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Justia › US Law › US Case Law › US Supreme Court › Volume 292 › Lindheimer v. Illinois Bell Telephone Co.
Lindheimer v. Illinois Bell Telephone Co.
1. Findings of a District Court, purporting to show the value of the property of a telephone company in its intrastate business, its net income therefrom, and the fair rate of return for each of a long series of years during which the State sought to impose a decrease of rates cannot be accepted as a basis for deciding whether the decrease would result in confiscation when, tested by the same findings, the existing rates, clearly adequate and under which the company operated with outstanding success throughout the same period and before, were themselves grossly inadequate. P. 292 U. S. 160.
2. Elaborate calculations which are at war with realities revealed by the financial history of the business are of no avail in determining the adequacy of rates prescribed for a public utility corporation. P. 292 U. S. 164.
3. To sustain its attack on a decrease of its rates as contrary to due process, a public utility must establish clearly and definitely that the decrease will bring about confiscation. P. 292 U. S. 164.
4. Charges to operating expenses may be as important as valuations of its property in determining the adequacy of a public utility's rate. P. 292 U. S. 164.
5. In determining reasonable rates for supplying public service, it is proper to include in the operating expenses -- that is, in the cost of producing the service -- an allowance for consumption of capital in order to maintain the integrity of the investment in the service rendered. P. 292 U. S. 167.
6. Broadly speaking, the term depreciation, as applied to the property of a public utility company, means the loss, not restored by current maintenance, which is due to all the factors causing the ultimate retirement of the property, these factors include wear and tear, decay, inadequacy and obsolescence. Annual depreciation is the loss which takes place in a year. P. 292 U. S. 167.
7. While depreciation is defined as the expense occasioned by the using up of physical property employed as fixed capital, and current maintenance as the expense occasioned in keeping the physical property in the condition required for continued use during its service life, it is evident that the distinction is a difficult one to observe in practice with scientific precision, and that outlays charged to current expenses may involve many substitutions of new for old parts which tend to keep down the accrued depreciation. P. 292 U. S. 173.
8. Where the amounts which a telephone company annually charges to operating expenses for depreciation and invests in plant and equipment are excessive, the telephone subscribers are, to the extent of such excess, required to provide capital contributions, not to make good losses incurred by the company in the service rendered and thus keep its investment unimpaired, but to secure additional plant and equipment upon which the company expects a return. P. 292 U. S. 169.
9. Confiscation being the issue in this case, the telephone company has the burden of making a convincing showing that the amounts it has charged for depreciation to operating expenses have not been excessive, and that burden is not sustained by proof that its general accounting system has been correct, since, though the calculations are mathematical, the underlying predictions of life of plant and salvage are essentially matters of opinion, involving many perplexing problems and the examination of many variable elements, in which opportunities for excessive allowances for depreciation, even under a correct system of accounting, are always present; the predictions must be checked by, and meet the test of, experience. P. 292 U. S. 169.
10. Giving full weight to the proposition that a reserve for depreciation built up by a telephone company according to the "straight line" method does not represent in any given year the amount of actual depreciation at that time, especially in a rapidly growing plant, such considerations fail to explain the great excess of depreciation reserve over actual depreciation in each of the many years involved in this case. P. 292 U. S. 171.
That the company has not established that the reserve merely represents consumption of capital in the service rendered; rather, it appears that the depreciation reserve to a large extent represents provision for capital additions, over and above the amount required to cover capital consumption, and the questionable amounts so annually charged to operating expenses for depreciation are large enough to destroy any basis for holding that it has been convincingly shown that the reduction in income through the rates in suit would produce confiscation. P. 292 U. S. 174.
12. Where a public utility has had abundant opportunity to prove that a rate is confiscatory, but adduces only elaborate estimates and computations which fail of their intended effect and do not justify the decree of the court below in its favor, it is not the function of this Court to construct independent calculations out of a voluminous record to invalidate the rate, but the decree should be reversed with directions to dissolve the interlocutory injunction, provide for refunding under the injunction bonds of amounts charged pendente lite in excess of the rate in question, and to dismiss the bill. P. 292 U. S. 175.
