FROM: Sid Hemsley, Senior Law Consultant
DATE: May 14, 2001
RE: Merger of municipal utilities
Two cities would like to merge their water systems. You have the following question: What is the process for the merger of such systems that would produce:
Joint ownership of the combined system;
The larger system will takeover the smaller system?
It appears to me that the cities’ best option is to proceed under the Interlocal Government Cooperation Act found at Tennessee Code Annotated, § 12-9-101 et seq., because that statute give them the most latitude in fashioning an arrangement to accomplish either of the above outcomes.
Unfortunately, considerable search of the records of the two cities does not indicate under what statutes the two water systems operate. Generally, municipalities in Tennessee operate their utilities under their charter, or under one or more of three state laws: Tennessee Code Annotated, §§ 7-34-101 et seq. (Revenue Bond Law); Tennessee Code Annotated, § 7-35-401; and Tennessee Code Annotated, § 7-52-101 et seq. (Municipal Electric Plant Law of 1935).
I will not discuss the possible application of Tennessee Code Annotated, § 7-52-101 et seq. (Municipal Electric Plant Law of 1935), because I am quite sure that neither water system is operated under that law. However, I will consider the Interlocal Government Cooperation Act found at Tennessee Code Annotated, § 12-9-101 et seq., which is an alternative and promising method for merging the two water systems.
The Cities’ Charters and Municipal Codes
The charter of the first city has some references to the power of condemnation with respect to utility property from the Tennessee Code of 1932, but the references to utilities are general and not helpful. [Section 5-B] That charter also contains authority for the city to own and operate an electric system, but the city obtains its electric power from another city. [Section 5-A] The second city has the authority under its charter to own and operate a variety of utilities, including “water works.” [Section 4(g)] Nothing in the municipal codes of either city points to the authority under which those municipalities’ water systems operate.
Generally, bond resolutions contain a statement of the authority under which municipal utilities operate. No such resolutions can be found, except a 1992 resolution from one city. The bond covered by that resolution was issued under the Local Government Public Obligations Law found at Tennessee Code Annotated, § 9-21-101 et seq., but which is not a statute under which municipalities are authorized to own and operate utility systems.
Sale or Transfer of One Water System to the Other Water System
Municipalities in Tennessee own and operate their utility systems in their proprietary, rather than their governmental, capacity. [Bybees Branch Water Association v. Town of McMinnville, 333 S.W.2d 815 (1960); City of Shelbyville v. Sate ex rel. Bedford County, 415 S.W.2d 139 (1967); Batson v. Pleasant View Utility District, 592 S.W.2d 578 (Tenn. App. 1980); Maury County Board of Public Utilities v. City of Columbia, 854 S.W.2d 890 (Tenn. App. 1993)]. Generally, the significance of the proprietary function is that the government can do anything a private business can do with respect to the acquisition and disposal of property, within the limitations prescribed by constitution and statute.
But the question of whether a utility district could sell all its assets to a private gas company arose in United Cities Gas Co. v. Wiggington, 815 S.W.2d 505 (Tenn. 1991). In holding that the answer was no, the Tennessee Supreme Court declared that the statutory powers contained in the Utilities District Law was limited to the exercise of such powers to carry out the purpose for which the utility district was organized, and:
The power to develop and operate a public utility does not include the power to sell the system and terminate the corporate existence of the district. Disposal of all corporate assets of the district is contrary to and in violation of the duty to operate the district for the benefit of the district’s customers. Under the statute, the obligation to operate the system can be avoided only by consolidation or merger with another utility district or transfer of the system to a municipality or county...[At 508-09]
The Court put considerable emphasis on the fact that a utility district was by definition in the Utility District Law a “municipality,” and that municipalities generally have no authority to end their existence except as prescribed by law. While a municipally-owned utility is a part of a municipality, and not a separate, “municipality” as is a utility district, the flavor of Wiggington still affects the statutory status of such utilities. Each of the two statutes under which a utility can be owned and operated by a municipality (and considered below) contains express provisions for what agreements can be entered into between municipalities with respect to the operation of their utilities.
Tennessee Code Annotated, § 7-34-101 et seq. (Revenue Bond Law)
If one of the cities has issued bonds under the Revenue Bond Law found at Tennessee Code Annotated, § 7-34-101 et seq., it is probably possible for that city to lease the water system to various governments, including the other city, and for the latter city to ultimately acquire, the water system, “all under such terms and conditions as may be mutually agreed upon,”
Including the transfer of title to such public works after all bonds issued to finance the acquisition or construction thereof and the interest thereon shall have been paid or provision made for the payment thereof.... [Tennessee Code Annotated, § 7-34-104]
That statute expressly provides how a transfer and sale of a public works project occurs under the Revenue Bond Law, and limits the transfer to another government. Arguably, the General Assembly intended the transfer to another government the exclusive form of transfer, at least for the term of the duration of bond issues under that statute.
