Citations
- 7 F. Supp. 214
Full opinion text
Findings of Fact.
The above-entitled ease paving come on to be heard on the pleadings, on the application of the plaintiff for a preliminary injunction (and the parties having stipulated that on the evidence to be produced there should also be a final decree on the merits) and the parties having appeared by their respective counsel and offered evidence in support of their respective contentions; the Court having heard arguments and being advised in the premises now finds as the findings of fact:
1. The fair value of all the plaintiff’s property, including working capital, cash capital, materials and supplies, considered as a going concern, as of December 31, 1933, is $39,541,921.27, of which 85% thereof, to wit, $33,610,632, is used and useful in the public service in its intrastate operations;
2. A fair allowance to the plaintiff company for working capital separately considered is $1,000,000 for its whole operation and $850,000 for its intrastate activities;
3. Going value has not been separately estimated but is included in the total $39,-541,921.27.
4. We find the reasonable and proper allowance for depreciation expense from the whole revenues of the plaintiff (both intra and interstate) will be $2,000,000 for 1934.
5. We find the probable net revenue of the Company for 1934 will be $2,742,005> resulting from all its activities interstate and intrastate, and 85% thereof, to wit, $2,330,-704, will result from intrastate activities alone.
6.We further find that the Maryland Public Service Commission has ordered a reduction in net revenues of the plaintiff derived from purely intrastate activities in the amount of $850,000 for 1934 and until further order. This deduction if made from plaintiff’s net revenues applicable to its intrastate business alone will leave net revenue sufficient to produce a return on the fair value of the plaintiff’s property at the rate of less than 4%%. We find that a return of less than 6% would be confiscatory under present conditions.
We refer to the opinion herewith filed for more detailed statement of facts and figures on which these ultimate findings are based.
Conclusions of Law.
From the above findings of fact we conclude as a matter of law:
1. The order of the Public Service Commission of Maryland dated November 28, 1933, herein sought to be enjoined is invalid and null and void because it deprives the plaintiff of its property without due process of law, under the 14th Amendment to the Federal Constitution;
2. Said order is in legal effect confiscatory of the plaintiff’s property.
3. The plaintiff is therefore entitled to an interlocutory and final injunction as prayed for in this ease.
4. Plaintiff should recover its taxable costs herein.
CHESNTJT, District Judge.
The Public Service Commission of Maryland by order dated November 28, 1933, required the Chesapeake & Potomac Telephone Company of Baltimore City (a Maryland corporation hereinafter called the company) to file new rate schedules effective on and after January 1, 1934, which would result “in a reduction of approximately $1,200',000' in the gross annual revenues of the said Company.” It was stipulated that the effect on net revenues of the Telephone Company would be a reduction of $1,000,000.
The Commission estimated that the Company’s net revenue for 1933 would be $3,-353,793, which would be sufficient to allow the Company a return of 6% on the fair value of its property of $32,621,190 as determined by the Commission. The Company’s computed net revenue for 1933 was $2,527,-961; the difference lying principally in the amount of the depreciation expense allowance which the Company determined to be $2,166,211; but wbieb was estimated by tbe Commission at $1,352,284. On the basis of the Company’s book accounts for 1933, the effect of the order was to require a reduction in net revenue of about 40%. On the Commission’s estimate of net revenue the deduction required was about 30'%. The Company’s net revenues had already declined 23% from their peak in 1931, $3,287,265, to $2,-527,961 in 1933, due to the general business depression. The combined effect of the economic condition and the Commission’s order is to reduce the estimated net earnings for 1934 (as we find them) as compared with 1931, nearly 50%.
On December 13, 1933, the Telephone Compaq filed its bill in equity in this ease to enjoin the enforcement of the Commission’s order on the ground that the reduction required was violative of the constitutional guarantee of due process of law contained in the Fourteenth Amendment to the Federal Constitution, and the new rates so ordered would be confiscatory of the plaintiff’s property. The bill alleged that under the reduced rates the Telephone Company would not be able to earn so much as 3% on the fair value of its property which it alleged had much greater value than that fixed by the Commission.
The bill prayed for a preliminary as well as a perpetual injunction. A restraining order was passed and became effective after the Telephone Company filed a bond with surety in the amount of $300,000' which provides for the refund to telephone subscribers of any rates paid by them in excess of the sums ultimately determined to be properly chargeable to them, if a preliminary injunction shall not be granted to the plaintiff. Thereafter a three-judge court was constituted in accordance with the requirement of United States Code, title 28, § 380 (28 USCA § 380), and the ease assigned for trial at the earliest practicable date in view of prior engagements of court and counsel. The hearing has now been held on the pleadings and very full proofs and the case has been submitted by counsel for decision on the application for preliminary injunction and also for final decree on the merits. The question presented can be simply stated — Does the order in effect confiscate the plaintiff’s property by allowing it less than a fair return upon the fair value of its property? The solution of the question necessitates a finding from the evidence of three controlling facts: (1) What is the fair value of the plaintiff’s property used and useful in the public service, and (2) what is the fair rate of return on the value of the property so found, and (3) what net revenue will the plaintiff have under the reduced rates ordered by the Commission.