13. A party has no right to appeal from a decree in his favor to procure a review of the findings. P. 292 U. S. 176.
Appeal and cross-appeal from a decree permanently enjoining the Illinois Commerce Commission from enforcing a reduction of the rates of the Telephone Company for intrastate service in the City of Chicago. The decree below also released the company from obligation to refund moneys collected by it during the suit. For other phases of this protracted litigation, see 269 U.S. 531; 282 U. S. 282 U.S. 133; 283 U.S. 794; 283 U.S. 808.
new findings and entered a final decree which permanently restrained the enforcement of the Commission's order and released the company from obligation to refund the moneys which had been collected pending the suit. Illinois Bell Tel. Co. v. Gilbert, 3 F.Supp. 595. The state authorities and the city bring this direct appeal. Jud.Code § 266. The company brings a cross-appeal to review the findings below, insisting that its property has been undervalued and that substantial amounts of its operating expenses have been disallowed.
with appellee, and its profits on sales, had been fair and reasonable, with the exception of an advance in prices of 10.2 percent effective on November 1, 1930. That advance the court disapproved, and, in determining the reasonable outlays to be allowed to appellee after that date, the court made a reduction of 10 percent from the prices charged by the Western Electric Company. [Footnote 4] Appellee contests this reduction, and appellants object to the amounts allowed.
The District Court made specific findings as to the character of the services rendered by the American Company under its license contracts with appellee and the amounts of the cost of these services which should be allocated to the operating expenses of the latter's intrastate business. In the years 1923 to 1928, inclusive, when the court found that the payments under the license contracts charged on appellee's books exceeded the cost as thus determined and allocated, only the cost was held to be chargeable to operating expenses, but in the years 1929 to 1931, inclusive, when the license payments as so charged were less than the cost, only the amount of the license payments was allowed as an operating expense. [Footnote 5] Appellants raise many questions in opposition to these determinations of costs and allocations, while appellee contends that the costs as found were less than the true costs and that the full amounts paid under the license contracts should have been allowed.
The evidence with respect to the value of appellee's property employed in its intrastate business at Chicago is voluminous. The evidence shows the original or book cost of this property, the market value of land, and estimates of the cost of reproduction new of the other physical property constituting appellee's telephone plant. There was also evidence of the condition of the property, together with estimates of accrued depreciation. Appellants submitted no valuations since one made by the Commission in 1923, [Footnote 6] but presented detailed criticisms of appellee's estimates. The District Court found that the method adopted by appellee's witness in ascertaining the cost of reproduction new was reliable, and that appellee's estimates were substantially correct. The court encountered difficulties in making its valuations for the years 1931 and 1932. It took notice of the general fall in values which had accompanied the depression in business. And, for that reason, the court fixed values for 1931 and 1932 which. in its opinion. "gave due consideration to the element of the present decline." The court found that the fair rate of depreciation to be applied to reproduction cost new was 16 percent for the years 1923 to 1928, inclusive, and 15 percent for the succeeding years, and that the amount to be added to reproduction cost new on account of going value was 8 percent of that cost. The court also made findings as to the appellee's working cash capital, the amounts invested in materials and supplies and in property in course of construction, and, as to these three items, there is no controversy.
Appellants contend that the findings as to fair value are excessive. Appellee insists that they are too low. In particular, appellee says that the property was undervalued through excessive deductions for existing depreciation. Appellee maintains that the evidence shows a maximum depreciation of 9 percent for the years 1923 to 1928, and of 8 percent thereafter, instead of the 16 percent and 15 percent deducted by the court.
would have thereby been reduced to the extent of $1,541,668 for 1923, and by somewhat greater amounts in later years except in 1931 and 1932. As thus estimated, the net revenue available for return from the intrastate business in Chicago under the rates in suit would have been as follows: 1923, $5,104,515; 1924, $5,932,959; 1925, $6,297,890; 1926, $6,402,128; 1927, $6,686,503; 1928, $6,914,459; 1929, $8,939,602; 1930, $8,492,385; 1931, $8,392,555; 1932, $6,750,000.
The court found that the fair rate of return on the average fair value of the intrastate property was 7 1/2 percent for each of the years 1923 to 1927, inclusive, 7 percent for each of the years 1928, 1929, and 1930, 6 1/2 percent for 1931, and 5 1/2 percent for 1932. On the basis of these findings of fact, the court concluded that the rates in suit were confiscatory at all times from the date of the Commission's order.
