A Requiem for the Presumption of Prudence after OPG and ATCO

I. Introduction

There was once a popular view that forecasted costs should be reviewed by the various utility regulatory bodies, such as the Alberta Utilities Commission (previously called “EUB”) or the Ontario Energy Board, under a forward looking ‘onus of proof on the utility’ reasonableness test, while already incurred costs should be reviewed under a presumption of prudence test.1  This view is no longer valid after the Supreme Court’s companion-cases of ATCO Gas and Pipelines v Alberta (Utilities Commission) [ATCO],2 and Ontario (Energy Board) v Ontario Power Generation Inc [OPG].3  The Supreme Court freed up regulators to review costs, regardless of whether they were incurred or forecasted, utilizing whichever statutorily compliant and reasonable test that the regulator chose.4

In this article, we canvass the case law that addressed the question of prudence.  We observe that while courts may have suggested that the presumption of prudence was a legal doctrine of public utility law, it never had much effect in reality.  This makes the point that post ATCO and OPG, we do not anticipate a fundamental change in regulatory policy.  We conclude by arguing that regulatory decisions will continue to balance the interests of customers and utilities as they always have.  In fact, the removal of the doctrine may even help utilities in the long run.

II. The Prudent Investment Test – The Case Law

a. The American Experience

Before examining the Canadian case law, a brief digression on the American experience is necessary to explain where the term “prudent investment” test or rule came from.  The prudent investment test was first proposed by United States Supreme Court Justice Brandeis in his concurring dissent in Southwestern Bell Telephone Co v Public Service Commission of Missouri.5  Justice Brandeis, however, did not propose the test as a presumptive test that granted utilities a presumption of prudence, but rather he proposed the test as an easier and more sensible method for determining the fair return allowed to utilities.  At that time, the test was whether the rates allowed to the utility were based on the fair value of the utilities’ property, a test that Brandeis argued was “legally and economically unsound.”6  Brandeis’s proposed test was meant to shift the focus from fair market valuations of the utilities to historical costs.

The U.S. Supreme Court adopted Brandeis’s view and shifted away from fair value as the basis for rate-setting in FPC v Hope Natural Gas Co.7  The Court held that the regulator was not bound to use any single formula in determining rates8 and that what mattered was that the rates allowed were sufficient for the maintenance of financial integrity of the utility, the attraction of capital, and the compensation of investors for the risks assumed when they invested in the utility.9  While the Court cited Justice Brandeis’s dissent for this proposition, the Court did not adopt any presumption of prudence for historically incurred costs.

Indeed, many years later, the Court in Duquesne Light Co v Barasch,10 reiterated that there was no single ratemaking theory mandated by the Constitution.  The Court in Duquesne upheld the disallowance of millions of dollars expended on a set of unbuilt power plants that were no longer needed.  In doing so, the Court rejected the idea that the Court should adopt the “prudent investment rule”, whereby utilities would be able to earn a rate of return on all prudent investments, as a constitutional safeguard for utilities.11

b. The Canadian Cases: The Supreme Court

When one turns to Canadian case law, the jurisprudence is no different.  The foundational case on the question of public utility rates is Northwestern Utilities Ltd v City of Edmonton.12  The case is often cited for Justice Lamont’s famous adage that duty of the regulator was “fair and reasonable rates; rates which … 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.”13  What is often overlooked when citing the case are the actual facts of the case.  Alberta’s Board of Public Utility Commissioners had previously set Northwestern Utilities’ gas rates, which included a 10 per cent return on investment.  A few years later, Northwestern Utilities’ applied for a continuation of the rates, but the Board reduced the rate of return to 9 per cent, without a hearing but simply based on the “altered conditions of the money market”.14  The Supreme Court of Canada upheld the Board’s decision, stating that the question of a fair rate of return is largely one of opinion which can be left to the Board’s expertise.  While the case did not address the question of prudence, it demonstrates the high level of deference to the Board’s expertise in determining the rate of return even in the absence of a formal hearing.

Many years later, the Supreme Court held that regulatory boards, barring explicit statutory language, had an obligation to provide a fair return to utilities for prudently acquired investments.15  Nonetheless, the Court held that such boards can consider all matters which they deem proper since there is no single definition of a fair return.  The Court did not address the question of whether there was a presumption of prudence for historically incurred costs.

