No. 11
FAIR RETURN FOR UTILITIES
Fair Return for Utilities – Concept or Reality ?
A. J. de Grandpr6, Q.C.*
Because they provide a service which is essential to the every
day life and since they are traditionally looked upon as natural
monopolies, public utilities are subject to governmental regulation.
Special administrative tribunals make sure that the utilities’ most
important obligation, namely to give the best available service at
the lowest possible price, is fulfilled. In the discharge of this obli-
gation, the regulatory authorities must not deprive the shareholders
of a, fair return on their investment.
Historically, public utilities have become monopolies for two
reasons: first, because it was found that public interest was best
served when costly duplication could be avoided; secondly, because
of the very high investment of fixed capital required for the setting
up of their operations and their continuous need for additional capi-
tal thereafter.
It must be borne in mind that public utilities considered for
the purpose of this article are privately owned corporations. There-
fore it is only natural that their owners will expect it to show a
profit at the end of the year. State-owned utilities are now taking
a more realistic view: they also expect earnings on their invest-
ments. In some cases the rate of return expected by the state is
determined in the enacting legislation.
In our economic system, profit is the goal to which everyone
reaches: motivation behind any investment will be to get a rea-
sonable return; in an ordinary or unregulated enterprise this will
depend on numerous factors such as the measure of demand for
the product sold or the services rendered, the ability to manage the
undertaking, etc. One factor is striking in the field of public utili-
ties: the demand is and will presumably remain constant since the
service is essential and the corporation is the only one capable
of satisfying it. Therefore, if public utilities were not regulated,
their profits might theoretically be the highest.
* Executive Vice-President – Bell Canada.
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[Vol. M6
It will be the regulatory body’s duty to “balance the investor
and the consumer interests”.’ For the latter’s benefit it will make
sure that the service is adequate and provided at just and reason-
able rates. For the corporation and its owners, it will ascertain that
these rates provide a sufficient income.
In curtailing the return or profits which a public utility compa-
ny may earn, the state is taking away something which in principle,
would rightly be its own. When the state of Illinois decided to
regulate the handling and storage of grain in Chicago, it reduced
the rates which were previously charged and one operator contested
that regulation alleging that it was contrary to the XIVth Amend-
ment: this amendment safeguards any citizen from having his
property confiscated by the state, without due compensation. The
Supreme Court of the United States held that the operations regu-
lated by the enactment had become business “affected with a public
interest and had ceased to be juris private only”. 2
But the idea that fixing low rates was equivalent to confiscation
was accepted and thence the concept of a “confiscatory rate of
return”. In the American system, the return to a utility is deter-
mined by a Commission or Board and will not be reviewed by the
Courts unless it is confiscatory. In such cases, the injured party
will seek a writ of certiorari against the Commission on the basis
that it has deprived him of rights guaranteed by the Constitution;
such matters must be dealt with by a Court of Law.
Although the Canadian Constitutional documents contain nothing
comparable to the American XIVth Amendment, the principle is
accepted. As will be seen, several provincial Acts on Public Utilities
guarantee a “just and reasonable” or a “fair” return. The same
principle underlies legislation regarding expropriations.
The Railway Act 3 and some provincial legislations do not specify
the right of a utility to a reasonable return but such right has
been taken for granted by Courts and regulatory bodies.
In 1960 the Supreme Court of Canada 4 clarified this problem in
the following manner: the Public Utilities Act of British Columbia0
‘Federal Power Commission, et al, v. Hope Natural Gas Co., 51 P.U.R. (N.S.)
103, 320 U.S. 591, at p. 603; Re: Area Rate Proceeding for Permian Basin,
75 P.U.R. (Sd) 257.
2 Munn v. Illinois, 94 U.S. .113, at p. 126.
3 R.S.C. 0tG52, c. 234.
4 B.C. Electric Railway Co. Ltd. v. Public Utilities Commission of B.C., [1960]
S.C.R. 837.
5R.S.B.C. 1048, c. 277.
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FAIR RETURN FOR UTILITIES
had repealed a disposition in the old Water Act 6 allowing a public
utility a “fair return on the value of all property acquired by it
and used in providing services to the public…”
The Court wondered if the repeal of that section took away from
the utility its right to a fair return. It decided in the negative and
considered such right as “a common law right”.7 It referred to a
decision of the Judicial Committee of the Privy Council which stated:
In considering the construction and effect of this Act the Board is guided
by the well known principle that a statute should not be held to take away
private rights of property without compensation, unless the intention to do
so is expressed in clear and unambiguous terms.8
Even if it is often mentioned in legislation and discussed by
the Courts, the rate of return has not judicially been defined, either
in the abstract or in its contents, in any exhaustive fashion.
The definition given by Barnes in The Economics of Public
Utility Regulation has been accepted and quoted in numerous in-
stances; it reads thus:
The rate of return is that percentage of the “rate base” which the utility
is entitled to earn for interests, dividend payments, and related requirements.9
In Canada, the following definition has been given:
The rate of return is that percentage which, when multiplied by the rate
base, provides a return which fairly compensates the company for the use
and risks inherent in the investment of its money.’ 0
In other words, the rate of return is the expression in percentage
of what the company is left with after operating expenses and taxes
have been paid and depreciation has been provided for. The con-
tents are subject to changes:
in Barnes’ explanation of “related
requirements”, such items as discounts and costs of marketing on
securities, underwriting fees, etc. are included. The Supreme Court
of the United States held that the return should also provide for
something to be posted to the surplus account.”
