TITLE 16. ECONOMIC REGULATION

PART 2. PUBLIC UTILITY COMMISSION OF TEXAS

CHAPTER 24. SUBSTANTIVE RULES APPLICABLE TO WATER AND SEWER SERVICE PROVIDERS

The Public Utility Commission of Texas (commission) adopts the repeal of 16 TAC §24.41, relating to cost of service; adopts new 16 TAC §24.41, relating to cost of service, and new 16 TAC §24.238, relating to fair market value; and also adopts amendments to 16 TAC §24.239, relating to sale, transfer, merger, consolidation, acquisition, lease or rental, and 16 TAC §24.243, relating to purchase of voting stock or acquisition of a controlling interest in a utility. New §24.238 is adopted with changes to the proposed text as published in the May 1, 2020, issue of the Texas Register (45 TexReg 2795) and will be republished. The repeal of §24.4, new §24.41, and the amendments to §24.239 and §24.243 are adopted without changes to the proposed text as published and will not be republished.

New rule §24.238 implements House Bill 3542 (HB 3542), passed in the 86th Legislature, Regular Session, which established a fair market valuation process that may be used by a Class A or Class B water or sewer utility that is acquiring another retail public utility or the facilities of another retail public utility. New rule §24.41 incorporates relevant aspects of proposed new rule §24.238 and will replace existing §24.41. New rule §24.41 also includes clarifying changes. The amendments to §24.239 incorporate relevant aspects of proposed new rule §24.238. The Commission adopts the repeal, new rules, and amendments in Project No. 49813.

New rule §24.238 implements House Bill 3542 (HB 3542), passed in the 86th Legislature, Regular Session, which established a fair market valuation process that may be used by a Class A or Class B water or sewer utility that is acquiring another retail public utility or the facilities of another retail public utility. New rule §24.41 incorporates relevant aspects of proposed new rule §24.238 and will replace existing §24.41. New rule §24.41 also includes clarifying changes. The amendments to §24.239 incorporate relevant aspects of proposed new rule §24.238. The Commission adopts the repeal, new rules, and amendments in Project No. 49813.

No public hearing was requested so no public hearing was held.

The Texas Association of Water Companies (TAWC) and National Association of Water Companies (NAWC) jointly submitted comments on the proposed new rule. The Office of Public Utility Counsel (OPUC), CSWR-Texas Utility Operating Company (CSWR Texas), and SJWTX, Inc. d/b/a Canyon Lake Water Service Company, LLC (CLWSC) also submitted comments.

TAWC and NAWC jointly submitted reply comments. OPUC, CSWR Texas, and the City of Houston (Houston) also submitted reply comments.

General Comments

TAWC and NAWC generally supported the proposed §24.238 and requested changes intended to improve the new fair market valuation process and encourage regionalization of Texas water and sewer systems. OPUC supported the overall important policy objectives behind the passage of HB 3542 and the proposed new rule. OPUC believed it is necessary to carefully evaluate the potential rate impacts of the proposed new fair market valuation rule. OPUC supported the creation of safeguards and criteria to help protect consumers from potential rate increases or other unintended consequences. CSWR Texas supported adoption of the proposed rule but encouraged the commission to consider certain changes to make the valuation procedures and the sale, transfer, merger (STM) approval process more efficient and cost-effective when the acquisition involves smaller water or wastewater systems in need of immediate investment to address critical water quality concerns.

In reply comments, TAWC and NAWC provided a general statement in support of the section-specific initial comments submitted by CLWSC and CSWR Texas.

Commission Response

The commission will respond to comments related to specific rule provisions in the discussion of those provisions.

§24.41(c)(2)(C)(i), Estimates and Trending Studies

Proposed §24.41(c)(2)(C)(i) provides that the commission may adjust rate base and the rate of return on equity associated with cost of plant and equipment that has been estimated by trending studies or other methods not based on historical records. TAWC and NAWC requested language that would permit the use of estimated or trending studies in lieu of historical records without a potential "penalty" detrimental to the financial integrity of the utility. TAWC and NAWC commented that often historical records are not available or are not reliable for a variety of reasons, and suggested that the fair market value process could be viewed as one method of estimation of original cost, and as such, the proposed rule language would conflict with new Texas Water Code (TWC) §13.305. Alternatively, TAWC and NAWC suggested that §24.41(c)(2)(C)(i) could be eliminated altogether because there is no similar language in TWC Chapter 13.

OPUC generally advised caution when using trending studies or other methods that are not based on historical documentation to establish original cost. OPUC recognized that adequate historical records and documentation are not always available for older and smaller water utility systems and supported allowing the use of trending studies or other estimation methods for older and smaller water utilities, as long as ratepayers are protected from use of potentially speculative methods to establish original cost.

In reply comments, TAWC and NAWC stated that they interpreted OPUC's comments as generally supportive of trending studies or other estimation methods for original cost. However, TAWC and NAWC sought clarification that there will not be a risk of incurring a potential "penalty" detrimental to the financial integrity of the utility, such as an adjustment to rate base or rate of return on equity simply for using these types of estimation methods.

CSWR Texas stated that OPUC's position encouraging the commission to use a higher standard of review for "overly speculative" valuations that are not supported by historical records and documentation is antithetical to the Legislature's intent to remove roadblocks to the acquisition of smaller older systems.

CSWR Texas supported inclusion of TAWC and NAWC's proposed changes. CSWR Texas also stated its support for the use of alternative valuation methods, such as real estate appraisals, that can be performed more quickly and at a lower cost than the fair market value process. CSWR Texas stated that the commission should encourage use of alternative valuation methods to incentivize the acquisition of smaller, older systems and that "threatening to penalize" a utility's rate base or rate of return when the utility may have no other choice but to utilize trending studies or other methods to set rate base does not provide such encouragement. CSWR Texas further stated that the commission already has the authority to deny rate base amounts it finds unreasonable so there is simply no need for the commission to "threaten" to reduce a utility's rate of return when it can simply deny costs it finds unreasonable.

Commission Response

Proposed §24.41(c)(2)(C)(i) is substantively the same as existing §24.41(c)(2)(B)(i). The commission currently allows original cost of plant and equipment to be based on trending studies or other estimation methods when historical records are unavailable, but may adjust rate base or rate of return when appropriate to ensure just and reasonable rates. The commission agrees with CSWR Texas that the commission has the authority to exclude unreasonable costs from rate base. The commission also has the authority to adjust the rate of return applied to the rate base. For example, TWC §13.184(b) requires the commission to consider, among other things, the quality of the utility's management in fixing a reasonable return on invested capital. Absence of records relating to original cost of plant or equipment could, in some cases, be a sign of the quality of the utility's management. The proposed rule does not require the commission to make adjustments to rate base or rate of return, but reflects the commission's authority to do so.

In situations where the fair market valuation process is not used, TWC §13.185(b) requires rates to be set based on original cost of the facilities unless the commission uses alternative ratemaking approaches authorized under TWC §13.183(c). While the commission's rules permit original cost to be set based on trending studies or other estimation methods when historical records are unavailable, use of real estate appraisals is not an appropriate way to estimate the original cost of facilities because such appraisals estimate market value. Proposed §24.41(c)(2)(C)(i) is not in conflict with TWC §13.305 because it does not apply to the ratemaking rate base established under §24.238, which is governed by §24.41(c)(2)(A). The commission adopts §24.41(c)(2)(C)(i) as proposed.

§24.41(c) and (d), Return on Rate Base and Positive Acquisition Adjustments

CSWR Texas encouraged the commission to include language in the proposed rules that would allow entities that are not Class A or Class B utilities "to take advantage of the benefits of the fair market value process, even if they are not permitted to take advantage of the fair market value process itself." CSWR Texas stated that in other states it has relied on real estate appraisals to help establish rate base for systems it hopes to acquire and that use of real estate appraisals would also be considerably less expensive and time-consuming than the fair market value approach. CSWR Texas noted that "other estimating methods" are already anticipated in proposed §24.41(c)(2)(c)(i) and that use of real estate appraisals, or other reasonable estimating methods, would provide a more efficient and cost-effective alternative to the fair market value approach when the acquisition involves a smaller system, and is particularly necessary when the acquiring entity would be ineligible to participate in the fair market value process.

