A RIVER RUNS THROUGH THE SUPREME COURT

Not all decisions of the U.S. Supreme Court make headlines in newspapers or excite panels of talking heads on television or in social media. However, this does not mean that such decisions have no importance.

One such "quiet" ruling was issued by the Court in February.* It involves the Republican River Compact, a contract between the states of Kansas, Nebraska and Colorado to allocate the "virgin water" originating in the Republican River basin Congress approved the Compact in 1943.

However, as can be the case with any contract, disputes arose. In 1998, Kansas sued in the Supreme Court ** asserting that Nebraska's increased groundwater pumping was regulated under the Compact to the extent that the pumping reduced stream flow in the basin. The Supreme Court agreed with Kansas, resulting in a settlement producing certain accounting protocols.

In 2007, Kansas sued again, alleging that Nebraska had exceeded its allowed allocation of water. In turn, Nebraska alleged that the accounting protocols under the Compact improperly charged it for using imported seater. The Supreme Court appointed a special master to hear the matter. The master's report concluded that Nebraska knowingly failed to comply with the Compact and recommended that Nebraska disgorge part of its gains and pay damages to Kansas. The Supreme Court agreed with these recommendations. It found that Nebraska knowingly exposed Kansas to a risk of receiving less water than its entitlement.

Interestingly, the Court stated that an award of damages in a case involving compact rights may be an inadequate remedy to deter an offending state from disregarding its obligations when it is advantageous to do so. Therefore, it stated, the additional remedy of disgorgement is appropriate to stabilize the Compact and to deter future breaches.

Water is a valuable resource and, when it runs though several jurisdictions, it must be shared in some structured manner. When states enter into contracts with each other, they, as is the case of contracts between people, must comply with their obligations or consequences follow. In this case, the consequences flowed through the Supreme Court.

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*Kansas v. Nebraska,574 U.S.__(2015)

**The Supreme Court has original
jurisdiction in controversies
between states

INTENTIONS OF LETTERS OF INTENT

Water utilities, and business entities in general, often sign letters of intent or memoranda of understanding as part of a contract negotiation process. Typically, parties may have had discussions resulting in agreement as to some terms of a proposed contract but need more time to resolve remaining issues and terms. To memorialize the understanding so far, they may enter into a letter of intent.

Depending how a letter of intent is drafted, it may have become or may not have become an enforceable contract. A letter of intent generally per se is not a contract. Enforceability of such a document depends on whether a court can find an intention to be bound by its terms and that those intentions and the stated terms are sufficiently definite and specific.

The most common method employed to assure that a letter of intent does not become a contract is to insert a provision to the effect that it is not a contract and there is no contract until and unless a written definitive agreement is developed and mutually signed by the parties in the future.

Even with such a provision, however, a non-contract can become an enforceable contract as to certain terms within the letter of intent. For example, it may include an agreement for a deadline in negotiations or preparation of a definitive agreement; or it may provide for confidentiality as to the negotiations or information exchanged between the parties; or it may include a prohibition against negotiating with other possible parties. These sub-agreements within a letter of intent may become enforceable by themselves, even if the letter of intent has not become enforceable as to the substance of the proposed underlying transaction.

As is true for all contracts generally, parties to a letter of intent must draft their document to clearly evidence their intent-- so clearly that a court can interpret the language as the parties truly intended and not order a result that no party ever intended. The road to court often is paved with the best of intentions until a pothole of un-clarity is encountered.

NO END TO CONTRACTS?

Water utility operations and services are governed by contracts with suppliers, employees, customers, consultants, engineers, accountants and even lawyers. The importance of crafting carefully such contracts, therefore, cannot be overstated. Sometimes, however, oversight or carelessness in drafting can cause unintended results--often by reason of a court decision.

