Request By:
Ms. Fair Anna H. Creech
Mayor, City of Harlan
P.O. Box 783
Harlan, Kentucky 40831
Opinion
Opinion By: Robert F. Stephens, Attorney General; By: Thomas R. Emerson, Assistant Attorney General
This is in reply to your letter raising questions concerning the municipal waterworks and the rates it may charge for services rendered to customers inside and outside of the city.
You state that the City of Harlan has encountered some financial difficulties. Back in March of this year the city council voted to increase water rates in an amount sufficient to cover debt service and operations and maintenance costs. Traditionally the city has increased rates at a higher percentage for users outside the city than for those users inside the city. Any additional revenue generated by the rate increase would be passed on to the city's general fund. The water system is managed and operated by a separate commission pursuant to the bond ordinance. That ordinance calls for a vote by the commission to turn over the "profit" from the water system to the city, something which has frequently occurred in the past.
Your first question is as follows:
"May a city alter its rate schedule from a system of same inside/ outside rates to one of different rates outside as inside the city? And, may different rates be charged out-of-town residents as opposed to in-city residents? "
We first direct your attention to OAG 77-410, copy enclosed, where we said that a city may charge higher rates outside the city than it charges inside the city. This general concept was approved by the
Court in McClellan v. Louisville Water Company, Ky., 351 S.W.2d 197 (1961), where a substantial increase in the rate for nonresident customers was upheld over that fixed for resident customers.
In considering this basic concept further we next direct your attention to OAG 71-341, copy enclosed, citing McQuillin Mun. Corp. (3rd Ed.), Vol. 12, § 34.101, to the effect that it is not unjust discrimination to make to one patron a lower rate than to another, where differences exist in conditions affecting the expense or difficulty of performing the service which fairly justify a difference in rates. Thus, as we said in OAG 71-341, if the difference in rates is based upon a reasonable and fair difference in conditions which equitably and logically justify a different rate, it is not an unjust discrimination to charge different rates to resident and nonresident customers of the water company.
While KRS 278.047 provides that the rates charged for services and the standards of services maintained by municipally owned electric utilities shall be the same for customers inside and outside the corporate limits, there is no such provision for municipal water companies. As we said above, water rates set by the city water company may vary for resident and nonresident users so long as they are based on reasonable and legitimate differences in connection with providing the water service. Although the city is under no obligation to furnish water service except upon the payment of reasonable charges,
Cassidy v. City of Bowling Green, Ky., 368 S.W.2d 318 (1963), the activities of the city in the operation of its water system may be reviewed by the courts to test whether such actions are clearly, palpably and grossly unreasonable,
City of Mt. Vernon v. Banks, Ky., 380 S.W.2d 268 (1964).
Your second question asks:
"Second, may a city elect to increase water rates beyond that required for debt service and normal operation management, and maintenance costs of the system? If so, what limitations, if any, exist for rate making under these conditions?"
While KRS 96.350 to 96.510 authorizes cities of the second through the sixth class to acquire and operate a waterworks system, KRS 96.200 provides that the legislative body of any city of the third through the sixth class may by ordinance provide in what manner and for what purpose any profits, earnings or surplus funds arising from the operation of any public utility owned or operated by the city, may be used and expended. In
Electric Plant Board v. City of Mayfield, 299 Ky. 375, 185 S.W.2d 411 (1945), the Court concluded, pursuant to KRS 96.200, that the city could, by ordinance, direct that the surplus over and above the operating and maintenance cost and the statutory sinking fund requirements, be paid into the general fund of the city to be used for public corporate purposes. See OAG 72-449, copy enclosed.
As can be seen from the provisions of KRS 96.200, profits in connection with the operation of a public utility by a city are not prohibited. The General Assembly intended that such profits, if any, be used to supplement the city's general fund. At page 413 of its opinion in the City of Mayfield case, supra, the Court said in part:
"Thus it will be seen that the Legislature intended that a city of the fourth class operating a waterworks plant should use the profits, if any, derived from its operation, to supplement the general fund of the city; and should not hold such profits in trust for the users of water unless, of course, they should exceed a fair return upon the property used and usable. This intention is so plainly manifested, that further comment would be superfluous."
In McQuillin Mun. Corp. (3rd Ed.), Vol. 12, § 35.37c, it is stated that the municipality may charge a rate which will yield a fair profit and it need not furnish the water service at cost. In § 35.37d of the same volume, the author says that the service charge of a municipally owned utility must have a relation to benefits to the user and to a reasonable return on the municipality's investment, based on the value of the plant. "A municipality owning its own utility is entitled to the same protection of the Fourteenth Amendment as any privately owned utility, and may not be deprived of a fair return on the value of its property." Furthermore, the rates of a municipal water system may properly reflect replacement for outmoded facilities, as well as the cost of extending service and the expense of connection to its water trunk lines. In addition, as previously discussed, a municipally owned utility with an indebtedness must be allowed to charge a sufficient rate to meet the interest and amortization requirements of the debt. See McQuillin Mun. Corp. (3rd Ed.), Vol. 12, §§ 35.37e and 35.37f.
We cannot specifically answer your question and can only respond with general principles which you can then apply to your specific fact situation. As discussed in response to your first question, the rates established by the water company must be reasonable and must be related to the costs expended by the city to provide the service to various classes of users. Furthermore, the rates should be sufficient to cover all operating and maintenance costs and statutory sinking fund requirements. In addition, the city is entitled to a fair return on its investment but we cannot determine what the specific figure would be in your particular situation. If after applying these concepts a profit results from the operation of the city's water system, such surplus may, following the appropriate procedures, be used to supplement the general fund. However, rates cannot be raised, excluding these principles, merely to generate more money for the city's general fund.