The governing principles of law for the determination of these two questions are thoroughly well settled by numerous recent decisions of the Supreme Court. The public is entitled to adequate service at reasonable rates. Correlatively the Telephone Company is entitled to a fair (nonconfiscatory) return upon the fair value of its property. The valuation must give due weight to present rather than past values, but the determination of present value is not an end in itself but rather to afford ground for - a prediction of future values upon which to determine valid future rates. Los Angeles Gas & Electric Corp. v. R. R. Commission, 289 U. S. 287, 311, 53 S. Ct. 637, 77 L. Ed. 1180. It is also well settled that in arriving at a fair valuation due allowance must be made for existing depreciation; and in determining the rate of return the Company is entitled to a rate equivalent to that “on investments in other business undertakings which are attended by corresponding risks and uncertainties,;” and “it should be reasonably sufficient to assure confidence in the financial soundness of the utility and should be adequate, under efficient and economical management, to maintain and support its credit and enable it to raise the money necessary for the proper discharge of its public duties”; and also that “a rate of return may be reasonable at one time and become too high or too low by changes affecting opportunity for investments and changes in the money market generally.” But the Company “has no constitutional right to profits such as are realized or anticipated in highly profitable enterprises or speculative ventures. Furthermore it is clear that this court does not sit as a board of revision but only to enforce constitutional rights.” The only question here is whether the rates fixed by the Commission are confiscatory. Upon that question the complainant has the burden of proof and the court should not “interfere with the exercise of the state’s authority unless confiscation is clearly established.” Bluefield Water Works & Improvement Co. v. Public Service Commission, 262 U. S. 679, 692, 693, 43 S. Ct. 675, 67 L. Ed. 1176; Los Angeles Gas Co. v. R. R. Comm., 289 U. S. 287, 304, 319, 53 S. Ct. 637, 644, 77 L. Ed. 1180; United Railways & Electric Co. v. West, 280 U. S. 234, 250, 50 S. Ct. 123, 74 L. Ed. 390.
We approach the consideration of this ease in the light of these principles. The primary question in this, as in all rate cases, is the determination of the fair value of the Company’s property. This must be determined from the evidence. Before analyzing it a further consideration should be stated.
The Maryland Commission has jurisdiction over the intrastate property and revenues of the Company and not over its interstate business, the latter being subject to the jurisdiction of the Interstate Commerce Commission (Interstate Commerce Act § 1, as amended, 49 USC, § 1 [49 USCA § 1]). In the Commission’s order, dated November 28, 1933, and its accompanying extended opinion, the property of the Telephone Company and its revenues both interstate and intrastate were treated jointly and not separately, but by stipulation of counsel and express agreement of the Public Service Commission of Maryland and a formal amendment of the original order, it is agreed that the property of the Company devoted to intrastate service is 85% of its whole property, and similarly that the net revenues applicable to intrastate operations are 85% of the whole net revenues of the plaintiff; and that the original order of the Commission was intended to effect a reduction of not less than $850,000 (instead of $1,000,000) in the net annual revenues of the plaintiff derived from intrastate business; and it was further agreed that the amended order shall be effective nunc pro tunc as of the date of the original order. Therefore, while it is recognized of course by all parties to the case, that its ultimate determination must depend upon a finding of the fair value of that portion only of the property which is devoted to the intrastate business and the revenues resulting therefrom, nevertheless it will be more convenient in the analysis of the evidence in the ease to consider the whole property and the whole revenues of the Company, as that was the basis on which the figures were originally submitted to and discussed by the Commission, and likewise here. By reason of the stipulation the legal result will be the same whether the property and revenues be considered as a whole or the intrastate portion of the business be considered separately.
The Fair Value of the Property — Three Standards Considered.
The evidence in this ease affords three separate methods or standards of depreciated valuation for the property of the Company. As of December 31, 1932, they are (without working capital) as follows:
The Commission’s valuation. .$32,610,327.00
Company’s valuation. 46,351,119'.0O
Book or historical cost of Company’s property. 39,701,966.12
The nature of book or historical cost needs no elaborate explanation. Actual “original” cost may of course be different from recorded book cost in some cases, but there is no such distinction here, where original or book or historical cost all have the same meaning. It represents the actual amount charged to capital on the books of the Company for plant and fixed assets devoted to the public service (after deduction for retirements) during the whole history of the Company which covers a period of 50 years, although 90%, approximately, of the Company’s property has been acquired since 1910. The Company’s accounts have been kept in compliance with the regulations and orders of the Interstate Commerce Commission since 1913 and the Company itself has been subject to Commission regulation in Maryland since 1910.
The method used by the Commission in arriving at its valuation was to take the rate base as determined by a three-judge court in this district as of December 31, 1923 [C. & P. Tel. Co. v. Whitman (D. C.) 3 F.(2d) 938], together with the annual net additions to the property since that date as recorded on the books of the Company and to re-price or rewalue, as of December 31, 1932, the said sums according to a so-called “index translator” of prices determined by the Commission to represent the fair value trend of prices for general commodities and construction work from 1923 to 1932. The method will be described in more detail hereafter.
The basis of valuation put forward by the Company is the familiar well-known “ro-pro-duetibn cost new less depreciation” theory of valuation.
No single one of these three methods of valuation is an exclusive or final test. But the amounts arrived at by the respective methods are all relevant facts for consideration together with other relevant facts appearing in the evidence. The determination of fair value for rate making purposes is necessarily a judicial function which calls for “a reasonable judgment, having its basis in a proper consideration of all relevant facts.” Minnesota Rate Cases, 239 U. S. 352, 434, 33 S. Ct. 729, 754, 57 L. Ed. 1511, 48 L. R. A. (N. S.) 1151, Ann. Cas. 1916A, 18; Ga. Ry. & Power Co. v. R. R. Comm., 262 U. S. 625, 630, 43 S. Ct. 680, 67 L. Ed. 1144; Bluefield Water Works & Improvement Co. v. Public Service Comm., 262 U. S. 679, 690, 43 S. Ct. 675, 67 L. Ed. 1176; Los Angeles Gas & Electric Co. v. R. R. Comm., 289 U. S. 287, 306, 53 S. Ct. 637, 77 L. Ed. 1180.
