned by functional deterioration

(obsolesence)*' and by exhaustion (depletion).*” Recoup-

ment of investment, particularly where the reduction is

gradual, is usually accomplished by annual or other perio-

dic allowances, commonly referred to as depreciation ex- ,

penses.*** Recoupment may, however, be effected by a single

charge, or by amortization of the investment loss against

the ratepayers, as is more frequently done in instances of

obsolescence and resulting abandonment of still, serviceable

FPC, 113 U.S.App.D.C. 94, 305 F.2d 763 (1962), cert. de-

nied, 372 U.S. 916 (1963) ; City of Detroit v. FPC, 97 U.S.

App.D.C. 260, 268, 230 F.2d 810, 813 (1955), cert. denied,

852 U.S. 829 (1956); Washington Gas Light Co. v. Baker,

supra note 128, 88 U.S.App.D.C. at 119-20, 122-23, 188 F.2d

at 15-16, 18-19; Public Utils. Comm’n v. Capital Traction

Co., 57 App.D.C. 85, 88, 17 F.2d 673, 676 (1927); Safe Har-

bor Water Power Corp. v. FPC, 179 F.2d 179, 193-99 (3d

Cir. 1949), cert. denied, 339 U.S. 957 (1950); City of Min-

neapolis v. Rand, 285 F. 818, 825-31 (8th Cir. 1923).

200 See cases cited supra note 198.

21 F.g., Los Angeles Gas & Elec. Corp. v. Railroad Comm'n,

supra note 129, 289 U.S. at 306-07; Pacific Gas & Elec. Co.

v. City & County of San Francisco, supra note 198, 265 U.S.

at 406-16; Kansas City S. Ry. v. United States, supra note

198; Washington Gas Light Co. v. Baker, supra note 128, 88

U.S.App.D.C. at 126, 188 F.2d at 22; Colorado Interstate Gas

Co. v. FPC, 142 F.2d 948, 959-61 (10th Cir. 1944) ; Minneap-

olis St. Ry. v. City of Minneapolis, supra note 185, 86 N.W.

2d at 665-68.

202 F.g., FPC v. Hope Natural Gas Co., supra note 133, 320

U.S. at 606 et seq; Dayton Power & Light Co. v. Public Serv.

Comm’n, 292 U.S. 290, 308-05 (1934); Arkansas-Louisiana

Gas Co. v. City of Texarkana, 17 F.Supp. 447, 460-63 (W.D.

Ark. 19386).

203 See cases cited supra notes 199, 201, 202.

ee —

46a

assets.2" Tn all cases, the expense levied against ratepayers

is the difference between the original cost of the asset and

its salvage value,?” estimated or actual.”

Computations of the cost of ordinary depreciation—nor-

mal physical deterioration—are made on the basis of esti-

mates of service life and salvage value, and charges there-

for are usually spread over the service period.*” Depletion

allowances are similarly based on estimates of productive

life, and usually are similarly spread.2” Even obsolescence

may sometimes be foreseen and calculated in much the same

manner.” It is evident that if all predictions are accurate

204 Consolidated Edison, 56 P.U.R.3d 337, 371-77 (N.Y.

Pub.Serv. Comm’n 1964) (losses incurred in retirement of

plant amortized); Lakewood Water Co., 78 P.U.R.3d 453,

457, 458 (N.J. Bd. of Pub. Util. Comm’rs 1968); Missouri

Cities Water Co., 53 P.U.R.3d 352, 354, 359-60 (Mo. Pub.

Serv. Comm’n 1965) (plant with life expectancy of 50 years

retired because of increasing saline content after only six

years of operation amortized over 10-year period) ; Howes

v. Mather Water Co., 13 P.U.R.3d 486, 490-91 (Pa. Pub. Util.

Comm’n 1956) (supply sources abandoned because of con-

tamination amortized). See generally, Washington Gas Light

Co. v. Baker, supra note 128, 88 U.S.App.D.C. at 123-27, 188

F.2d at 19-23.

205 See cases cited supra note 198.

206 See cases cited supra notes 198, 199, 201, 204.

207 As to the “service life theory of depreciation,” see par-

ticularly International Ry. v. Prendergast, 1 F.Supp. 623,

627-31 (W.D.N.Y. 1932). See also cases cited supra note 204.

Compare 1 A. Priest, Principles of Public Utility Regulation

117-24 (1969). In D.C. Transit Sys., Inc. (Order No. 4735),

supra note 164, 38 P.U.R.3d at 35, the straight-line method of

depreciation accounting, as opposed to the sum-of-digits

method, was approved for ratemaking purposes.

208 See:cases cited supra note 202.

209 See cases cited supra notes 201-04.

47a

and the asset remains in service for precisely the period

anticipated, the process will eventually yield to investors

the exact amount of their investment, and will ultimately

cost consumers the same amount. Consumers will thus

absorb the investment loss and investors will be made

whole.

But calculations, even of the highest predictive quality, °

sometimes go awry. Service life, productive life or salvage

value may turn out to be more or less than originally esti-

mated.”"° Obsolescence may be slower or faster than ex-

pected in the beginning,”"* or may arrive suddenly,” and

damage to or destrvetion of the asset may occur just as

suddenly.”** In most instances, however, the consumers’

financial obligation remains intact, the investors’ right to

210 See St. Joseph Stock Yards Co. v. United States, supra

note 198, 298 U.S. at 55-72; Lindheimer v. Illinois Bell Tel.

Co., supra note 141, 292 U.S. at 168-75; Williams v. Wash-

ington Metropolitan Area Transit Comm’n, supra note 16,

184 U.S.App.D.C. at 371-76, 415 F.2d at 951-56; Bebchick

v. Public Utils. Comm’n, supra note 185, 115 U.S.App.D.C. at

223-24, 318 F.2d at 194-95; California-Pacific Utils. Co., 71

P.U.R.3d 270, 272 (Nev. Pub. Serv. Comm’n 1967).

211 Williams v. Washington Metropolitan Area Transit

Comm’n, supra note 16, 184 U.S.App.D.C. at 372-76, 415 F.2d

at 952-56; D.C. Transit Sys., Inc. v. Washington Metropoli-

tan Area Transit Comm’n, supra note 18, 121 U.S.App.D.C.

at 390-91, 350 F.2d at 768-69; D.C. Transit Sys., Inc. (Order

No. 952), 80 P.U.R.8d 1 (WMATC 1969) ; Maui Elec. Co., 74

P.U.R.3d 140, 147-50 (Hawaii Pub. Util. Comm’n 1968) ; Hon-

olulu Rapid Transit Co., 68 P.U.R.3d 409, 414 (Hawaii Pub.

Serv. Comm’n 1967). Compare D.C. Transit Sys., Inc. (Or-

der No. 245), supra note 18, 48 P.U.R.3d at 405, 406 (allow-

ing reduction in service-life period).

212 F’.g., see cases cited supra note 204.

213 F.g., Missouri Cities Water Co. and Howes v. Mather

Water Co., both supra note 204.

tt > ~~~ a = = =

48a

recoupment remains unimpaired, and appropriate adjust-

ments must be made.*"* This is so although in terms of

original expectations, the loss of serviceability is prema-

ture.*** Consumers bear the risk of that loss *"* unless in-

vestors have been compensated for assuming it; *"" if, as is

more usual, investors have not, return of their investment

is fully assured.*"

In this milieu, the distribution of the risks and burdens

on utility assets is apparent. Consumers must ordinarily

bear the expense of normal maintenance *"* and, according

1 Abe + oot an ie

214 F.g., Wiliams v. Washington Metropolitan Area Transit

Comm'n, supra note 16, 134 U.S.App.D.C. at 374-78, 415 F.2d

at 954-58.

215 See cases cited supra notes 211-13.

216 See FPC v. Hope Natural Gas Co., supra note 133, 320

U.S. at 603; Bluefield Waterworks & Improvement Co. v.

Public Service Comm’n, supra note 181, 262 U.S. at 692-93.

Accord, Permian Basin Area Rate Cases (Continental Oil

Co. v. FPC), supra note 138, 390 U.S. at 792; Atlantic Ref.

Co. v. FPC, supra note 182, 115 U.S.App.D.C. at 27-28, 316

F.2d at 678-79.

217 Wiliams v. Washington Metropolitan Area Transit

Comm’n, supra note 16, 134 U.S.App.D.C. at 374-77, 415 F.2d

at 954-57; D.C. Transit Sys., Inc. v. Washington Metropoli-

tan Area Transit Comm'n, supra note 18, 121 U.S.App.D.C. at

394-95, 350 F.2d at 772-73, aff’g after remand in Bebchick v.

Public Service Comm’n, supra note 185, 115 U.S.App.D.C.

at 224, 318 F.2d at 195; Washington Gas Light Co. v. Baker,

supra note 128, 88 U.S.App.D.C. at 123-24, 188 F.2d at 19-20.

218 See cases cited supra note 217.

219 In re Northwestern Bell Tel. Co., 73 S.D. 37, 43 N.W.2d

553, 564 (1950), cert. denied, 340 U.S. 934 (1951); D.C.

Transit Sys., Inc. (Order No. 564), 63 P.U.R.3d 45, 55

(WMATC 1966); Cheyenne Light, Fuel & Power Co., 7

P.U.R.3d 129, 134 (Wyo. Pub. Serv. Comm’n 1955).