On this showing, the findings, if accepted, would compel the conclusion that, when the Commission's order was made in 1923, not only the new rates, but the existing rates as well, were grossly confiscatory; that appellee was receiving under the existing rates, according to its books, a net return of $5,347,533 when it was entitled to nearly $4,000,000 more, or $9,315,000, to prevent its property from being confiscated. The table shows a similar situation in the succeeding years. Again, the inference would be irresistible that the existing rates were confiscatory when they were prescribed by the Public Utilities Commission of Illinois (the predecessor of the present Commission) in December, 1920, to be effective January 1, 1921. In the comprehensive disclosure of appellee's financial condition, there is nothing to permit an inference of any radical change which would have made rates, compensatory in 1921, confiscatory in 1923.
of Illinois, entered on the 20th day of December, 1920, and now in full force and effect, are just and reasonable, and that the burden of proof is upon whomsoever avers, or seeks to show, that said rates and charges are unjust or unreasonable."
And, when this suit was brought in September, 1923, to prevent the enforcement of the new rates, appellee did not seek to enjoin the existing rates.
60 percent of the entire investment of appellee in the state. The book cost of the plant in service and general equipment in intrastate business in Chicago increased from $95,582,266 at the end of 1923 to $174,160,314 at the end of 1930, and to $177,384,652 at the end of 1931. [Footnote 10] "The gross additions" to the company's property in the Chicago area, the company states, "were spread fairly evenly over the period."
"The business expanded with great rapidity. The number of telephones in Chicago increased from 690,000 at the end of 1923 to 940,000 at the end of 1931, and was 987,000 at the peak in 1929."
During the nine years, "a greater amount of plant was added new to the property than was in service at the beginning of the term." The company informs us that the property was kept "at a high and even standard of maintenance throughout the years involved," and "was at all times capable of giving adequate telephone service abreast of the art." The property has been efficiently and economically operated, and the company has enjoyed excellent credit.
success. Elaborate calculations which are at war with realities are of no avail. The glaring incongruity between the effect of the findings below as to the amounts of return that must be available in order to avoid confiscation and the actual results of the company's business makes it impossible to accept those findings as a basis of decision.
2. The Effect of the Reduction through the Rates in Suit. The foregoing considerations limit our inquiry. It is not necessary to traverse the wide field of controversy to which we are invited and to review the host of contested points presented by counsel. In the view that the existing rates cannot be regarded as inadequate, the question is simply as to the effect of the reduction in net income by the rates in suit. The question is whether the company has established, with the clarity and definiteness befitting the cause, that this reduction would bring about confiscation. Los Angeles Gas & Electric Co. v. Railroad Comm'n, 289 U. S. 287, 289 U. S. 304-305. The amounts of the reduction for the respective years are not in dispute. [Footnote 11] It would have been $1,541,668 for 1923, would have been greatest at $1,740,000 for 1929, and least at $1,270,000 for 1932.
against the reductions which the rates in suit would have effected are the considerable sums which would be added to the amounts available for return by the adjustments in operating expenses made by the District Court. [Footnote 12] These adjustments embraced overpayments found to have been made by the Illinois Company in its transactions with the American Telegraph & Telephone Company and the Western Electric Company. In 1923, the overpayment to the former company, treating its outlay or the cost of its service to its subsidiary as the measure of the operating expense, was found to be $573,819; the average of the annual overpayments, as found for the years 1923 to 1927, inclusive, amounted to $545,443. [Footnote 13] It should be noted that, on the same basis of adjustment, there would have been an increase (averaging $256,036) in operating expenses for the years 1929 to 1931, when the cost of the service exceeded the license payments. [Footnote 14] The court below found overpayments to the Western Electric Company of $332,470 in 1931 and 1932, respectively. [Footnote 15] There are numerous contentions presented by each of the parties in relation to these adjustments -- by appellants, to decrease, and by appellee, to increase, the amounts of expense allowed -- but we shall not undertake to pass upon them in view of the determinative nature, for the present purpose, of the remaining question as to the sums which the company has annually charged to operating expenses for depreciation.
