Cost Containment Advisors

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Greenwich, CT 06830

December 2014 Newsletter

December 8, 2014 | Newsletter
ALASKA – Municipalities awarded attorneys fees and costs as prevailing parties in Trans-Alaska Pipeline Tax Appeal.  By statute, the Alaska Department of Revenue annually assesses the “full and true value” of oil and gas properties, including the pipeline transportation of gas or unrefined oil, for purposes of determining the property taxes due to the State and certain affected municipalities. After the Department determines the initial assessment, a property owner or affected municipality may informally appeal the valuation to the Department. The Department’s decision may be further appealed to the State Assessment Review Board, and ultimately, to the Superior Court for a trial de novo.

The Trans-Alaska Pipeline System stretches 800 miles from the oil fields of the North Slope to a terminal in the City of Valdez. The pipeline is jointly owned by BP Pipelines (Alaska) Inc. (46.9%); ConocoPhillips Transportation Alaska, Inc. (28.3%); ExxonMobil Pipeline Company (20.3%); Koch Alaska Pipeline Company, LLC (3.1 %); and Unocal Pipeline Company (1.4%), and is managed by their agent, Alyeska Pipeline Service Company. Following an initial assessment of $3.344 billion, the municipalities and owners appealed informally, and the Department adjusted the assessment to $3.641 billion. The municipalities and owners then appealed to the Board, which adjusted the assessment to $4.306 billion, and the owners and municipalities then appealed to the Superior Court, where a trial de novo was held.

The main dispute at trial was over the method used to calculate “the full and true value” of the pipeline. The municipalities proposed a valuation of $11.570 billion, employing a cost approach that analyzed the replacement cost of the pipeline while taking into consideration its enhanced value because of the profitability of the entire oil enterprise as an integrated entity. In contrast, the owners of the pipeline contended that it should be valued at $850 million, arguing for a tariff/income approach that considered only the income stream that the pipeline itself generated. In the agency proceedings, both the Department and the Board had opted for the cost approach, and the Superior Court agreed, finding the cost approach to be the best indicator of value. The Court applied a “replacement cost new less depreciation” method, which determines the current replacement cost of the property and then deducts for depreciation. The parties disagreed over which cost study should be used to calculate value: the owners’ study, which estimated the replacement cost at about $8.545 billion, or the municipalities’ study, which estimated the replacement cost at $18.712 billion. The Superior Court concluded that the municipalities’ study was more in accord with the statutory standards, determined the amount of depreciation to be deducted, and concluded that the pipeline should be valued at “approximately $9.977 billion-or just over 50% of its estimated replacement cost.”

This most recent decision concerns the costs and attorney’s fees awarded by the Superior Court. The Department and the municipalities asserted prevailing party status in the underlying case, and moved for attorney’s fees and costs against the pipeline owners. The owners opposed the award, arguing in part that Fairbanks/Valdez and North Slope had not prevailed against the owners, but rather had prevailed against the Department and the Board. The owners also contested portions of the municipalities’ fee requests and claimed that any attorney’s fees, if awarded, should be apportioned between the owners’ appeal and the Fairbanks/Valdez appeal and should not be subject to enhancement.

On appeal, the Supreme Court affirmed the Superior Court. The Supreme Court agreed that attorneys fees should be awarded pursuant to the civil rules, not the appellate rules, because the Superior Court had conducted a trial de novo. The Supreme Court rejected the pipeline owners’ argument that the municipalities were not prevailing parties for purposes of an attorneys fees award because their appeals were directed against the Department and the Board, not the owners, and therefore the municipalities did prevail against the owners. Citing an appellate rule to the effect that the party filing an appeal is the appellant, the Supreme Court reasoned that regardless of how parties are formally arranged, fees and costs may be awarded based on actual adversity of interests, and the pipeline owners were clearly aligned against the municipalities on every substantive issue. Finally, the Supreme Court held that attorneys fees were properly awarded under the civil rule applying to a non-monetary judgment, not under the rule applying to a monetary judgment, even though the resulting award was significantly less, because the final judgment in the case did not specify the amount of the owners’ tax liability nor direct the parties how to calculate the amount of taxes due, rather it “simply specified the general procedure” for determining that amount.

