Supreme Court Limits Regulator's Jurisdiction over Proceeds of a Discarded Utility Asset Sale

March 14, 2006

The recent decision of the Supreme Court of Canada in ATCO Gas & Pipelines Ltd. v. Alberta (Energy & Utilities Board), 2006 SCC 4 could have important implications for the interaction of regulatory powers with the private property rights of a utility and limit the scope of a regulator's condition-making power. At issue was the authority of the Alberta Energy and Utilities Board to review the allocation of proceeds from the disposition of a discarded utility asset when approving the sale.

The History of the Case

The case concerned the allocation of proceeds from the sale of buildings and land owned by ATCO in downtown Calgary that were no longer required for the provision of utility services. ATCO is a privately owned natural gas distributor in Alberta that is regulated by the Board and was required to get Board approval for the sale. The contentious part of the application was ATCO's proposal to distribute the net proceeds from the sale to its shareholders. The City of Calgary, representing the interests of ATCO's customers, opposed ATCO's proposed distribution and argued that ratepayers were entitled to a portion of any net gain on the sale.

After concluding that ATCO's customers would not be harmed by the disposition and approving the sale, the Board utilized its general authority to "impose any additional conditions that the Board considers necessary in the public interest" to re-allocate a portion of the net sale proceeds to ATCO's ratepaying customers. The Board determined it was necessary to balance the interests of both shareholders and ratepayers within the "regulatory compact" - under which a utility is granted a statutory monopoly in exchange for limitations on its rate of return and freedom to deal with property included in its rate base - and allocated one-third of the net gain to ATCO and two-thirds to the benefit of ratepayers. In the Board's view, it was not in the public interest to award the entire gain to the utility, as this might encourage speculation in non-depreciable property or motivate the utility to dispose of properties for reasons other than the best interest of the regulated business.

ATCO appealed the decision to the Alberta Court of Appeal on the grounds the Board lacked the jurisdiction to re-allocate the net sale proceeds and that the decision was unreasonable. The Court of Appeal agreed the Board had exceeded its jurisdiction and referred the matter back. The City subsequently obtained leave to appeal the decision to the Supreme Court.

In a 4-to-3 split decision, a majority of the Supreme Court determined the Board did not have the prerogative to revise the distribution of proceeds from the sale of a utility's discarded assets. The majority's decision was written by Justice Michel Bastarache, who held the applicable provisions were silent as to the Board's power to deal with sale proceeds and that the power could not be implied from the statutory regime as necessarily incidental to the Board's explicit powers. The decision of the three dissenting justices was authored by Justice Ian Binnie, who concluded that the public interest was a matter of opinion and discretion best left to the expertise of the Board.

As stated above, the decision has important implications for the interaction of regulatory powers with the private property rights of a utility and the scope of a regulator's condition-making power. Each of these implications will be examined in turn below.

The Balancing of Regulatory Power and Property Rights

In the majority decision, Justice Bastarache examined the relationship between the broad powers of a regulator and the property rights of utility owners, and took the opportunity to resolve a longstanding point of contention by ruling that the "regulatory compact" does not cancel the private nature of the utility or allow ratepayers to implicitly acquire ownership or control of the utility's assets by paying rates.

In reaching this conclusion, Justice Bastarache noted the Board had broad powers to supervise the finances of utilities and their operations, but held this authority was in practice incidental to fixing rates to ensure that all customers have access to the utility's services at a fair price. Although utilities have a "public interest" aspect, the capital invested is not provided by the public purse or customers, but is "injected into the business by private parties who expect as large a return on the capital invested in the enterprise as they would receive if they were investing in other securities possessing equal features of attractiveness, stability and certainty" and this will "necessarily include any gain or loss that is made if the company divests itself of some of its assets." He concluded the Board had misdirected itself by confusing the customers' interest in obtaining safe and efficient utility service with an interest in the underlying assets owned only by the utility.

Interestingly, Justice Bastarache dismissed the suggestion made by the Board that allowing a utility to retain the entire gain would encourage speculation in non-depreciable property. To the contrary, he was of the opinion that speculation would accrue even more often if the utility's shareholders were not the ones to benefit from the possibility of a profit because investors would expect to receive a larger premium for their funds through the only means left available - the return on their original investment - and would be less willing to accept any risk.

Justice Binnie took a decidedly different approach to this issue in his dissenting decision. At the outset, Justice Binnie rejected ATCO's characterization of the case as one of property rights. In sharp contrast to the majority's reasoning, Justice Binnie noted, "ATCO chose to make its investment in a regulated industry" and "the return on investment in the regulated gas industry is fixed by the Board, not the free market."

