Private Equity Ownership of Municipal Water in Montana

Montague
FINAL AWR: Private Equity Ownership of Municipal Water in Montana
10/8/2012
Private Equity Ownership of Municipal Water in Montana

By Ada C. Montague
Table of Contents
Introduction ..................................................................................................................................... 2 I. Review of the Sale of Mountain Water to the Carlyle Group ................................................. 2 A. B. C. History of Missoulas Municipal Water ........................................................................... 2 Sale of Mountain Water to Carlyle .................................................................................. 4 Water Rights Purchased in the Sale ................................................................................. 8
II. What does it mean for a private equity firm to own a city's drinking water in Montana? .... 11 A. B. III. A. B. Global to Local Context ................................................................................................. 11 Forms of Privatization of Municipal Water in the U.S. ................................................. 16 Laws and Regulations at Stake .......................................................................................... 23 Montanas Review.......................................................................................................... 23 Opportunities for Improvement ...................................................................................... 28
Conclusion .................................................................................................................................... 31
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Introduction
International attention on issues surrounding the private control of public water has grown in recent years due to controversies resulting from poor management and increased rates.1 The sale of Missoula, Montanas municipal water supply from Mountain Water Company (Mountain Water) to the Carlyle Group (Carlyle) in 2011 raised similar questions about the equitable provision of drinking water in the United States. Understanding the implications of the sale involves both the specific history of the citys water supply and the terms of the sale itself. In addition, the purchase of a water utility by a private equity firm is a new trend in the private provision of public drinking water. As a result, reevaluating Montanas governing rules and regulations is necessary in order to understand how to handle this new type of acquisition model. Investigating where improvements could be made will provide Montana, and potentially other communities facing similar sales, a more comprehensive way to address related public interest concerns. The sale of Mountain Water to Carlyle is a way to explore the currently limited information on private equity ownership of municipal water. This article begins in Part I with the factual background of the sale. Part I discusses the history of Missoulas municipal water supply, tracing its ownership from its origins through the recent sale to Carlyle. Part I then details the terms of the sale and the government review involved in its approval. Part II addresses the issue of what it means for a private equity firm to own a municipal water supply in Montana. To do so, Part II provides a global, national, regional, and local context for the sale. It investigates the evolving nature of water privatization and the differences between privatized municipal water and private equity ownership of municipal water. It also discusses three comparable sales to Carlyles purchase of Mountain Water and tracks the conditions of approval for each one. Part III turns to an analysis of the Montana laws and regulations implicated. It begins with the background legal principle of the public trust doctrine, explores the relevant portions of the Montana Constitution, as well as Montanas statutory law and administrative regulations. It next looks at the binding agreements and stipulations adopted as part of the approval of the sale. Part III concludes with opportunities for improvement in Montanas laws governing the review and approval of private equity ownership of municipal water utilities.
I. Review of the Sale of Mountain Water to the Carlyle Group

A. History of Missoulas Municipal Water
Understanding what it means for the water supply of a Montana city to be owned by a private equity company is difficult due to the limited information available about such sales. The sale of Mountain Water to Carlyle provides at least one example. In order to analyze the legal implications of the sale, a history of Missoulas water supply is necessary starting point. The water supply for the City of Missoula (the City) has always been privately owned. The sale of
1
Matthew S. Tisdale, Water Rights, 37 Suffolk U.L.Rev. 535, 535 (2004).
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Mountain Water to Carlyle is one of a string of transfers between private companies buying and selling the City of Missoulas drinking water. The following history of Missoulas municipal water supply shows the City consistently seeking public ownership. It also shows that the Citys recent decision to support the sale to Carlyle is part of this trend. The City is located west of the Continental Divide on the Clark Fork River in western Montana. It has an estimated population of 82,600 residents.2 Water for those residents comes from a privately owned community water system, which entails both the water supply infrastructure as well as the underlying water rights.3 Missoulas water supply has been privately owned since the Citys founding as a trading post in the 1860s. The first water provider was an individual named One-Eyed Riley who ran the Missoula Water Works, which in 1870 consisted of hauling water door-to-door by donkey.4 One year later the private funders, C.P. Higgins and Frank Worden installed pipes and mains and later sold the water utility to the Missoula Mercantile Co., which added an electrical plant.5 In 1905, one of the Copper Kings of Butte, William A. Clark, paid $900,000 for the system, which then became known as Missoula Light and Water.6 Ownership later passed to Montana Power Co. in 1929, to Mountain Water in 1979, and to Carlyle in 2011.7 Over the years, the City repeatedly sought public ownership of the water utility. As early as 1923 then-Mayor William Beacom made an argument to buy the water plant for $600,000 in public bonds.8 He claimed every city of any size in the state, with the exception of poor old Butte and Missoula, now owns its own water system and is getting better service and cheaper rates than under the old system of private monopoly and franchise.9 However, the voters rejected his argument. Over the years, the City continued to argue that a municipally-owned utility would provide better maintenance and service at over-all cheaper rates. The City made another attempt to obtain control of the utility in 1979 when it competed with Mountain Water to purchase the water utility from Montana Power Company. Mountain Water is a subsidiary of Park Water, a California-based, privately owned water utility that provides service to approximately eleven square miles of southeast Los Angeles and the community of Apple Valley, CA.10 The City, due to delays associated with municipal financing, was unable to fund the purchase before Mountain Water obtained ownership. The 1979 sale to Mountain Water, and its parent company Park Water, placed ownership in the hands of Henry Wheeler Jr., a resident
2
2010 US Census Interactive Population Search, MT Missoula CCD, http://2010.census.gov/2010census/popmap/ipmtext.php?fl=30 (accessed 3/10/2012). 3 Mountain Water, http://www.mtnwater.com/ (accessed 3/10/2012). 4 Clark Fork Coalition, Mountain Water FAQs, http://www.clarkfork.org/take-action/mountain-water-companysale.html (accessed 3/10/2012). 5 Rob Chaney, Missoula has never controlled its own water destiny, The Missoulian (Jan. 2, 2011). 6 Id. 7 Id. 8 Id. 9 Id. 10 Park Water, Our Service Area, http://www.parkwater.com/about-park-water/our-service-area (accessed Mar. 7, 2012).
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of California. Wheeler bought Mountain Water from Montana Power Co. for $7.5 million, and made himself and his successors majority owners of the conglomerate Park Water. Wheeler took an active role in managing the utilities and consistently refused to negotiate a sale of Mountain Water to the City.11 The Citys last attempt to acquire Mountain Water occurred in 1987 when it tried to use eminent domain to force a sale, basing its action on concerns over giardia contamination of Rattlesnake Creek.12 Mountain Water opposed the condemnation and the Montana Supreme Court denied the Citys action, finding that the Citys argument did not meet the required public interest protection threshold. In order to make the case that the publics interest would best be served by the City, evidence needed to show the Citys management would result in a net savings to the public. The Court found the proposed efficiencies argued by the City in the form of staffing changes did not provide the proof needed to show that there would be any savings of any consequence to the City.13 Meanwhile, Mountain Water also owned the water supply for another town, Superior, Montana.14 In 2000, Mountain Water sold the utility back to the Town of Superior without litigation.15 In 1997, former Mayor Mike Kadas managed to secure an agreement from Wheeler for the right of first refusal if Mountain Water was ever sold separately from Park Water.16
B. Sale of Mountain Water to Carlyle

Prior to Carlyles purchase of Mountain Water, the City remained interested in gaining control of Missoulas water supply.17 The utilitys infrastructure was known to leak and complaints about a slow and haphazard conversion from flat to metered rates were points of contention within the community and led consumers to consider public ownership an attractive alternative.
11
Keila Szpaller, Missoula, Mountain Water owner have contentious history, The Missoulian (Sept. 23, 2011) http://missoulian.com/news/local/article_cccd992e-e59e-11e0-a0eb-001cc4c002e0.html. 12 Missoula v. Mountain Water Co., 236 Mont. 442, 447 (Mont. 1989); see also Mont. Code Ann. 70-30-111 (2011) (Use of eminent domain must comply with Montana statute, which requires the following findings: (1) the use to which the property is to be applied is a public use pursuant to 70-30-102; (2) the taking is necessary to the public use; (3) if already being used for a public use, that the public use for which the property is proposed to be used is a more necessary public use; and (4) an effort to obtain the property interest sought to be taken was made by submission of a written offer and the offer was rejected). 13 Id. 14 In the Matter of the Complaint of the Town of Superior against Mountain Water Company Fire Hydrant Charges, Utility Division Docket No. 81.10.115, Order No. 4909 (Mont. Pub. Utl. Commn. June 22, 1982) (The Town of Superior filed a complaint with the PSC in 1981 regarding what they considered to be inflated rates for fire hydrant service. The Commission found the rates to be fair and reasonable). 15 Mountain Water, History, http://www.mtnwater.com/history.htm (accessed 3/13/2012); see In the Matter of the Application of Mountain Water Company for Approval of Transfer of Utility Assets and Operating Responsibilities to the Town of Superior, Montana, Utility Division Docket No. D2000.6.91, Order No. 6265, Sept. 26, 2000). 16 Jenna Cederberg, Mountain Water Sale: City Council has questions before taking a stance, The Missoulian, (Aug. 17, 2011), superseded, Ltr. from Thorvald Nelson to the Honorable John Engen, Mayor for Missoula, Letter Agreement between the City of Missoula, the Clark Fork Coalition, and Carlyle Infrastructure Partners 1 (Sept. 22, 2011) (on file with the Montana Public Service Commission, Docket No. D2011.1.8). 17 Mont. Code Ann. 7-13-4403-4404 (2011) (A city is given the power to negotiate and purchase a water utility from a private provider, based on the terms agreed to by the parties and to take control of a private utility by eminent domain in the event an agreement is not reached).