CSWR Texas also encouraged the commission to clarify the appropriateness of using positive acquisition adjustments, particularly where the acquiring entity is not eligible to participate in the fair market value process. CSWR Texas requested that the commission include language in the rules that would allow entities that invest in smaller systems to accrue Allowance of Funds Used During Construction (AFUDC) and defer depreciation for post-acquisition improvements in the same way provided for under the proposed rules for eligible utilities. CSWR Texas further stated that even when an acquiring utility is eligible to participate in the fair market value process, the purchase price for some systems is so small, it is unlikely the fair market value process would be used. CSWR Texas urged that acquiring entities should still be able to take advantage of the ability to accrue AFUDC and defer depreciation on post-acquisition improvements without having to spend the time and expense to seek unnecessary appraisals. CSWR Texas recommended that providing alternatives to the fair market value approach to rate base valuation for smaller water or wastewater systems, particularly when the acquiring entity is not eligible to utilize the fair market value approach, would provide flexibility and ratemaking clarity to entities seeking to acquire and upgrade those systems and ultimately result in safer, more reliable service.

Commission Response

The Commission declines to make the changes requested by CSWR. In enacting TWC §13.305, the Legislature set the parameters for use of fair market valuation to determine the ratemaking rate base purchased by the acquiring utility, including the type of utility that may use this process. The proposed rule reflects these limitations and requirements. If the fair market valuation process is not used, TWC §13.185(b) requires rates to be set based on original cost of the facilities unless the commission uses alternative ratemaking approaches authorized under TWC §13.183(c). While the commission's rules permit original cost to be set based on trending studies or other estimation methods when historical records are unavailable, use of real estate appraisals is not an appropriate way to estimate the original cost of facilities.

§24.41(g), Intangible Assets

Proposed §24.41(g) relates to the evidence that must be used to support the inclusion of intangible assets in rate base. In both initial and reply comments, TAWC and NAWC requested that proposed §24.41(g) be removed. TAWC and NAWC stated that neither TWC Chapter 13 nor the commission's rules applicable to electric utilities contain this language and that intangible assets are routinely allowed as part of rate base for other utilities without the conditions included in this rule. TAWC and NAWC stated that intangible assets will necessarily be valued as part of the appraisals prepared for fair market value determinations and §24.41(g) should be eliminated. Alternatively, TAWC and NAWC suggested this subsection be revised to simply state that intangible assets, including but not limited to a source of supply such as water rights, must be allowed in rate base and repeated this suggestion in reply comments.

OPUC supported the commission's treatment of intangible assets under new §24.41(g), stating that intangible assets are difficult to value and quantify. OPUC stated that intangible assets have some level of value and agreed with the safeguards and requirements in the proposed rule. OPUC encouraged the commission to keep these safeguards and requirements for the protection of ratepayers from overly speculative claims about the value of intangible assets.

In both its initial and reply comments CSWR Texas objected to proposed §24.41(g) because the requirement is not included in the TWC and does not apply to electric utilities under the Public Utility Regulatory Act (PURA) or the commission's rules. CSWR Texas stated it is not clear why such a heightened burden is applied to water or wastewater utilities. CSWR Texas further commented that intangible assets like land rights are simple to appraise, contribute to the real value of a system, are included in the definition of "facilities" used to provide service under TWC §13.002(9), and also may be the only undepreciated assets that a smaller, older distressed system owns. CSWR Texas stated that this subsection should be eliminated and encouraged the commission to include language in §24.238 that permits appraisers to consider intangible assets as part of their fair market valuations.

In reply, TAWC and NAWC disagreed with OPUC that there is any justification for intangible asset or rate base qualifiers when there are no such qualifiers in place for other types of utilities the commission regulates. TAWC and NAWC argued that intangible assets are not difficult to value and quantify as OPUC contended and are routinely valued by qualified appraisers and valuation experts. TAWC and NAWC further commented that OPUC offered no specific legal or factual basis in support of what it described as "safeguards."

In reply comments, OPUC stated that the commission already disallows intangible assets unless a water utility can meet certain requirements in §24.41(f). OPUC observed that new subsection (g) is a continuation of the commission's existing treatment of intangible assets with which water utilities should already be well familiar. OPUC supported the commission's proposed requirements for intangible assets in new subsection (g) because water utilities should be required to prove through documentation and testimony the reasonableness and necessity of costs that they are seeking to pass on to ratepayers. OPUC stated that these proposed requirements are important and necessary safeguards because intangible assets should not be allowed in a water utility's rate base without a robust assessment of the asset's reasonableness, necessity, and benefits to the utility's ratepayers.

Houston disagreed with TAWC's and NAWC's request that proposed §24.41(g) be removed. Houston noted that TAWC and NAWC requested removal of a requirement that already exists in the commission's rules at §24.41(f) and stated that TAWC's and NAWC's proposal falls outside the scope intended within HB 3542. Houston commented that intangible assets, and specifically the value of water rights, are issues unique to water utilities that could have a significant impact on allowable rate base. Houston stated that inclusion of intangible assets without limitation could result in a rate base that is not reflective of the actual investment made by a utility. Therefore, Houston encouraged the commission to reject TAWC's and NAWC's proposal.

CSWR Texas stated in reply comments that electric utilities commonly include in rates the value of intangible assets like software, franchises, and organizational costs, which should not be difficult to value or require a heightened burden of proof. CSWR Texas agreed with TAWC and NAWC that §24.41(g) should be eliminated. Alternatively, CSWR Texas agreed with TAWC and NAWC's proposed changes. In addition, CSWR Texas encouraged the commission to include express language in §24.238 that intangible assets should be considered as part of fair market valuations.

Commission Response

As OPUC noted, proposed §24.41(g) is substantively the same as current §24.41(f). The commission acknowledges that 16 TAC Chapter 25, which governs electric utilities, is silent on intangible assets. However, setting rates for water utilities presents issues and challenges that differ from electric utilities and the proposed rule reflects the need for different rules in some areas. Proposed §24.41(g) requires that the utility provide documentation for the amount and nature of the asset; establish through testimony that the amount is reasonable, necessary and a benefit to customers; and establish through testimony that the amount requested is properly included as a rate base asset. These basic requirements for recovery of costs from customers are included in the rule to provide guidance to water and sewer utilities that seek to include intangible assets in rate base. The commission adopts the subsection as proposed.

The commission responds to comments about inclusion of intangible assets in fair market valuations in relation to comments on §24.238(b).

§24.238(b), Definitions--Intangible Assets

TAWC and NAWC expressed concern that intangible assets, such as water rights, will not be considered during the fair market value appraisal process use to establish ratemaking rate base. TAWC and NAWC stated that while TWC §13.305(c)(4) limits the engineer's assessment to tangible assets of the selling utility, intangible assets can be equally or even more valuable and are ordinarily considered in assessing a utility's fair market value and its purchase price. TAWC and NAWC recommended that the utility valuation experts conducting appraisals should be instructed to specifically consider intangible assets. TAWC and NAWC suggested changing the definition of ratemaking rate base to include both tangible and intangible assets.

OPUC replied that TAWC's and NAWC's requested change to §24.238(b)(4) is unnecessary because the definition of "facilities" in TWC §13.002(9) includes intangible assets.

Commission Response

The commission declines to change the definition of ratemaking rate base as requested by TAWC and NAWC. As OPUC pointed out, the definition of "facilities" in TWC §13.002(9) includes intangible assets. However, to further clarify this point, the commission modifies §24.238(f)(2) to expressly state that the appraisal performed by the utility valuation expert will include intangible assets, as appropriate.

§24.238(b), Definitions--Selling Utility

OPUC recommended that the commission modify the definition of "selling utility" in subsection (b)(5) to limit the rule's applicability to the sale of Class C and D utilities. OPUC cited Chairman Dade Phelan's statements at the House State Affairs Committee meeting on April 1, 2019 to establish that the intent of HB 3542, which enacted TWC §13.305, was to help drive investment by private companies in small communities that have an urgent need for water system infrastructure, but cannot afford needed system upgrades. OPUC maintained that HB 3542 was not intended to include the acquisition of large Class A and Class B utilities, which do not face the same financial hurdles as smaller Class C and D utilities due to economies of scale and access to more financial resources. OPUC argued that allowing the fair market value of larger, well-functioning and financially healthy Class A and B utilities in the ratemaking rate base of purchasing Class A and B utilities would result in higher costs for ratepayers.

TAWC and NAWC objected to OPUC's recommendation that the proposed rule's definition of "selling utility" should be restricted to Class C and D utilities, stating that the suggestion is contrary to the plain language of the fair market value statute. TAWC and NAWC argued that it is well established in Texas that where text is clear, text is determinative of the Legislature's intent and that the words the Legislature chooses should be the surest guide to legislative intent. TAWC and NAWC contended that if enforcement of the plain language of a statute produces an absurd result or is ambiguous, then other considerations may come into play, such as legislative history, but OPUC did not contend there is ambiguity or an absurd result produced by TWC §13.305, and thus, it is not appropriate to look to the legislative history. Moreover, TAWC and NAWC continued, comments by a single legislator about one purpose for a statute does not show the exclusion of other purposes or reflect the collective intent of the entire legislative body. TAWC and NAWC concluded that not only does the plain language of TWC §13.305 not contemplate the type of limitation OPUC suggested, it specifically makes the fair market value process available to acquisitions of retail public utilities, which include water and sewer providers that are not investor owned.