Tbe Supreme Court lias been careful, in view of its distinctive function in the enforcement of constitutional rights, not to adopt any single or definite artificial rule or formula for invariable application in all eases. The judicial determination of what constitutes fair value must be determined from the special facts and circumstances of each particular case giving such relative weight to the several theories or methods of valuation in any particular ease which the circumstances thereof properly require. In the comparatively early ease of Smyth v. Ames, 169 U. S. 466, 18 S. Ct. 418, 42 L. Ed. 819 (still a leading authority in the field of utility rate regulation), it was said (page 546 of 169 U. S., 18 S. Ct. 418, 434, 42 L. Ed. 819):
"And, in order to ascertain that value, the original cost of construction, the amount expended in permanent improvements, the amount and market value of its bonds and stock, the present as compared with the original cost of construction, the probable earning capacity of the property under particular rates prescribed by statute, and the sum required to meet operating expenses, are all matters for consideration, and are to be given such weight as may be just and right, in each ease. We do not say that there may not be other matters to be regarded in estimating the value of the property. What the company is entitled to ask is a fair return upon the value of that which it employs for the public convenience. On the other hand, what the public is entitled to demand is that no more be exacted from it for the use of a public highway than the services rendered by it are reasonably worth.”
In later cases it has been appreciated that of the several matters for consideration here outlined relatively little weight can be given to the market value of the Company’s securities and its earning capacity under existing rates because these considerations necessarily beg the question to be determined. It has resulted therefore that in most cases of such valuation there are available only the actual book or "historical” cost of the property and the estimated cost of its reconstruction new. And of these two considerations the one more frequently applied in modem rate cases has been the estimated cost of reproduction. The reason for this is that in most cases the book or historical cost data axe either not complete or are unreliable or have been incurred under conditions dissimilar to those existing at the time of the rate inquiry. But where actual cost data are available and reliable and represent the actual expenditures for the public service under conditions reasonably approximating those prevailing at the time of the rate inquiry, cost has been given very great weight in determining present valúe. Thus, in several of the most recent cases in the Supreme Court, the valuation adopted or approved has been substantially book or historical cost rather than reproduction cost. Los Angeles Gas Co. v. R. R. Comm., 289 U. S. 287, 53 S. Ct. 637, 77 L. Ed. 1180; Clark’s Ferry Bridge Co. v. Public Service Comm. of Pennsylvania, 54 S. Ct. 427, 78 L. Ed. 767 (decided February 5, 1934); Dayton P. & L. Co. v. Public Utilities of Ohio, 54 S. Ct. 647, 78 L. Ed. 1267 (S. Ct. April 30, 1934).
Book or Historical Cost.
After consideration of all throe valuations, and the testimony in the ease with relation to them respectively, and all other relevant evidence bearing on valuation, we reach the conclusion that the fair value of the property of the Telephone Company used and useful in the public service, considering the Company as an efficiently managed and going concern with its attached business, without otherwise adding a specific sum for going value, but including an allowance of $1,000,000 for working capital, is $39,541,921.27, as of December 31, 1933. In reaching this conclusion we have given special weight, under the facts and circumstances of this particular case, to the historical cost of the property as it appears on the books of the Company diminished by the full amount carried in or credited to the depreciation reserve. The figures therefor as of December 31, 1933, are to bo found in Plaintiff’s Exhibit A 2, line 18, col. 3, as the aggregate book cost figure for total telephone plant (after deduction for retirements) $50,025,278.83, less depreciation reserves (line 42, col. 3) $11,483,357.56, to wit, $38,541,921.27, to which we add, for reasons hereinafter stated, the sum of $1,000,-000 as a reasonable allowance for working capital, thus making the total valuation as the rate base for further consideration and computation in this case in relation to the effect of the Commission’s order, $39,541,921.-27. While historical cost has been given dominant weight in the valuation in this particular case, it is to be observed that no specific additional allowance has been made for the element of intangible value, called going value, and the full depreciation reserve (now about $1,500,000 more than normal) has been deducted from the cost of the physical property. We will mention some of the special considerations which have led us to give dominant weig’ht to historical cost.
The history of this particular company covers a peiiod of 50 years. It began in 1884 with a telephone plant local to Baltimore City, and has gradually in subsequent years absorbed practically all other telephone companies both in Baltimore City and in the State of Maryland. The accuracy, fairness and completeness of the cost data as recorded in the books of the Company have not been challenged. Since 1910' it has been subject to Commission regulation in Maryland with requirements for full periodical reports, and since 1913 it has been obliged to comply with the requirements of the Interstate Commerce Commission in keeping its accounts. It has been not only under the constant current annual supervision of the Maryland Commission but it has frequently had rate hearings including several valuation .proceedings before the Commission and one in 1925 before a three-judge court in this district. (See C. & P. Tel. Co. v. Whitman (D. C.) 3 F.(2d) 938.) It appears from an examination of the opinions of the Commission in these eases that at all times up to the present the Commission has found approximately that the fair value of the Company’s tangible property for rate making purposes has been the same as the book costs and since 1916 there has always been allowed in addition for rate purposes an amount for intangible values of over $700,-000. Although the Commission has at times somewhat increased the value of the property of the Company over book costs, the latter have never been written up on the books, not even after a substantial increase made in 1925 as the result of the court valuation at that time. On December 30', 1911, the Maryland Commission filed an extended opinion with regard to the value of the property of the Company and its rate schedules, after hearing and consideration. As of September 30, 1910, it found that the fair value of the telephone property less depreciation, $5,665,729.-74, was almost identically the same amount recorded on the books of the Company at cost. On this value the Commission allowed an 8% return and a depreciation allowance of about 6% on an average, and the rates were fixed accordingly.
In 1914 in consequence of a petition by organized telephone subscribers (the Telephone Protective Association of Baltimore City), the Commission again held an elaborate rate hearing and on March 18, 1916, it filed an extended opinion of more than 100 printed pages reviewing the valuation and rates of the Company. In this case a physical valuation was made by engineers for the Commission as well as computation of cost of reproduction by engineers for the Company. The value then found for the physical property was substantially the same as the estimated original cost and only slightly less than the book value. After deducting existing depreciation found to be 20%, and then adding $705,000 for intangible values and an allowance of $500,000 for working capital, the final rate base was fixed at $11,554,758.
