Court Opinion

ID: 4207107
Source: CourtListenerOpinion
Date Created: 2017-09-28 15:08:30.217682+00
Date Added: 2024-06-11T09:36:42.482846
License: Public Domain

FILED
                                                                 Sep 28 2017, 10:23 am

                                                                      CLERK
                                                                  Indiana Supreme Court
                                                                     Court of Appeals
                                                                       and Tax Court

FOR APPELLANT                                             ATTORNEYS FOR APPELLEES
Randolph L. Seger                                         William Fine
Brian W. Welch                                            Daniel M. LeVay
Michael T. Griffiths                                      Scott C. Franson
Bingham Greenebaum Doll, LLP                              Abby Gray
Indianapolis, Indiana                                     Indiana Office of Utility Consumer
                                                          Counselor
                                                          Indianapolis, Indiana
                                                          Beth E. Heline
                                                          Jeremy Comeau
                                                          Patricia C. McMath
                                                          Indiana Utility Regulatory
                                                          Commission
                                                          Indianapolis, Indiana

                                            IN THE
    COURT OF APPEALS OF INDIANA

Hamilton Southeastern Utilities,                          September 28, 2017
Inc.,                                                     Court of Appeals Case No.
Appellant-Petitioner,                                     93A02-1612-EX-2742
                                                          Appeal from the Indiana Utility
        v.                                                Regulatory Commission
                                                          The Honorable Aaron A. Schmoll,
Indiana Utility Regulatory                                Senior Administrative Law Judge
Commission; Indiana Office of                             Trial Court Cause No. 44683
Utility Consumer Counselor;
and Apartment Association of
Indiana, Inc.,
Appellees-Respondents/Statutory
Parties and Intervenors.

Court of Appeals of Indiana | Opinion 93A02-1612-EX-2742 | September 28, 2017             Page 1 of 26
      Riley, Judge

                                STATEMENT OF THE CASE
[1]   Appellant/Cross-Appellee-Petitioner, Hamilton Southeastern Utilities, Inc.

      (HSE), appeals the Order of the Indiana Utility Regulatory Commission

      (Commission), in which the Commission authorized a 1.17% increase in HSE’s

      rate for sewer utility service.

[2]   We affirm in part, reverse in part, and remand.

                                                    ISSUES
[3]   HSE raises six issues on appeal, which we consolidate and restate as the

      following two issues:

      (1) Whether the Commission erred by excluding certain expenses from the

      calculation of HSE’s utility rate; and

      (2) Whether the Commission erred by approving an excessive system

      development charge in one of HSE’s service areas.

[4]   On cross-appeal, Appellee/Cross-Appellant-Respondent, the Indiana Office of

      Utility Consumer Counselor (OUCC), raises one additional issue, which we

      restate as: Whether the Commission erred by including income tax liability in

      its calculation of HSE’s utility rate.

                       FACTS AND PROCEDURAL HISTORY
[5]   HSE was founded in 1988 and is a for-profit public utility that provides “sewage

      collections and treatment services.” (HSE Exh. 4—Non-Conf. Exh. Vol. II, p.

      Court of Appeals of Indiana | Opinion 93A02-1612-EX-2742 | September 28, 2017   Page 2 of 26
      5). HSE “is the largest investor owned sewer utility in” Indiana and currently

      serves more than 20,000 customers in Hamilton County, Indiana. (OUCC

      Exh. 2—Non-Conf. Exh. Vol. IV, p. 57). As a public utility, HSE is subject to

      regulation by the Commission.

[6]   Since its inception, HSE has relied on an affiliate company, Sanitary

      Management & Engineering Company, Inc. (SAMCO), to carry out the

      operation, maintenance, and engineering functions of HSE’s sewage

      operations. HSE and SAMCO are governed by the same set of board members

      and have the same shareholders. HSE itself has only seven full-time employees

      to perform management and billing tasks. HSE and SAMCO operate pursuant

      to a Utility Services Agreement, which has been filed with the Commission as

      required by statute for affiliate contracts. Under the Utility Services Agreement,

      SAMCO bills HSE an hourly rate for services, which rates are annually

      negotiated by HSE and SAMCO. The Utility Services Agreement also provides

      that SAMCO is entitled to a 10% management fee for procuring equipment,

      supplies, and subcontractors on behalf of HSE. In addition to HSE, SAMCO

      services nineteen other clients. However, maintaining and operating HSE’s

      sewage system comprises approximately 50% to 60% of SAMCO’s business,

      and some SAMCO employees spend all of their time working on HSE’s system.

[7]   In a 2010 rate case, the Commission authorized HSE to charge a flat monthly

      rate of $34.63 per single family equivalent dwelling unit (EDU). In establishing

      this rate, the Commission approved a 9.8% rate of return for HSE. At some

      point, largely due to aging equipment, HSE began to experience “operational

      Court of Appeals of Indiana | Opinion 93A02-1612-EX-2742 | September 28, 2017   Page 3 of 26
      issues” that resulted in significant increased maintenance and operating

      expenses. (HSE Exh. 4—Non. Conf. Exh. Vol. II, p. 9). In 2013, a sewage

      overflow situation necessitated involvement by the Indiana Department of

      Environmental Management (IDEM). As a result, HSE entered into an agreed

      order with IDEM, which required HSE to implement a maintenance and

      operation plan for its entire system. Since the establishment of its current rates,

      HSE has expended “more than $11 million on system repairs and

      maintenance.” (HSE Exh. 4—Non-Conf. Exh. Vol. II, p. 8). In order “to

      ensure a safe and reliable system,” HSE anticipates that the increased

      maintenance and operating costs will continue for the foreseeable future. (HSE

      Exh. 4—Non-Conf. Exh. Vol. II, p. 10).

