I. License and Lease Agreement

Factual Background

In 1998, in Application (A.) 98-12-022, the former GTE California Incorporated (now Verizon)² sought approval of 59 license and lease agreements that it had executed between 1994 and 1997. In Decision (D.) 99-06-092, the Commission approved the transactions under Pub. Util. Code § 851. In doing so, the Commission noted that Verizon's failure to seek approval earlier was based on a mistaken belief that Section 851 did not apply to certain transactions involving surplus property.³ Therefore, the Commission directed Verizon to conduct a further review of lease and license agreements during and subsequent to 1990 for any other transactions that may not have been approved.

Through its Real Estate Services Department, and with the help of consultant Cushman & Wakefield, a real estate brokerage and consulting firm, Verizon conducted an internal audit of real estate records from three separate sources, cross-referencing the results. By this process, 17 additional transactions were identified and are included in this application. Verizon states that it now has identified all such transactions to the best of its knowledge. It states that it also has put in place mechanisms by which all such future transactions with third parties will be identified in a timely manner to permit prior Commission approval where required.

Verizon states that the leases and licenses addressed here involve either under-utilized space in existing Verizon facilities or surplus land where only part of a parcel is necessary in the utility's provision of telecommunications services. Verizon states that the excess space generally has been the result of consolidation of utility operations or the result of new technology and upgraded equipment requiring less space.

Verizon states that the leases and licenses considered here benefit Verizon customers by producing revenue for the company. Verizon states that none of the leases impair the utility's ability to serve its customers. All of the agreements require that the lessee's use of the property or facilities will not interfere with Verizon operations.

Nature of Leases and Licenses

Verizon has attached to its application copies of all of the leases and licenses for which it seeks approval. Also attached are the company's confidential fully allocated cost calculations for each property and a market analysis of fair rental value of each property. Verizon states that each of the leases with third parties was based on market valuations. In leases to affiliates, affiliates pay the higher of market value or Verizon's fully allocated cost plus return on investment. Verizon states that leases and licenses with affiliates have been amended where necessary so that the pricing is in accord with the Commission's affiliate transaction rules.

ORA, in its examination of the agreements, has divided them into two categories - third-party leasing/licensing agreements and affiliate leasing/licensing agreements. A representative sampling of the agreements in each of the two categories follows.

Third-Party Leasing/Licensing Agreements

Lane Mountain, San Bernardino. This lease granted a non-exclusive access easement of a 30x30-foot parcel of excess land to Total TV of Victorville for television cable operations.

210 West South Street, Lone Pine. This lease granted the California Highway Patrol access to 7,175 square feet of land on this underutilized central office site.

Mojave, Kern County. This lease allowed Bakersfield Cellular Telephone to use a 40x60-foot parcel of excess land to conduct cellular radio telephone operations.

390 North Rosemead Boulevard, Pasadena. This license granted Fidelity Tax Services the use of 23 parking spaces at an underutilized Verizon facility. This is a revocable license that Verizon may terminate on 30 days' notice.

One GTE Place, Thousand Oaks. This license granted the California Institute of Technology the use of a 3x2-foot storage room for installation and monitoring of seismographic equipment. This is a revocable license that Verizon may terminate on 30 days' notice.

ORA in its review concluded that the eight agreements with third parties involved about $40,000 in annual revenue to Verizon.

Affiliate Leasing/Licensing Agreements

Highway 58, California City. By this lease, Contel Cellular of California, Inc. (later GTE Mobilnet of Central California, Inc.) was granted access to an 80x60-foot parcel of unused land to conduct cellular radio telephone operations.

12501 Imperial Highway, Norwalk. This lease provided what was then GTE Intelligent Network Services with 800 square feet of excess office space for the affiliate's sales and technical support.

201 Flynn Road, Camarillo. This revocable license granted Verizon Communication Systems Corporation use of 5,600 square feet of unused warehouse space.

13155 Alondra Boulevard, Santa Fe Springs. This license granted Verizon Media Ventures Incorporated the use of 4,000 square feet of a parking lot that was excess to Verizon's needs.

ORA in its analysis stated that the annual revenue to Verizon from the agreements with affiliate corporations was about $100,000 annually. ORA noted that the affiliate transactions required more analysis than those with third parties, since the agreements must not have anti-competitive effects or result in cross-subsidization of non-regulated enterprises.

