Railroad Comm’n v. Pacific Gas & Electric Co., 302 U.S. 388 (1938)

MR. CHIEF JUSTICE HUGHES delivered the opinion of the Court.

This is an appeal from a final decree of the District Court, composed of three judges, 28 U.S.C. § 380, permanently enjoining an order of the Railroad Commission of the California.

The Commission, by its order on November 13, 1933, in a proceeding instituted on its own motion, fixed rates for gas supplied by respondent. In this suit, the validity of the order was challenged as depriving respondent of property without due process of law in violation of the Fourteenth Amendment of the Constitution of the United States. An interlocutory injunction was granted, and the cause was referred to a special master. The parties stipulated for the submission of the cause upon the record made before the Commission with certain supplementary evidence. Following a hearing, the master, on the basis of findings as to value, expenses, and revenues, concluded that the rates prescribed were confiscatory and void. 13 F.Supp. pp. 931-932. The District Court expressly stated that it did "not pass upon the factual exceptions to the master’s report," and did "not approve or reject his findings as to the fair value" of the property "or determine the net income" which would result from the assailed rates, "or determine what would be a fair rate of return," but rested its decision "solely upon the denial of due process of law by the Commission in fixing the rates in question." 13 F.Supp. 931 at 936. Rehearing was denied. 16 F.Supp. 884. On appeal here, the decree was affirmed by an equally divided court. 301 U.S. 669. Reargument was ordered (October 11, 1937), and has been had.

The parties have not brought before us the evidence that was taken before the Commission or that was before the court below, with the exception of certain affidavits by the president of the respondent and the president of the Commission, respectively, in relation to the proceedings before the Commission. Respondent has, in effect, challenged the action of the Commission as invalid upon the face of its opinion and order. 39 Cal.R.Com.Rep. 49. Appellants have accepted that challenge.

1. Respondent seeks to sustain the decree upon the ground that the Commission’s order was not authorized by the state law. Because of the federal question raised by the bill of complaint, the District Court had jurisdiction to determine all the questions in the case, local as well as federal. Siler v. Louisville & Nashville R. Co., 213 U.S. 175, 191; Louisville & Nashville R. Co. v. Garrett, 231 U.S. 298, 303; United Fuel Gas Co. v. Railroad Commission, 278 U.S. 300, 307.

The state statute to which our attention is directed, § 32 of the California Public Utilities Act, Cal.St.1923, p. 837, set forth in the margin,{1} provides that, whenever the Commission, after a hearing, shall find the existing rates charged by a public utility to be unjust, unreasonable, discriminatory, or preferential, the Commission shall determine the just and reasonable rates to be thereafter in force. In this instance, the Commission’s order shows on its face that the Commission found the existing rates to be unjust and unreasonable. 39 Cal.R.Com.Rep. p. 77. So far as respondent contends that this finding was not sustained by evidence, it is sufficient to say that the evidence is not here, and we cannot say that the ruling lacked support.

Respondent states that it was denied a proper hearing, but the record shows that the Commission held extended hearings at which the evidence offered by respondent was received and its arguments were presented.{2} 39 Cal.R.Com.Rep. p. 51. While these hearings were in progress, and on June 16, 1933, respondent was cited to show cause why interim rates should not be put into effect pending the proceeding. Respondent stipulated that it would complete the presentation of its evidence before October 1, 1933, and that the rates which the Commission established in the proceeding might, if lower than the existing rates, be made retroactive so as to apply to meter readings made after July 16, 1933, and before November 15, 1933. That date was later changed by stipulation to January 1, 1934. 39 Cal.R.Com.Rep. pp. 52, 53.

We have not been referred to any state decisions warranting the conclusion that the Commission did not afford a hearing in accordance with the state law. We turn to the constitutional question.

2. As the District Court did not deal with the issue of confiscation and the evidence is not before us, we are concerned only with the question of procedural due process -- that is, whether the Commission in its procedure, as distinguished from the effect of its order upon respondent’s property rights, failed to satisfy the requirements of the Federal Constitution. We examine this question in the light of well settled principles governing the proceedings of ratemaking commissions.

The right to a fair and open hearing is one of the rudiments of fair play assured to every litigant by the Federal Constitution as a minimal requirement. Ohio Bell Telephone Co. v. Public Utilities Comm’n, 301 U.S. 292, 304-305. There must be due notice and an opportunity to be heard, the procedure must be consistent with the essentials of a fair trial, and the Commission must act upon evidence, and not arbitrarily. Interstate Commerce Comm’n v. Louisville & Nashville R. Co., 227 U.S. 88, 91; St. Joseph Stock Yards Co. v. United States, 298 U.S. 38, 51, 73; Morgan v. United States, 298 U.S. 468, 480-481; Ohio Bell Telephone Co. v. Public Utilities Commission, supra. As we have seen, the respondent was heard, the Commission received the testimony of respondent’s witnesses, its exhibits and arguments. There is nothing whatever to show that the hearing was not conducted fairly.

