Water Foresight Podcast
Water Foresight Podcast
Is There a Future for Fair Market Value?
Is "fair market value" activity in trouble? Should public and private water utilities begin to worry? Does the recent Cicero v. Pennsylvania Public Utility Commission decision by the Commonwealth Court of Pennsylvania present a signal of change for the economic regulation of utilities? Or, is this simply a wild card? Cody Faulk with Spencer Fane LLP joins the Water Foresight Podcast to provide us with a balanced perspective on the future(s) of fair market value-based utility acquisitions. Is the public policy of utility consolidation dead or only if the utility is "troubled"? What is the nature of "affirmative public benefits"? What are the temporal limitations of the notion of "harm" (i.e., only in the present)? Are rate increases always "bad"? Is "same service" equal to "better service"? Is "capability" equal to "cost-effective"? How will states (and commissions) react? Legislative amendments? Rulemaking? What will consumer advocates or municipal leaders do next? Will the future of fair market value cases yield increased transaction costs--paid for by the ratepayers? What would Adam Smith do?
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Aqualars. This is the WaterForesight podcast powered by the Aqualars group, where we anticipate, frame and shape the future of water through strategic foresight. Today's guest is Cody Faulk, an attorney with Spencer Fain. Cody represents both investor-owned and municipally-owned utility clients in both routine and complicated administrative, transactional, operational and regulatory issues. Cody, welcome to the WaterForesight podcast.
Speaker 2:Happy to be here. I'm very excited to talk to you about all the issues in pooling water in this beautiful country of ours.
Speaker 1:Well, that's great. Today we return to really two lenses in the future of water. One is the legal lens and the other maybe is the economic lens. Maybe together they are represented in this recent case from the Commonwealth Court of Pennsylvania, cicero, versus the Pennsylvania Public Utility Commission, addressing a recent attempt by Aqua Pennsylvania wastewater to acquire the wastewater assets of East Whiteland Township in, I believe, chester County, pennsylvania, outside Philadelphia. This case centers on the notion of fair market value legislation. Before we begin, I wanted to just say these are just our discussions, our thoughts, and this is not legal advice by anyone, including you or your firm. We're going to just talk about some of the implications of this case through the lens of foresight as it pertains to the future of water. Fair enough.
Speaker 2:Sure, I'm very excited to talk about these kinds of issues.
Speaker 1:Wonderful Well, fair market value. Tell us briefly what is fair market value or fair market value legislation? What does it mean to people in the world of water?
Speaker 2:Sure, yeah, I think that a lot of folks, lay folks, will hear that term fair market value kind of naturally go to appraisals and those types of transactions.
Speaker 2:But traditionally in the world of water and wastewater acquisitions, utility acquisitions traditionally the value for a system that's being acquired is using the original cost of the plant, less depreciation, which takes the in-service capital costs of the assets and subtracts accrued depreciation. But that traditional concept tends to put distressed municipal and kind of smaller systems at a disadvantage, and so the intent and the concept behind fair market value allows the fair market value of the acquisition to be included in the rate base for utility rate making purposes, which often incentivizes entities acquiring systems to acquire those systems and then put them into rate base. So that's the general concept.
Speaker 1:So a good example and you can correct me a good example might be. I am a local municipal wastewater system and I would like to sell to a private water utility for one reason or another. And the regulators, the consumer advocate, the utility commission, they and their accountants tell me well, matt, your system is only worth $100,000. Now you may have an agreement to sell it for a million to the private water utility but, mr Private Water Utility, you're going to have to find a way to eat the cost of that $900,000. You can have an agreement to sell it for a million, but we're not going to let you put that entire $1 million onto the shoulders of the rate payers. You've got to have the shareholders pay that $900,000. We're only going to let that $100,000 be put into rates. Is that a fair example of how this works?
Speaker 2:That is well. That's a fair example of how it has worked in the past, correct? So the fair market value concept would then take that $1 million and say no, actually assuming that that is a fair market value and it's not an inflated cost, that instead of using the original plant cost minus depreciation, you can instead use the cost to acquire the system under a fair market value arms length transaction.
Speaker 1:Right In my example, the situation before fair market value legislation arrived. It seemed that in most cases the parties would just not come to agreement and walk away. In certain cases, the system that wanted to sell would further deteriorate or begin to deteriorate and perhaps have environmental non-compliance issues, customer service issues, things like that. Fair enough.
Speaker 2:That's fair and really the folks that would tend to settle in those instances are folks that are giving it away for a song, basically because the cost to continue to operate exceeds the revenue generated and the utility acquiring. It is really more taking it on as a public service than anything else, as opposed to an economic benefit for the utility.
Speaker 1:Now, fair market value legislation in the broad scheme of time is fairly new. There are a number of states in America that have adopted this legislation or are considering it. How many states have this type of fair market value legislation?