Although he also rejected the City's argument that ratepayers acquire title to a utility's physical assets, Justice Binnie broke from the majority by accepting what he called the "risk" theory. Under this approach, the allocation a portion of the net gain from an asset sale to ratepayers could be justified in some, but not necessarily all, circumstances because the ratepayers had guaranteed the utility "in bad times and good, a just and equitable return on its investment in this land and these buildings." He reinforced this argument later in the decision by pointing out that "ATCO's contention that it alone is burdened with the risk on land that declines in value overlooks the fact that in a falling market, the utility continues to be entitled to a rate of return on its original investment even if the market value at the time is substantially less than its original investment."

Looking forward, the majority's robust statement on the importance of maintaining private property rights and the entitlement to a fair return brings certainty to the contentious issue of whether ratepayers gain proprietary interest in a utility's assets. That the minority also agreed on this point will provide clarity for future regulatory proceedings. What is less clear is how the majority's rejection of Justice Binnie's "risk" theory will fare in actual practice. In light of the guarantee of a fair return under the regulatory compact, it is questionable whether utilities will risk a loss on an asset sale in a poor market where the option to continue employing that asset in a utility service and receiving a fair rate of return is available. The test of time will also determine whether the majority's reasoning as to why allocating the entire gain to shareholders will lessen, as opposed to increase, speculation proves to be accurate.

Limits of a Regulator's Condition-Making Power

The ATCO decision is also important because it provides guidance on the limits of a regulator's power to impose conditions in the public interest. On behalf of the majority, Justice Bastarache acknowledged the concept of "public interest" is very wide and elastic, but stated this does not mean unfettered discretion and a regulator's power "will necessarily be limited to only what is rationally related to the purpose of the regulatory framework".

With respect to this particular case, Justice Bastarache determined the Board's authority was grounded in its main functions of rate-setting and protecting the integrity and dependability of the supply system, and there was no evidence that it needed the power to re-allocate proceeds to accomplish its objectives. In his view, it was not necessary for the Board to have control over which party should benefit from the sale proceeds to fulfill those functions and such a power was not related to the purposes of the power to approve the sale, which he identified as: (i) preventing degradation in service quality; (ii) maximizing the aggregate economic benefits of utility operations; and (iii) preventing favouritism toward investors.

Justice Bastarache expressed the concern that allowing the Board to re-allocate proceeds in the absence of an express legislative authority would allow broadly drawn powers to be interpreted in a manner that could encroach on the economic freedom of the utility, which would be contrary to the well-established rule of interpreting potentially confiscatory legislative provisions cautiously. Nevertheless, Justice Bastarache was careful to make it clear that the decision did not mean the Board could never attach a condition to the approval of an asset sale. As examples, Justice Bastarache noted the Board could approve an asset sale subject to an undertaking to replace the assets and their profitability or to invest part of the sale proceeds in maintaining "a modern operating system" that achieves the optimal growth of the system.

By contrast, Justice Binnie rejected ATCO's contention that the case was about the Board's confiscatory power. In his view, the essential issue of the case was whether the courts were justified in limiting what the Board was allowed to consider necessary in the public interest. In that regard, he acknowledged that the Board's discretion is not unlimited and must be exercised in good faith for its intended purpose; however, as the public interest is largely and inherently a matter of opinion and discretion, the Court should not substitute its own view for that of the Board. Key to this determination was Justice Binnie's review of regulatory practice in Alberta and elsewhere, which demonstrated that a variety of approaches have been adopted by regulators in solving the problems confronting the Board. He noted that it would have been open to the Board to allow ATCO's application for the entire profit, but that the Board's decision was within the range of established regulatory opinion and did not call for judicial intervention.

The ATCO decision is notable because of the narrow approach the majority adopted toward the scope of a regulator's condition-making powers. The Court's approach is particularly striking in this case because the Board's enabling statute granted the regulator considerable discretion in imposing such conditions as it considered necessary in the public interest. The majority's narrow reading of the Board's condition-making power seems at odds with the recent judicial trend (reflected in the minority opinion) to defer to the expertise of regulatory bodies with respect to their exercise of discretion.

The practical outcome of the decision is that regulators will now be required to examine whether the use of their condition-making power is consistent with both the regulator's broader objectives and the purposes of the underlying request for approval. That said, the majority's framework for determining when a regulator can employ its condition-making power leaves considerable room for regulators and lower courts to distinguish future cases. Regulators and lower courts are likely to face some difficulty in future cases when determining whether a specific exercise of condition-making power is more analogous to the conditions imposed by the Board in this specific case or to the acceptable alternatives suggested by Justice Bastarache. Also, given the persuasive strength of Justice Binnie's dissenting opinion, it is difficult to know if the majority's limitation of a regulator's condition-making power will have an appreciable effect on the actions of regulators beyond the ATCO case.

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