Presented: The University of Texas School of Law s 2006 Texas Water Law Institute. December 7-8, 2006 Austin, Texas

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1 Presented: The University of Texas School of Law s 2006 Texas Water Law Institute December 7-8, 2006 Austin, Texas PETITIONS FOR EXPEDITED RELEASE FROM CCNS HOW ARE INCUMBENT UTILITIES RESPONDING? Leonard H. Dougal Leonard H. Dougal Jackson Walker L.L.P. 100 Congress Avenue, Suite 1100 Austin, Texas ldougal@jw.com (512)

2 TABLE OF CONTENTS I. Introduction... 1 II. Background... 1 III. CCN Release Process and Issues... 2 A. Pre-Petition Considerations... 2 B. The Petition for Expedited Release... 3 C. Procedural Considerations... 3 D. Appraisal and Compensation to the Incumbent Utility... 4 IV. Protection Afforded to an Incumbent Utility From Federal Debt... 5 A. Encroachment Protection... 6 B. Expedited Release Meets 1926(b)... 7 V. Conclusion... 8 i

3 PETITIONS FOR EXPEDITED RELEASE FROM CCNS HOW ARE INCUMBENT UTILITIES RESPONDING? By Leonard H. Dougal, Partner Jackson Walker L.L.P. 1 I. INTRODUCTION The passage of House Bill 2876 by the 79 th Texas Legislature changed the dynamics, and the dialogue, between incumbent CCN holders and owners of land. 2 The legislation certainly attracted the attention of holders of certificates of convenience and necessity ( CCNs ) and put those incumbent utilities on notice that they need to be responsive to landowner concerns related to the cost and timing of providing retail water and sewer service to new developments. Rural water supply corporations, Chapter 65 special utility districts, and any other district or municipality which has a large CCN area beyond its political boundary are the most likely form of incumbent utilities to be affected by the CCN release provisions of HB The true implications of this legislation have not yet been felt. At the date of this writing, only two petitions for expedited release from CCNs have been filed with the Texas Commission on Environmental Quality ( TCEQ ), and neither petition has successfully made it through the administrative and technical review process at the agency. It should be clear however, that the small number of petitions fails to reflect the true impact of the legislation on CCN holders. There can be no doubt that the threat of a CCN release has affected the negotiations, and dialogue, between incumbent utilities and developers of land and has certainly provided landowners more of a voice in how utility service will be provided to undeveloped property. The purpose of this paper is to highlight the new procedures and emerging trends which are becoming evident in the negotiations between landowners and incumbent utilities since the passage of House Bill This paper will describe the expedited release process, the considerations to be made in valuing a released CCN area, and how federal debt may affect the expedited release process. II. BACKGROUND Just a few years ago the policy debate involving water and sewer utility service was the extent to which the regionalization of utilities was appropriate. 3 In promoting regionalization, the TCEQ sought to limit the circumstances under which a new water or sewer utility would be created, and demonstrated a preference for connecting new services to established utilities. 4 The feasibility of regionalization is still a consideration when a person applies for a new, as opposed to amended, CCN. So, it would appear that HB 2876 has created a significant shift in policy by now creating 1 The views expressed in this article are solely those of the author and do not represent the views of the law firm of Jackson Walker L.L.P. or any of its clients. 2 The term incumbent refers to the established utility which is the holder of the CCN for an area, and is preferred over the more pejorative term entrenched that some developers might choose. 3 Regionalization policy and requirements are found in many places, including: Tex. Const. art. III, 49-d(a); TEX. HEALTH & SAFETY CODE ; and TEXAS WATER CODE (d). 4 TCEQ Regulatory Guidance RG-357 (January 2003). 1

