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Representing property
owners’ interests regarding the Kiawah Island Utility (KIU) was
one of the top three issues of concern to respondents in KPOG’s
recent survey of property owners. Not only do we agree that
this is a priority issue, we believe our effectiveness to date
in helping to contain utility costs may well be one of our most
significant contributions to the community. Previous
interventions by KPOG and, more recently the Town, have resulted
in savings of more than $6 million to KIU ratepayers over the
last 20 years. Read on to understand why this issue remains of
vital importance to Kiawah’s property owners.
This article begins a
new series about the utility. It explains concerns about
KRA’s (the Developer’s) relationship with this wholly owned
subsidiary, provides a brief history of regulatory and legal
actions against the utility and describes where things stand
today. Future articles will explain how our neighbor, Seabrook
Island, has solved its long-time utility issues, and will
explore the Town’s options in dealing with this ongoing
problem. As with the series we published recently regarding
negotiation of a new Development Agreement, these articles and
supporting documentation will be posted on our website (www.kiawah.org).
We always welcome reader comments
(KPOG@kiawah.org ).
KIU and KRA – The
Problem
KIU supplies water and sewer services to
all Kiawah property owners, both residential and
commercial. KIU is wholly owned by KRA, the developer of Kiawah
Island. Over the last 20 years, KPOG and, more recently, the
Town have challenged KIU rate increases when warranted based on
what we believe are the questionable financial practices of KIU.
Specifically, transactions between the two entities are not
conducted at “arms length.” In other words, the business
practices between these two entities are NOT conducted as they
would be were the two companies’ ownership and operations not so
entwined. There is no independent management protecting the
interests of the ratepayers in transactions between KRA and KIU.
Numerous ongoing
transactions between the two entities directly create profits
for KRA while at the same time creating additional debt for KIU.
KIU customers then pay the interest on that debt - interest of
almost $500,000 in 2004 alone. Thus, KRA through control of KIU
uses KIU funds which creates additional debt on KIU books that
we, as customers of KIU, must pay. In simple terms,
property owners are subsidizing KRA’s development costs.
Here are several
examples of how this is done:
Impact Fees:
In South Carolina, as in many other states, developers typically
pay utilities impact fees toward to buy into existing utility
capacity as well as to pay for construction of future utility
capacity to support new development. KRA principals are
required to pay these fees to Seabrook Island Utility for both
the Cassique development and Freshfields, both located on
Seabrook Island near the entrance to Kiawah. A 1999 survey of
15 coastal South Carolina utilities, established that KIU was
the only utility that did not charge developers (i.e.,
KRA) impact fees for water or sewer. While KRA gets a “free
ride” with KIU here at Kiawah, KRA is paying the Seabrook Island
Utility a $2,000 sewerage impact fee per lot at Cassique and
a $700,000 sewerage impact fee for the first phase of
Freshfields. $200,000 of the $700,000 fee for Freshfields has
already been paid. The previous owner of the property had
paid impact fees to the St. Johns Water Company for water
service.
If KRA constructs the
375 units it is allowed on Cougar Island and pays an impact fee
equivalent to the Cassique sewerage fees paid to Seabrook Island
Utility, KIU would receive $750,000 toward plant expansion.
Since KIU will provide both sewer and water, this is a
very conservative estimate of fair charges. However, KRA pays
no impact fees under its current agreement with KIU, so
the cost of extending service to that remote location, as well
as any sewage treatment plant expansion required to service it,
will be factored into future rate increases paid by KIU
customers – all Kiawah Island property owners.
Thus, Kiawah Island property owners are subsidizing KRA’s
development costs.
Certain Water and
Sewer Lines and Related Equipment: Utilities throughout
South Carolina usually require the developers to pay for these
lines and equipment and donate them to the utility for operation
and maintenance. KRA has paid for and donated those lines and
equipment installed in Cassique to Seabrook and St. Johns
utilities. The pumps and other sewer infrastructure at
Freshfields will be transferred to Seabrook’s utility once it
has passed all of Seabrook Island Utility’s engineering
inspections. On Kiawah, however, KRA sells, rather than
donates, such lines and equipment to KIU, which flies in the
face of standard practice. Over the last 20 years, KIU has
spent hundreds of thousands of dollars in these transactions –
and we Kiawah Island property owners have footed the bill.
Leased Lands:
Utility companies do not construct immovable assets on leased
properties. KIU, however, leases two properties from KRA. On
the Sora Rail property, KIU constructed a holding pond for
treated effluent. On the Governor’s Drive property, KIU
constructed a multi-million dollar storage tank and pumping
station. An independent utility would have required the
developer to donate land for these purposes or would have
assessed the developer an impact fee equal to the value to the
land.
