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OAG 97-14

May 9 , 1997

Subject: City - City Utility - Service Credits Program - Validity - Appropriation and Payment to Local Appliance Dealers

Written by: Thomas R. Emerson, Assistant Attorney General

Requested by: Alison Lobb Emmons

Syllabus: The strategy of a city owned gas utility to offer service credits, to be applied to the gas accounts, as an incentive to those who will switch from electric to gas service pursuant to fair and reasonable terms applicable to all customers and potential customers, does not violate sections 3 and 171 of the Kentucky Constitution.

A city utility cannot legally appropriate municipal funds to local appliance dealers as part of its service credits program applicable to customers and potential customers of the municipal gas company.

Constitutional Provisions Construed: Kentucky Constitution, 3, 171, 179

OAGs cited: OAG 84-161, OAG 79-509, OAG 79-67, OAG 82-366, OAG 81-193

Opinion of the Attorney General

This opinion addresses a matter affecting the Richmond Water, Gas & Sewerage Works, a city owned utility.

As an incentive to encourage customers to switch from electric to gas service and appliances the city would like to offer service credits in as yet unspecified amounts after certain terms and conditions have been met by the customers. The concept of service credits to customers has been adopted as a marketing strategy. In addition to giving service credits to all customers who switch from electric to gas in accordance with the proposed plan, the city utility proposes a dealer incentive of an undetermined amount to be paid to city appliance outlets.

The question presented is whether the city utility's strategy of service credits violates Section 3 of the Kentucky Constitution which provides:

All men, when they form a social compact, are equal; and no grant of exclusive, separate public emoluments or privileges shall be made to any man or set of men, except in consideration of public services; but no property shall be exempt from taxation except as provided in this Constitution, and every grant of a franchise, privilege or exemption shall remain subject to revocation, alteration or amendment.

That section has been construed to mean that public funds or privileges can only be granted in consideration of public service and that tax money of a governmental entity, such as a city, may only be spent for public purposes. See OAG 84-161, at page two, OAG 79-509, at page two, and OAG 79-67, at page three. Copies of those opinions are attached. In connection with the proper expenditure of public funds, see also Ky. Const., 171.

As to the duties and obligations, generally, of a municipal utility to render service, it is stated in 64 Am.Jur.2d, Public Utilities 38 as follows:

A public utility is under a legal obligation to serve the members of the public to whom its use extends, impartially and without unjust discrimination. Whether or not treatment or service accorded to different patrons of a public utility amounts to unjust or improper discrimination depends upon the surrounding circumstances. A public utility must serve alike all who are similarly circumstanced with reference to its system, and favor cannot be extended to one which is not offered to another, nor can a privilege given one be refused to another. Furthermore, a municipal corporation which operates a public utility is subject to the same strictures against discrimination as are binding on a private corporation.

Furthermore, in 64 Am.Jur.2d, Public Utilities 111 it is stated:

It is the general rule that when a municipality undertakes to furnish a public service, such as the supplying of electricity, gas, or water to consumers other than itself, it acts in its proprietary, and not in its governmental, capacity, and cannot grant free or reduced rates or otherwise make rate discriminations which would be unlawful if the service were rendered by an individual or private corporation; in other words, the fact that the service is by a municipal plant does not change the rule prohibiting unreasonable discrimination.

The courts and other authorities have also recognized that the furnishing of utility services by a city involves a proprietary function rather than a governmental function. In Williams v. City of Mount Dora, 452 So.2d 1143, 1145-1146 (Fla.App. 5 Dist. 1984), the court said, "The providing of utility services by a municipality is a private or proprietary function in the exercise of which the municipality is subject to the same legal rules applicable to private corporations." See also Colowyo Coal Company v. City of Colorado Springs, 879 P.2d 438 (Colo. App. 1994) and 12 McQuillin Mun. Corp. (3rd Ed., 1995 revised volume), 35.35.40 and 35.37.05.

The fact that a city operating a utility service is conducting a proprietary function enables it to adopt practices that can be utilized by a private company. In 64 Am.Jur.2d, Public Utilities 112 the following appears:

A public utility may follow modern business practices in the promotion of the sale of its services, subject, of course, to the qualification that such practices must not involve an arbitrary or unreasonable classification. Accordingly, it is proper for a public utility to adopt classifications providing for the encouragement of greater sales of its services by offering discounted or similar promotional inducements. In this respect, a municipal utility is held to no stricter limitations than is a private company.

Thus, the strategy of a city owned gas utility to offer service credits, to be applied to the gas accounts, as an incentive to those who will switch from electric to gas service pursuant to fair and reasonable terms applicable to all customers and potential customers, is not in violation of sections 3 and 171 of the Kentucky Constitution. Such a practice does not involve the expenditure of funds for other than public purposes or the granting of compensation for services not rendered but, rather, represents the utilization of a technique by a municipal utility to promote the sale of its services.

What is unconstitutional under the city utility's plan is that portion which authorizes the payment by the city utility to city appliance outlets as a "dealer incentive."

Section 179 of the Kentucky Constitution in part prohibits a city from appropriating money for, or loaning its credit to, any corporation, association, or individual with certain exceptions not applicable in this situation. A city utility, therefore, cannot legally appropriate municipal funds to local appliance dealers as part of its service credits program applicable to customers and potential customers of the municipal gas company. See OAG 82-366 and OAG 81-193, copies enclosed, concluding that a city cannot legally donate or contribute funds to private persons or corporations over which it has no control. Ky. Const., 3, 171, and 179.

ALBERT B. CHANDLER III

ATTORNEY GENERAL

THOMAS R. EMERSON

ASSISTANT ATTORNEY GENERAL