Source: https://supreme.justia.com/cases/federal/us/258/388/
Timestamp: 2019-04-19 02:22:49+00:00

Document:
1. The fact that a public utility, such as a street railway, may reach financial success only in time, or not at all, is a reason for allowing a liberal return on the money invested in the enterprise, but it does not make past losses an element to be considered in deciding what the base value is and whether a rate fixed is confiscatory. P. 258 U. S. 395.
2. A so-called "going concern value and development cost" based on calculations, for various periods, of past deficiencies of net income, allowing 4 percent for annual depreciation and 8 percent compound interest on the value of the property used as a fair return, should not be included in the base value of appellant's street railway in determining whether an existing rate is confiscatory. P. 258 U. S. 395.
3. Neither should an allowance for hypothetical brokerage fees based on a percentage customarily obtained by bankers for financing such enterprises. P. 258 U. S. 397.
4. In determining the sufficiency of such rates, the amount normally required for maintenance, not necessarily the amount expended, annually, should be allowed, and many items included in overhead cost of original construction may be excluded in calculating depreciation annuity. P. 258 U. S. 398.
5. Appellant's request that prospective cost of maintenance deferred during the war at the wish of the government be allowed from earnings of future years in testing the rate was an attempt to capitalize past losses, and rightly refused. P. 258 U. S. 399.
6. In calculating whether a rate fixed will yield an adequate return, income taxes which would be payable if a fair return were earned are appropriate deductions from gross revenue. P. 258 U. S. 399.
7. But, where the federal corporate income tax (Act of February 24, 1919, c. 18, §§ 230-238, 40 Stat. 1057, 1075-1080) is thus deducted, the exemption of the stockholder from the "normal" tax on dividends received from the corporation must be taken into consideration in determining what rate of return to the corporation shall be deemed fair. P. 258 U. S. 399.
8. An ordinance rate inadequate when adopted will be valid when, through change of conditions, it yield a fair return. P. 258 U. S. 400.
9. The Court knows judicially that price, in general, and current rate of return on capital have declined since the conclusion of the war, but not the extent to which the economic changes occurring have affected the gross revenues or the net return of the appellant company . P. 258 U. S. 402.
10. A decree of the district court dismissing without prejudice the bill of a street railway company to restrain enforcement of an ordinance rate as confiscatory affirmed where an operation test of more than a year and a half was inconclusive because of abnormal economic conditions then existing, and where the lower court's view of the probable future adequacy of the rate was necessarily based largely on prophecy, and was free from substantial error as to the elements to be considered, and where the actual facts were substantially undisputed and the evidence did not compel a contrary conviction. P. 258 U. S. 401.
Appeal from a decree of the district court dismissing without prejudice a bill brought by the appellant to restrain the appellees from enforcing a rate fixed for its street railway.
except during the period of eight months, from October 1, 1918, to June 5, 1919, when six cents was charged. This higher fare was authorized by ordinance of the municipal Board of commissioners, which possesses regulatory powers, and on June 5, 1919, the same Board reduced the maximum fare to five cents. The latter ordinance was passed after a hearing and a finding by the Board that with the reduced rate the company would continue to earn a fair return. Under the 1919 ordinance, the company operated for eleven months. Then it brought this suit in the Federal Court for Southern Texas to enjoin its enforcement. The company contends that the fare prescribed is confiscatory, in violation of the Fourteenth Amendment, the city, that it is sufficient to yield a return of 8 percent on the value of the property used in the public service.
"not satisfied that the ordinance produces a return so plainly inadequate as to justify this court in interfering with the action of the municipality in the exercise of its ratemaking function,"
and, in March, 1921, entered a decree dismissing the bill without prejudice. In April, he denied a petition for rehearing. 272 F. 147. The case comes here on appeal under § 238 of the Judicial Code.
had been $90,159, and for the year ending December 31, 1920, $109,286, and estimated that, for the year ending June 30, 1921, it would be at least $111,285. The return so found for the year ending June 30, 1920, is 6.8 percent of $1,325,825; for the calendar year 1920, 8.2 percent, and for the year ending June 30, 1921, 8.4 percent. The master made calculations only for the year ending June 30, 1920, and, mainly [Footnote 3] because he allowed an amount for maintenance and depreciation equal to nearly 18 percent of the prudent investment for the depreciable property (less accrued depreciation), found the net earnings to be only $50,249.60. This sum is 3.8 percent on the prudent investment value, less depreciation. But neither the district judge nor the master reached his conclusion as to net return by a calculation as simple as that indicated above.