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Though the City took no further legal action to obtain public control of the utility, it maintained an interest in purchasing it.18Mountain Water, on the other hand, continued to refuse to negotiate with the City for public ownership. Some suspected that Wheeler may have had a financial interest in maintaining private control of the utility.19 Mountain Water is a state-regulated water utility with no competition for water service in the Missoula area. As a result, it is guaranteed a stable rate of return. The Montana Public Service Commission (PSC) reviews and approves all rate changes for Mountain Water. The currently approved rate increase, prior to Carlyles purchase, of 8.77% guarantees the company a 10% rate of return.20 In terms of costs to ratepayers, Mountain Water charges around the highest rates in the state. Metered ratepayers often average $46.00 per month for water in Missoula. In contrast, Billings water users pay on average $22.42 per month, and in Helena bills are typically around $31.00.21 Both of these other cities have municipally-owned as opposed to privately-owned water utilities. Mountain Water serves 65,000 people in Missoula and is the only investor-owned utility in Montana (See Exhibit A: Mountain Waters Missoula Service Area).22 Wheelers unwillingness to negotiate a sale with the City changed the way it approached obtaining ownership of the utility. During the most recent sale to Carlyle, the current Missoula mayor, John Engen, (Mayor) took a more cooperative attitude than seen in 1987. From his perspective, Carlyle would be more willing to sell the utility than Wheeler. The Mayor concluded that the City should have the opportunity to negotiate a reasonable good-faith purchase of Mountain Water Co. with the Carlyle Group.23 The Mayor memorialized his perspective in an agreement with Carlyle allowing the City a right of first refusal, replacing the one penned in 1997 by Kadas. A local non-profit interested in protecting the greater Clark Fork River ecosystem, the Clark Fork Coalition, was also a party to the agreement. As a result, the new agreement included several measures to protect the sustainability of the water source and to prevent the potential for out-of-basin transfer of water.24 The PSC incorporated the agreement into its review of the sale. Members of the community were skeptical if the Mayors agreement
18
In the Matter of the Consolidated Petition by Mountain Water Company for Declaratory Rulings and Application for Approval of the Sale and Transfer of Stock in Park Water Company, Regulatory Division, Docket No. 2011.1.18 (Mont. Pub. Service Commn. Aug. 5, 2011). 19 Telephone Interview with Bruce Bender, Chief Admin. Officer, City of Missoula (Apr. 26, 2012). 20 Clark Fork Coalition, Mountain Water Company Sale, http://www.clarkfork.org/take-action/mountain-watercompany-sale.html (accessed Mar. 13, 2012). 21 Clark Fork Coalition, Mountain Water Company: Next Steps, http://www.clarkfork.org/take-action/mountainwater-company-sale.html (accessed Mar. 7, 2012). 22 Business Journal, Carlyle Group to Acquire Park Water Co., http://www.bizjournals.com/washington/quick_news/2010/12/carlyle-group-to-acquire-park-water-co.html (accessed Mar. 7, 2012). 23 John Engen, City looking to buy water system, The Missoulian (July 18, 2011) http://missoulian.com/news/opinion/columnists/article_a43a3620-b146-11e0-ab68-001cc4c03286.html. 24 Ltr. from Thorvald Nelson to the Honorable John Engen, Mayor for Missoula, Letter Agreement between the City of Missoula, the Clark Fork Coalition, and Carlyle Infrastructure Partners 1 (Sept. 22, 2011) (on file with the Montana Public Service Commission, Docket No. D2011.1.8) [hereinafter Agreement].
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would do enough to protect public interest due to the lack of transparency inherent in private ownership and Carlyles lack of experience in operating a water utility.25 Carlyle represents an entirely new type of private municipal water supply owner -- a global alternative asset management firm specializing in private equity. Its business model is a nontraditional investment strategy that explores investment opportunities beyond stocks, bonds, and real estate to include the acquisition of private companies.26 The firm has over 1,300 investment partners in 71 countries.27 A 2012 Private Equity International (PEI) ranking placed Carlyle as the fifth largest private equity firm in the world, behind TPG Capital, Blackstone Group and Goldman Sachs Principal Investment Area.28 Additionally, Carlyles 2010 Annual Report indicates that in the past five years the capital committed to Carlyles fund has increased by 286%.29 Not only is Carlyle a global entity with alternative investment practices, it has a reputation for questionable business practices. Carlyle best demonstrates its darker side by employing political figures such as Frank Carlucci, George H. W. Bush and James Baker III, who worked for Carlyle in either official or unofficial capacities after leaving office. The companys connections and knowledge of Washington politics allowed Carlyle to gain funding from sources such as the Bin Laden family, now famous for their estranged sons founding of Al Qaeda, as well as King Fahd of Saudi Arabia, and Park Tae-joon, former prime minister of South Korea.30 Initially, Carlyles profits resulted primarily from defense spending contracts and connections with the Pentagon. Today Carlyle reports assets in excess of $150 billion, diversified over 84 distinct funds, with Park Water as is its first and only water utility.31 In addition, Robert Dove heads Carlyles efforts to enter the water industry. Doves resum includes working for Bechtel, Ltd., where he became entangled in a Bolivian uprising over the privatization of water in 1999, known as the Cochabamaba Water Wars.32
25
John Engen, City looking to buy water system, The Missoulian (July 18, 2011) http://missoulian.com/news/opinion/columnists/article_a43a3620-b146-11e0-ab68-001cc4c03286.html. 26 Dictionary of Financial Terms, Private Equity, http://www.lightbulblabs.com/LBDictionary/default.aspx?id=13 (accessed Mar. 7, 2012). 27 The Carlyle Group: Global Alternative Asset Management, 2010 Annual Report, http://www.carlyle.com/Media%20Room/Annual%20Report%20Files/2010%20Annual%20Report%20%20English.pdf (accessed 3/7/2012) [hereinafter Carlyle Annual Report]. Carlyle employs more than 890 employees, including 495 investment professionals, in 20 countries with offices in the Americas, Europe, Asia, and Australia. Its portfolio companies employ more than 415,000 people worldwide. 28 Private Equity International, The PEI 300, http://www.peimedia.com/Pages.aspx?pageID=3391 (accessed May 11, 2012) (Carlyle was ranked first in the 2007 PEI 300 listing). 29 Carlyle Annual Report, supra n. 27. 30 Dan Briody, The Iron Triangle: Inside the Secret World of the Carlyle Group (John Wiley & Sons, Inc. 2003). 31 Carlyle Annual Report, supra n. 27. 32 Jim Shultz, The Politics of Water in Bolivia, The Nation (January 2005), http://www.thenation.com/article/ politics-water-bolivia [hereinafter Cochabamba]. Bechtels involvement in Bolivia in the1990s resulted in outright purchase of the countrys entire water agency. Bechtel helped form Aguas del Tunari, a consortium of international and Bolivian companies that purchased SEMAPA, Bolivias state-controlled water agency, from the Bolivian government. At that time, the World Bank encouraged municipal systems privatization, believing that
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Carlyle has no experience in owning and maintaining a public water utility. Purchasing Park Water marks Carlyles first venture into the water industry and its fifth investment out of its $1.15 million Carlyle Infrastructure Fund.33 Mountain Waters infrastructure is currently in a state of disrepair. An estimated leakage rate of up to 40% will require improvements in the shortterm future.34 In addition, service rates will improve with meter conversion, which is currently being done piecemeal with individual ratepayers on an ad hoc basis. Carlyle estimates the cost of updating Mountain Waters infrastructure to be in the area of $129 million.35 In December 2010 Carlyle announced its $102 million purchase of Park Water.36 Controversy surrounding the sale began to stir in Missoula when Mountain Water petitioned the PSC to waive its jurisdiction to review the sale, or to review it in an expedited manner.37 The PSC denied the request and commenced a formal review with four interested parties intervening. The interveners were (1) the City, representing the Missoula communitys long-standing interest in public ownership of the utility; (2) Carlyle, representing its interest in obtaining ownership of the utility as part of its purchase of Park Water; (3) the Montana Consumer Counsel (MCC), a public office created under the Montana Constitution to safeguard the interests of Montana consumers; and (4) the Clark Fork Coalition, seeking to protect the Clark Fork River and its related tributaries.38
"poor governments are often too plagued by local corruption and too ill equipped to run public water systems efficiently. ...[and that the use of private corporations] opens the door to needed investment and skilled management." Similar to the purchase of Mountain Water by Carlyle, Aguas del Tunari purchased SEMAPA on the promise that it would pay off the agencys $30 million debt and begin rebuilding the water delivery infrastructure. They also promised to further develop hydroelectric power. Problems arose when the consortium wanted to post positive financial gains and complete its repairs ahead of schedule. In its haste to achieve its goals, it decided to externalize the costs of all improvements on the municipal and agricultural water users within the consortiums sphere of influence. The result was a sizeable rate increase for people in Cochabamba, Bolivias third-largest city. The rate increases met with fierce protests that resulted in a prolonged uprising throughout 1999 and 2000, dubbed the Cochabamba Water Wars. The national government declared a state of emergency and sent the military to quell the riots, ending in bloodshed that stained Bechtels not to mention the World Banks reputation; see also William Finnegan, Leasing the Rain, The New Yorker (April 8, 2002), http://www.newyorker.com/archive/2002/04/08/ 020408fa_FACT1; see e.g. Interview with Marcus Pearson, Class of 2012, U. Wash. Sch. of Law (Sept. 11, 2011). 33 Private Equity International, Infrastructure Investor, http://www.infrastructureinvestor.com/Article.aspx?article=58439&hash ID=DB0DD75EF6A63A29B2FB12AC9F28BAF79B014013 (accessed 3/7/2012) [hereinafter Infrastructure Investor]. To date, Carlyles other infrastructure investments are all transportation related. 34 Jenna Cederberg, Infrastructure, rates present delicate balance for Mountain Water buyer, The Missoulian (Sept. 23, 2011), http://missoulian.com/news/local/article_2b325300-e659-11e0-88d5-001cc4c03286.html. 35 Id. 36 Infrastructure Investor, supra n. 33. 37 In the Matter of the Petition by Mountain Water Company for a Declaratory Ruling Disclaiming Commission Jurisdiction over the Sale and Transfer of Stock in Park Water Company, Utility Division Docket No. D2011.1.8 (Mont. Pub. Serv. Commn. Jan. 24, 2011); infra n. 139 (providing further analysis of the PSCs jurisdiction to review the sale). 38 Montana Consumer Counsel, Constitutional and Statutory Citation, http://leg.mt.gov/css/committees/administration/Consumer%20Counsel/membership.asp (accessed Mar. 9, 2012).
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Negotiations among the intervening parties resulted in two separate agreements with Carlyle. The first agreement, mentioned above, involved the Mayor and the Clark Fork Coalition which gave the City the right of first refusal should Mountain Water be sold separately from Park Water. It also protected the water resource from out-of-basin transfers. The second agreement, with the Montana Consumer Counsel, stipulated ring-fencing provisions that would encumber the sale. Ring-fencing is a legal and financial arrangement that separates the business dealings of a regulated company from the general business of an overarching parent company. Ring-fencing seeks to ensure that a utility is managed for the purpose of service delivery and that this purpose is not undermined by the parent companys other activities.39 The Montana Code Annotated does not currently contain any statutory authority expressly allowing ring-fencing; however, the PSC is given broad powers to enforce utility law as set forth in statute.40 After months of discovery, coupled with a public hearing to gather testimony and public comment, the PSCs review came to a close. On December 14, 2011 the PSC in a close vote of 3:2 approved the sale of Mountain Water, its infrastructure and underlying water rights to Carlyle.41 The PSCs approval included the settlement agreement reached between the Mayor, the Clark Fork Coalition and Carlyle and the ring-fencing provisions stipulated to between Carlyle and the MCC. The approval came close on the heels of the California Public Utility Commissions (CPUC) decision to approve the sale of Park Water to Carlyle, on December 1, 2011.42
C. Water Rights Purchased in the Sale

Along with the acquisition of Mountain Water, Carlyle also obtained all of the utilitys water rights. Carlyle now owns seventy-nine water rights in the Missoula Valley on record with the
39
Report of Finance and Transactions Committee, 23 Energy L.J. 541, 562 (2002) [hereinafter Ring-fencing] (Ring-fencing techniques include: creation of or conversion of subsidiaries into special purpose entities, or limited-purpose operating entities; adoption of certain structural devices and covenants which regulate the flow of internal financing to and the payment of dividends from the ring-fenced subsidiary; provision of a non-consolidation opinion; appointment of independent directors to the board of the ring-fenced entity obligated under relevant charter provisions to consider creditor interests in exercising their fiduciary duties and whose approval is required before the entity can file bankruptcy; and the pledging of the ring-fenced entity's assets and its ownership interests to creditors who are expected to rely on the ring fencing measures); see also Memo from the Montana Public Service Commission to the Energy and Telecommunications Interim Committee, Ring Fencing Statutory Authority (Oct. 31, 2003) (on file with the Montana Legislature). Ring fencing received legislative attention in Montana in 2003, when a memorandum informed the Montana legislatures Energy and Telecommunications Interim Committee on ring fencing provisions. The memo recommended creating express statutory authority for the PSC to establish requirements for the corporate and financial separation of an individual regulated public utility company from businesses that are not regulated public utilities in order to ensure that the actions of corporate affiliates have no material negative impact on the financial integrity of the regulated public utility or its customers. 40 69-3-110. 41 Mike Dennison, PSC approves sale of Missoulas drinking water to Carlyle Group, The Missoulian (Dec. 13, 2012), http://missoulian.com/news/state-and-regional/psc-approves-sale-of-missoula-s-drinking-water-tocarlyle/article_f229390c-25c3-11e1-a7fe-0019bb2963f4.html. 42 Mike Dennison, Calif. Regulators approve sale of Mountain Waters Parent Company, Park Water to Carlyle Group, The Missoulian, (Dec. 2, 2011), http://m.missoulian.com/mobile/article_55dc33de-1ca3-11e1-8e5d0019bb2963f4.html.
