Background

Since approximately 1913, residents of the vicinity several miles north of the Village of Aptos along Redwood Drive in Santa Cruz County have obtained public water service, initially through individuals and entities no longer of record, and subsequently at mid-century through the Aptos Water Company and its successor, the Monterey Bay Water Company.

In 1960, John S. Cavanaugh (Cavanaugh) and his wife Evelyn Cavanaugh (Mrs. Cavanaugh) and the Santa Cruz Land Title Company acquired approximately 290 small lots along Redwood Drive in a very rugged and forested mountainous area. The Cavanaughs were developers and sold home sites along Redwood Drive. About 1970, the Cavanaughs obtained the Title Company's interest in the remaining lots of the original 290.

Earlier, after having provided water service to some of the Cavanaugh's developed lots, Monterey Bay Water Company sold out to Soquel Creek County Water District, which entity later severed the connections to the Cavanaugh properties. Lacking the funds for what threatened to be a long and expensive legal battle, the Cavanaughs were forced to install their own well, storage tank and distribution main to serve their developed properties.

By 1970, the Cavanaugh Water System was serving 17 customers. As the result of a complaint by three of these, by Decision (D.) 77059 (April 7, 1970) the Commission determined that the system was a public utility. Further connections were prohibited until certain improvements were made.

Unable to obtain loans to sue Soquel Creek County Water District, or to sell lots without water connections, the Cavanaughs also were unable to obtain Commission approval for transfer of the water system as a proposed "mutual" to the customers (D.80469).

Finally, by 1973 a compromise to the impasse was approved by D.80999. A Plant Improvement and Replacement Fund (Fund) was established. A portion of the proceeds from each lot sale by the Cavanaughs was to be deposited in the Fund, with expenditures from the Fund to require approval from the Commission's Executive Director. However, after making a small initial deposit, the Cavanaughs bypassed the Fund, and paid the cost of needed facilities work directly without reference to the Executive Director.

By D.91980 in 1980, the Cavanaugh Water System was incorporated as the Greenbelt Water Company, Inc. (Greenbelt).

In 1982, Greenbelt was authorized and received a Safe Drinking Water Bond Act (SDWBA) loan of $128,440 to rebuild the failing system. By D.82-07-103, the Commission ordered consumers to pay a monthly surcharge to their water bill to repay the 30-year loan. Instead of contracting the rebuilding, Cavanaugh himself supervised the work. A 37-month delay by the Department of Water Resources (DWR) after authorization, but before actual funding during a period of soaring inflation, led to some improvements not being done, and to an inadequate road resurfacing on Redwood Drive.¹ However, the basic water system improvements were completed in 1984. Cavanaugh's supervision of the project led to questions from the States Controller's Office of his bidding and accounting practices. Despite inadequate recordkeeping by the Cavanaughs, it was concluded that the costs for the work done were commensurate with the loan funds expended.

Meanwhile, customer relations worsened. There were disputes over responsibility for maintaining Redwood Drive. Customers raised questions about the State Controller's audit of the SDWBA proceeds used to rehabilitate the water system. There were questions about Cavanaugh's compliance with his obligations under the Fund. The latter led to a 1990 Commission audit. This audit concluded that under the Uniform System of Accounts Cavanaugh was in non-compliance. The audit also questioned whether the Greenbelt rate base had been overstated in a prior rate proceeding. The Auditor, basing his computation on a form of pro-rata analysis rather than actual tracing of lots sold, concluded that Cavanaugh should have contributed $50,000 to the Fund for improvements.

The Auditor failed to consider the fact that after the Commission ordered establishment of the Fund in 1973, the County changed building site requirements from the earlier 4,000 sq. ft. to over 15,000 sq. ft. per site. Thus, 1973 era lots had to be combined to produce a single building site. The Cavanaugh contributions were based on building sites, not lots. Seventy-one percent (71%) of their land sales represented packaging of two to five historic plotted lots. The Water Division did its own audit, and used the County Recorder's official records to conclude that Cavanaugh's contribution obligation was actually $20,000, not $50,000.²

Using the 1984 rate base, a retroactive computation found that the possible 9.99% rate of return was still below the 11% the Commission was authorizing other small Class D water utilities, and that actual results showed Greenbelt barely operated in the black.

Finding that the Fund had been more than fully funded and that the funds generated from the land sales had been applied to appropriate plant improvements and replacements, the Fund was terminated by the Commission in 1994 (Becky Steinbruner et al. v. Greenbelt Water Company (1994) 54 CPUC2d 438). The Cavanaugh's were again ordered to maintain the books of account in compliance with the Uniform System of Accounts.

Subsequent Developments which Led to this OII

Repayment of an SDWBA loan is funded by a surcharge on each customer's monthly water bill. In the case of Greenbelt the individual monthly surcharge is $14.50. These surcharge collections are to be deposited in a trust account by the utility, and bi-yearly the utility makes a payment to the DWR from the trust account until the loan is finally repaid. For Greenbelt, this bi-yearly remittance was fixed at $5,772.00.