The complaint is not of the absence of these rudiments of fair play, but of the method by which the Commission arrived at its result. As to this, a fundamental distinction must be observed. While a fair and open hearing must be accorded as an inexorable safeguard, we do not sit as an appellate board of revision but to enforce constitutional rights. San Diego Land & Town Co. v. Jasper, 189 U.S. 439, 446. When the ratemaking agency of the state gives a fair hearing, receives and considers the competent evidence that is offered, affords opportunity through evidence and argument to challenge the result, and makes its determination upon evidence and not arbitrarily, the requirements of procedural due process are met, and the question that remains for this Court, or a lower federal court, is not as to the mere correctness of the method and reasoning adopted by the regulating agency, but whether the rates it fixes will result in confiscation.

We have recently had occasion to emphasize this distinction in passing upon an order of the appellant Commission in the case of Los Angeles Gas Corp. v. Railroad Commission, 289 U.S. 287, 304-305. We said:

The legislative discretion implied in the ratemaking power necessarily extends to the entire legislative process, embracing the method used in reaching the legislative determination as well as that determination itself. We are not concerned with either, so long as constitutional limitations are not transgressed. When the legislative method is disclosed, it may have a definite bearing upon the validity of the result reached, but the judicial function does not go beyond the decision of the constitutional question. That question is whether the rates as fixed are confiscatory. And, upon that question, the complainant has the burden of proof, and the court may not interfere with the exercise of the state’s authority unless confiscation is clearly established.

This controlling principle was reiterated, with due emphasis upon the necessity of a fair hearing, in the case of West Ohio Gas Co. v. Public Utilities Comm’n, No. 1, 294 U.S. 63, 70, in these words:

Our inquiry in rate cases coming here from the state courts is whether the action of the state officials in the totality of its consequences is consistent with the enjoyment by the regulated utility of a revenue something higher than the line of confiscation. If this level is attained, and attained with suitable opportunity through evidence and argument, Southern Ry. Co. v. Virginia, 290 U.S. 190, to challenge the result, there is no denial of due process though the proceeding is shot through with irregularity or error.

The statement is equally applicable, as the Los Angeles case shows, when the order of a state commission is assailed in a federal court.

3. The gravamen of respondent’s complaint is that the Commission refused to consider the fair value of respondent’s property, and, in fixing the rate base, "gave weight and effect solely to the historical cost."

Respondent supports its contention by referring to the statement of the Commission that, during its entire history,

to determine a proper rate base, this Commission has used the actual or estimated historical costs of the properties undepreciated, with land at the present market value,

and, consistently with that, the Commission has "used the sinking fund method to determine the allowance for depreciation to be included in operating expenses." The Commission gave its reasons why this "historical method has dominated the Commission’s findings." 39 Cal.R.Com.Rep. pp. 57, 58. The text of this portion of the Commission’s statement is given in the margin.{3} Reference is also made to statements of the Commission in its supplemental investigation in the light of the opinion of the District Court on the motion for an interlocutory injunction. 39 Cal.R.Com.Rep. pp. 198, 202; 5 F.Supp. 878.

But it does not follow from these statements that the Commission refused to receive evidence of the cost of reproduction, or to consider that or other evidence presented by respondent with respect to the value of its property. The contrary clearly appears.

Respondent submitted to the District Court affidavits of its president setting forth its contention that no consideration was given to reproduction cost. This contention was combatted by an affidavit of the president of the Commission in which it is stated that the Commission gave careful consideration to all the testimony of record relative to value and to the testimony offered by respondent respecting reproduction cost. These affidavits are of slight value, as we have the official opinion of the Commission stating the course which it pursued. That opinion shows precisely what the Commission has done in this instance. The Commission states, 39 Cal.R.Com.Rep. p. 64:

Testimony regarding the cost to reproduce the properties here under consideration was presented by the company’s valuation engineer on several price bases, all being developed through the application of price translation factors, and not through the application of appropriate prices to an inventory of the property. In each pricing period offered, the estimate to reproduce was higher than the historical cost. For the first six months’ period of 1933, the reproduction cost was shown as 8 percent higher than historical. A perusal of price trend charts introduced by the company elsewhere in the proceedings indicate that the estimate must be in error. It is not conceivable that a property 80 percent of which has been constructed in the high price period following 1919 could not be reproduced for a lesser cost under prices prevailing in the first six months of 1933. Witness for the City of San Francisco clearly indicated why the estimate was erroneous when he showed that the method used ignored certain factors tending in later years to decrease cost, such as improvement in construction materials and methods, increased use of mechanical equipment, and a lessening in the width of the excavations and pavement cut. The estimates of cost to reproduce are not at all convincing, and cannot be of positive value in this proceeding.