Even when the Supreme Court overturned a regulator’s determination of how to allocate the proceeds of the sale of a utility’s asset,16 the Supreme Court nonetheless mentioned that “the regulator limits the utility’s managerial discretion over key decisions, including prices, service offerings and the prudency of plant and equipment investment decisions.”17

Prior to his elevation to the Supreme Court, Justice Rothstein addressed the question of the proper rate of return in a Federal Court of Appeal judgment.18  While the judgment repeatedly acknowledged that the allowed rate of return would be based on prudently incurred costs, the judgment accepted that “there are numerous costing issues that may be subject to challenge [such as] … whether costs have been, or are being, prudently incurred”.19  It should have been no surprise, therefore, that Justice Rothstein, after his elevation to the Supreme Court, rejected the idea that there was a presumption of prudence in the twin cases of ATCO and OPG.20

c. The Canadian cases: The Appellate Courts

The lack of presumption of prudence in both the U.S. and Canada’s Supreme Court’s jurisprudence raises the question of where did this popular view come from?  The answer is that regulatory agencies and some appellate courts had articulated tests that suggested a presumption of prudence.  These statements, nonetheless also have suggested that such a presumption can be rebutted.  The resolution of almost all of the cases suggests that overcoming the presumption was not that high of a hurdle.  This is because, practically speaking, any rate hearing will always involve evidence presented by the utility that will be thoroughly tested by the boards’ staff and/or interveners.  Hence, even if the presumption existed in favor of the utilities, the utilities in making their case before a regulatory agency would be silly if they simply presented expenditures with no supporting evidence whatsoever on the grounds that such expenditures are presumed to be prudent.  The Agency staff and interveners would ask so many questions by interrogatories or during the hearing that the utility would ultimately be able to, or not, justify the expenditures.  As such, the idea that the presumption of prudence has never been of any practical use for the utilities.

The Ontario Energy Board (OEB), for example had developed the test as a policy tool that was seemingly enshrined as a legal doctrine by the Court of Appeal for Ontario in Enbridge Gas Distribution Inc v Ontario Energy Board (2006).21  In that case, Enbridge had appealed a decision from the Ontario Energy Board, in which the Board found that Enbridge’s costs were not prudently incurred and therefore could not be passed on to consumers. The Ontario Divisional Court allowed Enbridge’s appeal, stating that the Board used hindsight in its evaluation of prudence but Court of Appeal reversed.  The Court listed some of the principles behind OEB’s prudent investment test as follows:

  • Decisions made by the utility’s management should generally be presumed to be prudent unless challenged on reasonable grounds.
  • To be prudent, a decision must have been reasonable under the circumstances that were known or ought to have been known to the utility at the time the decision was made.
  • Hindsight should not be used in determining prudence, although consideration of the outcome of the decision may legitimately be used to overcome the presumption of prudence.
  • Prudence must be determined in a retrospective factual inquiry, in that the evidence must be concerned with the time the decision was made and must be based on facts about the elements that could or did enter into the decision at the time.22

After reciting the test with approval, the Court of Appeal nonetheless upheld the OEB’s rate determination for Enbridge.  In two subsequent cases the Court of Appeal continued to confirm the OEB’s power to set rates using whichever methodology it saw fit as long as the OEB’s decision was reasonable or not legally in error.  In Toronto Hydro-Electric System Ltd v Ontario (Energy Board),23 the OEB imposed on the utility the condition that it obtain approval from a majority of its independent directors prior to paying dividends.  The Court upheld the OEB’s imposition of that condition stating that the Board’s condition was within its jurisdiction of rate setting.  While not quite a prudence case, the OEB was concerned with the lack of possible expenditures on capital because of excessive dividend payouts.  The Court noted that:

The principles that govern a regulated utility that operates as a monopoly differ from those that apply to private sector companies, which operate in a competitive market. The directors and officers of unregulated companies have a fiduciary obligation to act in the best interests of the company (which is often interpreted to mean in the best interests of the shareholders) while a regulated utility must operate in a manner that balances the interests of the utility’s shareholders against those of its ratepayers. If a utility fails to operate in this way, it is incumbent on the OEB to intervene in order to strike this balance and protect the interests of the ratepayers.24