For example, a recent state appellate court decision involved a contract between a manufacturer and a sales representative for the manufacturer. The termination provision of the contract stated that the contract may be terminated only by the written agreement of both parties. The manufacturer sued, requesting a judicial ruling that it could terminate the contract unilaterally because the termination provision was unenforceable. It also stated that it was not represented by counsel during the negotiation and drafting of the contract.

In its decision, the Appellate Court stated that a contract that is terminable only upon the mutual agreement of the parties is indefinite in duration, and that state public policy prohibits contracts of indefinite duration. Therefore, the Court held that "as a result, a sales representative agreement terminable only upon the mutual agreement of the parties is not sufficiently definite in duration and in terminable at will." *

It bears repeating: contracts can be structured with care and clearly stating the parties' intent--with the assistance of counsel, or contracts may be structured by subsequent court decisions with possible unintended results for the parties. The choice should be obvious.
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*Rico Industries, Inc. v. TLC Group, Inc,
2014 IL.App. (1st)131522

UTILITY CONSTRUCTION SURETY BONDS, PART 2--PAYMENT BONDS

A performance bond is intended to assure a utility that a contractor will complete a contract according to its terms. A payment bond is intended to assure a utility that the contractor's labor subcontractors, and material and equipment suppliers, will be paid what is owed them by the contractor.

A payment bond can offer subcontractors an alternative to enforcement of mechanics liens. In some jurisdictions, a subcontractor on a public works project for a municipal-owned utility can assert a mechanics lien only against unspent funds held by the owner for that project. Thus, under some circumstances, subcontractor claims may exceed available funds held by a utility for the project.

Things may not be that much better in the case of an investor-owned utility. Several years ago, a contractor unpaid for work done on a component of a wastewater treatment plant foreclosed on a mechanics lien on the plant and acquired a partial ownership interest in the plant. The state utilities commission then cited the contractor for alleged violation of utility law requiring a certificate of public convenience and necessity as a regulated public utility.

When a contractor fails to pay subcontractors, claims for payment can be made against the surety on a payment bond. However, there are notice requirements in such a bond that must be followed. If a surety does not pay subcontractor claims, generally both the utility owner and affected subcontractors may sue the surety. However, a surety, as in the case of performance bonds, may assert defenses to liability. Thus, again, the bond can simply become a ticket to admission to a courthouse trial. The amount of a bond, of course, is the limit of a surety's financial obligation in any case.

A recent court decision addressed a situation where a contract between a municipality and a contractor for a public works project required the contractor to produce both a performance bond and a payment bond. However, the contractor failed to provide the required payment bond. The court held that an unpaid subcontractor was a third party beneficiary of the municipality's agreement with the contractor requiring the contractor to supply a payment bond. Accordingly, the court held that the subcontractor could sue the municipality for breach of contract and recover from the municipality payment for its work. (Lake County Grading Company, LLC v. Village of Antioch, 2013 IL.App.(2d)120474 (2nd Dist.)).

In short, it would seem prudent, and in some cases a legal requirement, for a utility to require its contractors to produce both performance and payment bonds, in adequate dollar amounts and issued by approved sureties.

UTILITY CONSTRUCTION SURETY BONDS, PART 1--PERFORMANCE BONDS

It is common for water and wastewater utilities to require contractors engaged in construction of infrastructure projects to provide performance and payment surety bonds. Indeed, some states mandate that municipal-owned utilities obtain such bonds from their contractors. One example of such a mandate is the Illinois Public Construction Bond Act (30 ILCS 550/1, et seq). That statute states that performance and payment bonds must be obtained for all "public works" projects costing more than $5,000.

This posting will focus on performance bonds. The following post will discuss payment bonds.

Performance bonds involve a three party arrangement. In the utility situation, the contractor is the "principal"; the utility is the "beneficiary"; and the third party, of course, is the surety.

