Canada: The Supreme Court Clarifies The Role And Nature Of The "Prudence" Test In Canadian Utility Regulation

Last Updated: November 25 2015
Article by Héloïse Apestéguy-Reux and Renée Zatzman

Most Read Contributor in Canada, September 2018

Background

The Supreme Court of Canada recently released its highly anticipated decisions on utility regulation in Ontario Energy Board v. Ontario Power Generation Inc., 2015 SCC 44 (noted as an Appeal to Watch in 2015 here) and ATCO Gas and Pipelines Ltd. v. Alberta (Utilities Commission), 2015 SCC 45 . These regulatory decisions analyzed a utility's ability to recover operating and capital costs from consumers through rate-setting, and the methodology to be used in approving rate increases.

The Ontario Power Generation Decision

In Ontario (Energy Board) v. Ontario Power Generation Inc., the Supreme Court reviewed the Ontario Energy Board ("OEB" or the "Board")'s decision to disallow $145 million in labour compensation costs applied for by Ontario Power Generation ("OPG") in its 2011-2012 rates application. The OEB had disallowed these costs, which were related to OPG's nuclear operations, on the basis that OPG's labour costs were not in line with comparable entities in the nuclear industry. The principal question on appeal was whether the Board should have used the "no-hindsight" prudence test to determine whether the labour compensation costs were reasonable.

Applying a standard of review of reasonableness,1 the Court overturned the decision of the Ontario Court of Appeal and reinstated the decision of the OEB and the Divisional Court, holding that the OEB's decision to disallow the $145 in labour compensation costs was reasonable.  The Court found that the costs in question were "best understood as at least partly committed"2 (as opposed to entirely "forecast" costs) because they resulted from collective agreements entered into between OPG and two of its unions but were also subject to management discretion because OPG had some flexibility to manage total staffing levels by way of, among other things, attrition of the workforce.

The Court focused on the statutory language pursuant to which the OEB is tasked to review payment amounts applied for by OPG, namely the language that requires the OEB to set "just and reasonable" payments and the absence of any other language prescribing the manner or methods to be used by the OEB under the relevant statutory provisions and regulations.3 The Court held that:

"[W]here a statute requires only that the regulator set "just and reasonable" payments, as the Ontario Energy Board Act, 1998 does in Ontario, the regulator may make use of a variety of analytical tools in assessing the justness and reasonableness of a utility's proposed payment amounts."4

The Court found that this was particularly true when, pursuant to section 6(1) of O. Reg. 53/05, the OEB is given express discretion over the "form, methodology, assumptions and calculations used in making an order that determines payment amounts for the purpose of section 78.1 [of the Ontario Energy Board Act]."5

The Court's analysis included an examination of the "prudence test" or "prudent investment test" as it has evolved in utilities regulation in the United States and Canada. The Court highlighted that a benefit of the prudence test is to ensure utilities recover the cost of failed investments that appeared reasonable at the time the investment decision was made, because to disallow recovery of such failed investments could imperil the financial health of utilities and therefore chill the incentive to make such investments.  This would in turn have negative long-run implications for consumers.6 Importantly, the Court found this key benefit of the prudence test applied particularly to capital costs as opposed to operational costs:

Prudence review of committed costs may in many cases be a sound way of ensuring that utilities are treated fairly and remain able to secure required levels of investment capital. [...] [P]articularly with regard to committed capital costs, prudence review will often provide a reasonable means of striking the balance of fairness between consumers and utilities.7

With the above in mind, the Court found that it was not unreasonable, under the particular regime under section 78.1 of the Ontario Energy Board Act, for the Board to evaluate committed costs using "a method other than a no-hindsight prudence review."8 Considering the nature of the costs – i.e., that they were operational costs as opposed to capital costs – and the circumstances under which they became committed – that is, that they were committed under a context of a "repeat-player", ongoing relationship between OPG and its unionized employees9 – the Court found that the OEB had not acted unreasonably in not applying the prudent investment test in determining whether the labour compensation costs were just and reasonable.

In dissent, Abella J. found that because the Board had said that it would utilize a prudence test for committed costs, it was not reasonable for the Board to not apply the prudence test to the costs in question, which Abella J. found to be for the most part non-reducible in nature due to the legally binding nature of the underlying collective agreements.10 Abella J. also points out a noteworthy aspect of the majority decision in respect of the use of the prudence test and the burden of proof set out in the Ontario Energy Board Act:

Applying a prudence review to these compensation costs would hardly, as the majority suggests, "have conflicted with the burden of proof in the Ontario Energy Board Act, 1998". To interpret the burden of proof in s. 78.1(6) of the Ontario Energy Board Act so strictly would essentially prevent the Board from ever conducting a prudence review, notwithstanding that it has comfortably done so in the past and stated, even in its reasons in this case, that it would review committed costs using an "after-the-fact prudence review" which "includes a presumption of prudence". Under the majority's logic, however, since a prudence review always involves a presumption of prudence, the Board would not only be limiting its methodological flexibility, it would be in breach of the Act.11

The above aspect of the majority's decision may indeed cause some confusion in future OEB rate cases.

The role of the Board in the appeal – tribunal standing and bootstrapping

The decision also considered the role an administrative decision-maker when  participating in the appeal or review of its own decisions. The Court reviewed the importance of ensuring that a tribunal's participation in the appeal of its decisions not give rise to concerns over the tribunal's impartiality while at the same time ensuring that a reviewing court's decision is fully informed in respect of the specialized matters considered by a given tribunal.