[8]   Because of the added expenses, HSE “achieved an average rate of return of just

      1.9%” between 2009 and 2015, even though the Commission had approved a

      9.8% rate of return. (HSE Exh. 4—Non-Conf. Exh. Vol. II, p. 10).

      Accordingly, on September 24, 2015, under Cause No. 44683, HSE filed a

      Verified Petition and Notice of Intent to File in Accordance with Minimum

      Standard Filing Requirements, seeking authority from the Commission “to

      increase its rates and charges for the sewage disposal utility service it renders to

      the public and for other related relief.” (Appellant’s App. Vol. II, p. 36).

      Specifically, HSE sought an across-the-board rate increase of 8.42% to produce

      additional revenues of $997,041 per year. This increase would amount to a

      monthly rate increase of $2.92 per EDU, for a monthly wastewater treatment

      bill of $37.55 per EDU.

      Court of Appeals of Indiana | Opinion 93A02-1612-EX-2742 | September 28, 2017   Page 4 of 26
[9]    HSE also requested, in relevant part, an increase to its system development

       charge (SDC) of $450 in all of its service areas. “All new development pays

       $2,400 [or $3,200 in the Flatfork Creek area, which is subject to an additional

       surcharge,] per EDU” to help fund the costs of capital projects. (HSE Exh. 3—

       Non-Conf. Exh. Vol. I, p. 172). Thus, HSE requested the approval of a $2,850

       SDC for all areas except Flatfork Creek, where it requested an SDC of $3,650.

       “SDCs provide a reasonable means of ensuring that existing retail customers do

       not subsidize the cost of new development.” (HSE Exh. 3—Non-Conf. Exh.

       Vol. I, p. 173). A portion of each SDC that HSE collects is also paid to either

       the City of Fishers or the City of Noblesville for a wastewater treatment plant

       capacity fee. 1

[10]   On February 24, 2016, the Commission conducted a hearing. HSE presented

       evidence from various accounting/utility experts, as well as the president of the

       company, to support its proposed rate increase. In response, the OUCC, which

       is a state agency that represents the interests of “ratepayers, consumers, and the

       public” in utility matters, presented its own calculations and requested that the

       Commission decrease HSE’s existing rates by 14.01%. Ind. Code §§ 8-1-1.1-4, -

       5.1(e). While the OUCC agreed with some of HSE’s proposed adjustments, it

       advocated for a rate reduction based on, in large part, its belief that HSE could

       operate more economically by eliminating its relationship with SAMCO in lieu

       1
         In its petition for a rate increase, HSE also sought authority to charge a monthly fee for its new FOG (fats,
       oils, and grease) management rules, as well as other miscellaneous changes to its tariff. However, the
       Commission’s decisions on these issues are not before us on appeal.

       Court of Appeals of Indiana | Opinion 93A02-1612-EX-2742 | September 28, 2017                      Page 5 of 26
       of performing those necessary tasks with in-house employees. After reaching

       certain stipulations with the OUCC, HSE ultimately reduced its requested rate

       increase to 6.27%.

[11]   On November 9, 2016, the Commission issued its Order, authorizing HSE “to

       increase its rates and charges for sewer utility service by 1.17%, or $139,305.”

       (Appellant’s App. Vol. II, p. 34). According to the Commission, such an

       increase would result in a monthly charge to customers of $35.04 per EDU and

       would provide a 9.60% rate of return to HSE. In relevant part, the Commission

       based its rate determination on a finding that expenses related to SAMCO

       should be eliminated from HSE’s working capital allowance; the Commission

       also declined to include SAMCO’s 10% management fee and a 3% increase to

       SAMCO’s contracted operating costs. However, contrary to the proposal

       advanced by the OUCC, the Commission determined that HSE could recover

       its income tax liability (which is passed through to and paid by its shareholders)

       in its rates. As to HSE’s request regarding its SDC, the Commission approved

       a $450 increase for all service areas.

[12]   On November 29, 2016, HSE filed a Petition for Reconsideration and

       Clarification. However, rather than waiting for the Commission to rule on this

       petition, on December 9, 2016, HSE filed a Notice of Appeal. The

       Commission never ruled on HSE’s reconsideration petition prior to this court

       Court of Appeals of Indiana | Opinion 93A02-1612-EX-2742 | September 28, 2017   Page 6 of 26
       assuming jurisdiction. HSE now appeals, and the OUCC cross-appeals.

       Additional facts will be provided as necessary. 2

                                 DISCUSSION AND DECISION
                                                 I. Motion to Dismiss

[13]   In its Notice of Appeal, HSE identified the Commission as an

       appellee/statutory party. However, on May 9, 2017, HSE filed a motion to

       dismiss the Commission from this appeal, clarifying that it had “mistakenly

       identified the Commission as a party on appeal.” (HSE’s Motion to Dismiss, p.

       4). HSE argued that the Commission was an improper party as it “acted as a

       fact-finding administrative tribunal, hearing evidence from the opposing parties,

       and rendering its Order purportedly based on the evidence.” (HSE’s Motion to

       Dismiss, p. 2).

[14]   Nevertheless, on June 9, 2017, the Commission filed an appellate brief, in

       which it responded to HSE’s claims of error and argued that the findings of its

       final Order were justified. In response to HSE’s motion to have it dismissed as

       a party to the appeal, the Commission contended that it is a proper party

       because this “case is not akin to a controversy between two parties.”