BP Pipelines (Alaska) Inc. v. State Dept. of Revenue, 327 P.3d 185 (Alaska, May 9, 2014).

CALIFORNIA – Court of Appeal holds that the drilling and deepening of oil and gas wells constitutes new construction, and that assessor’s use of the cost method was not unreasonable. Kern County issued supplemental assessments for three tax years of new construction consisting of the drilling, development and completion of oil and gas wells, and related improvements and facilities, on various oil and gas properties operated by Chevron USA, Inc. Chevron appealed. The trial court found the assessor erroneously used the cost method of valuation instead of the income method, and that the assessor unlawfully failed to assess only the increase in value of the appraisal unit occasioned by the new construction, instead simply enrolling the cost of construction. The trial court further rejected Chevron’s assertion that certain wells were exempt from supplemental assessment.

During the three tax years in question, Chevron drilled over 1,800 wells on the oilfields in Kern County. Chevron divided these wells into two categories: “infill wells” and “replacement wells.” Chevron defines “infill wells” as wells that increase or improve the drainage volume and overall well count; they typically “recover new reserves that were not being produced by existing wells.” In contrast, Chevron defines “replacement wells” as wells that are intended to continue production by replacing an existing producer without increasing the drainage volume or overall well count; these wells typically “recover reserves that were being produced by a failed well and not new recovery.”

Before 2006, the County issued supplemental assessments on new wells at 70 percent of the cost of drilling, exempting 30 percent of the cost as fixtures, and did not issue any supplemental assessments for replacement wells. Beginning in 2006, the County changed its policy and started issuing supplemental assessments based on the full reported cost of all of the subject wells, both infill and replacement. Chevron challenged these assessments by appealing to the Kern County Assessment Appeals Board, arguing that the cost approach to value was not the correct method of valuing the new wells, that the new wells could not be classified as new construction subject to supplemental assessment because the exemptions from supplemental assessment for repair and maintenance, or calamity and misfortune, applied, that the new wells added no value to the properties involved, and that the assessments constituted double taxation. On appeal to the Superior Court, the Court found the assessor’s use of the cost method of valuation was incorrect, that the assessor should have used the income method, and that the assessor should have limited the assessment increase to the increase in value of the appraisal unit occasioned by the new construction. The Court also found that found the replacement wells are new construction and do not constitute normal maintenance and repair, and that the exceptions for misfortune or calamity did not apply. Reserving jurisdiction, the Court remanded the matter to the Board with instructions to return the assessments to the assessor for a different valuation method
and to re-determine the value for supplemental assessment. Both parties appealed.

The Court of Appeal held that the drilling and deepening of wells constitutes new construction, and that the use of the cost method was not unreasonable nor a violation of law, provided that dry wells are not assessed, because the value of a new well is typically “significantly more” than its cost. The Court of Appeal also rejected Chevron’s argument that the replacement wells fall under the “normal maintenance and repair” exemption to supplemental assessments. The drilling of an entirely new well is not the equivalent of normal repairs and maintenance. The evidence before the Superior Court showed Chevron “made no effort to replace or repair any portion of a pre-existing well, which might constitute normal repairs and maintenance. The replacement of casing or repairing of rods, tubing, pumps, or motors, or other portions of the well might be considered repairs and maintenance, if not all done at once. The construction of an entirely new well does not constitute repairs and maintenance.” Nor did the “misfortune or calamity exemption apply, because the loss of wells was not sudden or unexpected, could be provided for and was not beyond Chevron’s control.

Chevron USA, Inc. v. County of Kern,— Cal.Rptr.3d —-, 2014 WL 5449610 (Cal.App. 5 Dist., October 28, 2014).

