On certification to the Superior Court, Appellate Division.
The opinion of the Court was delivered by Handler, J.
[121 NJ Page 50] This case concerns whether the developer of a large residential community or a utility should bear the original costs of main extensions to a new development. The developer deposited with the utility funds to cover the original expenditure for main extensions, and now seeks full repayment of the deposit. The utility claims that the developer is entitled only to a partial refund calibrated to the completion and occupation of individual units within the development. The case requires the Court to construe and apply a governing statute as well as to review the application of a regulation promulgated under that statute. The answer to the question here centers on whether the proposed
development represents sufficient business to require the utility to bear the original costs of the extensions.
The Appellate Division affirmed decisions by the Board of Public Utilities (Board) that required developers to bear the initial costs of the extensions and ordered a partial deposit refund linked to completion and occupation of individual units. We subsequently granted the developer's petition for certification. 117 N.J. 66, 563 A.2d 830 (1989).
In order to facilitate the construction of a new residential development, petitioner-appellants Van Holten Group (Van Holten) entered into water-main-extension loan agreements with respondent Elizabethtown Water Company (Elizabethtown). Van Holten is a group of three land developers. The development project involved the construction of residential units in Somerset and Mercer Counties. The main-extension agreements at the center of this dispute concerned 640 of those units. Under the agreements, Elizabethtown agreed to begin construction of the off-site and on-site main extensions necessary to serve the new units, and Van Holten agreed to deposit $1.028 million to cover the cost of the extensions. A "main extension" is any addition to an existing main. An "on-site" extension is one constructed on a tract under development, and an "off-site" extension is built on an existing public street. Only one of the extensions in this case is off-site. Van Holten made the deposit "under protest," thereby permitting construction to begin while preserving the right to seek administrative relief. Elizabethtown agreed to refund part of the deposit to Van Holten after each completed new unit was occupied by an owner and was connected to the water system. The maximum amount of the possible refund under the agreements was approximately $205,400. The parties disagree about the formula used to determine the total amount of the refund under the agreements, but the
result was roughly two times the estimated annual revenue from connected customers.
In March and April 1984, Van Holten filed five petitions with the Board against Elizabethtown contesting the validity of the loan agreements. Van Holten argued that under N.J.S.A. 48:2-27, the utility must refund all of the deposit on completion of the entire project. In the alternative, Van Holten requested that if Elizabethtown were not ordered to pay all construction costs, the Board establish a more reasonable refund formula than that contained in the agreements. N.J.S.A. 42:2-27 provides:
The [Board of Public Utilities] may, after hearing, upon notice, by order in writing, require any public utility to establish, construct, maintain and operate any reasonable extension of its existing facilities where, in the judgment of the board, the extension is reasonable and practicable and will furnish sufficient business to justify the construction and maintenance of the same and when the financial condition of the public utility reasonably warrants the original expenditure required in making and operating the extension.
Pursuant to N.J.S.A. 52:14F-1 to -11, the Board referred the petitions to the Office of Administrative Law as a contested case. At hearings before an Administrative Law Judge (ALJ), the parties presented conflicting evidence regarding whether the extensions would provide "sufficient business" for Elizabethtown and whether the financial condition of the utility reasonably warranted the original expenditure.
Van Holten's expert witness, a certified public accountant, testified that if the entire cost of the main extension deposits were refunded to Van Holten, the utility's overall rate of return would be reduced only from 8.95% to 8.93%, a .02% reduction. He estimated that to maintain an 8.95% rate of return, Elizabethtown need only increase its annual rate by sixty-five cents per customer. He concluded that except for a possible cash shortfall, a full refund would have "no material effect" on Elizabethtown's financial condition.
Elizabethtown's sole witness was its controller, also a certified public accountant. She testified that the statutory requirements of N.J.S.A. 48:2-27 had not been satisfied. She stated
that the Van Holten projects would not generate "sufficient business" to justify building the main extensions, and that the utility's financial position did not warrant installation of the extensions at its own expense. She maintained that the cost of a backup plant to service the new units is an expense that must be considered when determining Elizabethtown's profitability. After adding in that cost, she determined that Elizabethtown would lose approximately $135,000 if Van Holten were to receive a full refund. In her opinion, rate-payers would each have to pay an extra $1.88 per year if a full refund were made, assuming the utility sought to maintain its current rate of return. A full refund was feasible, she said, only if the amount of new business immediately generated would support payment of the refund.
Elizabethtown's expert also calculated an increase in the rate base needed to serve new customers, reflecting the costs of a backup plant and including the cost of new meters. If Van Holten received a full refund, Elizabethtown's investment cost would increase, which, according to her, would result in a decrease in the rate of return on the rate base from 11.31% to 11.22%.
The ALJ concluded that Van Holten's evidence was more "pertinent" than that provided by Elizabethtown and should be adopted. The Van Holten expert's figures "reveal[ed] beyond a doubt that requiring [Elizabethtown] to bear the costs of the main extension will not reduce its overall earnings below a tolerable level pending any rate increase."
The ALJ had little difficulty finding that the proposed on-site extensions were "reasonable and practicable," given Van Holten's undisputed testimony regarding the "hot" real-estate market in that area. Noting that although "at the time of construction all future business theoretically is speculative," he also concluded that "there exists little question that the main extensions ultimately will furnish sufficient business to the Company. . . ."
He then analyzed the third requirement of N.J.S.A. 48:2-27, i.e., whether "the financial condition of the public utility reasonably warrants the original expenditure required in making and operating the extension." He concluded:
(1) [A] utility is obligated to extend its main to serve the needs of its franchise area regardless of whether a profit immediately will be obtained since the basic inquiry is the effect on the overall rate of return of the utility stemming from the burden of the expenditure, if any; and
(2) [A]bsent an adequate showing by the utility of a legitimate adverse impact on its overall rate of return, it is an obligation of that utility, not to the consumer, to construct its system.
Consequently, because Van Holten had satisfied the requirements of N.J.S.A. 48:2-27, he held that Elizabethtown should bear the original cost of the on-site main extensions. He therefore ordered a full refund to Van Holten for the cost of the on-site extensions.
The ALJ rejected Van Holten's request for a pro-rata reimbursement for the off-site main extension. Van Holten had sought a refund of its deposit for the off-site extension if and when other developers connected to it. The ALJ found that the off-site extension was not a "system-wide" improvement that would permit pro-rata reimbursement: "[T]he eventual construction of homes and the hookup of customers by persons not known to the company at this time results in much too amorphous a situation to require the company to bear the cost."
Both parties appealed the ALJ decision to the Board. Elizabethtown sought to avoid the costs for the on-site extension, and Van Holten sought to obtain a refund for the off-site extension. The Board "reluctantly" adopted the ALJ's decision by a vote of two to one. It ruled that the requirements of N.J.S.A. 48:2-27 had been met, and thus the Board could not exercise its discretionary authority to determine the cost allocation based on equity principles.
The dissenting commissioner believed that the extensions were not "reasonable to the degree that ratepayers should absorb any costs for construction." In addition, he stated that the area served ...