Not surprisingly,
terms of the leases clearly favor KRA. Rental charges are
indexed to the CPI (Consumer Price Index), going up annually by
any rise in the CPI. However, if the CPI goes down, there is
no provision in the lease to reduce the rent. Further,
there was initially no provision for KIU to purchase the
property. Also of great concern is that the transactions were
not “at arm’s length.” The leases were signed by Charles S.
Way, Jr., then President of KRA and sole Director of KIU at that
time, and Charles P. Darby, III, President of KIU and principal
in KRA. In January 2000, KRA amended the lease on the
Governor’s Drive property to provide a purchase option, and yet
again, the terms favor KRA. Because of the overlapping
management between KIU and KRA, KRA essentially controls
establishment of a purchase price.
A 1994 Utility
Service Agreement between KRA and KIU requires that KRA provide
additional land to KIU at a price to be agreed upon, but no more
than half the fair market value of such property when
transferred. Further, it requires KRA to “assist KIU from time
to time in securing any necessary financing … in the form of
loans, mortgages ...”
Nevertheless, KRA
neither donated the two pieces of property nor paid impact fees
to offset the costs. Further, KRA did not agree to sell
the land at one-half the fair market value as required in its
own Utility Service Agreement with KIU. KRA required the
utility to enter into a long-term lease agreement based on 100%
of market value of the land in question, initially with no
stipulation regarding what would happen at the end of the lease
period. This deal ensures KRA will net another several million
dollars over the course of the agreement.
Management Fees:
KRA has charged KIU management fees since 1989 for management
services provided by people who are employees of both KRA and
KIU. During the early years, the fees ranged from $91,500 to
$129,600. The PSC significantly reduced the fees KRA could
charge and allowed only $36,000 annually for ratemaking purposes
in the 1990, 1992 and 1996 challenges. In 1996, KPOG requested
that the PSC direct KRA to return excess payments plus interest
to KIU, but the PSC order that followed failed to address this
issue. In its 2004 financial report to the PSC, KIU noted a
$100,000 management fee paid to KRA. Assuming that the PSC
continues to allow only $36,000 for rate-making purposes, KRA
continues to receive, in effect, an interest free, non-repayable
loan of approximately $65,000 each year. Through the end of
this year, the cumulative excess payments plus interest will
amount to over $2 million.
These are just four
easy-to-understand examples of how debt is created on KIU’s
books so that cash can flow to KRA and increase its profits.
Additional examples can be found in KPOG’s 2000 report, posted
on our website. No one begrudges KRA’s making a profit,
however, Kiawah property owners should not be funding this
profit through KIU, KRA’s utility.
KIU – Your Favorite Charity?
A “back of the envelope” analysis reveals
that approximately $10 of an average property owner’s monthly
KIU bill defrays KRA’s development costs. In a very
conservative analysis over an eight-year period (in which the
number of ratepayers does not increase and there are no
new development costs added), each property owner would “donate”
nearly $1000 to KIU ($10 per month x 8 years x 12 months per
year). Assuming 4000 property owners, this amounts to a
whopping ratepayer “donation” of over $3.8 million to KIU, a
wholly owned subsidiary of KRA.
If no impact fees are
paid when Cougar Island is developed, and a very conservative
estimate of $2,000 per unit would cover future water/sewage
transmission and treatment costs, KIU ratepayers will pay an
additional $740,000. [Note: The $2000 figure is conservative
for two reasons. (1) The $2000 per lot impact fee paid to
Seabrook Island Utility for Cassique covers only sewage, not
water. (2) Since Cougar Island is considerably further from
KIU’s treatment plant than Cassique is from Seabrook’s treatment
plant, transport from Cougar Island will likely require
installation of several pumping stations, which will increase
the cost.]
The 1994 Utility
Service Agreement between KRA and KIU gives KIU the right of
first refusal to provide water and sewer service to any areas
off of Kiawah that KRA may develop during the life of the
agreement. A recent KPOG study of undeveloped Johns Island
properties near Kiawah Island found that KRA or one or more of
its principals own seven such parcels totaling over 3600
acres. If we fail to address – and resolve – KRA’s and
KIU’s failure to operate “at arm’s length”, Kiawah property
owners may well subsidize KRA development off-island as well.
The South Carolina Public Service
Commission (PSC)
The purpose of the South Carolina Public
Service Commission is to represent the public’s interest in all
matters regarding their relationship with public utilities. The
PSC is the first avenue of appeal when customers have complaints
about service or pricing. The PSC’s highest priority is
guaranteeing uninterrupted utility service to the community.
While the PSC does oversee rate setting, it permits profits
based on a percentage of revenue. A utility must submit
proposed rate increases to the PSC for approval, and interested
parties such as KPOG and/or the Town can challenge them.
