Background

The allegations of regulatory noncompliance that caused us to institute this investigation fall into two general areas of Hillview's operations. The first area is the company's borrowing and lending activities, particularly where indebtedness was incurred without specific prior Commission approval. Our concern, and that of the statutes we enforce, is that we must be in a position to prevent potential harm to the utility's customers from unjustifiable rates or degradation of service quality as a consequence of improvident borrowing. The second area is that of the company's handling of advances and fees from developers and individuals for extending and increasing the company's facilities to meet the needs of new customers. Our concern here is with preventing the exaction of unauthorized fees and charges from these customers, resulting in unjust enrichment of the company and its owners. The facts that Staff brought to our attention about these two areas of Hillview's activities prompted our concern, and our decision to examine them more closely in this formal proceeding.

1. Hillview's Borrowing and Lending History

Several loan transactions, some of them interrelated with others, are the subject of this investigation. To make the regulatory compliance issues they pose understandable, we must recount a good deal of Hillview's borrowing history.

In 1980 we authorized Hillview to obtain a loan from the California Department of Water Resources (DWR) under the SDWBA. (D.91560 (April 15, 1980).) Our decision required Hillview to establish a surcharge for each service area to provide a means for repaying the loan. Hillview deposited the proceeds of the SDWBA loan surcharge in a special account maintained with Golden Oak Bank during the period pertinent to this proceeding. In 1987, we authorized Hillview to increase the borrowing from DWR by $262,283. (D.87-09-029, as modified by D.87-11-051.) Hillview used the same Golden Oak Bank account in connection with this new borrowing, and all customer surcharges continued to be deposited into this account.

As disclosed in the course of our Staff audit, between 1980 and 1994, 14 withdrawals totaling $141,516.61were made from this account without Commission approval, for reasons other than repaying the SDWBA loan. Seven withdrawals were made for rollovers of certificates of deposit in which Hillview had invested funds in order to obtain a higher interest rate. Hillview could not support or explain one withdrawal in the amount of $190 made on June 30, 1982. Another, in the amount of $350, was made on May 31, 1992, to correct a deposit error, according to Hillview.

One withdrawal of $25,000 was made on January 31, 1992, to be used for Hillview's general expenses. Hillview admits that we did not approve this withdrawal, but the company sought DWR's prior approval and received an affirmative response from DWR in a letter dated January 27, 1992. (Exhibit (Exh. 129.)⁷

The remaining four withdrawals were made, respectively, on June 30, July 31, September 30, and October 30, 1993. The first was in the amount of $2,220.17; each of the others was in the amount of $4,440.33. Forrester testified that the purpose of these withdrawals was to "make payment on the $350,000 obligation of Hillview" to Judith and himself. (Exh. 82A, pp. 16-17.) This obligation arose from a loan that the company had made to the Forresters shortly before, as explained in greater detail below.

Forrester concedes that none of these withdrawals was made with prior Commission approval. He testified that Judith withdrew the money on each occasion without his knowledge. As an officer of the company who handled office duties before her relationships with Hillview and Forrester ended, she was apparently in a position to do so. The respondents offer no specific evidence to indicate when the Forresters began to experience marital problems, but the timing of these withdrawals coincided with the approximate period Forrester indicated their marital breakdown occurred.

The $350,000 personal loan to which this testimony refers is part of a second transaction that aroused our concern when it came to light in the Staff audit. The structure of this transaction is somewhat intricate, and subsequent refinancings further complicate our ability to trace its history. Essentially, the chronology of relevant events began in April 1991, when Hillview needed funds to build two water treatment plants. Forrester testified that Hillview's credit at the time made it unlikely that the company would be able to obtain a commercial loan on favorable terms. However, Hillview had what Forrester characterizes as a "long history" of dealing with the individuals involved in 41/49 Highway Junction Projects, Limited (41/49), a commercial real estate developer in Oakhurst, and proposed to borrow the funds from that entity. Although unwilling to loan funds to Hillview, 41/49 was willing to make a personal loan of $350,000 to Forrester and Judith, secured by the couple's real and personal property. Forrester testified that his intention was in turn to lend the $350,000 to Hillview, and that he did not believe at the time that Commission approval was necessary in order to do so.