CSWR Texas opposed the limitations on the definition of selling utility proposed by OPUC. CSWR Texas stated that because it is not a Class A or B utility, it appears CSWR Texas is precluded from using the fair market valuation process and other incentives in the proposed rules. CSWR Texas argued that there is no reason that large, adequately capitalized, well-established entities seeking to bring new investment to smaller community-based water and wastewater systems in Texas should be excluded from such incentives, which were specifically designed to encourage the investment CSWR Texas seeks to make in Texas. CSWR Texas encouraged the commission to allow "capable" entities to utilize the fair market value procedures and to take advantage of other incentives.

Commission Response

The commission declines to change the definition of selling utility as recommended by OPUC because TWC §13.305 clearly does not limit the availability of the fair market value process to acquisitions of Class C and Class D water and sewer utilities. Similarly, the commission declines to change the definition as recommended by CSWR Texas, because TWC §13.305 limits use of the fair market valuation process to acquisitions by Class A and Class B utilities.

§24.238(c)(2), List of Qualified Utility Valuation Experts

OPUC supported the utility valuation expert disclosure requirements in proposed §24.238(c)(2). However, OPUC recommended that the commission also require a utility valuation expert to provide a list of all previous water utility-related employers to provide more transparency. OPUC stated that this additional disclosure requirement would help the commission determine whether a utility valuation expert has been employed by a water utility that is subject to the fair market valuation process and whether a utility valuation expert should be disqualified from the selection process.

OPUC contended that the additional disclosure requirement would provide the commission with more context on the utility valuation expert's past water utility-related experience when considering the expert's report. OPUC argued that while a utility valuation expert may not have been employed by a water utility in the previous year to warrant disqualification under proposed §24.238(e)(2)(B), the utility valuation expert may have been employed by a water utility several years ago and that past experience could affect the expert's analysis and report. OPUC stated that while a utility valuation expert's past water utility-related experience may not warrant disqualification, the commission should nonetheless be aware of the expert's water utility-related employment history in order to make an informed decision with more transparency in the fair market valuation process.

In reply, TAWC and NAWC opposed OPUC's proposed addition to §24.238(c)(2). TAWC and NAWC commented they do not believe that disclosure is necessary, noting that OPUC stated such experience would not necessarily call for disqualification. TAWC and NAWC stated that proposed §24.238(c)(2)(E) already requires a detailed description of a utility valuation expert's experience and OPUC's proposed language seemed overly broad and vague.

In reply comments, CSWR Texas expressed its concern that there will not be a sufficient number of participating appraisers to satisfy the potential demand for the new fair market valuation process and disagreed with any requirements that will discourage or limit the ability of a willing and available appraisal expert to participate in the fair market value process. CSWR Texas stated that the rules already include restrictions on who may participate as an appraiser, and prior employment by a water utility should not be grounds for disqualification of an appraiser or cause to dismiss or question the appraiser's conclusions. CSWR Texas further commented that the commission should clarify that providing consulting services as a third party vendor does not constitute "employment" under the rule because many qualified valuation experts may have worked as an outside consultant to a utility or other "utility-related" entities such as the commission, commission staff, OPUC, municipalities, or any number of other industry groups. CSWR Texas stated that requiring disclosure of an expert's prior work as an outside consultant could breach confidentiality agreements or otherwise discourage experts from taking part in the appraisal process. CSWR Texas opposed OPUC's proposed changes to §24.238(c)(2) and urged the commission to consider ways to encourage appraisers to participate in the fair market value process.

Commission Response

The commission declines to change the disclosure requirements as suggested by OPUC and CSWR Texas. Instead, the commission adds §24.238(e)(2)(C) to state that a utility valuation expert selected by the executive director or the executive director's designee must not have received compensation under a contract for consulting or other services with the acquiring or selling utility, or executed a contract with either utility, within one year of the date the utility valuation expert is selected. This additional language creates a clear distinction between the term "employment" as used in §24.238(e)(2)(B) and work as a third party contractor and sets reasonable parameters on when a utility valuation expert's previous work as a third party contractor poses a conflict of interest.

§24.238(d), Notice of Intent to Determine Fair Market Value

Proposed §24.238(d)(3) provides that a notice of intent to determine fair market value must not include the purchase price agreed upon by the acquiring utility and selling utility. Proposed §24.238(f)(4) provides that the appraisals performed by the utility valuation experts must not consider the purchase price negotiated by the acquiring utility and selling utility. TAWC and NAWC commented that the acquiring and selling utility should be permitted to share an agreed-upon purchase price with the utility valuation experts conducting appraisals. TAWC and NAWC stated that utility valuation experts should be able to consider all available information they believe is relevant to their appraisal task, which may include considering an established purchase price along with other available purchase price information in the market. TAWC and NAWC further stated that in light of the statutory five percent cap on compensation, the purchase price may provide an approximation of the amount the prospective utility valuation experts may be paid. TAWC and NAWC suggested revising the proposed rule to provide that the notice of intent may include the purchase price agreed upon by the acquiring utility and the selling utility.

OPUC disagreed with TAWC's and NAWC's recommendation that the acquiring and selling water utility should be permitted to share their agreed-upon purchase price with the utility valuation experts conducting the appraisals. OPUC stated that permitting the acquiring and selling utilities to share their agreed-upon purchase price with the utility valuation experts would introduce subjectivity and bias into a process that is intended to be an independent, neutral and objective evaluation of the fair market value of a selling utility or selling utility's facilities. OPUC commented that HB 3542 included several provisions that speak to the Legislature's intent to create a voluntary fair market valuation process that is independent, neutral and objective, including conflict of interest protections with regard to the utility valuation experts; selection of utility valuation experts by the commission, rather than the selling and acquiring utilities; appointment of three utility valuation experts to perform the fair market valuation appraisal; and the use of the average of the three utility valuation experts' appraisals, rather than relying upon a single appraisal, to determine fair market value. OPUC urged the commission not to allow the acquiring and selling utilities to share their agreed-upon purchase price with the utility valuation experts in the fair market valuation process.

CSWR Texas agreed with TAWC and NAWC that participating utilities should be permitted to disclose the purchase price of a system to the selected utility valuation experts for consideration as part of the fair market value process. CSWR Texas commented that there is often a lack of available cost information or market data necessary to appraise smaller water or wastewater systems and appraisers should be able to consider all available information they consider relevant to their appraisal report, including the purchase price reached by willing parties to a transaction, as long as their deliberations are consistent with the Uniform Standards of Processional Appraisal Practice. CSWR Texas further commented that by requiring the averaging of three separate appraisals, the proposed rule already has sufficient protections to ensure reasonable valuations based on all available information. CSWR Texas supported TAWC's and NAWC's proposed changes to this subsection.

Commission Response

TWC §13.305(c)(3) requires that utility valuation experts perform appraisals using certain approaches that do not include consideration of the agreed-upon purchase price. To protect the integrity of the valuation process, the commission declines to change the rule as requested by TAWC and NAWC and supported by CSWR Texas.

§24.238(e), Selection of Utility Valuation Experts

Proposed §24.238(e)(1) requires the commission's executive director to select three utility valuation experts who will perform appraisals after a notice of intent to use the fair market value process is filed. TAWC and NAWC commented that with respect to this subsection, it is helpful to consider what other jurisdictions with fair market value legislation have done regarding appraisals. TAWC and NAWC stated that they recognized the limitations of TWC §13.305(c)(2), which says the commission is to "select three utility valuation experts" from its list but stated that the statute does not prohibit recommendations from the buyer and seller regarding valuation experts that the commission should consider. TAWC and NAWC commented that it is important for the buying and selling parties to have input on the selection of the utility valuation expert because they are closest to the transaction and requested that the proposed rule be modified to require the commission's executive director or the executive director's designee to accept and consider one recommended utility valuation expert included in the list maintained under subsection (c) of this section from the acquiring utility and one from the selling utility with the notice of intent filed under subsection (d).

CLWSC requested that the rule explicitly provide that once the commission has selected the utility valuation experts, the selling and acquiring utilities are to contract with the utility valuation experts without involvement by the commission. CLWSC stated that would help all parties involved by allowing the parties to provide assurances to the appraisers about negotiation of terms.