VERMONT – Value of utility easements and rights of way held by electrical utility is not properly included in property tax assessment. Vermont Transco operates Vermont’s electric transmission system, consisting of five electrical substations, seven transmission lines, a fiber-optic line, land, and utility easements located within the Town
of Vernon designed and installed to handle the transmission of electric power generated by the Vermont Yankee Nuclear Power Plant and the Vernon Hydroelectric Station.
The Town set the total value of the property for assessment purposes at $92,023,693, and the State Appraiser affirmed. On appeal from the State Appraiser, the principal issue was the correct method of calculating depreciation with respect to the electrical equipment that comprises almost the entire value of the property. In addition, Vermont Transco claimed that the valuation should not have included the value of utility easements and rights of way held by taxpayer, estimated by the Town’s appraiser at
$277,100, and that depreciation should have been applied for certain equipment’s first year of life.

Vermont Transco argued that the State Appraiser should have used the “Iowa Curve” method of depreciation, by which depreciation is not straight lined, but curvilinear, because it had been approved by the court in prior litigation between the parties over valuation of its equipment. The “Iowa Curve” method provides for 30 to 40 years of economic life but compensates for remaining functional utility (a factor other than age) by leveling off after accelerated depreciation, thus avoiding excessive depreciation by keeping the depreciation from going to zero. The Town’s appraiser, George Sansoucy, was critical of the “Iowa Curve” method, noting that the curves had not been updated since 1942, and that they were not developed for high-voltage transmission lines, such as Vermont Transco’s, which have a relatively long useful life and are not retired in the same fashion as other industrial equipment. He testified that the trend in the utility industry was to move away from the “Iowa Curve” method because its use depreciates property too quickly. Because Vermont Transco did not distinctly raise this argument to the State Appraiser, the Supreme Court held that it failed to preserve the issue and so refused to consider it.

Vermont Transco further argued on appeal that the State Appraiser erred by accepting the Town’s valuation without making specific findings concerning the lifespans of the equipment to be used in depreciation or addressing the proper approach for estimating those lifespans. Vermont Transco’s appraiser used an “economic life” approach, resulting in estimated lifespans of fifty to sixty years for the equipment, while the Town’s appraiser employed a “useful life” approach, resulting in estimated lifespans of sixty-five to ninety years. Because the State Appraiser, which accepted the Town’s “economic life” approach, failed to explain its reasons for doing so, the Court remanded for further findings. The State Appraiser also failed to explain how it resolved the conflicting testimony as to whether taxpayer’s property, which was put into service in 2010, should have been depreciated for a full year, and the Court remanded on that issue also. Finally, the Court held that it was error for the Town to include utility easements in the assessment because “it is impossible to identify, value and tax the multitude of easements in a reliable, efficient manner.” Instead, the value of the fee interest is taxed to the fee owner without setoffs for easements conveyed to third parties, and this rule applies to all types of easements, including utility easements.

Vermont Transco LLC v. Town of Vernon,— A.3d —-, 2014 WL 4723620 (Vt., Sept. 19, 2014).

TEXAS – Court of Appeals reverses order requiring refinery owner to provide sensitive financial information, because not necessary to produce accurate appraisal.  Valero owns and operates a refinery in Houston, Texas. Valero appealed Harris County’s 2012 appraisal of the refinery, asserting that the appraised property-tax value of the refinery was over market and not equal and uniform. Harris County requested discovery of extensive financial data, including financial statements and operating business information relating to the market value of Valero’s refinery business, which Valero contested as requiring disclosure of information protected by the trade secret privilege. In particular, Valero argued that the document requests include within their scope Valero’s extremely secret and sensitive Business Unit Report, which contains Valero’s strategic plans and financial statements for all of Valero’s properties. Valero also objected that the requests were not likely to lead to the discovery of admissible evidence on the ground that the income and expense information sought was irrelevant because the income method of appraisal was not relevant or applicable. Harris County moved to compel production, arguing that it needed the information to prepare a market-value appraisal to defend against an unequal-appraisal claim using the income appraisal method. After the trial court ordered the disclosure, the Court of Appeals, siding with Valero, granted mandamus relief.