In Great Lakes Power Ltd v Ontario (Energy Board),25 the Court almost seemed to move away from the presumption of prudence, when the Board denied the power company’s request to recover costs through its rates without first being reviewed for reasonableness. The utility appealed, which was dismissed by both the Divisional Court and the Court of Appeal. The Court stated that “a utility must undergo a prudency review before passing along its costs to consumers”, and without doing so it “is not entitled to the benefit of an approved rate of return.”26

The presumption of prudence rule, therefore, seems to have only been enforced only once against the OEB, and that was in very case that led to the Supreme Court’s judgment in OPG, namely Power Workers’ Union, Canadian Union of Public Employees, Local 1000 v Ontario Energy Board.27  Therefore, although the test was repeatedly recited by the Court of Appeal of Ontario, the only time it decided to give the test some teeth, the Supreme Court reversed.

Outside Ontario, other appellate courts may have mentioned a presumption of prudence every now and then, but the outcomes of the appeals always were in favor of the regulator.  Consider for example, an earlier dispute between ATCO Electric and the Alberta’s Energy and Utilities Board (EUB).28  ATCO Electric had applied to the EUB for rate approvals for the 1999/2000 and 2001/2002 time periods using negotiated settlements.  The EUB approved the applications, but denied and reduced carrying costs for particular deferral accounts in three decisions.29  ATCO appealed arguing that the board should have provided the utility with fair and reasonable compensation for all its costs, as the Board could modify its previous approvals of negotiated settlements to allow for the recovery of certain carrying costs. The Court dismissed the appeal and upheld the Board’s decision, stating that the EUB’s duty to act in public interest did not include “saving a utility from itself.”30  The Board had discretion in fixing just and reasonable rates, which did not necessarily mean the lowest possible costs, but should allow the utility a “reasonable opportunity to recover its costs, providing they are prudent.”31  The Court approvingly cited the EUB’s observation that “while prudent costs does not mean the lowest possible costs [,] financing costs that are unnecessary and inflated, or alternatively, result in windfall profits to the utility cannot be considered prudent.”32  The Court even went on to state that a:

utility is not entitled to receive a higher rate of return on prudent expenditures simply because of the risk the Board will deny recovery of imprudent ones. To accede to this argument would reward imprudence. This cannot be. ATCO – and not its customers – bears the risks associated with any improper expenditures on its part.33

This suggests that the Court of Appeal did not view historically incurred costs as presumptively prudent, but rather placed the onus on the utility to show their prudence.

A year later, the Alberta Court of Appeal actually adopted the prudent investment test, presuming the prudence of incurred costs, but still upheld an EUB ruling against ATCO Gas.  In 2001, ATCO Gas had applied for an adjustment to its gas cost recovery rates in order to minimize the balance of its deferred gas account.34  The EUB held that ATCO had acted imprudently in its practice of withdrawing gas from one of its facilities, leading to $4 million in savings that could have been realized.  The EUB ordered ATCO to refund the amount to customers via its rates.  ATCO appealed on the basis that the Board did not use the proper test for prudence, but the Court of Appeal dismissed the appeal.35  The Court cited approvingly the EUB’s test of prudence, namely that:

a utility will be found prudent if it exercises good judgment and makes decisions which are reasonable at the time they are made, based on information the owner of the utility knew or ought to have known at the time the decision was made. In making decisions, a utility must take into account the best interests of its customers, while still being entitled to a fair return.36

The Court noted that a presumption of prudence would place the onus on the party questioning the prudence of the utility’s decisions, but once rebutted, the prudence of the decision would be reviewed by regulator using a reasonableness test.37  The Court was more concerned with the EUB acknowledging the presumption of prudence, as opposed to how the EUB went about evaluating the prudence of ATCO’s decisions.38  The actual evaluation of prudence, the Court held, was a question of fact, something that could not properly be presented to the Court.39

Although the case law from other jurisdiction have not spoken directly on the presumption of prudence, we note that other provincial appellate courts have deferred to regulators when it comes to the questions of determining rates.40  This suggests that, as George Vegh observed many years ago, there is no doctrine of Canadian public utility law.41  But that is not to say that the public utility regulation is lawless and arbitrary.  Rather, the practice of public utility regulation, and specifically when it comes to determining what costs to be recovered in rates, is highly nuanced and developed in the regulatory bodies, as opposed to the courts.

