Discussion - Corrective Measures

The final issue to be addressed is stated in the Assigned Commissioner's scoping ruling in the investigatory phase:

If the Commission determines that Arrowhead has failed to meet its obligations in any or all of these three areas [responsiveness to complaints and inquiries; compliance with health requirements; and compliance with SDWBA requirements], what action(s) should the Commission take?

Arrowhead believes that it should be granted a full return in its GRC using a 22% operating ratio; the SDWBA surcharge should be reinstated; the purchased water balance should be used to cancel out diverted SDWBA funds and any excess used to make plant improvements; and the purchased water and contract repair memorandum accounts should be continued. Arrowhead would have the Commission and its staff assist it in its negotiations with DWR to reduce the SDWBA loan principal and forgive penalties; would have staff meet with all potential buyers to help expedite a sale of Arrowhead's system; and would have staff assist it with DHS to expedite approvals for new SDWBA loans.²⁹

Water Division advocates reducing or eliminating Arrowhead's return in the GRC; seeking a court-appointed receiver for Arrowhead's system; allowing the receiver to collect from customers the undercollections accruing in the purchased water balancing account for the past three years only; recovering from Arrowhead the diverted SDWBA surcharge funds, less credit for three years worth of purchased water balancing account amounts; making Arrowhead responsible for all SDWBA loan penalties; and continuing the memorandum accounts only until a receiver is appointed.

Peters advocates denying Arrowhead any further rate increase and any recovery of the purchased water balancing account deficit; and placing the system in receivership. He might not object to future rate increases if the system were put under different management.

DWR seeks to persuade the Commission to require immediate reinstatement of the SDWBA surcharge and resumption of payments on all loan principal, interest and penalty amounts; and views receivership as the most appropriate means of achieving those goals.

Wanser favors receivership and objects to rate increases of any type.

Pretzinger signed the interim GRC settlement agreement, but did not participate further in either the GRC or the investigation.

We begin with the presumption that the various transgressions for which we find Arrowhead responsible were not due to its owners' dishonesty, but rather to their inability to cope with the challenges inherent in running a small water utility. Lance Johnson and Sally Johnson Hollingsworth through 1995, and Lance Johnson alone after that, were those owners, and both were deeply involved in the management and day to day operations of Arrowhead's water system. The evidence shows that they were the individuals responsible for those transgressions during their tenure, and both are now gone. The record also demonstrates that Arrowhead's water system suffers from, among other things, a lack of as-built plant records. Without adequate records, it is very difficult to locate mains, service connections, shutoff valves and the like to make repairs. By virtue of having lived and worked with the system since 1988, Lance Johnson knew it better than any other individual. Despite his management shortcomings, Arrowhead's water system will be more difficult to operate without him in the near future, not less.

In opening this investigation, we stated,

In this investigation, we shall consider whether existing circumstances warrant the filing of a petition pursuant to section 855 of the P. U. Code seeking the appointment of a receiver for the water system or whether further proceedings are needed to consider other remedies.

Every party has stated its belief that the best long-term solution would be the sale of Arrowhead's system to a willing and capable buyer. All except Arrowhead would support putting the system into receivership³⁰ if no buyer were forthcoming. Arrowhead's representative has repeatedly stressed the company's strong desire to sell the water system and, as we noted earlier, has held talks with at least four potential buyers in late-2000 and 2001. Despite its optimistic predictions and the extra time it was given in the proceeding to pursue that purpose, Arrowhead was never able to close a deal. It believes the reason is clear: "[T]he zero rate of return has been the single most important deterrent to achieving the primary goal of all Parties, the sale of AMWC to a larger operating company." Nonetheless, it still believes a sale is possible: "We urge the Commission to recognize the advances AMWC has made in the last year and allow us to go forward to improve the system and remove the uncertainties that have prevented us from being able to complete a sale to a larger agency or company. That is our goal." ³¹

We also would have preferred a sale to putting Arrowhead's system into receivership. Petitioning the Superior Court for the appointment of a receiver is a serious step, one that sets the Commission and the company on a potentially litigious path demanding scarce resources that would be better used to promote service and facilities improvements. It is not a step we take lightly. Nor could the Commission be assured of finding a willing and highly qualified operator; no party in the proceeding nominated a candidate who seems sure to be both qualified and willing. With no voluntary sale on the horizon, however, we are compelled to take the steps we outline below to put Arrowhead's water system on the path to recovery.