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Department of Natural Resources and Conservation (DNRC). The water rights, in general, are unique due to seniority, number and source (See Chart 1-1). Many of the water rights are historic claims and subject to current adjudication proceedings, which places Carlyle in the position of arguing for how much water these rights entitle the company.43 In addition, Carlyle can apply to the DNRC to change the use of its water rights, which could result in making water available for sale or lease. The majority of Mountain Waters municipal water comes from groundwater stored in the Missoula Aquifer. 44 The utility also holds storage rights to surface water contained in eight lakes in the Rattlesnake National Recreation Area.45 The lakes hold 820,000 gallons of water in a wilderness area that serves to protect resources from development. The resources protected include the clean, free-flowing waters stored and used for municipal purposes. 46 Mountain Water also owns several other water rights associated with irrigation and wells.47 Two of the wells, located on Rattlesnake Creek, supply 16.3% of Mountain Waters total entitled volume.48 The priority dates for the water rights that serve the two wells are 1866 and 1887, which are among the most senior dates for the area.49
43
Montana University System Water Center, Wading into Montana Water Rights, http://www.montana.edu/wwwwdr/manuals/rights.pdf (accessed May 25, 2012). Adjudication proceedings involve a series of fact checking procedures administered by the Montana Water Court, with assistance from the DNRC, to assess the legality of the amount of water claimed by holders of water rights created prior to the 1972 Montana Water Use Act. These procedures involve performing on-site and historical research, reviewing applications, collecting objections, conducting resolution meetings, and holding final decision hearings. (A decree is the final product of a basin adjudication. To reach completion, a decree progresses through several stages: examination temporary preliminary/preliminary decree public notice hearings and final decree.) 44 Missoula Valley Water Quality District, What is the Aquifer?, http://www.co.missoula.mt.us/wq/FAQs/pdfs/WhatistheAquifer.pdf (accessed 3/12/2012). Missoula sits on a glacially formed, shallow aquifer that provides easy access to drinking water; see also William W. Woessner, Missoula Valley Aquifer Study: Hydrogeology of the Eastern Portion of the Missoula Aquifer, Missoula County, Montana, iv (Water Development Bureau, Montana Department of Natural Resources and Conservation 1988). The total volume of the aquifer is unknown as it is stratigraphically complex, and reflects site specific depositional environments. The water table has lowered over the years affecting aquifer recharge. Studies show that since 1983, the main water producer in the valley, Mountain Water Company, more than doubled its groundwater pumping rate. As a result, a general lowering of the water table occurred at Mountain Water Company wells. However, mass balance calculations show that the primary reason for lowered aquifer recharge rates is related to fluctuations in precipitation and yearly flows of the Clark Fork River. 45 Mountain Water Company, Rattlesnake Lakes, http://www.mtnwater.com/rattlesnakelakes.htm (accessed Mar. 9, 2012). 46 16 U.S.C.A. 460ll (2012). 47 Montana Department of Natural Resources and Conservation, Water Rights Query System, http://nris.mt.gov/dnrc/waterrights/default.aspx (accessed Mar. 9, 2012). 48 Id. 49 Id.
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Chart 1-1: Mountain Waters Water Rights Water Uses 68 municipal 10 irrigation 1 multiple domestic well 22 from 1868-1899 15 from 1900-1950 41 from 1951-1994 1 undated 47 from groundwater 16 from Rattlesnake Creek 9 from Miller Creek 7 from wells Total CFS: 226.37 Total GPM: 42,549.43 177,081.50 AF/yr
Priority Dates
Sources
Flow Rates Total Volume Diverted
The irrigation rights held by Mountain Water are used for flood and sprinkler irrigation of crops. Prior to the sale, Mountain Water applied to change the use of one of its irrigation rights to mitigation water, and the application is now pending approval by the DNRC. Mitigation water can be leased or sold to others. The water right proposed for change has a flow rate of 455 gallons per minute (gpm) and a volume of 341.32 acre-feet/year (af/y).50 While many of Mountain Waters water rights exist under modern-day DNRC permits, Mountain Water also claims many historic rights that have not yet been adjudicated. These historic rights were developed prior to the 1973 Water Use Act and DNRC permitting system. Discerning ownership of historic rights often involves discrepancies and questions of fact. For this reason, all claimed rights are subject to adjudication, overseen by the Montana Water Court. The process begins with an examination of all the claims in a basin by the DNRC to determine the accuracy of the claims. Then there is a period where the Water Court issues preliminary decrees and conducts evidentiary hearings related to particular water rights where questions or concerns have been raised. Parties have an opportunity to object to one anothers claims during this period. When all federal and tribal reserved water rights are finalized and any remaining objections are settled the Water Court issues a Final Decree. Mountain Waters water rights are located in basin 76HB, which is in the early stages of the adjudication process with a Temporary
50
Id.
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Preliminary Decree for the associated water rights. Carlyle, therefore, now defends the companys senior water right claims in the event any are subject to objection.51 Second only to the resale of the utility to the City, is the treatment of the water rights associated with the Rattlesnake drainage. The agreement between the Mayor, the Clark Fork Coalition and Carlyle included several terms to address concerns related to the use of Mountain Waters water rights. The agreement includes protecting those water rights by requiring they remain beneficially used for the Missoula community and that any proposed changes in use will be preceded by notice from Carlyle to the City and the Clark Fork Coalition.52 The agreement concludes that the water rights held by Mountain Water will not be diverted outside the valley and will remain in use for the benefit of Missoulas residents. Notably, these provisions appear to limit Mountain Waters ability to change its water rights in the Rattlesnake Creek watershed. Outside of that watershed, Carlyle retains broader ability to change its water rights to other uses so long as the changed uses remain local and benefit Missoulas residents. Despite the best efforts of the Mayor, stakeholders, and PSC, there may be ways to improve the approval of the sale. Examples of conditions from other similar sales will aid in a discussion of what measures could be taken to develop the manner in which sales of municipal drinking water to a private equity corporation in Montana are handled. However, in order to provide the proper foundation for such an analysis, an assessment of the greater context of the sale of Mountain Water to Carlyle is first necessary.
II. What does it mean for a private equity firm to own a city's drinking water in Montana?
A. Global to Local Context
Unlike typical private water sales and contracts for municipal water, the sale of Mountain Water to a private equity firm with no experience in water utility management presents a new set of questions regarding equity, access, and public interest. To understand what it means for a private equity firm to own a citys drinking water supply in Montana, this section will highlight the difference between water privatization and private equity ownership of municipal water. Next, this section will discuss other sales of municipal water supplies to private equity firms and the conditions imposed by the involved states utility oversight agencies. Understanding the broader view of water privatization and the new trend of private equity ownership of municipal water supplies will lay the foundation for a discussion of the Montana laws and regulations at
51
Montana Water Court, Guide Book, http://courts.mt.gov/content/water/guides/step_guide_book.pdf (accessed Mar. 9, 2012). 52 Agreement, supra n. 34. (Mountain Water will continue to beneficially use its Rattlesnake drainage water rights for the benefit of the Missoula community. Prior to Mountain Water using these rights in any manner other than it currently uses them (alternative supply, emergency supply, and diversion out of eight wells), no later than 90 days prior to such change in use, Mountain Water shall notify the City and the CFC [Clark Fork Coalition] of its plans and discuss those plans with the City and the CFC.).
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stake. In addition, it will provide examples of how other communities have approached serving the publics interest in reasonably priced and sustainable drinking water supplies. On a global level, there are eight main players in the private sector provision of municipal water: Suez, Veolia, Bechtel-United Utilities, Thames Water, the United Nations, the World Trade Organization, the World Bank and the International Monetary Fund.53 Each one has a slightly different approach and objective in regards to water management, but all work to provide water resource solutions to large populations.54 The principal private sector providers are Suez and Veolia, which hold about 70 percent of the privatized water systems Worldwide.55 Both are originally based in France, but have hundreds of subsidiaries scattered throughout each country they serve.56 The subsidiaries of both companies are further divided into multiple individual providers within each country. For example, Veolia owns Veolia Water North America, which is the leading water contract operator, serving more than 14 million people in about 650 North American communities.57 These companies offer water provision and waste removal to municipalities that struggle to balance scarce resources with increasing demands. Previous efforts to encourage privatization of community water systems on a global scale met with controversy, as seen in events such as the Cochabamba Water Wars.58 Today, the United Nations (the U.N.) promotes responsible business practices and encourages privatepublic partnerships as opposed to complete privatization. In addition, the U.N. has partnered with the private sector to form the CEO Water Mandate (Mandate), which seeks to create water sustainability solutions by "mobilizing a critical mass of business leaders... in partnership with the United Nations, civil society organizations, governments, and other stakeholders."59 Ideally the Mandate will offer solutions to questions of access to water and sanitation through multistakeholder partnerships. The Mandate offers six tenets to guide public-private partnerships in the provision of water, which are transparency, community engagement, public policy, collective action, and supply chain and watershed management.60 Nothing in the mandate, however,
53
Institute for Agriculture and Trade Policy, Privatizing U.S. Water, http://www.iatp.org/files/451_2_99838.pdf (accessed Mar. 13, 2012). 54 Id. 55 Global Research: Center for Research on Globalization, The Global Crisis: Food, Water, and Fuel. Three Fundamental Necessities of Life in Jeopardy, http://www.globalresearch.ca/index.php?context=va&aid=9191 (accessed Mar. 20, 2012). 56 Veolia Environnement, Veolia Environnement Worldwide, http://www.veolia.com/en/group/locations/ (accessed Mar. 20, 2012); see also Suez Environnement, Sites, http://www.suez-environnement.com/group/internationalpresence/sites/ (accessed Mar. 20, 2012). 57 Food and Water Watch, A Closer Look: Veolia Environnement, http://documents.foodandwaterwatch.org/doc//veolia.pdf (accessed Mar. 20, 2012); (citing Veolia Environnement. U.S. Securities and Exchange Commission. Form 20-F. April 19, 2010 at 2, 18 and F-132, Veolia Water North America (August 4, 2010)). 58 Cochabamba, supra n. 32. 59 United Nations, The CEO Water Mandate, http://www.unglobalcompact.org/Issues/Environment/CEO_Water_Mandate/ (accessed Mar. 20, 2012). 60 The CEO Water Mandate, The CEO Water Mandate: An initiative by business leaders in partnership with the international community, http://ceowatermandate.org/files/Ceo_water_mandate.pdf (accessed Mar. 20, 2012).