Pe thin Pad, a ON ee ee ea Ue Pare ae OM

49a

to some decisions, of deferred maintenance as well.” Be-

yond that, consumers must usually absorb the investment

losses wrought by normal wear and tear on depreciable

assets," and by exhaustion of depletabie assets.2* Even

when an asset is underdepreciated at the time it is retired

from service, consumers must reimburse the investors

therefor. And when utility property becomes unsuitable

by reason of obsolescence before investors have fully re-

couped their investment in it, the loss is passed on to con-

sumers.***

In situations where consumers have shouldered these

burdens on an asset which produces a gain, the equities

clearly preponderate in their favor. This has been recog-

nized in eases holding that rents received by a utility from

the leasing of operating properties must be included in

the utility’s operating income. More directly in point,

220 F.g., Wall v. Public Util. Comm’n, 182 Pa. Super. 35,

125 A.2d 630, 638-39 (1956) ; Penn-York Natural Gas Co., 5

F.P.C. 33, 37, 63 P.U.R. (n.s.) 235, 238 (1946) ; Lucerne Water

Co., 52 P.U.R.3d 219, 224-25 (Cal. Pub. Util. Comm’n 1964).

221 See cases cited supra note 198.

222 See cases cited supra note 202.

223 Washington Gas Light Co. v. Baker, supra note 128, 88

U.S.App.D.C. at 123-24, 188 F.2d at 19-20; Minneapolis St.

Ry. v. City of Minneapolis, supra note 185, 86 N.W.2d at

660-68.

224 See cases cited supra note 201.

23 Fleming v. Illinois Commerce Comm'n, 388 Ill. 138, 57

N.E.2d 384, 395 (1944), appeal dismissed and cert. denied,

324 U.S. 823 (1945); Pekin Water Works Co., 82 P.U.R.3d

460, 466 (Ill. Commerce Comm’n 1970); Illinois Commerce

Comm’n v. Public Serv. Co., 4 P.U.R.(n.s.) 1, 27-30 (Ill. Com-

merce Comm’n 1934) ; Hillsborough & M. Tel. Co., 14 P.U.R.

3d 212, 217 (N.J. Bd. Pub. Util. Comm’rs 1956); Farmer's

Union Tel. Co., 84 P.U.R. (n.s.) 82, 85 (N.J. Bd. Pub. Util.

Comm’rs 1950) ; Public Serv. Comm’n v. Mountain Fuel Sup-

the cases, as we have seen, generally agree that consumers

have the superior claim to capital gains achieved on de-

preciable assets while in operation ** and this, we believe,

is as it should be. Investors who are afforded the oppor-

tunity of a fair return on a secure investment in utility

assets are hardly in position to complain that they do not

receive their just due from the traveling public. On the

other hand, it is eminently just that consumers, whose pay-

ments for service reimburse investors for the ravages of

wear and waste occurring in service, should benefit in in-

stances where gain eventuates—to the full extent of the

gain.**"

B. Application of Doctrine

In This Case

We direct our attention now to the situation presented

at bar with a view to resolving the conflicting claims of

ply Co., 73 P.U.R. (n.s.) 428 , 441 (Utah Pub. Serv. Comm’n

1947).

226 See discussion in Part II(A), supra.

227 The Commission has recognized that Transit’s fare-

payers are entitled to capital gains on depreciable assets with-

borne the financial burden of loss of serviceability of the with-

risk that such loss might occur prema-

Had the gain been too small to enable full reimburse-

they would have suffered the loss on the remainder.

E">mental justice requires that they be awarded the full gain,

even though it exceeds the amount necessary for reimburse-

5la

Transit’s investors and farepayers to the capital gains in

issue. At the outset, we lay aside the rule that capital

gain accompanies risk of capital loss. As we point out to-

day in No. 24,398, Democratic Central Committee v. Wash-

ington Metropolitan Area Transit Commission,” and as

the Commission itself admits,” there has never been any

risk of financial loss, actual or foreseeable, on the parcels

of land which concern us here. Despite an ever-present

risk of obsolescence of land for utility purposes, land val-

ues since acquisition of the properties by Transit have

climbed steadly in the Nation’s Capital, and throughout

Transit’s regulatory history could only hawe been expected

to do so. So, while the risk of obsolescence is insoluble, the

risk of any consequent financial loss has been foreclosed

by the rising real estate market. It would be little more

than an exercise in abstract logic to invoke the principle

of gain-follows-loss where the financial risk is wholly il-

lusory. Consequently, we confine ourselves to the second

doctrinal consideration discussed—that benefit follows

burden—in determining where the equities lie here. The

exploration we find we must make is ramified, necessitat-

ing examination of the history of the acquisition of the ques-

tioned assets, the allocation of burdens and the accrual of

advantages associated with the holding of tthose assets, and

thereafter a balancing of the respective imterests compet-

ing for the gains at stake. We undertake these tasks and,

discharging them, we conclude that Tramsit’s farepayers

must prevail.

—Acquisition History And

Allocation of Burdens

In 1956, Transit was awarded its franchise to operate

a mass transportation system within the Washington met-

228 Democratic Cent. Comm. v. Washington Metropolitan

Area Transit Comm’n, supra note 3, at nn. 101-06.

22° Brief for Respondent at 13.

52a

ropolitan area.” The franchise was conditioned upon

Transit’s acquisition of the assets of Capital Transit Com-

pany (Capital), which for many years had served the

area through a system in which both streetcars and buses

were employed. Transit purchased Capital’s assets and on

August 15, 1956, commenced its own operation. The par-

cels of realty upon which this litigation centers were a

part of Transit’s acq=‘sition from Capital.”

At the time of Transit’s takeover, Capital’s assets were

valued on its books at approximately $23.8 million.

Transit’s puderhase price was about $13.5 million,™ of

which only $500,000 represented an actual cash invest-

ment.2*> The balance ultimately came partly from Capital’s

cash on hand and partly from the sale of certain of Capi-

tal’s properties, but mostly from farebox revenues after

Transit went into business.”*

Transit’s franchise imposed the requirement that Capi-

tal’s streetcar-bus system be gradually converted into an

all-bus system throughout the metropolitan area.” This

230 Pub.L. No. 757, 70 Stat. 598 (1956) (Franchise Act).

See also H.R. Rep. No. 2751, 84th Cong., 2d Sess. (1956).

231 Jd. at tit. II, §§ 201(a), 202, 203.

232 See appendix.

233 S.Rep. No. 91-760, 91st Cong., 2d Sess. 3 (1970).

234 Jd.; D.C. Transit Sys., Inc. (Order No. 4631), supra

note 164, 33 P.U.R.3d at 158.

25S. Rep. No. 91-760, 91st Cong., 2d Sess. 3 (1970).

236 Td.

231 The Franchise Act, tit. I, pt. 1, §7, 70 Stat. 598, 599

(1956), provides:

The Corporation shall be obligated to initiate and

carry out a plan of gradual conversion of its street

railway operations to bus operations within seven years

53a

program necessitated the removal of the abandoned street-

ear tracks and the regrading and repaving of the aban-

doned track areas,” at an estimated cost of $10,441,958."

To accommodate that cost, PUC established a reserve for

track removal and repaving,”* and directed the accrual of

$1,044,196 thereto annually for ten years." And at an

early stage in Transit’s regulatory history, the question ~

arose as to whether those accruals should be made by

Transit’s investors through capital contributions or from

Transit’s consumers in the form of higher fares.

This was an expense with two aspects, and the nature of

each militated, in terms of ratemaking law, against the

ratepayers. The first was the loss incidental to abandon-

ment of the rail facilities which had passed from Capital

to Transit. As we have pointed out, it has ofttimes been

from the date of the enactment of this Act upon terms

and conditions prescribed by the Commission, with such

regard as is reasonably possible when appropriate to

the highway development plans of the District of Co-

lumbia and the economies implicit in coordinating the

Corporation’s track removal program with such plans;

except that upon good and sufficient cause shown the

Commission may in its discretion extend beyond seven

years, the period for carrying out such conversion. All

of the provisions of the full paragraph of the District

of Columbia Appropriation Act, 1942, (55 Stat. 499,

533), under the title “Highway Fund, Gasoline Tax and

Motor Vehicle Fees”, subtitle “Street Improvements”,

relating to the removal of abandoned track areas, shall

be applicable to the Corporation.

238 See District of Columbia Appropriation Act of 1942,

55 Stat. 499, 533 (1941).

239 D.C. Transit Sys., Inc. (Order No. 4631), supra note

164, 33 P.U.R.3d at 155.

240 Td.

241 Jd.

d4a

held that permanent losses on premature property retire-

ments are to be amortized as operating expenses for fu-

ture consumers to absorb.” In similar fashim. PUC,

Transit’s then regulatory agency, treated the undepreci-

ated cost of the tracks and streetcars acquired by Transit

as a part of the depreciation expense recoverable from

its farepayers.** This item of cost was anticipated to ag-

gregate more than $5 million.** The second aspect of the

expense was the cost of removing the tracks, and regrad-

ing and repaving the street areas from which they were

removed. That cost, too, PUC ruled, was to be paid by the

farepayers.*® The estimate of this item of cost was, as we

have stated, in excess of $10 million.

PUC’s treatment of the latter item did not, hovever, go

unchallenged. In Bebchick v. Public Utilities Commis-

sion,7 consumers contended that the expense of track

removal and street repaving was a burden which Transit’s

investors had assumed by the terms of the franchise **

and so was not properly an operating cost. They asserted,

in their words, that “it is unreasonable and unlawful to

require the farepayers to make contributions of capital to

Transit by the device of an allowance for track removal

and repaving.” ** To buttress this point, they adyerted to

Transit’s purchase of Capital’s assets at more than $10

242 See Part IV(A), supra, at notes 201, 211-18.

243 D.C. Transit Sys., Inc. (Order No. 4631), sepra note

164, 33 P.U.R.3d at 155-60.