       (Commission’s Br. p. 16). Rather, the Commission claimed to have been acting

       2
         On December 30, 2015, by order of the Commission, the Indiana Apartment Association, “a statewide
       trade organization” that represents the interests of several “multi-family housing units within HSE’s service
       territory,” intervened in the proceeding. (Appellant’s App. Vol. II, p. 47). The Apartment Association
       challenged HSE’s billing methodologies with respect to multi-family housing units; however, the
       Commission ultimately found HSE’s billing practices to be reasonable in this regard. The Apartment
       Association does not participate in this appeal.

       Court of Appeals of Indiana | Opinion 93A02-1612-EX-2742 | September 28, 2017                     Page 7 of 26
       in a legislative, not judicial, capacity in determining a proper utility rate. Thus,

       the Commission asserted that

               as an executive branch administrative agency acting in the public
               interest[,] [it] should be able to defend that its orders are in the
               public interest. It therefore brings a perspective useful to the
               Court of Appeals that may be helpful to proper resolution of the
               issues on this appeal and should be allowed to remain as an
               appellee.

       (Commission’s Br. p. 18).

[15]   “The Indiana General Assembly created the [Commission] primarily as an

       impartial fact-finding body with the technical expertise to administer the

       regulatory scheme devised by the legislature.” Duke Energy Ind., Inc. v. Office of

       Util. Consumer Counselor, 983 N.E.2d 160, 164 (Ind. Ct. App. 2012) (citing I.C. §

       8-1-1-5(a)). “The Commission cannot act in the role either of a proponent or

       opponent on any issue to be decided by it.” Id. (citing I.C. § 8-1-1-5(a)).

       Rather, the Commission’s role “is to ensure that public utilities provide

       constant, reliable, and efficient service to the citizens of Indiana.” Id.

[16]   In City of Terre Haute v. Terre Haute Water Works Corp., 180 N.E.2d 110, 111 (Ind.

       App. 1962), In Banc, this court held that it was improper to name the

       Commission as a party to the appeal on a rate-making decision it had rendered.

       The Terre Haute court stated that the Commission

               is a fact-finding administrative tribunal which acts in a quasi-
               judicial capacity. When there are two opposing parties before it,
               as here, its action in making findings and issuing an order

       Court of Appeals of Indiana | Opinion 93A02-1612-EX-2742 | September 28, 2017   Page 8 of 26
                deemed detrimental by one of the parties is similar to that of a
                court which makes a decision determining a controversy between
                adverse parties. A court is never a party to an appeal from its
                decision.

       Id. More recently, in Citizens Action Coal. of Ind., Inc. v. Indianapolis Power & Light

       Co., 74 N.E.3d 554, 557 n.2 (Ind. Ct. App. 2017), our court granted a motion to

       dismiss the Commission as a party on appeal, stating that “[b]ecause the

       Commission acted as a fact-finding administrative tribunal and no statute or

       administrative provision expressly makes the Commission a party on appeal, it

       is not a proper party on appeal from its own decision.”

[17]   The Commission cites two cases in support of its contention that this court has

       previously allowed the Commission to participate as a party in judicial review

       of the Commission’s own orders. See NIPSCO Indus. Grp. v. N. Ind. Pub. Serv.

       Co., 31 N.E.3d 1 (Ind. Ct. App. 2015), and Duke Energy Ind. Inc., 983 N.E.2d at

       160. 3 Although the Commission was a named party in these appeals, these

       decisions did not address the merits of whether the Commission was a proper

       appellate party and, thus, offer little value to the Commission’s position.

[18]   The Commission further contends that the present rate case did not involve “a

       controversy between two adverse parties.” (Commission’s Br. p. 17).

       Specifically, the Commission asserts that the OUCC cannot be considered an

       3
         The Commission cites a third case, Citizens Action Coal. of Ind., Inc. v. N. Ind. Pub. Serv. Co., 804 N.E.2d 289
       (Ind. Ct. App. 2004); however, we see nothing to indicate that the Commission appeared as a party in that
       appeal.

       Court of Appeals of Indiana | Opinion 93A02-1612-EX-2742 | September 28, 2017                         Page 9 of 26
       adverse party because it agreed with HSE “on a number of issues.”

       (Commission’s Br. p. 17). Moreover, the Commission points out that it would

       have had to consider and rule on HSE’s rate request regardless of whether the

       OUCC had posed any opposition; thus, “it is not accurate to consider a rate

       case before an administrative body the same as a complaint or petition of one

       party against another.” (Commission’s Br. p. 17).

[19]   We recognize that the Commission acts in a legislative, rather than judicial,

       capacity with respect to rate-making, and the General Assembly “has seen fit to

       establish a [C]omission for the express purpose of hearing evidence and

       balancing and weighing the many complicated factors which must be taken into

       consideration in setting utility rates.” Citizens Action Coal. of Ind., Inc., 74

       N.E.3d at 564. Nevertheless, the Commission is obligated to be “an impartial

       fact-finding body” in “all controversial proceedings heard by it.” I.C. § 8-1-1-

       5(a). Here, HSE sought an initial rate increase of 8.42%, which it subsequently

       agreed to reduce to 6.27%, whereas the OUCC presented evidence in an effort

       to convince the Commission to decrease HSE’s existing rates by 14.01%.