by the Interstate Commerce Commission. 177 I.C.C. pp. 408, 413. By this method, the annual depreciation charge is obtained by dividing the estimated service value by the number of years of estimated service life. The method is designed to spread evenly over the service life of the property the loss which is realized when the property is ultimately retired from service. According to the principle of this accounting practice, the loss is computed upon the actual cost of the property as entered upon the books, less the expected salvage, and the amount charged each year is one year's pro rata share of the total amount. [Footnote 21] Because of the many different classes of plant, some with long and some with short lives, some having large salvage and others little salvage or no salvage, and because of the large number of units of a class, the company employs averages -- that is, average service life, average salvage of poles, of telephones, etc.
precisely fulfilled, the depreciation reserve would represent the consumption of capital, on a cost basis, according to the method which spreads that loss over the respective service periods. But if the amounts charged to operating expenses and credited to the account for depreciation reserve are excessive, to that extent, subscribers for the telephone service are required to provide, in effect, capital contributions, not to make good losses incurred by the utility in the service rendered, and thus to keep its investment unimpaired, but to secure additional plant and equipment upon which the utility expects a return.
for excessive allowances, even under a correct system of accounting, the always present. The necessity of checking the results is not questioned. The predictions must meet the controlling test of experience.
"there are new plant groups in operation on which depreciation is accruing but which are not yet represented, or are but slightly represented, in the retirement losses."
Where, as in this instance, there has been a rapid growth, retirements at one point of time will relate for the most part to the smaller preceding plant, while the depreciation reserve account is currently building up to meet the "increased eventual retirement liability" of the enlarged plant.
"The reserve balance and the actual depreciation at any time can be compared only after examining the property to ascertain its condition; the depreciation, physical and functional, thus found can be measured in dollars, and the amount compared with the reserve."
"Condition new was assumed to be free from defects or impairment of any kind, that is, perfect or 100% condition, and the thing as it stood in actual use in the plant was compared with the same thing new. . . . All existing depreciation, both physical and functional, was reduced to a percentage, and subtracted from 100 percent."
"was not functionally deficient in any practical sense. This is not to say that parts of the plant did not from time to time become inadequate or obsolete, but that the Company continuously anticipates and forestalls inadequacy and obsolescence. Before a thing becomes inadequate or obsolete, it is removed from the plant."
points out that the Commission found, in its order of 1923, that the property was then "in at least 90 percent condition." "The weighted total or overall condition," the company shows, "is 91 percent for the years 1923-1928 and 92 percent for subsequent years."
annual allowances for depreciation charged to operating expenses.
"in an amount equal to 3 1/2 percent upon the difference between the depreciation reserve and the amount deducted from the valuation for existing depreciation."
The case has long been pending, and should be brought to an end. The company has had abundant opportunity to establish its contentions. In seeking to do so, the company has submitted elaborate estimates and computations, but these have overshot the mark. Proving too much, they fail of the intended effect. It is not the function of the court to attempt to construct out of this voluminous record independent calculations to invalidate the challenged rates. It is enough that the rates have been established by competent authority, and that their invalidity has not been satisfactorily proved.
provide for the refunding, in accordance with the terms of that injunction and of the bonds given pursuant thereto, of the amounts charged by the company in excess of the rates in suit, and to dismiss the bill of complaint.
No. 548. -- The Appeal of the Company. The company was successful in the District Court, and has no right of appeal from the decree in its favor. The company is not entitled to prosecute such an appeal for the purpose of procuring a review of the findings of the court below with respect to the value of the company's property or the other findings of which it complains. Its contentions in these respects have been considered in connection with the appeal of the state authorities and the city. The appeal of the Company is dismissed. New York Telephone Co. v. Maltbie, 291 U.S. 645.
* Together with No. 548, Illinois Bell Telephone Co. v. Lindheimer et al.
The order reduced rates for four classes of coin box service. Otherwise it kept in force the rates which were fixed by an order of December 20, 1920. The coin boxes are in private residences and places of business, and are not public pay stations.
The amounts of net revenue thus involved which appellants contend should not have been allocated (under the rates in suit) to the interstate service for the respective years are as follows:1923, $245,042; 1924, $262,398; 1925, $309,505; 1926, $317,915; 1927, $354,372; 1928, $427,655; 1929, $486,875; 1930, $472,469; 1931, $431,580.
