West v. Chesapeake & Potomac Telephone Co. of Baltimore

295 U.S. 662, 55 S. Ct. 894, 79 L. Ed. 1640, 1935 U.S. LEXIS 335

Opinions

Mr. Justice Roberts

delivered the opinion of the Court.

Early in 1933 the Public Service Commission of Maryland undertook an investigation of the rates and charges of the Chesapeake and Potomac Telephone Company of Baltimore, and after extended hearings entered an order November 28, 1933, directing the company to put into effect January 1, 1934, reductions in its rates, sufficient to diminish annual net income by $1,000,000. The company filed a bill in the District Court for temporary and final injunction; the application for interlocutory relief was heard by a court of three judges. A stipulation was made that the cause should be treated as upon final hearing and a decree was entered enjoining enforcement of the order.¹ This appeal challenges the court’s action.

The Commission determined the value of the property at December 31, 1932, as $32,621,190; estimated the net revenue for 1934 at $3,353,793; allowed for reasonable return 6% on value, — $1,957,271,—which the estimated revenue would exceed by $1,396,522. In view of the rise of the general price level during 1933, however, the Commission required a reduction of but $1,000,000. In computing net income the Commission accepted all the company’s figures for current expense, except the annual allowance for depreciation; the amount claimed on this head being $2,173,000, and the sum allowed $1,720,724. The company insisted on a 7% per cent, return.

The controversy in the District Court revolved around three matters — value, annual depreciation expense, and rate of return. The court found the value of the property to be $39,541,921, the necessary depreciation expense $2,000,000, the probable net return under the Commission’s order $1,742,005, or at the rate of 4% per cent., as against 6 per cent., which the court held was the limit below which the return could not be reduced without confiscation.²

All of the figures stated embrace both intrastate and interstate business, but the parties stipulated that in respect of value, expense and income, the former repre sented 85 per cent. ,and the latter 15 per cent, of the total. As the Commission dealt with the property as a whole, the parties, their witnesses and the District Court found it convenient to do so, having in mind the fact that in the final result only 85 per cent, of the amounts involved reflected intrastate business and the Commission’s order must be limited accordingly. For similar reasons, and with a similar reservation, we shall pursue the same course. For the purposes of this proceeding the Commission’s order, therefore, is to be considered as requiring a diminution of income from intrastate operations by $850,000, rather than $1,000,000.

In 1916 the Commission valued the property and prescribed rates. In 1923 the company applied for an increase ; the Commission after a hearing fixed value at approximately book cost, and refused to permit the rates to be raised. The District Court, pursuant to a bill filed by the company, found the actual value exceeded book value by some $6,000,000, and enjoined the Commission from enforcing the current rates.³ The Commission acquiesced in the decision and passed an order adopting the court’s finding of value and establishing new rates. So matters stood until the initiation of the present investigation.

The company’s books accurately show installations and retirements of plant and from them historical cost is ascertained to be $50,025,278 as of December 31, 1933, with a depreciation reserve of $11,483,357. The Commission made no appraisal of the physical plant and property, but attempted to determine present value by translating the dollar value of the plant as it was found by the District Court in the earlier case at December 31, 1923, plus net additions in dollar value in each subsequent year, into an equivalent of dollar value at December 31, 1932. Its theory was this: Value signifies in rate regulation the investment in dollars on which a utility is entitled to earn. The dollars when invested were free units of exchange value having an earning significance then and now only because they are such units of exchange. When invested they represented in the plant so many poles, miles of wires, and other items of equipment; on the other hand the same dollar units then represented certain quantities of government bonds, apartment houses, automobiles, food.and services, etc. The dollars invested in the company’s plant had no value unless they were exchangeable for other requirements and desires of the stockholders, and the corresponding requirements and desires of all persons who use the dollar as a measure of value. Thus a regulating body, in finding value, must find a number of universal units of earning power and purchasing power; that is, exchangeable dollars invested in place of present exchangeable dollars. How shall the relation be ascertained?

The Commission thought it found the answer in commodity indices, prepared to show price trends. It selected sixteen of these, one covering as many as 784 commodities, falling into different classes, and weighted for averaging; others much less comprehensive; and its witness calculated by the use of each index the reduction in value of the company’s assets considered as a conglomerate mass of dollar value from 1923, or subsequent date of acquisition, to 1932. As might be expected the results varied widely. The lowest value found by the use of any index was $24,983,624; the highest $36,056,408 — 48 per cent, higher. The Commission then weighted these sixteen indices upon a principle not disclosed, giving them weights of from one to four, and thus got a divisor of thirty-one for the total obtained by adding the weighted results of all. This gave what the Commission styled its “ fair value index,” which it applied to the 1923 value of the property then owned and to cost of all net additions in subsequent years, to obtain value as of 1932. The result, after adding some $660,000 for working capital, was a rate base of $32,621,190. The company submitted proof of estimated reproduction cost and accrued depreciation. The Commission examined and criticized this evidence, but none was offered in opposition, and the valuation was based squarely on the figures obtained by the use of its index.