The rate of return obtained from the financial statements of
a company will only become significant when compared to that of
6 R.S.B.C. &04 c. 271.
7 B.C. Electric Railway Co. Ltd. v. Public Utilities Commission of B.C., [1960]
8 Colonial Sugar Refining Co. v. Melbourne Harbour Trust Commissioners,
S.C.R. 837, at p. 845.
[1927] A.C. 3, at p. 359.
at p. 516.
280 U.S. 234.
0 I.R. Barnes, The Economics of Public Utility Regulation, (New York: 1047)
1ORe: Shell Oil of Canada, 31 P.U.R. (3d) 503.
11 United Railways & Electric Co. of Baltimore v. West, Chairman, et al,
McGILL LAW JOURNAL
[Vol. 16
other companies where the same investment would have earned more,
or less, or when it is related to general economic conditions.
As appears from these definitions, the rate of return is closely
tied with the rate base. It is not within the scope of this article
to discuss in detail the different methods of determining the rate
base.
Let us say that it varies from one case to another and the fol-
lowing may be considered: the owner’s equity; the total capital;
the net costs of equipment and plant; the net original cost of
same, etc. However, as a result of the Smyth v. Ames 12 decision,
emphasis has been put on the physical assets. In comparing rates
of return, great care must always be taken to make sure that the
rate base is the same in both cases.
The rate of return has been classified as reasonable, confiscatory
or non-reasonable and non-confiscatory. The reasonable rate of re-
turn is that which attracts new capital on favorable terms. As we
have stated earlier, the public utility is always concerned with
getting additional capital in order to meet the increasing demand
for its services, the increase in the price of equipment and labour
and to keep up to date with the latest technological developments.
The utility will therefore constantly be seeking to attract the pros-
pective investor who will look for the best return which his in-
vestment will bring; this, in turn, will be directly related to the
return which the corporation earns.
If the reasonable rate of return attracts additional capital, the
confiscatory one will either fail to do so or will provoke with-
drawals. In practice it is very difficult to diagnose such actions;
although a decrease in the market value might be a symptom, it
is by no means conclusive since it might coincide with a general
downturn in the stock market or profit taking by important stock-
holders. In Barnes’ opinion, a persistent and continued low market
price compared to the book value of the shares, combined with an
unusually high yield, the whole under normal general conditions,
will be a good indication of capital being withdrawn. 3
Between these two concepts stands a “zone of reasonableness”,
which is a zone between the lowest rate of return which is reasonable
and the highest confiscatory one. The concept was expressed by the
Supreme Court of the United States as follows:
12 169 U.S. 466.
1 3 Barnes, op. cit., p. 522.
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FAIR RETURN FOR UTILITIES
Statutory reasonableness is an abstract quality represented by an area
rather than a pinpoint. It allows a substantial spread between what is
unreasonable because too low and what is unreasonable because too high.14
These concepts are general and offer no precise formula to
determine the contents or even the principles governing the con-
tents of a just and reasonable rate of return. Basically, this is
always a question of fact that should be arrived at with good
judgment and common sense. We will ‘look at the ways in which
the Courts of Law and the regulatory bodies have elaborated on
these concepts in the United States and Canada.
American decisions
In 1898, the Supreme Court of the United States recognized and
confirmed that a public utility had a right to earn a “fair return”
and put down the basis of such upon the “reasonable value of its
property used and useful in the public service”. 15 The formula was
immediately subject to discussion in view of the vagueness of such
terms as “fair” and “reasonable value” which were not defined by
the Court. However the decision had settled an important point in
allowing the company the right to a return. Thereafter and to this
day, unless legislation provided otherwise, decisions have been di-
vided on how to ascertain the value of the property, some considering
the original cost and others the reproduction cost, amongst other
factors.
Once this right had been recognized, there remained to determine
the contents of the right and the methods of arriving at a specific
figure. The “cause c6l~bre” which established rules that were there-
after followed, discussed and applied at variance, was the 1923 case
of Bluefield Waterworks and Improvements Co. v. Public Service
Commission of West Virginia, where the rule was thus formulated:
What annual rate will constitute just compensation depends upon many
circumstances and must be determined by the exercise of a fair and en-
lightened judgment, having regard to all relevant facts. A public utility
is entitled to such rates as will permit it to earn a return on the value of
the property which it employs for the convenience of the public equal to
that generally being made at the same time and in the same general part
of the country on investments in, other business undertakings which are
attended by corresponding risks and uncertainties; but it has no consti-
tutional right to profits such as are realized or anticipated in highly profitable
enterprises or speculative ventures. The return should be reasonably suf-
14 Montana-Dakota Utilities Co. v. Northwestern Public Service Commission,
341 U.S. 246, at p. 25,1; see also Federal Power Commission v. Natural Gas
Pipe Line Co., 315 U.S. 575.
15 Smyth V. Ames, supra, n. 12, at p. 546.
McGILL LAW JOURNAL
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ficient to assure confidence in the financial soundness of the utility, and
should be adequate, under efficient and economical management, to maintain
and support its credit and enable it to raise the money necessary for the
proper discharge of its public duties. A rate of return may be reasonable
at one time and become too high or too low by changes affecting opportunities
for investment, the money market, and business conditions generally.18
It appears at the very outset that a Commission having to
determine a rate of return must decide on the merits of the facts
presented to it, just like any Court of Law. The decision must rest
on the evidence adduced before the Commission and should not be
set arbitrarily or with other considerations in mind.
