WATER AND SEWER RATES ‑- REASONABLE PROFIT ‑- TRANSFER SURPLUS TO GENERAL FUND

WATER AND SEWER RATES ‑- REASONABLE PROFIT ‑- TRANSFER SURPLUS TO GENERAL FUND

Cities may fix rates so that a reasonable profit results and transfer surplus to general fund in absence of agreement with bondholders to contrary.

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                                                                November 2, 1955

Honorable Ralph Purvis
State Representative
Twenty-third District
245 Fourth Street Building
Bremerton, Washington                                                                                                              Cite as:  AGO 55-57 No. 155

Dear Sir:

            You have requested the opinion of this office as to the power of a city to place an additional charge upon city water and sewage services for the purpose of providing additional revenue for the city's general fund.

            In our opinion, the city may fix rates so that a reasonable profit will be realized and transfer surplus accruing therefrom to its general fund in the absence of agreement with bondholders to the contrary.  What constitutes a reasonable rate is a question of fact to be determined in the light of the circumstances.

                                                                     ANALYSIS

            Authority for cities to acquire and operate water and sewage utilities is contained in chapter 80.40 RCW.  The functions are proprietary, rather than governmental.  Hutton v. Martin, 41 Wn. (2d) 780.

            RCW 80.40.010 provides in relevant part as to a water system that the city has

            "* * * full power to regulate and control the use, distribution, and price thereof:  Provided, That  [[Orig. Op. Page 2]] all water sold by a municipal corporation outside its corporate limits shall be sold at just and reasonable rates."

            RCW 80.40.020 provides in relevant part as to sewer systems that the city has

            "* * * full authority to manage, regulate, operate, and control them, and to fix the price of service thereof, within and without the limits of the city or town."

            We note that § 1, chapter 159, Laws of 1905 (p. 301), made substantially the same provisions with regard to municipal water and sewer systems.  InTwitchell v. Spokane, 55 Wash. 86, 89, the court held that a city could transfer profits from a water system to the general fund, and quoted with approval from 1 Farnham, Water and Water Rights, 885, § 162, as follows:

            "'When a municipal corporation owns its own plant for the supply of water to its inhabitants, the property is held for the common benefit, and every inhabitant has a right to the benefit of it on reasonable terms.  Therefore, although the municipality has a right to fix the terms by which the water will be supplied, and to establish the rates which shall be paid for it, the right must be exercised in a reasonable manner, so that the rates shall be reasonably proportionate to the service rendered.  The municipality, however, is not required to limit the rate to the actual expenses of furnishing the water, but may fix a rate which will result in some profit to it, which it may use to meet its other public needs.'"

            This appears to be the general rule.  See 12 McQuillin, Municipal Corporation (3rd ed.), 687, § 35.37:

            "* * * However, the rates must be reasonable, although the municipality may charge a rate which will yield a fair profit, and need not furnish the supply or service at cost; * * *"

             [[Orig. Op. Page 3]]

            Cases from at least twelve other jurisdictions are cited in support of the rule, in addition to the Twitchell case.

            It is true that there is language in Smith v. Seattle, 25 Wash. 300, at page 314 indicating that a city could not operate an assessment district in order to obtain a profit from water sold; but the court expressly stated the question was not before it.  Likewise inUhler v. Olympia, 87 Wash. 1, 13, it was said in an action to enjoin a bond issue for a water works that a city could not condemn a water system with intent to use it as a money-making venture.  TheUhler case remarks were made with reference to § 1, chapter 150, Laws of 1909, and not essentially different from the present provisions of RCW chapter 80.40, which are material here.  The cases collected in 90 A.L.R. 700 on this question, with some exceptions, seem to permit a reasonable profit.  However, inCarstens v. P.U.D. No. 1, 8 Wn. (2d) 136, 151, it is said with respect to a public utility district that

            "* * * a municipally owned enterprise of this nature may not be operated for profit, and must establish its rates at the lowest possible point."

            The only authority cited is the Uhler case.  TheCarstens decision was rendered in a condemnation action, and the court reversed the trial court, which had denied a certificate of public use and necessity.

            We are thus confronted with three cases, Smith, Uhler, and Carstens, stating that a profit cannot be contemplated by a municipal utility.  On the other hand, theTwitchell case, decided before the Uhler and Carstens cases, and ignored in them, holds that a profit is permissible; and it is supported by McQuillin and apparently by the weight of authority in other jurisdictions.  In theUhler andCarstens situations, the question before the court was the acquisition of a particular utility, and the language of theSmith case plainly shows that the court was not considering the question.  TheTwitchell case, however, was decided on a specific rate then being charged.

            In AGO 53-55 No. 349, on December 1, 1954 [[to Cliff Yelle, State Auditor]], our office approved the rule adopted in Twitchell v. Spokane, supra, in the following language:

            "* * * The rates charged must be commensurate with the various costs of operation of the water system.   [[Orig. Op. Page 4]] Since exactitude with reference to income versus outgo is next to impossible, there is no legal objection to making a small profit so long as the rates are not disproportionate to the operational costs.  In the event such disproportion arises, the validity of the rates may be challenged."

            This statement we think is sound.  The question of fact, as to whether rates are reasonable, should be decided with reference to the operational costs of the water or sewer system.  InPort Orchard v. Kitsap County, 19 Wn. (2d) 59, the issue was the reasonableness of the classification made under a Port Orchard sewer charge ordinance.  In holding that the rate schedule was not unreasonable, arbitrary or capricious the court appeared to rely on testimony that the council had engineering advice and inquired into the methods used by cities of comparable size in fixing sewage rates, and that they adopted methods of classification generally in use.  This would suggest that in adopting sewer and water rates a city council should be guided by more precise criteria than the financial condition of the city's general fund.  A large disproportion, arising as the result of an intent to substitute water or sewer charges for the normal sources of municipal revenue, would be an important factor in judicial consideration of the reasonableness of a particular rate.

            In our opinion last cited above to the state auditor, and in AGO 49-51 No. 339 to Senator Rogers on September 28, 1950, we have approved the transfer of water department surplus to the city general fund on the authority of theTwitchell case, and we adhere to those opinions.  Copies of both are enclosed for your convenience.

            We do not wish to be understood as expressing any opinion upon the power of a city to transfer a utility surplus to its general fund where the right to make such a transfer might be affected by the rights of the holders of bonds issued to finance construction or acquisition of the system.

            We hope the foregoing analysis will prove helpful to you.

Very truly yours,

DON EASTVOLD
Attorney General

MAURICE M. EPSTEIN
Assistant Attorney General