On June 5, 1991, the Forresters entered into a formal written loan agreement with 41/49. (Exh. 24.) The loan was secured by 500 shares of Hillview stock, and by a deed of trust recorded against title to real property owned by the couple. As part of the consideration for the loan, Forrester agreed that Hillview would issue a letter to the County of Madera, stating that 41/49 had no further obligation to provide supply and storage for certain commercial developments in Oakhurst. Forrester testified that he did not know 41/49's purpose in requesting this letter as part of the transaction. The Forresters received the loan proceeds in two equal payments of $175,000, the first upon signing on June 5, 1991, and the second on June 5, 1992.

Between June 30, 1991, and the end of December 1992 the Forresters loaned Hillview $160,553.03, interest-free. Forrester testified that this obligation of Hillview is evidenced by cancelled checks, journal entries, and bank statements, which were collectively received as Exh. 113A. He further testified that Hillview used these funds to build plant.

The Forresters' expenditure of these funds constituted part of the basis of a subsequent transaction, in which Hillview nominally loaned $350,000 back to the Forresters, that was recorded by Hillview as of December 31, 1992. This transaction was structured as follows. First, the Forresters forgave the $160,553.03 owed to them for the previous six months' expenditures, canceling that debt. Second, the Forresters assumed an unpaid $47,900 loan obligation arising from a loan that Linton, Forrester's father, had made to the company at a much earlier time, canceling that debt also. Third, Hillview would receive a note from the Forresters in the amount of $141,546.97. The total of these three figures is $350,000, the amount of the loan. There is no indication in the record that a cash disbursement of $141,546.97 was ever made to the Forresters in satisfaction of this note, and the only indication that the Forresters ever received any cash relating to this loan from Hillview is the evidence that Judith made four withdrawals totaling $15,541.16 between June 30 and October 30, 1993.

Hillview's 1992 Annual Report to the Commission, filed with the WD on March 6, 1993, reports this transaction as part of the company's long term debt, specifically as a "loan from individual" with a 12% interest rate and a 14-year term, incurred on June 7, 1992. (Exh. 26, p. 3, italics supplied.)⁸ Forrester admits that this entry is erroneous. He testified that the error occurred because the transaction was incorrectly recorded on Hillview's books, specifically by inadvertently being combined with another entry.

Notwithstanding the absence of evidence that the Forresters ever received all of the $141,546.97 they purportedly borrowed from the company in this transaction, Forrester testified that he paid off the full amount of the note in the first seven months of 1998. (Exh. 82A, p. 24.) The details of this reimbursement are set forth in Exh. 118, a compilation prepared by Peasley from Hillview's records to comply with the provisions of a loan agreement with another lender in a more recent refinancing.⁹ This document reflects that there were intervening transactions (discussed below) with respect to the original loan back to Forrester, because the repayment otherwise is not consistent with the record of funds received by the Forresters, or with the names shown for the borrowers reflected in Exh. 118.

Note 2 of the compilation reports that on January 31, 1998, Jacqueline Forrester (Jacqueline), who was by then Forrester's wife by remarriage following the dissolution of his marriage to Judith, agreed to apply the balance of a series of notes due her from Hillview, plus accrued interest, toward repayment of the $141,547 (a rounded figure). These notes reflected various amounts she had loaned to the company between April 9, 1997, and January 16, 1998, totaling $85,017. The remaining repayments reported in the compilation were in the form of a transfer of office furniture and equipment with a value of $4,288 from Jacqueline to the company on January 31, 1998; a cash payment of $40,000 on May 15, 1998; and another cash payment of $12,242 on July 7, 1998. Note 4 explains that the latter sum was part of a cash payment of $28,997 received from Forrester and Jacqueline, and that the remaining $16,755 was applied against a current cash receivable due to Hillview from Forrester alone.