The trade secret privilege seeks to balance two competing interests: a party’s intellectual property interest in the trade secret and the fair adjudication of lawsuits. A party is required to disclose a trade secret only if necessary to prevent fraud or injustice. Disclosure is required only if necessary for a fair adjudication of the requesting party’s claims or defenses. After determining that the information that the trial court ordered Valero to produce was protected as a trade secret, the Court of Appeals held that it was not necessary for a fair adjudication of the appeal. The Court explained there are three potential alternate methods that may be used to determine the market value of property: cost, income, and market data comparison. Although an ideal appraisal considers all three appraisal methods, depending on the circumstances, each of the three methods can produce a competent appraisal. Therefore, the Court of Appeals concluded that the information requested was “useful in that it will facilitate an income-method appraisal and perhaps reach an appraisal with more certainty,” but not necessary because an accurate appraisal can be completed without it. Valero could not be compelled to disclose this information, even though it was the appellant.

In re Valero Refining-Texas, LP, 2014 WL 4115917 (Tex.App.-Hous. (1 Dist.) August 21, 2014).

OHIO – Auction sale of foreclosed property could be considered voluntary and arm’s length such that auction price is evidence of value of property for tax purposes.  The Ohio Supreme Court was called upon in this case to interpret two conflicting statutory provisions: former R.C. 5713.03, which established a rebuttable presumption that a sale price is the best evidence of a property’s value for purposes of assessing real property tax, and R.C. 5713.04, which expressly states that a sale price from an auction or a forced sale “shall not be taken as the criterion of [the property’s] value.” The case involved the 2009 valuation of a single-family dwelling in Powell, Ohio. In October 2007, Countrywide Home Loans acquired the property for $450,000 at a sheriff’s sale pursuant to foreclosure, listed the property at $479,000 the following February, and in November 2008, held an auction for the property, selling it for $414,750. The Delaware County auditor valued the property at $826,100 for tax year 2009, and the new owner appealed.

The new owner argued that it proved that the auction was an arm’s-length sale because it was not a forced sale. At the hearing before the Delaware County Board of Revision, the new owner testified that he had no prior relationship with Countrywide or the auctioneer, and that he had learned about the auction when his wife saw advertisements on the Internet and in the newspaper several weeks before the auction date. Interested buyers were permitted to inspect the property both before the auction date and on the day of the auction before bidding began, 75 to 85 people attended the auction in person and 50 additional people participated online. Several people bid on the property before the new owner offered the last and highest bid-$414,750. Countrywide, which had retained the right to reject the highest bid, accepted his offer and closed on the sale. The Board of Revision reduced the valuation to $414,750, and the School Board appealed to the Board of Tax Appeals, which affirmed, and then to the Ohio Supreme Court.

The Supreme Court affirmed, refusing to hold that R.C. 5713.04 categorically prohibits reliance on an auction sale price to determine a property’s value. Both former R. C. 5713.03 and R.C. 5713.04 likewise require that each separate parcel of real property shall be valued at its taxable value. But unlike former R.C. 5713.03, R.C. 5713.04 includes a separate admonition that “[t]he price for which such real property would sell at auction or forced sale shall not be taken as the criterion of its value.” (Emphasis added.) Although the Court first construed R.C. 5713.04 to apply to both voluntary and involuntary auctions, and to consummated transactions as well as sales which have not yet occurred, the Court held that “[t]he reference to ‘forced sale’ ” in R.C. 5713.04 “codifies the basic proposition that a sale must be voluntary from the standpoint of both seller and buyer in order to qualify as an arm’s-length transaction,” but does not categorically prohibit reliance on the price from a foreclosure or auction sale as evidence of value. However, warned the Court, the burden to prove that an auction sale is evidence of value falls on the proponent of the sale price, and the proponent bears a heavier burden where the underlying transaction is involuntary.In this case, said the Court, the record contained sufficient evidence to allow the Board of Tax Appeals reasonably to conclude that all three factors relevant to deciding whether a transaction occurred at arm’s length were present: the sale was “voluntary; i.e., without compulsion or duress,” the sale “[took] place in an open market,” and both the buyer and seller “act[ed] in their own self-interest.” As a result, the Court deferred to the Board’s finding that this particular auction sale was voluntary and occurred at arm’s length.

Olentangy Local Schools Bd. of Education v. Delaware City Bd. of Revision, — N.E.3d—-, 2014 WL 5483938 (Ohio, July 8, 2014 ).