III. Prudence back at the Agencies

The Supreme Court’s removal of a formal presumption of prudence from the doctrine has not changed past practices regarding evaluating prudence at the various agencies.  Consider for example, Direct Energy Regulated Services’ (DERS) application to the Alberta Utilities Commission (AUC) to recover from its customers the costs it incurred settling a class-action against it.42  The class-action was brought against DERS for improper late-penalty charges that it had been charging regulated customers in the past.  The AUC could have easily been emboldened by the two recent Supreme Court cases and decided that such costs were imprudently incurred.  Instead it went through a detailed analysis of why DERS settled the class-action lawsuit and how the settlement could positively impact its customers.  The AUC allowed DERS to recover 75 per cent of the costs related to its defense of the class-action despite strong opposition from a customer group.43  One member of the AUC panel that approved the recovery of the costs, even felt compelled to concur separately to express his discomfort at the approved recovery.44  The full consideration of these difficult issues were ultimately resolved mostly in DERS’ favor, demonstrating that the removal of the presumption can still result in satisfactory outcomes that are not all or nothing.45

The AUC also recently issued a bulletin seeking commentary on whether it should conditionally exempt owners of public utilities from seeking the AUC’s approval prior to issuing equities and long-term debt.46  Perhaps, because of the two recent decisions by the Supreme Court, the AUC did not feel that it would be hamstrung by imprudent debt or equity issuances, and notes in the bulletin that “[n]othing in this [proposed] rule relieves [an] owner of a public utility from the necessity of demonstrating the prudence of an incurred cost of debt or equity in applicable Commission rate proceedings.”47  A presumption of prudence may have made the AUC more hesitant to remove its supervisory powers over the issuance of debt and equity.  As such, if the proposed rule goes forward, this will result in less regulatory burdens for the utilities.

IV. Conclusion

The presumption of prudence may have been a live legal doctrine, albeit for a short period of time, but it never really had any teeth.  Prior to the recent Supreme Court cases on the question of prudence, courts at best paid lip service to the doctrine evidenced by all the cases that affirmed the various boards and commissions when prudence was in question.  The death of the doctrine, however, means that regulators, utilities, and customers can work on sensible solutions at the regulatory agencies, which will benefit customers and utilities alike.

 

*Venessa Korzan is a Student-at-Law at DLA Piper (Canada) LLP.  Moin Yahya is a Professor of Law at the University of Alberta.  He is also an acting member of the Alberta Utilities Commission (AUC).  The commentary here is academic in nature and does not reflect on the merits of any proceedings past or pending before the AUC.  Additionally, Professor Yahya had no role in any of the AUC decisions referenced in this article.  We would like to thank participants at the Tenth Annual Energy Law Forum 2016, George Vegh, Glenn Zacher, Gordon Kaiser, and Willie Grieve for their insights. All errors are the authors.

  1. See for example Power Workers’ Union (Canadian Union of Public Employees, Local 1000) v Ontario (Energy Board), 2013 ONCA 359, 116 OR (3d) 793 ; Section III of Moin A. Yahya, “ATCO Pensions, Ontario Hydro, Prudency, and Reasonableness: a Case Comment on Ontario (Energy Board) v Ontario Power Generation Inc. & ATCO Gas and Pipelines Ltd. v Alberta (Utilities Commission)” (2015) 3:4 Energy Regulation Quarterly 49, online: ERQ < http://www.energyregulationquarterly.ca/case-comments/atco-pensions-ontario-hydro-prudency-and-reasonableness-a-case-comment-on-ontario-energy-board-v-ontario-power-generagtion-inc-atco-gas-and-pipeines-ltd-v-alberta-utilities-commission >.
  2. ATCO Gas and Pipelines Ltd v Alberta (Utilities Commission), 2015 SCC 45, [2015] 3 SCR 219 [ATCO].
  3. Ontario (Energy Board) v Ontario Power Generation Inc, 2015 SCC 44, [2015] 3 SCR 147 [OPG].
  4. See the discussion in Yahya, supra note 1.
  5. Southwestern Bell Telephone Co v Public Service Commission of Missouri, 262 US 276 (1923).
  6. Ibid at 290.  The test at the time was based on the case of Smyth v Ames, 169 US 466 (1898).
  7. FPC v Hope Natural Gas Co, 320 US 591 (1944).
  8. Ibid at 602.
  9. Ibid at 603.
  10. Duquesne Light Co v Barasch, 488 US 299 (1989).
  11. Ibid at 315.
  12. Northwestern Utilities Ltd v City of Edmonton, [1929] SCR 186.
  13. Ibid at 192-193.  Justice Lamont went on to state the test for a fair return as:

    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.”