The Commission was entitled to weigh the evidence introduced, whether relating to reproduction cost or to other matters. The Commission was entitled to determine the probative force of respondent’s estimates. That the Commission did so is apparent from both its statement to that effect and the reasons it gives for considering these estimates to be without positive value. The Commission compared them with other evidence, and found the estimates to be erroneous. It found that 80 percent. of the property had been constructed in the prior "high priced period," and the Commission thought it inconceivable that the property could not be reproduced "for a lesser cost under prices prevailing in the first six months of 1933." These statements not only do not suggest, but definitely rebut, an inference of arbitrary action.

There is no principle of due process which requires the ratemaking body to base its decision as to value, or anything else, upon conjectural and unsatisfactory estimates. We have had frequent occasion to reject such estimates. Minnesota Rate Cases, 230 U.S. 352, 452; Los Angeles Gas Corp. v. Railroad Comm’n, supra, pp. 307, 310-311;Lindheimer v. Illinois Bell Telephone Co., 292 U.S. 151, 163-164. Whether in this instance the Commission was in error in treating respondent’s estimates as without probative force we have no means of knowing, as the evidence is not before us, but its error in that conclusion, if error there be, was not a denial of due process. Los Angeles Gas Corp. v. Railroad Commission, supra; Ohio Bell Telephone Co. v. Public Utilities Commission, supra.

Nor did the ruling with respect to the weight of evidence as to reproduction cost leave the Commission without evidence of the value of respondent’s property. We have frequently held that historical cost is admissible evidence of value. For example, in the Los Angeles case, we said that

no one would question that the reasonable cost of an efficient public utilities system "is good evidence of its value at the time of construction,"

and that

such actual cost will continue fairly well to measure the amount to be attributed to the physical elements of the property so long as there is no change in the level of applicable prices,

citing McCardle v. Indianapolis Water Co., 272 U.S. 400, 411. And we added that,

when such a change in the price level has occurred, actual experience in the construction and development of the property, especially experience in a recent period, may be an important check upon extravagant estimates.

Los Angeles Gas Corp. v. Railroad Comm’n, supra, p. 306. While the court has frequently declared that, "in order to determine present value, the cost of reproducing the property is a relevant fact which should have appropriate consideration," we have been careful to point out that "the Court has not decided that the cost of reproduction furnishes an exclusive test," and, in that relation, we have "emphasized the danger in resting conclusions upon estimates of a conjectural character." Los Angeles Gas Corp. v. Railroad Comm’n, supra, p. 307. And, in the Los Angeles case, with the evidence before us which had been taken by the Commission and by the District Court, we held that, on that evidence, it did not appear to be

unfair to the company, in fixing rates for the future, to take the historical cost as found by the commission as evidence of the value of the company’s structural property at the time of the rate order.

Id., p. 309. In the instant case, we cannot say that the Commission, in taking historical cost as the rate base, was making a finding without evidence, and therefore arbitrary.

The decisions cited by respondent do not require a different conclusion. In Northern Pacific Ry. Co. v. Department of Public Works, 268 U.S. 39, 43-45, we said that the Commission’s action in reducing rates by an order dependent wholly "upon a finding made without evidence" or "upon a finding made upon evidence which clearly does not support it" in the face of unchallenged evidence of probative value showing that the rates were already confiscatory was an arbitrary act and a denial of due process. In so ruling, we fully recognized the principle that "mere error in reasoning upon evidence introduced" does not invalidate an order. In Chicago, M. & St.P. Ry. Co. v. Public Utilities Comm’n, 274 U.S. 344, the Idaho Commission and the state court had refused "to consider the evidence introduced by the carriers to show that the rates in question are too low and confiscatory." In West v. Chesapeake & Potomac Telephone Co., 295 U.S. 662, upon which the District Court relied, the Court took the view that the Commission had based its action upon the application of "general commodity indices to a conglomerate of assets constituting an utility plant," and had resorted, on account of the wide variation of results caused by the use of different indices, to what the Court described as a "rule of thumb corrective" by "weighting the several indices upon a principle known only to itself," and had substituted that sort of calculation "for such factors as historical cost and cost of reproduction." In that view, the Court thought that the Commission had acted arbitrarily, and hence that its order fell within the principle of the Northern Pacific case. No such procedure appears here. In St. Louis & O’Fallon Ry. Co. v. United States, 279 U.S. 461, the Court was not dealing with the order of a state commission, or with a question of due process, but with the command of Congress addressed to the Interstate Commerce Commission in relation to its valuations of railway property. The Court construed that command, and found that it had not been obeyed.