A Brief History of Appeals and Legal
Action
Since 1985, KPOG has been working to
constrain water and sewer costs on Kiawah. In 2000, the Town
joined KPOG and began to shoulder the legal expenses involved in
fighting excessive rate increases. During that time our
intervention on behalf of property owners has saved ratepayers
in excess of $6 million.
In 1985, the PSC
ruled favorably on a petition by KRG (KPOG’s predecessor
organization) and denied KIU a requested rate increase. In 1990
KPOG worked with KIU in developing the requested rates and
appeared before the PSC in support of the requested
increases. Rate increases in 1992 and 1996 were also challenged
by KPOG and were subsequently reduced by the PSC.
Dissatisfaction with the PSC’s failure to address the
relationship between KRA and KIU in its 1996 decision and in a
subsequent appeal to the PSC regarding that decision, led KPOG
to bring the issue before the Court.
A petition for
Judicial Review of the PSC order was filed in the Court of
Common Pleas, Fifth Judicial Circuit. No questions were asked
of either side during the subsequent hearing. In March 1998,
the court upheld the PSC action in a court order.
That decision was
appealed to the South Carolina Supreme Court in June of 1999
which, in September 1999, reversed and remanded the lower
court’s decision. The Supreme Court said that the PSC had not
explained its decisions sufficiently for the Court to accept
them. It also said that the lower Court should have remanded
the original PSC order and required the PSC to “fulfill its
responsibilities to the parties.”
In April 2000 the PSC
issued an order stipulating that the PSC staff should meet with
representatives of KIU and KPOG to coordinate a management audit
of KIU. The purpose of the audit would be to:
-
Conduct a comprehensive review of
the management practices of KIU and inter-company transactions
with its owner and developer, KRA
-
Settle ongoing litigation (At that
time, the 1996 and 1998 cases were still being appealed and
the 2000 rate case was under consideration.)
-
Avoid additional litigation
arising from future rate increase requests
But since the PSC had
made essentially the same ruling appealed in 1999, the case
found its way back onto the South Carolina Supreme Court’s
docket. In February 2004 the Supreme Court finally issued its
ruling. While KIU claimed victory in this matter, the Court
did not rule in KIU’s favor. In fact, the Court never
addressed or ruled on the legitimacy of the relationship between
KIU and KRA. The Court simply upheld the PSC’s ruling that it
(the PSC) had no authority to change the relationship
between KRA and KIU.
After considerable
discussion during 2001 and 2002, the interested parties agreed
on a consultant to perform a Management Audit of KIU and on how
the cost of the audit would be distributed. The Town and KPOG
agreed that the audit would be binding if conducted with the
proper scope. No agreement was ever reached on the scope of the
audit, however, as KRA and KIU wanted to limit the audit to a
Cost of Service Study which would only address how costs should
be allocated to various types of services going forward. They
would not agree to a full Management Audit of the system on the
core “arm’s length” issues in question, such as KRA/KIU
transactions building KIU debt, impact fees and the cost of
development, and the properties KIU leases from KRA, refusing to
“look back” at what had already occurred.
Discussions on the
audit were stalled when the State announced that qualifications
for PSC Commissioners were being changed and that all
Commissioners would be up for re-election in 2003. The State
House and Senate could not agree on new qualifications, however,
and this issue remained unresolved until 2004. At that time,
the PSC was reorganized so that we now have a dedicated PSC team
responsible for conducting Management Audits such as the one
ordered of KIU in 2000.
Where Things Stand Today
For the past several years, KIU has been
permitted to pass the increased cost of purchased water directly
through to its customers. What happens when the next rate
increase application is submitted? Will the reorganized PSC
force the Management Audit ordered in 2000? What other options
are available and what are the pros and cons of each?
Stay tuned as we
continue to analyze this issue. Next month’s article will look
at Seabrook Island and explore how they’re doing after making
some hard decisions about their utility.
References used
in developing this article and posted at
www.kiawah.org:
- Kiawah
Property Owners Group,
Containing the Cost of Water and Sewer Service on Kiawah
Island, September 2000.
- Opinions of
the Supreme Court and Court of Appeals of South Carolina filed
during the week ending February 9, 2004, pp 14-23.
- “Property
Owners vs. Utility,” TALK, July/Aug. 2003, p 1.
- Utility
Service Agreement Between Kiawah Resort Associates and Kiawah
Island Utility, July 29, 1994.
- “What’s
Happening with the Management Audit?,” TALK, October
2003, p 1.
- “Where Do We
Go From Here With the Utility Issue?,” TALK, November
2003, p 1.
- “Who Pays?
Residents or KRA,” TALK, September 2003, p 1.
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