During the World War the telephone property was taken over by the Government for operation and the rates were raised. When the property was restored to private ownership, the Commission, on the petition of the Protective Telephone Association of Baltimore City, held another rate hearing and thereafter filed another, extended opinion under date of August 18, 1920. From the Commission’s opinion (Defendant’s Exhibit D 16, page 9) it appears that the book value of the telephone property as of December 31, 1919, was $18,523,885. In determining the fair value as of that date the Commission adopted as total cost new a slightly larger figure, $19,272,057, the difference between the net increase in book value and in reproduction cost new increase being due to the fact that since 1914 plant retirements had been credited to book values at the average book cost but were valued for the purpose of bringing up to date previous reproduction figures at the average price used by the Commission in the previous ease. The Commission again deducted depreciation at the rate of 20% and again added $705,000 for intangible values and allowed $750,000 for working capital, thus making the fair value, as of December 31, 1919', depreciated $16,725,532. Rates were fixed which were calculated to allow the Company a return of 5.30% on an estimated average fair value in 192.0 of $17,250,000.
In 1924 the Company aske(l for an increase in rates which, after a contested hearing, was refused by the Commission in an extended opinion filed December 29, 1924. The Company contended in justification for its requested increase in rates, that the value of its property had greatly increased over the amounts previously allowed as fair value by the Commission and claimed on the basis of an appraisal made by its experts, that the depreciated value of its property by one appraisal was $41,541,110 and by another $37,-115,153, as of December 31,1923. The Company’s book cost of that date after deducting depreciation reserve was $21,563,683. The Commission rejected the Company’s appraisals and adhered to the valuations on the principles laid down in the former cases which was slightly more than book cost, increased by an allowance for working capital, and intangible values, less depreciation reserve, thus arriving at a fair value of $24,350',944. Working capital was increased from $750,000 to $975,000. In the opinion it was said:
“The Commission is convinced that the rate base established in case No. 690 (in 1914) was generous to the Company and was to be regarded as final, and that changes in it were to be made on the basis of net additions. The Commission therefore feels in duty bound to adhere to it.”
It found that the return to the Company at the then prevailing rates would be 5.96%. The Commission was apparently greatly impressed with the consideration that the local Telephone Company was in practical effect a branch or department only of the national American Telephone & Telegraph Company and that the contract between the two companies whereby the local company paid the A. T. & T. Company 4%% of revenues was too favorable to the parent company and that in fairness to the Maryland telephone subscribers the revenues of both companies from their operations in the state, should be blended and pooled in the determination of what was a fair return. (This payment has now been reduced to 1% and is not in issue.)
The Company appealed to this court for injunctive relief which, after hearing by a three-judge court, resulted in the issuance of an injunction with opinion holding in substance that the fair rate base for December 31, 1923, was $29,507,949 (after deducting depreciation but including working capital and going value), and that the Company was entitled to a return of not less than 6% thereon. The effect was to increase the Commission’s valuation by over $5,000,009 and to increase valuation over book cost almost $5,-750,090. Neither party appealed from the decision and on remand of the case to the Commission, the latter redetermined the value as of December 31,1924, at $33,399,530 by adding to the value as determined by the court subsequent additions with adjustment for decrease in depreciation reserve, on which new rates were based to yield 6% return. The rates so fixed remained unchanged by the Commission until the latter instituted the present rate case of its own motion on January 19, 1933, which resulted in the order for a reduction of rates, the validity of which is involved in this proceeding.
From this review of the history of the relations of the Company and the Commission, it appears that the book cost of the property with relatively small additions for intangible values and working capital, has been substantially the constant basis of valuation for rate making since 1912. with the exception of the period beginning in 1925 when the valuation was raised as a result of the court proceedings. This increase in valuation as appears from the opinion in the ease [(D. C.) 3 F.(2d) 988] resulted from the conviction that materially higher price levels over those prevailing at the time of the original physical valuation of the Company’s property in 1914 had been reached and seemed to be permanent, and the decision was evidently made in deference to the effect of binding decisions that valuation of the Company’s property was required to be on the basis of present values. Since then it is undoubtedly true, as has been noted in recent eases in the Supreme Court, that there has been a very general decline in values with corresponding increase of the purchasing power of the dollar, and earjy in 1933 when the pending rate ease was begun by the Commission this change in the general level of prices seemed again comparatively permanent in its nature; so that it is not surprising to find the Commission in its opinion in this case saying (page 2):
“The proceeding grew out of a conviction on the part of the Commission that, in view of the general decline in values of all property, the public was entitled to a reduction in the rates charged by utilities generally and that such reductions should be based on the value of utility properties at present day prices. Acting on this conviction, the Commission, when it became convinced that the lower level of prices was not merely temporary, but that, to use the words'of Chief Justice Hughes of the United States Supreme Court in the opinion in the Los Angeles Case, we were ‘upon a changed economic level,’ began discussions with utility managers throughout the State looking to a lowering of their charges.”
It appears further in the opinion that voluntary reductions in rates were made by many public utilities in the State but that the Telephone Company declined to make any reduction, possibly because it had already sustained a substantial reduction in its revenues in the loss of many telephone subscribers. It was natural and reasonable for the Commission to feel that, as the Company had a substantial increase in its rates as the result of the Court’s increase in the valuation of the Company’s property in 1925 by reason of generally increased values, there should be a corresponding decrease of rates and if necessary a new reduced valuation of the Company’s property when again there seemed to be a new and much lower economic level. The Commission, however, in its new valuation, not only eliminated the increase in value which had been made in 1925 but went vefy much further, and in the new valuation fixed it approximately $7,000,000 below book cost less depreciation reserve; and in doing so the Commission did not return to the principles of valuation which it had announced in successive eases prior to the court proceeding and which, as stated by it in the 1924 ease, were to be regarded as final. In the present case no doubt the Commission felt that in view of the Company’s repudiation of the prior basis of valuation the Commission was itself under no obligation to adhere thereto. The position is logical, but the question still remains as to whether the valuation so now fixed by the Commission is not so unreasonably low as to amount to confiscation. If the book values under all the circumstances of this ease are nearly a fair measure of present value (both physical and intangible), the valuation found by the Commission is undoubtedly confiscatory.