  14. Ibid at 186-187.
  15. British Columbia Electric Railway Co v Public Utilities Commission of British Columbia, [1960] SCR 837.
  16. ATCO Gas and PipelinesLtd v Alberta (Energy and Utilities Board), 2006 SCC 4 [Stores Block].
  17. Ibid at para 4.
  18. TransCanada Pipelines Ltd v National Energy Board, 2004 FCA 149.
  19. Ibid at para 34.
  20. See discussion supra note 1.
  21. Enbridge Gas Distribution Inc v Ontario Energy Board, 210 OAC 4.
  22. Ibid at para 10.
  23. Toronto Hydro-Electric System Ltd v Ontario (Energy Board), 2010 ONCA 284, 99 OR (3d) 481.
  24. Ibid at para 50.
  25. Great Lakes Power Ltd v Ontario (Energy Board), 2010 ONCA 399.
  26. Ibid at para 22.
  27. Power Workers’ Union, supra note 1 reversed by OPG, supra note 3.
  28. ATCO Electric Ltd v Alberta (Energy and Utilities Board), 2004 ABCA 215.
  29. Re Year 2000 Outstanding Matters Deferral Accounts (Other than Pool Price) Part B (27 November 2001), 2001-83; Re Genco & Disco 2000 Pool Price Deferral Accounts Proceeding (12 December 2001), 2001-92; Re 2000 Pool Price Deferral Accounts Proceeding (22 December 2001) 2001-93.
  30. Supra note 28 at para 9.
  31. Ibid at para 131.
  32. Ibid at para 179 (citations omitted).
  33.  Ibid at para 186.
  34. Re Methodology for Managing Gas Supply Portfolios and Determining Gas Cost Recovery Rates Proceeding and Gas Rate Unbundling Proceeding, 2001-110, online: AUC <http://www.auc.ab.ca/applications/decisions/Decisions/2001/2001-110.pdf>.
  35.  ATCO Gas and Pipelines Ltd v Alberta (Energy and Utilities Board), 2005 ABCA 122.
  36. Ibid at para 22.
  37. Ibid at para 66.
  38. Ibid at para 74.
  39. Ibid.
  40. See e.g. Consumers’ Assn of Canada (Manitoba) Inc et al v Manitoba Hydro, Electric Board, 2005 MBCA 55; BC Hydro and Power Authority v Terasen Gas (Vancouver Island) Inc, 2004 BCCA 346;  Re Section 101 of the Public Utilities Act (Newfoundland), [1998] 164 Nfld & PEIR 60; Newfoundland Light & Power Co v Board of Commissioners of Public Utilities, [1987] 37 DLR (4th) 35, 4 ACWS (3d) 1 (Nfld CA); Re City of Dartmouth, (1977) 17 NSR (2d) 425.
  41. George Vegh, “Is there a Doctrine of Canadian Public Utility Law?” (2007) 86:2 Can Bar Review 319.
  42. Direct Energy Regulated Services: 2015 Late Payment Penalty Charge Settlement Agreement (10 August 2016), 20732-D01-2016, online: AUC <http://www.auc.ab.ca/regulatory_documents/ProceedingDocuments/2016/20732-D01-2016.pdf>.
  43. Ibid at para 4.
  44. Ibid at paras 252-257.
  45. See also AltaLink Management Ltd: 2012 and 2013 Deferral Accounts Reconciliation Application (6 June 2016) 3585-D03-2016, online: AUC <http://www.auc.ab.ca/regulatory_documents/ProceedingDocuments/2016/3585-D03-2016.pdf>.
  46. Alberta Utilities Commission, AUC Bulletin 2016-13 (27 May 2016), online: AUC <http://www.auc.ab.ca/news-room/bulletins/Bulletins/2016/Bulletin%202016-13.pdf>.
  47. Ibid at 3.

 

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