244 Jd. at 156-57.

245 Td. at 155-56.

246 See text supra at note 239.

247 Supra note 185.

248 See note 237, supra.

249115 U.S.App.D.C. at 220, 318 F.2d at 191.

€

;

‘

;

€

;

eee rer ag <x PNP ace ETP Di ti bara a wy Sy Yt

5da

million less than their book value, and argued that that

came about in consequence of Transit’s assumed track re-

moval and repaving obligation. The argument failed, how-

ever, and the point respecting track removal and repaving

costs was lost, when this court concluded that the benefit

of the reduced purchase price was being passed on to Tran-

sit’s consumers.” :

A full understanding of the basis of so much of our hold-

ing in Bebchick requires some elaboration of the technique

PUC utilized in dealing with the $10 million difference

between Capital’s book value and Transit’s purchase price

of the acquired assets. The portion of the purchase price

assignable to road and equipment, including the parcels of

realty under scrutiny now, was $10,339,041 less than the

depreciated original cost of assets in those categories as

carried on Transit’s books.*? As we were later to explain,

Transit’s allowances for depreciation thereon could,

of course, have been related to its own acquisition

costs; but this would have required the development

of new depreciation rates computed on remaining life,

and new depreciation bases derived in part from

distribution of the purchase price among the items

of property acquired. To save the labor incidental

to that process, however, [PUC] . . . ordered that

two things be done. One was the establishment of

[an] acquisition adjustment account to accommodate

an amortization, over a ten-year period beginning

August 15, 1956, of the $10,339,041 difference in ac-

quisition costs to Capital and Transit, respectively.

25° Id. at 221, 318 F.2d at 192.

251 See D.C. Transit Sys., Inc. (Order No. 3592), at 5,

—- (D.C. Pub. Utils. Comm’n Nov. 27, 1957) (unre-

ported).

32 D.C. Transit Sys., Inc. (Order No. 4631), supra note

164, 33 P.U.R.3d at 1565.

Cs a 2s oe oe 5 me a — = — , ee . . ™

56a

The other was a direction that depreciation be ac-

crued on the basis of Capital’s original cost and at the

rates previously fixed for Capital, with ten annual

offsetting credits to operating expenses of $1,033,904

derived from the amortization.**

The objectives of this accounting arrangement thus

appear sharply. With the addition to Transit’s pur-

chase price of annual offsetting credits to operating ex-

penses, Transit’s investors would ultimately pay Capital’s

book value of road and equipment in full. And fare-

payers, in consequence of the offsetting credits, would

ultimately contribute $10 million less to Transit’s opera-

tional costs. The investors would, of course, benefit from

depreciation at Capital’s depreciation rates; theoretically,

post-acquisition depreciation by this method would work

out to the same amounts as if new depreciation bases

had been established at Transit’s acquisition costs. So,

in Bebchick, after examining PUC’s explanation of the

foregoing, we concluded that “[i]n this manner the

Commission gave consideration to the reduced purchase

price by Transit.”** “The farepayers,” we explained,

“will receive benefit in the form of reduced depreciation

in the total amount of $10,399,041 to be written off an-

nually in the amount of $1,033,904.” a8

—Accrual of Advantages

As we have stated, the properties upon which our pres-

ent inquiry focuses were all acquired by Transit from

Capital in 1956. They came to Transit as a single pack-

253 Williams v. Washington Metropolitan Area Transit

Comm'n, supra note 16, 134 U.S.App.D.C. at 367, 415 F.2d

at 947.

254 Bebchick v. Public Utils. Comm’n, supra note 185, 115

U.S.App.D.C. at 220-21, 318 F.2d at 191-92.

255 Jd. at 221, 318 F.2d at 192.

256 Td.

Se ae oe

57a

age—all of the assets Capital then owned; Transit got the

assets, not by buying them as such, but rather by buying

all of Capital’s outstanding capital stock.** And in the

great majority ‘of instances, the purchased real estate

which is no longer devoted to public use was removed

from service because of the conversion from a trolley-bus

to an all-bus system of transportation. These were par-

cels on which were located carbarns, repair shops and

other buildings used and useful when the streetcars were

still running ;*** because these properties were unsuited

to Transit’s all-bus operation, the conversion rendered

them surplus to Transit’s needs. And, lest we forget, the

financial burden of the conversion was, in its entirety,

placed upon those who rode Transit’s vehicles.”

From the foregoing discussion, the realities of the situ-

ation become plain enough. Transit got from Capital

an on-going transportation system, including improved

land, which the latter had acquired years before on

obviously lower real estate markets. The price Transit

paid Capital was calculated, not on fair market value of

the acquired assets, but on a fixed per-share valuation

of Capital’s stock, which worked out to much less than

even the value of the assets as depreciated on Capital’s

books.?° We know that the price of Capital’s road and

equipinent was some $10 million less than book value,?*

and we cannot approximate how much less than fair mar-

ket value at the time of acquisition the total price for all

*7 D.C. Transit Sys., Inc. (Order No. 4631), supra note

164, 33 P.U.R.3d at 155-60.

*58See appendix.

259 See text supra at notes 242-56.

700 D.C. Transit Sys., Inc. (Order No. 4681), supra note

164, 33 P.U.R.3d at 158. ;

761 See text supra at notes 233-34.

a = . — . oe en

58a

assets may have been.”*? There is nothing to justify an

assumption that the price allocable to the parcels of realty

here involved was anywhere near their true market

value.?®

In addition to what ostensibly was an acquisition of the

properties at an excellent bargain,” Transit secured other

valuable advantages—all at the expense of its traveling

public. Within four years after commencing operations,

Transit, largely as a result of legislative policy declared

in its franchise,*® began obtaining fare increases on the

basis of its gross operating revenues rather than on the

282'The original cost of Capital’s road and equipment

alone was $49,818,718. D.C. Transit Sys., Inc. (Order No.

4631), supra note 164, 33 P.U.R.38d at 162. The remaining

assets purchased, amounting to $8,592,952.54, consisted in

cash and miscellaneous items. D.C. Transit Sys., Inc. (Order

No. 3592), supra note 251, at exh. 2.

263 Jt was for this reason that PUC, in establishing Tran-

sit’s rate base prior to shifting to the operating ratio

method, see note 266, infra, refused to accept the price

which Transit paid to Capital as a true reflection of the

fair value of the assets acquired. D.C. Transit Sys., Inc.

(Order No. 4631), supra note 164, 33 P.U.R.3d at 155.

264 PUC’s utilization of the acquistion adjustment account,

see text supra at notes 251-56, in no way qualifies this

characterization. The acquisition adjustment device raised

the investors’ cost-of-purchase from $13.5 million to $23.8

million, but the $23.8 million was Capital’s book value, not

the fair market value, of the assets acquired. Original cost

of those assets exceeded $58 million, see note 262, supra.

The land included among those assets, acquired much earlier

on obviously much lower markets, surely had a market value

at Transit’s acquisition which was greatly higher than

Capital’s book value based on original cost. See text supra

at notes 260-62 and note 262, supra.

265 See Franchise Act, tit. I, pt. I, § 4, 70 Stat. 598 (1956).

59a

system rate base which had been employed for Capital.’

Thus Transit could carry on its transportation business

with a minimum of invested capital, and that it has done

as long as it has been a public utility.” With the franchise-

conferred monopoly * of the lion’s share of mass trans-

portation in the Washington metropolitan area, Transit

266 When Transit succeeded Capital, the latter’s rates were

set on a rate base established on original cost. See Speigel

vy. Public Utils. Comm’n, 145 F.Supp. 679, 680 (D.D.C. 1956),

aff'd, 101 U.S.App.D.C. 98, 94-95, 247 F.2d 84, 85-86 (1957).

In Transit’s first fare proceeding, PUC declined to switch

to the operating ratio method, D.C. Transit Sys., Inc. (Order

No. 4480), 25 P.U.R.8d 871, 374 (1958); instead, it fixed

the rate base at $14,167,375 by giving equal weight to Capi-

tal’s depreciated original cost and Transit’s purchase price.

Id. at 374-76. See also D.C. Transit Sys., Inc. (Order No.

4681), supra note 164, 38 P.U.R.3d at 163-64. In 1960,

however, PUC permitted the shift to operating ratio, with

the rate-base rate of return method as a check on reason-

ableness of the return. Jd. at 144-48. See also D.C. Transit

Sys., Inc. (Order No. 4735), supra note 164, 38 P.U.R.3d at

25-26. We approved the shift in Bebchick v. Public Utils.

Comm'n, supra note 185, 11i U.S.App.D.C. at 219-20, 318

F.2d at 190-91.

On the advantage a transit company derives from use of

the operating ratio method rather than a system rate base,

see 1 A. Priest, Principles of Public Utility Regulation 221-

24 (1969); Wright, Operating Ratio—A Regulatory Tool,

51 Pub. Util. Fort. 24-29 (1953).

267 See S. Rep. No. 91-760, 91st Cong., 2d Sess. 3 (1970) ;

D.C. Transit Sys., Inc. (Order No. 1216) (WMATC May

19, 1972), at 9-10 (as yet unreported), quoted on affirmance

in D.C. Transit Sys., Inc. v. Washington Metropolitan Area

Transit Comm’n, supra note 171, —— U.S.App.D.C. at ——

n.28, 466 F.2d at 398 n.28.