The purpose of a performance bond is to assure the completion of the project in accordance with the contract terms. Typically, in the event that a utility declares a contractor default, the surety becomes obligated to cause the contract to be performed and completed. If the surety fails to undertake its obligations with reasonable promptness, the utility is free to enforce available legal remedies. If the surety does comply with its obligations, it becomes subrogated to the utility's claims against the contractor.

So, what does a performance bond really do? In reality, for the utility as beneficiary the bond is not a guarantee that the contract will be completed. It often becomes simply a ticket of admission to the court house for the principal. That is, the beneficiary winds up suing the surety. A surety may decline to perform by raising defenses to its obligations such as a failure by the beneficiary to give proper notice or a breach of the construction contract by the beneficiary itself.

In accepting a performance bond provided by a contractor, a utility should be satisfied as to the financial standing of the surety and as to the various terms and conditions of the bond. A bond may be well written but of no value if the surety is insolvent.

Completion of a construction contract does not necessarily end the matter, although it may end the bond. The problem is that after completion defects in construction may develop or are discovered necessitating repairs and correction by the contractor. In turn, such repairs can be expected to cause extensions of the applicable warranty period. A utility should be aware of the need to extend bond protection either by terms set forth in the original performance bond or by a requirement for a new maintenance or performance bond covering such repair obligations and warranty extensions.

RETAINING CUSTOMERS CONSIDERING DISCONNECTION AND SELF-SUFFICIENCY

Last month, the Wall Street Journal reported that more commercial and manufacturing customers are generating their own electricity supplies instead of purchasing power from electric public utilities. (September 18, 2013, page A1). This trend, which has quadrupled since 2006, in turn is threatening the revenues and growth of the utilities losing such loads on their systems.

Regulators as well as electric utilities are concerned. As large electric users leave a utility system, the remaining customers, including residential users, likely will pay higher rates to produce sufficient revenue to pay costs associated with infrastructure such as power generation facilities and transmission and distribution lines.

The movement to self-generation appears to be driven by advances in solar panels, fuel cells, wind turbines, and natural gas turbines and reciprocating engines, which make energy independence economically feasible. In addition, for some, self-generation may seem to be more reliable.

Water utilities also can experience a similar trend toward customer water self-suffiency. For example, a large commercial or industrial water user may decide to install its own wells and to disconnect from its local water utility. Or, the customer may retain connection only for standby purposes. The effect upon remaining customers of the utility can be quite dramatic. They will likely experience rate increases necessary to bear the full revenue requirements for the infrastructure such as wells, treatment facilities, pumping and storage facilities and mains.

Can a water utility protect its customers and itself when faced with a significant revenue shortfall resulting from a large volume customer leaving the system? I think there are some possible measures.

For example, a large user institutional customer of one of my water utility clients threatened to leave the system to become self-sufficient by drilling its owns wells and constructing its own treatment facilities. The utility and the customer negotiated a long term contract under which the customer agreed to purchase all its water requirements from the utility at a discounted rate which covered variable costs plus a contribution to fixed costs. The arrangement provided an attractive alternative to the customer building its own system. Retention of the customer benefited the other customers because the special rate produced revenue to cover a portion of fixed costs. The regulatory agency approved the contract.

Where a large water user installs its own water supply but seeks to retain a connection to the water utility for standby purposes, it would seem appropriate for the utility to develop a standby service rate or readiness to serve rate that would produce revenue sufficient to recover the customer's allocable share of revenue requirements associated with infrastructure needed to provide service if called upon.

Some municipalities require that all residents take water service from the municipal-owned water utility. Some court decisions have upheld such requirements. Accordingly, a large water user in such a municipality may not have the option to become water self-sufficent. When a potential large water user requests service from a utility, and infrastructure expansion or upgrade is necessary to provide the requested service, contracts can be structured to obtain from such a customer advances for the cost of such construction and commitments for a term of service.

WATER UTILITY SECURITY BEGINS AT HOME

In reaction to the events of 9/11, water utilities have initiated enhanced security measures, including performance of vulnerability assessments and installation of gated fences, video monitoring, visitor identification protocols and the like.

