Opinion ID: 1568028
Heading Depth: 1
Heading Rank: 1

Heading: Phoenix Utility Company Construction Fee

Text: Construction work upon the project was done by Phoenix Utility Company under a cost plus fixed fee contract. The fee of 3% amounting to $197,596.35 paid by the licensee to Phoenix under this contract was disallowed by the Commission because of the affiliation which existed between Phoenix and the licensee through Electric Bond and Share Company. In doing so the Commission applied its no profit to affiliates rule. The rule was stated in Louisville Hydro-Electric Company, 1 F.P.C. 130 (1933). In that case the Commission was called upon to determine actual legitimate original cost as that term was used in the Federal Water Power Act. The Commission there said (p. 136): In making a determination of the actual legitimate original cost of the project constructed under this contract, the Commission is not blinded by legal technicalities nor misled by attenuated theories. Where there is admitted control of both the licensee and the service company and where, as here, the two companies are virtually departments of an integrated system, the Commission must, under the provisions of the Federal Water Power Act, disregard the contract and hold that cost to the licensee can be no more, though it may under certain circumstances be less, than the cost of such service to the service company. Since the relationship of these two companies so unmistakably points to the existence of a superimposed power arbitrarily to dictate contracts and fix charges for services, the Commission cannot be bound by the terms of such contract, but must demand evidence of the cost to the Byllesby Service Co. of the services rendered. Congress was informed of this interpretation of the statutory phrase actual legitimate original cost by the Commission in its Fourteenth Annual Report transmitted December 1, 1934, in which the Commission said (p. 2):    the Commission has sought to protect the public interest by denying claims of costs for services to the licensee, performed by holding companies or affiliated service corporations, pending production by the licensed operating company of the original records of cost. In considering such claims the Commission holds that `cost to the licensee can be no more, though it may under certain circumstances be less, than the cost of such service to the service company.' In 1935 Congress made extensive amendments and additions to the Federal Water Power Act but retained without change the act's use of the phrase actual legitimate original cost. [2] Immediately after the enactment of the 1935 amendments the Commission again applied its no profit to affiliates rule. Northern States Power Co., 1 F.P.C. 329, 344, 345 (1936). The licensee urges that since Section 3 of the act states that `net investment' in a project means the actual legitimate original cost thereof as defined and interpreted in the `classification of investment in road and equipment of steam roads, issue of 1914, Interstate Commerce Commission', the interpretation of the phrase actual legitimate original cost by the Interstate Commerce Commission is controlling. It urges further that the Interstate Commerce Commission has so interpreted the phrase as to allow profits paid by a carrier to an affiliated construction company to be included in cost without differentiating between them and payments made to non-affiliated contractors. The licensee relies primarily upon Texas Midland Railroad, 1918, 75 I.C.C. 1, 176, as authority for this proposition. The Commission cites, as authority for an opposite conclusion, Kansas City Southern Railway Company, 1919, 75 I.C.C. 223, 233. Before considering these cases, however, we note that the Valuation Act of 1913, 37 Stat. 701, 49 U.S.C.A. § 19a, under which the classification of investment in road and equipment of steam roads was issued in 1914 by the Interstate Commerce Commission pursuant to the mandate of the act to the Commission to investigate and report upon the original cost, inter alia, of the physical property of the carriers subject to its jurisdiction, refers merely to original cost and does not use the qualifying adjectives actual and legitimate. Likewise the classification itself does not use these adjectives as qualifying original cost. Its purpose was to define and classify the elements entering into the cost of road and equipment and to prescribe the several general and primary accounts in which the costs thus defined and classified were to be entered. The only provisions of the classification touching our present problem are the following statements appearing in the general instructions:  Costs shall be actual money costs to the carrier. (p. 10). The cost of construction shall include the cost of labor, materials and supplies,    contract work,    and other analogous elements in connection with such work. (p. 11).  Cost of contract work includes amounts paid for work performed under contract by other companies, firms, or individuals, and costs incident to the award of the contract. (p. 12). We find nothing either in the general instructions or in the body of the classification bearing upon the question whether work done by affiliated service or construction companies is to be deemed work performed under contract by other companies or whether the corporate forms are to be disregarded and the work is to be deemed to have been performed by the carrier itself acting through the instrumentality of its corporate affiliate. Turning to the Interstate Commerce Commission's opinion in the Texas Midland Railroad case we find nothing therein which may fairly be construed as dealing with the question whether the Interstate Commerce Commission interpreted original cost so as to include profits paid by a carrier to an affiliated corporation. In that case the issue which the Interstate Commerce Commission was called upon to decide was whether in determining the cost of a project the amounts actually expended by the carrier or the fair average cost must prevail. It ruled in favor of the amounts actually expended. Nor is the case upon which the Federal Power Commission relies authority for its present contention. In Kansas City Southern Railway the carrier paid profits not only to independent subcontractors who did the actual construction but also to affiliated corporation contractors which had sublet the construction work to the independent subcontractors. The Interstate Commerce Commission allowed the profits paid to the independent subcontractors to be included in the cost. It disallowed the claim for profits paid to the carrier's affiliated corporations, not because of the affiliation but because they had not done the work and therefore were not entitled to any profits based upon construction work done. We conclude that the classification of investment in road and equipment of steam roads, issue of 1914, Interstate Commerce Commission, to which the Federal Water Power Act referred as defining and interpreting actual legitimate original cost, did not determine whether profits paid by a carrier to an affiliated construction company were to be included in determining such cost and does not in fact throw any light upon the meaning