Authority Of Certain Second Class Cities To Transfer Surplus Funds From Their Utility Accounts To Current Expense Funds

CITIES AND TOWNS—MUNICIPALITIES—UTILITIES—Authority Of Certain Second Class Cities To Transfer Surplus Funds From Their Utility Accounts To Current Expense Funds
1.         A city subject to RCW 35.23.535 may transfer excess income from its utility fund to its current expense fund.

2.         The annual charge under RCW 35.23.535 paid from a city’s utility fund to the current expense fund authorizes a city to recover costs not accounted for in direct repair, replacement, interest, or depreciation charges.

3.         Under RCW 35.92.050, a city has authority to determine its utility rates. If ratepayers challenged the rates in court, a court would review the rates under a deferential standard, but might reject rates it deems unreasonable, arbitrary, or capricious.

August 4, 2015

Dear Representative Short:

            By letter previously acknowledged, you requested our opinion on the interplay between and limits of RCW 35.23.535, RCW 35.37.020, RCW 35.92.050, and RCW 43.09.210 [1] and asked three specific questions that we paraphrase as follows:

1.         Must a city subject to RCW 35.23.535 reduce its utility rates if it routinely has a yearly surplus in its utility account, or may the city regularly transfer the yearly excess to its current expense fund?

2.         RCW 35.23.535’s definition of “maintenance and operating charges” includes an annual charge paid to a city’s current expense fund. What is the purpose of this charge?

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3.         Does a city have sole discretion to determine whether its power utility rates are reasonable under applicable law?

BRIEF ANSWERS

            1.         A city subject to RCW 35.23.535 must charge enough to cover its utility maintenance and operation costs. If a city routinely has a surplus in its utility fund, the city has discretion to choose between (1) reducing its utility rates and (2) transferring the surplus to its current expense fund. Nonetheless, a substantial surplus in the utility fund year after year may call into question whether the city is charging reasonable utility rates, an issue discussed further in response to question 3 below.

            2.         The purpose of RCW 35.23.535’s annual charge paid from the city’s utility fund into the current expense fund is to compensate cities for costs incurred in owning a utility that are not accounted for in direct repair, replacement, interest, or depreciation charges.

            3.         A city generally has authority to determine whether its power utility rates are reasonable. If displeased, ratepayers can indirectly affect a city’s utility rates by replacing the city’s elected officials at the next election. The rates are also potentially subject to judicial review as unreasonable or arbitrary and capricious. A court reviewing a city’s utility rates would give deference to the city and likely would find such rates to be reasonable and not arbitrary or capricious if the rates are reasonably related to the city’s actual cost of providing the service.

BACKGROUND

            Your questions ask about the interplay among four statutes: RCW 35.23.535, RCW 35.37.020, RCW 35.92.050, and RCW 43.09.210. Each addresses, at least in part, the accumulation and transfer of monies in certain cities’ power utility accounts. For a city to be subject to all four statutes, it must be a second-class city with less than 20,000 persons. The more specific statutes expand upon, or provide exceptions to, the more general statutes. In analyzing the statutes, this opinion responds to general questions rather than applying the statutes to particular facts. Further, this opinion focuses on power utilities, though three of the statutes additionally address other types of utilities.

            Under RCW 43.09.210, all local taxing or legislative bodies must keep separate accounts for every appropriation or fund and track each payment from each account (when, how, and the reason a payment is made, as well as to whom it is made). Taxing districts also must keep separate accounts for each “department, public improvement, undertaking, institution, and public service industry[.]” The statute generally prohibits transferring anything of value from one account to another unless the taxing district is able to show that the transferring accounts exchanged assets or services of equal value. A specific statutory exemption may override the obligation to show an exchange of equal value. See AGO 1994 No. 24, at 9 (citing State v. Grays Harbor County, 98 Wn.2d 606, 610, 656 P.2d 1084 (1983)).

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            RCW 35.92.050 authorizes cities and towns to acquire, maintain, and operate a supply system for lighting, heating, fuel, and power purposes. It grants municipalities “full authority to regulate and control the use, distribution, and price[.]” RCW 35.92.050 applies to all categories of cities and towns.

            The legislature adopted the earliest version of the provision now codified as RCW 35.92.050 in 1890. Laws of 1890, p. 520, § 1. The legislature has since replaced, added to, divided, and recodified the provisions of the 1890 act several times. The substance of the provisions concerning power utilities, however, has remained relatively unchanged. See City of Tacoma v. Taxpayers of the City of Tacoma, 108 Wn.2d 679, 696, 743 P.2d 793 (1987).