268 Franchise Act, tit. I, pt. 1, §3, 70 Stat. 598 (1956).

29 Transit was one of four utilities operating regular-

route transportation systems in the area. One of the other

60a

was enabled not only to function with a capital outlay of

but $500,000 plus reinvested gains and earnings from

operations,” but also to distribute $4,390,000 in dividends

—an actual paid-out return of 830 percent on original

equity—during the first decade of its existence.*”

To the foregoing circumstances must be added others—

hardly less important, and equally contributors to a

potential windfall. After Transit’s acquisition from Capi-

tal, the properties now questioned remained in operating

status for various periods, and indeed two apparently

always so remained.” In that status they have pos-

sessed incidents and immunities they could not summon

below the line. They have commanded preferred real

estate tax treatment.*" They were, as above-the-line

assets, a part of Tran it’s rate base during the years

prior to adoption of the operating ratio method of estab-

lishing its margins of return.2"* Even under the latter

method, in vogue since 1960,? the properties have counted

three was a wholly-owned subsidiary of Transit, and the

other two commanded but fragments of the transit market

and operated almost exclusively in suburban areas.

2% See sources cited supra note 267.

“715. Rep. No. 91-760, 91st Cong., 2d Sess. 3 (1970).

And see D.C. Transit Sys., Inc. v. Washington Metropolitan

Area Transit Comm’n, supra note 171.

*72 See appendix.

273 See Franchise Act, tit. I, pt. 1, §9(g), 70 Stat. 598,

601 (1956), prescribing a statutory formula which requires

a Commission determination that Transit failed to earn a

612% rate of return during the previous year. From 1961

to 1968, inclusive, real estate taxes from which Transit

was exempted totaled $1,381,177. S.Rep. No. 91-760, 91st

Cong., 2d Sess. 3 (1970).

274 See note 266, supra.

275 See note 266, supra.

Gla

in the computation of Transit’s equity, a factor in turn

influencing Transit’s rate of return from transportation

operations.*"° And they have continued to appreciate in

value on the steadily rising local real estate market, which

unhesitatingly we notice judicially, while enjoying these

advantages as operating properties.

Surely the greatest advantage to Transit’s investors—

and one more specifically referable to the problem at

hand—was derived from the scrapping of Capital’s street

railways in favor of a motorized transportation system.

The changeover, as we have said, was mandated by Tran-

sit’s franchise,*"" and the treatment accorded the change-

over program worked strongly in Transit’s favor. As-

sessment of the incidental loss of more than $5 million on

Transit’s riders ** resulted in rapid recoupment of in-

vestors’ equity in the abandoned rail facilities by amor-

tization through Transit’s fareboxes. The expense of track

removal and repaving to date—some $10 million more—

was likewise assessed against the farepayers.*” Thus the

conversion to Transit’s all-bus operation has been speedily

accomplished, and wholly without expense to Transit.

And the crowning consideration is the incontrovertible

fact that the conversion, at full cost to the farepayers,

was the sine qua non to release of valuable real proper-

ties from operating roles in the transportation scheme

for uses in non-transportation ventures.”

Both the Commission and this court have recognized

the efficacy of this relationship of Transit’s large-scale

276 See note 266, supra.

277 See note 237, supra.

278 See text supra at notes 243-50.

279 See text supra at notes 245-50.

280 See appendix.

62a

retirement of real estate from operating status to the

track removal and repaving program and the financial

burdens it imposed on Transit’s farepayers. In 1959,

Transit’s sale of its Fourth Street Shops and Southern

Carhouse *** was examined, and a decision was made as

to the allocation between Transit’s consumers and _ its

investors of the net profits attributable to the physical

improvements on those properties, PUC declared:

In light of the franchise of the company requiring a

gradual program of conversion from railway to bus

operations over a 7-year period from January 24,

1956, we are unable to dissassociate the instant trans-

action from the imminent retirement of all rail prop-

erty under the mandate contained in the franchise.

We cannot ignore the probability that full provision

for depreciation will not have been provided when

the rail facilities are abandoned and retired by rea-

son of conversion. The company has consistently

taken the position that any retirement loss in this

connection should be recovered by charges against

the customers, and the staff has heretofor indicated

its agreement.*** However, if the customers are to be

required to bear the burden of extraordinary retire-

ment losses incident to the whole conversion program,

it appears equitable that they should share, at least

to some extent, in extraordinary retirement gains

of the nature here under consideration.*™*

The extent of the sharing, PUC made clear, was to be

ascertained by “a fair balance between the interests of

251 Supra note 33.

282 See Part II(A), supra at notes 33-55. See also Beb-

chick v. Public Utils. Comm’n, supra note 185, 115 U.S.App.

D.C. at 219-23, 318 F.2d at 190-94.

283 This position later gained full administrative and judi-

cial acceptance. See text supra at notes 243-56.

28430 P.U.R.3d at 412.

ew gl pe: WEF Regn Reg NS Ie nee tare te ee Te EE: Lo ee 1 UN Fg RAS Fe Tem rn a BE PORE

ai we wan to .% ‘ we = _ :

63a

the public and those of the company’s investors;”** and

on judicial review of Order No. 4577, we affirmed.***

Six years later, in D. C. Transit System, Inc. v. Wash-

ington Metropolitan Area Transit Commission, this

eourt sitting en banc, was called upon to scrutinize the

transaction in a different context. An objection to al-

lowance of a depreciation charge for abandoned rail fa-

cilities was predicated in part on the claim that the sales

were occasioned by the conversion program, and that, in

consequence, the profits realized should be deemed a

recoupment of obsolescence.*** Transit asserted, inter

alia, that the sales were unrelated to the program, and

although we acknowledged “some force to Transit’s

contention,” *** we neither reexamined nor disapproved the

Commission's resolution on that score.*° But our opin-

ion made manifest our view that if, as the Commission

thought, there was a connection between the sales and the

conversion program, farepayers’ sharing in the proceeds

was consonant with the equities of the situation.*”

This became the plainer when we moved to a consid-

eration of a second transaction urged in support of

disallowance of the depreciation charge.** That trans-

action was Transit’s sale of its Georgia and Eastern

= id.

286 D.C. Transit Sys., Inc. v. Public Utils. Comm’n, supra

note 51.

287 Supra note 18.

288 Jd. at 396-97, 350 F.2d at 773-74.

28° Jd. at 397, 350 F.2d at 775.

29° See id.

291 See id.

282 See id. at 397-98, 350 F.2d at 775-76.

—

3 a

ERAS Se FELL ROLF PN VR, EE ERS FEE RS CO ES ELLE FOG SOOO GEE

= — = =

ere ad

64a

Terminal in 1962, in which it allegedly reaped a sub-

stantial profit on the depreciable portion of the realty.

The parties had made no effort to establish the reasons

for the sale, apparently because it had occurred after the

close of the audit period on which the Commission’s proj-

ections were based.*"* Transit argued, however, that the

only evidence of record demonstrated the disassociation

of the sale and the conversion program, basing that posi-

tion on testimony that before the sale the terminal “was

used for bus operations also.” ** We pointed out that that

testimony “suggests that it may have been used in

Transit’s rail operations as well,” ** and that “it may

or may not be true that the sale was in some way related

to Transit’s conversion to an all-bus system.” 7"? “If it

was.” we continued, “the Commission should address. it-

self to the question, as did the PUC in the case of the

Fourth Street Shops, of whether the riders should be

afforded some participation in the benefits of the sale.” °°

And we admonished that “[{flollowing our remand, .. .

the Commission should determine whether the sale of the

terminal was occasioned, in whole or in part, by the

abandonment of rail operations, and, if it was, whether

and to what extent the farepayvers should share in the pro-

ceeds,” #¢¢

"2 But see Part II(A), supra, at notes 60-64.

24121 U.S.App.D.C. at 397-98, 350 F.2d at 775-76.

2% Id. at 398, 350 F.2d at 776 (emphasis in original).

208 Id.

wt id.

208 See Part II(A), supra, at notes 33-35.

29 121 U.S.App.D.C. at 398, 350 F.2d at 776.

#0 Td, On remand, D.C. Transit Sys., Inc. (Order No. 563),

supra note 18, the Commission found that the abandonment

En ee ee TTT AE eT

adn el nay ree STs RN cls Rete PEE SET ITEM ATE OTE LN AR MEL RR: : eo renin glial a *

—— : = ere = . ey tmenereenrnee

It cannot be gainsaid, then, that several important

propositions are firmly imbedded in our jurisprudence.

Transit’s investors cannot automatically garner the profits

achieved on dispositions of depreciable real estate which

in some way have been affeeted by the conversion pro-

gram. Relevant inquiries are whether the disposition “was

oceasioned, in whole or in part, by” the conversion pro-

gram“ or “was in some way related to” it8°? If so,

—

of the terminal and its subsequent sale were unrelated to

the conversion program. It said:

A review of the transcript reveals that retirement of

this property was not associated with the retirement of

rai! property. While the rail system was in use, the

Georgia and Eastern Terminal served in a dual capacity,

both as a terminal for rai] service and for bus service.

After the rail system was phased out, the terminal!

was used exclusively in bus operations. Sometime there-

after, due to the request of riders to move the terminal

further north, the company relocated its termina) in

Silver Spring and discontinued the terminal facilities

at the Georgia and Eastern location. It is apparent to

the commission that the termination of this facility as

property used and useful in the transit business was

predicated solely on the realignment of its bus terminal

facilities and its removal from service was completely

disassociated with the termination of the rai! operation.