4 a new opportunity for landowners to participate in selecting who provides them utility service, and perhaps cause the fragmenting of existing utility service areas. Not every developer wants to avoid the incumbent utility. Ironically, some landowners located adjacent to, but outside of, an established utility s service area have labored to be added to the service area. Those landowners have learned that rarely is there a good way to compel an adjacent utility to provide them service, even when it would appear to benefit both the utility and the landowner. III. CCN RELEASE PROCESS AND ISSUES The new law allows a landowner with at least 50 acres, that is not in a platted subdivision currently receiving water or sewer service, to petition for release of the land from the incumbent utility s CCN area. 5 A. Pre-Petition Considerations Prior to filing a petition for expedited release, the landowner will need to evaluate the advantages and disadvantages of receiving retail service from the incumbent utility. Typically, that evaluation will be conducted by the landowner and his engineer, and will necessarily involve a dialogue with the general manager and engineer of the incumbent utility. At the same time, the landowner will need to evaluate what alternative service providers are located in close proximity to the land and will need to perform due diligence on those alternative providers, including an assessment of their cost of service and their ability to serve. Except for the largest landowners, the proximity of location to the alternative service provider s facilities is likely to be the prime factor of interest to the landowner in his decision on whether or not to file a petition for expedited release. Given the different types of service providers which are typically found operating beyond the corporate limits of cities -- water supply corporations, special utility districts, municipal utility districts and other forms of districts and investor-owned utilities -- it will not necessarily be possible to make an apples to apples comparison of providers. Additionally, while cost of service is often a major consideration for a developer of land, factors such as reliability of water service, quality of service and timing of service should be important considerations. Prior to filing a petition for expedited release, and depending on the results of the evaluation of the incumbent utility (and alternative provider) the landowner has to make a formal request for service to the incumbent utility, including supplying the necessary information to allow the incumbent utility to determine whether it can meet the service requirements, as well as the capital improvements that may be necessary. The request for service is a pre-requisite for filing a petition. As explained below, in the event the landowner ultimately files a petition for expedited release, it will need to include a commitment letter from the alternative utility service provider including detailed information on that provider s ability to serve. 5 TEXAS WATER CODE (a-1). 2

5 B. The Petition for Expedited Release The requirements for a petition for expedited release are set forth in rules adopted by the TCEQ. 6 Additionally, TCEQ has prepared a regulatory guidance document entitled Preparing a Petition for Expedited Release from a Certificate of Convenience and Necessity. 7 A copy of this regulatory guidance is attached as Exhibit A. The petition must contain the elements set forth in 30 TAC (b) which include a number of administrative items such as a written request for service, a map and description of the area to be released, correspondence between the parties, and the incumbent utility s response to the service application. However, the most important components of the petition, many of which arise from the correspondence between the parties, are likely to be the following: a statement of the landowner s current needs and a projection (including dates) of future needs for retail service; the level, including quantity and quality, and manner of service (facilities, supply and costs) for current and projected needs and the projected land uses that support the requested level and manner of service; an explanation as to why the incumbent utility s response to the request for service is unacceptable (e.g., has refused to provide service, is not capable of providing service, or conditions the provision of service on a payment of costs not properly allocable directly to the petitioner s service request); an explanation of why the alternative service provided is better suited; and a commitment letter from an alternative utility service provider including the information contained within 30 TAC (b)(1) proving that the alternative provider can fulfill the level and manner of service needed by the landowner. C. Procedural Considerations The process starts by the landowner making a request for service to the incumbent utility. The request for service should be complete and provide the incumbent utility with a map of the land at issue (including a legal description consistent with the TCEQ s CCN mapping requirements), the time frame within which service is needed, the level and manner of service, and other information reasonably requested by the utility. 8 The incumbent utility then has 90 calendar days to respond to the request. The incumbent utility s response will allow the landowner to file a petition for expedited release, if the utility: 1) has refused to provide service, 2) is not capable of providing adequate service within the time frame, at the level, or in the manner reasonably requested by the landowner, or 3) 6 30 TEX. ADMIN. CODE (b). 7 TCEQ Regulatory Guidance RG-441 (October 2006) TAC (b)(1). 3