Let us consider the factors which should, according
to the
Supreme Court decision in the Bluefield case, 17 be accounted for in
determining the reasonableness of -a rate of return.
1. As already stated, the public utility is, by the nature of
its obligations,’8 always concerned with attracting additional capital.
Conditions being normal, the utility should be able to do so under
favorable terms, if it offers an interesting return to the investor.
If, for such purpose, the utility has to continually increase its
dividend payments or offer an interest rate on its bonds or de-
bentures higher than that paid by other business or even equal to
the latter (considering that the risk involved is lesser), there is no
doubt that investors will not consider its return adequate since they
will have to be attracted by such extraordinary and artificial means.
2. The comparison that is called for by the Court between the
public utility and “other business undertakings” is vague and has
led to many discussions on its terms. The Court has definitely ruled
out, and understandably, the “highly profitable enterprise” and the
“speculative venture”. If we compare the earnings of two corpora-
tions upon their physical assets, we might be led into error for
we have no assurance that these assets were valued under the same
rules. Since special accounting methods are prescribed for public
utilities, a comparison between two of them might be more appro-
priate, but nowhere is it indicated that both terms of the compari-
son should be utilities. As a matter of fact, if comparisons were
limited to other utilities there would be created a special category,
set apart from general enterprises. This would be nonsense in view
16 262 U.S. 670, at 693.
17 Ibid.
18 In the B.C. Electric Co. Case, supra, n. 4, at p. 852, the Supreme Court
of Canada stated: “These four sections last mentioned involve a statutory
obligation on the part of a public utility to make capital outlays for extension
of its services.”
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FAIR RETURN FOR UTILITIES
of the very important contribution that utilities make to the econo-
my generally. The determination of the rate of return would become
meaningless and fall in uniformity, the comparison with other fields
and economy in general being absent.
A more accurate and realistic approach might be to compare the
return of the particular utility with an average index of all utilities
or industrials, or of a certain number of large corporations of a
particular nature, etc. Such indexes are easily obtainable and will
certainly give an adequate image of the present conditions. Much
later, the Supreme Court of the United States defined the terms
of the comparison as including any “enterprise having corresponding
risks”. 10
3. The third factor to be considered in arriving at a reasonable
rate of return is the general economic conditions. When a public
utility applies for a review of its rates, the data which is furnished
to the Commission is forcibly very recent or is estimated for the
year or years to come, since the changes which it is seeking will
apply in the future. Economic conditions vary from year to year,
even from month to month and this is why it has been often re-
peated that in determining a rate of return a Commission should
not rely on past decisions. These might be considered to ascertain
the variation in economic conditions over a given period of time
but even this might not be indicative of what will happen in the
future. Fortunately, numerous studies and expertises are constantly
being made and adjusted for that purpose, and they may be relied
upon. This is perhaps the most delicate aspect of the decision to be
made by a Commission, for even a slight change in economic con-
ditions may result in the rate of return being confiscatory, if it has
been set on the borderline.
4. The cost of capital is another factor in the making of the
rate and has often been the most important, if not the sole factor.
Both the cost of debt and the cost of equity must be ascertained.
Consideration may be given to the current cost of money or the
historical cost to the company. The former is indicated by the offi-
cial interest rate or the interest on bonds; however utilities usually
pay less because of the reduced risks and the assurance of a quasi
constant demand for services.
If the cost of debt is reasonably easy to ascertain the cost of
equity is far more difficult to determine.
What has been called the “historical cost” of money to the utility
might be an appropriate indication: a computation of the interest
19 FederaZ Power Commission v. Hope Natural Gas Co., supra, n. 1, at p. 603.
McGILL LAW JOURNAL
[Vol. 16
on bonds and the yield on equity which the utility had to offer in
the past to attract investors should help in determining future re-
quirements. This is not to say however that the investor will be
satisfied with a low return even if the risk is considerably reduced
when he can fare much better in an ordinary business undertaking.
This is especially proven nowadays when large corporations with
brilliant prospects affording diminished risks are offering a good
yield and a possibility of capital appreciation.
The capital structure of the company will have a direct bearing
on the cost of its capital, the overall cost being the sum of the cost
of equity and debt capital. 20 As a rule public utilities may have a
higher debt ratio than ordinary enterprise without endangering their
attractiveness to investors because of the lesser degree of risk. The
ratio is of importance to a regulatory body if it considers total capital
as a rate base. The cost of total capital investment will be higher
if it comprises mostly equity capital which costs more to a company.
The reasonableness of the ratio is a question of fact left to the
appreciation of the board or court.
It is often argued that if utilities increased their debt ratio, their
cost of capital would be reduced since the cost of debt is less than
the cost of equity. This may be true, but then the rate of return
would have to be increased under the risk factor since the interest
has to be paid before dividends and the investor might find himself
deprived of dividends because of insufficient earnings.
5. The general feeling is that utilities are not subject to risks.
This may be true to a certain extent only when compared to other
corporations. However, the utility is subjected to general economic
conditions like any business; more so since it is expected to go on
providing services, even if it is deprived of its usual sources of
capital due to a shortage of money, or if the economy is in an
upswing. The same deprivation may occur because of a determined
and fixed return which would render it unattractive to the investor.
Another risk related to its fixed earnings may be that the com-
pany would be left with no alternative but to reduce its dividends
if expenses increase drastically.
