8. Ratemaking Treatment of Investments in Shares of Fontana Union Water Company

On February 14, 2002, Dr. Thomas Slemmer and several other persons filed the Slemmer suit in San Bernardino Superior Court (Court) against SGV and other defendants. The plaintiffs claimed treble damages in the range of tens of millions of dollars. The suit alleged the plaintiffs' rights as minority shareholders in FUWC had been violated by the defendants who together owned a majority of the FUWC shares.

Among the plaintiffs' allegations were that the defendants violated federal and state anti-trust laws by settling a lawsuit with West Valley Water District involving access to Lytle Creek surface water that had the effect of prohibiting the plaintiffs in this case from selling the water rights represented by their shares in FUWC to third parties. Another issue was whether the plaintiffs received a reasonable price for 358.6 shares previously acquired by SGV.

The parties entered into a settlement (Slemmer settlement) that was approved by the Court on July 24, 2006. As part of the Slemmer settlement, the suit was dropped, SGV paid $4,200,000 to the plaintiffs and SGV received 179.2 shares of FUWC stock.

8.1. Positions of Parties

As part of the settlement in this proceeding, DRA and SGV agree to the inclusion of the $4,200,000 Slemmer settlement payment in ratebase.

COF states that the Slemmer settlement amount of $4,200,000 divided by the 179.2 shares acquired as a result of the Slemmer settlement amounts to $23,438 per share. COF states that this equates to $9,375 per acre foot of water rights assuming each share conveys 2.5 acre feet of annual water rights. COF represents that the suit was between shareholders of FUWC and not ratepayers. COF also states that SGV was already using essentially all of the water rights of FUWC prior to the litigation. Therefore, COF states that the $4,200,000 cost of the Slemmer settlement should be excluded from ratebase.

FUSD agrees with the position taken by COF.

SGV states that, since the Slemmer settlement resolved issues related to 358.6 shares previously acquired, the correct analysis of the costs per share is $4,200,000 plus $686,350 paid for shares previously acquired divided by 537.8 shares (179.2 shares plus 358.6 shares previously acquired). This equates to $9,086 per share. Assuming a share carries with it water rights to 2.5 acre feet of water per year, the cost per acre foot would be $3,634. SGV states that recent sales of water rights have ranged from $3,540 to $5,534 per acre foot. Thus, SGV states that the Slemmer settlement cost amounts to the purchase of FUWC shares, and the corresponding water rights, at a reasonable price.

8.2. Discussion

The purpose of the $4,200,000 Slemmer settlement amount was to settle the Slemmer suit. It was not an arms length purchase of FUWC shares. Thus, the Slemmer settlement costs are not necessarily indicative of the value of the 179.2 shares acquired or the value of removal of the plaintiffs' claim regarding the 358.6 shares previously acquired. The question is whether any of the $4,200,000 should be recovered from ratepayers by being included in ratebase, as proposed by SGV and the settlement.

SGV's insurance company, Kemper Insurance Company (Kemper), which also insured FUWC, accepted the obligation to defend SGV and FUWC in the suit. Due to the complexity and risk exposure of the litigation, all of the parties, including SGV, retained outside counsel in addition to the attorneys provided by Kemper. As a result, SGV incurred $938,934 in litigation costs.

Kemper subsequently faced insolvency and decided in mid-2006 to claim that it was not obligated to defend SGV and FUWC or be responsible for any judgments against them. Kemper was part of the Slemmer settlement and paid $6 million into the Slemmer settlement.

SGV stated that the Slemmer settlement suit would prevent further costly litigation and even costlier litigation by third parties who would claim the right to the water supplies. Given this representation by SGV, the Commission finds SGV would have incurred additional costs if the suit had gone to hearing. Still more costs would have been incurred if the verdict in the suit was appealed. Additionally, if SGV lost the suit, it may have had to pay treble damages. Added to the likelihood of additional costs for SGV is Kemper's insolvency and its position that it would or could no longer defray the litigation costs. Without Kemper's participation, SVG would have had to pay a portion of the costs Kemper would have defrayed. Thus, it appears likely that SGV would have incurred significant additional costs absent the Slemmer settlement.

The Slemmer suit was not foreseen in the previous GRC and estimated costs were not included in rates. This means Slemmer suit costs would have been paid for by SGV's shareholders, not ratepayers. Additionally, the Commission did not authorize any balancing account treatment of these costs or any other mechanism that would have provided for recovery of these costs from ratepayers at a later date. Thus, SGV's shareholders benefited significantly from the Slemmer settlement by avoiding additional costs related to the Slemmer suit.

The record does not indicate that SGV intended to buy the additional water rights it received in the Slemmer settlement prior to the Slemmer settlement. Prior to the Slemmer settlement, SGV and some other owners of FUWC were using the water rights of FUWC to the extent they needed to do so. However, other owners of FUWC were seeking to sell their shares, which could have allowed other entities to use portions of the FUWC water rights. This raises the possibility that SGV could have reduced access to FUWC water rights in the future.

The record does not indicate that a reduction in SGV's access to FUWC's water rights was very likely to occur. SGV's acquisition of additional shares as a result of the Slemmer settlement eliminates this possibility, however remote it may have been. Therefore, the additional 179.2 shares of FUWC stock acquired as a result of the Slemmer settlement have some value to ratepayers. The record shows that the water rights have a value of $3,540-$5,534 per acre foot. Since the risk to ratepayers of SGV losing access to FUWC water rights does not appear to be very high, the acquired water rights will be valued at $3,540 per acre foot. This translates to a stock value of $8,850, or $1,585,920 for the 179.2 shares.

SGV represents that the Slemmer suit was without merit. Thus, the record does not indicate that SGV was at any significant risk of having to pay more for the 358.6 shares previously acquired. This supports the conclusion that there is little if any value to ratepayers of the Slemmer settlement regarding these shares. For SGV to lose the suit, it would have been found to have acted improperly regarding the purchase of the 358.6 shares previously acquired. If that had happened, there would be no reason for ratepayers to pay for the results of SGV's wrongdoing. As a result, the Slemmer settlement had no significant value to ratepayers regarding the 358.6 shares previously acquired. Therefore, there is no reason to allow an additional portion of the costs of the Slemmer settlement in ratebase.

For the above reasons, $1,585,920 of the Slemmer settlement costs attributable to the value to ratepayers of the additional 179.2 shares of FUWC stock will be allowed in ratebase. None of the other Slemmer settlement costs are allowed in ratebase. The settlement, without this alternative term, is not in the public interest.