Our obligation in reviewing transactions like these under Section 851 is clear. As we have stated:

"The Commission reviews these transactions to ensure that the transactions will not impair the utility's ability to provide service to the public. The Commission must also ascertain whether the transactions are accounted for properly. This requires ensuring that any revenues from the transactions are accounted for correctly, and that the utility's rate base, depreciation, and other accounts accurately reflect the transactions. The Commission will also consider benefits to the utility's customers and the public from the proposed lease." (Re Pacific Bell (1997) 71 CPUC2d 192, 193.)

Verizon states that these requirements have been met here. The agreements involved unused, excess space that was either within Verizon facilities or on Verizon property. Verizon states that the leases did not impair Verizon's provision of telecommunications service to the public, and revenues from these transactions were properly recorded. Verizon states that the agreements with affiliates are in compliance with the Commission's affiliate transaction rules, and that they involve no cross-subsidization. In addition, Verizon has amended its internal guidelines for leasing real estate assets to include mandated procedures for the proper review of California transactions.

Environmental Review

The California Environmental Quality Act (CEQA) requires the Commission to consider the environmental impacts of certain actions that it takes. (Pub. Res. Code §§ 21000, et seq.) The Commission is required to consider the environmental consequences of its discretionary approval of Section 851 applications. (Pub. Res. Code § 21080.) All of the licenses and leases are several years old and any activity which took place that may have warranted our timely CEQA review has already taken place. Thus, it can be seen with certainty that the discretionary approval sought here will have no significant effect on the environment.

30-Day Revocation

In addition to seeking approval of these leases and licenses, Verizon asks that the Commission exempt from Section 851 review any license in which Verizon has retained the right to revoke or terminate the arrangement without cause within 30 days. The Commission has previously ruled that property arrangements that could be terminated at any time at the sole discretion of the property owner constituted revocable licenses not subject to Section 851 review because the property was not "encumbered." (Re Pacific Bell (1996) 65 CPUC2d 324, 328.) Verizon states that a limited notice period of 30 days would more reasonably satisfy the needs of licensees in a realistic business setting, would as a practical matter constitute little or no encumbrance, and would still preserve the Commission's regulatory responsibility.

ORA Protest and Verizon Amendment

A protest to the application was filed in 1999 by ORA. ORA stated that it was in the process of investigating whether Verizon met all requirements of Section 851 and the Commission's affiliate transaction rules as to the license and lease agreements. ORA asserted that an audit would be necessary to determine if the transactions were being properly booked and were in compliance with the Commission's cost allocation and affiliate transaction rules.

ORA noted that it was conducting a NRF audit of Verizon, and that this audit would cover affiliate transactions and cost allocation issues.

Since filing its protest, ORA has completed its audit as part of Phase 1 of the NRF proceeding. At ORA's suggestion, Verizon, on October 15, 2002, filed an amendment to this application to modify the application in the following two ways:

1. The amendment adds a sublease for Verizon Select Services Inc. (VSSI). During the audit, it was found that several VSSI employees occupied 1,800 square feet of space in a leased Verizon building in Thousand Oaks. While VSSI compensated Verizon for the use of this space, no lease documentation could be found. VSSI vacated the office space in June 2000, and the lease runs only through that date.

2. The amendment expands what Verizon calls a "shared asset methodology" from its use with two affiliates to include a third affiliate, Verizon Data Services, Inc. (VDSI). As part of the audit of Verizon's former California headquarters building, the parties determined that a small number of VDSI employees occupied space that was not documented by a formal lease. VDSI provides data processing services to the Verizon corporate family, and the employees of the affiliate locate on-site at a client company for a period of time. Because of the shifting nature of the VDSI employees' location, Verizon and ORA agreed that such space occupancy would best be reflected in the shared asset methodology described in Verizon's original application.

ORA Recommendations

Based on its further discovery, ORA states that it does not oppose Commission approval of the 18 lease and license agreements. Moreover, ORA has no objection to the Commission granting the request that Verizon need not in the future submit for Section 851 approval those license agreements with third parties that are terminable on 30 days' notice.

Initially, ORA proposed deferral of the issue of Verizon's shared asset methodology pending completion of the NRF audit. The audit has since been completed, and Verizon has adopted ORA's recommendation that VDSI's occupancy of Verizon office space be included in this application and in the shared asset methodology. However, ORA in its brief filed on June 6, 2003, stated that further investigation of the shared asset methodology now prompts it to recommend that the Commission either deny approval of the methodology or order extensive changes. We deal with the issue of the shared asset methodology in Part II of this decision.