            RCW 35.37.020 affects cities and towns with less than 20,000 inhabitants and owning “utilities and institutions.” The statute provides that if revenue from the municipality’s utility does not cover the utility’s operation and maintenance costs, the municipality must pay for the deficit out of its current expense (general) fund. The municipality also must transfer any year‑end surplus in its “waterworks fund, lighting fund, cemetery fund, or other like funds” into the current expense fund. The city or town can avoid transferring the surplus if its governing body finds that the utility account needs the surplus to:

            (1)       Extend or repair the utility;

            (2)       Pay interest or principal of any indebtedness incurred in the construction or purchase of the utility; or

            (3)       Create or add to a sinking fund for the payment of any indebtedness incurred in the construction or purchase of the utility.

            The legislature originally adopted the provisions in RCW 35.37.020 in 1897 as an act concerning “taxes and funds of municipal corporations having less than twenty thousand inhabitants.” Laws of 1897, ch. 84. The act generally provided for a system of accounting and a means for such municipalities to acquire and calculate debt. At the time of enactment, the legislation affected all cities and towns other than first-class cities. See Laws of 1889-90, p. 140‑41, § 12 (classifying first-class cities as those with more than 20,000 inhabitants). The act directed all such municipalities to establish a “current expense fund,” an “indebtedness fund,” and a separate fund for each of the utilities owned by the municipality. Laws of 1897, ch. 84, §§ 1, 10.

            RCW 35.23.535 concerns second-class cities. A second-class city is currently defined as a city with a population of 1,500 or more at its last organization that is not a charter city under article XI, section 10 of the Washington Constitution nor a code city under RCW Title 35A. [2] RCW 35.01.020. The statute prohibits second-class cities from imposing taxes for the maintenance and operation costs of public utilities. Instead, such cities must adopt ordinances to

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fix utility rates sufficient to meet “all operating and maintenance charges.” The statute defines “maintenance and operating charges” to include “all necessary repairs, replacement, interest on any debts incurred in acquiring, constructing, repairing and operating plants and departments and all depreciation charges.” The term also includes an annual charge that the utility must pay into the current expense fund—but only if the utility has no outstanding utility bonds. The annual charge is equal to four percent of the cost of the plant or system (the state auditor determines the value). If the city’s utility rates produce a “greater amount than is necessary to meet operating and maintenance charges” (which includes the four percent charge), the statute provides that “the rates may be reduced or the excess income may be transferred to the city’s current expense fund.”

            When originally enacted in 1915, the provision now codified as RCW 35.23.535 applied to third-class, not second-class, cities. Laws of 1915, ch. 184. Otherwise, the substance of the act has remained relatively unchanged since enactment. Third-class cities were municipal corporations with less than 10,000, but more than 1,500 inhabitants. See Laws of 1889-90, p. 140-41, § 12. The 1994 legislature consolidated third-class cities into a new definition of second-class cities. Laws of 1994, ch. 81, §§ 4, 90.

ANALYSIS

            The element common to all the referenced statutes is that each affects the accumulation and transfer of monies in a city’s power utility account. Different statutes relating to the same subject matter “are to be read together as constituting a unified whole, to the end that a harmonious, total statutory scheme evolves which maintains the integrity of the respective statutes.” Hallauer v. Spectrum Props., Inc., 143 Wn.2d 126, 146, 18 P.3d 540 (2001) (quoting State v. Wright, 84 Wn.2d 645, 650, 529 P.2d 453 (1974)). Where statutes cannot be reconciled, the more specific statute prevails over the more general, unless the legislature has otherwise indicated. Hallauer, 143 Wn.2d at 146. In reconciling statutes, the sequence of all statutes relating to the same subject matter may be considered. Id.

            The most general of the four statutes is RCW 43.09.210. It establishes a uniform system of public accounting for all local taxing or legislative bodies. It prohibits transfer between funds without consideration.

            RCW 35.92.050 is more specific than RCW 43.09.210 because it concerns only cities and towns, not all taxing districts. It also is specific in that it grants an explicit power to cities and towns to acquire, maintain, and operate power systems. This includes “full authority to regulate and control the . . . price[.]” RCW 35.92.050.

            RCW 35.37.020 is more specific than RCW 35.92.050, obligating cities and towns with a population of less than 20,000 to pay for maintenance and operation of utilities out of the current expense fund if the rates set for the utility are insufficient to pay for utility maintenance and operating charges. The statute thus provides an exception to RCW 43.09.210’s limitation on transfers between accounts. It also requires municipalities with less than 20,000 inhabitants to

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transfer any surplus from a utility account to the city’s current expense fund unless the municipality determines that the surplus in the utility account is necessary for utility expansion or repair, debt repayment, or management of the debt through a sinking fund.