Speaker 2:So, based on my research and I'm not going to say this is exhaustive there's currently 12 states that have the fair market value legislation, the bigger ones being California, Illinois, New Jersey, Ohio, Pennsylvania, Texas and Virginia, Texas, where I practice primarily we adopted fair market value legislation back in 2021. It's really just now really taking a flight. And then I do know that Florida, Tennessee and Kentucky all have fair market value legislation proposals, but those haven't been adopted yet. So it does appear that it's growing. It hasn't reached critical mass nationwide yet, but I do think that at least some states are looking at it as something of a potential policy to be adopted.
Speaker 1:Wonderful. Let's turn to our case, the Cicero case. In short, what is the ultimate decision in this Cicero case?
Speaker 2:So this may take me a little bit to explain, but, big picture, it was a decision rendered by the Pennsylvania Commonwealth Court. So for those of you who don't practice law in Pennsylvania, like myself, this is not the Supreme Court of Pennsylvania, but it is the court that precedes it. And it was an administrative appeal by the Pennsylvania consumer advocate, cicero, appealing a Pennsylvania PUC decision to approve an acqua application to acquire a wastewater system that you talked about, east Whitehouse, whiteland Township. The court found that the commission erred and abused its discretion in concluding that acqua established substantial affirmative public benefits that outweighed the acknowledged harms of acqua's acquisition of the East Whiteland system, as required by the Pennsylvania approval mechanism, which included the fair market value concept to support the approval of the application and grant the certificate of convenience.
Speaker 2:A note though in this case is that and we can get into the details as we discuss this but is that the state, puc and acqua cited to the state's policy of promoting consolidation and regionalization in the state's passage of fair market value acquisitions of municipal water and wastewater systems as a basis for this transaction serving the public interest. So they were looking at policy, and specifically the fair market value policy, as grounds for authorizing this transaction, and the court ultimately disagreed, looking to the specific known harms associated with this proposed transaction.
Speaker 1:Now we don't know whether this case will go up on appeal to the Pennsylvania Supreme Court. As we are recording this and I don't think we've taken the time, we're not here to pick over the record and things like that. We'll let the lawyers do that in their bar association newsletters. But one of the things that's interesting about your practice, cody, is that you represent both public and private water systems, water and wastewater systems. How, what's your hat on if you're talking to one of your municipal or governmental clients versus one of your private utility clients? How do you look at this case briefly, and what's your reaction to each one of those hypothetical clients?
Speaker 2:Sure, yeah, and you know, again, it's a tough kind of analysis to do, but if at least I was practicing in Pennsylvania, looking at this case now, what I would say is simply wanting to get out of the utility business or simply wanting to get a financial benefit for my citizens is not going to be enough to justify a transaction like this.
Speaker 2:In this case, the ALJ found that the township was already providing safe and reliable service and had the financial ability to make capital investment.
Speaker 2:So really wanting to get out of the utility business or securing cash for other city projects will not support an acquisition being found in the public interest.
Speaker 2:You have to show some sort of benefit, and so it is. You know not to say that those things can't be proven for municipality, it's just a little higher standard. And so I think that that you know you're going to have to show there's some sort of cost savings or some sort of, you know, uncalculable benefit to the citizens of this, of this, of this system that will benefit them beyond just some sort of getting out of the utility business. Now, with a private utility, I would start second guessing my acquisition strategy and identify systems that would clearly benefit from an operation and service perspective, and that those are the the ones that are going to be the low hanging fruit. Yes, it would be great to acquire these systems that are being run really efficiently and don't really have any operational concerns. But from a regulatory perspective and ease of approval, you're going to want to focus on those systems that have some sort of operational concerns that that would benefit from from your utility services, yeah, and that you know the cost efficiencies from a larger utility.
Speaker 1:It seems that this decision would make both of your hypothetical clients unhappy. You know both are sitting there trying to work with each other and in arms length transactions, spending lots of time on consultants and lawyers to arrive at an agreement, only to perhaps reach a decision like this.
Speaker 2:Sure, yeah, and I will say from the, from the municipal perspective it is, and I've had this conversation with with clients before at least in Texas it is.
Speaker 2:it is not easy to sell a municipal system. It's not. You have to. There are a lot of local controls put in place to sell a public system because it is a system that is owned by the citizens of that community, and so you know, there's that, that regulatory hurdle to cross first and then then to have to kind of come to this point and then say, well, you haven't proved it up enough, despite having the, you know the buy in from the community would be, would be a tough pill to swallow, in my opinion.