Thus, it is our determination that the sale of the ter-

minal was occasioned neither in whole nor part by ihe

abandonment of rail operations. Therefore, the rate-

payer is not entitled to share in any portion of the pro-

ceeds of that sale, unless there was a profit on the de-

preciable portion of the asset sold. There was none in

this case.

Id. at 33-34. In this aspect, Order No. 563 was not brought

under judicial review.

a ahon’, i leabimaNtl Maples Abbess one

“1 See text supra at note 300.

2 See text supra at note 299.

66a

Transit’s farepayers are entitled to a fair share of

such profits. The extent to which they are to share

depends upon “a fair balance between the interests of the

public and those of the company’s investors.” *”

—The Commission’s Claimed Accounting Practice

We are advertent to the consideration that the proposi-

tions just diseussed have developed in litigation directly

referable to allocations of profits gained on disposition of

depreciable utility assets. We think, however, that no

difference in principle ean be justified solely on the ground

that the asset in question, or some part thereof, happens

to be nondepreciable. Both PUC and the Commission

have made such a distinction on the stated theory that

capital gains from nondepreciable property invariably

belong to investors.** Counsel for the Commission con-

tends additionally that we should defer to a uniform

accounting rule to that effect which the Commission is

said to have pursued. For two reasons, we reject these

positions.

In the first place, neither the Commission nor its

counsel has pointed to any agency-promulgated accounting

rule operative as to the value-appreciations on the lands

in question. The Compact empowered the Commission

to prescribe uniform systems of accounts for carriers

functioning under its jurisdiction, but required that its

authority to do so be exercised “by regulation.” *°* No

303 See text supra at note 285.

3 See Part III(B), supra, at notes 96-111.

305 “Bach carrier subject to the Commission shall keep

such accounts, records, and memoranda with respect to

activities in which it is engaged . . . as the Commission by

regulation prescribes. The Commission shall by regulation

prescribe the form of such accounts, records, and memo-

52 LP ELS pea ge Se aE — —_

ELBE EPPS SE BRE SRA DE ES

67a

such regulation of the Commission or its predecessor

agency relevant to the problem at hand has ever been

identified either in the Commission’s opinions or its coun-

sel’s argument.* The opinions contain only the gratui-

tous pronouncements on the subject to which we have

alluded,*** and the argument is similarly unrevealing.

In 1966, the Commission did adopt an accounting regu-

lation dealing with allocations of value-appreciations of

depreciable properties.*°* Since then, the Commission

has made explicit reference to that regulation in its

decision-making and in its argument here.*” It is difficult

to believe that if indeed the Commission had a counterpart

applicable to the nondepreciable properties under scrutiny,

it would leave us in the dark about it. We may assume

that, as a matter of unwritten policy, the Commission

has indulged accounting techniques conformable with its

randa, and the length of time that such accounts, records

and memoranda shall be preserved.” Compact, supra note

12, tit. II, art. XII § 10(b) (emphasis supplied). ;

806 While “[a]ll rules, regulations, orders” and “decisions”

of PUC, and “[a]ll’” “other action prescribed” by it, survived

the Commission’s succession until changed, id. § 21, there is

no showing that PUC ever acted formally on the matter un-

der discussion or that, if it did the Commission ever rested

its own action thereon.

407 See text supra at notes 89-111.

308 Regulation 61, which we discuss in No. 23,720, Beb-

chick v. Washington Metropolitan Area Transit Comm'n,

supra note 3, and No. 24,398, Democratic Cent. Comm. v.

Washington Metropolitan Area Transit Comm'n, supra note

3, in connection with issues raised in those cases. That regu-

lation, treating as it does gains on depreciable assets, has

no direct applicability to the issue involved in the instant

case.

: 3 See D.C. Transit Sys., Inc. (Order No. 1090), supra

| note 64, 85 P.U.R.3d at 513-14.

AN LOMO OCA OTE TPL ELE EPEAT LAD AOA AIOE AL Oe en rte een nna ONE mee apa

-——= om Se eA mA AAEM Re IAN EEO LEE POE

eM a ee St ee

68a

mistaken notion of a settled principle on the subject,3!°

but that is a far ery from the deliberate, reasoned rule-

making which the Compact obviously contemplates.“ In

sum, neither PUC nor the Commission has ever spoken of

an extant accounting regulation treating gains on the

nondepreciable assets in issue, and it is well settled that

counsel’s own post foc rationalizations are not an ae-

ceptable substitute.*

Moreover, even if we could agree that the Commission,

by virtue of its brief comments in Orders Nos. 245 and

563 and those of PUC in Order No. 4577,°" had ordained

that on Transit’s hooks the appreciation on in-service non-

depreciable assets should be eredited to investors, the

mere adoption of such an accounting practice would not

terminate our inquiry. Accounting procedures are not

self-justifving; like other regulatory action of the Com-

mission, they must refleet a rational allocation of economic

rights and responsibilities between a utility's investors and

econsumers.*'* The simple facet that an ageney treats an

item a certain way for purposes of its uniform system

of accounts does not mark the end of judicial serutiny;

on the contrary, a reviewing court must assure itself that

the accounting practice prescribed is consistent with under-

*10 See text supra at note 107.

*11 See note 305, supra.

2 E.g., Burlington Truck Lines v. United States, 371 U.S.

156, 168-69 (1962); SEC v. Chenery Corp., 318 U.S. 80,

92-95 (1942); Local 833, UAW v. NLRB, 112 U.S.App.D.C.

107, 112-13, 300 F.2d 699, 704-05, cert. denied, 370 U.S. 911

(1962).

313 See text supra at notes 50-64, 96-111.

*14 See Williams v. Washington Metropolitan Area Transit

Comm’n, supra note 16, 184 U.S.App.D.C. at 350, 358-59 &

n.86, 415 F.2d at 930, 938-39 & n.86.

RIES ROWS COT SLOPE OLY GEL CGI ORO LOLOL AD EAL GAEDE GE GO LESLIE IGE I LEL LE _

sb a ae ee ; ee , oo _— ——= —_ —-—~- :

“

lying substantive principles of public utility law.“ To

permit an accounting device to dictate the rule of law is to

allow ‘he tail to wag the dog. To judicially aecept an ae-

counting method without inquiry as to its reasonableness is

to pervert the law. And to yield, on judicial review, un-

questioning obeisance to administrative authority over

utility accounting is to abdicate the responsibility to -

review.

69a

In the final analysis, administrative regulation by

prescription of accounting methods stands on no higher

ground than regulation by adjudication where substan-

tial interests of investors and consumers are at stake.

Accounting directives, no less than other exertions of admin-

istrative power, must survive the test of rationality.*'

15 See In re Republic Light, Heat & Power Co., 265 App.

Div. 53, 37 N.Y.S.2d 947, 949 (Sup.Ct.App.Div. 1942); New

York Edison Co. v. Maltbie, 244 App.Div. 685, 281 N.Y.S.

223, 226 (Sup.Ct.App.Div. 1935), aff'd, 271 N.Y. 103, 2 N.E.

2d 277, 279 (1936).

“16 Legislative grants of administrative authority over

public utility accounting are designed to meet the informa-

tional needs of effective regulation and the public needs of

economical rates, particularly as either may be affected by

inflationary write-ups or expense padding. American Tel. &

Tel. Co. v. United States, 299 U.S. 232, 237, 239, 240, 246

(1936) ; Norfolk & W. Ry. v. United States, 287 U.S. 134,

140 (1932) ; Kansas City S. Ry. v. United States, supra note

198, 231 U.S. at 440, 449; ICC v. Goodrich Transit Co., 224

U.S. 194, 211, 216 (1912). Compare United States v. New

York Tel. Co., 326 U.S. 688 (1946) ; Northwestern Elec. Co.

v. FPC, 321 U.S. 119 (1944). Supervision of accounting,

of course, is due the same respect accorded other adminis-

trative action, and “in gauging rationality, regard must

steadily be had to the ends that a uniform system of accounts

is intended to promote.” American Tel. & Tel. Co. v. United

States, supra, 299 U.S. at 287. Deference to an agency’s

Saas .

ae REM RYe R Ri a oon ANREP NE AREER AT PSE NITE OAR SLEEP NILE SINAN

70a

And the validity of the administrative exercise must be

judged solely on the grounds upon which the agency based

it."7 Our examination of the grounds which the Commis-

treatment of accounting problems reaches its zenith where

the issue is one of pure accounting, notwithstanding inci-

dental intrusion upon management prerogatives, see F'PC v.

East Ohio Gas Co., 388 U.S. 464, 474-76 (1950); United

States v. New York Tel. Co., supra, 826 U.S. at 654-55;

Northwestern Elec. Co. v. FPC, supra, 821 U.S. at 123-24;

American Tel. & Tel. Co. v. United States, supra, 299 U.S.

at 236-37; Norfolk & W. Ry. v. United States, supra, 287

U.S. at 141-43; Kansas City S. Ry. v. United States, supra,

231 U.S. at 441, 444, but even those features of agency

action may be judicially examined for arbitrariness. North-

western Elec. Co. v. FPC, supra, 321 U.S. at 124; American

Tel. & Tel. Co. v. United States, supra, 299 U.S. at 236-37;

Norfolk & W. Ry. v. United States, supra, 287 U.S. at 143;

Arkansas Power & Light Co. v. FPC, 87 U.S.App.D.C. 385,

387, 185 F.2d 751, 753 (1950), cert. denied, 341 U.S. 909

(1951). See also Kansas City S. Ry. v. United States,

supra note 198, 231 U.S. at 452-53, 456-57. A fortiori,

judicial responsibility is as grave where the accounting is-

4 sue draws in substantive relationships of utility and con-

sumers. As this court has specifically held, accounting ac-

tions of the very type involved here—those which in effect

regulate allocations of value-appreciations achieved on op-

erating utility assets—may be freely reviewed to enable

decision of “questions of law’ and determination as to

whether the basis for action is “unreasonable, arbitrary, or

capricious.” D.C. Transit Sys., Inc. v. Public Utils. Comm’n,

supra note 51, 110 U.S.App.D.C. at 242, 292 F.2d at 735.

