Case Title: In the Matter of National Fuel Gas Distribution Corporation v. Public Service Commission of the State of New York

Citation: 

Docket Number: 

State: new-york

Court: New York Appellate Court

Date: 2011-03-29T00:00:00Z

Document:
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This opinion is uncorrected and subject to revision before
publication in the New York Reports.
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No. 33  
In the Matter of National Fuel 
Gas Distribution Corporation,
            Respondent,
        v.
Public Service Commission of the 
State of New York,
            Appellant.
Jonathan D. Feinberg, for appellant. 
Neil L. Levine, for respondent.
GRAFFEO, J.:
In this appeal, we consider the legal standards that
apply when a utility company seeks permission from the Public
Service Commission (PSC) to recoup from ratepayers certain
environmental remediation costs it has incurred.  We hold that
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when the PSC reviews a management decision of a utility to assess
its prudence, the Department of Public Service (DPS) bears the
initial burden of showing that the utility may have acted
imprudently based on what was known at the time the challenged
decision was made.  Furthermore, there must be a rational basis
in the record evidence to support the grounds cited in a PSC
order for a finding of imprudence.
I
Petitioner National Fuel Gas Distribution Corp. (NFG
Distribution) is a natural gas delivery utility that operates in
western New York and is regulated by the PSC under article 4 of
the Public Service Law.  NFG Distribution is a subsidiary of the
National Fuel Gas Company (National Fuel) and has a number of
corporate affiliates.
In the 1990s, National Fuel (the parent company) began
pursuing insurance coverage for potential environmental cleanup
costs at its former manufactured natural gas plants.  National
Fuel had commissioned an environmental report (the "IES report"),
issued in 1996, which estimated that site investigation and
remediation (SIR) expenses at the former plants would be
approximately $300 million.  The IES report further attributed
64% of the potential SIR liabilities to NFG Distribution.  To
determine the extent of its insurance coverage for these
estimated remediation expenses, National Fuel filed notices of
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potential claims with its general liability insurance companies
and provided copies of the IES report to its insurers.  All of
the insurance carriers initially denied coverage.
Eventually, the insurers and National Fuel reached two
separate settlements in 1999, totaling approximately $37 million. 
All but one of the insurers settled with National Fuel for about
$16 million.  Additionally, Aegis Insurance agreed to issue a
replacement policy providing $20.8 million in future SIR
coverage.  Since the estimated SIR liability of just one of
National Fuel's subsidiaries (such as NFG Supply) could have
exceeded the total amount of the settlements, it was conceivable
at the time the parties entered into the agreements that one
environmental remediation claim by a single subsidiary could
exhaust the entire settlement fund to the detriment of the other
subsidiaries and their ratepayers.1  
National Fuel therefore decided to allocate the
proceeds of the settlements among its subsidiaries that had been
covered by the insurance policies through the use of a "premiums
paid" formula of allocation.  Under this approach, each
subsidiary received an amount from the settlements proportionate
1 In New York, utility rates are set by the PSC so that a
company may earn a reasonable return on its investment (see e.g.
Matter of Rochester Tel. Corp. v Public Serv. Commn. of State of
New York, 87 NY2d 17, 29 [1995]).  Normal operating costs that
are incurred by a utility are usually passed along in the rates
charged to the utility's customers.
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to its share of the insurance premiums paid and its contribution
to the costs incurred in obtaining the settlements.  As a result,
NFG Distribution received almost 46% of the settlement proceeds 
-- approximately $8.3 million (about 52% of the cash settlement)
and approximately $8.5 million in future coverage under the Aegis
policy (about 41% of the new SIR insurance).  A similar
percentage of the total recovery was allotted to two other
regulated National Fuel subsidiaries (NFG Supply and Pennsylvania
NFG Distribution).  The unregulated subsidiaries received
approximately 7% of the total settlement, but their share
apparently did not consist of cash proceeds, just future SIR
coverage under the Aegis policy.