The intervening transactions occurring between the loan to the Forresters recorded on December 31, 1992, and the apparent payoff of the remaining balance of that loan in 1998, are a series of refinancings that were accomplished in and after 1994. Forrester testified that in that year Hillview refinanced its $350,000 obligation to Forrester and Judith by obtaining a loan from the United States Small Business Administration (SBA) through Golden Oak Bank in the amount of $424,000. Forrester admits that he did not obtain Commission approval for this loan, because he was "focused on Hillview's needs and [his] personal problems with [his] ex-wife." (Exh. 82A, p. 25.)

Hillview's unauthorized borrowing had come to our attention by the time we granted Hillview's August 2, 1993 request for a general rate increase. In Resolution (Res.) No. W-3833, issued March 9, 1994, we noted that Hillview had incurred long-term debt without Commission authorization as required by Section 816, and that the company should request authorization for the debt it had incurred as soon as possible. The Commission awarded Hillview a rate of return at the low end of the range recommended by Staff in that rate case as a consequence of Hillview's failure to comply with this loan authorization requirement.

Several months later that year, Hillview obtained two new loans from the National Bank of Cooperatives (CoBank). The first, in the amount of $540,000, was obtained to refinance the existing unauthorized commercial debt. The other, in the amount of $960,000, was to be used to refinance the existing SDWBA loan and to pay for approximately $266,650 in improvements. Hillview had sought prior approval of this transaction from the Commission by filing a draft AL on October 6, 1993. We granted the request on November 22, 1994, in Res. No. F-632, which noted that Hillview was in violation of Section 825 for failing to secure prior approval of the commercial debt, citing three Golden Oak Bank loans and one from General Motors Acceptance Corporation. We also granted authority for the company to apply the SDWBA reserve, and any remaining surcharge overcollection relating to the SDWBA loan, to reduce the amount of the $960,000 CoBank loan.

Using the proceeds of the CoBank loan, Hillview repaid the SDWBA loan. However, in Res. No. F-644 (March 13, 1996) we granted Hillview authority to use $112,000 of the remaining SDWBA loan reserve and surcharge overcollection to finance the construction of certain new facilities, rather than paying down the CoBank loan. We did so to enable Hillview to avoid additional borrowing that would otherwise have been necessary to finance these improvements. Staff claims that Hillview understated the balance remaining in the surplus account by $135,812 after repaying the SDWBA loan, and that as a consequence, Res. No. F-644 granted Hillview authority to borrow more funds than necessary from CoBank. Staff contends that this resulted in overstatement of the company's rate base, producing higher rates for customers.

2. Fees for Facility Additions

Hillview's history is closely associated with the development of real property by builders and developers in the rural territory it serves, and its facility expansion is interrelated with that property development.¹⁰ In 1985, the company first began charging a "Supply and Storage" fee under the terms of a main extension agreement it executed with the developer of a development known as Indian Springs. Under the agreement the developer would pay Hillview a specified amount for supply and storage for each lot in the development that was connected for service.

Under this arrangement the obligation to pay the fee to Hillview was that of the developer, who in turn passed the fee on to each individual lot purchaser. As a consequence, no individual purchaser made a payment of this fee directly to Hillview. Hillview says it agreed to this arrangement, under which the developer paid the fee on a per-lot basis at the time each service connection was made, rather than all at once when it commenced development of the entire parcel, for two reasons. First, it spared the developer from having to commit costly capital to the payment of fees that it might not be able to recover

for many years. Second, Hillview did not anticipate that the supply and storage facilities to be financed with these fees would be needed until the development grew to a certain size, so the company did not need to collect the funds immediately in Forrester's judgment.