       Additionally, the Indiana Apartment Association appeared as an intervenor to

       challenge HSE’s billing practices with respect to multi-family housing units in

       HSE’s service area. Although the Commission wields wide discretion in

       determining an appropriate rate, it cannot be said that the parties appearing

       before the Commission did not advocate for competing interests. Furthermore,

       we find that the Commission’s Order should speak for itself, without the need

       Court of Appeals of Indiana | Opinion 93A02-1612-EX-2742 | September 28, 2017   Page 10 of 26
       to further rationalize its decision to our court. Accordingly, the Commission is

       not a proper party on appeal from its own decision and should be dismissed. 4

                                              II. Standard of Review

[20]   Judicial review of the Commission’s decisions is governed by Indiana Code

       section 8-1-3-1, which provides that

               [a]ny person, firm, association, corporation, limited liability
               company, city, town or public utility adversely affected by any
               final decision, ruling, or order of the [C]ommission may, within
               thirty (30) days from the date of entry of such decision, ruling, or
               order, appeal to the court of appeals of Indiana for errors of law
               under the same terms and conditions as govern appeals in
               ordinary civil actions, except as otherwise provided in this
               chapter and with the right in the losing party or parties in the
               court of appeals to apply to the supreme court for a petition to
               transfer the cause to said supreme court as in other cases. An
               assignment of errors that the decision, ruling, or order of the
               [C]ommission is contrary to law shall be sufficient to present
               both the sufficiency of the facts found to sustain the decision,
               ruling, or order, and the sufficiency of the evidence to sustain the
               finding of facts upon which it was rendered.

[21]   More specifically, our review is two-tiered:

               On the first level, it requires a review of whether there is
               substantial evidence in light of the whole record to support the
               Commission’s findings of basic fact. Such determinations of
               basic fact are reviewed under a substantial evidence standard,
               meaning the order will stand unless no substantial evidence

       4
         A separate order granting HSE’s motion to dismiss the Commission as a party to this appeal will be issued
       simultaneously with this decision.

       Court of Appeals of Indiana | Opinion 93A02-1612-EX-2742 | September 28, 2017                 Page 11 of 26
        supports it. In substantial evidence review, “the appellate court
        neither reweighs the evidence nor assesses the credibility of
        witnesses and considers only the evidence most favorable to the
        [Commission’s] findings.” The Commission’s order is
        conclusive and binding unless (1) the evidence on which the
        Commission based its findings was devoid of probative value; (2)
        the quantum of legitimate evidence was so proportionately
        meager as to lead to the conviction that the finding does not rest
        upon a rational basis; (3) the result of the hearing before the
        Commission was substantially influenced by improper
        considerations; (4) there was not substantial evidence supporting
        the findings of the Commission; (5) the order of the Commission
        is fraudulent, unreasonable, or arbitrary. This list of exceptions is
        not exclusive.

        At the second level, the order must contain specific findings on
        all the factual determinations material to its ultimate conclusions.
        McClain [v. Review Bd. of Ind. Dep’t of Workforce Dev., 693 N.E.2d
        1314, 1317-18 (Ind. 1998),] described the judicial task on this
        score as reviewing conclusions of ultimate facts for
        reasonableness, the deference of which is based on the amount of
        expertise exercised by the agency. Insofar as the order involves a
        subject within the Commission’s special competence, courts
        should give it greater deference. If the subject is outside the
        Commission’s expertise, courts give it less deference. In either
        case[,] courts may examine the logic of inferences drawn and any
        rule of law that may drive the result. Additionally, an agency
        action is always subject to review as contrary to law, but this
        constitutionally preserved review is limited to whether the
        Commission stayed within its jurisdiction and conformed to the
        statutory standard and legal principles involved in producing its
        decision, ruling, or order.

Court of Appeals of Indiana | Opinion 93A02-1612-EX-2742 | September 28, 2017   Page 12 of 26
       Citizens Action Coalition of Ind., Inc., 74 N.E.3d at 562-63 (internal citations

       omitted) (quoting N. Ind. Pub. Serv. v. U.S. Steel, 907 N.E.2d 1012, 1016 (Ind.

       2009)).

[22]   The Commission’s “authority ‘includes implicit powers necessary to effectuate

       the statutory regulatory scheme.’” United States Gypsum, Inc. v. Ind. Gas Co., 735

       N.E.2d 790, 795 (Ind. 2000) (quoting Office of Util. Consumer Counselor v. Pub.

       Serv. Co., 608 N.E.2d 1362, 1363-64 (Ind. 1993)). As a legislative creation, the

       Commission is limited to exercising “that power which has been conferred

       upon it by statute.” Citizens Action Coal. of Ind., Inc., 74 N.E.3d at 562. With

       respect to matters within its jurisdiction, it is well established that the

       Commission “enjoys wide discretion.” Id. at 565. We will not override the

       Commission’s findings and decision simply “because we might reach a contrary

       opinion on the same evidence.” Id. The party challenging the Commission’s

       decision bears the burden of showing there is insufficient evidence in the record

       to support the Commission’s findings; it is not enough to “merely cite to other

       evidence of record which would support a determination more favorable to

       their position.” Id. at 565-66.

                                        III. Utility Rate Determination

[23]   It is a well-established “basic legislative policy that questions of rate-making

       methodology are best consigned to the Commission’s expertise.” Id. at 562. In

       rate cases, “the Commission’s primary objective is to establish a level of rates

       and charges that will permit the utility to meet its operating expenses plus a

       return on investment which will compensate its investors.” Id. “In determining

       Court of Appeals of Indiana | Opinion 93A02-1612-EX-2742 | September 28, 2017   Page 13 of 26
       fair rates, the Commission considers a representative level of anticipated

       revenues and expenses and the property employed by the utility to provide

       service to its customers.” United States Gypsum, Inc., 735 N.E.2d at 798. When

       the Commission “determines that a utility’s rates have become unjust and

       unreasonable, it may modify them by ordering just and reasonable rates to be

       charged prospectively.” Id. Because the “rate-setting procedure is

       comprehensive[,] the Commission must examine every aspect of the utility’s

       operations and the economic environment in which the utility functions to

       ensure that the data it has received are representative of operating conditions

       that will, or should, prevail in future years.” Id. (internal quotation marks

       omitted).