However, for some utilities one form of internal security risk may have been overlooked. A common form of access to water system facilities occurs when outside engineers, consultants, contractors, suppliers and others inspect the facilities or view drawings and records in the course of performing work for a utility. Fencing, gates and video cameras do not control such access, if unfettered. Indeed, such access, if uncontrolled, can expose sensitive information to such persons, and indirectly to third persons, thereby possibly increasing vulnerability risks to utility assets.

Even simple forms of such access can cause risks. For example, when a utility initiates a public bidding process for a proposed construction project, potential bidders likely will have access to drawings, specifications, records and even the facility itself. These forms of access can result in sensitive information about a utility to remain in files of unsuccessful bidders as well as engineers, contractors, etc., with such files being available to persons not directly related to a project for the utility.

One way a utility may be able to protect its sensitive information from unauthorized use is by means of protective agreements with such persons needing access to facilities and information, including potential bidders. Such agreements can establish boundaries for access, use, retention and disposal of sensitive information obtained by persons given access to such information. In addition, protective agreements can specify consequences, both monetary and otherwise, for any breach of such an agreement. Protective agreements can be stand alone agreements or can be incorporated in the terms of agreements for services, purchases, or construction and in bidding documents. Of course, as in the case of any agreement, compliance with the terms of a protective agreement should be monitored carefully.

HANDSHAKE MISTAKE: THE IMPORTANCE OF WRITTEN CONTRACTS

In a "comic" strip several years ago, Lucy promised Charlie Brown to stop pulling the football away when he tried to place kick it. They shook hands on the promise. But, when he ran up to the football, she again pulled it away, and he went flying. When he complained to her, she said that a woman's handshake is not legally binding.

Utility systems operate by many contracts-with customers, vendors, construction contractors, engineers, developers, consultants, accountants, attorneys, other utilities, etc. Often times, these contracts are oral-a handshake, if you will-or if in writing, the writing is sketchy or incomplete.

Oral agreements may be workable as long as no dispute arises. However, many different kinds of disputes can arise over the terms of an oral agreement, such as price, completion date, performance standards, etc.

If a contract is not in writing, or the writing is incomplete, any dispute is a ticket to the courthouse. There, the terms of the agreement-if in fact the court concludes an agreement exists-will be determined by a judge or jury, not by the parties to the contract.

The purpose of a written contract is to fully state the intent of the parties. In such a case, any dispute will be resolved in court by review solely of the "four corners" of the document. External evidence of the parties' intent-extrinsic or parol evidence-is not to be presented.

As the Illinois Supreme Court has stated, "an agreement, when reduced to writing, must be presumed to speak the intention of the parties who signed it. It speaks for itself, and the intention which with it was executed must be determined from the language used. It is not to be changed by extrinsic evidence." Air Safety, Inc. v. Teachers Realty Corp, 706 N.E. 2d 882, 884 (1999).

However, if a contract is oral, or incomplete or ambiguous if written, extrinsic evidence generally is allowed to be presented by witnesses, prior conversations, documents, etc. J & B Steel Contractors, Inc. v. C. Iber & Sons, Inc., 642 N.E. 2d 1215, 1217 (1994). In other words, a he said/she said situation arises. The risks of such litigation and uncertainty of outcome are apparent.

What conclusions follow?

1. Water and wastewater utilities should reduce agreements to writing.

2. Written agreements should contain accurately all terms and conditions intended by the parties in unambiguous language.

3. If a written agreement is prepared by the other party, the utility should carefully read and understand all terms. This is true particularly for the so-called "boiler plate" provisions.

4. The agreement should be signed by representatives of all parties with evidence of their authority to sign.

5. The agreement should contain an "integration clause" to the effect that the contract contains the full agreement of the parties.

6. At least non-routine or complex agreements should be crafted or reviewed by counsel.