Between 1998 and 2006, NFG Distribution incurred actual
SIR expenses of almost $27 million -- 85% of National Fuel's
aggregate environmental remediation costs during that period --
which depleted the company's proceeds of the monetary settlement
and its share of coverage under the Aegis policy.  As a result,
in 2007, NFG Distribution petitioned the PSC for tariff
amendments to increase its rates in order to pass its uninsured
SIR costs to its customer base.  At that time, NFG Distribution
was collecting $600,000 per year for SIR expenses from
ratepayers.  The tariff request sought to increase that amount to
$1.7 million.  
DPS challenged the requested increase, arguing that it
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had been unreasonable for National Fuel to use the premiums paid
methodology to allocate the settlements because the percentage of
premiums paid by each subsidiary bore no relation to the amount
of the settlement funds.  According to DPS, the settlements
should have been distributed to the subsidiaries based on the
actual SIR expenses incurred.  DPS requested that the PSC impute
approximately 85% of the total settlement to NFG Distribution,
thereby reducing the proposed tariff request accordingly.  NFG
Distribution countered that National Fuel chose the premiums paid
methodology in 1999 because the IES report provided only
preliminary estimates of potential SIR expenses as of 1996; that
not all of National Fuel's former manufactured natural gas sites
were included in the report; and it would have been too
speculative to attempt to determine the actual SIR costs that
each subsidiary would ultimately incur.  Consequently, NFG
Distribution urged that it was reasonable for its corporate
parent to utilize the premiums paid formula at the time the
settlements were disbursed in 1999.
The administrative law judge ruled in NFG
Distribution's favor, concluding that the premiums paid formula
was "not unreasonable on its face" since DPS had failed to
demonstrate that some other settlement distribution method would
have been reasonable at the time the corporate decision was
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made.2  The recommended decision determined that no additional
portion of the settlements beyond the 46% that NFG Distribution
actually received should be imputed to the company.  The ALJ
recommended that NFG Distribution be permitted to increase its
rates to collect $1.7 million annually for environmental
remediation expenses, the amount requested by NFG Distribution.
Exceptions were filed to the ALJ's decision and the
matter was brought before the PSC.  DPS continued to assert that
it was unreasonable for National Fuel to have employed the
premiums paid method and asked the PSC to impute 85% of the
settlements to NFG Distribution.  In the alternative, DPS argued
that the settlements should have been distributed to the
subsidiaries based on the percentage of SIR costs that were
attributable to them in the IES Report, which method would have
resulted in 64% of the settlement proceeds directed to NFG
Distribution.  During the evidentiary hearing, a DPS employee
testified that it had been unreasonable to allocate the
settlements based on premiums paid because the claims that were
presented to the insurance carriers were premised on costs
associated with specific sites and the amount of settlement
proceeds "was not related in anyway [sic] to the insurance
2 The settlement distribution issue was only one of many
issues that were before the administrative law judge.  Because
those other issues are not raised in this appeal, we do not
address them.
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premiums paid."  According to the DPS employee, the settlements
were "based on the estimated remediation costs, and presumably
other litigation factors, which had no relation to the amount of
insurance premiums paid."
The PSC concluded that National Fuel had acted
imprudently, finding that "the 46% allocation of the insurance
proceeds was unjust and unreasonable at the time it was made"
because National Fuel "should have taken into account the
estimates that were available at the time of the liabilities that
each subsidiary company was facing."  The PSC determined that the
proper allocation to NFG Distribution in 1999 should have been
64% of the settlements and ordered that the company be imputed
with an additional 18% of the settlements in developing the
proper rate structure.3
NFG Distribution then commenced this CPLR article 78
proceeding to contest the PSC's determination.  The case was
transferred to the Appellate Division, which annulled the PSC's
imputation of additional settlement proceeds to NFG Distribution
(71 AD3d 62 [3d Dept 2009]).  The court held that it was
reasonable for National Fuel to use the premiums paid formula in
1999, reasoning that the IES report contained only preliminary
3 As with the ALJ's decision, this was one component of the
PSC's determination, which addressed a host of other issues that
are not before us.