                                                 A. SAMCO Fees

[24]   HSE first challenges the Commission’s exclusion of certain SAMCO-related

       expenses from its rate calculation. In August of 2015, HSE and SAMCO

       negotiated a 3% increase to SAMCO’s contracted billing rates, and the affiliate

       Utility Services Agreement entitles SAMCO to a 10% management fee for

       procuring materials and subcontractors. In its Order, the Commission

       determined that HSE was not permitted to recover either the 3% contract

       increase or the 10% management fee through its utility rate. Specifically, the

       Commission found:

               As noted by the OUCC, [the National Association of Regulatory
               Utility Commissioners (NARUC)] guidelines call for affiliate
               pricing to be at market price, or the fully allocated cost,
               whichever is lower. Here, HSE presented evidence that shows

       Court of Appeals of Indiana | Opinion 93A02-1612-EX-2742 | September 28, 2017   Page 14 of 26
        SAMCO’s rates are at or below the rates charged by other similar
        firms, but presented no evidence concerning what SAMCO’s
        fully allocated cost actually is. While we agree with HSE that the
        OUCC’s 20% ($690,506) downward adjustment is arbitrary, the
        Commission would note that it is HSE, not the OUCC, which
        has the burden to prove its costs are reasonable. Because HSE
        failed to produce any evidence concerning SAMCO’s fully
        allocated cost, the Commission is unable to determine whether
        the market prices charged by SAMCO, while at or below costs of
        its competitors, are at or below SAMCO’s fully allocated cost.

        Similarly, while the 10% management fee may be customary in
        the industry, SAMCO has failed to provide any evidence of what
        the actual fully allocated management cost is. In the absence of
        any evidence of actual cost, we decline to include the proposed
        management fee in rates.

        Despite the failure to provide fully allocated cost information, we
        decline to deny recovery of all SAMCO-related expenses.
        Regardless of what entity performs the services tasked to
        SAMCO, those services are reasonable and necessary to the
        provision of utility service. The issue is the level of expense that
        should be approved in light of the evidence of record. Because
        HSE failed to demonstrate SAMCO’s fully allocated costs, the
        Commission declines to approve [HSE’s] proposed $115,498
        ($54,728+$60,770) 3% increase in its contract operations cost
        with SAMCO, and accepts the OUCC’s proposed $62,330 10%
        management fee reduction. Accordingly, we find SAMCO’s pro
        forma Contract Services-Other expenses are at $2,003,649 and its
        pro forma Contract Services-Engineering expenses are
        $1,822,762.

        In its next rate case, we direct HSE to offer evidence supporting
        SAMCO’s fully allocated cost so that the Commission may
        determine the appropriate level of SAMCO expenses that should
        be included in HSE’s rates. Further, we direct HSE to file with

Court of Appeals of Indiana | Opinion 93A02-1612-EX-2742 | September 28, 2017   Page 15 of 26
               the Commission all current affiliate agreements within 30 days of
               the date of this Order.

       (Appellant’s App. Vol. II, p. 27).

[25]   NARUC “has issued guidelines for cost allocations and affiliate transactions.”

       (OUCC Exh. 1—Non-Conf. Exh. Vol. III, p. 38). These guidelines “are

       intended to provide guidance to jurisdictional regulatory authorities and

       regulated utilities and their affiliates in the development of procedures and

       recording of transactions for services and products between a regulated entity

       and affiliates.” (OUCC Exh. 1—Non-Conf. Exh. Vol. III, p. 171). NARUC

       recommends that “[g]enerally, the price for services, products and the use of

       assets provided by a non-regulated affiliate to a regulated affiliate should be at

       the lower of fully allocated cost or prevailing market prices. Under appropriate

       circumstances, prices could be based on incremental cost, or other pricing

       mechanism as determined by the regulator.” (OUCC Exh. 1—Non-Conf. Exh.

       Vol. III, p. 174).

[26]   Evidence presented at the hearing indicates that in HSE’s prior rate case, the

       Commission found SAMCO’s rates to be reasonable based on evidence of

       SAMCO’s “market rates for its services” without regard to evidence of

       SAMCO’s fully allocated costs. (OUCC Exh. 1—Non-Conf. Exh. Vol. III, p.

       40). By suddenly shifting course in the present case and requiring compliance

       with the standard suggested by NARUC, HSE now contends that the

       Commission engaged in improper rulemaking contrary to the Administrative

       Rules and Procedures Act. However, we need not consider whether the
       Court of Appeals of Indiana | Opinion 93A02-1612-EX-2742 | September 28, 2017   Page 16 of 26
       Commission has attempted to promulgate a new rule without going through the

       appropriate channels because we agree with HSE’s alternative argument that

       the Commission acted arbitrarily. See Citizens Action Coalition of Ind., Inc., 74

       N.E.3d at 563 (noting that the Commission’s order is binding unless it is

       arbitrary) (quoting N. Ind. Pub. Serv., 907 N.E.2d at 1016). We are mindful of

       the Commission’s broad discretion and responsibility for considering all aspects

       of a utility’s operations to determine a just and reasonable rate. United States

       Gypsum, Inc., 735 N.E.2d at 798; see I.C. § 8-1-2-4. Nevertheless, the

       Commission’s unexplained reliance on a heretofore unapplied standard

       recommended by NARUC renders its decision arbitrary. See BLACK’S LAW

       DICTIONARY 112 (8th ed. 2004) (defining “arbitrary” as “[d]epending on

       individual discretion . . . rather than by fixed rules, procedures, or law”).

