The COVID-19 pandemic has caused companies, individuals and municipalities to even more closely examine their budgets and services to determine how they can reduce compliance risks, operating expenses and future capital expenditures. Often, Pennsylvania municipalities own and operate water and wastewater systems. These systems are highly regulated and capital intensive.
As townships go through the budget process, there is at least one option available that could decrease compliance risks, operating expenses and remove certain future capital expenditures while creating an influx of cash and reducing debt: the sale of the water or wastewater systems.
Selling is not the right choice for every municipality, so having experienced financial and legal advisors is vital. In recent years, certain changes in law have caused municipalities to look more closely at this sale option.
In 2012, Governor Tom Corbett signed Act 11 into law, which, subject to Public Utility Commission (the “PUC”) approval, permits regulated utilities to combine its water and wastewater customer bases when setting rates. This allows the PUC to set rates for regulated utilities that spread the cost of wastewater system capital improvements over its entire customer base instead of just the wastewater customers. Prior to Act 11, regulated utilities were hesitant to acquire wastewater systems due to the ongoing and costly capital and maintenance required to keep the system in operation and fear of rate shock to customers in that particular community.
In addition to cost spreading, the PUC sale process did not value these systems in a way that reflected market realities. This was because the purchase price was determined by the depreciated original cost of the system assets. As a result, considering a sale made less sense because: (i) the amount of debt on the system might be in excess of the depreciated original cost; and (ii) since the systems are generating revenue and the replacement costs of the system would be far in excess of depreciated original cost, selling the system would arguably not produce a price worth considering.
In 2016, Governor Wolf signed Act 12 into law, which permits municipalities to sell their assets to a regulated utility for fair market value. This change enables sellers to negotiate an agreed upon sale price based on a fair market value of the system instead of the original depreciated costs of the assets. This has driven many municipalities to think about the possibility of a sale. Since Act 12’s enactment, many municipalities have sold their systems to regulated utilities. In addition to the fair market valuation, Act 12 accelerates the PUC approval process by requiring that approval come within six-month of the application’s acceptance. However, obtaining PUC approval can take up to a year from signing a deal since it takes time and effort to compile the application itself.
Obtaining PUC approval requires substantial time and effort. Typically, the main focus of the proceeding is ensuring that the sale is in the public interest. The proceedings also include public notices to customers and a public interest hearing that gives customers the ability to voice support or concern about the potential transaction.
While Act 12 may increase the purchase price, it is important to weigh that increased purchase price against potential future rate increases.
As budget season is underway, it might be a good time to determine if the sale of your water or wastewater systems makes sense for your community. While Act 11 and Act 12 do not apply to them, there are also many municipal authorities who are actively looking to buy municipal systems as well. Since our office works everyday with municipal managers, boards, their solicitors and financial advisors, we know there is no “one-size fits all” solution and having the right information and the right team is crucial.