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estimates of SIR costs, it did not address every potential claim
of former manufactured gas sites and there was no evidence in the
record to demonstrate that the report was intended to reflect all
accurate SIR claims when it was drafted in 1996 or when the
settlements were allocated in 1999.  The Appellate Division also
observed that the premiums paid formula allowed National Fuel to
reasonably compute each subsidiary's share of the insurance
premiums and the methodology assured that each subsidiary and its
ratepayers would receive the benefit of the settlements in
proportion to what each subsidiary had paid for insurance
coverage.  Although the court agreed with the PSC that it would
have been a reasonable alternative for National Fuel to have
allocated the settlements in 1999 using the potential claims that
were listed in the IES Report, the Appellate Division determined
that the record did not support the PSC's finding that the
premiums paid formula was unreasonable.  The Appellate Division
therefore concluded that the PSC erred by imputing additional
settlement proceeds to NFG Distribution beyond the 46% that it
actually received.
We granted leave to appeal (14 NY3d 709 [2010]) and now
affirm.
II
Generally, a deferential standard of review applies to
PSC orders because establishing utility rates is a "highly
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technical" matter (Matter of Abrams v Public Serv. Commn. of
State of N.Y., 67 NY2d 205, 211-212 [1986]) and the PSC possesses
specialized knowledge and expertise in rate-setting matters (see
Matter of New York Tel. Co. v Public Serv. Commn. of State of
N.Y., 95 NY2d 40, 48 [2000]).  Judicial review is therefore
limited to determining whether record evidence provides a
rational basis for a PSC order (see Matter of Rochester Tel.
Corp., 87 NY2d at 28-29).
But it is also a bedrock principle of administrative
law that a "'court, in dealing with a determination . . . which
an administrative agency alone is authorized to make, must judge
the propriety of such action solely by the grounds invoked by the
agency'" (Matter of Scherbyn v Wayne-Finger Lakes Bd. of Coop.
Educ. Servs., 77 NY2d 753, 758 [1991], quoting Matter of Montauk
Improvement v Proccacino, 41 NY2d 913, 913 [1977]; see e.g.
Matter of Consolidated Edison Co. of N.Y. v Public Serv. Commn.,
63 NY2d 424, 441 [1984]).  If the reasons an agency relies on do
not reasonably support its determination, the administrative
order must be overturned and it cannot be affirmed on an
alternative ground that would have been adequate if cited by the
agency (see Matter of Scherbyn, 77 NY2d at 758).
Although both of these principles are relevant here,
this case is not the typical appeal of a PSC order.  In assessing
the requested tariff amendments to increase NFG Distribution's
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rates, the PSC first had to consider whether National Fuel's
settlement distribution formula was "prudent" when it was devised
in 1999 (see Matter of Crescent Estates Water Co. v Public Serv.
Commn. of State of N.Y., 77 NY2d 611, 617 [1991]).  A utility's
decision is prudent if it acted reasonably based on the
information that it had and the circumstances that existed at the
time (see Matter of Long Is. Light Co. v Public Serv. Commn. of
State of N.Y., 134 AD2d 135, 143-144 [3d Dept 1987]).  A decision
may be viewed as prudent even though a different course of action
would ultimately have been more advantageous to the utility or
its ratepayers.  In this regard, hindsight is irrelevant to a
prudence analysis because the utility must make a determination
that addresses its business prospectively.  Thus, if more than
one course of action was reasonable at the time of decision-
making, the utility may choose among them.  The PSC cannot
overturn a prudent decision by a utility because it believes that
another course of action would have been preferable.
The usual burdens of proof are also slightly different
in this case.  A utility company seeking a rate change has the
burden of proving that the requested regulatory action is "just
and reasonable" (Public Service Law § 66 [12] [i]; see id. § 72;
16 NYCRR 61.1; Matter of St. Lawrence Gas Co. v Public Serv.
Commn. of State of N.Y., 42 NY2d 461, 464 [1977]).  However, a
utility's decision to expend monetary resources is presumed to
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have been made in the exercise of reasonable managerial judgment
(see Matter of Long Is. Lighting Co., 134 AD2d at 144).  DPS
carries the initial burden of providing a rational basis to infer
that the utility may have acted imprudently before the burden
shifts to the utility to demonstrate that its decision was
prudent when made (see Matter of New York Tel. Co. v Public Serv.