[27]   In Cellco Partnership v. Ind. Utility Regulatory Comm’n, 810 N.E.2d 1137, 1144

       (Ind. Ct. App. 2004), the Commission departed from its own precedent

       concerning the confidentiality of certain data. Our court found no error in the

       Commission’s decision “to take a different approach” because the

       Commission’s findings made it clear that the Commission had “fully examined

       the issues” of the case and clearly explained why it had decided inconsistently

       with its own prior orders. Id. See also Ind. Bell Tel. Co. v. Ind. Util. Regulatory

       Comm’n, 810 N.E.2d 1179, 1186 (Ind. Ct. App. 2004) (“We note that an agency

       may change its course and is not forever bound by prior policy or precedent.

       That is, where a policy or precedent is flawed and needs to be changed, the

       agency may change the course as long as it explains the reasons for doing so.”),

       Court of Appeals of Indiana | Opinion 93A02-1612-EX-2742 | September 28, 2017   Page 17 of 26
       trans. denied. Here, the Commission found that the evidence established that

       SAMCO’s rates are “at or below the” prevailing market rates, and that its

       management fee is “customary in the industry.” (Appellant’s App. Vol. II, p.

       27). Even though this type of evidence was sufficient to establish the

       reasonableness of SAMCO’s charges in HSE’s prior rate case, the Commission

       failed to explain its decision to now adhere to the standard advocated by

       NARUC that the test for reasonableness is the lower of fully allocated cost or

       prevailing market prices. Moreover, although the OUCC presented vague

       evidence indicating that the Commission has “approved affiliate guidelines and

       cost allocation guidelines” in other utility cases, there is no evidence that it has

       previously enforced NARUC guidelines in this manner. Accordingly, we

       reverse the Commission with respect to the SAMCO fees and remand for either

       additional support for its decision or a recalculation of HSE’s rate.

                                         B. Working Capital Allowance

[28]   HSE also claims that the Commission erroneously excluded SAMCO’s charges

       from its calculation of a working capital allowance. “Cash working capital

       represents the funds needed to be invested in the utility to give the utility the

       financial wherewithal to pay reasonable [operating and management] expenses

       in the ordinary course of business prior to recovery in rates.” (Appellant’s App.

       Vol. II, p. 15). “In other words, working capital is the money a utility must use

       to provide utility service before it receives payment for that service.” (OUCC

       Exh. 1—Non-Conf. Exh. Vol. III, p. 24). “Working capital is considered an

       investment necessary for providing utility service and is included in rate base for

       Court of Appeals of Indiana | Opinion 93A02-1612-EX-2742 | September 28, 2017   Page 18 of 26
       investor-owned utilities.” (OUCC Exh. 1—Non-Conf. Exh. Vol. III, pp. 24-

       25).

[29]   In this case, HSE calculated its working capital by using the Federal Energy

       Regulatory Commission’s (FERC) 45-day methodology, which the

       Commission has previously approved.

                The FERC 45 day formula method calculates a percentage of
                operating expenses as the estimate of the working capital
                requirements for a utility. This method assumes the difference
                between the lead/lag periods[5] . . . is 45 days and calculates
                12.5% (45 days/360 days) of adjusted annual operating expenses
                as cash working capital. This methodology typically adjusts
                operating expenses for those items known to be paid after the
                receipt of revenues or paid “in arrears.” The advantage of the
                formula method is that it is quick and inexpensive and has
                generally been thought to be a reasonable estimate of what a
                lead/lag study would produce without the related expense of a
                lead/lag study.

       (OUCC Exh. 1—Non-Conf. Exh. Vol. III, p. 26). HSE requested “an

       allowance for 45 days capital in the amount of $813,089.” (HSE Exh. 3—Non-

       Conf. Exh. Vol. I, p. 169). However, the OUCC, in addition to arguing about

       the impropriety of the FERC 45-day methodology, sought the removal of

       5
         A lead/lag study “measures the differences between (1) the time services are rendered until the revenues for
       that service are received, and (2) the time expenses are incurred until those expenses are paid.” (OUCC Exh.
       1—Non-Conf. Exh. Vol. III, p. 25).

       Court of Appeals of Indiana | Opinion 93A02-1612-EX-2742 | September 28, 2017                    Page 19 of 26
       SAMCO’s charges from the working capital calculation. In particular, the

       OUCC’s evidence provided that

               [t]he fees and cost reimbursements HSE pays to SAMCO are
               generally billed at the end of the month and paid during the
               subsequent month. Therefore, SAMCO charges are paid in
               arrears when HSE has begun receiving revenues from its
               customers. There is no lag between when the expense is paid and
               when revenues are received. Therefore, there is no need to
               include these costs in the calculation of working capital.

       (OUCC Exh. 1—Non-Conf. Exh. Vol. III, p. 27).