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addresses the control of municipal water supplies by private equity firms and the unique set of market-related interests held by these companies. The review, permitting, and regulation of private equity purchases of municipal water supplies would likely be served by guidance from the U.N. and the international business community. At the national level, the United States is experiencing a trend towards privatization of public water services.61 Data from 2000 indicated that water from privately owned water utilities or ones managed under a public-private partnership served nearly 73 million Americans.62 In addition, private water companies owned about 16% of the nations community water systems, produced 4.6 billion gallons of water per day and generated $4.3 billion per year as a business industry.63 Today, the largest private water provider is American Water Services, which serves 15 million people in thirty states and part of Canada.64 In 2009, 33% of all community water systems were privately held, approximately double the number since 2000.65 The regulation of private municipal water supply is done by the individual states and the level of regulatory control varies greatly as a result. Many states enable public entities to contract with private ones for long-term operation or lease of public water works facilities, or even to sell these facilities to private buyers, in some cases with few to no significant conditions to safeguard the public.66 Jurisdictions have traditionally been split regarding a citys power to sell a public water supply without express statutory authority.67 The current trend is to allow sales even without statutory authority, on the theory that water services are a proprietary, not governmental, function of municipalities and therefore can be transferred to private entities.68 However, other states have comprehensive privatization statutes that detail the types of privatization authorized, mandate specific standards and conditions, and provide procedures for the governance of local private water services.69 The New Jersey Water Supply Public-Private Contracting Act (Act), for example, has a series of twenty-seven statutes dealing with the provision of municipal water through solely private entities, or through public-private partnerships.70 Areas covered by the Act include qualifications of vendors, review criteria for
61
Craig Anthony Arnold, Water Privatization Trends in the United States: Human Rights, National Security, and Public Stewardship, 33 Wm. & Mary Envtl. L. & Policy Rev. 785, 758 (2009). 62 National Association of Water Companies, Private Water Service Providers Quick Facts, http://www.nawc.org/uploads/documents-and-publications/documents/document_ecf5b3ac-c222-4b6c-b99fa0128ae1e9aa.pdf (accessed Mar. 20, 2012) (citing US Environmental Protection Agency, 1995 and 2000 Community Water System Survey, and NAWC member data). 63 Id. (citing US Environmental Protection Agency, 2000 Community Water System Survey; NAWC Financial and Operating Data and US Environmental Protection Agency, 2000 Community Water System Survey). 64 American Water, Our States, http://www.amwater.com/working-with-us/our-states.html (accessed Mar. 20, 2012). 65 Arnold, supra n. 61 at 791-92. 66 Id. 67 Craig Anthony Arnold, Privatization of Public Water Services: The States' Role in Ensuring Public Accountability, 32 Pepp. L. Rev. 561, 576 (2005). 68 Id. (citing Boyle v. Mun. Auth., 796 A.2d 389 (Pa. Commw. Ct. 2002)). 69 Arnold, supra n. 61 at 793. 70 N.J. Stat. Ann. 58:26 (2012).
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proposals, negotiation procedures for contracts, public access to information, public hearing procedures, and approval and conditional approval requirements. The Act also provides mandatory provisions for contracts, including risk allocation procedures for financing and constructing water supplies, risk assessment for operation and management, provisions for default, reporting, contract renegotiation intervals, and employment contracts, and formulas for determining rates.71 In contrast, Montanas statutes do not deal specifically with the provision of municipal drinking water through private-public partnerships, but do leave the potential for the PSC to apply conditions similar to those in New Jersey under its general powers.72 In general, over the last twenty-five years, the debate over privatization of public water supplies in the United States has narrowed to three main arguments.73 First, water is seen as an economic opportunity that can be treated as a commodity through pricing, trading, and private sector management.74 Second, clean water is seen as a human right to which all people should have access to survive.75 Finally, water is held as a public trust, where the state maintains title to water resources and must manage them in the interest of greatest societal benefit.76 The traditional interpretation of the public trust doctrine in the United States emphasizes the importance of waterways for navigation and commerce, but recent legal activity has challenged this interpretation and argued for a broader view that encompasses protection of natural resources for current and future generations.77 These three themes are instructive when analyzing different approaches to the review and conditioning of the sale and purchase of public water at the state level. In Montana the sale of municipal water is an infrequent event. The sale of Mountain Water to Carlyle was the first sale of a municipal water utility in Montana since Dennis Washington sold Buttes water utility to the Butte-Silverbow city-county government in 1992.78 Privately held water utilities in all Montana cities were sold back to the public, with the exception of Missoula, beginning with Helena in 1864, Billings in 1885, Great Falls in 1895, Bozeman in 1900, and
71
Id. at 58:26-15. Mont. Code Ann. 7.13.43 & 44 (2011) (regulation of public provision of municipal water); 69-3-103 (regulation of private provision of municipal water through the PSC, including its duties and review procedures). 73 Barton H. Thompson, Jr., Water as A Public Commodity, 95 Marq. L. Rev. 17, 17-18 (2011). 74 Id.; see e.g., Jennifer Davis, Private-Sector Participation in the Water and Sanitation Sector, 30 Ann. Rev. Env't & Resources 145, 153-56 (2005) (detailing the privatization of water supply and sanitation services in both developing and industrial nations). 75 Id.; see Erik B. Bluemel, The Implications of Formulating a Human Right to Water, 31 Ecology L.Q. 957, 967-77 (2004) (general analyses of water as a human right); see also Peter H. Gleick, The Human Right to Water, 1 Water Pol'y 487 (1999). 76 Illinois Cent. R.R. Co. v. Illinois, 146 U.S. 387, 458, 13 S.Ct. 110, 120 (1892). 77 Thompson, Jr., supra n. 74, at 17-18; citing Alison Rieser, Ecological Preservation as a Public Property Right: An Emerging Doctrine in Search of a Theory, 15 Harv. Envtl. L. Rev. 393, 393-96, 402-09 (1991); see also Marks v. Whitney, 491 P.2d 374, 380 (Cal. 1971) (concluding that the public uses which the trust protects are sufficiently flexible to encompass changing public needs, including ecological preservation). 78 Bob Chaney, Water key to cities success through Montana history, The Missoulian (Jan. 9, 2011), http://missoulian.com/news/local/article_cdc10e0e-1bbb-11e0-a7a7-001cc4c03286.html.
72
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Hamilton in 1982.79 Today, Montana has 717 community water systems, of which only Missoulas is privately owned.80 In general, Montana appears to have little experience with the privatization of water utilities in todays context, particularly in comparison to states such as New Jersey. As a result, Montanas rules and regulations could better protect public interest concerns related to affordable, clean water. Furthermore, the sale of Mountain Water to an private equity firm is a unique type of sale with the potential for additional unforeseen effects. With Missoulas local water utility now owned by a private equity corporation, ratepayers have concerns that parallel those of other communities in the nation and the world whose water is privately controlled. Questions raised during the review of the sale of Mountain Water included issues such as rate increases, potential for water quality to suffer, limits on the power of private ownership, whether profits would be reinvested with the local utility, water exportation and sale, and the ability to obtain future public ownership. During the PSCs review of the sale, an activist group, Missoula Water Now, petitioned the PSC with 1,200 signatures requesting a firm statement from Carlyle that the public would obtain ownership by a date certain.81 While the concerns of the public were taken into account in the PSCs review, it did not require a guarantee of public ownership from Carlyle. The Mayor assured the public that the sale terms adequately addressed the provisions of the agreement reached between the City, Carlyle and the Clark Fork Coalition, and would allow the City to bid on the utility in the future.82 Questions lingered for the local community, though, regarding the adequacy of the PSCs review and the conditions placed on the sale to protect the publics interest. Questions include whether or not Carlyle will indeed sell to the City, and, if it does, whether the City will be able to afford to pay for the utility. In addition, fears surrounding an even more distant and geographically diffuse owner and its ability to properly manage the utility persist. Paramount is a concern that local control and input regarding drinking water supplies is absent and that regulations are inadequate to effectively meet the public interest in clean, affordable and sustainable drinking water. According to the National Research Council of the National Academy of Sciences, Communities are nearly always concerned about the possible loss of control over a vital public service.83 Typically, these fears can be mitigated by government restrictions that ensure the private provider will continue to meet service expectations. However, the natural monopolies of water utilities remain threatening to the public interest because contract terms governing the sales may serve as the only guarantee of an expected level of performance.84 Another concern is
79 80
Id. US Census 2009, Public Drinking Water Systems Number and Population Served by State (2009), http://www.census.gov/compendia/statab/2012/tables/12s0959.pdf (accessed Mar. 20, 2012). 81 Jenna Cederberg, Mountain Water sale gives Missoula hope of ownership, mayor says, The Missoulian, (Dec. 14, 2011) http://missoulian.com/news/local/mountain-water-sale-gives-missoula-hope-of-ownership-mayorsays/article_7fb6207a-2603-11e1-a431-0019bb2963f4.html. 82 Id. 83 National Research Council, Privatization of Water Services in the United States: An Assessment of Issues and Experience, http://www.nap.edu/openbook.php?isbn=0309074444 (accessed Mar. 15, 2012). 84 Id.
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the lack of recourse, requiring the sale to be carefully spelled out in legal and financial terms. Questions about transparency, the long-term protection of the water supply, and concern for utility workforce are also typical causes for distress.85 The following section will detail private sector provision of public water in the United States. The analysis will provide insight on the difference between the traditional form of privatized water and the new trend of private equity ownership of municipal water. It also will investigate sales similar to that of Mountian Water to Carlyle in order to provide a relevant platform from which to discuss any possible solutions to the concerns raised by such a transaction.
B. Forms of Privatization of Municipal Water in the U.S.

Private water utility service can take one of six forms. The first occurs when a public water utility outsources one or more specific services, such as water provision or sanitation, to a private firm. The second occurs when a private entity fully operates and maintains an existing facility (OMM contract). The third occurs when a private firm designs, builds, and operates a new facility, also known as a design-build-operate (DBO) contract. The fourth is a design-build-ownoperate-transfer (DBOOT) contract, where the utility is ultimately transferred back to the local government for operation after the initial setup period is complete. The fifth is a sale of an existing municipal water system to a private firm whose purpose is water supply.86 A newly emerging form is the sale of water utilities to private equity investment firms, exemplified by the sale of Mountain Water to Carlyle. Private equity purchases of water utilities began in 2005.87 Of the approximately 137 sales of water utilities tracked by Food and Water Watch, a non-profit advocacy group, from 1991 2010, all were sold to companies whose sole purpose is to provide water utility services.88 However, according to a 2011 survey of private equity firms by Janney Montgomery Scott, a financial services firm, water is now the number one private equity investment sector.89 As a result, entities with business purposes other than water supply are now acquiring water utilities. Examples of private equity acquisitions of water utilities are limited at this time. A total of three have occurred in the United States since 2005.90 Water utility purchases made by the private equity firms AIG Highstar, Macquarie, and JP Morgan all parallel the purchase of Park Water by Carlyle. A better understanding of these sales will yield a more thorough picture of what the
85 86
Id. Craig A. Arnold. Privatization of Public Water Services: The States Role in Ensuring Public Accountability, 32 Pepp. L. Rev. 561, 570 (2005). 87 Global Water Intelligence, Deal Flow Belies Private Equity Interest in Water, http://www.globalwaterintel.com/news/2011/34/deal-flow-belies-private-equity-interest-water.html (accessed Mar. 25, 2012). 88 Food and Water Watch, Trends in Privatization, http://www.foodandwaterwatch.org/factsheet/trends-in-waterprivatization/ (accessed Mar. 25, 2012). 89 Global Water Intelligence, Deal Flow Belies Private Equity Interest in Water, http://www.globalwaterintel.com/news/2011/34/deal-flow-belies-private-equity-interest-water.html (accessed Mar. 25, 2012). 90 Id.