            The most specific statute is RCW 35.23.535. It affects only second-class cities. It explicitly requires such cities to use utility rate revenue, not taxes, to pay for operation and maintenance of utilities. It adds detail to RCW 35.92.050’s general authority for cities to establish the price of utility use by requiring second-class cities to charge rates sufficient to pay for maintenance and operation. Like RCW 35.37.020, it provides an exception to RCW 43.09.210’s limitation on transfers between accounts, allowing second-class cities to transfer utility surpluses to their current expense accounts. Unlike RCW 35.37.020, however, it does not require second-class cities to pay for utility deficits from the current expense account. Finally, the statute specifies what a second-class city must include in maintenance and operation charges: repairs, replacement, interest on debt, depreciation, and—if the utility does not have unpaid bond debts—an annual charge of four percent of the cost of the plant or system.

            The sequence in which the legislature enacted the three statutes concerning municipally owned utilities mirrors the general-to-specific spectrum. Beginning in 1890, the legislature enacted the most general of the statutes, now codified as RCW 35.92.050, providing broad authority for all cities and towns to acquire and maintain utilities. The 1897 legislature amended the general authority in the more specific provision now codified as RCW 35.37.020; as a result, municipalities other than first-class cities were obligated to resolve surpluses and deficits in utility accounts through exchanges with a current expense account. Next, the 1915 legislature further narrowed the authority of third-class cities in the most specific provision now codified as RCW 35.23.535 which requires such cities to use revenue, not taxes, to pay for maintenance and operation of utilities. Finally, seventy-nine years after enacting RCW 35.23.535, the legislature consolidated the third-class cities into second-class cities, thereby making all second-class cities subject to the limitations previously reserved to only third-class cities.

            With this harmonized statutory framework in mind, we turn now to your particular questions:

1.         Must a city subject to RCW 35.23.535 reduce its utility rates if it routinely has a yearly surplus in its utility account, or may the city regularly transfer the yearly excess to its current expense fund?

            When analyzing the meaning of a statute, the “fundamental objective is to ascertain and carry out the Legislature’s intent[.]” Dep’t of Ecology v. Campbell & Gwinn, L.L.C., 146 Wn.2d 1, 9, 43 P.3d 4 (2002). A statute’s plain language expresses legislative intent where the meaning of a statute is clear on its face. Id. Where a statute contains both “shall” and “may,” the presumption is that the legislature intended different meaning for each, with “shall” as mandatory and “may” as permissive. Scannell v. City of Seattle, 97 Wn.2d 701, 704-05, 648 P.2d 435, 656 P.2d 1083 (1982).

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            RCW 35.23.535 states that a second-class city “shall” fix utility rates by ordinance “sufficient to pay for all operating and maintenance charges.” If the rates produce more revenue than needed for such charges, then RCW 35.23.535 provides that the city “may” reduce rates or “may” transfer the excess income to its current expense fund. The statute’s use of “shall” and “may” provides a plain indication of legislative intent: (1) the city must charge rates sufficient to cover its utility operation and maintenance charges as defined in RCW 35.23.535; (2) if the rate charged produces more revenue than needed for operation and maintenance, then the city has discretion to choose either to reduce rates or to transfer the excess to its current expense fund.

            The underlying issue, however, is whether it is permissible for a city routinely to have a yearly surplus in its utility account, especially if that surplus is substantial. A second-class city’s only statutory obligation in setting rates under RCW 35.23.535 is to charge enough to cover maintenance and operation charges. Is it then reasonable for a city to charge more than is statutorily required, thereby creating a yearly excess in its utility account that can be transferred to its current expense account and used for other purposes? We address this issue below because it also underlies your third question: whether a city has sole discretion to determine whether its utility rates are reasonable.

2.         RCW 35.23.535’s definition of “maintenance and operating charges” includes an annual charge paid to a city’s current expense fund. What is the purpose of this charge?

            RCW 35.23.535 specifies the items a second-class city can calculate as maintenance and operation “charges” that must be covered by utility rates. These include “all necessary repairs, replacement, interest on any debts incurred in acquiring, constructing, repairing and operating plants and departments and all depreciation charges.” Such charges also expressly include an annual “charge” equal to four percent of the cost of the plant or system. The legislature offered no explicit statement of purpose in authorizing this “charge.”