The valuation which we conclude to be reasonable is supported and measurably confirmed by other important evidence in the case. It is approximately the amount of actual cash investment made to produce the property. In the Company’s balance sheet (Exhibit A 2, lines 32, etc., col. 3) we find that the amounts invested in the capital stock and funded liabilities and surplus of the Company amount to $39,214,980. Of this amount $3,000,000 of preferred stock has been issued at par plus a premium of $15,-419 and $30,000,000 of common stock has also been apparently subscribed and paid for at par (for the most part definitely shown to have been paid in cash or by the exchange of stoek for cash previously loaned) much the greater part of which has been advanced since the Company has been under Commission regulation. • There is no convincing proof that any of this money has been unwisely or imprudently invested.
Cost of Reproduction.
Another relevant fact for consideration as to value is the Company’s estimated cost of reproduction new of the property less depreciation. In the very carefully considered 1916 case the Commission itself used this method of valuation and found the results substantially accorded with the book costs. In subsequent cases, up to the present, the Commission has adhered in substance to book costs as the basis for valuation. We do not consider the cost of reproduction so reliable for valuation of a public utility as book costs (when the latter are accurate and complete and have been built up under conditions not greatly dissimilar to those prevailing at the time of the rate ease, and likely to prevail in the near future) because it necessarily proceeds upon hypotheses as contrasted with ae-tualities, and is so greatly dependent upon estimates only, supported largely by merely expert opinion, and involves many highly speculative features. Nevertheless, as indicated in many authoritative judicial decisions, it is a relevant fact and entitled to fair consideration. We have so considered it here. While we cannot accept its final -figures for the ultimate valuation, yet on analysis we do find, in certain of its important elements, substantial confirmation of the valuation that we have concluded is fair and just both to the Company and the public.
The estimate of cost of reproduction as submitted by the Company is summarized in Plaintiff’s Exhibit A 32 where the depreciated value as of December 31, 1933, is estimated to be $48,422,816. And the component figures are supported by numerous exhibits and the oral testimony of witnesses in great detail. The plan of this method of valuation is to value directly the principal elements of the Company’s property by estimating first the “directly distributed costs” thereof at present prices for labor and material and to add thereto, for necessary incidental further costs of construction, percentages sometimes called “overheads” but here called “undistributed construction costs.” To the aggregate so produced there is further added the costs of certain land not previously included, and all rights of way and other generally necessary equipment and also substantial allowances for working capital and intangible values called “going value”; to none of which are the so-called overheads applied. The elements of property contained in the appraisal under the heading of “directly distributed costs” include the important items of land and buildings. In this case the value of the land is covered by stipulation of counsel and is therefore not in dispute; and the depreciated value of the buildings is given in the uncontradieted testimony of two very competent local builders. . The remainder of this class of property consists of what is peculiarly telephone apparatus and equipment, such as central office and private branch exchange and other station equipment, pole lines and wires and aerial and underground and submarine cables. The whole of this peculiar telephone property was not directly appraised but representative portions or samples thereof were directly inventoried and valued at prices currently paid for iabor and materials. Some of it was valued by translating original cost into 1933 values, by an index translator of actual telephone property costs for materials and estimated wages.
If we omit for the moment the allowance made for working capital and going value, and the particular amount deducted for depreciation, we find no substantial objection to the general plan of valuation adopted for the other items in the appraisal, although in so doing we are not to be understood as adopting for valuation the particular figures in the appraisal. The general plan that has been followed is, we understand, consistent with the theory of this method of valuation. Counsel for the Commission emphasizes specifically two objections to the appraisal other than for the items of working capital and going value. These objections are (1) that the prices used for the present cost of labor and materials are too high, the latter being based on the prices currently charged by the Western Electric Company, a subsidiary of the American Telephone & Telegraph Company, the owner of all common stock of the local Telephone Company, and (2) that the percentages allowed for “undistributed eonstruction costs” are excessive. As to ’Western Electric prices (of which more will be said hereafter) it is sufficient here to say that if the criticism is accepted as valid, the result, under the uneontradieted testimony, would be to reduce the aggregate of the appraisal by only $1,500,000. As to the labor cost, we do not find the criticism valid. Although the price level of wages generally has declined in recent years, this is not equally true with regard to public service wage rates in Baltimore City. The uncontradicted evidence is that the Telephone Company’s wage rate has been rising rather than falling. This is explained on the ground that in some respects the Company’s wage rate had been unduly low in past years and certain adjustments in recent years have been made with the effect of a general increase in the average rate paid. The evidence is not susceptible of a definite determination in dollars as to the relative influence of the wage rate and trend of prices for telephone apparatus as affecting ultimate cost in recent years. With regard to the percentages allowed for “undistributed construction costs” it will be observed from the Exhibit referred to that the total allowance amounts to $7,494,998 on a base of $39,536,-404, not quite 19%. Without specifically approving these particular percentages, or the several items thereof, we observe that as a whole they are not excessive when compared with allowances of the same nature which have been made in other eases where reliance has been placed upon this method of valuation.