the master's prophecy of 33 1/3 percent. [Footnote 4] Thus, both master and court assumed a reproduction cost, after deducting accrued depreciation, of about $1,625,000. On this sum, the net earnings found by the court yielded, after deducting a 4 percent depreciation annuity on property subject to depreciation a maintenance charge, and a charge for taxes, other than the federal income tax a net return of 5 1/2 percent for the fiscal year ending June 30, 1920, of 6.7 percent for the calendar year 1920, and the promise of more for the fiscal year ending June 30, 1921. But, to fix base value, the master added, and the court disallowed, items aggregating nearly $600,000, which must now be considered.
makes allowance is the cost of developing the operating railway system into a financially successful concern. The only evidence offered or relied upon to support his finding is a capitalization of the net balance of alleged past deficits in accordance with what was said to be the Wisconsin rule. [Footnote 5] The experts calculated this sum in various ways. One estimate placed the development cost at $2,000,000; a more moderate estimate by the company's expert was $575,300, and the city's expert made a calculation by which he estimated this so-called cost at $212,452.
The fact that a utility may reach financial success only in time or not at all is a reason for allowing a liberal return on the money invested in the enterprise, but it does not make past losses an element to be considered in deciding what the base value is and whether the rate is confiscatory. A company which has failed to secure from year to year sufficient earnings to keep the investment unimpaired and to pay a fair return, whether its failure was the result of imprudence in engaging in the enterprise or of errors in management, or of omission to exact proper prices for its output, cannot erect out of past deficits a legal basis for holding confiscatory for the future rates which would, on the basis of present reproduction value, otherwise be compensatory. Knoxville v. Knoxville Water Co., 212 U. S. 1, 212 U. S. 14.
not wholly misconceived. It is doubtless true, as the master indicated, that a prospective purchaser of the Galveston system would be willing to pay more for it with a record of annual losses overcome than he would if the losses had continued. But would not the property be at least as valuable if the past had presented a record of continuous successes? And shall the base value be deemed less in law if there was no development cost because success was instant and continuous? Or, if the success had been so great that, besides paying an annual return at the rate of 8 percent, a large surplus had been accumulated, could the city insist that the base value be reduced by the amount of the surplus? Compare Newton v. Consolidated Gas Co., ante, p. 258 U. S. 165.
are not to be included in the base value for the purpose of determining whether a rate is confiscatory.
The other item included by the master in determining base value, but disallowed by the court, is $67,078 for brokerage fees. There is no evidence that any sum was in fact paid as brokerage, and there was included, as above shown, the sum of $73.281 for organization and business management in calculating the historical reproduction cost. The finding of the master rests upon testimony that bankers customarily get, in some form, compensation equal to 4 percent on the money procured by them for such enterprises. [Footnote 7] But compensation for bankers' services is often paid in the lessened price at which they take the company's securities, and is thus represented in the higher rate of interest or dividend paid on the money actually received by the company as capital. The reason given by the master for including the allowance for an assumed brokerage fee, is that a brokerage fee is "a normal incident of large industrial investments, and has not been amortized," since "the record shows that the plant has been operated at a loss." If base value were to be fixed by the money expended, brokerage fees actually paid might with propriety be included, as are taxes paid pending construction. But, as the base value considered is the present value, that value must be measured by money, and the customary cost of obtaining the money is immaterial. We cannot say that the court erred in refusing to include in base value an allowance for hypothetical broker's fees.
value instead of 33 1/3 percent, as the master and the court assumed. The appellees insisted, on the other hand, that an item of $142,281 for grade raising included by master and court in the historical cost should be eliminated. We cannot say that there was error in overruling these contentions.
may properly be excluded in calculating the amount of the depreciation annuity. We cannot say that the court erred in limiting the year's maintenance and depreciation allowances to an aggregate of $115,245.
The company asked to have allowed as a further charge $29,500 a year on account of what it called deferred maintenance. The contention is that, during the war and two years following, the company had deferred maintenance, pursuant to a policy established at the express request of the government, to the end that material and labor might be released for war purposes; that, to make good, this deferred maintenance would cost $197,000, and that, in order to amortize this amount, an annual allowance from earnings of $29,500 should be made for five years. This is an attempt, in another form, to capitalize alleged past losses, and the request was properly refused both by the master and the court.
It is thus clear that both in the year ending June 30, 1920, and in the calendar year 1920, the net earnings of the system were less than 8 percent of its value, whether the value be estimated on the basis of prudent investment or on the basis of the reproduction cost actually adopted. When the court rendered its decision, the ordinance had been tested for more than a year and a half -- a period ample in ordinary times to test the current effect of the rate prescribed and to indicate its probable effect in the near future. The times here involved were, however, in a high degree abnormal. It did not follow that, because the system had earned less than 8 percent in 1919 and in 1920, that it would earn less than 8 percent in 1921. A rate ordinance invalid when adopted may later become valid, just as an ordinance valid when made may become invalid by change in conditions. Municipal Gas Co. v.