CSWR Texas agreed with TAWC and NAWC that it is important for the buying and selling utilities to each have input as to the selection of the utility valuation experts. CSWR Texas supported TAWC's and NAWC's proposed changes to this subsection. OPUC opposed TAWC's and NAWC's proposed changes arguing that allowing the buying and selling utilities input into the selection of the utility valuation experts introduces subjectivity and bias into what is intended to be an independent, neutral, and objective process.

Commission Response

The commission declines to change the proposed rule as requested by TAWC and NAWC and supported by CSWR Texas. In developing the proposed rule, the commission reviewed the processes used by other jurisdictions, as suggested by TAWC and NAWC. TWC §13.305 places responsibility for selecting the utility valuation experts solely with the commission. Selection of the utility valuation experts by the executive director or the executive director's designee, without input from persons who have an interest in the transaction, will contribute to preserving the integrity of the fair market valuation process.

In response to CLWSC's comments, the commission modifies proposed §24.238(e)(4) to clarify that once the commission has appointed the utility valuation experts, the acquiring utility must proceed to enter agreements with the selected experts.

§24.238(f), Determination of Fair Market Value--Engineering Assessment

Proposed §24.238(f) requires the three utility valuation experts to retain a licensed engineer to assess the tangible assets of the selling utility or the facilities to be sold to the acquiring utility. TAWC and NAWC recommended that the rule allow the seller and buyer to agree to rely on an engineering assessment that one or both has already conducted as part of the due diligence process rather than have another assessment performed. TAWC and NAWC suggested that proposed §24.238(f)(1) be modified to provide that if the commission is informed by verified affidavit of either the acquiring or selling utility that an engineering assessment was previously undertaken and is in compliance with §24.238(f)(1)(A) through (C), then upon acceptance by the commission's executive director or the executive director's designee, the requirement for a new engineering assessment is waived.

In reply comments, OPUC once again stated its concern that the involvement of the selling and acquiring water utility in aspects of the fair market valuation process introduces bias and subjectivity into a process intended to be independent, neutral, and objective. OPUC maintained that the conflict of interest provisions in HB 3542 show that the utility valuation experts are supposed to be independent parties in the fair market valuation process. OPUC argued that TAWC's and NAWC's recommendation to use an engineering assessment performed during the utility's due diligence process conflicts with the intent of the legislation and should not be adopted by the commission.

Houston recognized that the avoidance of duplicative engineering work can save time and potentially reduce transactional costs passed on to ratepayers, but recommended inclusion of additional requirements to provide for verification of the assessment by the engineer if the commission modifies the proposed rule as recommended by TAWC and NAWC. Houston proposed that the engineer responsible for conducting the assessment provide an affidavit in addition to the affidavit recommended by TAWC and NAWC. Houston further recommended that the rule require the engineer to attach the engineering assessment report to the affidavit and require the report to bear the professional engineer's seal and signature to authenticate the engineering assessment as accurate and independent. Houston provided recommended amendments to the §24.238(f)(1) language proposed by TAWC and NAWC.

CSWR Texas agreed with TAWC's and NAWC's recommendation that the appraisers be permitted to utilize complete and accurate engineering studies or appraisals that have already been performed by the acquiring or selling utility. CSWR Texas expressed concerns that for smaller systems with fewer assets, the cost of fair market value appraisals could far exceed the caps imposed under the statute. CSWR Texas stated that the cost of hiring an engineer as part of the fair market value process will be a significant driver of these appraisal costs, so to the extent the buyer and seller agree to the use of such information, the commission should permit the acquiring and selling utilities to provide such information to the appraisers and allow the appraisers to determine whether such information can be reasonably substituted for an entirely new engineering analysis. CSWR Texas agreed with TAWC's and NAWC's proposed changes to this subsection.

Commission Response

TWC §13.305(c)(4) requires the three utility valuation experts selected under §13.305(c)(2) to jointly retain a licensed engineer to conduct an assessment of the tangible assets of the selling utility or the facilities to be sold. The statute does not provide for use of a previous engineering assessment. The proposed rule appropriately reflects the statutory process; therefore, no amendments are necessary.

§24.238(f), Determination of Fair Market Value--Filing of Notice of Intent and Sale, Transfer, Merger (STM) Application

CSWR Texas commented that the commission should allow the acquiring and selling utilities to file their STM applications concurrently with the fair market value appraisal process. CSWR Texas also encouraged the commission to find other ways to compress the schedule as much as possible. In addition, CSWR Texas encouraged the commission to require appraisers to complete appraisals for Class D utilities within 60 days after appointment.

Commission Response

The commission addresses the timing of filing the notice of intent and STM application in relation to proposed §24.239. The commission declines to shorten the time period for the utility valuation experts to file their reports when the selling utility is a Class D utility. The commission retains the proposed time period as an outer limit to ensure the utility valuation experts have adequate time to prepare their reports.

§24.238(f), Determination of Fair Market Value--Engineer's Role

TAWC and NAWC recommended that the rule should specifically identify the engineering "assessment" as an inventory of the assets being sold rather than any type of valuation. TAWC and NAWC suggested that proposed §24.238(f)(1)(C) be modified to specify that the engineer should develop an inventory of the used and useful utility plant assets to be transferred that is compiled by year and account, separately identify any utility plant that is being held for future use, and develop a list of all non-depreciable property such as land and rights-of-way. Further, TAWC and NAWC recommended that the rule should require that the inventory must be developed from available records, maps, work orders, debt issue closing documents funding construction projects, and other sources to ensure an accurate listing of utility plant inventory by utility account.

Houston commented that although it supports clarity regarding the engineering assessment process, TAWC's and NAWC's proposal is too narrow and inappropriately limits the role of the engineer. Houston stated that it is common for the appraiser to consider both the age and condition of the asset within the subject transaction. Houston commented that the engineer conducting the engineering assessment may be the most qualified individual to assess the condition of the assets in question, and that the engineer should not be limited in providing their opinion. Houston recommended amendments to the language proposed by TAWC and NAWC.

Commission Response

The commission declines to change the proposed rule as recommended by TAWC and NAWC. The commission agrees with Houston that the recommendation inappropriately limits the role of the engineer.

§24.238(f), Determination of Fair Market Value--Consideration of Purchase Price

For the reasons discussed with respect to proposed §24.238(d)(3), which prohibits including the agreed upon purchase price in the notice of intent to determine fair market value, TAWC and NAWC requested that proposed §24.238(f)(4) be modified to provide that the appraisal may consider the purchase price negotiated by the acquiring utility and the selling utility.

CLWSC stated that the commission lacks authority to prevent selling or acquiring utilities from sharing the purchase price or the process of arriving at the purchase price with the appointed utility evaluation experts. CLWSC stated that information is an important indicator of market value, especially when appraising assets that are not widely traded, and nothing in the statute authorizes the commission to limit information flow between a utility and a utility valuation expert. CLWSC noted that the statute merely holds utility valuation experts to the Uniform Standards of Professional Appraisal Practice and dictates the methods of valuation each expert is to employ. CLWSC took issue with the assumption that an appraisal will fail to be independent if the utility valuation expert receives information from the selling or acquiring utilities about the facilities in question. CLWSC further commented that the statute does not call for an "independent" appraisal, but reads "...each utility valuation expert shall perform an appraisal in compliance with Uniform Standards of Professional Appraisal Practice, employing the cost, market, and income approaches, to determine the fair market value...."

Commission Response

The commission declines to make changes to the proposed rule. TWC §13.305 provides an alternative, voluntary method for determining the appropriate rate base value for an acquired retail public utility or facilities. The statute does not expressly address the flow of information between the utility valuation experts and the acquiring and selling utility. Further, it does not expressly prohibit the commission from enacting rules to ensure that the information shared does not jeopardize the independence of the utility valuation experts and their appraisals. Although TWC §13.305 does not use the word "independent," it is reasonable to require that the appraisals provided by the utility valuation experts not be influenced by the agreed-upon purchase price or the methodologies or process used to arrive at the purchase price. The commission modifies §24.238(f)(4) to further clarify what information must not be considered by the utility valuation expert.

§24.238(f), Determination of Fair Market Value--Engineer's Fee

TAWC and NAWC stated that the proposed rule is unclear whether the fee for the engineer retained by the three selected utility valuation experts described in proposed §24.238(f)(1)(D) is subject to the same fee limitations expressed in subsection (k). TAWC and NAWC suggested additions to subsection (k) intended to clarify this issue.

Commission Response

The commission declines to make changes to the rule in response to TAWC's and NAWC's comments. TWC §13.305(e) specifically refers to fees paid to utility valuation experts. Because the utility valuation experts will retain and compensate the engineer, proposed §24.238(f)(2)(D) provides that the engineer's fee may be included in the utility valuation expert's compensation under subsection (k). Therefore, under the proposed rule, the engineer's fee is indirectly subject to the five percent cap, and no changes are necessary.