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regulatory review and conditioning of such a sale should entail and how Montanas review of Carlyles purchase compares. In 2006, AIG acquired Utility, Inc. in the first private equity investment in municipal water service in the United States.91 The acquisition was similar to Carlyles purchase of Park Water. Like Carlyle, AIG Global Investment Group (AIGGIG) is made up of a group of international companies, managing approximately $532.9 billion in assets, with more than 1,600 employees in 44 offices around the world.92 Highstar acquired Utilities, Inc., an entity similar to Park Water, though larger, with approximately 305,000 customers in fifteen states. The sale was subject to review by each of the fifteen states public utility commissions. A sample of some of the fifteen states review procedures provides insight into the end structure of the sale. In Pennsylvania the sale was subject to customary conditions, including the receipt of Hart Scott Rodino approval and other regulatory approvals.93 The Pennsylvania Public Utility Commission raised several concerns regarding the transaction. Commissioner Wendell F. Holland issued a statement that AIGs corporate structure is complex and lacks transparency. It may not be in the public interest to have these regulated utilities as a part of an organization structured in this manner.94 Nevertheless, the commission approved the sale without conditions based on the fact that the utility would remain the same in terms of operation and management, just with a different funding source. In Kentucky the sale was approved on condition that, Highstar adequately fund, construct, operate and maintain treatment, transmission, and distribution systems; comply with all applicable Kentucky statutes and administrative regulations; and supply the needs of Water Services customers. Highstar objected to the condition, arguing that its subsidiary Hydro Star would deal with all management of the utility and it should therefore not be tied to the day-to-day functioning of the utilities. The Kentucky Attorney General and Public Service Commission did not agree and the conditions
91
CFO Magazine, Water for Profit, http://www.cfo.com/article.cfm/8582008?f=singlepage (accessed Mar. 25, 2012). 92 Alix Stuart, AIG Highstar Announces the Acquisition of Utilities, Inc. From Nuon, United Newswire (April 25, 2006), http://www.prnewswire.com/news-releases/aig-highstar-announces-the-acquisition-of-utilities-inc-fromnuon-56545537.html. AIG Highstar Capital II, L.P. (Highstar) is AIGs equivalent of Carlyles Western Water Holdings, Carlyles management entity for the water-oriented business being done under its Carlyle Infrastructure Fund. 93 Datamonitor, AIG Group Subsidiary Acquires Utilities, http://www.datamonitor.com/store/News/aig_group_subsidiary_acquires_utilities?productid=B5AEE456-4CC9432D-A96F-935443284C2B (accessed Mar. 25, 2012); see Federal Trade Commission, Hart-Scott-Rodino Premerger Notification Program, http://www.ftc.gov/bc/hsr/index.shtm (accessed 3/25/2012) (The Hart-ScottRodino Act established the federal premerger notification program, which provides the FTC and the Department of Justice with information about large mergers and acquisitions before they occur. The parties to certain proposed transactions must submit premerger notification to the FTC and DOJ. Premerger notification involves completing an HSR Form, also called a Notification and Report Form for Certain Mergers and Acquisitions, with information about each companys business. The parties may not close their deal until the waiting period outlined in the HSR Act has passed, or the government has granted early termination of the waiting period). 94 Statement of Chairman Wendell F. Holland, A-210072F0003, A-230063F0003, A-230013F0004, A-210093F0002 (Pa. Pub. Serv. Commn. Mar. 16, 2006).
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remained in place. In Florida, a citizen of one of the sixteen utilities in the state objected to the sale based on two issues: (1) lack of response to water quality, which exceeded state standards for levels of trithalomethane (TTHM), and (2) lack of operational utility experience of the buyer.95 The Florida PSC found that the citizen did not allege facts sufficient to show that he has a substantial interest in the outcome of the proceeding and that the buyer had provided sufficient details to show it was experienced in water and wastewater operations.96 The Florida PSC approved the sale without condition reasoning that the transfer of control is two steps removed from the operating utility and that the transfer would not cause any change in how the utilities were managed.97 All fifteen public utility commissions ultimately approved the sale and Utility, Inc. became an asset of AIG. Five years later, on November 14, 2011, Highstar announced its plan to sell Utilities, Inc. for approximately $500 million.98 Just three months later on February 20, 2012, Corix Utilities agreed to acquire the entire membership interests in what is now the parent company of Utilities, Inc., known as Hydro Star, from Highstar Capital Fund II.99 The sale raised concern regarding the potential for private equity interests to flip water utilities and further dilute public control over drinking water supplies in the process. Corix is a franchisee/owner/developer/operator whose sole purpose is the provision of sewer, water and related environmental services.100 A company whose primary purpose is the provision of water utility services may be able to provide improved service and more financial resources at lower costs than can be achieved by local governments.101 Corix asserts that the sale, align[s] well with Corix's commitment to working closely with local communities in providing sustainable utility infrastructure solutions across North America.102 It is not clear from the sale whether the
95
Order Granting Motion to Dismiss and Approving Application for Transfer of Majority Organization Control: Reissued, 2006, 050499-WS at 3 (Fla. Pub. Serv. Commn. Feb. 9, 2006). 96 Id. at 6. 97 Id. 98 Research Views, Corix Utilities To Acquire Hydro Star From Highstar Capital Fund II, http://www.researchviews.com/energy/cleantechnology/DealReport.aspx?sector=ct&DealID=180579 (accessed Mar. 25, 2012). 99 Id. 100 Corix Group of Companies, Corix Companies, http://www.corix.com/corix-companies/default.aspx (accessed Mar. 25, 2012). 101 State Environmental Resource Center (SERC), Water Privatization: Policy Issues Package, http://www.serconline.org/waterPrivatization/fact.html (accessed Mar. 25, 2012); (citing Erika Hobbs, Low Rates, Needed Repairs Lure Big Water to Uncle Sams Plumbing, The Center for Public Integrity, http://www.icij.org/water/report.aspx?sid=ch&rid=54&aid=54 (accessed Mar. 25, 2012). Not all contracted private water companies are able to provide better service at cheaper rates. For example, Atlanta, Georgia contracted with United Water in 1999 for the provision of water services to the city. The deal was a twenty-year, $21.4 million/year public-private partnership to manage the citys water system. After four years, an audit of the companys practices revealed it was only saving the city about half the $10 million initially promised by United Water. The audit also revealed poor service, fraudulent billing, and poor water quality. Mayor Shirley Franklin canceled the contract on January 24, 2003.) 102 Reuters, Correction from Source: Corix Utilities to Acquire Utilities, Inc. From Highstar Capital, http://www.reuters.com/article/2012/02/20/idUS146307+20-Feb-2012+MW20120220 (last updated Feb. 20, 2012).
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underlying water rights were transferred as part of the utilities sold, as was the case in Carlyles purchase of Mountain Water. Macquaries purchase of Aquarion in 2006 was very similar to AIGs acquisition of Utility, Inc. Aquarion operates in New England and was one of the ten largest privately owned municipal water suppliers in the US at the time of the sale.103 Similar to AIG and Carlyle, Macquarie is a global provider of banking, financial, advisory, investment and funds management services with more than 70 offices in 28 countries.104 The sale fell under the purview of the public utility commissions of Connecticut, Massachusetts, New York and New Hampshire.105 The New York and Connecticut commissions approved the transfer of ownership without conditions. Connecticut Department of Public Utility Control commissioner John Betkoski indicated that, Macquarie's decision to keep current management at Aquarion, along with its investment in other U.S. utilities, was a factor in his decision to approve its purchase of the Connecticut-based water company.106 The New York Public Service Commission Chairwoman Patricia L. Acampora, stated, The ownership transfers will benefit customers because they provide for geographic aggregation and a consolidation of smaller water companies into larger water utilities with greater resources in such areas as security, reliability, water quality, access to capital and research and development.107 The New Hampshire PSC, in its review, required inquiry into whether the sale not only had no adverse impacts but was also lawful, proper and in the public interest.108 A settlement agreement reached between Aquarion and New Hampshire required Aquarion maintain the companys current management structure, maintain a customer advisory council, not seek to recover costs of the acquisition or maintenance of pension plans through rates, and continue to maintain an office for bill payments and customer service in New Hampshire.109 The settlement agreement also required the New Hampshire Public Utility Commission (PUC) make a finding that the indirect acquisition of Aquarion-NH by Macquarie would not result in adverse impacts on rates and was consistent with the publics interest. The PUC based its conclusion on the companys representations that no change in any terms or conditions of water service would occur and that the new ownership would provide an efficient capital structure that could fund needed capital additions to meet new state and federal standards for drinking water.110
103
Macquarie, Macquarie Bank-led consortium to acquire US water utility, Aquarion Company, http://www.macquarie.com/mgl/com/news/2006/20060224b.htm (accessed Mar. 25, 2012). 104 Id. 105 Id. 106 CFO Magazine, Water for Profit: Undaunted by tight regulations and huge infrastructure costs, companies dive into the water business, http://www.cfo.com/printable/article.cfm/8582008/c (accessed Mar. 25, 2012). 107 PSC Approves Water Company Stock Transfer, No. 07-W-0176 (N.Y. Pub. Serv. Commn. Apr. 21, 2012). 108 Aquarion Water Company of New Hampshire, Petition for Approval of Indirect Acquisition by Macquarie Utilities, Inc., Order Approving Acquisition and Settlement, No. 24,691(N.H. Pub. Util. Commn. Oct. 31, 2006). 109 Id. 110 Id.