[30]   Although it approved the FERC 45-day methodology, the Commission

       otherwise agreed with the OUCC and found:

               The reason that purchased utility expenses have been removed in
               accordance with the 45-day method is that such services are
               payable after utility customers make payment for the utility
               service that utilized the expense. For affiliate expenses such as
               those at issue here, we see little reason to require ratepayers to
               provide a return to the shareholders when the shareholders are on
               both sides of the transaction, especially in light of our concerns
               over the cost of the SAMCO services . . . . There is no reason that
               SAMCO could not adjust billing cycles so that SAMCO bills
               would be payable after customer payments were received by
               HSE. Ultimately, we agree with the OUCC that SAMCO
               expenses should be removed from HSE’s working capital
               calculation.

       (Appellant’s App. Vol. II, p. 16). After removing SAMCO expenses and

       making other adjustments, the Commission determined that HSE’s “revised

       working capital allowance is $111,779.” (Appellant’s App. Vol. II, p. 16). HSE

       Court of Appeals of Indiana | Opinion 93A02-1612-EX-2742 | September 28, 2017   Page 20 of 26
       now asserts that the Commission improperly “disallowed the SAMCO charges

       because of HSE’s purported failure to provide evidence of SAMCO’s ‘fully

       allocated cost’ information and its unwarranted assumption that SAMCO could

       simply delay billing HSE.” (HSE’s Br. p. 48).

[31]   In HSE’s prior rate case, the Commission approved SAMCO’s charges in

       HSE’s working capital. However, based on the OUCC’s testimony in the

       present case, the Commission found that SAMCO’s “services are payable after

       utility customers make payment for the utility service that utilized the expense.”

       (Appellant’s App. Vol. II, p. 16). As described by the OUCC, the FERC 45-day

       methodology “adjusts operating expenses for those items known to be paid . . .

       in arrears.” (OUCC Exh. 1—Non-Conf. Exh. Vol. III, p. 26). During rebuttal,

       HSE simply argued that “[t]he OUCC’s proposal for working capital is

       completely unreasonable for a utility even a fraction of the size of HSE.” (HSE

       Exh. 7—Non-Conf. Exh. Vol. IV, pp. 107-08). HSE also noted that

       “everything is paid in arrears, but so are the revenues. The revenues are billed

       in arrears and collected in arrears also, so there still has to be money to—you

       can’t operate with no money in the bank.” (Tr. Vol. II, pp. 18-19).

[32]   Notwithstanding the Commission’s other findings relating to its concerns about

       SAMCO’s excessive cost or its ability to adjust its billing cycle, there is evidence

       to support the Commission’s determination that SAMCO’s expenses are paid in

       arrears. To find otherwise would amount to reweighing the evidence.

       Accordingly, we find no error in the Commission’s decision to exclude

       SAMCO’s charges from the calculation of HSE’s working capital.

       Court of Appeals of Indiana | Opinion 93A02-1612-EX-2742 | September 28, 2017   Page 21 of 26
                                        III. System Development Charge

[33]   Upon HSE’s request, the Commission granted a $450 increase to HSE’s SDC in

       all service areas. This amounted to a total of $2,850 per EDU for most areas

       and $3,650 for the Flatfork Creek area. As HSE explained, the Flatfork Creek

       area required a higher SDC because the developer was entitled to an $800

       surcharge “until 1750 EDUs are developed in the . . . area.” (HSE Exh. 3—

       Non-Conf. Exh. Vol. I, p. 164). The OUCC agreed with the SDC increase.

[34]   After the parties had presented their evidence, on May 17, 2016, HSE filed its

       Submission of Exceptions and Reply Brief in response to the OUCC’s proposed

       order for the Commission. In its Exceptions and Reply Brief, HSE stated:

               In October 2015, after HSE filed this rate proceeding, HSE’s
               commitment to the seller of the Flatfork utility to pay $800 for
               each EDU developed in the Flatfork [area] w[as] satisfied, and
               HSE stopped collecting the $800 supplemental SDC in the
               Flatfork [area]. Therefore, Section 14 of HSE’s Proposed Order
               submitted to the Commission on April 1, 2016, should be
               changed to reflect that the $800 supplemental SDC in the
               Flatfork . . . area is no longer being collected, and that the tariff
               filed in this rate matter should reflect a uniform SDC of $2,850
               per EDU in all service areas of HSE, including the Flatfork . . .
               area.

       (Appellant’s App. Vol. III, p. 39).

[35]   HSE now argues “that the Commission erred in approving an SDC of $3,650

       per EDU for the Flatfork Creek service area when HSE only sought an SDC of

       $2,850 per EDU.” (HSE’s Br. p. 52). However, as the OUCC points out,

       Court of Appeals of Indiana | Opinion 93A02-1612-EX-2742 | September 28, 2017   Page 22 of 26
       HSE’s Exceptions and Reply Brief “is argument of counsel and is not evidence

       that was entered into the record.” (OUCC’s Br. p. 46). While we certainly

       recognize that HSE should not be collecting excessive fees, it cannot be said

       that the Commission somehow erred by relying on the evidence that was

       properly before it.

                    IV. Cross-Appeal: Inclusion of Income Taxes in Rate Calculation

[36]   The OUCC claims that the Commission erred by allowing HSE to recover

       income taxes in its rates. During the hearing, evidence was presented that HSE

       is organized as an S Corporation. Thus, “[f]or federal and state income tax

       purposes, the shareholders of HSE have consented to have HSE’s income taxed

       directly to them.” (HSE Exh. 2—Non-Conf. Exh. Vol. I, p. 125). “In lieu of

       HSE paying taxes, the shareholders of an S Corporation are taxed on their

       proportionate share of the company’s taxable income at each individual

       shareholder’s respective tax rate.” (HSE Exh. 2—Non-Conf. Exh. Vol. I, pp.