The possibility that on the long range the service provided for
by the utility might become obsolete as a result of technological and
20 The cost of capital may be arithmetically put as follows:
(The figures
are hypothetical)
50% debt @
+ 50% equity @ 10%
Total Cost
5% =
” =
2.50%
5.00%
7.50%
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FAIR RETURN FOR UTILITIES
scientific developments constitutes another important risk – wit-
ness what water transportation has lost to railways and in turn
what these have lost to airways. This is why, in order to survive,
utilities must innovate and diversify. A necessary expense of a
healthy utility is one on research and development. A static utility
is heading for the graveyard.
We have now examined two of the leading cases up to 1944, in
the field of rate-making in the United States; the first (Smyth V.
Ames) determined the basis on which the rate of return should be
calculated. Unless special legislation provided otherwise, the fair
value of the property “used and useful in the service of the public”
should be taken. The second (Bluefield) set forth the factors which
were to be considered in order to arrive at that percentage of the
base constituting a reasonable return.
In 1944 came -another important decision from the Supreme Court
in the same field, the case of Federal Power Commission v. Hope
Natural Gas Co.21
The Court stated two general principles: first that a presump-
tion of validity is attached to a commission’s decision and the burden
of proving the contrary rests on the utility; secondly that regulation
does not insure a utility that its business will produce net revenues.
This should not, however, be interpreted as meaning that owners
of the utility are not entitled to a dividend: the “economic obliga-
tion to pay dividends” had been stated in Smyth v. Ames.
It then re-asserts the factors enumerated in the Bluefield decision
to arrive at a just and reasonable rate of return:
From the investor or company point of view it is important that there be
enough revenue not only for operating expenses but also for the capital costs
of the business. These include service on the debt and dividends on the
stock. By that standard the return to the equity owner should be commen-
surate with returns on investments in other enterprises having corresponding
risks. That return, moreover, should be sufficient to assure confidence in
the financial integrity of the enterprise, so as to maintain its credit and
to attract capital… 2 2
… Rates which enable the company to operate successfully, to maintain
its financial integrity, to attract capital, and to compensate its investors
for the risks assumed certainly cannot be condemned as invalid, even though
they might produce only a meager return on the so-called “fair value” rate
base.X
We haive already noted the emphasis put by the Court on the
risk factor in comparing a particular utility with any enterprise.
21 Supra, n. 1.
22 Ibid., at p. 603.
23 Ibid., at p, 605.
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The important and innovating pronouncement of this decision is
the following:
Nor is it important to this case to determine the various permissible ways
in, which any rate base on which the return is computed might be arrived
at. For we are of the view that the end result in this case cannot be con-
demned under the act as unjust and unreasonable from the investor or
company viewpoint.24
This was a radical change in the interpretation which had been
given the Smyth v. Ames decision on the rate base being the value
of the property. In stating that the end result was the only point
of consideration, whatever the means of arriving thereat, the Court
opened the door to a wide variety of ways and means to arrive
at a proper calculation of returns. In effect, it left the valuation of
rate bases to the Commissions’ or Courts’ discretion.
The valuation of the property advocated by the first decision
had given rise to innumerable views and endless discussion. Some
had considered the original cost, less depreciation; others had ac-
cepted the reproduction cost; others yet had devised other formu-
lae. Furthermore, additional discussions arose within one field be-
tween experts retained to assess such values. 25
In examining Canadian provincial legislation, we will see that
the components of the “fair value” basis may differ.
For the case under consideration, the Court considered the
owners’ equity, or the net worth of the company without regard
to the debt capital.
The Hope decision also broadened the Bluefield case geographi-
cally. It will be remembered that the latter considered that the return
in the general
should be equal to “that generally being made..,
part of the country”. 26 It
is important to note that the Hope
decision omitted this factor. This omission is quite understandable
in view of the great facility with which a person may invest in any
part of the country if it should be more satisfactory to him. In the
early part of the century the general economic conditions were cer-
tainly different in the Western States and the risks were certainly
greater in that part of the country. The same reasoning would cer-
tainly apply to Canada.
Thereafter, we will find that decisions have considered numerous
rate bases according to the case presented before the Board.
24 Ibid., at p. 603.
25 In this case, experts estimated the reproduction costs of the assets at
$66,000,000 so that the company’s return to the previous years would have
been S.27% whereas its rate of return on investment had been 9%.
26 Supra, n. 16.
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FAIR RETURN FOR UTILITIES
One of the more often used rate base, when legislation does
not provide otherwise, is the capitalization of the utility. Although
it had been mentioned as a relevant factor in the Smyth v. Ames
case, it had been practically disregarded by subsequent decisions.27
In its rejection of security capitalization as a rate base, the Court has not
distinguished between those situations where the security issues were largely
fictitious (that is, where the securities were issued without the receipt of
equivalent consideration by the issuing corporation) and those where changes
in prices left the outstanding capitalization excessive with respect to con-
temporary costs of construction. Undoubtedly one of the most potent reasons
for the rejection of capitalization as a measure of the company’s right to
income has been the fact that these securities had been issued without any
supervision by public authority. It is significant that in Massachusetts, where
the issuance of utility securities has been regulated from the virtual inaugu-
ration of the industry, the commissions of that state have based their regu-
lation of rates largely on a consideration of the revenue required to meet
the interest and dividend payments on outstanding securities.28
Now that the Commissions have such an absolute control over
securities issued by the utilities, the capitalization as a rate base
offers no threat to the investor.