Over time this practice was converted to a third-party beneficiary arrangement under which the lot purchasers each paid a per-lot share of the total directly to Hillview, in contrast to the previous practice, under which the developer collected the fee from each new purchaser and remitted it to Hillview. This fee was paid on behalf of the developer at the time a lot owner desired the service, and Hillview agreed to accept payment in this manner. In addition to supply and storage fees, fees for main extensions (to the extent that they were the responsibility of the developer) also were handled in this manner.

The form of written main extension agreement Hillview used to establish these obligations was one of several forms approved by the Commission to implement tariff rules. Hillview modified one version of this form by inserting a provision concerning payment of the supply and storage fee, a term that is not used in any applicable tariff. Forrester testified that the company used the term interchangeably with "special facilities fee," a tariff term. Hillview ceased to use "supply and storage fee" after the practice came under criticism by Staff.

Forrester testified that the specific method of payment of these fees depended upon the circumstances of the developer or the particular development. Payment of main extension fees was required from a developer either initially upon execution of a main extension agreement, or on a per-lot basis. A developer that negotiated a per-lot supply and storage fee in its main extension agreement either had to pay a proportional fee directly to Hillview upon connection of water service to a lot, or out of escrow from the developer's proceeds upon sale of the lot. Forrester testified that the selection of the method was left to negotiation between the developer and the lot purchaser.

Forrester testified that he now understands that, following revision of the applicable tariff in 1982 and until at least 1993, supply and storage fees were permitted to be collected only from developers. At the time of these events, on the other hand, he believed it was permissible to accept payment of these fees from individual lot purchasers on behalf of the developer. All of these fees were recorded as Contributions in Aid of Construction (CIAC) and were used to construct supply and storage facilities. They were not included in Hillview's rate base, with the consequence that the company has not earned any return on them, and customers other than those within the affected developments did not pay for the facilities. (Exh. 87A, p. 10.)

The procedure Hillview followed for recording supply and storage fees was to list in its Supply and Storage Fee Account Passbook (Exh. 217) the name of the person for whose lot the fee was paid, the lot number, the date, and the amount paid. The funds were then deposited into the Supply and Storage Fee account. (Exh. 87A, p. 10.) Notwithstanding the existence of these records, the parties have not been able to compile a reliable list of all such fees collected that could be used to refund amounts Staff claims are due under tariff requirements. As nearly as we can determine, this is because the way in which the receipt of some of the fees was recorded may not have accurately reflected their purpose, and because the fractionated manner of collecting these fees on individual lots rather than entire development parcels, coupled with the subsequent resale of

some of the lots, make them impossible to trace. Even when the respondents were working cooperatively with several members of our Staff over a lengthy period to develop an accurate list as part of their settlement efforts, they were unable to do so. The best list they could compile (Exh. 102) indicated in many instances that proof of payment of the fee was missing, and would have to be furnished by claimants if Hillview became obligated to refund the fees under the terms of the settlement.

In 1993, Staff performed a limited audit of Hillview, and examined the company's CIAC account as part of that audit. In their Report on Audit, dated June 25, 1993 (Exh. 105), the auditors stated:

Initially, [we] had concerns with some amounts

recorded in the CIAC account which Hillview called "Supply and Storage Fees" in [its] contributions contracts and in [its] accounting records. This concern focused on whether these fees should be considered to be contributions under existing tariffs. Further examination revealed that these amounts in fact were for Other Special Facilities as allowed under tariff rule 15 and were

appropriately recorded in Hillview's CIAC accounts. After

clearing up this concern [we] found Hillview's

contributions and advance account balances...to be correct. (Id., p. 3.)

As a result of correspondence from members of our Staff beginning in early 1994, the respondents became aware that WD believed Hillview's direct receipt of supply and storage (or special facilities) fees from any individual customer, under any circumstances, was contrary to Commission-approved tariffs. Accordingly, in June of that year Forrester instructed his staff not to include supply and storage fees in the company's Main Extension Contracts or accept such fees from individuals, and the practice was discontinued.