Speaker 1:Yeah, that's interesting. I I'm old enough to remember and I'll go back. I'll go into the way back machine and you probably remember this too. But the municipal landfill, the county landfill, right, remember when governmental entities were in the solid waste business, and some may still be, but over the years, with with rickra and superfund and other environmental laws, they said you know, we're probably not the right people to be in this business, right, it's a lot of money, a lot of risk. And they decided to get out of the business. They sold or did contracts and we really don't have this notion of a municipal or the city dump, the county landfill anymore. Is there something to be said for that environmental history? And where we are today with water and wastewater systems? Is this really what you know local units of government should be doing or not? You know? Just an open question your thoughts.
Speaker 2:Well, sure, yeah, I think that that inherently comes down to the individual communities.
Speaker 2:Whether it's something communities should or should not be doing is really should be dictated by the populace and in those communities and some of these communities that I've worked with have had, have been operating their own utility since, you know, the light bulb was invented and so, you know, this is part of the community. But also, when it becomes too burdensome, when there are things that are bigger priorities, there should be some flexibility in being able to, you know, get out of that business If it's not either lucrative, if it's too much of a administrative burden, it's too much on the taxpayers. You know that that should be an option and I think that you know to the extent that we're making it harder or regulators are making it harder, I think you know that remains to be seen as to what the ultimate cost will be on taxpayers. But there there should be some sort of, you know, agency when it comes to to these, these utilities, and being able to do as necessary if that is the best thing for that community.
Speaker 1:Yeah, that was one of my underlying questions just reading this opinion and we'll get to my next question in a minute but it doesn't seem like there are that many hurdles, at least facially, on a local unit of government wanting to sell the system. You know local control. If I don't want to do this anymore, I should be able to, you know, sell it or do concessions or contract operations, whatever you call it, and perhaps there's a trend here where that may not be the case. Going forward, People vote us into office to lead the locality and if they don't like the decisions we're making, they can vote us out of office.
Speaker 1:And so it kind of interested me greatly that there is this notion of affirmative public benefits. I think that's been sort of embedded in case law in Pennsylvania. That has to be demonstrated as part of these fair market value transactions. Do you have a sense of what is this term? Affirmative public benefits? This sort of? I think it's a narrative standard. I don't think there's a rule or regulation that specifies what those elements are, but your thoughts on that as a way to get these parties together?
Speaker 2:Right, and so I think you know again you're seeing this in the Cicero decision and there's some of this in other states about the public interest finding public benefits. It's kind of the same. It's kind of you know when you see it and that you know it's really, from my perspective, a public benefit, just as in the harms, is in the eye of the beholder and ultimately it's the commission that has to weigh those benefits versus those harms. And I think when they were saying affirmative, it really means measurable. But you know the case in Cicero they do talk about that. You know these things don't have to necessarily be measurable, but there needs to be some element to that.
Speaker 2:But public benefit, in my view, is really meaning that there is going to be some measurable component that is going to be ultimately beneficial, either economically or from operations and services perspective. That will be better than where you found it in the end. So the public and the service will be ultimately better in the long run than when you found it, when you acquired it. And that's really the question that I think needs to be asked is is this transaction going to result in the system being better than it was when it was acquired? That's the way I look at it, and I think limiting that to one specific issue is really not the best way to do that analysis. That's not to say that that's not how it's been done.
Speaker 1:Your discussion raises my next question, which is just reading the decision, it struck me that there's this surreptitious temporal issue where it seems that the court is focused on today, and, as you and I know, these types of transactions can take years. You'll spend years building the relationship, having discussions that may be on and off, and even within the regulatory system, it may take a year or two for the transaction to conclude, and the record could be two years old when you do these things, and so I'm interested in your thoughts on when you talk about affirmative public benefits, how do you measure that? Not only with concrete evidence, but projections, models, or this has happened in the past and is likely to happen in the future, and that can be both positive and negative. Right, we'll get to rate increases in a minute, but you could project out higher or low rate increases.
Speaker 1:But it seemed to me the case mentioned, for example, I think it was 2019 where the locality had some environmental non-compliance challenges, that, as of the I guess, the timing of the hearing, that had been rectified. But does that mean there's absolutely no challenges in the future, no more main breaks, no more customer services problems? And I'm interested in your thoughts on if we look at affirmative public benefits, how does either a private utility or a public utility, or even a commission think about that from the past, present and future? And are all those three dimensions available for the evidentiary bucket, if you will?
Speaker 2:Sure, and I'll say this, is that the way I you know, reading the CISRA case, the way I view this, as more of utilities are going to have to both sides the joint applicants, the seller and the buyer all have to look at all different things temporarily past, present and future and use anything to their advantage to show that there is a public benefit. And that includes showing a history of operational issues that have to be remedied or have been remedied as making a case for saying, well, look, we're not going to have to expend city money to pay for these operational environmental compliance costs, present issues. What are those benefits there? Benefits of volume, benefits of not having the administrative costs on the city or the township. What have you?