Canadian decisions
As in the United States, certain regulated enterprises come under
federal jurisdiction while others fall under provincial legislation;
both levels of Government have created regulatory bodies to deal
with these businesses. As a rule, utilities which affect more than
one province or which are declared to be operated for the “general
advantage of Canada” are regulated through Boards or Commis-
sions created by federal statutes; the others, whose fields of action
are restricted to one particular province are attended to by provin-
cial Boards or Commissions.
1. Federal Boards.
The Canadian Transport Commission established by the National
Transportation Aet 29 succeeded the Board of Transport Commis-
sioners for Canada which in turn had succeeded the Canadian Rail-
way Commission. The Commission has jurisdiction over all trans-
port by railway, air, water, over pipe lines or roads, and, through
the Railway Act,80 over telephone and telegraph companies.
271t had been advocated by Justice Brandeis (in a dissenting opinion)
in
Missouri ex rel Southwestern Bell Telephone Co. V. Public Service Commission,
262 U.S. 276.
28Barnes, op. cit., at p. 375.
29 14-15-16 Bliz. II, c. 69.
so R.S.C. 1952, c. 234, s. 372 et seq.
McGILL LAW JOURNAL
[Vol. 16
It is of importance to note that nowhere is it mentioned in the
relevant legislation that in the fixing of rates and charges the
Commission is to consider the return to the utility nor does it
contain provisions regarding the valuation of the rate base.
Since they found no English decisions for lack of regulatory
bodies in the United Kingdom, Canadian Courts and Commissions
have constantly referred to American decisions. 31 This was certainly
a most sensible solution in view of the great similarities between
general and economic conditions in both countries.
As we have seen, the Supreme Court of Canada, in 1960, went
to ai common law principle to assert the origin of the right of a
public utility to a fair return. However such a right had been
recognized and taken for granted. As early as 1921, this was stated
as a fact:
It is obvious that as a Railway is under private management, a return on
capital is necessary if additional capital is to be obtained as needed.32
In several instances, the Canadian Railway Commission stated
that in fixing rates, it should be ascertained that the utility will
get, from these rates, enough income to provide for: 1) operating
costs including all taxes; 2) maintenance costs; 3) provisions for
depreciation, renewals and replacements; 4) provisions for a just
and reasonable return to the company on its capital investment. 33
Since the Railway Act does not provide for a rate base, the Boards
acting under its authority and the Courts have been at liberty to
take whichever they felt was warranted.
The Canadian Railway Commission, from the very beginning
showed reluctance in accepting the reproduction cost as the fair
value. In City of Montreal v. Bell Telephone Co.,34 it refused to decide
between the original cost and the replacement cost and found that
the Company being in a satisfactory financial condition, there was
no need to increase rates. In another case in 1927, 35 it considered
capital as a rate base and stated that it could not “assent” to the
“propriety” of reproduction cost. The capital investment was de-
finitely the most often used rate base by the Commission and was
accepted by the Supreme Court of Canada in Northwestern Utilities
v. City of Edmonton where it said:
31 For statement that American decisions should be given due consideration
by Canadian Boards, see Ottawa v. Ottawa Electric Railway Co., 59 C.R.T.C.
136; The King v. Rideaut, et al, [149] 4 D.L.R. 61C.
3 2 In re: Nipissing Central Railway Co., XI B.J. 196.
33 B.C. Telephone Co. v. Vancouver, (1921), 27 C.R.C. 259.
34
35Bell Telephone Co. v. Montreal, Toronto, Ottawa, (1927), 34 C.R.C. 1.
lph15 C.R.C. 11.8.
No. 1]
FAIR RETURN FOR UTILITIES
… The duty of the board was to fix fair and reasonable rates; rates which,
under the circumstances, would be fair to the consumer on the one hand, and
which, on the other hand would secure to the company a fair return for
the capital invested. By a fair return is meant that the company will be
allowed as large a return on the capital invested in its enterprise (which
will be net to the company) as it would receive if it were investing the
same amount in other securities possessing an attractiveness, stability and
certainty equal to that of the company’s enterprise. In fixing this net return
the board should take into consideration the rate of interest which the
company is obliged to pay upon its bonds as a result of having to sell them
at a time when the rate of interest payable thereon exceeded that payable
on bonds issued at the time of the hearing. Properly to fix a fair return the
board must necessarily be informed of the rate of return which money would
yield in other fields of investment. Having gone into the matter fully in
1922 and having fixed 10% as a fair return under the conditions then existing,
all the board needed to know in order to fix a proper return in 1927, was
Whether or not the conditions of the money market had altered, and, if so,
in what direction, and to what extent.6
The Bluefield decision had a great influence on Canadian deci-
sions. It was specifically referred to in several instances 3 and the
factors which it said should be considered in determining the rea-
sonableness of the rate of return were constantly applied.
In 1964, the Board of Transport Commissioners for Canada
requested a public hearing into several aspects of the operations
of The Bell Telephone Company of Canada and announced its in-
tention to look into the rate of return of the Company.
In the judgment which it rendered after a lengthy hearing 38 the
Board examined the jurisdictional aspect of its order and following
the same line of reasoning which the Supreme Court had followed
in the B.C. Electric Railway Co. case, 39 decided that the provisions of
the Railway Act were wide enough to give it jurisdiction.
