Request By:
Hon. Kenny Fankell
Mayor
City of Olive Hill
Opinion
Opinion By: JACK CONWAY, ATTORNEY GENERAL; Matt James, Attorney General
Opinion of the Attorney General
Hon. Kenny Fankell, Mayor of Olive Hill, has requested an opinion of this office regarding how a city that operates a utility may utilize surplus funds from that utility. We advise that a city may by ordinance specify how to utilize surplus funds. Until such an ordinance is passed, the surplus funds shall be deposited in the general fund of the city for general purposes.
Mayor Fankell informs us that Olive Hill operates its own electric system and purchases power from American Electric Power. Annually, American Electric Power compares the money paid by Olive Hill for electricity to the actual cost of the electricity, in what is known as a "true-up." Historically, the cost of the electricity has exceeded the money paid by the city, resulting in additional charges to the city. However, this year, decreasing utility costs resulted in an overpayment of $ 172,000 by the city. Mayor Fankell has specifically asked whether the overpayment must be returned to the city's customers, or may be used by the city to upgrade its electric system or hold the funds in escrow for future environmental compliance costs. 1
KRS 96.200 provides:
. . . the legislative body of any city of the third through sixth classes inclusive 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 . . . Until such an ordinance is enacted any surplus earnings shall be paid into the city treasury, to be expended for the general purposes of government in the city.
KRS 96.200 thus provides that a city may by ordinance specify how to use surplus utility funds. Until such an ordinance is passed, the surplus funds are to be paid into the city treasury and to be expended for general government purposes.
Although KRS 96.200 allows for payment of surplus funds into the city treasury for general purposes, "surplus" has been very narrowly construed. In
Electric Plant Bd. of City of Mayfield v. City of Mayfield, 185 S.W.2d 411 (Ky. 1945), the court directly addressed how to interpret KRS 96.200. It held that "the City of Mayfield has the authority to, as it did by ordinance, direct that the surplus, over and above the operating and maintenance costs and statutory sinking fund requirements, be paid into the general fund of the city." Id. at 413. However, it interpreted "surplus" very narrowly, finding that "it is obvious, from reading the Statutes hereinbefore referred to, that the city has no right to withdraw any sum of money from the revenues of the water plant until first funds sufficient in amount to cover operating, maintenance, and sinking fund requirements shall have been set aside." Id. The court held that although cities have the authority to deposit surplus utility funds into the general fund, the funds must truly be surplus, meaning operating, maintenance, and any other costs for the utility must first be accounted for before any surplus utility funds are paid into the city treasury.
In OAG 78-656, we followed the guidelines in City of Mayfield :
the rates should be sufficient to cover all operating and maintenance costs and statutory sinking fund requirements . . . 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.
Id. While we followed the guidelines of City of Mayfield , we further added that a city may not use a utility simply to generate more money for the city's general fund. 2
KRS 96.200 and City of Mayfield provide that a city may by ordinance specify how to deal with surplus utility funds, but until that ordinance is passed, the funds shall be deposited in the general fund. In order to truly be surplus funds, all utility expenses should be paid for before any funds are deposited into the general fund. Regarding the specific questions asked by Mayor Fankell, a city may by ordinance elect to return the surplus funds to customers as a refund. In another context, we advised that "there does appear to be authority for refunding any excess tax payments by benefited property owners back to the property owners." OAG 80-110 (citing 14 MCQUILLIN MUN. CORP. § 38.336). 3 Returning surplus utility finds to customers is thus a permissible and perhaps favored method of using surplus utility funds, and a city may by ordinance do so. It may also by ordinance use those funds to upgrade its utility system or hold them in escrow for future environmental compliance costs. While the city may pass no ordinance and pay the surplus funds into the treasury, given the narrow construction of surplus funds and the potential for misuse in the general fund, prescribing the use of the surplus funds by ordinance seems preferred.
In summary, a city that operates a utility may by ordinance specify how to use utility funds that are surplus after accounting for all utility costs. Until it passes such an ordinance, such surplus funds are to be paid into the city treasury.
Footnotes
Footnotes
1 Mayor Fankell notes that many customers have moved, either in or out of Olive Hill, and there would be difficulties in both finding out which customers are entitled to refunds and in calculating the amount of any refunds.
2 The City of Olive Hill has previously been found to have misused utility funds by depositing them directly into the city's general fund without accounting for utility expenses. AUDITOR OF PUBLIC ACCOUNTS, SPECIAL EXAMINATION OF CERTAIN FINANCIAL ACTIVITIES TRANSACTED BY THE CITY OF OLIVE HILL 6-8, (Aug. 15, 2000). In the context of this history, we reiterate that a utility should not set rates that result in a shortfall or surplus, but should take care to set reasonable rates that reflect its actual costs.
3 OAG 80-110 dealt with surplus funds in a flood wall bonding account. We discussed KRS 96.200, but noted that there was no corresponding statute for a flood wall bonding account, and concluded that "we seriously doubt that the surplus funds from the flood wall bonding account collected from the benefited property owners can be placed in the general fund in the absence of any specific or implied authority to do so." OAG 80-110.