Commn. of State of N.Y., 190 AD2d 217, 221 [3d Dept 1993]; Matter
of Long Is. Lighting Co., 134 AD2d at 144). 
Based on these principles, the issue before us distills
to whether DPS adequately raised a reasonable inference of
imprudence and, if so, whether there is a rational basis in the
record to support the grounds cited by the PSC for its conclusion
that National Fuel acted imprudently when it used the premiums
paid formula for the distribution of the settlement proceeds in
1999.
We conclude that DPS failed to meet its initial burden
of rebutting the presumption of prudence.  The only DPS employee
to testify -- a public utility accountant -- opined that the
premiums paid formula was unreasonable because the settlements
were not procured in relation to the amount of premiums paid.  In
our view, this testimony did not provide a rational basis to
infer that National Fuel acted imprudently or sought to maximize
future recovery from utility rates.  The record does not reveal
what factors prompted the insurers to settle, nor does it
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definitively exclude as a relevant factor the amount of premiums
collected from each subsidiary.  In deciding to settle, the
insurers may have factored in the total amount of premiums that
they had been paid in conjunction with their maximum financial
exposure, along with the likelihood that a court might have
concluded that the terms of the policies extended coverage to
environmental remediation costs.4  The DPS employee also did not
explain why the factors that led the insurers to settle should
have dictated National Fuel's allocation method.  In light of the
uncertainty of coverage under the policies and the lack of
definitive information pertaining to all potential SIR claims, we
view the testimony of the DPS employee as too conclusory to call
into question the prudence of National Fuel's allocation decision
or to shift the burden of proof to the utility.
We also note that the only ground cited by the PSC was
that the premiums paid methodology was unjust and unreasonable
because National Fuel could have used the IES report's estimate
4 At the time of the settlements, the coverage issue was an
open question of law.  After the settlements were reached, the
availability of SIR coverage under general liability insurance
policies was restricted in New York by our holding in
Consolidated Edison Co. of N.Y. v Allstate Ins. Co. (98 NY2d 208
[2002]), where we ruled that the insured bears the burden of
proving that environmental pollution was caused by a "fortuitous"
event.  National Fuel's decision to settle its claims, rather
than litigate, therefore provided its ratepayers with a benefit 
-- almost $37 million in SIR resources that otherwise might have
been unavailable.
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of SIR subsidiary liabilities.  But there are often multiple ways
to reasonably address an issue that arises in a business setting
and the fact that it may have been prudent for National Fuel to
use the estimated liabilities method did not, standing alone,
make the use of the premiums paid approach imprudent.5
In addition, the 1996 IES report supplied only
preliminary estimates of potential SIR liabilities and was
prepared as part of the effort to convince the various insurers
to settle and maximize National Fuel's recovery.  Simply put, its
purpose was to persuade the insurers to avoid litigation, not to
determine the extent of environmental contamination with
scientific certitude.  Nor does the record reveal that the IES
report addressed every potential SIR site and, for the sites that
were reviewed, the report was not designed to definitively assess
the costs of individual SIR claims.  Hence, the figures included
5 Our dissenting colleagues attempt to justify the PSC's
finding of imprudence on the alternative ground that the amount
of premiums paid were irrelevant because the insurance provided
general liability, rather than environmental, coverage (see
dissenting op at 5).  Because the PSC did not rely on this
distinction, the order cannot be upheld on this basis (see Matter
of Scherbyn, 77 NY2d at 758).  Thus, the dissent overlooks the
fundamental principle of administrative law that the propriety of
an agency's action is judged solely by the grounds that were
invoked by it (see e.g. Matter of Consolidated Edison Co. of N.Y.
v Public Serv. Commn., 63 NY2d at 441).  In any event, we
question the dissent's underlying premise that the premiums paid
were "completely unrelated" to the settlement proceeds
(dissenting op at 5) since the premiums were used to secure
coverage that ultimately funded the settlements.