intended by Congress to be given to the qualifying words actual and legitimate as used in the Federal Water Power Act, since those words did not appear in the statute under which the classification was issued. We further conclude that up to the time of the enactment of the Federal Water Power Act in 1920 the Interstate Commerce Commission had not ruled upon the question whether under the Valuation Act of 1913 and the classification issued in 1914 profits paid to an affiliated construction corporation by a carrier were includible in determining original cost of the road. The Interstate Commerce Commission cases decided after the passage of the Federal Water Power Act and cited [3] by the licensee have no bearing on the question before us since they could not have been in the contemplation of Congress when it passed the act and do not deal with the meaning of the statutory phrase with which we are concerned  actual legitimate original cost. We must, therefore, determine whether the Federal Power Commission's no profit to affiliates rule is justified by the statutory direction that the original cost which is to be determined must be actual and legitimate. We think that the Commission's no profit to affiliates rule is in accord with the statutory mandate that costs are to be restricted to actual expenditures and are not to be illegitimately inflated by any device. Had the licensee itself constructed the project one could hardly contend that it could charge as a part of the cost any profit to itself. Clarion River Power Company, 1 F.P.C. 269, 279 (1935). Such a charge would not be an actual or legitimate item of cost. But payment of profits to an affiliated corporation may for all practical purposes be the equivalent of payment of profits to the licensee itself. In such a case the interposition of the corporate veil between what may be in fact, if not in law, mere departments of a single integrated system will not serve to legitimize what otherwise would be an illegitimate item of cost. For an intercorporate profit which upon a consolidated income statement of the affiliated group would disappear entirely is too lacking in substance to be treated as an actual cost. Our view in this respect is in accord with the rulings in two recent cases. In Alabama Power Co. v. McNinch, 1937, 68 App.D.C. 132, 94 F.2d 601, the profit fee was denied as an item of cost by the Commission because the construction corporation was found to be but a department of the licensee. Upon appeal the licensee contended, as does the licensee in this case, that the item must be allowed when reasonable as measured by amounts which would have been charged by others for the performance of like services. The court answered this contention by saying (page 94 F.2d at 618): The statute in insisting upon actual legitimate cost must be taken to forbid inflation of cost by any device; and the finding that the Dixie Construction Company was a department of the licensee, since it is supported by substantial evidence, cannot be disturbed. If, as the Commission found, the Dixie Company was but the construction department of the Power Company, to allow a 3% fee on the costs of the `Dixie Company' would be to allow 3% more than the actual cost to the Power Company of the work. Our conclusion is that the disallowance of the Dixie fee was correct. The same power company, Alabama, and the same construction company, Dixie, were again involved in Alabama Power Co. v. Federal Power Commission, 5 Cir., 1943, 134 F.2d 602. However, whereas, Alabama had owned all the stock of Dixie during the construction period involved in the McNinch case, it had subsequently transferred that stock to a company which was wholly owned by the same holding company which owned Alabama's stock. The Circuit Court of Appeals for the Fifth Circuit held that the 3% fee paid by Alabama to Dixie was an intercorporate profit and not a cost of construction. The court said (page 134 F.2d at 609): The purpose of the determination of original legitimate cost is to protect the public against exaggerated claims by licensee utility companies of their investments in respect of which they are entitled to a return. Holding companies have much confused the matter. This is a situation in which the corporate fiction may be carefully scanned and separate corporate entities ignored when they are used to evade the law. So long as Alabama owned Dixie, there was no strain in holding it a mere department of Alabama. The matter is not much changed by the shift of stock ownership so that the same corporation owns them both. Legitimate costs cannot in either case be swelled beyond what they would have been if the construction had been done by the ultimate owner of the project. Legitimate cost includes everything spent that would have been rightly spent if there had been but one corporation, but not profits charged by one wholly owned corporation against another. The facts of the present case justify the Commission's conclusion that a close relationship existed in the Electric Bond and Share holding company system among the licensee, Phoenix and Electric Bond and Share. Since the incorporation of Phoenix in 1906 as a construction company Electric Bond and Share has owned its total outstanding stock of 20 shares having a par value of $100 each. Aside from its name Phoenix has no genuine corporate existence. It operates with no funds of its own, has no construction equipment, no officers or employees of its own but only such as are supplied by Electric Bond and Share or by the operating companies, and pays none of their salaries. It operates only within the Electric Bond and Share system and obtains none of its contracts as a result of competitive bidding. From the date of its organization in 1920 to December 31, 1934, the date as of which the cost of the project is to be determined, the entire common stock and the majority of the outstanding voting stock of the licensee was owned by Lehigh Power Securities Corporation, a subsidiary of Electric Bond and Share. While Electric Bond and Share owns but 15% of Lehigh's voting securities it possesses working control of Lehigh through voting trust agreements and service contracts. [4] Phoenix and the licensee are thus both puppets in the Electric Bond and Share system. Moneys paid by the licensee to Phoenix at the behest of Electric Bond and Share and designated as a fee for construction work might without altering the essential nature of the transaction have been paid by the licensee directly to the corporation which pulled the strings, Electric Bond and Share. The Commission was amply justified in its conclusion that by reason of the control exercised by Electric Bond and Share over both Phoenix and the licensee and the intercorporate relationship there was no arm's length dealing in the arrangement whereby the licensee agreed to pay Phoenix a fee of 3% of the cost of constructing the project. The fee thus exacted by Electric Bond and Share for its corporate dummy was not a legitimate item of cost. We conclude that the Commission properly applied its no profit to affiliates rule and properly disallowed the licensee's claim of $197,596.35 paid to Phoenix as an item of actual legitimate original cost.