June 6, 2007
Dear City Attorney:
You have several questions related to the construction by the City of water mains inside a gated residential complex by city forces. In the project contemplated, the city would obtain an easement from the developer for the water mains, would construct a water system inside the gated community to the individual meter boxes at each residence, would own the water system it constructs from the beginning of the project, through the project, and after the project is done. The city would be reimbursed for the project by the developer, but the developer would have no ownership interest in the water system.
1. Is the project legal?
Upon reflection, the project is legally questionable, although I suspect that such projects are done in Tennessee.
An argument can be made that utilities enter into contracts in their proprietary capacity, and that for that reason the contract at issue would be valid. That does not appear to be a good argument for the reasons stated below.
It has been held that cities in Tennessee operate their utilities in their proprietary, rather than their governmental, capacities. The significance of that doctrine is seen in Bybees Branch Water Association v. Town of McMinnville, 333 S.W.2d 815 (Tenn. 1960):
‘A municipal corporation engaged in the business of supplying public utilities and facilities is regarded as a public corporation
transacting private business for hire, and, in that respect and to that extent, as a public or quasiprivate corporation.’ 62 C.J.S. Municipal Corporations, Sec. 3, p.73.
‘The city in its operation of utilities herein does so in its proprietary or individual capacity rather than in its legislative or governmental capacity. It is thus governed, for the most part, by the same rules that control a private, individual or business corporation. [206 Tenn. 375] City of Knoxville v. Heth, 186 Tenn. 321, 210 S.W.2d 326, 329.
[Also see City of Shelbyville v. State ex rel Bedford County,, 220 Tenn. 197, 415 S.W.2d 139 (Tenn. 1967); Batson v. Pleasant View Utility District, 592 S.W.2d 578 (Tenn. App. 1980); City of Parsons v. Perryville Utility District, 594 S.W.2d 401 (1980); Maury County Board of Public Utilities v. City of Columbia, 854 S.W.2d 890 (Tenn. App. 1993)]
Batson is particularly instructive on the proprietary capacity issue. In that case a developer and the utility district entered into a contract under which the developer would entirely at his cost extend water lines from the utility districts mains to his new subdivision. The contract provided that the city would be entitled to charge a meter deposit for each meter it installed, and that after the lines had been installed and inspected, their ownership would vest in the utility district. After a majority of the lines had been installed and inspected the utility district imposed a $500 tap fee per residence. The developer argued that its contract with the utility district prohibited the latter from charging a tap fee, and the utility district argued that under Tennessee Code Annotated, sections 6-2610(f) [now 7-82-304(6)] and 6-2625 [now 7-82-403], the utility district had not only the authority but the duty to fix and revise rates and charges so that they would always be adequate to insure that the utility was self-supporting. In holding for the developer, the Court declared that the statutes cited by the utility district did not dispose of the question because, “A city operates its utilities in a proprietary or individual capacity and not in its legislative or governmental capacity. [Citation omitted] A contract made by a city in the course of its operation of a utility is in its proprietary capacity.” [Citations omitted] It was true, continued the Court, that generally a city could not contract away its legislative or governmental functions, but:
T.C.A. section 6-2607 [now 7-82-301] states that an incorporated district shall be a municipality or public corporation. T.C.A. 6- 2610(d) [now 7-82-304(4)] grants any district the power to make and enter into contracts.
As a ‘municipality’ operating its utility in a proprietary or individual capacity, the rules that control private individual or corporate business generally apply. [Citation omitted]
It has been held that state laws permitting a municipality to contract in its proprietary capacity suspend the municipality’s power to regulate rates during the contract period. St. Cloud Public Service Co. v. City of St. Cloud, 265 U.S. 352, 44 S. Ct. 492, 68 L.Ed. 1050 (1924).
By acting in its proprietary capacity, the defendant has obligated itself by contract to provide ‘tapping on’ without charge. This is not in abrogation of its statutory authority to fix or revise rates or charges in its legislative or governmental capacity.
The addition of ‘tapping on’ charge constitutes a unilateral modification of the contracts. Modification requires the mutual assent and meeting of the minds required by contract. [Citation omitted] [At 582]
Private corporations can enter into arrangements like or similar to those contemplated by the City’s question. If that is so, what is stop the city from entering into the contract in question even in the face of Tennessee Code Annotated, § 7-35-401?an public utilities, even to the extent of contracting away their rate-making powers with respect to tap fees.
The answer is that the utility’s proprietary general authority to enter into contracts collides head-on with Tennessee Code Annotated, § 7-35-401. That statute gives municipalities the authority to own and construct, etc, water and sewer systems, but it contains a reservation with respect to “project[s] for private purposes:”
(c)(1) The power to own, acquire, construct, extend, equip, operate and maintain water or sewerage service shall not include the power to bid on, or construct any project for a private purpose. As used in this subsection (c):
(B) “Project for a private purpose” includes, but is not limited to:
(i) Any commercial project, commercial subdivision, private residence or residential subdivision that is owned by a nonpublic entity;
(ii) The construction of individual water or sewerage lines beyond a meter that measures service or consumption, or onto private property, unless such water or sewerage line is owned by, or a utility easement has been obtained by, the municipal corporation;
(iii) Any other projects that are not part of the normal operation of a municipal corporation in providing water or sewerage services and which projects are otherwise constructed by private contractors who are subject to the sales tax, the business tax and other tax laws and licensure laws of this state; and
(C) “Project for a private purpose” does not include the renewal or replacement of any existing water or sewerage lines that are owned by the municipal corporation.