Speaker 2:Sharing those costs amongst a larger pool of customers and then in the future I think that that is something else that can be proven up about increased costs, inflation and again, those things not having to be born by a citizenry taxpayers and instead can be shared amongst a larger pool of customers that capital costs and capital investment is going to be necessary in the future. Yes, it's operating smoothly and efficiently right now, but there's 30 million, 50 million worth of capital improvements that are going to be required over the next three to 10 years and we just don't have the financial wherewithal to fund it. All of those things can be shared? I just don't think, at least from the court's perspective. In Cicero they felt like Aqua and the township did a good enough job identifying those things.
Speaker 2:And instead just focusing on the just kind of financial and technical capabilities of Aqua and then the policy decisions of the legislature in encouraging regionalization.
Speaker 1:It seemed to me that the court may be telling the local unit of government that everything's fine and you know what? More than that, everything's going to be fine into the future. That you know, and it struck me that you know. If you predict the things are going to be good into the future, why is it not appropriate to maybe consider that things may not be good into the future? You know that there could be some sort of debt issue or environmental compliance issue or something else, like they had in 2019, for example.
Speaker 2:Based on my review of the case and the record, the ALJ looked at the operational concerns as they existed at the time of the you know, the proposed transaction and it didn't really delve into those things into the future. But I also don't think that that was really presented in any real way, and so I think you know there's going to need to be more of an argument made by these utilities that are selling to say, you know, here is why this is the right time for us to divest.
Speaker 1:You're kind of not to put words in your mouth, but you're suggesting that in this particular case, maybe there needed to be more factual discussions by the parties in front of the commission about existing historic and even future challenges that may arise or may likely arise. Is that fair?
Speaker 2:Yeah, and that is fair, and I think you know again, I have not spent hours pouring over the records here and I don't practice them in Pennsylvania, but from my understanding though, reading up on this case is that you know there's probably a reason why that evidence wasn't presented in much detail, and that's because the commission in Pennsylvania had been approving Aqua's similar types of applications based on the similar type of evidence they could have presented in this case, and they had no reason to really put in as much detail as what the court in Cicero felt was necessary.
Speaker 1:So I think they were yeah, Go ahead.
Speaker 2:Yeah, so it seems like while that wasn't here in this case, you know they're going to need it in the future. Assuming the Supreme Court doesn't in Pennsylvania, should it here, it, you know, reverse the decision, Cicero, and I really don't know where that might land.
Speaker 1:I hear you saying the bar is likely going to be higher from an evidentiary standpoint. That's maybe the signal you're getting from this decision.
Speaker 2:I would say if I was to go solely off of this decision, my recommendation would be to folks is put everything in anything you can to support, you know the public benefit even if it's remotely relevant and I would say, using the local community folks to explain why this transaction was in their interest and this community's interest would go a long way.
Speaker 1:One side note there is another legislative framework called a Water Quality Accountability Act and that was in the back of my mind. I think it's in New Jersey, indiana, maybe some other places where municipal utilities, among other things, have to demonstrate or show compliance with requirements for cybersecurity and asset management, and I don't believe that that was discussed in this case at all. Whether the local system was on track to not. That that's the rule in Pennsylvania, but are they up to date on cybersecurity protocols, as it may be established by the federal or state government? Do they have an asset management plan or asset management system, and would the acquirer, in this case Aqua, be more adept at satisfying those and preventing challenges related to cyber issues or asset management problems than the local system? I mean, that might be something that, as evidence of what you're talking about, more information about how the acquirer would be providing affirmative public benefits over the seller. Is that fair?
Speaker 2:Sure no, and I think we could, you know, look into all sorts of different things that would extend beyond even utility service as far as public benefit, because, you know, municipally owned utilities, publicly owned utilities, they are run by governments that have, you know, business operations, business concerns that extend far beyond running utility, and so there may be factors as to justifying their divestment of their utility that are not even specifically related to costs associated with running utility.
Speaker 2:There may be other regulatory issues or other kind of factors that are going into the economic development or economic decline of a community that really, you know, justify that divestment. It's not just operational concerns of utility, it could be operational concerns of the city as a whole. And then, as far as the acquiring utility, yeah, I think you know you have to look at those things. As you know, do they have the technical and technical and operational capabilities more adept to providing a long term operation of this utility? One of the things that a lot of folks are struggling with now is, you know, recruiting and retaining talent, and it's harder for some of these smaller communities to retain talent for folks that can operate these utilities long term. So there's a number of things that you could start using as justification, and I think really what the CISRA case is saying is you need to point those out, for us.