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in the IES report were estimations, whereas each subsidiary's
share of the premium payments could be accurately tallied.  As a
result, the IES report was not the sole rational means for
reasonably allocating the proceeds of the settlements.
In sum, there was no evidentiary foundation to infer
that National Fuel may have acted imprudently in 1999 when it
decided to use the premiums paid formula.  We therefore conclude
that the PSC's finding of imprudence was erroneous as a matter of
law.
Accordingly, the judgment of the Appellate Division
should be affirmed, with costs.
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Matter of National Fuel Gas Distribution Corporation v Public
Service Commission of the State of New York
No. 33 
LIPPMAN, Chief Judge (dissenting):
The Public Service Commission (PSC) found that National
Fuel's allocation of the insurance settlement proceeds based on
the premiums paid by each of its subsidiaries "was unjust and
unreasonable at the time it was made" and that the proceeds
should have been apportioned, instead, based upon the potential
liabilities each subsidiary faced for certain environmental
remediation expenses.  Since there is substantial evidence to
support the PSC's conclusion, I would reverse.
Among the general powers accorded to the PSC by statute
is the authority to evaluate proposed utility rate changes and to
set just and reasonable rates (see Public Service Law §§ 66
[12][f]; 72).  "Indeed, it has been recognized that when it comes
to setting rates for [gas and electric] service the Commission
has been granted 'the very broadest of powers,' the Legislature
mandating only that the rates fixed be 'just and reasonable'"
(Matter of Niagara Mohawk Power Corp. v Public Serv. Commn. of
State of N.Y., 69 NY2d 365, 369 [1987] [citations omitted]).  The
burden of proving that any proposed rate change is just and
reasonable rests with the utility (see Public Service Law § 66
[12][i]).
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Our review of PSC determinations involving rate-setting
has always been deferential.  We have emphasized that the
standard of review is meant to be flexible and that the
determinations "'may not be set aside unless they are without 
rational basis or without reasonable support in the record'"
(Matter of New York Tel. Co. v Public Serv. Commn. of State of
N.Y., 95 NY2d 40, 48 [2000]), quoting Matter of Rochester Tel.
Corp. v Public Serv. Commn. of State of N.Y., 87 NY2d 17, 29
[1995]).  It is well settled that "substantial evidence consists
of proof within the whole record of such quality and quantity as
to generate conviction in and persuade a detached fact finder
that, from that proof as a premise, a conclusion or ultimate fact
may be extracted reasonably -- probatively and logically" (300
Gramatan Ave. Assoc. v State Div. of Human Rights, 45 NY2d 176,
181 [1978]).  Such deference is appropriate since rate-setting
"presents 'problems of a highly technical nature,'" which are
well within the particular expertise of the PSC (see New York
Tel. Co., 95 NY2d at 48, quoting Matter of Abrams v Public Serv.
Commn. of State of N.Y., 67 NY2d 205, 211-212 [1986]).
The determination of whether a utility acted prudently
is made by assessing whether its actions were reasonable under
the circumstances existing at the time they were made, without
the benefit of hindsight (see Matter of Long Is. Light Co. v
Public Serv. Commn. of State of N.Y., 134 AD2d 135, 143-144 [3d
Dept 1987]).  Significantly, "the PSC's broad ratemaking powers 
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. . . are sufficient to allow it generally to assess the prudence
of a utility's actions as those actions impact upon the
ratepayers.  Indeed, a specific function of the rate-making power
is to protect the utility's ratepayers" (Matter of Crescent
Estates Water Co. v Public Serv. Commn. of State of N.Y., 77 NY2d
611, 617 [1991]).  Through this power, the Commission ensures
that unreasonable or excessive rates are not inflicted upon the
utility's customers (see e.g. Matter of General Tel. Co. of
Upstate N.Y. v Lundy, 17 NY2d 373, 381 n 3 [1966]).
