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In re Water Rate Request of Hillcrest Utility Operating Company, Inc.

Court of Appeals of Missouri, Western District

March 14, 2017



          Before Division One: James E. Welsh, Presiding Judge, Anthony Rex Gabbert, Judge and Edward R. Ardini, Jr., Judge


         The Office of Public Counsel ("the OPC") appeals the Report and Order of the Public Service Commission ("the Commission") authorizing new rates for Hillcrest Utility Operating Company, Inc. ("Hillcrest") which provides water and sewer services in Cape Girardeau County. The OPC argues that the Commission's Report and Order was unlawful, unreasonable, arbitrary, capricious, and not supported by the evidence. Finding no error, we affirm.

          Factual and Procedural Background

         Hillcrest is a water and sewer utility company as defined by the laws of the state of Missouri. The company provides services to approximately 218 residential customers, 20 apartment customers, and 4 commercial customers. Hillcrest is a wholly owned subsidiary of Hillcrest Utility Holding Company, Inc., which is wholly owned by First Round CSWR, LLC ("First Round"), which, in turn, is managed by Central States Water Resources, Inc. Hillcrest's president is Josiah Cox ("Cox").

         The water and sewer systems that are the subject of this appeal were originally owned by Brandco Investments, LLC ("Brandco"). Hillcrest set out to acquire the systems from Brandco in 2014. At the time, the Brandco systems were in a state of severe disrepair. The wastewater system had been the subject of multiple compliance and enforcement actions from both the Missouri Department of Natural Resources ("MDNR") and the Missouri Attorney General, while the drinking water system had been put on an eight-week boil order due to positive test results for E. coli. Prior to acquiring Brandco, Hillcrest entered into an agreement with the MDNR under which it committed to making necessary repairs to the systems and taking emergency steps to ensure that residents would be able to receive water services which included Hillcrest paying for emergency drinking water repairs, on-going drinking water system inspections, and a temporary chlorine disinfection system. Hillcrest anticipated that the necessary improvements would cost upwards of $1, 230, 000.

         On May 13, 2014, Hillcrest filed with the Commission a request for approval of the acquisition of the Brandco systems, as well as the right to issue indebtedness and to encumber the acquired water and sewer systems in order to fund the improvements necessary to bring the systems into regulatory compliance. After some initial disagreement, Hillcrest and the Staff of the Commission ("Staff") filed a non-unanimous[1] stipulation and agreement that would permit Hillcrest to acquire the Brandco systems subject to certain conditions. As part of the stipulation and agreement, Hillcrest was authorized to finance the acquisition through a loan agreement with Fresh Start Ventures, LLC ("Fresh Start").[2] The Commission issued an order in that case on October 22, 2014, that approved the stipulation and agreement and granted Hillcrest a certificate of convenience and necessity.[3] The transaction between Hillcrest and Brandco closed on March 13, 2015, and Hillcrest began making improvements approximately thirty days after acquisition. Hillcrest completed the improvements in the fall of 2015 after investing approximately $1, 205, 000 into the systems.

         Prior to the acquisition by Hillcrest, the Brandco systems had not received a rate increase since 1989. On September 15, 2015, Hillcrest filed a letter with the Commission requesting an increase to its annual water and sewer operating revenues. Hillcrest met with Staff in an attempt to settle the issues surrounding the rate increase. A consensus was eventually reached between Staff and Hillcrest as to some of the issues, and the two jointly filed a Partial Agreement setting out the resolved issues while simultaneously setting aside the remaining issues for resolution at an evidentiary hearing before the Commission. A hearing was held before the Commission on May 19, 2016, during which the parties put forward evidence regarding the unresolved issues.

         One of the issues which was addressed at the evidentiary hearing, and which forms the primary point of contention in the appeal now before us, was the cost of debt component of Hillcrest's capital structure.[4] Hillcrest presented evidence that Cox, in attempting to secure financing for Hillcrest's repair of the Brandco systems, had met with over 50 specialized infrastructure institutional investors, private equity investors, investment bankers, and commercial banks to no avail. Cox testified that, in the end, the only financing that could be acquired was the financing agreement entered into on March 6, 2015, with Fresh Start at an interest rate of 14%. Hillcrest argued that the Commission should use the actual 14% rate from the financing agreement as its cost of debt for purposes of determining the proper rate of return.

         Staff disagreed with Hillcrest's assessment of its cost of debt. They argued that the commission should impute a cost of debt between 8.88% and 10.13%.[5] Staff pointed to the fact that prior to March 6, 2015, two new investors had acquired 100% interest in Fresh Start as well as an 87% stake in First Round. They were concerned that the investment structure of Hillcrest and its associated entities was consequently too complex, not transparent, and consisted of non-traditional affiliations between investors. As a result, Staff suspected that the 14% interest rate had not originated from an arms-length, good-faith transaction. The Commission acknowledged Staff's concerns but found Cox's testimony regarding his efforts to acquire financing from other sources to be credible and declined to impute a lower cost of debt to Hillcrest. The Commission issued a Report and Order with findings of fact and conclusions of law establishing new rates for Hillcrest calculated, in part, using the 14% cost of debt contained in the financing agreement. The OPC filed an application for rehearing, which was denied. This appeal follows.

         Points Raised on Appeal

         The OPC raises two points on appeal. First, they argue that the Commission erred in setting rates for Hillcrest's customers because it unlawfully applied the presumption of prudence to Hillcrest's cost of debt, which they characterize as an affiliate transaction. Second, they argue that the Commission's Report and Order is unlawful, unreasonable, arbitrary, capricious, and not supported by the evidence claiming that the Commission ignored Staff's evidence regarding the proposed imputed cost of debt.

         Standard ...

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