317 SEC v. Chenery Corp., supra note 312, 318 U.S. at

87; Bond v. Vance, 117 U.S.App.D.C. 203, 204, 327 F.2d

901, 902 (1964) ; Local 833, UAW v. NLRB, supra note 312,

112 U.S.App.D.C. at 113, 300 F.2d at 705; NLRB v. Capital

Transit Co., 95 U.S.App.D.C. 310, 318, 221 F.2d 864, 867

(1955) ; Democrat Printing Co. v. FCC, 91 U.S.App.D.C. 72,

77-18, 202 F.2d 298, 302-03 (1952); Mississippi River Fuel

Corp. v. FPC, 82 U.S.App.D.C. 208, 224, 163 F.2d 433, 449

(1947). 3

7la

sion, when it acted, proffered in support of the accounting

practice under scrutiny has left us wholly unsatisfied as

to its rationality. We have adverted to the two premises

upon which the Commission has rested its distinctive

treatment of gains on nondepreciable property.*"® We have

also noted that by our appraisal those premises are fatally

defective.*® It necessarily follows that we must now re- |

ject the claim that the Commission has effectively decreed

the disposition of value-appreciations on nondepreciable

utility assets by an appropriate exercise of its authority

over utility accounting.

—The Balance Here

The allocation between investors and consumers of

capital gains on in-service utility assets, we have declared,

rests essentially on equitable considerations.* The allo-

cative process, we have said, necessitates a delicate

balancing of the interests of investors and consumers in

light of the governing equitable principles.*** The con-

stant effort must be a distribution of the gains as fair-

ness and justice may require. In particular instances,

however, the direction in which the equities lie is so

vividly marked by the circumstances of the case that the

allocation properly to be made emerges plainly. We

think such an instance is presented here.

The relevant principles can be stated simply. Con-

sumers become entitled to capital gains on operating

utility assets when they have discharged the burden of

preserving the financial integrity of the stake which in-

vestors have in such assets.**? Their entitlement is estab-

318 See text supra at notes 107-11.

319 See text supra at notes 110-11.

820 See text supra at Part IV(A).

321 See text supra at note 177.

822 See Part IV(A), supra, at notes 181-227.

72a

lished, too, when it is manifest that investors have bene-

fitted measurably from special treatment accorded those

assets in the past." And in appraising the equities,

neither administrative nor judicial tribunals are. at

liberty to ignore economic reality. The stark reality

here is that) Transit's farepayers have long been

saddled with the burdens incidental to the proper-

ties in issue while they remained in operating status.

Theirs were the expenses of ordinary maintenance **

and depreciation’ and the risks of loss from = casu-

alty ** and obsolescence,*? associated with those prop-

erties. These they shouldered over the years not only for

Transit but also for Capital, Transit’s predecessor. Theirs

also were the losses wrought by the conversion program.

which direetly made transfers of some assets, nondepre-

clable as well as depreciable, from above to below the

line possible?* And Transit’s investors have profited,

not only from these arrangements of burdens, but alse

from favorable treatment of the operating assets in other

ways." By our assessment, these circumstances tip the

scale in favor of Transit’s farepayers, so much so as to

earn for them the gains beyond the shadow of a doubt.

This court has never adopted the Commission's position

that capital gains on nondepreciable assets inure to

investors only." We decline to adopt that position now.

“8 See Part IV(A), supra, at notes 272-82.

“4 See Part IV(A), supra, at notes 219-20.

“25 See Part IV(A). supra, at notes 197-218.

“28 See Part IV(A), supra, at note 186.

See Part IV(A), supra, at note 201.

S28 See Part 1V(B), supra, at notes 243-46. .

8” See Part IV(A), supra, at notes 272-82. F

“S@ See Part II(B), supra, at notes 96-111. As we there

point out, the Commission’s several pronouncements on that

seore have never been subjected to judicial review.

PENS DSF HL RCN ANTE OT LITE MOT RE IAN LION LLL IT TS EP OED DT BE IMENT LONI EE Te

SS BE ge ay ie a ae ea

73a

Our historical analysis of the interests of investors in

value-appreciations of operating utility assets demon-

strates beyond a doubt that the burden of safeguarding

the utility's investment in all of its assets—depreciable

and nondepreciable—is legally assigned in its entirety to

consumers." As we have further pointed out, even were

the risk on the lands involved here theoretically one

which had been carried by the investors, that risk be-

comes mythical when viewed in light of the high unlikeli-

hood that the value of the lands would deeline.““?. Fur-

thermore, measuring the equities of the situation by

relevant doctrinal considerations, it is plain that Transit's

busriders have shouldered a very significant financial

onus with respect to those lands, and that Transit's inves-

tors have benefitted uniquely in their ownership of them,*

and that a reasonable and fair allocation of their appre-

ciation in market value accords that gain to the farepay-

ers."4 Unlike situations wherein the basis for profit-

sharing by farepayers may consist solely in the loss-risk

factors associated with depreciable property ** and the

burden of contributions to depreciation reserves ®*—

considerations largely or entirely absent in instances of

nondepreciable — property—farepayers’ equities founded

upon their assumption of the remaining economic respon

sibilities *"— ineluding those occasioned by a costly con-

version program *“—and upon investors’ enjovinent of

“See Part III, supra.

%82 See text supra at notes 228-29.

“8 See text supra at notes 264-76.

‘4 See Part IV(B), supra.

“® See Part III(A), supra.

“6 See Part III(A), supra.

7 See text supra at notes 257-76.

“88 See text supra at notes 277-300.

r, enhcsaei ante atone BPO GL NT SATB PEN ALT TERT LE ORS EER

és solar LA kg coer te Rene ee aa RI EIRELD LIM KLE RON IEA ISG GE ee LOA PALS PAT RATS ae =: ,

74a

especially-conferred advantages not generally available to

others," are precisely the same whether the source of

the gain is depreciable or nondepreciable property. We

hold that a farepayers’ claim so predicated must be rec-

ognized and effectuated whether the property be of the one

character or the other.

With respect to the properties not directly related to

Transit’s conversion to an all-bus transportation system,

the equities also weigh in the riders’ favor. Transit ac-

quired all of its landholdings at a tremendous bargain

when it assumed Capital's franchise,“ and enjoyed val-

uable special benefits for them in the years which fol-

lowed.**" In none of these benefits did the farepayers

share, although they had been charged with major eco-

nomic responsibilities stemming from Transit’s takeover

of its predecessor's operations.**? Given these circum-

stances, we would be loath to say that the riders are not

equitably entitled to the value appreciations on these

properties as well. We hold that the farepayers were

entitled to all appreciations in the value of the assets in

issue, depreciable and nondepreciable,** accruing during

their tenure as operating properties.

338 See text supra at notes 264-76.

34° See text supra at notes 260-64.

341 See text supra at notes 265-76.

342 See text supra at notes 237-50.

343 In referring to the amount of appreciation or gain on

the assets while in service, we are speaking of a net figure.

The amount which should be credited to the farepayers is

not the entire difference between book value and market

value of the assets at the time of transfer, but rather that

sum minus the taxes and sale expenses which would have

been deducted from Transit’s profit if the assets had been

sold outright instead of simply being moved into nonoper-

ating status.

We also reject the contention that the right of the fare-

BP Se Re RG a Ri a Sa te SR RP A tre eu Bee —

‘ pte - — = . _ _ . ~~ Sl

DISPOSITION

The foregoing considerations lead us to the conclusion

that Order No. 773 is invalid and must be set aside.

Thus we reach, as the final chapter of this review, the

disposition required by the circumstances that the fares

fixed hy that order have been charged and paid sinee it

went into effect. To this matter we now proceed.

A. Responsibility For Fashioning Relief

The initial question is whether the fashioning of relief

from the predicament we face lies properly within the

judicial sphere or, instead, the administrative. It is clear

to us beyond peradventure that this court and the Com-

mission should share the burden in this case.

A judicial determination that a Commission fare order

was invalid has normally ealled for remediation in a dual

aspect. First because the invalid order could not be in-

dulged continued operation, a resetting of fares was

payers to gains in the value of these properties does not

ripen until the properties are sold. Our reasons for holding

that the right accrues at the time the assets are removed

from operating status are discussed more fully in Bebchick

v. Washington Metropolitan Area Transit Comm’n, supra

note 2, at 31-33 and in Democratic Cent. Comm. v. Wash-

ington Metropolitan Area Transit Comm’n, supra note 3,

at 29-30. It suffices here to point out that the Commission’s

own Regulation 61 crediting value-appreciations on depre-

ciable assets to the farepayers specifies this practice, and

: we see no reason for treating nondepreciable assets dif-

, ferently. See Bebchick v. Washington Metropolitan Area

Transit Comm'n, supra note 2, at 32-33.