We have made the following comparison between valuations by book cost and by estimate of cost of reproduction in this case. The figure for book costs new is $50,025,278, which, of course, does not include any specific sum for going value. The comparable figure in the estimate of cost of reproduction, deducting the $4,500,000 allowed for going value, and $1,615,000 for working capital is $49,031,267. Both of these figures are unde-preciated. To compare fair value as we have determined it with cost of reproduction necessitates some adjustments in the latter. Our valuation proceeds on the basis' of taking the total book cost,of the property new and deducting the full depreciation reserve and adding thereto $1,000,000 for working capital ($615,000 less than allowed in cost of reproduction new), and without specific additional allowance for going value. To adjust the estimate of cost of reproduction to a comparable basis we must make certain deductions therefrom; (1) the reproduction appraisal deducts for depreciation only $6,723,451; the comparable item deducted by us is $11,483,-357 — a difference of $4,759,906; (2) the appraisal allows $1,615,000 for working capital; our allowance is $1,000,000 — a difference of $615,000'; (3) for the comparison only there may also be deducted from the reproduction appraisal the amount of $1,500,-000 which counsel for the Commission contends is an excessive amount allowed for cost of material. The sum of these three deductions is $6,874,906, which must be subtracted from the estimated cost of reproduction new, less depreciation, $48,422,816, thus reaching $41,547,910 as the figure given by the estimated reproduction cost (including going value, at $4,500,000) as comparable with our valuation of $39,541,921 (which includes going value although not specifically appraised, therein). The difference between these two figures, to wit, $2,005,989, represents what we consider at least an excessive allowance for going value in the cost of reproduction.
Therefore, comparing the two methods of valuation, book cost and cost of reproduction new, as they appear in the evidence in this case (with the adjustments that we have indicated with regard to the latter, which make it fáirly comparable to the former), the fair inference is that each tends to confirm the other and to indicate that the present value of the property, whether considered from the standpoint of actual historical cost or based on cost of reproduction new at present prices, and giving adequate consideration to intangible values, is approximately the same, and is between $39,000,000 and $40,000,000. But even if it could fairly be said that the adjustments we have made in the Company’s estimate of cost of reproduction new are too drastic, we nevertheless adhere to our view above expressed that dominant weight should be given in this case to actual historical cost in preference to other methods of valuation. As was said in the Los Angeles Gas & Electric Company Case, page 308 of 289 U. S., 53 S. Ct. 637, 645, 77 L. Ed. 1180:
“The weight to he given to actual cost, to historical cost, and to cost of reproduction new, is to be determined in the light of the facts of the particular ease. McCardle v. Indianapolis Water Co., supra [272 U. S. 400, 47 S. Ct. 144, 71 L. Ed. 316].”
Nor do we think the valuation so arrived at can be justly regarded as unfairly high to the public. As we have pointed out it is almost exactly equivalent to the aetual dollars invested in the property. It eliminates the additional value of $5,750,000 allowed by the court in 1925 over and above book costs.
Going Yalue.
It also eliminates any specific allowance for going value which was fixed by the Commission in the 1916 ease at $705,000 after full consideration. The theory of an allowance for going value is that the property as a going concern with attached business of many thousands of telephone subscribers and with a large and substantial ineome therefrom is obviously of substantially greater value than that inhering in the mere physical structures constituting the telephone plant. It is difficult to prescribe a formula for the admeas-urement of this intangible element of value. But that it is intrinsically an item for important consideration in rate making is generally recognized in all rate cases. In not making a specific allowance for going value in this case we wish to make it plain that we have not failed to consider it as an important element in the valuation. But as admitted by counsel for the Company a specific additional allowance for going value has much less support in reasoning and authority when the valuation is based on historical cost than when based on cost of reproduction new. And intrinsically considered on the merits it must be realized whatever intangible element of value inheres in the property and business by virtue of its efficient management and integration as a going concern, accumulates not as a separate and independent element of value but gradually from time to time coincident with the growth and manágement of the business and is in substance an incident to the development of the business contemporaneously paid for in the expense of operation and maintenance taken out of the rates paid by the public.
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. Dayton Power & Light Co. v. Public Utilities Comm. of Ohio, 54 S. Ct. 647, 656, 78 L. Ed. 1267 (U. S. S. Ct. April 30, 1934).
It is also relevant to the ease to point out that, as fair valuation in this case is the same as book cost less depreciation reserve, further rate litigation, so expensive primarily to the Company and ultimately to the public may, it is hoped, be avoided and subsequent changes in the rates when necessary in fairness either to the Company or to the public can, it is hoped, be met by action of the Commission in reducing or increasing the rate of return. The re-establishment of book value less depreciation as the rate base will also enable the Commission to return to the principle of valuation which obtained prior to 1925 and was then regarded by the Commission as fixed and final. And it has the added advantage of enabling the accounting for depreciation annuities or annual expense to be hereafter as well as heretofore on the base of cost as required by the uniform system of accounting of the Interstate Commerce Commission for telephone companies.
Deduction of Depreciation.
As already indicated, we have reached our conclusion as to valuation by deducting from historical book cost new the whole amount carried as depreciation reserve which, as of December 31, 1933, amounts to $11,-483,357.56 and represents approximately 23% of tbe cost new of total fixed capital (Plaintiff’s Exhibit A 2). In so doing we have not overlooked tbe Company’s contention that only existing and accrued depreciation may properly be deducted from value new. See McCardle v. Indianapolis Water Co., 272 U. S. 400, 416, 47 S. Ct. 144, 71 L. Ed. 316.