§24.238(f), Determination of Fair Market Value--Information Used by Utility Valuation Expert

TAWC and NAWC asked the commission to specify that the utility valuation experts and engineer should confer with the acquiring utility and selling utility to obtain available valuation and asset information as part of the fair market valuation determination process. TAWC and NAWC stated that ultimately the utility valuation experts will prepare their appraisal reports independently, but it is important for the best information available to be considered. TAWC and NAWC stated that most often, the acquiring and selling utilities will have that information, so the utility valuation experts should be compelled to request and consider information from the acquiring and selling utilities to the extent it is available.

Commission Response

The rule as proposed does not preclude the utility valuation experts from communicating with the selling and acquiring utilities to obtain information needed to perform the cost, market, and income analyses. However, the commission declines to expressly require that they do so.

§24.238(g) through (i), Cost Approach, Income Approach, and Market Approach

CSWR Texas commented that the requirements for the three valuation methodologies exceed the statutory requirements because TWC §13.305 does not prescribe any specific methodologies or requirements for the cost approach, income approach and market approach. Rather, it only requires the utility valuation experts to comply with the Uniform Standards of Professional Appraisal Practice. CSWR Texas stated that the proposed rule's appraisal process may be appropriate for larger, more sophisticated systems with adequate records, but it would be "inefficient or ineffective" for appraising smaller systems that lack data or comparable sales. CSWR Texas noted that the proposed rule does not appear to allow the utility valuation experts any discretion to apply their individual and specialized expertise to determine the most appropriate manner to determine fair market value. CSWR Texas was also concerned that the requirements on how appraisals must be performed could conflict with the Uniform Standards of Professional Appraisal Practice, with which the utility valuation experts are required to comply under TWC §13.305(c)(3), proposed §24.238(f)(2), their state licensing requirements, and the industry's ethical standards. Such a conflict could discourage utility valuation experts from participating in the fair market value process. To resolve these concerns, CSWR Texas encouraged the commission to include language in subsections (g), (h) and (i) that allows the utility valuation experts to use "other reasonable methodologies that are consistent with the Uniform Standards of Professional Appraisal Practice" to perform each of the three approaches. In addition, CSWR Texas recommended that the commission clarify that an appraiser has discretion to use only those appraisal analyses the appraiser determines will result in reasonable or accurate valuations. According to CSWR Texas, allowing use of discretion is consistent with the Uniform Standards of Professional Appraisal Practice, would result in more accurate valuations, and would eliminate the time and expense of performing unnecessary or ineffective analyses.

Proposed §24.238(g)(1) states that a cost approach appraisal performed must be based on the investment required to replace or reproduce future service capability or the original cost of the facilities. TAWC and NAWC commented that there are other cost approach valuation methods that could potentially be utilized and paragraph (g)(1) should be revised to permit a cost appraisal to be based on other reasonable cost approach valuation methods in addition to those listed in the proposed rule.

Commission Response

TWC §13.305(c)(3) requires the utility valuation experts to perform appraisals using the cost, market, and income approaches. The proposed rule appropriately incorporates the statutory requirements; therefore, the commission declines to change the rule as recommended by CSWR Texas. The commission also declines to allow use of other cost approach valuation methods. Original cost and replacement cost are generally accepted methods for determining the value of facilities and are sufficient for the purposes of the fair market valuation process.

§24.238(h), Income Approach

Proposed §24.238(h)(2) provides that an appraisal that uses the income approach must exclude consideration of future capital improvements. TAWC and NAWC commented that future capital improvements are used in the development of the discounted cash flow method and excluding consideration of them will artificially increase the overall income approach value. TAWC and NAWC stated that proposed §24.238(h)(2) should be deleted.

Commission Response

The commission declines to delete or change §24.238(h)(2) because consideration of future capital improvements unnecessarily introduces additional uncertainty and inaccuracy into the income method.

§24.238(j), Contents of Utility Valuation Expert Report

OPUC supported the commission's inclusion of the conflict of interest provisions for engineers in subparagraph (f)(1)(A) of the proposed rule. Additionally, OPUC supported the required information sharing between the engineer and utility valuation expert in proposed §24.238(f)(1)(B). OPUC, however, noted that the engineer's information is shared with only the utility valuation experts and the utility valuation experts are not obligated to disclose the engineer's information in their reports. OPUC commented that transparency and holistic commission oversight are essential to the new fair market valuation process, and the engineer's information is just as important as the utility valuation expert's information for purposes of ensuring a non-biased valuation of a retail public utility or the facilities of a retail public utility. OPUC recommended that the commission modify proposed §24.238(j) to require the disclosure of information provided by the engineer to the utility valuation expert pursuant to §23.238(f)(1)(B) in the utility valuation expert's report.

In reply comments, TAWC and NAWC stated that OPUC's proposed addition to §24.238(j) that would require inclusion in the utility valuation expert's report of "the information submitted by the licensed engineer under subsection (f)(1)(B) to the utility valuation expert" may not be necessary given that proposed §24.238(j)(3) requires the utility valuation expert's report include "a detailed list of the utility plant assessed by the engineer."

Commission Response

In response to OPUC's comments, the commission modifies §24.238(j)(3) to require that the utility valuation expert's report must include the assessment prepared by the licensed engineer under §24.238(f)(1), including a detailed list of the utility plant assessed by the engineer.

§24.238(k), Transaction and Closing Costs

TAWC and NAWC expressed concern that proposed §24.238(k), which allows a fee paid to a utility valuation expert to be included in the transaction and closing costs associated with an STM, leaves open for future determination in a rate case the amount of transaction and closing costs, the acquiring utility may recover in rates. TAWC and NAWC stated that they think the intent of the statute is that the five percent cap should represent a total amount for all appraisal work and engineer fees. Further, TAWC and NAWC requested the commission not leave to a future case the determination of whether a fee amount other than the five percent will be approved. TAWC and NAWC noted that TWC §13.305(g) and (h)(3) require ratemaking rate base to be established for incorporation into the acquiring utility's rate base in its next rate case and be included in the STM application for the transaction, but TWC §13.305(h)(4) specifies that transaction and closing costs to be included in the acquiring utility's rate base are to be included in a fair market value STM application. TAWC and NAWC offered revisions to proposed §24.238(k)(2) that would require the commission to approve the collective fee amounts as part of the fair market value determination proceeding.

CSWR Texas commented that the actual costs for the utility valuation experts to perform appraisals could be significantly higher than five percent of the purchase price. For example, for a smaller system with a fair market value of $100,000, the appraisal and engineering fees would likely far exceed the five percent cap. CSWR Texas stated that it agrees reasonable caps should be placed on appraisal costs, but it will be difficult to find appraisers willing to engage in this process and hire outside engineers to assess these much smaller systems if their costs are not recoverable. The fact that the statutorily mandated caps may not allow valuations of these smaller systems supports adoption of more expedient and cost-effective alternatives to the proposed fair market valuation approach.

CLWSC commented that the five percent cap should apply to the combined fees paid to all three appraisers, and that the rule could state that combined fees of up to five percent is the maximum that may be recovered in rates, while allowing the acquiring utility to agree to whatever fees they negotiate with the appraisers. CLWSC stated this approach would allow the appraisers to be assured of a fee that they deem to be acceptable, but it would create a limit more in line with market conditions on how much of those fees could be expected to be passed on to ratepayers.

With respect to the appraisal fee referenced in TWC §13.305(e)(2), CLWSC advocated for a published fee schedule to be promulgated by the commission to create clarity and certainty in the fair market value determination process. The fee schedule would not be a requirement for what utilities must pay an appraiser, but rather would aid utilities in understanding what costs are recoverable once the utility has completed the fair market value determination process and proceeded with its STM application.

In reply comments, OPUC agreed with the concerns raised by TAWC, NAWC, and CLWSC relating to the five percent cap on fee amounts included in transaction and closing costs that are recoverable in rates. Although TWC §13.305(e) sets a five percent cap for recovery of utility valuation expert fees, TWC § 13.305(e) does not specify whether the five percent cap applies collectively or individually to the utility valuation expert and licensed engineer fees. OPUC agreed that the suggested language revisions to §24.238(k) proposed by TAWC and NAWC are consistent with the legislative intent of HB 3542 and that the five percent cap should apply collectively to the utility valuation expert and licensed engineer fees. OPUC stressed that the revised language proposed by TAWC and NAWC allows flexibility for the selling and acquiring water utility to negotiate a higher contractual price for the services of the utility valuation expert and licensed engineer, but limits the costs passed on to ratepayers.