First, based on our findings above in the investigatory phase of the proceeding, we conclude that Arrowhead has been unable or unwilling to adequately serve its ratepayers, and that it has been unresponsive to the rules and orders of the Commission. We will direct the Commission's General Counsel to petition the Superior Court of San Bernardino County to appoint a receiver for Arrowhead's water system, in accordance with Section 855.

Second, we note that the Arrowhead water system is in dire need of rehabilitation. To accomplish that, future rates will need to be higher than those we authorize today, and that will remain true regardless of whether the future operator is Arrowhead, a new owner, or a receiver. Our decision to begin strengthening the rate structure now by authorizing a return based on a 15% operating ratio is explained in the general rate case discussion section above. Maintaining artificially low rates to penalize Arrowhead would promote additional rate shock for customers later and make capable buyers less willing to consider a purchase. In addition, any receiver that may be appointed will need a strong cash flow to overcome the neglects of the past decade and longer.

Third, we reinstate a SDWBA surcharge. Our suspension in I.00-03-016 has served its purpose: to halt the diversion and allow time to develop an evidentiary record leading to this order. No party wishes to see DWR's late payment penalties increase further. We expect Arrowhead or its receiver to meet with DWR to attempt to work out a new loan amendment that will recapitalize back interest (but not penalties, which are to remain an Arrowhead obligation not recoverable from ratepayers) and take into account the time necessary for Arrowhead's new surcharge to build up sufficient funds to resume regular payments.

We will assign our Water Division in its advisory role to designate an experienced staff person as a liaison to be in frequent contact with the system's management over the next year, and longer if necessary. The staff liaison should have substantive telephone discussions with company management no less frequently than monthly, and should be receptive to any information Arrowhead's customers, DHS, DWR, and the other parties may wish to convey. We are particularly sensitive to ensuring that Arrowhead complies with our orders regarding its SDWBA loan surcharges, payments and penalties. The Water Division staff liaison should pay particular attention to obtaining positive confirmation every month that funds collected by the surcharge are being deposited in the trust account, and that DWR is timely receiving scheduled payments in full. Water Division management will keep us informed and suggest for our consideration any follow-up actions that may be necessary.

As an added level of assurance that surcharge collections will be applied as intended, we will include a provision that causes the GRC increases and SDWBA surcharges we authorize today to expire automatically on February 15, 2003 if not sooner extended. This is 45 days after the January 1, 2003 DWR payment is due. Arrowhead will be authorized to submit an advice letter not sooner than the date the payment is actually made and not later than January 31, 2003 (i.e., 30 days after the payment is due) to reset the clock for an additional six months (i.e., a new expiration date 45 days after the July 1, 2003 payment is due), after which the advice letter extension process is to be repeated for each subsequent payment due date until further order of the Commission. Those advice letters are to become effective upon Water Division's confirmation with DWR that DWR has received the corresponding payment in full. Since the contract is between Arrowhead and DWR, repayment of the loan is Arrowhead's legal obligation; a claim of shortfall in surcharge funds collected or of funds in the reserve account will not be considered justification for non-payment or partial payment, or for late payment beyond the 30-day grace period Arrowhead's contract with DWR allows before penalties are applied. We will consider in a future decision, perhaps when we authorize a transfer of control of Arrowhead's system, or after a receiver has been appointed, whether to discontinue this provision.