            Without a statutory definition for a term, its meaning may be ascertained from an ordinary dictionary definition. Lindeman v. Kelso Sch. Dist. 458, 162 Wn.2d 196, 201-02, 172 P.3d 329 (2007). The word “charge,” when used as a noun in a financial context, has the ordinary meaning of “expenditure or incurred expense [for] payment of costs.” Webster’s Third New International Dictionary 377 (2002). The statute’s language thus suggests that the purpose of the four percent charge is to authorize second-class cities to recover “expenditure[s] or incurred expense[s]” that arise from owning a utility but may not be reflected in direct charges to the utility. That said, because the legislature has specified the amount that “shall be” charged, the charge does not require a showing that the city actually incurred such additional costs in connection with the utility.

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3.         Does a city have sole discretion to determine whether its power utility rates are reasonable under applicable law?

            Our office’s longstanding view is that cities generally have broad authority to set utility rates, which may include a small profit. We caution, however, that there is uncertainty in the case law concerning municipal rate setting authority, and this authority is not unlimited. A court would likely invalidate rates that become too remote from actual costs and are clearly being set to subsidize other city services.

            Statutory law appears to favor broad authority for municipalities to set rates. RCW 35.23.535 sets the minimum that a second-class city must charge for utilities, but otherwise does not require a particular method of setting rates. At the same time, RCW 35.92.050, provides that cities and towns have “full authority to regulate and control the. . . price” of the utility. Taken together, the statutes suggest that a city has sole discretion to control its utility rates, so long as second-class cities set rates sufficient to cover certain expenses specified in that statute. The question, then, is whether some other statute or common law principle limits cities’ control over utility rates.

            No other statute appears to limit municipal rate setting authority. Though RCW Title 80 subjects rates set by certain private utilities to review by the Washington Utilities and Transportation Commission, the legislature has not created an agency to review the rates set by publicly owned utilities such as city-owned utilities or public utility districts governed by RCW Title 51. One reason treatment of private and public utilities differs may be that elected officials in publicly owned utility jurisdictions are accountable to voters. Snohomish County Pub. Util. Dist. 1 v. Broadview Television Co., 91 Wn.2d 3, 8-9, 586 P.2d 851 (1978); see also Earle M. Jorgensen Co. v. City of Seattle, 99 Wn.2d 861, 867, 665 P.2d 1328 (1983).

            As for common law principles, although no statute explicitly allows judicial review of municipal utility rates, our state courts have routinely stated or assumed that public utility rates are judicially reviewable. See, e.g., Faxe v. City of Grandview, 48 Wn.2d 342, 294 P.2d 402 (1956); Earle M. Jorgensen Co., 99 Wn.2d at 870 (recognizing “judicial power to set aside discriminatory, arbitrary, and unreasonable rates”); King County Water Dist. 54 v. King County Boundary Review Bd., 87 Wn.2d 536, 546, 554 P.2d 1060 (1976) (“nonresidents of the city are protected from truly discriminatory, arbitrary and unreasonable rates by the courts”). [3] We therefore believe that such rates are subject to judicial review, but under a deferential standard

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            A ratepayer challenging a public utility rate as excessive faces a heavy burden. Washington courts have consistently held that ratemaking is a legislative function. See People’s Org. for Washington Energy Res. v. Washington Utils. & Transp. Comm’n, 104 Wn.2d 798, 807‑08, 711 P.2d 319 (1985). Thus, ratemaking is entitled to the deference ordinarily given to legislative acts, and a court will not usurp for itself legislative authority to fix rates. Id. “Rates established by a municipality for utility service to inhabitants are presumptively reasonable.” Faxe, 48 Wn.2d at 352 (citing City of Detroit v. City of Highland Park, 326 Mich. 78, 39 N.W.2d 325 (1949); Durant v. City of Beverly Hills, 39 Cal. App. 2d 133, 102 P.2d 759 (1940)). A court will review a city’s ratemaking decision only to consider whether the rates are “reasonable, nondiscriminatory, [and] not arbitrary or capricious.” Earle M. Jorgensen Co., 99 Wn.2d at 868. In general, a court will find a local government’s action to be arbitrary and capricious if the action is willful and unreasoning, without consideration, and in disregard of the facts and circumstances. Abbenhaus v. City of Yakima, 89 Wn.2d 855, 858-59, 576 P.2d 888 (1978). The burden of showing that a rate is arbitrary and capricious is on the party challenging the rate. E.g., Faxe, 48 Wn.2d at 352; Town of Port Orchard v. Kitsap County, 19 Wn.2d 59, 61, 141 P.2d 150 (1943).