       125-26). Accordingly, the OUCC insists that “authorizing HSE to include any

       state or federal income tax liability in its revenue requirement means HSE will

       be allowed an expense HSE will never incur.” (OUCC’s Br. p. 46).

[37]   The Commission must “establish a level of rates and charges sufficient to allow

       the utility to meet its operating expenses as well as a return on investment to

       compensate its investors.” South Haven Waterworks v. Office of Util. Consumer

       Counselor, 621 N.E.2d 653, 654 (Ind. Ct. App. 1993). “Operating costs

       represent one component in the equation to determine the utility’s total revenue

       requirement[,]” and “[t]he taxes paid by a utility are included within its

       Court of Appeals of Indiana | Opinion 93A02-1612-EX-2742 | September 28, 2017   Page 23 of 26
       operating costs.” Id. In the absence of an “adjustment for taxes, operating

       expenses will be lower resulting in a lower total revenue requirement.” Id. at

       654-55.

[38]   Although HSE’s tax liability is passed through to its shareholders, the

       Commission has previously recognized “the benefits of S Corporations as

       compared to C Corporations” because “the S Corporation structure tends to

       benefit both shareholders and ratepayers, under current tax laws, by avoiding

       higher C Corporation tax rates.” (HSE Exh. 2—Non-Conf. Exh. Vol. I, pp.

       127-28). As HSE explained, if, in the calculation of its rates, it were prohibited

       from including the tax liability that its shareholders incur, it “would inevitably

       convert to a . . . C [C]orporation” so that it could recover its tax expense. (HSE

       Exh. 8—Non-Conf. Exh. Vol. IV, p. 136). This would result in HSE paying

       higher taxes, “and in turn, HSE’s customers would pay more tax expense.”

       (HSE Exh. 8—Non-Conf. Exh. Vol. IV, p. 137). In the present case, the

       Commission found:

               We previously addressed treatment of S-Corporation taxes in
               Cause No. 43761, and decline the OUCC’s invitation to
               reconsider our conclusion in that Cause, with the exception of
               the appropriate federal rate applicable to each shareholder. HSE
               included in its cost of service calculation an effective income tax
               rate based upon the Commission’s methodology approved in
               Cause No. 43761. In that proceeding, the Commission found the
               appropriate method to determine actual federal income taxes is
               based on the individual shareholder’s rates used by the Internal
               Revenue Service during the test year as if no other income is
               earned by the shareholder. Using the Commission’s approved
               methodology from Cause No. 43761, HSE calculated a

       Court of Appeals of Indiana | Opinion 93A02-1612-EX-2742 | September 28, 2017   Page 24 of 26
               combined federal and state tax rate of 27.43% to be used in its
               cost of service calculations.

               During the hearing, the OUCC established that HSE’s
               shareholders have differing filing statuses, such as married filing
               jointly. In Cause No. 43761, it appears that the Commission
               calculated HSE’s tax rate using the tax rates applicable for single
               filing status. We find that it would be more appropriate to use
               the actual filing status of each HSE shareholder to calculate the
               tax rate. In doing so, HSE’s combined federal and state tax rate
               shall be 26.82%.

       (Appellant’s App. Vol. II, p. 29).

[39]   In South Haven, 621 N.E.2d at 655, this court determined that the utility, an S-

       Corporation, was “not entitled to an adjustment to operating expenses” based

       on its purported income tax. Although the South Haven court recognized that

       the utility itself does not incur a tax liability, it did not hold that S-Corporations

       are precluded from recovering the tax liability that is passed through to

       shareholders in its rates. Id. Rather, there was no evidence presented that the

       utility’s “shareholders actually paid income taxes attributable to income from

       [the utility] during the test year or at any other time. The adjustment for

       income tax expenses of a corporation is available only when the corporation

       can demonstrate that taxes were actually paid.” Id. Without evidence of the

       actual taxes paid, the South Haven court determined that to assign a certain tax

       liability as an operating expense incurred by the utility “would be speculative,

       arbitrary, hypothetical and unsupported by the record.” Id.

       Court of Appeals of Indiana | Opinion 93A02-1612-EX-2742 | September 28, 2017   Page 25 of 26
[40]   Conversely, in the present case, evidence was presented that the shareholders of

       HSE actually paid income taxes at their personal rates for income attributable

       to HSE. The Commission clearly recognized that ratepayers would be

       subjected to higher rates to compensate for increased operating costs if the

       utility had to pay the higher tax rates of a C Corporation. The Commission

       exercised its discretion to calculate a just and reasonable rate. Therefore, we

       find no error in the Commission’s determination that HSE may recover, as part

       of its operating costs, the income taxes its shareholders actually paid.

                                              CONCLUSION
[41]   Based on the foregoing, we conclude that the Commission is not a proper party

       to this appeal and is hereby dismissed. We further conclude that the

       Commission acted arbitrarily in excluding HSE’s affiliate expenses (the 3%

       contract increase and 10% management fee) from HSE’s rate calculation by

       relying on the NARUC guidelines without explanation; however, the

       Commission was within its discretion to consider the evidence and exclude the

       paid-in-arrears affiliate expenses from HSE’s calculation of working capital. In

       addition, we conclude that the Commission did not err in its conclusion

       regarding HSE’s SDC based on the evidence presented. Finally, the

       Commission properly permitted HSE to recover its passed-through income tax

       liability in its rates.

[42]   Affirmed in part, reversed in part, and remanded.

[43]   Robb, J. and Pyle, J. concur

       Court of Appeals of Indiana | Opinion 93A02-1612-EX-2742 | September 28, 2017   Page 26 of 26