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COROLLARIES FROM PROPOSITION II A.

Certain general conclusions must necessarily follow from the power of a State to fix rates, subject to a right of review in the courts to ascertain whether the rates thus fixed are so low as to amount to a deprivation of property.

1. The fixing of rates, whether by a State Legislature or its agents, being a legislative or administrative, and not a judicial act, the courts, in reviewing a State rate, do not undertake to fix the rate itself or to say what rate would not be obnoxious to the Fourteenth Amendment; but simply inquire whether the rate fixed is, under all the circumstances of the case, so low as virtually to deprive the company of its property.

"The Courts do not determine whether one rate is preferable to another or what would be fair and reasonable as between the carriers and the shippers. They do not engage in any mere administrative work." - Mr. Justice Brewer, in Reagan v. Farmers' Loan & Trust Co.1

"The Court has no power to fix rates. It may not declare what rates would be reasonable, and by its decree establish those rates as the rates to be charged. Its power is exhausted on this point when it has duly passed on the reasonableness of the rates as fixed in the ordinance." - Per Cur. in Capital City Gas Light Co. v. Des Moines.2

2. The fixing of rates, whether by a State legislature or its agents, being the act of the State itself, it matters not that the agents have not properly exercised their powers.

Their act is the act of the State; and if, being authorized (expressly or by construction) to establish only reasonable rates, so that in establishing unreasonable rates they are in a sense acting ultra vires of their statutory authority, yet their action in establishing rates which are unreasonable is held to be the action of the State. And, if such action operates as a deprivation of property, it is held to be a deprivation by the State within the meaning of the Fourteenth Amendment.

The same principle holds as to laws of a State alleged to violate the contract clause of the United States Constitution. Thus an ordinance of a city council purporting to have been passed under legislative authority is a State "law," irrespective of its validity. Such ordinances, says the Court, in Penn Mutual Life Ins. Co. v.

1 154 U. S. 362, 397. See also Osborne v. San Diego Water Co., 178 U. S. 22. 2 72 Fed. Rep. 818. And see Michigan Tel. Co. v. St. Joseph, 121 Mich. 502.

Austin,1 are "but the exercise by the city of a legislative power which it assumed had been delegated to it by the State, and were therefore in legal intendment the equivalent of laws enacted by the State itself." 2

3. The fixing of rates, even by a State commission, being in legal contemplation, no matter what the designation or powers of the commission, an administrative, legislative, or political act of the State itself, it further follows that the citizen who has been or will be deprived of his property through the operation of the rates thus fixed does not lose his right to a review by the courts simply because he may have been given full opportunity to present his case to the commissioners before action on their part.

The reasonableness of the rates that is, the question whether they conflict with the Fourteenth Amendment is a question of law, which the citizen is entitled to litigate in the courts of law.3 This has been the uniform rule adopted by the United States courts; and the intimation to the contrary in Minneapolis Eastern Ry. Co. v. Minnesota, has never been followed; although, if no opportunity to be heard is given before the rates are fixed, that might of itself be an independent and sufficient reason to set them aside.

4. Depreciation that is to say, the amount in excess of the annual expenditures for repairs, which in a properly managed enterprise must be annually applied or set aside to provide for the final renewal of the several parts of the plant is a proper charge upon income.

Whether or not it is to be regarded as "operating expense" is rather a question of book-keeping than of law; but, in any event, a proper annual allowance for depreciation must be taken into account in determining the validity of an order fixing rates.

1 168 U. S. 685.

2 See, also, City Railway Co. v. Citizens' Co., 166 U. S. 557; Walla Walla v. Walla Walla Water Co., 172 U. S. 1; Illinois Central R. R. v. Chicago, 176 U. S. 646; Anoka Water Co. v. Anoka, 109 Fed. Rep. 580.

8 See Chicago, M. & St. P. R. R. v. Minnesota, 134 U. S. 418; Reagan v. Farmers' L. & T. Co., 154 U. S. 362; San Diego Land Co. v. Jasper, 89 Fed. Rep. 274; Louisville & N. R. R. v. M'Chord, 103 Fed. Rep. 216, in which, notwithstanding that the complainant had had full opportunity to be heard before the commission, the rates fixed by the latter were declared void by the Court.

4 134 U. S. 467, 482.

5 The Board of Gas and Electric Light Commissioners of Massachusetts has recently advised or prescribed the entering of an allowance for depreciation as a separate item in the annual accounts rendered to it by the companies under its supervision. It is believed that the general practice of such companies throughout the country has here. tofore been to enter such items in the operating expense account.

"Compensation," says Judge Brewer in Chicago & N. W. R. R. v. Dey,1 "implies, . . . cost of service," and that "implies keeping the road-bed and the cars and machinery and other appliances in perfect order and repair."

In So. Pacific R. R. v. Commissioners, Judge McKenna, in granting a continuance of a temporary injunction against the enforcement of rates established by a State commission, held that, in ascertaining the cost of operating a railroad in reference to the reasonableness of rates, the expenses of operation are not to be strictly limited to the cost of running trains, excluding all betterments, but the cost of reasonable renewals and improvements of road-bed, track, and equipment, must be included.