In the District Court the company offered evidence of historical cost and estimates of reproduction cost less depreciation; the Commission relied solely upon the figure resulting from trending the dollar value of plant owned in 1923 and cost of net additions subsequently made. The court held the indices used inappropriate for determining present value and discarded them. It purported to consider both book cost and reproduction cost; but, in fact, as plainly appears from the opinion,⁴ derived present value by the use of two figures only, — book cost as at December 31, 1933 ($50,025,278) less the entire depreciation reserve shown by the books ($11,483,357), — and thus fixed value at $38,541,921. To this is added $1,000,000, for working capital (instead of $660,000 allowed by the Commission), giving a rate base of $39,541,921. Annual depreciation expense was raised from $1,352,284 as determined by the Commission to $2,000,000. The appellants charge that in all these respects the court’s action was arbitrary and cannot stand. We are not satisfied with the methods pursued either by the court or the Commission.

First. The Commission took the value of the physical plant in 1923 (exclusive of the then depreciation reserve), $35,147,912, and trended it to $23,689,693 as of 1932. It took annual net additions to plant (exclusive of depreciation reserves) and similarly trended them. This gave plant value exclusive of the plant represented in the depreciation reserve. It took the depreciation reserve as at 1923 (invested in plant) and the yearly net additions to the reserve and trended each figure to 1932 value. In this way it reduced the book reserve which, at cost, stood at $10,405,147, to $7,318,086, and deducted the latter from total plant value. A table found in the Commission’s report showing the operation in detail is copied in the margin.⁵

This method is inappropriate for obtaining the value of a going telephone plant. An obvious objection is that the indices which are its basis were not prepared as an aid to the appraisal of property. They were intended merely to indicate price trends. Indeed the record shows that one index used by the Commission and given a weight of 3,— that of the Interstate Commerce Commission, — bears a notation that it should not be used “ in the determination of unit reproduction costs ” upon individual properties. Doubtless the authors of the other indices would have issued a similar warning, if they had supposed anyone would attempt such a use.

Again, the wide variation of results of the employment of different indices, already mentioned, impugns their accuracy as implements of appraisal. Sensible of this discrepancy, the Commission attempted a rule of thumb corrective, by weighting the several indices upon a principle known only to itself, and thus rendered its process of valuation even more dubious and obscure. The possible factors of error are increased by the use of some indices such as that constructed by the Commission’s witness upon Western Electric prices. The evidence is that these apply to about 25 per cent, of the company’s purchases; that during the period of rising prices, 1924-1929, they rose more slowly than prices of other commodities and manufactured articles; that though in 1930 other prices fell, Western Electric’s were raised an average of 10 per cent. In constructing an index from these prices, the witness disregarded the increase during the period 1930-1932. The Commission gave the index a weight of 3 and applied it to all purchases of the company, although confessedly it was applicable to only one-fourth of them.

The established principle is that as the due process clauses (Amendments V and XIV) safeguard private property against a taking for public use without just compensation, neither Nation nor State may require the use of privately owned property without just compensation. When the property itself is taken by the exertion of the power of eminent domain, just compensation is its value at the time of the taking. So, where by legislation prescribing rates or charges the use of the property is taken, just compensation assured by these constitutional provisions is a reasonable rate of return upon that value.⁶ To an extent value must be a matter of sound judgment, involving fact data. To substitute for such factors as historical cost and cost of reproduction, a “ translator ” of dollar value obtained by the use of price trend indices, serves only to confuse the problem and to increase its difficulty, and may well lead to results anything but accurate and fair. This is not to suggest that price trends are to be disregarded; quite the contrary is true. And evidence of such trends is to be considered with all other relevant factors. St. Louis & O’Fallon Ry. Co. v. United States, 279 U. S. 461, 485; Clark’s Ferry Bridge Co. v. Public Service Comm’n, 291 U. S. 227, 236.

