January 1, 1900

Nielsen V. Lewis

To promote the "smart growth" policy goals of former Governor James E. McGreevey's administration, the New Jersey Board of Public Utilities (BPU) has adopted controversial new rules determining who pays for extensions of public utility facilities to serve new development - rules of enormous statewide impact that should have the undivided attention of every builder in New Jersey. To take effect on March 20, 2005 and be phased in over three years, the new rules apply broadly to all "regulated entities," including water, sewer, electric, gas and telecommunica- tion companies.

Simply put, future responsibility for paying for utility main extensions will depend on where the development is located. Public utilities may pay for main extensions to "designated growth areas" shown on the State Plan Policy Map of the New Jersey State Planning Commission, but with minor exceptions they are prohibited from paying for all other extensions. In other words, developers generally must bear the costs of extending service in all other parts of the State. The BPU's new policy runs counter to accepted principles of public utility law and practice over the years controlling distribution of the costs of extending service between utilities and developers.

The "Sufficient Business" Test For Extensions

Who should pay the costs of extending utility facilities to serve new development? This is not really a new problem. In the past, the resolution of this question has been based on need and economic considerations, including the utility's obligation to provide safe, adequate and proper service and its ability to earn a reasonable return on its capital investments. Where the parties cannot agree, the statute empowers the BPU to require public utilities to construct and operate extensions of their 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 expen- diture required in making and operating the extension."

The statutes also provide that the BPU may order a public utility to pay the costs of constructing an extension where sufficient customer revenues are forecast to recapture the costs and the utility's financial condition permits it.

On the other hand, it is recognized that public utilities are not in business of real estate investment and speculation. In principle, New Jersey courts have recognized the right of a public utility to decline to underwrite extensions to serve risky development ventures, such as requests to serve remote areas or vacant lands. Balancing the needs of growing communities and the economic vitality of utilities, courts have resolved some disputes by initially requiring developers to fund extensions to cover the risk that the development will not materialize, but ultimately - if the revenue generated by the development is adequate - requiring the utility to bear the financial burden and reimburse the developer, so that service is provided to all on the basis of substantial equality.

In recognition of these principles, the BPU long ago adopted a rule, "Suggested Formulae for Extension of Utility Service," providing guidelines for determining who, as between the utility and the developer, should pay for extensions of service. Under the guidelines, the developer makes an initial deposit in the amount of the estimated cost of the extension to cover the risk that the development will fail. Then, as homes are constructed and connected to the system generating revenues for the utility, portions of the deposit are refunded to the developer in accordance with the formulae. Should there be a shortfall in anticipated customer yield, the developer must financially contribute to the costs of the extension.

General Principles of Prior Law Governing Public Utility Service

A cardinal principle of public utility statutes is equality and uniformity of treatment. Customers situated alike must be treated in the same manner by the utility--it cannot grant arbitrary or undue preferences to a particular customer. Different treatment of customers must be based on some rational standard grounded in public utility law and the utility's duty to provide safe, adequate and proper service. Closely related to this overarching principle is the rule that any extension costs borne by the developer must be reasonably proportionate to the need created by, or the benefits conferred on, the development served. Over the years, these basic principles have governed the operations of municipally-owned utilities, municipal utility authorities and privately-owned public utilities alike.

Public Utilities Have Not Been Land Use Planning Bodies

Consistent with these accepted principles of public utility law, it is well- established that public utilities are not in the business of land use planning and zoning. Their obligation is to reasonably anticipate and serve the needs of future growth. As the Supreme Court of New Jersey once observed:

A public water company is under a duty as a public utility to supply water to all inhabitants of the community who apply for the service and tender the usual rates. The obligation includes the establishment of a distributive plant adequate to serve the needs of the municipality and the enlargement of the system to meet the reasonable demands of the growing community. The utility is under a duty to serve all within the area who comply with fair and just rules and regulations applicable to all alike.

The high court has overturned a municipal utility's refusal to extend service to new development based not on economic criteria, but on "wholly alien considerations related to planning and zoning." Land use planning and policy has not previously been the province of public utilities or the BPU regulating them. This has now been changed.

The BPU's New "Smart Growth" Extension Rules

The BPU's new "smart growth" policy controlling main extensions turns well-settled public utility law and regulation on its head. Under the new rules, payment for main extensions outside of designated growth areas is assigned to developers without regard to anticipated customer revenues or the utility's financial condition. Instead, the regulatory agency's determination of "who pays" is based on land use policy goals in the State Plan that are foreign to public utility law and ratemaking.

There is no explicit statutory authority for the BPU to substitute "smart growth" criteria for the economic standards historically controlling its determination of the utility's obligation to extend service to new customers. As a legal justification for this dramatic change in policy, the BPU relies on a statute providing that the "board may, after public hearing, upon notice in writing, require any public utility to furnish safe, adequate and proper service, including furnishing and performance of service in a manner that tends to conserve and preserve the quality of the environment and prevent the pollution of the waters, land and air of this State, and·which preserves and protects the water quality of a public water supply."

That language is questionable support for the BPU's unprecedented foray into the arena of growth control. Not in the original statute, the "quality of the environment" clause was added by an amendment in 1970 coinciding with legislation creating the Department of Environmental Protection. Nothing in the legislative history of the statute suggests that it was intended to confer power on the BPU to make decisions about extending public utility facilities to advance land use planning goals or steer growth. No court has construed "environmental quality" as legal authority for the BPU to approve or deny proposed extensions of utility service to serve amorphous "quality of life" objectives.

The BPU's new utility extension rules designed to advance "smart growth" goals would, if upheld, reverse almost a century of statutory interpretation and public utility law defining the basic duty of public utilities to extend service to meet the reasonable demands of a growing population. They raise substantial legal issues that may well require resolution by the New Jersey courts.

Nielsen V. Lewis is a partner of the firm's Environmental Practice Group and a member of the Land Use Division. He concentrates his practice in the areas of environmental law, insurance law and land use, with an emphasis on prosecuting and defending complex environmental litigation.