Houston replied to TAWC's and NAWC's concern that transaction and closing costs associated with the fair market value process will not be considered by the commission until the rate case in which the fees are requested for recovery. Houston noted that as support for including transaction and closing costs in the fair market valuation process, TAWC and NAWC refer to the requirements of TWC §13.305(h)(4) that the STM application must include the transaction and closing costs incurred by the acquiring utility that will be included in the utility's rate base. Houston agreed that if the transaction and closing costs are to be included in rate base through the fair market valuation process in accordance with the proposed language in §24.41(c)(2)(A), then it does follow that the fair market valuation process would need to include consideration of these costs.

Houston expressed concern that considering these costs as part of the fair market valuation would circumvent the typical rate-making process and effectively deny ratepayers the opportunity to comment on the reasonableness and necessity of these costs. Houston further commented that if included, the costs would continue to be a component of the fair market value rate base until depreciated over the life of the plant assets without having had the same scrutiny that is afforded affected parties in general rate proceedings. Houston noted that the use of system-wide or region-wide rates by Class A and B utilities complicates the situation. Houston stated it would need to intervene in all STM filings that could potentially result in a change in rate base underlying the rates charged to customers within its municipal limits to ensure adequate protection to ratepayers within Houston's original jurisdiction. Houston expressed uncertainty about whether it would have standing to intervene in such proceedings. Houston stated that, should intervention be granted, it could further complicate and delay the STM process, which could further hamper and delay much needed improvements in service to customers.

Houston agreed with TAWC and NAWC that the proposed rules appear to create confusion on when the transaction and closing costs associated with fair market value determination would be calculated and approved. However, Houston stated that the STM should not be conflated with the ratemaking processes and strongly urged the commission to ensure that ratepayers maintain the ability to comment on the reasonableness and necessity of the transaction and closing costs within the standard ratemaking process as opposed to including it within the fair market valuation or STM process.

Commission Response

The statutory framework for the fair market value process requires the commission to establish the ratemaking rate base in the STM proceeding. The commission's role in establishing the ratemaking rate base is not adjudicatory. No hearing on the issue will be required or permitted because the ratemaking rate base must be based on the utility valuation experts' reports or the purchase price. In contrast, determination by the commission of reasonable and necessary transaction and closing costs, including utility valuation expert fees, to be recovered in rates will be an adjudicatory process that may require a hearing. The proposed definition of ratemaking rate base in §24.238(b)(4) clarifies that transaction and closing costs are not part of ratemaking rate base, and therefore, are not required by TWC §13.305 to be determined in the STM case. The commission does not determine in the STM case the amount of transaction and closing costs properly included in rates.

The commission agrees with the commenters that the five percent cap should apply to the overall amount of utility valuation expert fees, including the engineer's fee, that may be recovered through rates and clarifies §24.238(e)(4) accordingly. The commission also has the authority under TWC §13.305(e)(2) to approve a different amount. The acquiring and selling utilities will negotiate the fees of the utility valuation experts, and as with other costs incurred by utilities, bear the risk of a commission finding that the fees are not reasonable, necessary, or recoverable through rates. The determination of the amount of transaction and closing costs that may be included in rates is properly carried out in a rate case where affected persons such as Houston, OPUC, and utility customers may intervene.

The commission declines to adopt a fee schedule as suggested by CLWSC because the reasonableness of the closing costs, including the utility valuation experts' fees, is appropriately decided on a case-by-case basis.

The commission declines to make changes to the proposed rule in response to CSWR's comments. The proposed rules implement HB 3542 and make corresponding changes to existing rules. Changing the proposed §24.238 to provide for more expedient and cost-effective alternatives to the fair market value approach is beyond the scope of this project and the authority granted in HB 3542. The rule precludes rate recovery of amounts for utility valuation expert fees that exceed the five percent cap, but does not prevent utilities from paying utility valuation experts fees that exceed that cap.

§24.239 Sale, Transfer, Merger, Consolidation, Acquisition, Lease or Rental--Timing of Fair Market Valuation and STM Application

TAWC and NAWC expressed concern about the extended length of time it could take to complete an acquisition using the §24.238 fair market valuation process if the STM application could not be filed until after the valuation was determined by the commission.

TAWC and NAWC stated that the commission's determination of the appropriate fair market valuation and approval of a transaction itself under §24.239 should occur at the same time and in the same proceeding. TAWC and NAWC stated that until valuation is settled, the buyer will not know if it can earn a return of and on capital used to acquire the property of the seller such that an STM cannot be consummated until after the fair market valuation is pronounced by the commission. TAWC and NAWC recommended that this determination should occur as promptly and efficiently as possible. TAWC and NAWC stated that customers and employees also benefit from the STM proceeding not lingering too long becaduse existing management may be less likely to approve capital improvements and make other decisions that would benefit service during the pendency of a sale of the system, while employees will be operating under the uncertainty of their continuing positions with the new owner. TAWC and NAWC cited TWC §13.305(h) as indicative of clear legislative intent to consider the asset acquisition and its proper valuation in the same proceeding. TAWC and NAWC recommended that the commission should also recognize TWC §13.305(i), which specifies that the commission's order approving the acquisition must determine the acquiring company's ratemaking rate base. TAWC and NAWC commented that TWC §13.305(h)(4) also requires inclusion of the "transaction and closing costs incurred by the acquiring utility that will be included in the utility's rate base." TAWC and NAWC proposed that the commission replace proposed §24.239(d)(2) with language that would require approval of transaction and closing costs in the STM proceeding rather than deferring consideration to the next rate case.

CSWR Texas encouraged the commission to include language in proposed §24.239(d) that would allow an entity to file its STM application concurrently with its fair market value appraisal and to supplement the application to include the appraiser reports and costs once the fair market valuation is finalized. This would expedite the acquisition time by four to five months, increase regulatory certainty, and reduce costs.

In reply comments, CSWR Texas agreed with TAWC and NAWC that the commission should include language in the rule that allows a utility to engage in the fair market value process and file its STM concurrently. CSWR Texas noted that an STM proceeding can already take over a year, and the fair market valuation process could add an additional five to six months.

Commission Response

The commission disagrees that concurrent filing of the notice of intent to use the fair market value process and the associated STM application will result in the efficiencies projected by TAWC, NAWC, and CSWR Texas. TWC §13.305 clearly contemplates a two-step process. TWC §13.305(c) requires the acquiring utility and selling utility to notify the commission of their intent to use the fair market valuation process so that the commission may select the utility valuation experts. TWC §13.305(h) requires an acquiring utility that uses the fair market valuation process to submit copies of the three utility valuation expert appraisals in the STM application submitted under TWC §13.301. The commission cannot set an intervention date, provide for notice, determine whether a hearing is necessary, or evaluate the merits of the STM application without a complete application.

Further, the fair market valuation process is voluntary and any concerns about the additional time required to complete this process before filing an STM application can be weighed against the benefits of obtaining a fair market valuation before filing a notice of intent initiating the process. Therefore, the commission adopts the rule as proposed.

§24.239 Sale, Transfer, Merger, Consolidation, Acquisition, Lease or Rental--Ability to Contest Appraisals

TAWC and NAWC requested that parties to an STM proceeding have the opportunity to contest a fair market valuation based upon the existence of fact and mathematical errors in the appraisals or engineer's assessment. TAWC and NAWC stated that there is no indication that the legislature intended to eliminate the commission's ability to analyze and challenge the appraisals and the resulting rate base value. TAWC and NAWC commented that the appraisal process involves facts and assumptions that may be incorrect and in need of revision; the process is not simply the mathematical exercise of taking three appraisals without inquiry and dividing the sum of them by three. Rather, TAWC and NAWC stated that the commission has a statutory duty to assure the public interest and compliance with the TWC and commission rules.

TAWC and NAWC suggested adding a new paragraph to §24.239(d)(3) that provides that parties to an application proceeding that includes a fair market valuation may challenge the facts and assumptions made in an appraisal or engineering assessment relied upon in an appraisal.

CSWR Texas agreed with TAWC and NAWC that there should be a process to allow parties to identify and correct mathematical errors or underlying data in the appraisal reports or engineer analyses. While TAWC and NAWC recommended including language in §24.239 to address this within the context of an STM proceeding, CSWR Texas suggested allowing the utilities to communicate any errors to the appraisers once their reports are issued and allowing the appraisers to issue a corrected report within a reasonable amount of time. Allowing for correction of errors will improve the fair market valuation process and protect both the utility and customers.