*# Compare Williams v. Washington Metropolitan Area

Transit Comm’n, supra note 16, 134 U.S.App.D.C. at 358-59,

415 F.2d at 938-39.

An,

ire: Ss reece ce QR AS? PROSE SS Py EEE OT Tt RO ER OBO

=S ae Hoe ey oa ne eo =~ +

T6a

ordinarily needed for the future” When there was such

a need, it is evident that it had to be met by the Commis-

sion. We possess no ratemaking powers as such; our

authority is confined within the traditional bounds of

judicial review. “Our function” in relation to pure rate-

making “is normally exhausted when we have determined

that the Commission has respected procedural require-

ments, has made findings based on substantial evidence,

and has applied the correct legal standards to its substan-

wise at an end when we have ascertained that the Com-

mission has not done so.” On the other hand, “even

where ageney action must be set aside as invalid, but the

ageney is still legally free to pursue a valid course of

action,” ““—not the present situation “’—‘“a_ reviewing

court will ordinarily remand to enable the ageney to enter

a new order after remedying the defects that vitiated the

original action.” *°”

The seeond, but quite different, aspect of the relief

required where a court has declared a Commission fare

order to he invalid, is remediation of the consequences

wrought by the order while it was actually operative.

This is a problem which can neither be addressed nor

solved by another order merely purporting to fix rates.

“The Commission.” we have declared, “possesses no au-

“5 That is not invariably the situation, however. See text

infra at notes 354-55.

46 Williams v. Washington Metropolitan Area Transit

Comm'n, supra note 16, 134 U.S.App.D.C. at 362, 415 F.2d

at 942 (footnote omitted).

“47 Td. at 362-63, 415 F.2d at 942-43 (footnote omitted).

348 Td. at 359, 415 F.2d at 939.

%49 See text infra at notes 390-403.

350 Jd. at 359-60, 415 F.2d at 939-40 (footnote omitted).

EN ERAS PTE FORE Mi ERE POLS LEE LLLP ELE LLNS ELE IE SEL UG LS

thority to fix rates for the past.”™" As we have pointed

out, “[ajn order prescribing the lawful fares to be

charged by a public utility, being essentially legislative

in character, ordinarily speaks only for the future.” *?

We have heretofore admonished that “we find nothing in

the statutory provisions governing the Commission's

regulatory responsibilities that indieates an intent to

depart from [the] ‘customary pattern of fixing rates

prospectively.’ ** Moreover, Order No. 773 has been

superseded by later fare orders ™* and, because Transit’s

transportation operations have since Order No. 773 been

publiely assumed, there is no possibility of any additional

ratemaking by the Commission. Reetifieation of the

77a

illegal consequences of an unlawful rate order must then

consist in something other than retroactive ratemaking.“**

1 Williams v. Washington Metropolitan Area Transit

Comm'n, supra note 16, 134 U.S.App.D.C. at 360, 415 F.2d

at 940.

“2 Id. (footnote omitted).

8 Td. at 360-61, 415 F.2d at 940-41 quoting Transconti-

nental & Western Air, Inc. v. CAB, 336 U.S. 601, 605

(1949) (footnotes omitted).

4 See D.C. Transit Sys., Inc. (Order No. 882) (WMATC

Oct. 29, 1968) (unreported) ; D.C. Transit Sys., Inc. (Order

No. 984), supra note 165; D.C. Transit Sys., Inc. (Order No.

1052), 85 P.U.R.3d 1 (WMATC 1970). There is thus in this

case the identical problem we encountered in Williams v.

Washington Metropolitan Area Transit Comm’n, supra note

16, 134 U.S.App.D.C. at 360, 415 F.2d at 940.

*9 See text infra at notes 390-403.

** Compare Williams v. Washington Metropolitan Area

Transit Comm'n, supra note 16, 134 U.S.App.D.C. at 360-

61, 415 F.2d .at 940-41. See also Bebchick v. Public Utils.

hn eg) hil IDR PLR ASN AEE NA RGITADS “4

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78a

B. The Restitutional Remedy

The remedy, rather, is restitution. That was made

plain by the decision of this court en banc in Williams v.

Washington Metropolitan Area Transit Commission™

There we found that two orders of the Commission fixing

fares for Transit were invalid, and that remand to the

Commission for reconsideration of those orders would

be futile.*** “[I]t follows,” we held, “that Transit must

be compelled to make appropriate restitution for the in-

creased fares it collected” under those orders.*® We drew

support for that conclusion from the “ ‘principle, long

established and of general application, that a party against

whom an erroneous judgment or decree has been carried

into effect is entitled, in the event of a reversal, to he

Comm'n, supra note 185, 115 U.S.App.D.C. at 232-33, 318

F.2d at 203-04; Washington Gas Light Co. v. Baker, 90 U.S.

App.D.C. 98, 104-05, 195 F.2d 29, 35 (1951). And see Wis-

consin v. FPC, 373 U.S. 294, 304-06 (1963).

357 Supra note 16.

358 Williams v. Washington Metropolitan Area Transit

Comm’n, supra note 16, 184 U.S.App.D.C. at 359-61, 415 F.2d

at 939-41. There, as here, in addition to the obstacle of

retroactive ratemaking, the orders under review had been

superseded by subsequent fare orders. Jd. at 360, 415 F.2d

at 940.

359 Jd. at 362, 415 F.2d at 942 (footnote omitted). We

added:

This conclusion is unaffected by the fact that we do

not decide that the fares authorized are unjust or un-

reasonable as a matter of law. Our role as a reviewing

court is not to make an independent determination as

to whether fares fixed by the Commission are just and

reasonable, but rather to insure that the Commission

in, exercising its rate-making power, has acted ration-

ally and lawfully.

Id.

restored by his adversary to that which he has lost there-

by.’” 5% “This principle,” we explained, “is no less ap-

plicable to erroneous orders of an administrative agency

than to those of a court.” **' Here, no less than in Wil-

liams, “given our conclusion” that in formulating Order

No. 773 “the Commission failed to apply appropriate cri-

teria, and failed to make the inquiries prerequisite to .

valid exercise of its ratesetting authority, we could not

permit Transit to retain the increased fares, since to do

so would be to give legal effect to the Commission’s in-

valid order.” **

Thus the division of labor to which we have adverted **

becomes apparent. While promulgation of fares is admini-

79a

360 Jd. at 362 n.97, 415 F.2d at 942 n.97, quoting Arka-

delphia Milling Co. v. St. Louis S. W. Ry., 249 U.S. 134, 145

(1919). See also Baltimore & O. R.R. v. United States, 279

U.S. 781, 785-86 (1929) ; Atlantic Coast Line R.R. v. Florida,

295 U.S. 301, 309 (1935).

361 Williams v. Washington Metropolitan Area Transit

Comm’n, supra note 16, 134 U.S.App.D.C. at 362 n.97, 415

F.2d at 942 n.97. This was well established long prior to

Williams. See United Gas Pipe Line Co. v. Mobile Gas Co.,

350 U.S. 332, 347 (1956) ; Atlantic Coast Line R.R. v. Flor-

ida, supra note 340, 295 U.S. at 309-11; Bebchick v. Public

Utils. Comm’n, supra note 185, 115 U.S.App.D.C. at 218-19,

232-38, 318 F.2d at 189-90, 203-04; Washington Gas Light

Co. v. Baker, supra note 128, 88 U.S.App.D.C. at 127, 188

F.2d at 23.

362 Williams v. Washington Metropolitan Area Transit

Comm’n, supra note 16, 134 U.S.App.D.C. at 363, 415 F.2d at

943 (footnote omitted). As we added there, “[t]his is so

notwithstanding that we have held neither that the Commis-

sion lacked power to order a fare increase, nor even that the

fares authorized are, as a matter of law, unjust or unrea-

sonable.” Jd. (footnote omitted). See also note 359, supra.

363 See text supra at notes 345-56.

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“ana a eal 80a

Strative business,*“ the fashioning of restitutional reme-

dies is a judicial function. We are thus brought to a

consideration of the criteria by application of which the

amount of restitution in this case must ultimately be

determined.

Restitution is essentially an equitable remedy. As we

said in Williams, “our decision in this regard is to be

governed by the equitable considerations which apply to

suits for restitution generally.” * So, “[{t]he basie ques-

tion” in quests for restitution “is whether ‘the money was

obtained in such cireumstances that the possessor will give

offense to equity and good conscience if permitted to retain

it’ and is ‘no longer whether the law would put him in pos-

session of the money if the transaction were a new one.” " "°°

To be sure, “[o]rdinarily ... the proper disposition on set-

ting aside a rate inerease unlawfully ordered by the Com-

mission would be to compel the regulated company to re-

store the entire difference between the higher fares collected

under the invalid order and the amount that it would have

received from the fare schedule previously in effect,” **

54 See text supra at notes 345-48.

*65 See cases cited supra note 361. This is not to say that

the court cannot utilize the administrative expertise of the

agency to assist the discharge of the judicial function. In-

deed, we do so in this very case. See text infra at notes 377-

87.

*6 Atlantic Coast Line R.R. vy. Florida, supra note 360,

295 U.S. at 309; Restatement of Restitution $ 142, comment

a at 568 (1937).

** Williams v. Washington Metropolitan Area Transit

Comm'n, supra note 16, 134 U.S.App.D.C. at 364, 415 F.2d

at 944 (footnote omitted).

““ Id., quoting Atlantic Coast Line R.R. v. Florida, supra

note 360, 295 U.S. at 310.

*6° Williams v. Washington Metropolitan Area Transit

Comm'n, supra note 16, 134 U.S.App.D.C. at 364, 415 F.2d at

944 (footnote omitted).