And it is further contended by tbe Company that tbe amount of tbe depreciation reserve does not necessarily, and under proper straight line depreciation accounting will not, accurately measure existing accrued depreciation, but should always exceed it. It bas been held that a surplus accumulation in tbe depreciation reserve over and above that reasonably necessary may not constitutionally be applied by Commission order to supplement a deficiency in future net earnings under prescribed rates (Board of Public Utility Com’rs v. N. Y. Tel. Co., 271 U. S. 23, 46 S. Ct. 363, 70 L. Ed. 808); and it has also been recently judicially “recognized that accrued depreciation, as it may be observed and estimated at a given time, and an appropriate allowance of depreciation according to good accounting practice, need not be the same” (Clark’s Ferry Bridge Co. v. Public Service Comm. of Penna., 291 U. S. 227, 54 S. Ct. 427, 431, 78 L. Ed. 767," Supreme Court, February 5, 1934). There is, however, force in tbe contention that in tbe case of an old company, as here, where, over a long period of years in the past, the ratio of the depreciation reserve to the cost new of the whole plant has remained relatively stable, after deductions for retirements of plant (as is true for ten years or more in the ease of this Company), it is fair to infer that the amount of the depreciation reserve does approximately measure tbe existing accrued depreciation. This view has been approved by the Interstate Commerce Commission in telephone property accounting and has been in substance judicially applied. Depreciation Charges of Telephone Companies, 177 I. C. C. 397; N. Y. Tel. Co. v. Prendergast (D. C.) 36 F. (2d) 54, 65. See, also, Railroad Comm. v. Cumberland T. & T. Co., 212 U. S. 414, 424, 29 S. Ct. 357, 53 L. Ed. 577; C. & P. Tel. Co. v. Whitman (D. C.) 3 F.(2d) 938; Idaho Power Co. v. Thompson (D. C.) 19 F.(2d) 547, 566. Viewing the matter simply as a question of fact, to be determined from the evidence, it is clear that the burden of proof is on the plaintiff to establish to our satisfaction that the amount of the existing depreciation is actually less than the reserve therefor. N. Y. Tel. Co. v. Prendergast, supra. The only testimony so offered by the Company is that of the witness Sloan, and we are not satisfied that his estimate of accrued depreciation makes sufficient allowance for all the elements constituting real existing depreciation. On the contrary the history of the depreciation reserve of this Company furnishes much affirmative proof that the book reserve measures approximately the existing depreciation in the plant. The subject was elaborately considered by the Commission in the 1916 case, which then found the value new to be $13,682,197, and the existing depreciation amounted to $2,612,439, just 20%. At that time the depreciation reserve was only $1,367,700, about 10%. But the Commission, pursuant to what it deemed good policy, continued the Company’s rates which were estimated to yield not more than an 8% return and sufficiently more to build up the reservo to 20%, and thereafter to keep it uniform at that amount. Again in 1920 the Commission considered evidence that the structural value of the property was approximately 70% of its cost new, but that the depreciation reserve was only 16.88%. Nevertheless it adhered to its policy of deducting for depreciation only 20!% and allowed the Company to continue to build up the reserve to 20%. In subsequent years the Company has added to the depreciation reserves out of gross revenues until for the past ten years or more the reserves have averaged or approximated 20% of the fixed plant. For 1938 the percentage was about 23%.
Again in 1924, the Commission in determining the valuation adhered to its uniform principle of deducting 20'% of cost new for depreciation. In the ensuing court ease [ (D. C.) 3 F.(2d) 951] the valuation adopted was diminished by the full depreciation reserve adjusted consistently with the cost new to the then price level as determined by the Court. The Commission has similarly treated this item in this case with adjustment of price level as determined by it.
In view of this history we think it only fair to the public and not unfair to the Company to take the whole depreciation reserve from the book cost new. We do not mean to imply that the public owns any part of the reserve, or that the Company is not entitled to earn on the whole (which has been invested in the plant and not kept intact in a separate fund) fair value of its property, but viewing the whole evidence, the fair value of the plant is the book value less the reserve. 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 as compared with the practice in the earlier Commission eases of deducting a fiat 20'% irrespective of the actual reserve which was expected, however, on the average to be just 29%. 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.
The Commission’s Method of Valuation.
We come now to a more detailed consideration of the method of valuation adopted by the Commission. As already indicated we have approached the problem in the light of the presumptive correctness of the Commission’s valuation which we would not be warranted in disturbing unless clearly erroneous. Perhaps it would have been more logical to direct our consideration in this opinion first to tire valuation made by the Commission. But we have postponed the discussion until now in order that it could be better understood in the light of the historical matter above presented.
What the Commission did was this. It approached the rate hearing under the conviction that the Telephone Company’s rates must be reduced in view of the general changed economic level of prices. In its investigation it made no new physical inventory or appraisal of the Company’s property and produced no testimony either in the hearing before the Commission or here as to valuation except to depreciate book costs (as enhanced by the court’s finding of value in the 1925 ease) by applying to the valuation as found by the court in 1925 and the net additions to the plant in subsequent years, a so-called “index translator” of values to reduce values as established in 1925, with subsequent annual additions, to values as of December 31, 1932, in accordance with an index of prices determined by the Commission to represent the “fair value trend.” In other words, the Commission valued the Company’s property on the basis of the ratio that values in 1925 and subsequent years respectively bore to values in 1932 as determined by this so-called fair value trend. This method of valuation was adopted by the Commission in order to save the time and expense that would be involved in a physical appraisal. Nevertheless the Company did submit in the hearing before the Commission full data in support of its valuation based on reproduction cost new less depreciation. The Commission, however, disregarded this in its conclusion. The Commission’s method in obtaining the so-called index translator to establish the relationship between values in 1925 and succeeding years with those of 1932 is fully explained in its opinion and is graphically illustrated by a chart appearing opposite printed page 29’. The Commission developed an index for yal-ues which it called a “fair value” trend. This it evolved as a composite of several separate price trend curves which are referred to in the opinion and included in tables appearing at pages 24 to 28, inclusive. The Commission described its method in a note on page 26 as follows:
“These ‘Fair Value’ Translators are based upon December 31, 1932, as 109, and are intended to be, respectively, the percentages which, when applied to the value of the dollar at December 31,192¡3, and to the average value for each of the years 1904 to 1931, inclusive, will produce value as of December 31, 1930.”