4. The contention that the Commission failed to find the fair value of respondent’s property presents substantially the same question in another form. What the Commission found appears by its own opinion. The court below was bound to go to that opinion to ascertain the Commission’s findings. The Commission specifically found what it considered to be the rate base. 39 Cal.R.Com.Rep., supra, p. 76. The Commission found that rate base to be reasonable. Cal.R.Com.Rep. p. 77, note. The import of its opinion is that the rate base represented the Commission’s conclusion as to the value which should be placed upon respondent’s property for the purpose of fixing rates. It was upon that valuation that the Commission distinctly ruled that the rates it established would "assure the Company a fair return on its properties." Respondent was entitled to contest the value thus placed upon its properties, or any part of them, to insist that the value taken as the rate base was too low, and that, in consequence, the prescribed rates were confiscatory. That was the issue upon which the court below should have passed. But respondent cannot successfully contend that it was not heard by the Commission, that the evidence respondent offered was not received and considered, and its competency and weight determined by the Commission, or that the Commission did not place its valuation upon the property and fix the rates upon the basis of that valuation. Respondent utterly fails to show that in the procedure of the Commission it was denied due process of law.

5. There is a further contention as to the burden of proof. But the applicable rule is clear. Respondent is in a federal court complaining of the constitutional invalidity of state-made rates, and respondent is held to the burden of showing that invalidity by convincing proof. Los Angeles Gas Corp. v. Railroad Comm’n, supra, p. 305; Lindheimer v. Illinois Bell Telephone Co., supra, p. 169; Dayton Power & Light Co. v. Public Utilities Comm’n, 292 U.S. 290, 298.

Respondent suggested in the argument at bar that the Court should direct the evidence to be sent up for the purpose of determining the points presented on this appeal. We see no sufficient reason for that course. The parties agreed upon the record to be submitted.

The main issue in this litigation is whether the rates as fixed by the Commission’s order are confiscatory. The District Court did not determine that issue. The District Court should determine it. The decree is reversed, and the cause is remanded for further proceedings in conformity with this opinion.

Reversed.

MR. JUSTICE BLACK concurs in the reversal of the decree.

MR. JUSTICE SUTHERLAND took no part in the consideration and decision of this case.

1.

Sec. 32. Power to change unjust rates. Power to fix new rates. Preservation of adequate service. (a) Whenever the commission, after a hearing had upon its own motion or upon complaint, shall find that the rates, fares, tolls, rentals, charges or classifications, or any of them, demanded, observed, charged, or collected by any public utility for any service or product or commodity, or in connection therewith, including the rates or fares for excursion or commutation tickets, or that the rules, regulations, practices or contracts, or any of them, affecting such rates, fares, tolls, rentals, charges or classifications, or any of them, are unjust, unreasonable, discriminatory, or preferential, or in anywise in violation of any provision of law, or that such rates, fares, tolls, rentals, charges, or classifications are insufficient, the commission shall determine the just, reasonable, or sufficient rates, fares, tolls, rentals, charges, classifications, rules, regulations, practices, or contracts to be thereafter observed and in force, and shall fix the same by order as hereinafter provided.

2. The opinion of the Commission states that,

In all, 81 exhibits were introduced presenting in great detail the underlying data of this proceeding, and 3729 pages of testimony and argument were transcribed. Many witnesses testified upon various issues pertaining to a general rate case.

The opinion lists the witnesses on both sides. 39 Cal.R.Com.Rep. pp. 51, 52.

3.

During its entire history, in establishing reasonable rates for utilities similar to this company, to determine a proper rate base, this Commission has used the actual or estimated historical costs of the properties undepreciated, with land at the present market value. Consistent with this, it has used the sinking fund method to determine the allowance for depreciation to be included in operating expenses.

This historical method has dominated the Commission’s findings for several principal reasons. It is well grounded upon established facts, it is not subject to the vagaries of pet theories, unlimited imagination, and abrupt fluctuation of current prices and passing conditions, and therefore indicates a truer measure of value upon which, through the application of rates, a return may be allowed to reimburse the owner for his enterprise and insure the integrity of his capital honestly and prudently invested. At the same time, it prevents unwarranted demands upon the consumer through the projections of future rates on ephemeral values and stabilizes rates, so that economic shocks from such changes are reduced to a minimum.

It is an economical procedure where the books of the companies are reasonably well kept, as obtains in practically all of the major utilities of this State, full compliance with which will prevent unwarranted expenditures of money by the Commission, the public, and the company, which inures to the benefit of both the consumers and the utility. It is a more rapid procedure, insuring quicker compliance with necessities as they arise.