The principal section of the Railway Act which confers jurisdiction on the
Board over the Company is section 380 which, by subsection (13) thereof,
extends and applies the provisions of the Act to the Company, with the
exception of certain specified sections, “insofar as reasonably applicable and
30 [1029] 2 D.L.R. 4, at p. 8; for detailed studies of invested capital see:
Ottawa v. Ottawa Electric Railway Co., supra, n. 31, Re: Pipe Line Matters,
50 C.R.T.C. 145; Re: B.C. Telephone Co., Increase in Rates & Charges, (I50),
66 C.R.T.C. 7.
37 Ottawa Electric Railway Co. v. City of Ottawa, 41 C.R.T.C. 86; Ottawa
v. Ottawa Electric Railway Co., 59 C.R.T.C. 136.
3856 B.T.C. 535.
39 Supra, n. 4; where in searching for a justification of preserving the utility’s
right to a reasonable rate of return in an act which simply provided for “just
and reasonable rates”, the Court interpreted such provision as meaning that in
addition to being so for the public, these rates should be so for the Company
and that they should provide for a rate of return.
McGILL LAW JOURNAL
[Vol. 16
not inconsistent with this section or the Special Act”. Amongst the sections
of the Act so extended and applied to the Company are most, but not all,
of the sections dealing with traffic, tolls and tariffs, and one of the most
important sections in this group is section 328(5) which applies to the
Company and confers on the Board powers to “fix, determine and enforce
just and reasonable rates, and to change and alter rates as changing condi-
tions or cost… may from time to time require…” Section 380(2) of the
Act provides that all telephone tolls are subject to the approval of the Board;
section 380(3) provides for the filing of tariffs and prohibits the Company
from charging tolls which have not been approved by, and filed in a tariff
with, the Board; and section 380(4) provides that the Board may deal with
telephone tolls in the same manner as provided by the Act for freight tariffs,
insofar as applicable and not inconsistent with the provisions of section 380.40
Since it had not the power to determine a rate base and to fix
a rate of return, the Board did not see the determination of the
latter as a goal in itself but -as part of the rate-making process.
The Board in this case accepted capitalization as a rate base
since all parties to the proceedings agreed to it: however, there was
discussion as to which part of the capital should be considered, one
of the parties favouring the equity only. The decision gives no rea-
son for rejecting the latter consideration and accepts total average
capitalization. It furthermore accepted the concept which we have
discussed earlier of a “zone of reasonableness”.
The Board, in that same decision, expressed some concern over
the fact that it might be said that in fixing a rate of return, it
was committing itself to adjusting the utility’s charges to a level
providing for that return. This would certainly be contrary to regu-
latory practice since it had often been repeated that the determi-
nation of a rate of return did not guarantee such return to the
company. 41
In the latest judgment regarding an application by Bell Canada
for -an increase in rates, 42 the Railways Transport Conmittee declined
to consider the rate of return aspect in fixing the rates, although
it had noted that the Company had been unable to raise the required
additional capital on favourable terms and that the cost of its new
debt capital was higher than the permissive rate of return fixed
in the previous decision. In considering that the fixing of the rate
of return was not the “sole test of the justness and reasonableness
40 56 B.T.C. 535, at pp. ‘715-716.
41 In the Hope Case, supra, n. 1, at p. 603, the Supreme Court said: “Thus
we stated in the Natural Gas Pipeline Co. case that ‘regulation does not insure
that the business shall produce net revenues.’
42 Decision rendered on September 25, 1969; R.T.C. File No. C-995, 178.
No. 1]
FAIR RETURN POP. ‘UTILITIES
of rates”, the Committee was right to a certain extent.43 But if it
is not the sole test, it certainly is an important one and in omitting
to consider it, the Committee failed to fulfil its duty of “balancing
the consumer’s and the investor’s interests.” In a way, such finding
does not even protect the consumer’s interest, which is to pay the
lowest possible price but also to get the best service and to be offered
all the latest technological advancements. It is a fact that to meet
these two last mentioned expectancies, the utility needs the additional
capital. If the interest of the person who is providing this capital
is not taken into account, he will not provide it and the consumer
will resultingly suffer.
Provincial legislation
All provinces in Canada have legislation creating administrative
tribunals of the nature of the Canadian Transport Commission, which
are regulatory bodies for the public utilities under their jurisdiction.
Provincial Acts (except those of Quebec, Ontario and Saskatchewan)
contain special provisions concerning the rate base and the rate of
return.
In the first category, all acts recognize the utility’s right to a
just and reasonable rate of return in very clear and specific lan-
guage. 44 It follows that the Board acting thereunder cannot refuse
to consider this aspect.
Determination of the rate base is generally left to the Board
but certain guidelines are provided. Allowances for various items
such as working capital, reasonable organization expenses and con-
struction overhead are provided for in the Newfoundland, 45 Nova
Scotia 4 6 and Manitoba 47 legislation.
The rate base itself is usually the cost of property: fair depreciated
value and original cost less depreciation in Newfoundland; prudent
original cost in Nova Scotia, Prince Edward Island, 48 Manitoba and
43
1n the Permian Basin Area Case, supra, n. 1, the Supreme Court of the
United States said that investors’ interest provide only one of the variables
in the constitutional calculus of reasonableness.’
441n most instances the Acts use the phraseology: “a just and reasonable
rate of return” and in two cases, the words “in addition to operating expenses”
are added, (Newfoundland and Nova Scotia).