The amounts of the license payments thus disallowed by the court, as being in excess of the cost of the service, for the years 1923 to 1928, inclusive, are as follows: 1923, $573,819; 1924, $631,549; 1925, $531,233; 1926, $432,704; 1927, $558,011; 1928, $31,553. The amounts by which the cost to the American Company exceeded the license payments, for the years 1929 to 1931, are as follows:1929, $206,253; 1930, $327,751; 1931, $234, 104.
See Smith v. Illinois Bell Tel. Co., 38 F.2d, 77, 86; 282 U. S. 282 U.S. 144, 282 U. S. 145.
Column (1) gives the net intrastate income in Chicago as shown by the company from its books; column (2) the amount as adjusted by the District Court, and column (3) the amount required by the court's findings.
The "fixed capital reserves" are the depreciation reserve and the reserve for amortization of intangible capital. The latter reserve ranged from $182,041.50, in the year 1923 to $274,086.36 in 1930, and to $289,018.77 in 1931.
This is according to the company's "Plant and General Equipment Accounts for the Chicago and State Areas."
The book cost of the "Plant in Service and General Equipment" for the Chicago area, including both interstate and intrastate business, rose from $100,040,051 at the end of 1923 to $191,286,165 at the end of 1930 and to $195,422,113 at the end of 1931.
See comparison of the amounts of net return as shown by the company with the amounts as adjusted by the District Court, in table, supra, p. 292 U. S. 161.
Smith v. Illinois Bell Tel. Co., 38 F.2d 77, 86, 87.
"is the loss in service value not restored by current maintenance and incurred in connection with the consumption or prospective retirement of property in the course of service from causes against which the carrier is not protected by insurance, which are known to be in current operation, and whose effect can be forecast with a reasonable approach to accuracy."
See Knoxville v. Knoxville Water Co., 212 U. S. 1, 212 U. S. 13-14; Kansas City Southern Ry. Co. v. United States, 231 U. S. 423, 231 U. S. 448; Denver v. Denver Union Water Co., 246 U. S. 178, 246 U. S. 191; Southwestern Bell Telephone Co. v. Public Service Comm'n, 262 U. S. 276, 278 [argument of counsel -- omitted]; Georgia Railway & Power Co. v. Railroad Comm'n, 262 U. S. 625, 262 U. S. 633; United Railways & Electric Co. v. West, 280 U. S. 234, 280 U. S. 253, 280 U. S. 260; Smith v. Illinois Bell Telephone Co., 282 U. S. 133, 282 U. S. 158; Clark's Ferry Bridge Co. v. Public Service Comm'n, 291 U. S. 227.
"The proper interpretation of the data regarding plant life and salvage obtainable from accounts, records, and statistics is of equal importance with the integrity of the data themselves. It would seem that we should have first: investigations of past service life and salvage through sound accounting and statistical methods; second: investigations of the conditions surrounding the employment of such plant in the past and of the extent to which such conditions still prevail; third: the best possible forecast of conditions looming in the future which should exert a modifying influence upon either life or salvage. And then, the active judgment which fuses the experience of the past, so far as it is still pertinent, and the expectation for the future, so far as it is presently pertinent, into a just and reasonable determination of the current rate of depreciation for the time being."
"the percentage of depreciation in the various classes of plant did not vary materially during the period, with the exception of three classes -- namely, central office equipment, private branch exchanges and booths and special fittings. In the case of central office equipment, there were large installations of new equipment in 1929 which had the effect of raising the percent condition for the entire class from 92 percent for prior years to 93 percent for 1929 and subsequent years. In the case of private branch exchanges, the percentage condition improved gradually from 88 percent in 1923 to 94 percent in 1930 due to the large proportion of new installations and correspondingly large retirements of the old. In the case of booths and special fittings, the percentage condition gradually improved from 78 percent in 1923 to 85 percent at the end of the period, in this case also because of abnormally large changes of booths at pay stations. These are the changes which, in the main, account for the fact that the overall condition of the plant rose from 91 percent for the years 1923-1928 to 92 percent thereafter."