A more fundamental defect in the Commission’s method is that the result is affected by sudden shifts in price level. It is true that any just valuation must take into account changes in the level of prices.⁷ We have therefore held that where the present value of property devoted to the public service is in excess of original cost, the utility company is not limited to a return on cost. Conversely, if the plant has depreciated in value, the public should not be bound to allow a return measured by investment. Of course the amount of that investment is to be considered along with appraisal of the property as presently existing, in order to arrive at a fair conclusion as to present value, for actual cost, reproduction cost and all other elements affecting value are to be given their proper weight in the final conclusion.⁸

But it is to be remembered that such a property as that here under consideration is a great integrated aggregate of many and diverse elements; is not primarily intended for sale in the market, but for devotion to the public use now and for the indefinite future; and has, so far as its market value is concerned, no real resemblance to a bushel of wheat or a ton of iron. While, therefore, the owner of such a property must assume and may not pass on to the pub- lie the risk involved in a general decline in values, and may have the advantage also of a general rise in such values, it would not only be unfair but impracticable to adjust the value and the consequent rate of return to sudden fluctuations in the price level. For in its essence this is the sort of aggregate whose value is not fairly or accurately reflected by such abrupt alterations in the market. A public service corporation ought not, therefore, in a rate proceeding, to be permitted to claim to the last dollar an increased value consequent upon a sudden and precipitate rise in spot prices of material or labor. No more ought the value attributable to its property to be depressed by a similar sudden decline in the price level. The present case affords an excellent example. As shown by the Commission's exhibits, the price trend was gradually ascending from 1923 to 1929. It then suffered a precipitate decline so that at December, 1932, the date of the Commission's valuation, it was at the nadir. Since then it has made a sharp recovery. The Commission recognized this. Its report and order were made November 28, 1933. At that time the price level, as shown by the all-commodities index of the United States Department of Labor, had risen 13.1 per cent, over that of December 31, 1932. For this reason the Commission, instead of cutting the net income of the company $1,396,000, allowed what has been called a “ spread ” or “ cushion ” of $396,000, by ordering a reduction of $1,000,000. The price level has since continued to rise. By the application of the same index a valuation would have beén obtained at December 31, 1934, of $38,390,922, and at February, 1935 of $39.691,-038, or more than $1,000,000 greater than the amount fixed by the court as of December 31, 1933. It thus appears that the so-called spread or cushion has already been absorbed if judgment is to be based on rapid rise in spot commodity prices. What the Commission in effect did was to take the temporary low level of December, 1932, and apply this low level for the indefinite future in ascertaining the so-called fair value of the company’s plant and property. The experience of the two years which have elapsed since the Commission’s order clearly indicates the impropriety of the use of its method in the appraisal of a property such as that of this company.

We agree, therefore, with the view of the District Court, that the method was inapt and improper, is not calculated to obtain a fair or accurate result, and should not be employed hi the valuation of utility plants for rate making purposes. As that court observed, it is not the function of a tribunal inquiring into the question of confiscation to set aside the legislative finding for mere errors of procedure. The duty of a court is merely to ascertain whether the legislative process has resulted in confiscation. In Los Angeles Gas & Electric Corp. v. Railroad Commission, supra, this Court said:

“ The legislative discretion implied in the rate making power necessarily extends to the entire legislative process, embracing the method used in reaching the legislative determination as well as that determination itself. We are not concerned with either, so long as constitutional limitations are not transgressed. When the legislative method is disclosed, it may have a definite bearing upon the validity of the result reached, but the judicial function does not go beyond the decision of the constitutional question. That question is whether the rates as fixed are confiscatory.” (p. 304.)

The language was used in respect of the claim that values of various elements had been ignored by the Commission. It was found, however, that though error might have been committed in respect of the items specified, other allowances neutralized the possible error. See, also, Dayton, P.& L. Co. v. Public Utilities Comm’n, 292 U. S. . Nothing said in either of these cases justifies the claim that this court has departed from the principles announced in earlier cases as to the value upon which a utility is entitled to earn a reasonablé return or the character of evidence relevant to that issue. It is apparent from what has been said that here the entire method of the Commission was erroneous and its use necessarily involved unjust and inaccurate results. In such a case it is not the function of a court, upon a claim of confiscation, to make a new valuation upon some different theory in an effort to sustain a procedure which is fundamentally faulty.