45 S.N. 1,964, No. 39.
46 R.S.N.S. 19G7, c. 258 (note that all the list is exhaustive under this Act).
47 S.M. 1959, c. 51.
48 R.S.P.E.I. 1951, c. 1433.
McGILL LAW JOURNAL
[Vol. 1c
Alberta, 49 while legislation in British Columbia”0
is content with
the general expression coined in, Smyth v. Ames, 51 of value of the
property of the public utility used in serving the customers.
In New Brunswick 52 the law merely states that the Board will
fix a reasonable rate of return upon the investment of the utility.
The Supreme Court of that province decided that since there were
no provisions in the Act to determine the rate base, the Board or
the Court had full discretion to choose whatever method of valuation
it saw fit;5 3 the Court heavily relied on American decisions, more
especially on the Bluefield,54 and Hope,5 cases.
The Ontario and Quebec Public Utilities Acts 5 contain no special
provision on the rate of return and rate base. However the Boards
have always recognized the right of the utility to earn a fair rate
of- return.
The Ontario Energy Board stated in a 1961 decision:
Historically it appears clear to the Board that in Ontario and in other
jurisdictions in Canada and in the United States the fundamental matters
to be considered in determining whether rates of a natural gas utility
are just and reasonable are two-fold, firstly, from the standpoint of the
consumers, the rates charged should be just and reasonable for the
services furnished by the utility and secondly, from the standpoint of the
utility, the rates charged should provide a just and reasonable return on
its capital employed in the utility operations …
Obviously, the Board must use certain tools or yardsticks in arriving
at its decision in relation to these concepts. Again, in Ontario and in other
jurisdictions in Canada and the United States, the yardstick which has
been and is used almost without exception is the rate base –
rate of
return method, the rate base being the capital employed in the utility
operation as referred to above, and the rate of return being the return
earned by the utility on that amount. The return to the Applicant should
be sufficient to provide revenue for the Applicant to pay for its cost of
operation together with a fair return to the owners of the utility and
further should be such as to enable the Applicant to attract on a reasonable
basis the necessary capital for further extension and the proper maintenance
of its services…57
49S.A. 1960, c. 85.
oR,.B.C. 10.60, c. 323.
5lSupra, n. 12.
52R.S.N.B. 1052, c. 186.
53 The King v. Rideout, supra, n. al.
54 Supra, n. 16.
55 Supra, nl.
56 R.S.O. -1060, c. 335; R.S.Q. 11964, c. 229.
57 In re: Consumers Gas Company Rcte Application, decided August 15, 191,
at p. 9.
No. 1]
FAIR RETURN ‘FOR UTILITIES
In Quebec, the Public Utilities Board Act 5s gives wide powers
to the Board in fixing rates which are to be just, fair and reasonable:
the interpretation of such a clause by the Supreme Court of Canada
to the effect that rates must be fair and reasonable for the utility as
well as the customer may be applied here. 59
The right of the utility to a reasonable rate of return underlies
the following pronouncements by the Board:
… l’exp6rience d6montre que des taux d’abonnement
insuffisants ‘pour
permettre au propridtaire de l’entreprise de s’acquitter convenablement de
ses responsabilit6s comportent une ddficience organique qui entrame
la
confiscation lente de la propri6t6, ce qui est contralre i l’intfrtt bien compris
des abonnds et cause, en m~me temps, une injustice h 1’endroit du pro-
priftaire. 60
… laissant un revenu disponible pour les intgr~ts et les dividendes de
$35,968 repr~sentant un pourcentage de 5% de la valeur d6pr6ci6e de l’actif
immobilis6 de V’entreprise.
L’addition de ce revenu au revenu disponible pour int6rtt et dividende
mentionn6 prcdemment fournirait un total de $49,434 repr6sentant un
pourcentage de 6.9% de la valeur d6pr6ci~e de l’actif immobilis6 et de
5.8% de la valeur non-fpr~ci~e de l’actif immobilisg de l’entreprise.
… il faut admettre que les pourcentages rWalis~s restent en dega des
limites qui pourraient 6tre considdr~es comme indispensables pour permettre
h l’entreprise d’obtenir des capitaux requis de temps A autre pour d~frayer
le coat des am~liorations et des agrandissements requis pour satisfaire aux
exigences du service et de continuer 4 fournir le service le plus moderne
possible.61
The Electricity and Gas Board Act, 2 like other provincial legis-
lations, makes it a duty for the Board to allow a reasonable rate
of return to the utility,6 3 and specifies that this return shall be
based upon the physical assets of a company. It then goes on to
exhaustively enumerate what are to be comprised in these assets.
Conclusion
Public utility companies are in Canada and (though to a lesser
extent) in the United States, one of the most important contributing
factors to the national economy. In the United States, the American
Telephone & Telegraph is, in terms of assets,” the largest corpo-
GsR.S.Q. 19,64, c. 229.
59B.C. Electric Railway Co. Ltd. v. Public Utilities of B.C., supra, n. 4.
ORe: Til~phone Lotbiniare & Nicolet, (1957) Ordonnance 6142.
0 iRe: Telephone Dorchester Inc., (1961) Ordonnance 7130.
62R.S.Q. 1064, c. 87.
63 bid., s.
64 $40 B compared to General W Votors’ $23 B.
.