In reply comments, OPUC expressed concern that including language in the proposed rule that permits challenges to the facts and assumptions of an appraisal or engineering assessment in the fair market valuation process will create an opportunity for parties to modify the results of the appraisal and engineering assessment and could result in unnecessary litigation that will negate the intended legislative purpose of incentivizing private investment in water and wastewater infrastructure in smaller communities that are in critical need of the infrastructure. OPUC recognized the validity of the concern raised by TAWC and NAWC, but stated that their proposed language exceeds the scope of their concern. OPUC provided language for a proposed new subsection if the commission wants to address TAWC's and NAWC's concern that allows for the opportunity to "correct factual and mathematical errors" rather than the opportunity to "challenge the facts and assumptions made."

Commission Response

The commission disagrees with TAWC and NAWC regarding the legislature's intention to eliminate the commission's ability to analyze and challenge the appraisals and the resulting rate base value. TWC §13.305(g) states that the ratemaking rate base is the lesser of the purchase price or the fair market value. TWC §13.305(f) states that the fair market value is the average of the three utility valuation experts appraisals.

However, factual or mathematical errors could be present in an appraisal report prepared by a utility valuation expert. Therefore, the commission modifies §24.238(f)(5) to require the acquiring and selling utilities to review the reports for mathematical and factual errors and notify the utility valuation experts of any mathematical or factual errors they identify, regardless of whether the errors increase or decrease the appraisal. The utility valuation expert may promptly revise the report in response to the utilities' notification. This change builds the review into the fair market valuation process before the adoption of a ratemaking rate base rather than waiting until the STM proceeding, which occurs after the ratemaking rate base is set.

All comments, including any not specifically referenced herein, were fully considered by the commission. In adopting this section, the commission makes other modifications for the purpose of clarifying its intent.

SUBCHAPTER B. RATES AND TARIFFS

16 TAC §24.41

Statutory Authority

This repeal is adopted under the Texas Water Code §13.041, which provides the commission with the authority to make and enforce rules reasonably required in the exercise of its powers and jurisdiction; and §13.305, which establishes a voluntary process for the valuation of utilities or facilities acquired by Class A or Class B utilities.

Cross reference to statutes: Texas Water Code §13.041 and §13.305.

The agency certifies that legal counsel has reviewed the adoption and found it to be a valid exercise of the agency's legal authority.

Filed with the Office of the Secretary of State on July 31, 2020.

TRD-202003127

Andrea Gonzalez

Rules Coordinator

Public Utility Commission of Texas

Effective date: August 20, 2020

Proposal publication date: May 1, 2020

For further information, please call: (512) 936-7244


16 TAC §24.41

Statutory Authority

This new rule is adopted under the Texas Water Code §13.041, which provides the commission with the authority to make and enforce rules reasonably required in the exercise of its powers and jurisdiction; and §13.305, which establishes a voluntary process for the valuation of utilities or facilities acquired by Class A or Class B utilities.

Cross reference to statutes: Texas Water Code §13.041 and §13.305.

The agency certifies that legal counsel has reviewed the adoption and found it to be a valid exercise of the agency's legal authority.

Filed with the Office of the Secretary of State on July 31, 2020.

TRD-202003128

Andrea Gonzalez

Rules Coordinator

Public Utility Commission of Texas

Effective date: August 20, 2020

Proposal publication date: May 1, 2020

For further information, please call: (512) 936-7244


SUBCHAPTER H. CERTIFICATES OF CONVENIENCE AND NECESSITY

16 TAC §§24.238, 24.239, 24.243

Statutory Authority

The new rule and rule amendments are adopted under the Texas Water Code §13.041, which provides the commission with the authority to make and enforce rules reasonably required in the exercise of its powers and jurisdiction; and §13.305, which establishes a voluntary process for the valuation of utilities or facilities acquired by Class A or Class B utilities.

Cross reference to statutes: Texas Water Code §13.041 and §13.305.

§24.238.Fair Market Valuation.

(a) Applicability. This section applies to a voluntary arm's length transaction between an acquiring utility and a retail public utility under TWC §13.305 for which approval is required under TWC §13.301. This section does not apply to a transaction between a utility and its affiliate.

(b) Definitions. In this section, the following words and terms have the following meanings, unless the context indicates otherwise.

(1) Acquiring utility -- A Class A or Class B utility that is acquiring a selling utility, or the facilities of a selling utility.

(2) Allowance for funds used during construction (AFUDC) -- An accounting practice that recognizes the capital costs, including debt and equity funds, that are used to finance a transferee's construction costs of an improvement to a purchased asset.

(3) Fair market value -- The average of the three appraisals conducted under subsection (f) of this section.

(4) Ratemaking rate base -- The dollar value of the selling utility or the sold facilities of a selling utility that is incorporated into the rate base of the acquiring utility for post-acquisition purposes. The ratemaking rate base is the lesser of the purchase price negotiated by an acquiring utility and a selling utility or the fair market value. The ratemaking rate base does not include transaction and closing costs.

(5) Selling utility -- A retail public utility that is being purchased by an acquiring utility or is selling facilities to an acquiring utility.

(c) List of qualified utility valuation experts. The commission will maintain a list of qualified utility valuation experts to perform appraisals to determine a fair market value of a selling utility or facilities of a selling utility.

(1) A utility valuation expert may request to be included on the commission's list by submitting, under the control number designated for that purpose, the required information.

(2) The request filed by the utility valuation expert must include:

(A) The expert's name, mailing address, telephone number, and email address;

(B) The name of the company with which the expert is employed or associated, or the name under which the expert conducts business;

(C) The names of the principal officers of the company with which the expert is employed or associated, if applicable;

(D) The name and mailing addresses of any affiliates of the company with which the expert is employed or associated, if applicable; and

(E) A detailed description of the utility valuation expert's qualifications, such as professional licensing, certifications, training or past experience conducting economic evaluations of water and sewer utilities.

(3) The utility valuation expert must update the information in its request on file with the commission within ten business days of a material change to the information.

(4) A utility valuation expert who wishes to be removed from the list maintained by the commission under this subsection must file a letter with the commission requesting to be removed from the list. This letter must be filed under the control number designated for that purpose. The commission will acknowledge the removal request in writing.

(d) Notice of intent to determine fair market value.

(1) A selling utility and an acquiring utility that agree to use the fair market valuation process described in subsection (f) of this section must file a notice of intent to determine fair market value in the control number designated for that purpose.

(2) The notice of intent must include the following:

(A) The name and certificate of convenience and necessity (CCN) number of the acquiring utility. If the acquiring utility holds multiple CCN numbers, the acquiring utility must provide all the CCN numbers.

(B) The name and contact information of the acquiring utility's representative.

(C) The number of connections served by the acquiring utility.

(D) The name and CCN number of the selling utility.

(E) The name and contact information of the selling utility's representative.

(F) The number of connections served by the selling utility.

(G) The estimated closing date of the planned acquisition.

(H) A list of the utility valuation experts on the commission's list of qualified experts who, as of the date of the notice of intent, are precluded under subsection (e)(2)(B) of this section from performing an appraisal of the transaction.

(3) The notice of intent must not include the purchase price agreed upon by the acquiring utility and the selling utility.

(e) Selection of utility valuation experts.

(1) The commission's executive director or the executive director's designee will select three utility valuation experts from the list maintained under subsection (c) of this section no later than 30 days after the filing of a notice of intent to determine fair market value that meets the requirements of subsection (d) of this section.

(2) The utility valuation experts selected under paragraph (1) of this subsection may not:

(A) derive material or financial benefit from the sale other than fees for services rendered;

(B) be or have been within the year preceding the date the service contract is executed a director, officer, or employee of the acquiring utility or the selling utility or an immediate family member of a director, officer, or employee of the acquiring utility or the selling utility; or

(C) have received compensation under a contract for consulting or other services with the acquiring or selling utility, or executed a contract for consulting or other services with the acquiring or selling utility, within the year preceding the date the utility valuation expert is selected.

(3) The commission's executive director or the executive director's designee will base the selection of utility valuation experts on the following:

(A) Qualifications of the utility valuation expert.

(B) Availability of the utility valuation expert during the required time frame.

(C) Absence of conflicts of interest described in paragraph (2) of this subsection.

(D) Other factors relevant to a utility valuation expert's ability to perform an appraisal under this section.

(4) The acquiring utility must contract directly with the selected utility valuation experts and the commission will not be a party to the contract. Subsection (k)(2) of this section, which limits the amount of transaction and closing costs that may be recovered in rates, does not apply to the fees for service agreed to in the contract. If the acquiring utility and any of the utility valuation experts selected under subsection (e)(1) of this subsection are unable to reach agreement on the terms and conditions for performing the appraisal, including the amount of the service fee, the acquiring utility or utility valuation expert may submit a request for selection of a different utility valuation expert under the control number designated for that purpose. If the commission's executive director or the executive director's designee selects a different utility valuation expert, the time period for all utility valuation expert to submit a report under subsection (f)(5) of this section begins when the different utility valuation expert is selected.