The Commission developed its own curve or trend by taking a “weighted average” of 16 separate indices for prices of certain commodities and eonstruetion costs. Taking the whole value of all the price trends considered as indicated by the number 31, it assigned (on-what exact basis does not clearly appear) a value to each of the several price trends. Thus to the United States Department of Labor “all commodities” trend it assigned a value of 4; to the National Association of Purchasing Agents (commodity) trend, a value of 2', etc. As a result it deduced a price curve or ratio of price which was not greatly different from the so-called “all commodities” average put out by the United States Department of Labor. The latter is understood to represent the average price trend from 1928 to 1932, inclusive, of 784 commodities as raw materials. These 784 items are themselves subdivided into a number of different subclasses. The items in the subclasses vary greatly as to their respective price trends. And the values which would be produced by the several price trends considered by the Commission also vary widely. By comparison we note that the value produced by the “fair value trend” of the Commission as of December 31,19'32, for the Company’s property (after deducting depreciation) was $32,-610,327, but as of December 31,1933, the application of the all-commodities price trend (which for December 31,1932, was at a lower level than the Commission’s fair value trend) produced $34,332,453.56; while the price trend of the Engineering News Record (given a weighted value of 2 by the Commission) produced $41,036',789.48 (see Defendant’s Exhibit D 5, page 71). It is apparent that the Commission in a general way was seeking to value the telephone property on the basis of an average trend of cost of materials, labor and construction, but instead of taking an absolute average trend of all costs it took a so-called weighted average of only certain costs. The difference is, however, in our opinion not of fundamental importance. In either ease there is the essential fallacy of assuming that an average trend of all prices, whether absolute or weighted, is a true index for the trend of construction costs of the spe7 eial kind of property with which we are here dealing. Whether the valuation of telephone property is based on historical cost or reproduction new, it is, we think, obvious that the price change over a period of years can only fairly be reflected by developing a price ratio or trend for the costs entering into this particular kind of property. It is quite erroneous to assume that changes in the price level of certain commodities or the average of any number of commodities is similar to that of a particular commodity or property. This fact is amply demonstrated in the tables to be found in the Commission’s opinion and in many of the exhibits filed by its counsel in this ease. The fallacy of the Commission’s method is also thoroughly and convincingly demonstrated in the oral testimony of the plaintiff’s witnesses Barker, a valuation expert for the Vermont Commission, and a Dr. King, an experienced economist and statistician. To some extent the Company’s estimate of cost of reproduction new is based on the use of price trends but the trend or curve so developed is based definitely on telephone plant construction prices. If this valuation method is to be used at all, we think it entirely clear that the only proper use is that adopted by the Company and not that used by the Commission; provided, of course, the cost data used by the Company represented fair and reasonable prices for telephone apparatus and construction work. It is the contention of the Commission that the costs so used in its estimate of reproduction by the Company are not fair and reasonable. They were admittedly based for the purchase of materials on prices of the Western Electric Company from which the Company purchased all its telephone apparatus and equipment and on the wage scale paid locally by the Company, with some adjustment for wholesale construction work. We will consider this objection more fully hereafter.
While in the exercise of our limited constitutional function, we are not permitted to reject the Commission’s valuation merely because of an erroneous method, it is our duty to look at the result obtained by the Commission and to contrast it with other standards of valuation appearing in the evidence. Looking at the result reached by the Commission’s method we find that it contrasts very sharply with other valuations in this case. In our opinion it produces an unreasonably low valuation.
Counsel for the Commission contend that the court may not disturb the Commission’s valuation unless the Company has proved beyond a reasonable doubt “that the Commission has been wrong to such an extreme degree that in the light of all present circumstances, no reasonable body of men could have reached such a conclusion.” But the law is otherwise. On the issue of confiscation the Court must exercise its own independent judgment of law and fact. Ohio Valley Water Co. v. Ben Avon, 253 U. S. 287, 40 S. Ct. 527, 64 L. Ed. 908; United Railways v. West, 280 U. S. 234, 251, 50 S. Ct. 123, 74 L. Ed. 390; State Corporation Comm. v. Wichita Gas Co., 290 U. S. 561, 560, 54 S. Ct. 321, 78 L. Ed. 500.
Another objection to the method used is the highly variable results by the application of the method in a period (such as the present) of changing prices. We have above noted the increase in valuation by the application of the “all commodities” index, of nearly $21,000,000 occurring in the single year of 1933. If the present general upward trend of prices continues (and there is very determined public policy to make it do so), the Company would clearly be entitled in another year or two to a new valuation of its property on this method as it is undoubtedly the law, as pointed out by counsel for the Commission, not only that rate valuation must be based largely on present price but also “it is well established that values of utility properties fluctuate, and that owners must bear the decline and are entitled to the increase.” McCardle v. Indianapolis Water Co., 272 U. S. 400, 47 S. Ct. 144, 148, 71 L. Ed. 316.
The Commission’s method of valuation is also erroneous in its assumption' that Telephone Company property fluctuates approximately in accordance with general conditions. There is much evidence in the case to the contrary, and this is to be expected in the .ease of a utility subject to Commission regulation. The maximum earnings of utility companies by law never attain the peaks realized in general trade and business. Nor in time of depression do their earnings fall in proportion to that of general business. The service afforded by a well-managed utility is a common necessity for which there is a comparatively constant demand. Thus we find that despite the onset of economic depression in 1929' the volume of the Telephone Company’s business constantly increased through 1930 and 1931, reaching its peak in the latter year; and it was not until 1932 that the earnings began to decline. And since January 1st last, the growth has again begun and is so marked that counsel for the Commission in argument notes an increase in net operating income of more than $300,OOQ is indicated for the current year.
Despite tbe relative stability of earnings of publicly regulated utilities and particularly well-managed telephone companies as shown by the evidence in the case, it seems to be the theory of the Commiss