McGILL LAW JOURNAL
[Vol. 16
ration: this means that it attracts more investors, pays more wagescu
and pays more taxes. Bell Canada is to the Canadian scene what
A. T. & T. is to the American. But this is not to say, however, that
their economic performance will set the general trends or that it will
be indicative. Over a ten year period, the growth rate of A. T. & T.
has been slightly over 5%, a figure very rare indeed amongst the
500 largest industrials. Yet, although they are monopolies, they
still are privately owned and there is no reason why, all factors
considered, they should be at a disadvantage in terms of earnings.
Simple business and common sense direct unregulated enterprises
to offer the best possible service and goods adapted to modern
science and technology so that they will meet competition and earn
the best return. Utilities being legally obliged to offer the same
thing should at least have equivalent rights. Competition is not
altogether absent in the field of utilities. One has several choices
of transportation. Even if there is but one choice of a utility, it does
not mean that good financial results are automatic for the company
offering it. This is why so much emphasis is and should be put by
regulatory bodies on the comparable earnings test.
Unregulated business automatically reflects inflation, an important
factor nowadays and one which definitely constitutes a risk for the
investor. Regulated undertakings will not follow and immediately
their level of earnings will be less than the former, even though they
were comparable at one point. In surveying the financial position
of the largest American corporations, the editors of Fortune stated,
Probably no industry suffered more from inflation last year than the
heavily regulated utilities. Rising demand for services boosted the operating
revenues of every one of the 50 largest utilities … But the net income
gain was only 1.9%, the smallest recorded since 1956.66
This is one example of the effectiveness of applying the “zone of
reasonableness” concept in determining a rate of return: it would,
moreover, call for a wider zone.
The independence of our judiciary towards the executive and
legislative branches of government has always been considered one
of the more attractive factors of our constitutional arrangement.
Let not the regulatory bodies, which are not part of the judiciary,
become agents of the financial policy of a government trying to
control inflation. The utility is a privately owned company and there
is no reason why its owners should be penalized separately from the
ones of business in general. “It is, however, plain that power to
65 Except for General Motors which has over 700,000 employees as compared
to A.T. & T.s near 700,000.
66Fortune Magazine, May 15, 1969 issue, Vol. LXXIX, No. 6, p. 199.
No. 1]
FAIR RETURN FOR UTILITIES
regulate is not a power to destroy”, stated the Supreme Court of
the United States in the Permian Basin Area case.
The constantly changing economic conditions are perhaps a good
reason why there should be no stringent rules for determining a rate
of return. As was often stated, the process is one which calls for
common sense, good judgment and a proper appreciation of al
surrounding factors. As numerous as axe the regulation bodies in
the United States, the methods axe still changing and as recently
as 1962, the New York Public Service Commission said:
The question of fair rate of return continues to give regulatory agencies
much concern. The issue is most important as well as highly controversial.
There are no absolutes in arriving at a proper determination of what is a
fair rate of return. Perhaps the one thing upon which all students of the
subject would agree is that the determination of a fair return is, in the
last analysis, a matter of judgment. This is not to say, however, that
such determination is or can properly be an arbitrary one, devoid of any
reference to and consideration of the relevant underlying factors.
Another point upon which all should agree is that there is no one
element, consideration, test, or criteria which can at all times and
in
all cases be singled out or given predominant emphasis. Sound judgment, as
we see it, entails consideration of numerous factors. 67
which proves that concepts are still changing and therefore remain
adaptable.
Even if there are no definite rules to set a rate of return, at
least the Constitution offers a safeguard to American utilities against
regulatory decisions. We have no such thing in Canada and it is
in
only through interpretation of texts, which otherwise exist
American legislation, that our courts have recognized the utilities’
right to a return. True, we have been following American juris-
prudence on that subject. However, the extent to which such following
should go has at times been questioned. 68 However, our Canadian
Constitution or Bill of Rights does not contain any provision similar
to the XIVth Amendment of the American Constitution. The absence
of this provision against confiscation makes the recourse to our
common law tribunals more difficult. The ready-made remedial
vehicle of the United States’ system is latent but not specific under
our system, inasmuch as our Canadian Courts have accepted the basic
principles outlined in the United States decisions.
If, judicially, our regulatory bodies have seen fit to go to American
decisions for principles which are after all, the product of a different
system of law, it is even more natural that they should seek the
67 1n re: Consolidated Edison Company of New York, 41 P.U.R. (3d) 805.
6 8 Surrey Co-operative Association of B.C. v. C.N.R. & C.P.R., 54 C.R.T.C. 62;
In re: Telegraph Tolls, 20 C.R.C. 1.
McGILL LAW JOURNAL
[Vol. 16
economic application of these principles from their American
counterparts. Indeed, business conditions are strikingly similar in
both countries, except that Canada is in need of more foreign capital.
If its attraction is one of the more important factors in determining
a rate of return, it follows that Canadian utilities’ return should be
as high, if not higher, than those fixed in the United States. However,
in practice the contrary is true: 69 it is a fact that the rate of return
allowed either directly as such or through the fixing of rates and
charges by regulatory bodies in the United States is higher than
that in Canada. There is no obvious reason for such, nowadays, when
the absence of frontiers between the two countries makes it as easy
for a Canadian to invest in American Telephone & Telegraph through
his Montreal agent as for a New Yorker to find attractiveness in
shares of Bell Canada.
69 Rate of return of A.T. & T. on total capital 8% –
; rate of return
of Bell Canada on total capital 7-7.3%. Both cases decided in the Fall of 1969.
8.5