6 conditions the provision of service on a payment of costs not properly allocable to the petitioner s service request. 9 The landowner is to serve a copy of the petition on the incumbent utility by certified mail, prior to filing with the TCEQ. Upon receipt of the petition the TCEQ will perform an administrative review and send a notice of deficiency for any information which is lacking. After the petition is deemed administratively complete, the TCEQ has 90 days to make its decision. The agency s decision is made without resorting to a contested case hearing. The rules provide that the TCEQ shall grant the petition unless the agency makes an express finding that the petition failed to satisfy the elements set forth in the agency s rules. 10 If a petition is granted, the process then moves to valuation and compensation, if any, to the incumbent utility. A party aggrieved by the decision of the TCEQ on an expedited release petition (whether the landowner or the incumbent utility) appears to only have a right to seek reconsideration of the action within the agency, but may not appeal the decision to district court. The statute provides that the decision of the commission on the petition is final after any reconsideration authorized by the commission s rules and may not be appealed. 11 D. Appraisal and Compensation to the Incumbent Utility The appraisal of retail public utility CCN areas and facilities is a quite specialized area of practice. However, a number of engineers and consultants in the State of Texas have developed this expertise. The factors required by TEXAS WATER CODE (g), to compensate the incumbent utility for its loss, include valuing real property as determined by standards set forth in Chapter 21 of the Property Code. Although, in a typical expedited release petition it would seem unlikely that the alternative service provider would actually seek to acquire real property owned by the incumbent utility. Rather, that real property would likely remain with the incumbent utility and the alternative service provider would instead construct its own facilities on newly acquired easements and real property. The statute provides a second compensation component to provide just and adequate compensation to the incumbent retail public utility for its personal property, which requires assessment of the following: 1. the amount of the retail public utility's debt allocable for service to the area in question; 2. the value of the service facilities of the retail public utility located within the area in question; 3. the amount of any expenditures for planning, design, or construction of service facilities that are allocable to service to the area in question; 9 30 TAC (b)(3) TAC (d). 11 TEXAS WATER CODE (a-4). 4

7 4. the amount of the retail public utility's contractual obligations allocable to the area in question; 5. any demonstrated impairment of service or increase of cost to consumers of the retail public utility remaining after the decertification; 6. the impact on future revenues lost from existing customers; 7. necessary and reasonable legal expenses and professional fees; and 8. other relevant factors. 12 How these factors will ultimately translate into an actual compensation amount is yet to be known. If real property condemnation proceedings are any indication of the process, it is possible that each party s appraiser will come up with wildly different valuations, which would then have to be reconciled by the third appraiser appointed by the TCEQ. These eight factors are similar to the valuation factors to be used pursuant to Water Code , which allows a municipality to condemn and acquire the service area and facilities of certain types of pre-existing water or sewer service providers located in areas annexed into a city. The Section condemnation and valuation procedure has been in place since at least the 1980 s, yet no case has made it all the way through the valuation process at TCEQ. 13 Presumably, most cases have settled as the public boards of the parties grew tired of the expense of the process or perhaps the frustrated applicants decided the customer base was not worth the cost, and withdrew. While it is obvious that the CCN valuation will be a case specific analysis, any compensation which is finally ordered by the TCEQ will be of great interest to practitioners on both sides of the docket. It may be that in a few years there will be a public database of the value of CCNs resulting from these petitions, which could remove the CCN valuation process from the mysterious world where it now resides. IV. PROTECTION AFFORDED TO AN INCUMBENT UTILITY FROM FEDERAL DEBT Many rural water systems, including water supply corporations and special utility districts, as well as some small cities, are indebted to the U.S. Department of Agricultural Rural Utility Service, through loans made pursuant to 7 U.S.C That federal law prohibits a competing utility from encroaching upon the service area of a federally indebted utility. The majority of 1926(b) cases involve the encroachment on a federally indebted rural utility by an adjacent municipality. The expedited release process creates a new complexity to the federal debt issue, given that the state agency which grants CCNs now has the express authority to release a portion of a CCN at 12 TEXAS WATER CODE (g); 30 T.A.C (k). 13 The valuation factors, and procedure, in Section have changed over the years, most recently with the enactment of HB