Approval of Lease and License Agreements

In D.99-06-092, we gave Section 851 approval to leases and licenses similar to those here. Verizon stated that it entered into these agreements without first seeking Commission approval because it believed at the time that approval was not necessary if the leased or licensed space was surplus to the utility's needs.

ORA has conducted discovery and analyzed the 18 agreements at issue. It states that it had some concern about accounting issues in certain of the leases and licenses, but it states that these accounting issues are not so significant as to delay approval of these agreements. It has joined Verizon in recommending that approval be granted. In view of this, and in consideration of the record as a whole, our order today grants the parties' joint recommendation and approves the agreements in this application.

In D.99-06-092, we examined 59 license and lease agreements that Verizon had executed between 1994 and 1997. We concluded that those agreements, including two sublease agreements with affiliates, were subject to Section 851 and should have been presented to us for prior approval. While we declined to impose a penalty under Pub. Util. Code § 2107, we adopted ORA's proposal to require Verizon to conduct a further search for the period 1990 to the present to determine if there were any similar lease and license transactions that had not been brought to us for prior approval.

As noted, Verizon retained outside consultants and conducted an internal audit of its real estate records, cross-referencing the results from three different sources. The 17 agreements identified in the audit, and the one additional lease identified in ORA's investigation, are similar to those for which we gave approval in D.99-06-092. Verizon states that it now has identified all such transactions to the best of its knowledge, and it assures us that its addition of a new Section 851 checklist to its corporate lease guidelines will ensure that all future leases will be in compliance with Section 851 requirements.

We conclude on this record that the 18 agreements examined here are subject to Section 851. However, as we found in D.99-06-092, the failure to obtain prior approval was based on a mistaken interpretation of the rules governing surplus space, and Verizon has acted diligently to correct that error. We agree with ORA, and we so find, that approval of these 18 agreements is appropriate on this record. We also find, as we did in D.99-06-092, that no sanctions beyond the additional audit requirement is necessary.

We conclude that the 18 agreements comply with our affiliate transaction rules and that they involve no cross-subsidization. Revenues from these transactions are properly recorded.

While the Commission in 1999 gave retroactive approval to the 59 lease and license agreements executed between 1994 and 1997, the Commission since that time has limited the use of retroactive approval. As we determined in D.03-05-033 and D.03-06-069, the authority that we grant today should apply prospectively, and not on a retroactive basis. One of the purposes of Section 851 is to enable the Commission to review a proposed encumbrance on utility property before it takes place, in order to take such action as the public interest may require. Granting the application on a retroactive basis would thwart the purpose of Section 851. Since we do not grant retroactive authority, the transactions are void under Section 851 for the period of time prior to the effective date of this decision.⁴ Verizon is at risk for any adverse consequences that may result from its having entered into the contracts without prior Commission authority.

ORA also states that it has no objection to the Commission granting Verizon's request that license agreements with third parties terminable on 30 days' notice not be required to have Section 851 approval. ORA recommends that the Commission rule that license agreements containing such a provision need not be submitted for approval in the future. License agreements are generally governed by G.O. 69-C. The G.O. provides an exception to the Section 851 requirement for prior Commission approval of an encumbrance of utility property. The G.O. provides that a utility may convey licenses, easements, permits or other limited uses of land to third parties without prior Commission approval. The G.O. establishes three key criteria for permitting a utility to grant minor interests in utility property. These are:

(1) The interest granted must not interfere with the utility's operations, practices, and services to its customers;

(2) The interest granted must be revocable either upon the order of the Commission or upon the utility's determination that revocation is desirable or necessary to serve its patrons or consumers (i.e. at will); and

(3) The interest granted must be for a "limited use" of utility property.

Consistent with this standard, agreements which meet each of the three key criteria of G.O. 69-C are not subject to Section 851 approval. We make no specific findings regarding applicability of G.O. 69-C to the transactions in this application because a) Verizon has requested Section 851 review; and 2) we note several agreements contemplate revocation only with cause (as opposed to "at will" or by order of the Commission), may otherwise not fit the criteria of the G.O., and/or are leases which by definition require Section 851 approval.⁵