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A search of the Massachusetts Department of Public Utilities (Department) docket database did not reveal any records detailing review and approval of the transfer of ownership from Aquarion to Macquarie in that state.111 However, it does contain complaints of Aquarions service after the companys transfer to Macquarie. In 2012, twenty customers of the Town of Hull, Massachusetts requested review of the quality of the service provided by Aquarion in regards to a water main break in 2009.112 The Department found that while there was nothing deficient in Aquarions maintenance practices the Company did perform inadequate flushing of water mains that resulted in greater than necessary customer inconvenience after the break.113 In addition, the Companys communication with town officials and the general public after the water main break was found to be insufficient.114 Other municipalities in Massachusetts, particularly in the Boston area, have also issued complaints about Aquarion since the transfer in ownership to Macquarie. There is some indication that these towns are now seeking to distance themselves from Aquarion-owned infrastructure due to rate increases.115 The mayors of several towns in Massachussetts are seeking ways to purchase their towns water utilities back from Aquarion. While they have not done anything official, there is area-wide concern that Aquarion may be a poor choice for water provision. As one town manager explained, One has to be very concerned when other municipalities are making decisions about leaving Aquarion. Common sense signals a warning sign.116 Prior to Carlyles purchase of Park Water, the most recent acquisition of municipal water by a private equity firm was JP Morgan/Water Asset Managements merger with SouthWest Water Co. (SWWC) in 2010.117 Like AIG, Macquarie and Carlyle, JP Morgan is a private equity firm; however, its investment strategy is based solely on real estate and infrastructure. As of June 2010 the company had approximately $44.6 billion in real estate and infrastructure assets under management.118 SWWC is based in Los Angeles, California and operates 130 regulated water
111
Massachusetts Department of Public Utilities, Water Utilities Docket, http://www.env.state.ma.us/DPU_FileRoom/frmDocketLookupSP.aspx (accessed Mar. 25, 2012). 112 Petition of Twenty Customers in the Town of Hull, Massachusetts, to the Department of Public Utilities, No. D.P.U. 09-48 (M.A. Dept. Pub. Util. Mar. 30, 2012). 113 Id. 114 Id. 115 Jessica Bartlett, Officials weigh idea of buying water system, The Boston Globe (Jan. 25, 2012), http://articles.boston.com/2012-01-26/south/30662010_1_water-system-aquarion-water-rate-increases. 116 Id. 117 National Regulatory Research Institute, Private Equity Buyouts of Public Utilities: Preparation for Regulators (Dec. 2007), http://www.dps.ny.gov/07M0906PolPnlEx22.pdf (The type of merger on which we focus here, private equity buyouts of public utilities, falls into the conglomerate merger, in which the acquiring firm purchases operations that are dissimilar to its own. In a private equity buyout, the acquiring firm is a group of investors. These investors are known as the equity partners. The group includes the general partner (who has responsibility for managing the investment, i.e., determining how the acquired firm will be operated), plus other partners (called limited partners) who contribute capital, but are otherwise passive owners. The business of private equity firms is investing, and is different from the business of, for example, manufacturing or transportation, or operating a public utility). 118 Businesswire, SouthWest Water Announces Completion of Merger, http://www.businesswire.com/news/home/20100913006921/en/SouthWest-Water-Announces-Completion-Merger (accessed April 26, 2012).
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and wastewater systems representing about 160,000 residential and business connections in Alabama, California, Mississippi, Oklahoma and Texas.119 The sum for the merger was approximately $275 million in cash, and it functioned similarly to those previously discussed, with individual state utility commissions review and approval.120 During the review of the sale, the California Public Utilities Commission (CPUC) received a protest from the Division of Ratepayer Advocates (DRA), Californias equivalent of Montanas MCC. The DRAs concern dealt with intercompany relationships among the parties, and the effect these might have on ratepayer interests.121 To address these concerns the CPUC reviewed the transaction based on whether it would adversely affect the public interest. The CPUC found that all indications are that the transfer will provide greater access to needed capital, and that its customers will benefit from the resultant improvements.122 A settlement agreement between the state and SWWC supplemented the transaction and provided nineteen general conditions and sixteen transaction rules. The conditions dealt primarily with customer service, basis for rates, outstanding debt, and the capital needed to run the public utilities in question. While the conditions are similar to the ringfencing provisions imposed on the sale of Mountain Water to Carlyle, none were designed to specifically insulate the utility from the outside business dealings of JP Morgan. The transaction rules covered access to information, treatment of employees and affiliates, transfer of property and debt, confidentiality and pricing of services.123 Shareholders of SWWC are now calling the terms of the sale into question. According to the Shareholders Foundation, a private foundation providing information on asset management, a law firm is investigating whether the sale terms were fair. The shareholders argue the sale at a value of $11.00 per share may have been opportunistic in light of the current economic downturn. The undisclosed law firms investigation of JP Morgan concerns whether the SWWC Board of Directors breached their fiduciary duties to SWWC shareholders by failing to [have] adequately shopped SWWC before entering into this transaction and whether the institutional investors advised by J.P. Morgan Asset Management may be underpaying for
119 120
SouthWest Water Company, Who We Are, http://southwestwater.com/who-we-are/ (accessed Mar. 25, 2012). Shareholder Foundation, SouthWest Water Company Board Under Investigation, http://shareholdersfoundation.com/caseinvestigation/southwest-water-company-board-under-investigation (accessed Mar. 25, 2012) [hereinafter Shareholders Foundation]. 121 Joint Application of Suburban Water Systems (U339W), SouthWest Water Company, SW Merger Acquisition Corp., IIF Subway Investment LP, and USA Water Services, LLC for Commission Authorization of a Transfer of Indirect Control of Suburban Water Systems, No. 10-04-009 (Cal. Pub. Util. Commn. Sept. 2, 2010). 122 Id. 123 California Public Utilities Commission, Water Division, Non-Tariffed Service Offerings and Information on Affiliate Transactions, Standard Practice U-21-W, http://docs.cpuc.ca.gov/published/Graphics/123523.PDF (Oct. 2005). California has since passed general transaction rules for all water and sewer companies with regard to transactions with a parent company and/or affiliates, and with regard to the use of regulated assets and personnel for non-tariffed utility products and services. These rules cover the same general areas as stipulated to in the transactional rules in the SWWC transaction.
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SWWC, thus unlawfully harming SWWC shareholders.124 An argument is being put forth by the investigating law firm that independent financial review of due diligence practices in the valuation of sales is needed in order to maintain appropriate pricing for water resources.125 The CPUC also reviewed the sale of Park Water to Carlyle due to the fact that Park Water owns California water utilities as well. Similar to the previous private equity transactions, a settlement agreement was relied upon to address public interest concerns.126 The agreement between Park Water and its California subsidiary, Apple Valley Ranchos Water Company, Carlyle and the DRA established the regulatory practices and policies that will govern rates, and required that rates will only be increased in accordance with CPUC approval.127 The agreement also addressed the adjudication of the Mojave Basin where the water rights held by Apple Valley Ranchos Water Company are located. The CPUC held that, These water rights cannot be encumbered, diminished, or transferred by Ranchos, Western Water Holdings LLC, Carlyle Infrastructure Partners Western Water L.P., or Carlyle Infrastructure Partners, L.P., without specific order by this Commission.128 In addition, the CPUC required Carlyle submit a proposed plan for orderly transition from Park Waters ownership within eighteen months of the transactions completion.129 The above transactions illustrate some typical conditions imposed on a private equity companies purchasing municipal water utilities. However, private equity acquisitions may require additional types of conditions as well. Areas that remain of concern include the potential for flipping or quickly reselling a water utility, as seen in the case of AIGs purchase of Utility, Inc. On the one hand, such a transfer of ownership may improve public input and stable provision of efficient services. On the other, it could dilute provisions that protect the public interest. Another concern is the potential for unreasonable rate increases, as seen in the sale of Aquarion to Macquarie. An undervalued sale, as potentially occurred in JP Morgans acquisition of SWWC, also remains troubling. Finally, in the review of Carlyles purchase of Park Water, the water rights included in the transaction were encumbered by the adjudicatory judgments for the Mojave Basin. The publics interest may best be served when water rights sold are backed by at least a good faith defense of those water rights in any pending adjudication proceedings. Further analysis of the laws and regulations governing municipal water supplies in general and, in Montana specifically, will assist in determining how future private equity ownership of municipal water in Montana should be structured.
124
Shareholders Foundation, surpa n. 119. Id. 126 California Public Utilities Commission, Findings of Fact, http://docs.cpuc.ca.gov/PUBLISHED/FINAL_DECISION/154603-09.htm#P184_37517 (Dec. 1, 2011). 127 Application of Western Water Holdings, LLC, PWC Merger Sub, Inc., Park Water Company (U314W) and Apple Valley Ranchos Water Company (U346W) for Authority for Western Water Holdings, LLC to Acquire and Control Park Water Company and Apple Valley Ranchos Water Company, Application No. 11-01-019 (Cal. Pub. Util. Commn. Jan. 21, 2011). 128 Id. 129 Id.
125
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III. Laws and Regulations at Stake

A. Montanas Review
Successful private sector provision of water depends, in part, on the way in which the governing body overseeing the sale performs its review. The provision of water is not like the provision of goods and services typical of the private sector. Safe, clean drinking water is one of lifes most basic necessities and poor planning and management can result in complications for society beyond market trends and economic declines.130 In addition, water is always in demand and provides a unique business model in that it allows for a natural monopoly.131 Furthermore, water rights, under western water law, are a usufructory property right, where the owner has the right to enjoy the water, but property ownership belongs to the state.132 The sale of a utility where the underlying water rights are a part of the transaction triggers the states duty to protect interests associated with water as a common resource. There is judicial authority recognizing a public trust in a citys water system, which prohibits city officials from avoiding trust duties by transferring their power to private entities.133 As a result, there is a fiduciary component to the review of a public water utility in order to protect long-term enjoyment of the water. The potential for litigation may be prompted where water rights, environmental impacts, and other public interests are not properly taken into account. In regards to regulating sales of public water utilities, jurisdictions in general have traditionally been split over whether a city has the power to sell a public water supply without express statutory authority.134 The current trend, though, allows sales even without statutory authority, on the theory that water services are a proprietary, not governmental, function of municipalities and therefore can be transferred to private entities.135 The Montana Constitution protects, All surface, underground, flood, and atmospheric waters within the boundaries of the state and holds they are the property of the state for the use of its people and are subject to appropriation for beneficial uses as provided by law.136 This provision has been held to include a public trust over state waters.137 Municipal drinking water is a part of the state waters held in trust for the public. The state therefore has fiduciary obligations to meet when municipal drinking supplies are sold. Craig Arnold in his article Water Privatization Trends in the Unites States: Human Rights, National Security, and Public
130
Arnold, supra n. 86 at 576 (citing Leonard S. Hyman et al., The Water Business: Understanding the Water Supply and Wastewater Industry 23 (1998). 131 Id. at 579. 132 Symposium, Changing Conceptions of Water in the Law, Managing Water Rights Using Fishing Rights as a Model, 95 Marq. L. Rev. 91, 92 (2011) (citing Tulare Lake Basin Water Storage Dist. V. U.S., 49 Fed. Cl. 313, 318 (2001)). 133 Id. (citing Pikes Peak Power Co. v. City of Colorado Springs, 105 F. 1 (8th Cir. 1900); Huron Waterworks Co. v. Huran, 62 N.W. 975 (S.D. 1895). 134 Id. at 576. 135 Id. (citing Boyle 796 A.2d at 389). 136 Mont. Const. art. IX, 3(3) (2011). 137 Montana Coalition for Stream Access, Inc. v. Curran, 682 P.2d 163 (Mont. 1984).