Commission, 225 N.Y. 89, 96. Compare Willcox v. Consolidated Gas Co., 212 U. S. 19; Newton v. Consolidated Gas Co., ante, 258 U. S. 165.
prove inadequate. Compare San Diego Land & Town Co. v. National City, 174 U. S. 739, 174 U. S. 754; San Diego Land & Town Co. v. Jasper, 189 U. S. 439; Knoxville v. Knoxville Water Co., 212 U. S. 1, 212 U. S. 17.
experience of the utility might show it entitled to, and the decree was thereupon entered without prejudice.
The district judge refused a temporary injunction, and did not exact a bond. Hence, the only relief we can grant is such as operates in futuro. Compare Duplex Printing Press Co. v. Deering, 254 U. S. 443, 254 U. S. 464. An injunction should not issue now, unless conditions are such that the prescribed rate is confiscatory. As, by the reservation in the decree, appellant may secure protection against the ordinance if, under existing conditions, the five-cent rate appears to be inadequate, the decree should be affirmed. Compare Lincoln Gas & Electric Co. v. Lincoln, 250 U. S. 256, 250 U. S. 268; Ex parte Lincoln Gas & Electric Co., 256 U. S. 512; 257 U. S. 257 U.S. 6.
"the estimated undepreciated cost of reproduction of railway property of the company on the historical basis, exclusive of franchise value, going concern value, bond discount and brokerage fee,"
but with land and right of way which cost about $15,000 estimated at their present value of $58,836. It was also agreed, for the purpose of dividing joint items, that one-fifth of the property of the company was devoted to its light and power business.
See Richberg, 31 Yale Law Journal, 263, 266, 279; Hale, 30 Yale Law Journal, 710, 720; Henderson, 33 Harvard Law Review, 902, 1031; Friday, 36 Quarterly Journal of Economics, 197, 211.
He allowed also on account of federal income taxes a sum of $8,008, which the court disallowed.
From the agreed valuation of $1,715,825, the court deducted $425,117 for property not subject to this appreciation -- land, already given its market value, and capital acquired recently (all acquisitions before January 1, 1915, being assumed to have been at the 1913 price level, all since that date at the new level). The balance was appreciated one-third; the $425,117 was added again, and accrued depreciation, likewise appreciated one-third, was subtracted. The court thus obtained a base value of $1,626,061. The master's figure was slightly smaller (but for his inclusion of development cost and brokerage), for he excepted more property from this 33 1/3 percent appreciation.
Hill v. Antigo Water Co., 3 Wis.R.Com. Reports 623, 705-723. But see Cunningham v. Chippewa Falls Water Co., 5 Wis.R.Co.Reports 302, 315; Appleton v. Appleton Waterworks Co., 5 Wis.R.Co.Reports 215, 277; In re Purchase Racine Waterworks Plant, 19 Wis.R.Co.Reports 83, 140.
On the other hand, if what is to be considered in determining the net deficit is not the result of operations from the beginning of the enterprise, but the result of operations since the present owner acquired it -- in other words, the return on its investment -- we are left without the data necessary to determine the fact. For the record does not disclose what the present company paid when it purchased the property in 1905 as a going concern. For aught that appears, appellant has received full 8 percent annually on that amount and later additions to capital.
The record cost of the property was originally used as the base for this calculation. But the figure $67,076 was tacitly agreed by both parties to be the amount, if any, that should be allowed for brokerage.
It is difficult to see how, on the facts presented, so large a sum as $16,254 could have been paid on account of the year's operation. Indeed, the court, in disallowing the item of federal income tax, deducted not $16,254, but $8,008. Even this seems too large, for the net earnings, without deduction of the $16,254 attributed to income tax, for the year ending June 30, 1920, as found by the master, were $66,503.60. From this, interest paid or accrued on indebtedness is to be deducted before computing the net income on which the tax is payable. A large part of the capital of utility companies is ordinarily represented by interest-bearing bonds and notes, and there is evidence that such indebtedness of the appellant was "in the neighborhood of $1,400,000." The interest on this debt chargeable to the railway system would be at least $50,000. There is further an exemption from tax of $2,000 of the net income. So a 10 percent tax on the balance would amount to less than $1,500.
In the record and briefs elsewhere, the income tax is reckoned at between $8,000 and $10,000, which is a proper figure if there be an 8 percent return on $1,626,061.
See Federal Reserve Bulletin, January, 1922, pp. 5, 79, 113; February 1922, pp. 156, 157.

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