Speaker 1:Yeah, we could probably spend a whole another hour discussing affirmative public benefits in so many different ways and dimensions from both sides. I want to ask an interesting question that seemed to attract the attention of the court and it deals with this idea of a rate increase, and they talked quite a bit about what I would frame as maybe an aspirational discussion or a proposed rate increase, what it might look like, and they seem to really be viewing that as a bad thing, a negative thing in terms of public benefits, and I'd like to get your thoughts on this notion of a rate increase. And is a rate increase really a bad thing or is it a good thing, especially when you go back to the maybe the policy reasons for this fair market value legislation. I mean, is it good to just have a $5 a month wastewater bill and wear that as a badge of pride? I will go out on a limb and just say make an argument and you can attack it. A rate increase is a very good thing and I'll let you respond.
Speaker 2:Sure, you know when you kind of put it that way and you're asking.
Speaker 2:You know, simply, is a rate increase in and of itself a negative or a bad thing?
Speaker 2:I think in this day and age in which costs are rising exponentially, a rate increase, regardless of whether it is justified, will be viewed and I'm not saying this is the right or wrong way to view it but will be viewed as a harm or negative consideration.
Speaker 2:My view is that it should only be viewed as a quote negative if it truly you know the rate increase, the rates themselves, truly exceed the cost. To provide retail service you have to have rates that recover the cost of service. Otherwise you are going to see a decrease in the operations and resulting operational failures, you're going to see a lack of investment. You're going to see all of those things decrease and there is only a set amount of time before having rates lower than the cost of service and what you will be able to sustain that utility. So my view is that you know you should make sure that the utility is going to be recovering its service efficiently. And you know, and I do I can see where the harm of a rate increase there can be a harm when it's not done often enough, and the result is huge percentage increases as opposed to gradual increases. Right.
Speaker 2:That's where right shock, right shock comes into play and there's always these things, these, these comments about trying to mitigate it and, and you know, regulatory lag. It has a lot to do with with that. Yeah, it is expensive to file rate cases, it is time consuming, and and so you're, you're applying for rates, usually on a backward looking test year, and so you're trying to recover costs from several years ago, right, or the cost to provide service several years ago, and so again, I don't. I think, as far as the Cicero case is concerned, it was easier for the consumer advocate to point to the perspective, potential cost increase, rate increase, when you know using that as a harm, a measurable harm, when looking, you know, as compared to the arguments being made by the utility and the commission and basically citing two kind of broad policy arguments for why this was a benefit.
Speaker 1:And it. I think you, you, you really hit the nail on the head where you look at the cost of service, and not that we're suggesting that a full blown cost of service study will be part of these fair market value transactions, but it really didn't seem to be evaluated very critically in anything that I read where they said you know, I wonder if 30, what was it? $33 a month is the fair and reasonable rate to charge customers for the cost of service, of providing this wastewater service. Fair it could be.
Speaker 1:Maybe the parties just agreed not to dig that issue up out of out of just sensitivity, where the real analysis is, you know, $60 to $70 a month, and so that may be quietly one of the reasons that they wanted to sell. They don't want to look like there's local challenges. You know anything more than what is necessary to sell the system. And it just seems to me that when you add I think there was an agreement to hold rates steady for three years, I mean when you put that on top of that, it just seems like there's an analysis there where no one really looked at the current rate and said you know, that's a bad rate Makes sense. It just because rates are low doesn't mean that those rates are good, if you will, makes sense, and that a rate increase just because it's higher or double doesn't necessarily mean that is bad. Is that a fair observation?
Speaker 2:Sure, and again, the record is kind of vague on that analysis and I would be, you know it would be, I really would hope in these kinds of cases you're not digging too much into these rates issues because they're so dependent on market forces, on regulatory forces etc. But to the extent you know, the record is kind of absent. As to, you know, maybe the township you know it was under recovering and was facing the possibility of having to increase their rates to $100 a month and the fact that you know AQUA was coming in and doing a rate freeze at $33 a month for a year or two and then potentially increasing to $77, would ultimately be a net benefit to those customers because they're not having to pay $100 a month immediately and in long term. Yeah, again, not there to challenge it.
Speaker 2:I don't think you know the record was not, you know, full of that kind of discussion. But again, you know in the future making those arguments about why, on a long term time horizon, it's going to be ultimately financially beneficial to, you know, the citizens or the folks that were receiving service in the long run, and that can also again be shown by saying what we're going to use the money from this divestment for, you know, because you know, unfortunately, excuse me, fortunately when a city sells its system, the economic gains of that sale are not a dividend to shareholders, their funds going back into the general fund of the city to be used for, you know, all sorts of projects, local public benefits, right, right, right. There, then I mean, you've got, you know, millions of dollars that can be used to supplement other public programs, yeah, streets and libraries, fire stations, parks, sure, yeah.