8 the request of a landowner. Will the new state law influence future decisions in 1926(b) cases? More specifically, will a court view an expedited release petition (filed by a landowner) differently from the typical 1926(b) case where a competitor (typically an encroaching municipality) seeks to acquire customers or territory from a rural utility? If a CCN is granted under state law, what keeps the state from amending, revoking or releasing the CCN? A. Encroachment Protection A rural water utility which has borrowed money from the United States Department of Agriculture - Farmers Home Administration 14 in accordance with 7 U.S.C. Section 1926(a) is accorded federal protection from encroachment on its water service area by another utility. 15 This federal protection is sometimes at odds with the Water Code provisions which would otherwise allow, for example, a municipality to annex an area, pay compensation to the existing water provider, and then acquire the exclusive right ( single certification ) to provide water service in the area. 16 In City of Madison, Mississippi v. Bear Creek Water Association, the Fifth Circuit noted that Section 1926(b) serves two congressional purposes: (1) to encourage rural water development by expanding the number of potential users of such system, thereby decreasing per-user cost, and (2) to safeguard the viability and financial security of such rural water providers to ensure repayment of FmHA loans. 17 The Court stated: Under the Consolidated Farm and Rural Development Act, local governments may not encroach upon services provided by a water association indebted to Farmers Home Administration, be that encroachment in the form of competing franchises, new or additional permit requirements, or similar means, such as condemnation of the association s facilities or certificate of public convenience and necessity. 18 The Court also recognized the economic incentives at play with new subdivisions located at a city s edge and noted that Congress did not intend to allow expanding municipalities to skim the cream by expanding into the service area of a federally indebted rural utility. In the encroachment cases, federal preemption of state law occurs and federal courts have uniformly applied Section 1926(b) to preclude the application of state law from usurping a federally indebted rural utility s certificated service area or otherwise curtailing the utility s 14 The Farmers Home Administration ( FmHA ) is now known as the Rural Utility Service Administration, as per U.S. Secretary of Agriculture Memorandum (October 20, 1994). 15 Such loans are made to non-profit utilities that provide water service to rural areas. As security for a utility s indebtedness to the FmHA, the United States Department of Agriculture typically takes a security interest in all of the utility s facilities and takes a pledge of both current and future customer accounts to the United States Department of Agriculture, so as to secure the repayment of the loan. 16 TEXAS WATER CODE City of Madison, Mississippi v. Bear Creek Water Association, 816 F.2d 1057 (5th Cir. 1987). 18 Id., 816 F.2d at

9 water service rights. The language of the statute is clear and unambiguous as to the protection afforded the federally indebted utility. Title 7 U.S.C. Section 1926(b) provides: The service provided or made available through any such association shall not be curtailed or limited by inclusion of the area served by an association within the boundaries of any municipal corporation or other public body, or by the granting of any private franchise for similar service within such area during the term of such loan. Disputes involving Section 1926(b) typically involve the issue of whether the federally indebted utility has made service available to the area in question. In cases outside of Texas, where there may be no certificated service right by state law, the issue of whether service is available is a factual determination which considers whether the utility has pipes in the ground or the ability to serve the subject area within a reasonable period of time. 19 Because a CCN obligates a utility in Texas to render continuous and adequate service to every customer within the CCN area, the Fifth Circuit has held that state law duty is the legal equivalent of making service available. 20 In Texas, a federally indebted utility protects its entire CCN area from encroachment. The Fifth Circuit in North Alamo Water Supply unequivocally proclaimed the sanctity of the service area of a federally indebted utility, as follows: The service area of a federally indebted water association is sacrosanct. Every federal court to have interpreted Section 1926(b) has concluded that the statute should be liberally interpreted to protect FmHA-indebted rural water associations from municipal encroachment. 21 B. Expedited Release Meets 1926(b) However, it should be noted that there could well be distinctions between the types of cases which have traditionally arisen under 1926(b), those involving a competing utility encroaching on the rural utility, and the decision from the regulator of CCNs (here the TCEQ) to release the CCN as to a particular tract of land pursuant to a state law process. Cases from the State of Missouri involving detachment of land from a rural water district may be of interest to both landowners and incumbent utilities involved in the expedited release process. Missouri state law provides a mechanism for a landowner to force detachment of his land from a water district by demonstrating that: 1) the land is not being served by the district, 2) written consent of any lienholder of the District has been obtained, and 3) the detachment is in 19 Moongate Water Co. v. Butterfield Park Mut. Domestic Water Ass n, 291 F.3d 1262, 1267 (10 th Cir. 2002). 20 North Alamo Water Supply Corporation v. City of San Juan, 90 F.3d 910, (5 th Cir. 1995), cert. denied, 117 S.Ct Id. at