(f) Determination of fair market value.

(1) The three utility valuation experts selected under subsection (e) of this section jointly must retain a licensed engineer to conduct an assessment of the tangible assets of the selling utility or the facilities to be sold to the acquiring utility.

(A) The engineer may not be or have been within one year preceding the date the service contract is executed a director, officer, or employee of the acquiring utility or the selling utility or an immediate family member of a director, officer, or employee of the acquiring utility or the selling utility.

(B) The engineer must provide the following information to the valuation experts:

(i) Qualifications that demonstrate the engineer's ability to provide the requested assessment;

(ii) The engineer's fees for other similar assessments; and

(iii) Other relevant information requested by the utility valuation experts.

(C) The engineer's assessment must include a separate assessment for each type of facility based on the applicable National Association of Regulatory Utility Commissioners (NARUC) account for the facility.

(D) The fee charged by the engineer must be shared and paid equally by the three utility valuation experts and may be included as part of the utility valuation expert compensation under subsection (k) of this section.

(2) Each utility valuation expert must perform an independent appraisal of the selling utility, including the valuation of intangible assets as appropriate, in compliance with Uniform Standards of Professional Appraisal Practice, using the cost, market, and income approaches in accordance with subsections (g) - (i) of this section.

(3) The appraisal must not take into account the original sources of funding, including developer contributions or customer contributions in aid of construction, for any of the utility plant that is assessed by the engineer or the utility valuation experts.

(4) The appraisal must not take into account the purchase price negotiated by the acquiring utility and the selling utility or methodologies or process used to arrive at the purchase price.

(5) Each utility valuation expert must submit a completed report to the acquiring utility and the selling utility no later than 120 days after the date the commission's executive director or the executive director's designee selects the utility valuation expert under subsection (e) of this section. Before the submission of the report, the acquiring and selling utilities must review the report for mathematical and factual errors, and notify the utility valuation expert of any mathematical any factual errors they identify. The utility valuation expert may promptly revise the report in response to the utilities' notification.

(6) The ratemaking rate base established under this section will be the rate base for the system or facilities acquired in the transaction. Nothing in this section alters the requirements for multiple system consolidation in §24.25(k) of this title, relating to Form and Filing of Tariffs.

(g) Cost approach.

(1) A cost approach appraisal performed under this section must be based on one of the following:

(A) the investment required to replace or reproduce future service capability; or

(B) the original cost of the facilities as adjusted for depreciation.

(2) A cost approach appraisal performed under this section must:

(A) incorporate the results of the assessment performed by the engineer selected under subsection (f)(1) of this section;

(B) exclude from consideration overhead costs, future improvements, and going concern value; and

(C) use a consistent rate of inflation for all classes of assets unless use of different rates is reasonably justified.

(h) Income approach.

(1) An income approach appraisal performed under this section must be based on one of the following:

(A) capitalization of earnings or cash flow; or

(B) the discounted cash flow method.

(2) An income approach appraisal performed under this section must exclude consideration of the following:

(A) going concern value;

(B) future capital improvements; and

(C) erosion of cash flow or erosion on return.

(3) An income approach appraisal performed under this section must be supported by the following:

(A) an explanation of how the capitalization rate was calculated, if a capitalization rate was used;

(B) an explanation of the basis for the discount rates used; and

(C) an explanation of the capital structure, cost of equity and cost of debt used.

(i) Market approach.

(1) A market approach appraisal performed under this section must be based on the following:

(A) the current connection count of the selling utility at the time of the appraisal;

(B) use of a proxy group that includes companies that have made acquisitions that were not based on a fair market valuation methodology; or

(C) comparable sales that did not include the value of future capital improvement projects in the selling price.

(2) A market approach appraisal performed under this section must not consider the following:

(A) a net book financials multiplier or speculative growth adjustments;

(B) the value of future capital improvement projects; or

(C) a value or adjustment for the goodwill of the selling utility.

(j) Contents of utility valuation expert report. A report submitted under paragraph (f)(5) of this section must include:

(1) a copy of the service contract executed by the utility valuation expert and the acquiring and selling utilities;

(2) the fee charged by the utility valuation expert along with documentation supporting the amount of the fee;

(3) a copy of the engineer's report, including a detailed list of the utility plant assessed by the engineer;

(4) an explanation of how the cost, market, and income approaches were incorporated into the calculation of the fair market value of the selling utility or the selling utility's facilities; and

(5) a notarized affidavit stating that:

(A) the appraisals described in the report were conducted in compliance with the most recent edition of the Uniform Standards of Professional Appraisal Practice;

(B) the utility valuation expert will not derive material or financial benefit from the sale other than the fee for services rendered;

(C) the utility valuation expert is not currently and was not within the year preceding the date of the contract for service executed between the utility valuation expert and the acquiring and selling utilities, a director, officer, or employee of the acquiring utility or the selling utility or an immediate family member of a director, officer, or employee of the acquiring utility or the selling utility; and

(D) the utility valuation expert did not receive compensation under a contract for consulting or other services with the acquiring utility or selling utility, or execute a contract for consulting or other services with the acquiring or selling utility, within the year preceding the date the utility valuation expert was selected to perform the appraisal that is the subject of the report.

(k) Transaction and closing costs.

(1) A fee paid to a utility valuation expert to perform an appraisal under subsection (f) of this section may be included in the transaction and closing costs associated with a transaction approved under §24.239 of this title, relating to Sale, Transfer, Merger, Consolidation, Acquisition, Lease or Rental.

(2) The commission will review the transaction and closing costs, including fees paid to utility valuation experts, in the rate case in which the acquiring utility requests rate recovery of those costs. The fee amounts included in transaction and closing costs that are recoverable in the acquiring utility's rates may not exceed the lesser of:

(A) five percent of the fair market value; or

(B) the fee amounts approved by the commission in the rate case in which the acquiring utility requests rate recovery of the transaction and closing costs.

The agency certifies that legal counsel has reviewed the adoption and found it to be a valid exercise of the agency's legal authority.

Filed with the Office of the Secretary of State on July 31, 2020.

TRD-202003130

Andrea Gonzalez

Rules Coordinator

Public Utility Commission of Texas

Effective date: August 20, 2020

Proposal publication date: May 1, 2020

For further information, please call: (512) 936-7244


PART 3. TEXAS ALCOHOLIC BEVERAGE COMMISSION

CHAPTER 35. ENFORCEMENT

SUBCHAPTER A. TRANSPORTATION OF LIQUOR

16 TAC §35.7

The Texas Alcoholic Beverage Commission adopts new 16 TAC §35.7 without changes to the proposed text as published in the June 5, 2020, issue of the Texas Register (45 TexReg 3717). The rule will not be republished.

In 2019, the 86th Texas Legislature passed Senate Bill 1450 which amended the Alcoholic Beverage Code to allow holders of certain mixed beverage permits to deliver alcohol to off-premise locations along with food orders. The bill also created the consumer delivery permit, which authorizes its holders to employ or contract with delivery drivers to deliver alcoholic beverages from retail locations to consumers (new Tex. Alco. Bev. Code Ch. 57).

The legislature provided that a consumer delivery permit holder may use a software application in deliveries of alcohol to the consumer to qualify for certain limitations on liability under the new consumer delivery permit. It directed the TABC to adopt minimum standards for such software applications (Tex. Alco. Bev. Code §57.09(a)(2)). New rule §35.7 provides the minimum standards for alcohol delivery compliance software applications, including features designed to ensure that alcoholic beverages are not delivered to persons who are intoxicated or under the age of 21 and ascertain whether a particular type of alcoholic beverage can be delivered legally to the consumer's address (wet/dry status). An applicant or permit holder may request an evaluation of its software application from the TABC, which will provide an opinion as to its compliance with the requirements of the rule; however, pre-approval is not required.

No comments were received.

The new rule is authorized by Alcoholic Beverage Code §57.09(a)(2), which requires the Texas Alcoholic Beverage Commission (commission) to establish minimum requirements for alcoholic beverage delivery software applications.

The agency certifies that legal counsel has reviewed the adoption and found it to be a valid exercise of the agency's legal authority.

Filed with the Office of the Secretary of State on July 30, 2020.

TRD-202003093

Shana Horton

Rules Attorney

Texas Alcoholic Beverage Commission

Effective date: August 19, 2020

Proposal publication date: June 5, 2020

For further information, please call: (512) 206-3451