The proprietary nature of utility contacts does not support the proposition that when utilities enter into contract, they can simply ignore statues that govern such contracts. The above cases are rate-making cases in which the courts made as determination of whether the general authority of those utilities to enter into contracts contravened state statutes governing the rate-making power of utilities. Not all those cases upheld the contract at issue. In distinguishing the rate-making contract involved in particular cases with the one at issue in Maury County Board of Public Utilities, above, the court distinguished between the provision of the rate-making contact in City of Parsons, above, from the rate-making contracts in other cases:
Hence, when a city contracted to provide water service at a rate which could not be increased to reflect the cost of increased capitalization of the water system, the contract provision on rates was unenforceable. That part of the contract which precluded a rate increase for increased capitalization acted as a bar to the City’s statutorily required flexibility and discriminated against the City’s direct customers not covered by the agreement. [At 391]
The term there, was “statutorily required flexibility.” When the rate-making statute containing the statutorily required y flexibility collided with the utility’s general authority to enter into contracts, the former won. The City’s utility system undoubtedly has the general authority to enter into contracts. In fact, that authority may stem from the general contract authority found in Tennessee Code Annotated, § 7-35-412. Whatever the case there, Tennessee Code Annotated, § 7-31-401 is a statutory limitation on the kinds of contracts the utility can execute. There are other statutes that apply to all utilities, for example Tennessee Code Annotated, § 7- 34-115. It cannot be seriously argued that utilities are free to pick and choose among the limitations contained therein with respect to the contracts into which they enter.
Tennessee Code Annotated, § 7-35-401 has never been interpreted by the courts, but on its face it appears to state a legislative policy of the state that narrow the proprietary powers of municipalities constructing water and sewer projects on private property. There appears to be no reason under that statute why the developer could not himself build the water system inside the gated community, and upon the completion of the project dedicate it to the city, and the city accept and own the project. Under subsection (c)(1)(c), the city could renew and replace the water lines after the city became the owner of the lines. But in this case the city proposes to build the water system inside the gated community with its own forces, after having obtained from the developer the easement for the lines, and the developer would reimburse the city for the construction of the project. But the city would own the lines from the beginning of the project.
Such an arrangement makes practical sense: The city could intimately control the construction of a water system for which in the future it would be responsible for maintaining. However, Tennessee Code Annotated, § 7-35-401 does not appear to contemplate such an arrangement because of the definition of “project for a private purpose.” The project appears to run afoul of subsection (c)(1)(B) because:
- Under (I) a “project for a private purpose” includes “private residence or residential subdivision that is owned by a nonpublic entity.” That description appears to include the gated community in question.
- (ii) has given me some trouble, but I think I have settled on this interpretation: It allows the construction of individual (not main) water and sewer lines past the meter box, or on to private property if the city owns the line or has a utility easement. I am not sure why that was such a revelation to me, but it took me awhile to have it.
- The definition of a “project for a private purpose” in (ii), probably encompasses the construction of a water system in the gated community. That is a project which is probably “not part of the normal operation of a municipal corporation in providing water or sewage services,” and which “are otherwise constructed by private contractors who are subject to the sales tax, [etc.].” I think that, “normally,” municipalities do not construct water and sewer main lines on private property with their own forces, except in some cases perhaps to cross private property to reach a customer’s property the most expedient way; that is a job generally done by the developer’s contractors, after which the system constructed by the contractor is dedicated to the city, and the city accepts the dedication. Until then, the system is owned by the developer.
It seems difficult to find the wisdom in allowing a utility to construct water lines past a meter box onto private property under Tennessee Code Annotated, § 7-35-401, but prohibiting it
from constructing main lines on private property before the reach the meter box, under the facts reflected in the City’s question, but that wisdom is not for me to question. from constructing main lines on private property before the reach the meter box, under the facts reflected in the City’s question, but that wisdom is not for me to question.
The next three questions assume, for the purpose of their answers, that the project is legal.
2. Does the Contractor’s Licencing Law apply to the project?
The answer is probably no. It is true that the definition of “Contracting ” in the Contractor’s Licensing Law was broadened in 1994. However, the broadening of that definition still did not bring local government construction projects done by those government’s own forces within its scope. I have attached Tennessee Attorney General’s Opinion 99-013 to support that conclusion.
3. Is an architect or engineer required to sign off on the project?
The best answer I can give you on this question is to read Tennessee Code Annotated, § 62-2-107, and my article in Tennessee Public Works Magazine, March/April, 1993, which appears to still be current. I have attached that article. Tennessee Code Annotated, § 62-2-107 says:
(a) Neither the state, or any county, city, town or village...shall engage in the construction or maintenance of any public work involving architecture, engineering or landscape architecture for which the plans, specifications and estimates have not been made by a registered architect, registered engineer or registered landscape architect.
(b) Nothing in this section shall be held to apply to such public work wherein the contemplated expenditure for the complete project does not exceed twenty-five thousand dollars ($25,000), and such work does not alter the structural, mechanical or electrical system of the project.
My article, above, wrestles with what that statute means.
4. Would the developer of the gated community owe sales tax on the materials used by the city to construct the water mains?
As per our discussion of this matter on the telephone yesterday, if the project is truly a city project and no laundering has gone on–the project is done by city forces, and the city owns the water lines from the beginning of the project, through the project, and after the project, it is legitimately a city project, and sales tax (actually a use tax equal to the sales tax) is owed on the project. [See Shelby County v. King, 620 S.W.2d 493 (1981), and other material, which is attached.]
Sidney D. Hemsley
Senior Law Consultant