10 the interest of the landowner and will not adversely affect the remainder of the district. 22 However, where the district is entitled to 1926(b) protection, Missouri courts consider the state detachment law to be preempted by federal law, and will not grant detachment. Whether it is easier or cheaper for a property to obtain service from a competing utility is irrelevant, where federal debt is involved. 23 Although mentioned in the case, the court in North Alamo Water Supply avoided the state law issue. In the case, the encroaching municipality filed applications with the predecessor to the TCEQ seeking to decertify portions of the rural utility s service area and sought to re-certificate the area in the city s name. But, before the agency acted on the applications, the trial court enjoined the city from further actions to serve the disputed area. On appeal, the Fifth Circuit mentioned, but chose to not address, the complex issue of whether a federal court could purport to control the actions of a state regulatory body through an injunction. The Court stated: Such an injunction, purporting to control the actions of the Commission, a state regulatory body, would create a considerably more difficult federalism question: Namely does 1926(b) also preclude a state regulatory agency from modifying the service area of a federally indebted utility. But we leave that issue for another day. 24 Hence, the issue has yet to be addressed, but may soon be ripe for consideration. An easier scenario would be a case where the incumbent utility has failed to satisfy the minimum state law requirements to continue to hold the CCN. For example, if the utility has a history of such substandard service that it has failed to provide continuous and adequate service within its CCN, as required by Water Code (a), it would appear to be obvious that federal debt would not protect the incumbent utility from action by TCEQ to remedy the utility s failure to meet state law requirements, up to and including action to revoke or amend the CCN. Finally, it should be noted that TCEQ rules require the incumbent utility to submit to TCEQ, within 10 calendar days after receipt of notice that a decertification process has been initiated, a list of lienholders and the amount of debt. The rules also require the utility to notify the lienholders of the decertification process. 25 We will have to wait to see how the lienholders choose to respond. V. CONCLUSION House Bill 2876, enacted in 2005, is the most significant new legislation affecting water and sewer certificates of convenience and necessity in recent memory. Although only a few landowners have sought to obtain expedited release of their land from a CCN, the implications 22 Robertson Properties, Inc. v. PWSD #8, 153 S.W.3d 320 (Mo. App. 2005); Allen v. Public Water Supply Dist. No. 5, 7 S.W.3d 537 (Mo. App. E.D. 1999). 23 Robertson Properties at North Alamo Water Supply, at 917 fn TAC (q). 8

11 of the new law are causing incumbent utilities to be more responsive to landowner concerns about the cost and timing of providing retail water and sewer service to new developments. The details of the expedited release process, including what showings by a landowner are required and how TCEQ will respond to the petitions, are just now becoming clear. It remains unclear whether a federally indebted rural utility will be protected by 7 USC 1926(b) from the expedited release process to the same extent that federal law protects the utility against encroachment by a competitor. 9

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