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“2

and we have had previous oceasion to do just that.”

“TR Jestitution,” however, “is not a matter of right, but is

‘er gratia, resting in the exercise of a sound discretion; "37

it “is granted to the extent and only to the extent that

justice between the parties requires.” "7 Tt aceordingly

“lies within our authority to direct restitution in an amount

less than the whole sum of the increased fares collected

under the invalid order, or to deny it altogether, if com-

pelling equitable considerations so dictate.”

“8la

We think the proper measure of restitution in this case

lies somewhere between these two extremes. Here, as in

Williams, “we have found the Commisison’s action in ap-

proving the fare increase to have been invalid, and... we

3 See Bebchick v. Public Utils. Comncn, supra note 185, 115

U.S.App.D.C. at 232-33, 318 F.2d at 2038-04: Washington

Gas Light Co. v. Baker, supra note 128, 88 U.S.App.D.C. at

127, 188 F.2d at 23.

1 Williams v. Washington Metropolitan Area Transit

Comm'n, supra note 16, 134 U.S.App.D.C. at 364, 415 F.2d

at 944 (footnote omitted), quoting Atlantic Coast Line R.R.

v. Florida, supra note 360, 295 U.S. at 310.

2 Williams v. Washington Metropolitan Area Transit

Comm'n, supra note 16, 134 U.S.App.D.C. 364 n.106, 415

F.2d at 944 n.106, quoting Restatement of Restitution ch.

8 at 596 (1937).

3 Williams v. Washington Metropolitan Area Transit

Comm'n, supra note 16, 134 U.S.App.D.C. at 364, 415 F.2d

at 944 (footnote omitted). As we put it there, “[t]he exer-

cise of such an equitable discretion by this court is by no

means an usurpation of the administrative powers of the

Commission nor is it an arbitrary extension of judicial au-

thority; it is ‘mere inaction and passivity in line with the

historic attitude of courts of equity for centuries.’” IJd.,

quoting Atlantic Coast Line R.R. v. Florida, supra note 360,

295 U.S. at 315.

PR lbs: MB tac UE Eke YN 4

have no basis in later valid action of the Commission for

inferring that the rates set by [that order] were in fact,

just and reasonable. .. .”°* Here, no more than there, do

we find warrant to “give legal effect to those rates by with-

holding restitution altogether.” * At the same time, as in

Williams, “we see no obstacle to our permitting the Com-

pany to retain some, though not all, of the proceeds of a

fare increase if there is reliable evidence suggesting that

it would be inequitable to compel restitution in a greater

amount.” #76

~- 82a -

C. The Commission's Role

As already indicated, the restitutional task at hand, as

a judicial function,* has become the responsibility of this

court.*** We inherit that responsibility as an inseparable

incident of our duty to review Commission action when it

is properly challenged,*” and to specify appropriate reme-

diation when the action reviewed is found to be erroneous.*®

v4 Td.

375 Td.

376 Td, at 364 n.106, 415 F.2d at 944 n.106. “The right of a

person to restitution from another because of a benefit re-

ceived is terminated or diminished if, after the receipt of the

benefit, circumstances have so changed that it would be in-

equitable to require the other to make full restitution.” Re-

statement of Restitution § 142(1) (1937).

877 See text supra at notes 357-65.

ee Pen er

378 Williams v. Washington Metropolitan Area Transit

Comm’n, supra note 16, 134 U.S.App.D.C. at 361-66, 415 F.2d

at 941-46.

31° Compact, supra note 12, tit. II, art. XII, § 17.

380 When our authority to review a Commission order is

properly invoked, we have “exclusive jurisdiction to. . .

83a

In discharging the obligation thus entrusted to us, we must

draw upon the resources at our command.** As we observed

in Williams, “[{iJn laying down a standard by which to

measure Transit’s right to retain funds collected under the

fare increase, we are aware that we are ill-equipped, even

were we authorized to do so, to search the record and reach

our independent conclusions as to what would have consti-

tuted reasonable fares for the period in question.” ** But

“njevertheless, the duty to reach a just decision in this

regard cannot be shirked, and our effort must be to find a

solution which lies within our competence as a reviewing

court, while at the same time responding in the fullest pos-

sible measure to the equitable considerations that must

guide us.” *8%

We believe that the best approach to adjustment, in the

restitutional sense, of the competing interests of Transit’s

investors and farepayers in this litigation is a combined

effort of the Commission and this court.*** The administra-

modify . . . such order.” Compact, supra note 12, tit. II, art.

XII §17(a). And see Williams v. Washington Metropolitan

Area Transit Comm’n, supra note 16, 134 U.S.App.D.C. at

361-66, 415 F.2d at 941-46.

381 See, e.g., In re Peterson, 253 U.S. 300, 312-14 (1920).

And when “the public interest is involved . . . equitable

powers assume an even broader and more flexible character

than when only a private controversy is at stake.” Porter v.

Warner Holding Co., 328 U.S. 395, 398 (1946).

382 Williams v. Washington Metropolitan Area Transit

Comm’n, supra note 16, 1384 U.S.App.D.C. at 366, 415 F.2d

at 946.

383 Id.

384 An available alternative is a reference to a master for

aid in working out the amount and details of restitution. See

In re Peterson, supra note 381, 253 U.S. at 312-14. See also

NLRB v. Arcade-Sunshine Co., 76 U.S.App.D.C. 312, 132

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84a

tive expertise of the Commisison is in any event a poten-

tially valuable aid to solution of the restitutional problem,

and is the more so in light of the Commission's familiarity

with many of its facets. “Judicial and administrative agen-

cies,” we recall, “‘are to be deemed collaborative instru-

mentalities of justice.’”*** We are also reminded that

“(ejourts have frequently called upon administrative bodies

... for assistance in connection with the issues falling

within the area of administrative competence.” *“* In recent

vears, we have had occasion to enlist the Commission’s

assistance in working out the elements of restitution made

necessary by another order invalidly raising Transit's

fares.*** In the case at bar, we do so once again, and we

F.2d 8 (1942); NLRB v. Remington Rand, Inc., 130 F.2d

919, 924-25 (2d Cir. 1942). For reasons stated in text, we

deem the assistance of the Commission preferable.

5 Bethlehem Steel Corp. v. Grace Line, 135 U.S.App.D.C.

81, 93, 416 F.2d 1096, 1108 (1969), quoting United States

v. Morgan, 313 U.S. 409, 422 (1941). See also United States

v. Ruzicka, 329 U.S. 287, 295 (1946); S. S. W., Ine. v. Air

Transport Ass'n, 89 U.S.App.D.C. 278, 280, 191 F.2d 658,

664 (1951), cert. denied, 343 U.S. 955 (1952).

“86 Bethlehem Steel Corp. v. Grace Lines, supra note 385,

135 U.S.App.D.C. at 93, 416 F.2d at 1108. There we directed

a court to stay a pending controversy to permit its considera-

tion by an administrative agency, the agency’s determination

to play an advisory role in the court’s resolution of the con-

troversy. Jd. at 91-94, 416 F.2d at 1106-09. See also, e.g.,

Order of Ry. Conductors v. Pitney, 326 U.S. 561, 567-68

(1946) ; Atchison T. & S. F. Ry. v. Aircoach Transp. Ass'n,

102 U.S.App.D.C. 355, 363-64, 253 F.2d 877, 885-86 (1958) ;

Capital Transit Co. v. Safeway Trails, Inc., 92 U.S.App.D.C.

20, 23, 201 F.2d 708, 711 (1953).

387 Williams v. Washington Metropolitan Area Transit

Comm'n, supra note 16, 134 U.S.App.D.C. at 361-66, 396-97,

415 F.2d 941-46, 976-77. See also Washington Gas Light Co.

v. Baker, supra note 356, 90 U.S.App.D.C. at 104-05, 195

F.2d at 35.

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85a

take this opportunity to outline the techniques the Com-

mission may utilize in providing that assistance.

First, the amount of restitution must be ascertained.

This determination will require identification of all proper-

ties which Transit shifted from above to below the line

prior to issuance of Order No, 773. Once identified the mar-

ket value of the properties at the time of their transfer to *

nonoperating status will have to be established. The dollar

amount of restitution can then be arrived at by subtract-

ing the book value of the properties from the market value

at the time of the transfer. This figure will represent the

appreciation in value of the assets, which should have been

credited to the riders when the fares preseribed by Order

No. 773 were set.

It can be readily seen that this method of determining

the amount of restitution will in no way reduce Transit's

return during the period the order was in effeet to a con-

fiscatory level. As we have pointed out, the only vitiating

defect in Order No. 773 was the Commission's failure to

allocate to the riders the gain in value of the properties

with which we are concerned; in all other respects the

fares set by that order must be accepted as just and reason-

| able. Thus, restitution of the gain to the riders has the

automatic effect of reducing the fares collected during the

operative period of Order No. 773 to the level of reasonable

return to which Transit was entitled.

There remains only the problem of how the amount of

restitution, once determined, is to be applied to benefit

the farepaying public. As we have observed, regulatory

agencies may only fix rates for the future.**? Moreover,

public takeover of Transit’s franchise has occurred,” and,

388 See note 16, supra.

389 See text supra at notes 351-56.

$99 See text infra at notes 394-403.

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86a x

as a result the Commission will no longer be setting fares

for Transit." Thus the rate mechanism cannot be the

instrumentality for channeling relief to the busriders, but

there are many ways in which the sum owing in restitu-

tion could he utilized profitably for the bus-riding publie.

The choice will become the task

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