In July of 1994, DWR informed the Water Division that in the past Greenbelt had at times been late or had even missed payments, but that these lapses had always been corrected, albeit at an interest and penalty cost. But by July of 1994, Greenbelt was delinquent $18,052.96.

Staff Auditors began a preliminary investigation in early 1995. Cavanaugh agreed to provide records including bank statements but did not deliver. He also agreed to set up a proper fiscal agent. After repeated efforts, Staff Auditor Wong in early 1995 met with the Cavanaughs. By that time Cavanaugh was blind, and as the result of a stroke, Mrs. Cavanaugh could communicate with only a "yes or no" nod. The Cavanaughs produced miscellaneous records, including some ledger books and spreadsheets, but with gaps. Based on a 4-month sample of customer remittance slips in the records, Wong extrapolated to conclude that from 1982 to June of 1995, customer surcharge collections by the Cavanaughs approximated $45,000. In January of 1996, staff told Cavanaugh to either pay the delinquency of $45,667.40 or suggest a payment plan. He was also told to open a trust account with a fiscal agent, and that all future surcharge collections were to be deposited with that agent.

By March of 1996, no fiscal agent account had been opened. Cavanaugh did remit two payments of $1,000 each directly to DWR. On April 16, 1996, Staff personnel met with the Cavanaughs and their daughter, Mary. A Bank of America fiscal arrangement was set up, and Cavanaugh agreed to deposit to the account all the surcharge collections each month, or $1,000; whichever was the higher amount. As to the past delinquency, Cavanaugh stated he could repay only if he could sell some of the vacant land parcels he still owned in the Greenbelt service area. In July of 1996, Cavanaugh informed Wong that title to the lots was finally clear so that they could be offered for sale.

It further was ascertained by Staff that Greenbelt had also not remitted Public Utilities Reimbursement Fees for 1994 and 1995, nor had the Cavanaughs filed Annual Reports for 1993, 1994, and 1995.

Concerned to keep public utility water service operating for the customers (given the physical condition of the Cavanaughs), Commission Engineer Smegal met with Mike Mills in June 1996. Apart from being one of the resident-customer, Mills is a plumber contractor, and had been operating the water system on an unpaid basis for Cavanaugh (who owed Mills $3,500 for materials furnished). Smegal also met with Opal McAllister (also a resident-customer) who had been doing the monthly billing for the Cavanaughs. She told Smegal that although the water bills, fees, and surcharges were being collected and she intended to deposit the surcharge amounts with the Fiscal Agent, Cavanaugh had ordered her to send all the money collected to him.

It was against this background that Staff asked the Commission to open an investigation proceeding, resulting in Investigation (I.) 96-09-002 opened in September of 1996.

The I.96-09-002 Order

The investigation order was very broad in its scope. It directed that determinations were to be made whether:

a. Respondents were competent to operate and maintain the system

b. Rates collected were being used to maintain the system

c. Respondents were making necessary and prudent repairs

d. Required books of account were maintained, and surcharges were collected and deposited

e. Respondents failed to remit the $54,358 surcharge revenue

f. Respondents failed to file annual reports, remit PUC surcharges and misstated income

Respondents were ordered to remit any and all SDWBA loan surcharge payments to the Fiscal Agent; that the company, its officers and directors may be ordered to repay the $54,358 (as of March, 1996) to the Fiscal Agent; that the Commission may petition Superior Court to appoint a receiver; that an evidentiary hearing would be held to decide whether to fine and take other actions specified. And finally, a prehearing conference (PHC) was ordered to determine whether Staff had additional evidence.

The November 26, 1996 Prehearing Conference

A PHC was held in Santa Cruz before Administrative Law Judge (ALJ) John B. Weiss on November 26, 1996. Present and participating were the Cavanaughs, Mills and McAllister, Water Branch staff, and members of the public.

Cavanaugh stated that since July of 1996 he had made a single $3,000 payment direct to DWR, plus monthly $1,000 payments to a Bank of America Fiscal Agent, for a total of $11,000; that he had employed Mike Mills and Opal McAllister to operate the utility and handle its accounts, as being blind he could not. He stated that the State Employment Development Department (EDD) without legal process known to him had seized funds from his account, assertedly for various taxes related to his contracting work on the 1982 SDWBA work on the system, and that these EDD actions had caused his problems.

Mills and McAllister, respectively, described their work for the system. McAllister told how Cavanaugh had the $14.50 monthly surcharge payments put through a Comerica Bank pass through account to his personal account to avoid further EDD levies, and merged personal expenses with the balances.

Water Branch personnel stated that when the periodic payments to DWR ceased, interest and penalties caused the open-balance to go to $132,000 on the original $128,000 loan; that the system had had no rate relief since 1984, and was a candidate for use of the Operating Ratio Method in view of its depreciated plant. Branch proposed consideration of a trust assignment of the system to Mills and McAllister pending final disposition and the Cavanaughs agreed to this.

Vallerga preferred such an assignment rather than the Commission getting Superior Court to appoint a receiver in view of the fact that the ratepayers would incur another surcharge to pay the several thousand dollars per month salary of a receiver. Vallerga expressed the wrath of the ratepayers over diversion of their SDWBA surcharges to Cavanaugh personal expenses.