The Court determined that tribunal standing in this context is to be determined by the court conducting the first-instance review "in accordance with the principled exercise of that court's discretion".12 The Court provided the following non-exhaustive factors to assist courts in this respect:

  • If an appeal or review were to be otherwise unopposed, a reviewing court may benefit by exercising its discretion to grant tribunal standing.
  • If there are other parties available to oppose an appeal or review, and those parties have the necessary knowledge and expertise to fully make and respond to arguments on appeal or review, tribunal standing may be less important in ensuring just outcomes.
  • Whether the tribunal adjudicates individual conflicts between two adversarial parties, or whether it instead serves a policy-making, regulatory or investigative role, or acts on behalf of the public interest, bears on the degree to which impartiality concerns are raised. Such concerns may weigh more heavily where the tribunal served an adjudicatory function in the proceeding that is the subject of the appeal, while a proceeding in which the tribunal adopts a more regulatory role may not raise such concerns.13

With the above factors in mind, the Court found that it was not improper for the Board to have participated by arguing in favour of the reasonableness of its decision on appeal: the Board was the only respondent in the initial review of its decision14 and the Board is a public interest regulator with a broad mandate as opposed to a tribunal whose function is to adjudicate individual conflicts between two or more parties15.

The Court then turned to whether the substance of the Board's arguments amounted to "bootstrapping", which occurs when a tribunal "seeks to supplement what would otherwise be a deficient decision with new arguments on appeal."16 The Court found that the OEB did not step impermissibly beyond the bounds of its original decision as its submissions either highlighted what was apparent on the face of the record or responded to parties' arguments.17

The ATCO Decision

This appeal was brought by ATCO Gas and Pipelines Ltd. and ATCO Electric Ltd. ("ATCO") from an Alberta Court of Appeal judgment affirming the Alberta Utilities Commission (the "Commission") decision that rejected ATCO's request to recover certain pension costs in the 2012 year.18 Specifically, ATCO sought to recover the pension costs associated with setting the cost of living adjustment ("COLA") at 100% of the annual consumer price index ("CPI") up to a maximum of 3% for 2012. Instead, the Commission held that a COLA at 50% of annual CPI up to a maximum of 3% was reasonable as ATCO's proposal was not "an acceptable standard practice" among comparator groups and a reduction in the COLA would not limit ATCO's ability to attract new employees, or encourage existing employees to leave.19

The Supreme Court, using a standard of review of reasonableness,20 unanimously dismissed ATCO's appeal. In its analysis, the Court found that the Commission was entitled to set rates pursuant to the Alberta's Electric Utilities Act and Gas Utilities Act (collectively, the "statutory framework"). This statutory framework permitted the Commission to set just and reasonable rates, and provided Utilities with a reasonable opportunity to recover costs, so long as the costs were prudent.21

In its analysis, the Court held that the prudence requirement is to be understood in its ordinary meaning, and that a prudent cost is a reasonable cost. 22 The Court rejected ATCO's argument that the Commission must use a "prudence " or "no-hindsight" test in qualifying the costs that a Utility is entitled to recover, and found that no specific methodology is set out by the statutory framework to determine whether costs are prudent. 23  The Court went further and added that the Commission is permitted to use a variety of analytical tools and evidence to make that prudence determination, so long as the ultimate rates decided are just and reasonable to consumers and the utility.24 The Court also rejected ATCO's argument that a Utility's costs are presumed to be prudent, and instead held that it is the Utility's burden to establish prudence.25 The Court also clarified that regulators are not permitted to "justify a disallowance of prudent costs solely because they would lead to higher rates for consumers", but are permitted to consider the "magnitude" of any particular costs in determining whether that cost is prudent.26

Significance

These decisions are important because they serve as a clarification that as long as a regulator's review of a utility's rates is guided by the statute which gives the regulator its authority, it otherwise has the discretion to apply the methodologies it sees fit in order to determine whether rates are just and reasonable.  As the Court stated in the OPG case, the Court of Appeal had "made certain statements that suggest that the prudent investment test was a necessary approach to reviewing committed costs."27  The OPG decision makes it clear that this is not the case.

Also notable is that the Court's decisions in ATCO and OPG uphold a decision of the applicable province's energy regulatory body to reduce a utility's applied-for amounts after considering benchmarking or comparator group evidence which weighed in favour of the reduction in question. These decisions will therefore likely be seen as consistent with trend towards benchmarking as a key tool in utility regulation.

Finally, the OPG decision also provides helpful guidance in respect of the participation of administrative decision-makers in the review or appeal of their decisions.

Case Information

Ontario Energy Board v. Ontario Power Generation Inc., 2015 SCC 44

ATCO Gas and Pipelines Ltd. v. Alberta (Utilities Commission), 2015 SCC 45

Date of Decisions: September 25, 2015

Footnotes

1 Ontario Energy Board v. Ontario Power Generation Inc., 2015 SCC 44 ["OPG"] at para 73.

2 OPG, para. 106.

3 OPG, para. 103.

4 OPG, para. 103.

5 OPG, para. 103.

6 OPG, para. 91.

7 OPG, para. 104.

8 OPG, para. 104.

9 OPG, para. 109.

10 OPG, para. 134.

11 OPG, para. 151.

12 OPG, para. 57.

13 OPG, para. 59.

14 OPG, para. 60.

15 OPG, para. 61.

16 OPG, para. 64.

17 OPG, para. 70.

18 ATCO Gas and Pipelines Ltd. v. Alberta (Utilities Commission), 2015 SCC 45 at para. 1 ["ATCO"].

19 ATCO at paras. 19-20.

20 ATCO at paras. 26-28.

21 ATCO at para. 29.

22 ATCO at paras. 33-38.

23 ATCO at paras. 30-31, 46-47.

24 ATCO at paras. 42-45.

25 ATCO at paras. 42 and 45.

26 ATCO at paras. 60-62

27 OPG at para. 100.

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