See supra, p. 292 U. S. 167.
The evidence does not show that the amounts taken by the company from revenue and charged to the depreciation reserve were required for the maintenance of the property, or that the amounts allowed by the lower court for that purpose were needed. The ruling in condemnation of the charges to the depreciation reserve is so important that, even at the risk of duplication, emphasis should be laid upon some facts and reasons that may be cited in its support.
company's handling of the depreciation reserve account.
in 1922. The amounts attributable to the intrastate property alone show an average annual increase of more than $2,300,000. That amount is greatly in excess of the reduction of revenue that would have resulted if the rate order had been enforced.
The actual annual expenditures to keep the plant in proper condition for service are made up of the amounts included in current maintenance and those taken from the depreciation reserve. The table next below is illustrative and is intended to show by years in column (1) that total, in column( 2) the revenue, in (3) the percentage that the former is of the latter.
serves to test the claim that the depreciation reserve is needed in order to equalize annual cost of upkeep in relation to revenue. If the period covered is typical, the last statement strongly suggests that no reserve account is necessary for that purpose. And that impression is confirmed by a similar comparison of the percentages in table IV. It shows the relation of current maintenance plus depreciation reserve charges to revenue. Comparing the percentage in each year (during the period covered by table V) with the percentage in each of the other years, the lowest is 31.5 % (1924), the highest is 39.5 (1931).
From the foregoing it justly may be inferred that charges made according to the principle followed by the company create reserves much in excess of what is needed for maintenance. The balances carried by the company include large amounts that never can be used for the purposes for which the reserve was created. In the long run, the amounts thus unnecessarily taken from revenue will reach about one-half the total cost of all depreciable parts of the plant. The only legitimate purpose of the reserve is to equalize expenditures for maintenance so as to take from the revenue earned in each year its fair share of the burden. To the extent that the annual charges include amounts that will not be required for that purpose, the account misrepresents the cost of the service.
additions to operating expenses. In the absence of proof definitely establishing what annual deductions from revenues were necessary for adequate maintenance of the property, the company is not entitled to have the rate order set aside as confiscatory.
This is not in harmony with the principle of our decision in United Railways & Electric Co. v. West, 280 U. S. 234, 280 U. S. 253-254, which requires replacement cost to be taken as the basis of calculation.
The following is § 23, Uniform System of Accounts for Telephone Companies, promulgated by the Interstate Commerce Commission, effective January 1, 1913. It will serve to disclose the underlying principle on which the reserve charges are made.
"Depreciation of Plant and Equipment. -- Telephone companies should include in operating expenses depreciation charges for the purpose of creating proper and adequate reserves to cover the expenses of depreciation currently accruing in the tangible fixed capital. By expense of depreciation is meant --"
"(a) The losses suffered through the current lessening in value of tangible property from wear and tear (not covered by current repairs)."
"(b) Obsolescence or inadequacy resulting from age, physical change, or supersession by reason of new inventions and discoveries, changes in popular demand, or public requirements, and"
"(c) Losses suffered through destruction of property by extraordinary casualties."
"The amount charged as expense of depreciation should be based upon rules determined by the accounting company. Such rules may be derived from a consideration of the company's history and experience. Companies should be prepared to furnish the Commission, upon demand, the rules and a sworn statement of the facts, expert opinions, and estimates upon which they are based."
"The estimate for depreciation of physical property should take into account --"
"(a) The gradual deterioration and ultimate retirement of units of property which may be satisfactorily individualized, such as buildings, machines, valuable instruments, etc., to the end that, by the time such units of property go out of service, there shall have been accumulated a reserve equal to the original money cost of such property plus expenses incident to retirement less the value of any salvage."
"(b) The depreciation accruing in property which cannot be readily individualized, such as pole lines, wires, cables, or other continuous structures, where expenditures for repairs or replacements of individual parts ordinarily are not actually made until the later years of the life in service of such property, and, when made, may therefore be classed as extraordinary repairs."
"The rate of depreciation should be fixed so as to distribute, as nearly as may be, evenly throughout the life of the depreciating property the burden of repairs and the cost of capital consumed in operations during a given month or year, and should be based upon the average life of the units comprised in the respective classes of property. . . ."

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