The principle applicable in circumstances such as this record discloses was announced in Northern Pacific Ry. Co. v. Department of Public Works, 268 U. S. 39. There a state commission set out to determine rates for intrastate transportation of logs in carloads. The carriers introduced evidence that existing rates did not yield any return on the property employed or defray the operating costs of the traffic and its proportionate taxes. The commission, without introducing evidence in contradiction of the proof submitted by the carriers as to actual operating costs, entered an order lowering the rates on the basis of a composite figure obtained largely from data in the reports submitted by the carriers and their exhibits in the proceeding, representing the weighted average operating cost per thousand gross-ton-miles of all revenue freight transported on the carriers’ systems, including main line and branch line freight, interstate and intrastate, carload and less than carload. The supreme court of the State sustained the order, and this court reversed, holding that the error in the method pursued was fundamental and amounted to a denial of due process. It was said (p. 43):

“A precise issue was the cost on each railroad of transporting logs in carload lots in western Washington, the average haul on each system being not more than 32 miles. In using the above composite figure in the determination of this issue the Department necessarily ignored, in the first place, the differences in the average unit cost on the several systems; and then the differences on each in the cost incident to the different classes of traffic and articles of merchandise, and to the widely varying conditions under which the transportation is conducted. In this unit cost figure no account is taken of the differences in unit cost dependent, among other things, upon differences in the length of haul; in the character of the commodity; in the configuration of the country; in the density of the traffic; in the daily loaded car movement; in the extent of the empty car movement; in the nature of the equipment employed; in the extent to which the equipment is used; in the expenditures required for its maintenance. Main line and branch line freight, interstate and intrastate, car load and less than car load, are counted alike. The Department’s error was fundamental in its nature. The use of this factor in computing the operating costs of the log traffic vitiated the whole process of reasoning by which the Department reached its conclusion.

“. . . But where rates found by a regulatory body to be compensatory are attacked as being confiscatory, courts may enquire into the method by which its conclusion was reached. An order based upon a finding made without evidence, The Chicago Junction Case, 264 U. S. 258, 263, or upon a finding made upon evidence which clearly does not support it, Interstate Commerce Commission v. Union Pacific R. R., 222 U. S. 541, 547, is an arbitrary act against which Courts afford relief. The error under discussion was of this character. It was a denial of due process.”

To the same effect see Chicago, M. & St. P. Ry. Co. v. Public Utilities Comm’n, 274 U. S. 344, 351.

There is a suggestion in the report to the effect that the Commission’s method was agreed to by both parties.⁹ We find, however, in the District Court’s opinion, a statement that the use of index figures was the subject of contest.¹⁰ We think the apparent contradiction is explained by reference to the record, which discloses the company used price relation to obtain the present value of certain property, but separated from other sorts each kind of property so treated. This is comparable to the practice of the Interstate Commerce Commission in translating the value of specific railroad property, e. g., steel rails, by the use of the differential between the per ton price in 1914, the date of original appraisal, and the price prevailing at a later date.¹¹ In this sense the company employed price indices; but it is plain that such a use of relation of values of specific articles as of two given dates is quite distinct from the application of general commodity indices to a conglomerate of -assets constituting an utility plant. Much is made of the fact that in the suit brought by the company in 1923 the District Court applied a price index to cost, and thus determined the then value of the property. But this fact cannot justify the application of the same procedure here, in the face of the challenge of its propriety. In the present case the company did not put into evidence any such price indices as were used by the Commission but on the contrary offered evidence to show that the use of them as a sole criterion of value would be improper.

Second. As already stated, the District Court condemned the method pursued by the Commission, and adopted one of its own. This consisted in deducting the company’s depreciation reserve from book cost and adding to the difference an allowance for working capital. It is true that the court discussed the company’s evidence as to cost of reproduction new, less depreciation, but did so only to indicate its disapproval of certain large amounts embodied in the total claimed and to reconcile the figures with its own estimate. A careful reading of the opinion leaves no doubt that all other measures of value were discarded in favor of cost less depreciation reserve.

It is clear that in a period of low prices costs incurred when the price level was much higher are not a safe guide in appraising present value. The court so conceded. The depreciation reserve was built up on the straight line theory.¹² The company asserted that the amount of the reserve did not represent observed and accrued depreciation at the date of valuation,¹³ as much of the total consisted of funds provided in anticipation of future depreciation and obsolescence. The court agreed and further found that on account of decreased demand for service, with consequent diminishment of obsolescence, the percentage of reserve had in recent years sharply increased. The question of going value was the subject of controversy. The court recognized that this element must be considered, but refused to make any separate allowance for it.

What the court did in fact was this: It found that book cost less actual accrued depreciation would probably give too high a figure. It sought to correct the probable error by deducting from cost the entire depreciation reserve, though conceding this exceeded actual depreciation. It felt that this large deduction would also redress any excess of cost over present value; and finally it said the result of its method would be appropriate to allow for going value.

Two quotations from the opinion will illustrate the basis of the court’s action.