In Cotting v. Kansas City Stock Yards, Judge Thayer says:

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At the same time, as buildings, pens, pavements, and other similar structures deteriorate in value somewhat from year to year, even where they are repaired in the ordinary way, it is eminently proper, in estimating any profits, to set aside annually out of the gross income a certain sum to cover such depreciation."

And Mr. Justice Brewer, in Reagan v. Farmers' Loan & Trust Co., in stating the opinion of the Court that such expenditures should be considered as proper to be paid from income, says:

"In the operation of every road there is a constant wearing out of the rails and a constant necessity for replacing old with new. The purchase of these rails may be called permanent improvements or by any other name. But they are what is necessary for keeping the road in a serviceable condition."

"The annual depreciation of the plant," as distinguished from cost of operation, is enumerated by the court in San Diego Land Co. v. National City," as one of the matters which "ought to be taken into consideration."

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'Ordinary improvement," as distinguished from repairs, are also a charge that "may properly be made against earnings," says Mr. Justice Bradley in an interesting discussion of depreciation in railroad property in Union Pac. R. R. v. U. S.o

5. Where the complainant is bound by the common or the statute law to the performance of public services and duties, the price at which it may sell its commodities must clearly be high enough to

1

35 Fed. Rep. 866, at p. 879.

3 82 Fed. Rep. 839, 850, at p. 855.

174 U.

J. S. 739, 757

2 78 Fed. Rep. 236.
4154 U. S. 362, at p. 407.

6 99 U. S. 402, 421, 422.

enable it properly and satisfactorily to perform these public obligations, as well as to earn a reasonable profit on its plant.

Speaking of the duties of railroad companies as common carriers and of the compensation they are entitled to receive, Judge Brewer says:1

"They may not employ poor engineers, whose wages would be low, but must employ competent engineers, and pay the price needed to obtain them. The same rule obtains as to engines, machinery, road-bed, etc.; and it may be doubted whether even the Legislature, with all its power, is competent to relieve railroad companies whose means of transportation is attended with so much danger from the full performance of this obligation to the public."

6. What sum or value is to be taken as the principal in determining whether the legislative rates will yield an income unreasonably low?

This question presents difficulties, and cannot also be said to have been finally answered by any decision of the Supreme Court. We believe, however, that the answer will be found to be the sum representing the fair cash value at the time the rates are established of all the property then used by the Company in its business. This rule denies to the Company the right to collect returns upon a fictitious or inflated capital, while giving it the benefit of such additions to the plant as may have been contributed by the stockholders from earnings which would otherwise have been paid out in dividends; and, although the question cannot be said to have been finally settled, this rule has been favored by some eminent judges and rejected, we believe, by none.

The outstanding stock and bonds may not represent money actually invested in the plant, or even if fairly representing the original cost, may be largely in excess of the present value of the property. In such cases it is well settled that the thing to be kept in mind is the value of the plant, not the amount of stock and bonds.2 Conversely we may suppose the case of a corporation as much undercapitalized as most public service corporations are overcapitalized. No such case has, it is true, ever been presented for judicial decision, but if such a situation should arise, the injustice of any method of valuation, or determination of the reasonableness of rates, based upon the amount of the outstanding stock, would at once become apparent. Moreover, such a basis of decision would be inapplicable to companies the stock of which has no par,

1 Chicago & N. W. R. R. v. Dey, 35 Fed. Rep. 866.

2 164 U. S. 578, 596–7; 169 U. S. 466, 544; 174 U. S. 739, 757.

and to individuals and partnerships. We conclude that in all cases the sum upon which the company is entitled to a reasonable return is the present value of the property actually used in its business. The judicial references to this subject are as follows:

In the Kansas City Stock Yard case,1 the Court says that "the owner is entitled to the benefit of any appreciation in value above original cost resulting from natural causes." It would seem that he should, a fortiori, be entitled to any increase in value due to improvements and extensions paid for out of income.2

In Northern Pacific R. R. v. Keyes, Judge Amidon says:"The fundamental question in all cases like these is, Will the rates prescribed by the State pay the expenses of doing the business and leave to the carrier a reasonable compensation upon the fair value of the property which it employs in performing the service?"

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The fair value of the property rather than the amount of stock or bonds outstanding is relied upon by the Supreme Court in Smyth v. Ames, as the proper basis for determining the reasonableness of a State rate. Mr. Justice Harlan, speaking for the Court, says:

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"We hold . . . that the basis of all calculations as to the reasonableness of rates to be charged by a corporation maintaining a highway under legislative sanction must be the fair value of the property being used by it for the convenience of the public."

And in San Diego Co. v. National City, Mr. Justice Harlan, speaking for the Court, says:

"What the company is entitled to . . . is a fair return upon the reasonable value of the property at the time it is being used for the public."

7. The mode of valuation.

Certain difficulties will generally be encountered in attempting to apply to concrete cases the test implied in such expressions as "fair cash value," "fair value," and "reasonable value." To develop all the implications of these and similar expressions as applied to the class of cases with which we are dealing would carry us far beyond the limits set for this article. A few suggestions may, however, not be out of place. Waterworks, including sources of

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• In the lower court (74 Fed. Rep. 79) Ross, J., says at p. 83: "It is the actual value of the property at the time the rates are to be fixed that should form the basis upon which to compute just rates."

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