Speaker 1:Yeah, paydown debt, I think, was one of the issues that was discussed. It seems to me from this particular rate discussion, all things being equal, and we don't know where this case will go, but we may see in the future a more robust discussion of rates on both sides of the matter, where the local units of government may have to provide some testimony on their rates and trajectories and things like that, and the private utility will have to offer a more robust discussion on rates to sort of add to the record about where things have been, what it takes to run the system and then where things are going to go, especially when you have these rate moratoriums that are somewhat common, I believe, in these acquisition deals. So that's sort of my thought on where this will take us into the future. But I just remain concerned about how we view rate increases. They are just inherently bad.
Speaker 1:It's like going to college and saying, well, the tuition is bad, and so I want to take classes, but I don't want to pay tuition because that's bad. You know, rate or my tuition increase is bad, things like that. So anyway, there's this notion of and passing. The court says well, hey, the township is providing the same service that Aqua would provide, so we don't really know that this transaction needs to conclude. I noted that and I thought well, I thought Aqua was claiming to provide better service. Is it just kind of struck me? I don't know if you have any thoughts on that.
Speaker 2:So, yeah, I think again making the declaration that there's nothing wrong with this system, so there's inherently not really any kind of benefit from a larger utility coming in, and I think it really same service versus better service what those arguments are. I don't. It's very difficult in these types of transactions and these types of reviews to make that kind of judgment call as to who is or is not the better provider. Yeah, sometimes it's very easy. I've had I've had not personally had some of these cases, but I've been made aware of certain cases in Texas where the current provider is nowhere to be found or in jail, and so it's very clear is that who's going to be providing better service? But the question of same service versus better service, as I think of unique one, I think it again is really going to be having to make that argument on the long term perspective and supporting that in the record as to why this utilities, economies of scale, will ultimately provide quote better service.
Speaker 1:Yeah Well, I want to talk about this case in light of maybe some of the possible plausible or probable futures for both governmental utilities and private utilities. And we don't know a whole lot about, again, the record of this case. We don't know whether it will be appealed and, if so, what will happen on appeal. But if maybe this is an easy first question. But if this is appealed and this decision is reversed, we're sort of back to where we were before this case. But again, if you're going to put on your hat and look at it through the lens of private and governmental utilities, what will you tell each client going forward? What might you do to the hypothetical private utility or public utility going forward to prepare for future fair market value transactions?
Speaker 2:So I think, obviously, as you said, depending on the outcome of any appeal, and I think, at least in the context of PA, acquiring utilities and selling utilities are going to have to be well, let's focus on the acquiring utilities. They're going to have to be more cautious with their acquisition targets, as I mentioned before. They're going to have to focus on the ones that they're going to be able to point to as far as not only operational benefits but ultimately economic benefits, and at the very least, develop more fully their arguments in support of a public benefit fund.
Speaker 1:Yeah, good point, even environmental benefits.
Speaker 2:Environmental benefits, anything and everything, but the things that they can see as things that are just on their face it is going to be better for this utility to come in and acquire, and then, as far as the selling utility, again, they're going to have to present their argument for why this is in the best interest of their community. Not just in the best interest, in my view, not just in the best interest of the utility itself, but to the community, and that can be shown in a number of ways, and I think obviously, utility, service and costs are a big component of that, but making the argument for this is in the best interest of the community. Now, what can this appeal, though? If this is appealed and is subsequently overturned Not saying that that's what's going to happen? I have no idea, but, hypothetically, if it was, or really, any opinion from the Pennsylvania Supreme Court is going to show whether legislative policy is a sufficient justification for finding a public benefit for a transaction using fair market value.
Speaker 2:And so you know, I think in this case at least, the Pennsylvania Public Utility Commission took a macro policy justification for finding that this transaction was in the public benefit. And the consumer advocate and the court took more of a micro approach and saying you know, there were no operational deficiencies and there was a perspective rate increase. Those harms are not outweighed by just the policy considerations alone. So an appeal may kind of further highlight how much you weigh legislative policy in reviewing these types of transactions.
Speaker 1:There will be much to discuss for those respective types of clients who may have shared interests. But if this is appealed and the appeal is successful and this case is reversed, there will be much to discuss. One thought is we have this legislative. Is we have this legislative or, I'm sorry, we have this judicial decision and people are in the world of water, watch these things very closely and on both sides, both private interests as well as public interest folks, do you see any activity from this case, regardless of whether it's appealed to maybe amend legislative or even regulatory pronouncements related to fair market value, to maybe set into stone some of these, these statements in this decision, or to prevent that from happening in other jurisdictions? Your thoughts?
Speaker 2:You know, I think it remains to be seen. I don't think this case will be a quote tipping point. It will be monitored closely. But you know, assuming no appeal or a Supreme Court affirmation, you know I definitely think industry folks will be taking note and asking you know, okay, what do we need to do, say present, to get these transactions approved? I think you know I don't think there there's going to be a significant legislative push. But again, I you know there are 12 states that have this fair market value construct.