“We are not unmindful that at the present time the depreciation reserve is slightly higher than normal and to the extent that it is, it is unfavorable to the company in the final result . . . But this disadvantage to the company is, we think, off-set by allowing it the full of its actual costs despite the generally lower trend of prices.¹⁴

“All relevant facts considered, we are of the opinion that a fair allowance for going value is made when we value the telephone property as a whole and as a going concern at its actual book costs less full depreciation.” ¹⁵

The opinion in essence consists of the conclusion, that, all the circumstances considered, it will be fair to appraise the property at cost less depreciation reserve. This rough and ready approximation of value is as arbitrary as that of the Commission, for it is unsupported by findings based upon evidence.

Third. For the reasons stated we cannot sustain the District Court’s valuation. We have shown that the Commission’s order violates the principle of due process, as the measure of value adopted is inadmissible. It is not our function, and was not the function of the court below, to do the work of the Commission by determining a rate base upon correct principles. The District Court, upon finding that the Commission reached its conclusions as to fair value from-data which furnished no legal support, should have enjoined enforcement of the rate order. The court’s action was therefore right, regardless of the method it pursued in reaching the decision that the order was confiscatory.

The grounds upon which we decide the case render it unnecessary for us to consider the appellants’ challenge of rulings of the District Court respecting working capital and annual depreciation allowance, or to discuss the rate of return to which the company is entitled in view of the agreement of the court and the Commission upon this point.

The decree is

Affirmed.

Footnotes

1

Chesapeake & Potomac Telephone Co. v. West, 7 F. Supp. 214.

2

The Commission also allowed a return of 6 per cent, upon the value of the property as determined by it.

3

Chesapeake & Potomac Telephone Co. v. Whitman, 3 F. (2d) 938, 943, 953.

4

7 F. Supp. 219, 222, 228.

5

The table is as follows:

6

Railroad Commission Cases, 116 U. S. 307, 331; Dow v. Beidelman, 125 U. S. 680, 691; Georgia Railroad & Banking Co. v. Smith, 128 U. S. 174, 179; Chicago, M. & St. P. Ry. Co. v. Minnesota, 134 U. S. 418, 458; Reagan v. Farmers’ Loan & Trust Co., 154 U. S. 362, 399; Ames v. Union Pac. Ry. Co., 64 Fed. 165, 176; Smyth v. Ames, 169 U. S. 466, 526, 541-2, 544, 546; San Diego Land & Town Co. v. National City, 174 U. S. 739, 757; San Diego Land & Town Co. v. Jasper, 189 U. S. 439, 442; Stanislaus County v. San Joaquin C. & I. Co., 192 U. S. 201, 215; Knoxville v. Knoxville Water Co., 212 U. S. 1, 13, 18; Willcox v. Consolidated Gas Co., 212 U. S. 19, 41; Lincoln Gas Co. v. Lincoln, 223 U. S. 349, 358; Minnesota Rate Cases, 230 U. S. 352, 434, 454; Denver v. Denver Union Water Co., 246 U. S. 178, 190; Houston v. Southwestern Bell Telephone Co., 259 U. S. 318, 324, 325; Bluefield Waterworks Co. v. Public Service Comm’n, 262 U. S. 679, 690; Dayton-Goose Creek Ry. Co. v. United States, 263 U. S. 456, 481; Board of Commissioners v. New York Telephone Co., 271 U. S. 23, 31; McCardle v. Indianapolis Water Co., 272 U. S. 400, 408-409; United Railways v. West, 280 U. S. 234, 249; Smith v. Illinois Bell Tel. Co., 282 U. S. 133, 149; Los Angeles Gas Co. v. Railroad Commission, 289 U. S, 287, 305.

7

Minnesota Rate Cases, supra, 454; McCardle v. Indianapolis Water Co., supra, 410; Los Angeles Gas Co. v. Railroad Commission, supra, 311.

8

Los Angeles Gas Co. v. Railroad Commission, supra, 306.

9

“ Both the Company and the Commission realized that to attempt to find the present day fair value of the Company’s property by the usual method of taking an inventory of all items of property owned by the Company and pricing out those items at present day prices would not only take at least two years of constant work but would cost the Company not less than $300,000 and cost the State a very substantial sum. It was agreed that index numbers should be used in arriving at present day costs.”

10

7 F. Supp. 233.

11

Compare St. Louis & O’Fallon Ry. Co. v. United States, 279 U. S. 461, 486-7,

12

See Lindheimer v. Illinois Bell Telephone Co., 292 U. S. 151, 167-8.

13

Compare Clark’s Ferry Bridge Co. v. Public Service Comm’n, supra, 239.

14

7 F. Supp. 228.

15

7 F. Supp. 226.