            No court has squarely applied the arbitrary and capricious standard to a city’s ordinary rate setting practices under RCW 35.92.050. In early statehood, the Washington Supreme Court noted in Twitchell—a case clarifying that water rates are not taxes—that a “municipality . . . is not required to limit the rate to the actual expenses of furnishing the water, but may fix a rate which will result in some profit to it, which it may use to meet its other public needs.” Twitchell v. City of Spokane, 55 Wash. 86, 88, 104 P. 150 (1909) (quoting 1 Farnham, Water and Water Rights § 162). Later courts moved away from this early acceptance of profit without citing Twitchell or explaining the change. In Uhler, a case concerning water utility bonds issued by a city, the Court refused to interpret a statute as allowing a city to acquire a waterworks system and then “use it as a money-making venture.” Uhler v. City of Olympia, 87 Wash. 1, 13-14, 151 P. 117, 152 P. 998 (1915). “The object of municipal ownership is to give the citizen the best possible service at the lowest possible price.” Id. Later, when considering the authority of a public utility district to condemn property in Carstens, the Court rejected a concern that utility users outside the district’s territory would not “share in the profits of the operations” because “a municipally owned enterprise . . . may not be operated for profit and must establish its rates at the lowest possible point.” Carstens v. Pub. Util. Dist. 1, 8 Wn.2d 136, 150-51, 111 P.2d 583 (1941).

            Recognizing the tension in the prior cases, our office concluded in a 1955 opinion that a city may fix utility rates to obtain a reasonable profit. AGO 55-57 No. 155 (Nov. 2, 1955). Acknowledging the Uhler and Carstens cases discussed above, the opinion noted that the statements regarding whether a city could obtain a profit were not central to those cases’ outcomes and so amounted to judicial editorializing (dicta). More relevant was the earlier Twitchell case, which had addressed rate-setting specifically, as was the fact that allowing for a

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small profit appeared to be the general rule among other states. Twitchell, 55 Wash. at 2 (citing 12 McQuillin, Municipal Corporations § 35:37 [4]). We continue to believe that while the current state of the law is uncertain, our earlier analysis that a city may make a reasonable profit was correct.

            Although we conclude that a city may operate a utility so as to make a reasonable profit, two distinct lines of cases show that the rates should be set with reference to the costs of the utility rather than the unrelated revenue needs of the city. The concerns raised by the cases do not change our general conclusion that cities have the authority to determine utility rates, but suggest caution given the possibility of judicial review of those rates.

            First, our courts have repeatedly recognized that the purpose of authorizing municipal utilities is to provide utilities as a public benefit rather than provide a revenue source to the municipality. For example, when discussing the purpose of RCW 35.92.050 in City of Tacoma, the Court observed that “[i]n 1909, the policy underlying legislative authorization of municipal utilities was the belief that municipalities could provide lower cost and more efficient electrical service.” City of Tacoma, 108 Wn.2d at 696 (citing 3 J. Dillon, Municipal Corporations § 1291, at 2094 (5th ed. 1911)). The Court in Snohomish County Public Utility District 1 found protection against excessive rates in the “facts that the [public utility] district is publicly owned and operated and that it has no profit motive.” Snohomish County Pub. Util. Dist. 1, 91 Wn.2d at 9. Given these background principles, a court could conclude that a city must exercise its authority to set rates primarily to provide a public benefit rather than to generate revenue.

            Second, a utility rate detached from the costs of providing the service but instead intended to provide revenue for other purposes may be considered an illegal tax. In Okeson, the Court considered a city ordinance to pay for streetlights by increasing the rates paid by customers of the city’s power utility. Okeson v. City of Seattle, 150 Wn.2d 540, 544, 78 P.3d 1279 (2003). The Court held that the rate increase was a tax because (1) it raised revenue for a general governmental purpose and not to regulate, (2) the money raised was not allocated for a regulatory purpose, and (3) there was no relationship between the rate increase and either a service provided to the ratepayer or a burden caused by the ratepayer. Id. at 552-56. The Court then concluded that the tax was unlawfully imposed because the rate increase—and the subsequent statutory amendment authorizing the rate increase—did not explicitly state that it was imposing a tax or the object to which the tax would be applied. Id. at 556, 558. Thus, a court might find that a city that sets its rates with the intent to use its yearly utility fund surplus to fund another governmental function is imposing an illegal tax.

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            In summary, we conclude that cities have broad authority to set utility rates. A ratepayer challenging a public utility rate as excessive would face a heavy burden of proof, and a reviewing court would give substantial deference to the city. But if ratepayers can show that the rates are untethered from costs and set primarily to generate revenue to fund other programs, a court might well invalidate the rates and direct a city to revise them.

            We hope that the foregoing will be useful to you.

ROBERT W. FERGUSON
Attorney General

JANIS SNOEY
Assistant Attorney General

wros

enclosure

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[1] The four statutes are attached as an appendix to this opinion for ease of reference.