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Stewardship, argues that public stewardship of water imposes a fiduciary duty on state and federal governments to provide secure, stable and sustainable water supplies for the benefit of the public.138 He argues this fiduciary duty imposes the duty of security, conservation, sustainability, equity, investment, and long-range, place-based planning.139 The recent sale of Mountain Water to the Carlyle Group raises a question about whether such a fiduciary duty was adequately addressed by Montanas review procedures. The review of public utility sales to private interests in Montana seeks to balance the interests of ratepayers with those of the private companies providing municipal water.140 Montana sets forth in statute how a city can purchase a private water supply system or acquire it through eminent domain.141 In contrast, the PSC oversees privately owned water utilities, which is primarily concerned with the review and approval of rate change requests. 142 Unlike states like New Jersey where the sale of municipal water to private entities is expressly discussed in statute, Montanas approach is less clear. Furthermore, the statutes and regulations currently in effect appear to anticipate a sale of a municipal water supply from a public entity to a private one or vice versa, but leave the possibility of a private-to-private transfer to the undefined discretion of the PSC.143 The relevant portions of Montanas statutes dealing with public water supplies pertain to the rates charged for services.144 In Montana, a municipal government must take into account the service provided and benefit received when establishing rates and charges for service, and those charges must be equitable in proportion to the services and benefits rendered.145 In setting rates for services and facilities, the government should ensure rates are sufficient to provide enough revenue to cover the cost of operation and maintenance, plus a portion paid into the sinking fund, and for accumulation to pay for depreciation and replacement of systems as necessary.146
138 139
Arnold, supra n. 61 at 790. Id. 140 Montana Public Service Commission, How the Public Service Commission Works, http://psc.mt.gov/Commission/workings.asp (accessed May 9, 2012). 141 Mont. Code Ann. 7-13-4403, 4404 (2011). 142 Mont. Code Ann. 69-2-101 (2011); Admin. R. Mont. 2501 2514 (2011). 143 Mont. Code Ann. 7.13.43 & 44 (2011) (regulation of public provision of municipal water); Mont. Code Ann. 69-1-110 (2011) (regulation of municipal water through the PSC, including its duties and review procedures). 144 Mont. Code Ann. 7-13-43 (2011). 145 Mont. Code Ann. 7-13-4303(1) (2011). 146 Mont. Code Ann. 75-6-323 (2011) (Sinking fund for revenue bonds. At or before the time of the issuance of any bonds under this part, the governing body of the authority shall by resolution or in the trust indenture provide for the creation of a sinking fund and for monthly payments into the sinking fund from the revenue of the water supply, wastewater transportation, or treatment system operated by the authority sums in excess of the cost of maintenance and operation of the properties that will be sufficient to pay the accruing interest and retire the bonds at or before the time that each will respectively become due and to establish and maintain reserves for the bonds. All sums that are or should be, in accordance with the provisions, paid into the sinking fund must be used solely for payment of interest and for the retirement of the bonds at or prior to maturity, as may be provided or required by the resolutions.); see also 7-13-4307.
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In contrast, the pertinent statutes regarding the PSCs review of sales of private municipal water supplies set forth the procedures for rates, noticing, public input, and the role of interveners.147 Nowhere are any guidelines for the review criteria or conditions that should be imposed on a sale of a private municipal water supplier to another private entity. The PSC is given the general power to adopt reasonable rules relative to inspections, tests, audits, and investigations.148 The PSC may not set unreasonable rates, and if any rate is found to be unreasonable it is per se unlawful.149 The MCC can contest any rate increase, and the PSC must defer to the MCCs representation of consumer interests.150 The PSCs authority to adopt reasonable rules is expressed in a series of regulations under the Administrative Rules of Montana, which govern the way the PSC reviews private water utilities.151 The regulations provide general rules for how water service is provided, discontinued, and rules for flat and metered rates.152 However, the PSCs jurisdiction to review sales of privately held utilities would benefit from more express authority. In addition, more clearly defined review criteria detailing the terms and conditions of private-to-private transfers would improve predictability. In the sale of Mountain Water to Carlyle, the first legal issue to be raised was the authority of the PSC to review and approve the sale. Mountain Waters counsel John Alke stated, Theres always been a question in Montana about the PSCs authority over transfers. There is no statute for the jurisdiction.153 Mountain Water asked the PSC to waive any jurisdiction it may have and to defer review to the CPUC. Montanas statutes provide the PSC with general power to assert jurisdiction where necessary, stating, The commission is hereby invested with full power of supervision, regulation, and control of such public utilities, subject to the provisions of this chapter and to the exclusion of the jurisdiction, regulation, and control of such utilities by any municipality, town, or village. 154 The statute broadly describes the PSCs jurisdiction to regulate and control public utilities. Although oversight over utility sales is not specifically mentioned, the PSC interprets its authority to include the review of utility sales. The PSC held that its authority over the sale and transfers of assets or utilities can be inferred from the unique status of public utilities.155 Back in 1930, the Montana Supreme Court
147 148
Mont. Code Ann. 69-3-102 to 3-106 (2011). Id. at 69-3-103. 149 Id. at 69-3-201. 150 Id. at 69-2-102. 151 Admin. R. Mont. 38.5.25 (2011). 152 Id. at 38.5.2501-2514; 38.5.2506 (A utility may adopt, subject to the approval of the Commission, either a flat rate or a meter rate schedule, or both. In addition to the general flat rate and meter rate rules, a utility may adopt, subject to the approval of the Commission, other rules to be designated as special rate rules, to fit local conditions.). 153 Jenna Cederberg, Mountain Water Co. asks PSC to waive jurisdiction, approve sale to Carlyle Group, The Missoulian (Jan. 28, 2011), http://missoulian.com/news/local/article_ee3d0b5c-2a9c-11e0-b12c001cc4c002e0.html#ixzz1XP0yxx9v. 154 Mont. Code Ann. 69-3-102 (2011); supra n. 37 (discussing the PSCs jurisdiction to rule on the terms of the sale). 155 In the Matter of the Consolidated Petition by Mountain Water Company for Declaratory Rulings and Application for Approval of Sale and Transfer of Stock in Park Water Company, Regulatory Division Docket No. D2011.1.18, Order No. 7149c (Mont. Pub. Serv. Commn. Sept. 14, 2011).
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affirmed this special status in Great Northern Utils. Co. v. Public Serv. Commn.156 The Court held, When one devotes his property to a use in which the public has an interest, he in effect grants to the public an interest in that use, and must submit to be controlled by the public for the common good to the extent of the interest he has thus created[.]157 The PSC based its decision on the fact that Mountain Water is a regulated and public utility.158 The PSC also relied on its history of taking jurisdiction in merger and acquisition cases.159 The PSC went on to complete a one-year review of the sale of Mountain Water, including notice to the public of all activity during the review, allowance for a range of different stakeholders to intervene, public hearings, questioning of the parties and their experts, discovery of documents, and the imposition of conditions on the final approval of the sale. It also provided an important role for the MCC which ensured adequate ring-fencing provisions were put in place.160 In addition to the review performed by the PSC, the settlement agreement between Carlyle, the Mayor, the Clark Fork Coalition and the ring-fencing stipulations made between Carlyle and the MCC further control the sale and protect the public interest. Based on the other private equity sales reviewed above, it appears the use of settlement agreements and stipulations are typical in addressing case-specific concerns regarding private equity ownership of a public water supply. In the sale of Mountain Water to Carlyle, Montanas rules and regulations structured the authority for the PSCs review, but the individual agreements between the Mayor and Carlyle and the MCC and Carlyle provided the controlling terms. The MCCs stipulated conditions on the sale focused on ring-fencing the utility, which will help Mountain Water operate independently from Carlyle and its affiliates. The provisions will also ensure ratepayers are better protected from any unknown consequences of Carlyles ownership. However, the MCC originally recommended several provisions that would more thoroughly protect against risks associated with Carlyles debt management. The MCCs expert
156 157
Great Northern Utils. Co. v. Public Serv. Commn, 88 Mont. 180, 205, 293 P. 294, 298 (1930). Id.; see also 69-3-103 (2011). The PSCs authority does not include judicial power and its decisions may be contested. nothing in this chapter shall be construed as vesting judicial powers on said commission [PSC] or as denying to any person, firm, association, corporation, municipality, county, town, or village the right to test in a court of competent jurisdiction the legality or reasonableness of any fixed order made by the commission in the exercise of its duties or powers; see also In the Matter of the Consolidated Petition by Mountain Water Company for Declaratory Rulings and Application for Approval of Sale and Transfer of Stock in Park Water Company, Regulatory Division Docket No. D2011.1.18, Order No. 7149c (Mont. Pub. Serv. Commn. June 28, 2011). To make a determination regarding its jurisdiction to review the sale, the PSC held a regularly scheduled business meeting on June 28, 2011 and voted unanimously to deny Mountain Waters request for a declaratory ruling. 158 Id. 159 Mont. Pub. Util. Commn., PSC Asserts Jurisdiction in Proposed Mountain Water Sale, http://psc.mt.gov/news/pr/20110628_PSC_Asserts_Jurisdiction_in_Proposed_Mountain_Water_Sale.pdf (June 28, 2011) (The jurisdiction of the Commission over the sale and transfer of Park stock is based on Mountain Waters status as a regulated subsidiary of Park and its public utility status in Montana.). 160 Ringfencing, supra n. 32. Ring-fencing is a legal and financial arrangement that separates the business dealings of a regulated company (typically a utility) from the general business of an overarching parent company. Ringfencing seeks to ensure that a utility is managed for the purpose of service delivery and that this purpose is not undermined by the business dealings of its parent company. It protects not only the company and its assets but also protects ratepayers from wide fluctuations in rates when the market becomes unstable.
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John W. Wilson stated, All the major rating agencies stress limitations on dividend payment to parent companies as a key means of maintaining strong utility capitalization and credit ratings. They also support strict limitations on affiliate loans, money pools and other financial support, as well as mandated capital structure limits.161 The MCC originally requested the ability to review debt and cash management practices during market changes, to have unrestricted access to documents provided to bond and rating analysts, to receive notice of contemplated fund transfers, and to review any intra-corporate financing with Carlyle affiliates.162 The final version of the stipulations is less restrictive than the original and reduces cash management review to an opportunity to review instead of unrestricted access to documents provided to bond and rating analysts. Notice of contemplated fund transfers is also less specific and intra-corporate financing reviews are more cursory.163 Predictability about the type of ring-fencing provisions likely imposed on the sale of a water utility may be improved if set forth in statute or regulation. At the least, it appears ring-fencing may be worth defining in statute and clearly establishing as a tool available for use by the PSC and MCC. The agreement among Carlyle, the Mayor and the Clark Fork Coalition also established the terms of the sale. The Agreement generally states that Carlyle will at any time consider in good faith any offer from the City to purchase Mountain Water, which could include the company itself, the water system assets (water rights and infrastructure), or company stock.164 This provision essentially states what would already be the case between an ordinary seller and buyer that a seller would consider offers to purchase its property. The City presumably requested this provision because Mountain Waters current owner consistently refused to consider purchase offers from the City. The Agreement lays out two additional scenarios under which the City may have an opportunity to purchase Mountain Water. First, if any offers are made to purchase Mountain Water separately from Park Water, the City will be notified prior to any sale and if the City makes a reasonable offer Carlyle must accept it. Second, if Carlyle later chooses to offer Mountain Water, Park Water, or any future parent company of Mountain Water for sale jointly, the City will be notified. Carlyle will consider the Citys offer in good faith but does not have to accept it. Furthermore, the agreement provided for certain protections of the water source. The parties agreed that the future use and control of Mountain Waters water rights are ultimately a matter for the Montana Water Court and DNRC to review. Carlyle did agree to provide notice if any changes in the use of existing water rights should occur and that all of Mountain Waters water rights will continue to be used beneficially . . . to provide water for its customers and the Missoula community and will not be diverted outside of the Missoula area for use elsewhere.165
161 162
Id. In the Matter of the Consolidated Regulatory Division Petition by Mountain Water Company for Declaratory Rulings and Application for Approval of Sale and Transfer of Stock in Park Water Company, Docket No. D2011.1.8 (Mont. Pub. Util. Commn. Jul. 29, 2011). 163 Id. 164 Agreement, supra n. 24. 165 Id.