Even assuming that our traditional deference to the PSC
is skewed toward the utility for the purpose of prudence
determinations (see majority op. at 9-10), the PSC has provided a
rational basis for its determination that National Fuel acted
imprudently.
The PSC order notes that, at the time the insurance
proceeds were distributed, National Fuel was aware of the
projected liability for environmental remediation faced by its
subsidiaries, including that NFG Distribution's potential
liability accounted for 64% of the total estimated liability. 
Instead, only 46% of the proceeds were allocated to NFG
Distribution based on its proportionate share of the premiums
paid for the subject general liability insurance policies.  By
use of this allocation method, a portion of the settlement
proceeds was distributed to National Fuel's non-regulated
affiliated companies.  The PSC concluded that National Fuel
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should have taken into account the available estimates of
potential environmental liability for each subsidiary that were
available at the time the proceeds were allocated and that the
appropriate distribution should have been made in proportion to
that prospective liability.  The PSC therefore determined that
the 46% allocation to NFG Company was "unjust and unreasonable."
A review of the record as a whole provides ample basis
for the PSC's conclusion.  The PSC's expert testified that the
allocation of proceeds on the basis of insurance premiums paid
was "not accurate and [made] no sense."  He concluded that the
settlements were reached on the basis of projected environmental
liabilities and "had no relation to the amount of insurance
premiums paid."  PSC's expert relied, in part, on the answers to
interrogatories that were provided by National Fuel.  It was
clear from this evidence that National Fuel sought coverage for
its environmental liabilities under its general liability
insurance policies.  After those carriers initially denied the
claims, National Fuel retained environmental consultants to
estimate the potential environmental site investigation and
remediation costs.  The attorney who represented National Fuel in
the settlement negotiations submitted an affidavit, affirming
that the environmental report was prepared "explicitly for
insurance settlement negotiation purposes only, in order to
identify actual and potential environmental risks" and that
counsel used the report "to present settlement demands" to the
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insurance companies.  Although the insurers asserted that the
policies did not apply to environmental liability, they
ultimately settled.
The evidence in the record therefore establishes that
the insurance proceeds were pursued and obtained for the specific
purpose of dealing with potential environmental liability.  Given
that the policies at issue were general, and not environmental,
liability policies, the proportion of premiums paid by the
various entities was completely unrelated to the settlement
proceeds.  The IES report was at least related to the subject of
the settlement -- environmental liability.  The methodology the
majority embraces as beyond the reach of the PSC has no
demonstrated relationship to that issue, the settlement
negotiations or the settlement proceeds.  We simply are not
confronted with a choice of two prudent methodologies.
The idea of dividing insurance proceeds among insureds
in proportion to premiums is strange at best.  The reason for
buying insurance is to protect against unforeseen losses, not to
get a return on premiums paid.  The "premiums paid" methodology,
as applied in this case, gives "protection" against environmental
liabilities to companies that suffered no environmental loss,
including some that may never have had any environmental risk. 
If a utility had negotiated such an allocation at arm's length
with independent co-insureds, the agreement would raise a serious
question of prudence.  Here, where the allocation of insurance
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proceeds was among affiliated companies, whose management had an
obvious interest in maximizing the burden on the ratepayers in
order to minimize cost to the shareholders, the PSC was all the
more justified in looking at that allocation with a skeptical
eye. 
 
In these circumstances, the PSC clearly had a rational
basis to conclude that the allocation of proceeds to its
subsidiaries based on premiums paid was imprudent.  There is
substantial evidence to support the PSC's determination and
therefore the Appellate Division judgment should be reversed.
*   *   *   *   *   *   *   *   *   *   *   *   *   *   *   *   *
Judgment affirmed, with costs. Opinion by Judge Graffeo. Judges
Ciparick, Read and Jones concur. Chief Judge Lippman dissents and
votes to reverse in an opinion in which Judges Smith and Pigott
concur. 
Decided March 29, 2011
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