Cavanaugh told of the 72 non-buildable lots remaining which had value only were an adjacent property owner interested in augmenting his property. These had been tied up by a legal claim that was now resolved, and if he could sell them, the proceeds could help pay the SDWBA deficiency.

As direct and current data on the SDWBA loan was lacking, and a DWR representative would not be available until February 1997, continuation of the proceeding was necessary to allow Branch to work with DWR on the status of the SDWBA loan balance. During the interval Branch would work up an agreement allowing Mills and McAllister to operate the utility for the Cavanaughs.

The January 1997 Cavanaugh-Mills, McAllister Stipulations

Late in January 1997 the Cavanaughs stipulated in an agreement with Mills and McAllister, pending a final decision in I.96-09-002, that the Cavanaughs would cede control of the finances and operation of the Greenbelt system to Mills and McAllister. The latter were to establish appropriate books and accounts, make system repairs as needed, operate the system, and remit the surcharges for the loan repayment to the Fiscal Agent. Branch agreed to initiate a rate increase for Greenbelt.

The March 27, 1997 PHC

The second PHC was held by ALJ Weiss in Santa Cruz on March 27, 1997, shortly after the death of John Cavanaugh. Mrs. Cavanaugh was unable to attend. However, representatives from the Fiscal Services Department of DWR, the Santa Cruz County Health Services Agency, the Office of the Santa Cruz District Attorney attended along with Mills and McAllister and customers

Mills reported that each month he had been depositing the customer surcharge payments on the DWR loan with the Bank of America Fiscal Agent Account, and had also taken action as previously directed by the ALJ to clean up past due customer accounts. The six-month remittance amount to DWR is $6,300, and if the Account of the Fiscal Agent builds any significant surplus above that amount, the overage would also be remitted to DWR.

DWR reported that as of March 1997 their books showed a loan balance of $137,127.40. Of this $113,106.19 represented principal and $24,026.21 represented interest. But these figures did not include penalties due because of missed payments.

Morgan C. Taylor, Assistant District Attorney in the Consumer Protection Unit of the Santa Cruz County Office, reported that while criminal prosecution had been considered, because of the age and health of the Cavanaughs, they have not been prosecuted. However, in view of a formal complaint filed against the Cavanaughs by two Greenbelt customers, Steinbrenner and Vallerga, the Consumer Protection Unit had under consideration an unlawful business practices suit against the Cavanaugh Estate and Mrs. Cavanaugh for the purpose of establishing some kind of a security interest in the water company on behalf of the customers.

Branch reported that it was working with Mills and McAllister on a rate increase application, and planned to convert Greenbelt to an Operating Ratio Return system in view of the utility's small rate base.

Noting that DWR had delayed over a year and a half before advising the Commission that Greenbelt was not making its loan payments, the ALJ stated that the ratepayers, who had regularly paid their surcharge payments to Greenbelt, could not be expected to make up the lost payments on the loan; that the ratepayers were not the surety for the loan, Greenbelt and the Cavanaughs were. The ratepayers could not be held liable for the failure of DWR to have been more diligent in its collections on the loan. Thus, in essence DWR would have "to eat" the missed year and a half of Greenbelt payments, or seek to recover from the Cavanaughs. But, as the ALJ pointed out, if DWR foreclosed on the Greenbelt assets it acquired a water system that would find few buyers, and what would happen to the system customers. The DWR representative flatly stated that DWR did not want the water system. The ratepayers' representative, Vallerga stated that the customers also did not want the system. The ALJ pointed out that a Court appointed receivership would add $13 to $25 monthly to each customer's bill for salary alone, given the remote location and condition of the system. The ratepayers did not want that solution either.

It appeared to all present that the best result would be to keep the system going with the Mills-McAllister combination operating it. Mills stated that he and McAllister would be interested in owning Greenbelt if they would not be assuming past liability "to some old stuff." Meanwhile, Mills is getting certified as a licensed water system operator.

For the customers Vallerga stated that their position was that if any recovery could be obtained from the Cavanaugh's property, with reference to the parcel fragments still owned by the Cavanaughs, such recovery should be applied to replenish the stolen surplus accumulated from the ratepayers $14.50 monthly surcharge payments before DWR or the Cavanaughs should receive any of it.

Further proceedings were put on hold pending receipt of more data from DWR; information on the liens reportedly held by other governmental agencies against Greenbelt and/or the Cavanaugh estate; and decisions by the District Attorney's Office whether or not to pursue legal suits.

The Unlawful Business Practices Suit

In 1998, the District Attorney's office filed an Unlawful Business Practices Suit against Greenbelt, Mrs. Cavanaugh and Does 1-20 inclusive, in Santa Cruz County Superior Court (No. 134142), seeking recovery for unlawfully converted surcharge funds. Recovery was to be sought from the various land parcels now held by Mrs. Cavanaugh, but it was recognized that to obtain any significant value from the lots it would be necessary to combine several into single parcels and obtain land use planning assistance. It was felt that a simple default judgment and execution upon it would be ineffective. In September of 1998, the suit was continued for six months.