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The PSCs review of the sale of Mountain Water to Carlyle, and the important roles played by the MCC, the Clark Fork Coalition and the Mayor, improves upon some of the similar efforts seen in previous private equity acquisitions of municipal water supplies. In particular, the inclusion of ring-fencing stipulations and agreement terms prohibiting out-of-basin transfers of the water rights obtained through the sale further protect the publics interest in affordable, sustainable drinking water. However, concerns remain given the potential for increased water rates, decreased transparency, and the unknown consequences of private equity ownership of municipal water. Issues include the potential for Park Water to be sold to another entity in a way that precludes the Citys ability to purchase Mountain Water separately. In addition, there is concern that Carlyle will seek unreasonable rate increases and that public input will not have a significant impact on future rate and ownership decisions. Other fears deal with whether claimed water rights will be properly defended in adjudication proceedings. In general, Carlyle may not be able to effect a smooth transition in ownership and perform as well as, if not better than, Mountain Water, due to its lack of experience. Will Carlyle be able to efficiently update the Citys infrastructure? Will water quality suffer due to the change in ownership? Will the agreement and ring-fencing terms prevent negative impacts from Carlyles outside dealings?
B. Opportunities for Improvement

The privatization of municipal water through private equity acquisitions is a new trend and, as a result, the regulatory measures needed to address related concerns remain in flux. The positive side of private equity ownership of public utilities is that it can make more capital available for needed and expensive investments, such as improvements to failing infrastructure. However, it also has the potential to undermine public interests with decreased transparency, uncertainty about future ownership, potential for unnecessary rate increases, and lack of local control in decision making. Despite the lack of knowledge about how private equity ownership performs over the long run, it is clear that, in general, the privatization of municipal water is best managed through comprehensive state legislation that sets forth the types of privatization authorized and the standards, conditions and procedures for governance of locally privatized municipal water.166 Improvements in Montanas review may help address future private equity sales and future reviews involving Mountain Waters services. In addition, communities in other areas may benefit from an analysis of what measures could advance the review of private equity purchases of municipal water supplies. The conditions placed on sales of other utilities to private equity firms discussed above, all help meet the fiduciary duty governments owe the public in providing safe, affordable and sustainable municipal drinking water.167 Measures used include:
166 167
Arnold, supra n. 86 at 576. Stephen G. Hill, National Regulatory Research Institute, Private Equity Buyouts of Public Utilities: Preparation for Regulators, hhtp://www.dps.ny.gov/07M0906PolPnlEx22.pdf (last updated December, 2007). According to the National Regulatory Research Institute, concerns to be addressed in private equity buyouts of public utilities include, If the new company operates less efficiently, at current or higher cost, is forced to sell necessary assets to buy down acquisition debt, installs management unfamiliar with a regulatory environment, compensates that management based on performance criteria inconsistent with the utilitys public service function, or cuts costs in areas necessary
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Connecting private equity owners to the day-to-day functioning of acquired utilities. Maintaining the purchased companys existing management structure. Establishing a customer advisory council. Preventing the recovery of acquisition and maintenance costs or pension plans through rates. Requiring findings of no adverse impacts to rates or public interest by the sale to a private equity firm. Ensuring review criteria are being analyzed and formally applied.
The fiduciary duty owed by governments to the public in the provision of water is defined by a variety of sources of law. For example, state ownership, the public trust doctrine, permit systems, prohibitions against wasteful use, public interest criteria, and the right of other holders of interests in water (e.g., other appropriators, other riparian landowners, or other owners of land overlying underground aquifers) all influence what duty is owed by the government to the public.168 In general, when reviewing and regulating water utilities the government must consider accountability to the public.169 Protecting accountability to the public means deciding whether a particular utility should be privatized, what conditions make privatization desirable, what the standards are for optimal service, and how agreements can be terminated or modified.170In order to better serve the public interest, improvements in Montana could include clear statutory authority for review, a description of review procedures for the type of sale (private-to-private, public-to-private, or private-to-public), and an outline of the requirements for approval, including review criteria and standard conditions, such as ring-fencing and measures to protect the sustainability of the water resource. Protecting the public interest is not limited to PSC review that is just one part. To ensure duties of conservation and sustainability are met, there could be a tandem review between the PSC and the DNRC, the state agency in charge of reviewing water right changes.171 Part of the work performed by the DNRC is to assist the Water Court with the adjudication of existing water rights, which is implicated by Carlyles water rights ownership in the Missoula Valley. Future PSC reviews could be done in coordination with the DNRC, which could comment on how the ownership transfer impacts the overall water supply in the area. Then, the task would not be left to private interest groups such as the Clark Fork Coalition. This would potentially improve the
for the maintenance and improvement [of] its service quality, utility customers would be disadvantaged. Also, if the change of control is able to effect substantial cost savings, and those cost savings are not passed on to customers, regulatory legal obligations are not being realized because utility service is not being provided at the lowest reasonable cost. 168 Arnold, supra n. 86 at 566. 169 Id. 170 Id. 171 Montana Department of Natural Resources and Conservation, Water Rights Bureau, http://dnrc.mt.gov/wrd/water_rts/default.asp (accessed Apr. 26, 2012).
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exchange of information between the government entities and allow a more thorough understanding of how the adjudication, ownership and use of Mountain Waters water rights might impact water provision for ratepayers in Missoula. It may also provide important notice to other water right holders associated with Carlyles rights. In addition, Montanas Department of Environmental Quality (DEQ) is already implicated in the review of Carlyles ownership of Mountain Water through its Public Water Supply Program.172 The DEQ must already review and approve all public water systems to ensure, that the public health is maintained through a safe and adequate supply of drinking water. This function is achieved by technical review, including sanitary surveys, licensing, certifications, compliance monitoring, training and technical assistance.173 Thus, DEQ could also provide comment during PSC review. It is not clear if the PSCs review in rate cases or in the outright purchase of water utilities is tied to either the DNRC or the DEQ at this point. By linking the PSCs review to existing Montana water supply, environmental and health oversight bodies, accountability to the public may be improved. Another possible method to address fiduciary duties to the public is to create a position within the government to track, facilitate and act as a liaison between the government and the private equity provider. This position could serve either at the state level, perhaps as staff for the PSC, or at the municipal level where public water systems are in private control. Funding for the position could be through an assessment of the private equity firm purchasing the public utility. Ideally, the facilitator position could help coordinate varying interests and schedules, provide tracking and reporting of issues, serve as a negotiator in subsequent transactions, and work to maintain open lines of communication between all interested parties.174 The position could, for example, track Carlyles infrastructure replacements. By documenting updates to Missoulas public water infrastructure, the facilitator could simultaneously gather information for the public and the PSC while at the same time provide oversight of Carlyles practices. The information gathered could assist the PSC in determining actual costs through an independent review and therefore better enable the PSC to evaluate the potential for transfer of those costs to ratepayers. The facilitator could also provide feedback to Carlyle about community and PSC concerns, areas where expectations are being met and also where improvements should be made. In addition, the position could coordinate the various branches of government, whose input would improve
172
Montana Department of Environmental Quality, Public Water Supply Program, http://www.deq.mt.gov/wqinfo/pws/default.mcpx (accessed Apr. 24, 2012). 173 Id. 174 District Energy of Portland: Laying the Groundwork for Implementation, Development, Ownership and Governance Models, http://www.portlandonline.com/bps/index.cfm?a=349828&c=54886 (March 31, 2011). The concept of a coordinator position is based on the City of Portlands efforts to prepare governance models for efficient energy development and transmission. The report states the facilitator position, is essentially the Citys designated district energy champion. This is an extremely important role, because the economic benefits of a municipal-scale, multi-stakeholder district energy system are often too dispersed to motivate any one self-interested party to drive the process. Because district energys benefits accrue to the public as well as the private sector, individual private actors tend not to take on this time consuming and expensive facilitation role. As a result, without a strong facilitator driving the process, even an economically viable project can easily fall by the wayside.
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protection of public interests. Making sure the DNRC, DEQ and PSC are all informed of subsequent activity in the private provision of municipal water would ensure that environmental, public health, and economic concerns are addressed. While private equity ownership of municipal water supplies is not well understood at this point, there are some areas where the public interest would clearly benefit. Private equity ownership is not inherently detrimental to public interests, however, it could be if not properly managed. Government oversight of both sales and management can be improved through more specific statutes regarding review criteria, standard conditions, such as ring-fencing, measures to protect against short-term ownership and rapid resale, and encouraging collaboration among government agencies. How oversight is defined and coordination is improved will take place on a state-by-state basis. In Montana, for example, the DEQ and DNRC may be important entities for the PSC to consult in its regulatory oversight of privately held water utilities. In addition, clear statutory authority and better communication among Montanas government agencies would better serve the publics interest in affordable, sustainable sources of clean drinking water.
Conclusion
The sale of Mountain Water to Carlyle plays a role in the larger discourse on water privatization in the world. It is part of an evolving chapter where private equity firms with a global presence are purchasing municipal water supplies for investment purposes. Providing the latest example of private equity acquisition of a municipal water supply, Carlyles purchase of Mountain Water and the PSCs review of the sale demonstrate both the positive aspects of agency review and areas where new approaches are warranted. Gathering data and critically thinking about how public interests are protected in sales such as this one is important given the complex nature of the transaction and what is at stake -- the water a community drinks. Montanas laws and regulations helped improve the review of Carlyles purchase of Mountain Water in comparison with other states. The level of review performed by other communities faced with private equity purchases of municipal water overlooked certain provisions such as ring-fencing, water right transfers and changes, and buying back the utility. Montanas PSC, MCC, and Missoulas Mayor and Clark Fork Coalition established solid provisions to protect the assets involved. However, more may be necessary in order to prevent potential negative results, which are only beginning to be understood. Improving Montanas examination of municipal water sales may be through comprehensive, multi-agency, independent review. Such oversight could include assessment of adjudication and environmental impacts through participation from other state agencies. Another measure may be to better coordinate and gather information regarding drinking water resources and to ensure economic and environmental sustainability is being addressed by all parties. Finally, ongoing tracking of private equity ownership of municipal water suppliers will assist in anticipating potentially harmful situations in the future and hopefully aid in taking appropriate action.
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While the sale of Mountain Water to Carlyle is only the fourth such transaction since 2005 in the United States, its review and approval provides a unique model due to the use of ring-fencing provisions. Only time will tell if such measures are sufficient to protect the public interest in affordable drinking water or if more should be done. In the meantime, Montanas statutes could more clearly define the PSCs authority and review criteria in order to protect municipal drinking water in sales of privately held municipal water utilities to other private entities.
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FINAL AWR: Private Equity Ownership of Municipal Water in Montana