We recognize that these second and third measures mean real and significant rate increases for customers, but bringing the Arrowhead water system into compliance with Commission and DHS orders and the DWR contract requires the funds they will generate. With Lance Johnson gone, control of Arrowhead, and thus its water system, will change. The record does not indicate who is managing the company on an interim basis in Lance Johnson's absence. Whoever ultimately assumes control must not be handicapped going forward.

Fourth, we find that Arrowhead should receive credit for an undercollection in its purchased water balancing account; that Arrowhead should be held liable to its customers for the full amount of past SDWBA surcharge revenues collected from customers and not applied toward the SDWBA repayments for which the SDWBA surcharge was authorized; and that the two amounts are, to the extent they can be determined, approximately equal and offsetting. For our determination that they are equal and offsetting, we rely only in part upon the figures Arrowhead and Water Division present in their November 6, 2000 Motion for Adoption of Stipulation and its attached Stipulation. While we grant the motion, we accept the figures only as a starting point. We note that we have not had the opportunity to apply the same level of scrutiny to the water balancing account figures that they would have received had Arrowhead been submitting claims more frequently. Also, we note that the three-month commercial paper rate has been applied as the interest rate for both the diverted funds and the balancing account. While that is our standard rate for many purposes and not an unreasonable rate to use here, we also note that SDWBA interest has been accumulating at the 7.4% SDWBA loan rate DWR has applied from 1989 forward, not the three-month commercial paper rate. If we were to apply the 7.4% rate after 1989, the final figure for SDWBA funds diverted would be higher and even more nearly equal to the balancing account shortfall. Thus, we find the stipulated figures are reliable for our purpose here, but given these considerations and how near to equal they are, not sufficiently certain to justify ordering a rate surcharge or surcredit based on any small arithmetic difference there may be between them.

Fifth, we find that Arrowhead alone should be responsible for all penalties, past, present and future, generated under its SDWBA loan contract with DWR. Those are not obligations of Arrowhead's ratepayers and are not reasonably recoverable in future rates. As Arrowhead points out on brief in an attempt to deflect responsibility for its penalties,

This loan is between AMWC and the DWR, not the CPUC. Furthermore, our customers should not be penalized for additional penalties imposed by the agency responsible to protect their interests or by penalties resulting from the Commission terminating the customer surcharge for a two-year period of time.

Arrowhead at one point urged the Commission to require DWR to cancel the penalties, but as DWR's attorney correctly informed Arrowhead's representative in our hearings, "[T]he Commission doesn't have that kind of authority over DWR to instruct us what to do with our loan program." Late in the proceeding, Arrowhead modified its request to having the Commission and its staff assist it in its negotiations with DWR to reduce the SDWBA loan principal and forgive penalties. While DWR's forgiving Arrowhead's penalties could hasten the company's financial recovery and ultimately benefit DWR by making full repayment of the loan principal and interest more likely, we leave those negotiations up to the contracting parties: "This loan is between AMWC and the DWR, not the CPUC."

Should Arrowhead or its receiver be successful in negotiating a sale of the system before all penalties are discharged, we will expect the sales agreement to include a provision for paying any remaining penalties from the sale proceeds or, if the proceeds are less than the penalties, an explicit acknowledgment from a financially capable buyer that it alone is accepting the obligation for the penalties and that they are not recoverable in future rates.

Sixth and lastly, we will order Arrowhead to prepare and submit to the Commission's Water Division within nine months a comprehensive, long-range plan for system infrastructure and operational improvements. The plan is to include cost estimates and identify sources of funding. If low interest rate state funding is not available, we expect the plan to identify realistic, alternative sources. If Arrowhead is unable to obtain financing, we will take that as an additional indication of financial inability or unwillingness to adequately serve its ratepayers. Regardless of its past difficulties, from today forward we expect and will require Arrowhead to engage in a proactive program of infrastructure, service and health compliance improvement measures.