Tennessee Code Annotated, § 7-35-401 et seq.
The purchase and merger of water and sewer works is contemplated in Tennessee Code Annotated, § 7-35-402:
One (1) or more waterworks and/or sewerage systems, owned by one (1) or more persons or corporations, may be acquired under authority of this part as a single enterprise, and the governing body of such city or town shall be and is empowered to enter into agreement with the owners as to the value thereof, and to purchase the same at an agreed price to be fixed by resolution passed by the governing body of the city or town upon three (3) separate readings on three (3) separate days. Such city or town shall be understood to have all authority necessary to combine new works acquired under the provisions of the part by purchase, construction or otherwise with any similar existing works, owned by the city or town, all to be part of the same single enterprise under the same supervision and control. [Emphasis is mine]
Tennessee Code Annotated, § 7-35-401 et seq. is “supplementary” and appears to be capable of application to any water or sewer system organized and operating under another statute or charter. However, it does not appear to me that Tennessee Code Annotated, § 7-35-402, contemplates the merger of two city-owned systems. The “one (1) or more persons or corporations” emphasized above appears to apply to utilities owned by private persons or corporations. In fact, in the definitions section of that statute, while the term “municipal corporations” is defined, the term “corporation” is not defined. [Tennessee Code Annotated, § 7-35-401(C)(1)(A)] Under the rules of statutory construction one probably must assume that the General Assembly made a deliberate distinction.
The Interlocal Government Cooperation Act (Tennessee Code Annotated,
§ 12-9-101 et seq.
It is probably not necessary to absolutely determine the authority under which each of the two water systems operate. The Interlocal Government Cooperation Act found at Tennessee Code Annotated, § 12-9-101 et seq. generally permits two governments to enter into agreement to do cooperatively or jointly what either of them can do as individual entities. Such agreements can be made between the two governments themselves, or in the case where the function in question is being performed by an independent body, between those independent bodies, with the approval of the two parent governments. [Tennessee Code Annotated, § 12-9-104] The agreement must contain the minimum provisions:
2. “The precise organization” of any separate legal or administrative entities;
3. Its purpose or purposes;
4. The manner of financing the “joint or cooperative undertaking, etc.;
5. Manner and methods of terminating the agreement and disposition of any property;
6. Any other necessary or proper matters.
If the agreement does not establish a separate legal entity to conduct the joint operations or cooperative undertaking, it must also include the following:
1. Provision for an administrator or joint board. If there is to be a joint board, the public agencies to the agreement must be represented on the board.
2. The manner of acquiring, holding and disposing of real and personal property used in the joint or cooperative undertaking.
If a separate legal or administrative entity is created to operate the joint or cooperative undertaking, it cannot:
A. Assess, levy or collect ad valorem taxes;
B. Issue general obligation bonds; or
C. Exercise the power of eminent domain.
However, those powers may be exercised by the governments creating the separate entity.
Incidently, Sections 48–51 of one City Charter contains provisions similar to those contained in Tennessee Code Annotated, § 12-9-101 et seq.
Potential Problem with Bond Covenants
If either city has issued water bonds under any statute, it may have entered into a contract with the bond holders for the administration of the water system. In State v. Town of Selmer, 417 S.W.2d 523 (1967), the City of Selmer issued gas utility bonds under the Revenue Bond Law. At the time the bonds were issued in 1952 until 1965, the Board of Waterworks and Sewer Commissioners operated the water, sewer and gas systems of the city, as was authorized by statute. In 1965, the Board of Mayor and Aldermen elected to perform the duties of the Board of Waterworks and Sewer Commissioners. While that, too, was authorized by statute, declared the Court, with respect to the gas system the bond resolution expressly contained a provision requiring the gas system to be operated by the Board of Waterworks and Sewer Commissioners. For that reason, concluded the Court:
So long as any of the 1952 bonds are outstanding, we are of the opinion that the terms and conditions of the bond resolution must be adhered to by the governing body of the municipality. Of course, when all of the bonds are called or retired by consent or according to their terms, a different situation would be presented, because we find nothing in the Bond Revenue Law, T.C.A. § 6-1301 et seq. to prevent the governing body from controlling and operating the natural gas system. [At 535]
Selmer is a very good reason for the cities to determine precisely the bond covenants, if any, that would limit a joint or cooperative effort between the two cities to operate a unitary water system.