Speaker 1:I have not looked at every single one.
Speaker 2:But you know, if it's really the policy of the states to promote this consolidation, promote this regionalization, and the legislative mandate is not clear enough that they want these types of transactions to occur, then yes, I do think you know there's going to need to be some sort of a legislative action, but you know that does kind of remain to be seen as to how these cases will be treated in the future. Yeah, you have touched on this in our discussion, but let me try and ask this question.
Speaker 1:We can maybe unpack it a little further, but do you think private utilities will take this case very seriously and respond in these fair market value cases with overwhelming evidence from a multitude of experts? I'm going to bring in my cost of service expert, I'm going to take this as an example and I'm going to bring in my national asset management expert, my cyber security expert, my environmental compliance expert, my capital planning expert, my national asset management expert, my cyber security expert, my environmental compliance expert, my capital planning expert, my workforce development expert. You know to really spend the time and money to drill down on some of these issues that were just from this decision where we're kind of maybe not very well discussed or addressed and say, wow, this system is headed for a real problem here, and really bring in those experts and take the time and the money to fill the record with an overwhelming amount of evidence that you know this system should be sold and your thoughts on that.
Speaker 2:Yeah.
Speaker 2:I think it's going to be on a case by case basis, but for these larger acquisitions, I would recommend that utilities file their applications with well argued economic and public benefits for that specific transaction, including expert testimony, if it's available, including, you know, internal and external folks that can support this. You know these are sizable transactions, you know, and things that provide or a lot of money for, you know, even larger utilities and a lot of money for these communities, and I also would think that local government officials could provide really good evidence in support of what the public benefit is. And that's what I've been talking about before. You know, establishing that it's not just a utility focused benefit is it is a benefit to the community in itself, just as the utility has been a benefit to the community as a whole.
Speaker 2:you know the the divestment is a benefit to the community as a whole yeah, yeah, but but again there are smaller acquisitions where it may not be justified to go to that cost and expense associated with that, but in these larger ones, I think most definitely that those should be. Those should be things that are apologizing for that.
Speaker 1:But no, you know for larger acquisitions.
Speaker 2:I think they should definitely be be, you know, fully supported by record evidence.
Speaker 1:And you raise a good point that, as the private water utility and the public utility are kind of even though their arms length, they're still kind of collaborating on this, on this matter, and you're right to point out that the local, the mayor, the council can support this with their own evidence, even bringing in more than just the public works director.
Speaker 1:They can bring in the local economic development leader and they can bring in the chief of the fire department Look, we're, we've been trying to build the new fire department over here and with this transaction we'll get the $10 million we need to build our fire station or, you name it right the parks director. So just in reading this case, I was contemplating both the substance and extent of what may be necessary, not just your own people within your organizations, but external experts that may have the enhanced credibility to say I've looked at the information and, yes, it's worse than you think, and this transaction should be supported and approved. However, that leads me to another question Ultimately, who pays for these transactions? And if these fair market value transactions move from a kind of administrative process to a more, you know, it looks more like a piece of complex litigation with expert witnesses and expert testimony. Who pays for this? And ultimately do the rate payers and the taxpayers end up putting the bill for all this like a rate case.
Speaker 2:So sure and this I think it fluctuates from state to state, based on my review of the Pennsylvania statutes that the costs of the transaction in the regulatory approvals can be included in the in the FMV finding for rate based. So it you know, it will. You know, assuming that the transaction is ultimately approved and the fair market value is included in rate based, yeah, that that is going to be included in in the costs for service eventually. You know, there there is, you know, no such thing as a free lunch. Somebody is going to bear these costs and and so you know, will the costs increase for these kinds of cases. You know, again, no economist, but safe to say, the cost of everything is going up these days and you know, I don't think even in this case, utilities are financially disincentivized to pursue these transactions. Yeah, so costs for fair market value acquisitions in general will continue, continue to rise regardless, but, but they're going to be maybe increasing more.
Speaker 2:So with what? This increased regulatory review, and then that ultimate, you know, cost is going to be borne by rate payers. You know, it's interesting in this case because if, ultimately, I don't know how the transaction is set up, how they have to purchase agreement set up. But if it's ultimately not approved, you know the city, the township is out. You know, not only the funds associated with concluding the transaction but all the costs associated with litigating this. So those costs we're going to have to be borne by by the citizens, yeah, yeah. So it is interesting, you know, seeing, you know the cost of regulation going up is they are going to get passed down, it's going to get flowed through.
