CHAPTER IX Property Constructed out of Surplus § 200. Valuation of property constructed out of surplus. 201. Pennsylvania Supreme Court in Brymer v. Water Company, 1897. 202. Maine Water Plant Condemnation Case, 1902. 203. Interstate Commerce Commission in Spokane v. Northern Pacific, 1909. 204. Right to a rate of return adequate to construct betterments. 205. Betterments out of earnings-New York Public Service Commission, 1911. 206. Betterments out of earnings-American Telephone and Telegraph Company, 1912. § 200. Valuation of property constructed out of surplus. In valuation for rate purposes the question is sometimes raised as to whether that portion of the property that has been constructed out of surplus earnings should receive any different consideration from that constructed from funds secured from the sale of securities. If a company has charged rates, not alone adequate to pay a fair and reasonable profit to the stockholders, but also to permit the building out of earnings of extensions and improvements aggregating as much as the total investment of the security holders, there is some justice in the argument that unless this has been done for the benefit of the consumers it represents pure extortion. Profits in excess of a fair return should either be distributed to the consumer in lower rates or if used for extensions and improvements should be deemed to be held in trust for the exclusive benefit of the consumer. But this argument would apply as well to excess profits that had been distributed in dividends as to excess profits that had been used for improvements. It would imply that the Government's right to regulate was retroactive and failure to exercise it for a great many years would not prevent it from requiring at any time an accounting of all profits from the initiation of the enterprise and a virtual refund of any amounts paid to the investors in excess of a fair return. On the other hand it is sometimes argued that any failure to earn a fair return at any time in the past should give the company a right to recoupment through an added capital value termed cost of establishing the business or going value. Past surplus profits create a present negative going value while past deficits create a present positive going value. It is probable that for rate purposes neither past failure to earn a fair return nor past earnings in excess of a fair return should be considered in connection with the fair value of the property. They are doubtless matters worthy of careful consideration but they are questions of return and not of cost or value and should influence the determination of the present fair rate of return and not that of the present fair value. Authoritative decisions on this point are lacking. The question seems for the most part to have been ignored. It is referred to by the United States Supreme Court in Louisiana Railroad Commission v. Cumberland Telephone and Telegraph Company, decided February 23, 1909. In this case the court apparently takes the ground that extensions or improvements constructed from the proceeds of the reserve set aside for depreciation, are not to be included in the fair value for rate purposes. Justice Peckham, however, says: "We are not considering a case where there are surplus earnings after providing for a depreciation fund, and the surplus is invested in extensions and additions. We can deal with such a case when it arises." 2 1 Louisiana Railroad Commission v. Cumberland Telephone and Telegraph Company, 212 U. S. 414, 424, 425, 427, 29 Sup. Ct. 357, 53 L. ed. 577, February 23, 1909. 2 For a more complete abstract of this case, see § 424. In Massachusetts the treatment of property constructed out of surplus is of special importance, owing to the control that has been exercised for many years over capitalization and rates. The Board of Gas and Electric Light Commissioners seem to have consistently held to the position that while the property constructed out of surplus profits undoubtedly belongs legally to the stockholders, equitably it requires a different treatment in a rate case from money actually contributed by the stockholders. This is shown in the memorandum of the Commission on the East Boston petition printed in the ninth annual report of the Commission, 1894, pages 9-16. The position of the Commission is more clearly outlined in the Haverhill petition printed in the sixteenth annual report, 1901, pages 9-13. This case was a petition by the mayor of Haverhill for a reduction in the price of gas supplied by the Haverhill Gas Light Company. The Commission, after a hearing, reduced the price from one dollar to eighty cents per thousand. In discussing the treatment of property constructed out of surplus, the Commission says (at page 9): The Haverhill Gas Light Company was organized under a special charter in February, 1853, and later in that year began the supply of gas in Haverhill. Its capital stock was originally $45,000, which was increased in 1871 to $75,000. ... It has enjoyed the exclusive privilege of supplying gas to the city and people of Haverhill, and, with the exception of a period in its earliest history, has been uniformly prosperous. Its management appears to have been exceptionally careful and conservative, so that, in addition to the payment of an average dividend of about 8 per cent., it has accumulated a surplus invested in its plant estimated to represent from $275,000 to $300,000. It is probable that a part of this will disappear in the near future, through the abandonment of existing plant in making improvements which are likely to prove necessary for properly supplying the public, but the surplus is much larger than can be utilized for any such purpose. It is unnecessary at this time to give particular consideration to the wisdom or unwisdom of creating a surplus of this size and character, but rather to consider how it has arisen and how it should be treated as an existing fact. It does not appear that it is due to extravagant prices for gas or to a niggardly policy toward the public; the prices have in fact been as low or lower than in other companies of its class in the State, while the quality of the service, so far as the Board has been able to ascertain, has been equal to the best. This accumulation appears rather to have been due in part to exceptional care in the management and in part to a rapid gain in wealth and population in the community supplied. Its growth has been steady through a long series of years and not excessive in any single year. Its existence thus appears to be due in part to causes over which the company has had no control and for which it is entitled to no particular credit. Accumulated, as it has been, out of profits in the performance of a public service, its existence affords exceptional facilities and imposes peculiar duties upon the corporation in its relation to the public. As the company has applied this surplus to the cost of improving and enlarging its plant as has been needed to satisfy the public demand, the property in which it has been invested must otherwise have been represented by new capital contributed by the shareholders. Such use of surplus may properly be made of substantial benefit to the consumers and shareholders alike: to the former, by relieving them of some portion of the burden which the investment of fresh capital necessarily imposes, by affording the most ready facility for minor extensions of the company's lines, for superior excellence in its product and by aiding to the most satisfactory performance of its varied duties toward the public; to the latter, by strengthening the corporation in enhancing the security of the original investments of the shareholders, and in bringing to them a return somewhat higher than that to which they might otherwise be entitled. Such a surplus is by every principle of law the property of the corporation. It has an undoubted legal right to distribute it as a dividend as it is acquired, or pro rata to its shareholders in case of liquidation; but, notwithstanding this, the circumstances attending its accumulation impose upon the company, so long as it continues to exercise the functions of a public monopoly, the duty to employ it for the joint advantage of the consumers and the corporation. It need not be dealt with as the exclusive property of either. Fortunately, in the majority of companies of this class in this State, the recognition of this duty by the directors has been a part of the policy of their management; until recently this has been true also of the company in Haverhill. Now, however, its policy appears to have undergone a very decided change. The company brought an action in the Circuit Court of the United States to restrain the enforcement of the Commission's order reducing the price to eighty cents. The case dragged along for many years and was finally compromised. Another petition asking for a reduction in the price charged by the Haverhill Company is now before the Commission, and the decision will doubtless hinge largely on the treatment of property constructed out of surplus. Under the Massachusetts system of regulation, there is an argument in favor of the consumer's equity in the surplus which probably could not be so effectively used in other states. The laws have since 1894 prevented a capitalization of property constructed out of surplus and have required the sale of new shares at approximately the market value. And with the supervision over rates exercised by the legislature and the state commissions, it seems probable that if a company, such as the Haverhill Gas Light Company, had attempted to pay out all its profits in dividends instead of using surplus profits for betterments, the legislature or the state commission would soon have reduced its rates. § 201. Pennsylvania Supreme Court in Brymer v. Water Company, 1897. In Brymer v. Butler Water Company, 179 Pa. 231, 36 |