Speaker 1:Yeah, you use the famous quote. You know there's no such thing as a free lunch. But also it might be appropriate to say be careful what you wish for, you may get it. We stopped this particular. You know the consumer advocates who offer their thoughtful and often well reasoned opinions in these matters. They may win a case, but at what cost, for example? You know you may win this battle, but they're in the war that will continue.
Speaker 1:I think, as you said, these fair market value cases aren't necessarily going away, but the costs and the level of involvement may increase, which may end up really hurting rate payers in the long run. But a question and this goes back to my earlier thoughts on the time in which you look at these particular acquisitions. You know in the past or the present or even the future, but let's say that a fair market value case does not move forward. And a case like this? And then a year or two down the road, five years down the road, in a particular city, somewhere, there's a major crisis, water contamination or a loss of water supply or a cyber incident. Who gets the blame for that? What's going to happen? Is it too late to point fingers? And, hey, we should have sold this five 10 years ago when we brought it in front of the.
Speaker 1:Some state commission Is not a local unit of government. Being prudent, engaging with foresight and saying we want out of the business, is that not demonstrating some level of prudence by putting it out there and seeing what perhaps private system would want to acquire it, with the thought that we don't want to be held accountable for challenges and problems in the future? Thought thinking about that, those possible dire situations that may occur in the future.
Speaker 2:Yeah, you know, dire situations occur and we've seen that kind of nationwide with some of the reports on operational failures of certain utilities in both municipal and investor owned. But ultimately who's to blame is obviously going to depend on who you ask. Of course, finger pointing always occurs in these kinds of instances. I think there's going to be a lot of folks to blame to go around. I think it will ultimately be determined by who is running the utility and that's going to be the entity that the public is more likely to quote blame for the operational failings.
Speaker 2:I think it doesn't matter if you tried to sell it or looked into selling it or the PUC denied it or what have you. Ultimately, if you were at the wheel, I think that that's the one holding the wheel, holding the keys. You're responsible. I don't care if you try to get out of it Now. I will say that you know, seeing how that's played out in certain communities probably is giving some other communities a lot to think about, in the sense that do they want to be in this business long term, knowing that you know when things go wrong it can be a big problem for you politically.
Speaker 1:Yeah, and we know that there are good utilities and bad utilities out there. It's not a discussion of one type is good and the other type is bad, and bad things happen to good people and they happen to good utilities. And so, thinking about how a local government wants to take action the voters have elected them. If they don't like these decisions, they can vote them out of office. But at some point could there be a reaction to a dire situation where back to my legislative question where municipal organizations right, you have a strong one there in Texas where they will go to the legislature and say look, we want to change fair market value legislation to make it easier for us, lower the hurdles for us to sell our systems if we want to do it and we voted out of office because we had a problem at the local water or wastewater utility we want to put it in the hands of somebody else and we don't want to have to jump through all these hurdles. Is that a scenario that you could see happening in the future?
Speaker 2:I think that just depends on you know the regulatory environment in the respective states how much harder it becomes to run and operate a utility not to kind of. You know switch topics, but you know the PFAS, regulatory issues and testing requirements may become so financially burdensome that municipalities are going to have to go to their legislatures and say we need to get out of this business. It is too expensive, and so I do think that that is definitely a possibility and I think you know. But again, it's going to be on a community by community basis. How does the community? Do they want to be in charge of their own? Do they feel like their leaders have the knowledge and wherewithal and financial and technical capability to take the utility into the future? Or do they feel like their resources are better spent elsewhere? Yeah, and how do they go about doing that?
Speaker 1:Yeah, you know one example that you raise how many wastewater treatment systems in the future have biosolids programs that have PFAS contaminated, biosolids that they've sold or given away? How many of those will become involved in superfund, enforcement actions or civil actions?
Speaker 2:Right, I have. Yeah, I mean again remains to be seen in those things it would be, you know, talking about the parade of horribles. You know, that's kind of looking backwards and some of those municipal-owned utilities are going to say, man, I wish I had divested a long time ago.
Speaker 1:Yeah, yeah, yeah. Well, cody, I want to thank you for being a guest today on the Water Foresight podcast. There is so much to discuss from this interesting and thoughtful case. There's more to watch on the world of fair market value, cody. How can folks get ahold of you if they want to discuss fair market value and other water-related issues?
Speaker 2:Sure, yeah, I'm a partner a utility partner in the law firm Spencer Fane here in Austin Texas, but we have offices nationwide. But, the easiest way to contact me is at my email at C for Cody Falk F-A-U-L-K at Spencer Fane F-A-N-E dot com and my team and myself are working the utility space, water or wastewater and electric issues and we're very well-versed in all of these kinds of issues at the state and federal level, so happy to answer any questions folks have.
Speaker 1:Thank you for listening to the Water Foresight podcast powered by the Aqualars Group. For more information, please visit us at aqualarscom or follow us on LinkedIn and Twitter.
