Municipalities; Water and Sewer Systems; Corporations; Purchase of Property

I. FACTS AND ANALYSIS IN THE REQUEST FOR OPINION.

The facts as set out in the request for an opinion are as follows. The City operates and maintains a consolidated water and sewer system throughout Mecklenburg County pursuant to interlocal agreements with Mecklenburg County and the Towns of Cornelius, Davidson, Huntersville, Matthews, Mint Hill and Pineville. Under these agreements, the City owns the consolidated water and sewer system and is obligated to provide water and sewer service throughout the County (including within the Towns) under uniform policies. The City is phasing in a uniform rate structure. Effective July 1, 1993, water and sewer rates for City customers will be the same throughout Mecklenburg County, without regard to whether the customers reside within the corporate limits of the City. Under these agreements, the City is required to use all water and sewer revenues for water and sewer purposes and may not use any portion of those revenues to subsidize another operation.

Effective June 30, 1991 the City involuntarily annexed an area, which includes a residential subdivision receiving water and sewer service from the Corporation which is a private utility. The City is required to make water and sewer service available to the annexed area, including this subdivision, in accordance with Part 3 of Article 4A of Chapter 160A of the General Statutes.

The Corporation and its shareholders desire to get out of the business of providing water and sewer service and are willing to sell all of the Corporation’s water distribution and sewage collection systems to the City on or before June 30, 1993. Those systems are located wholly within Mecklenburg County and a portion is located within the annexed area described above. By selling all of its systems, the Corporation will be entitled to retain the full economic benefit of the sale. If only a portion of its systems were sold, the Utilities Commission would require that any gain on that sale be shared with the Corporation’s remaining customers. In the Matter of Application of Carolina Water Service, Inc. of North Carolina, Docket Nos. W-354, Sub 86, 87,

88. Therefore, under any transaction with the City, the goal of the Corporation and its shareholders is for the net proceeds of any sale to end up in the hands of the shareholders. The Corporation must secure the Utilities Commission’s approval of any sale.

The Corporation and its shareholders have offered to sell these water and sewer systems to the City for approximately $ 4 million or, alternatively, to sell all of the stock in the Corporation to the City for approximately $ 3.5 million. The sole reason for the approximate difference of $ .5 million arises from the application of Federal tax law. If the Corporation sells the water and sewer systems directly to the City and distributes the net proceeds of the sale to its shareholders, tax liability will be incurred both at the corporate and the shareholder levels. If the City purchases all of the stock of the Corporation and causes the Corporation to transfer the Corporation’s water and sewer systems to the City, the Corporation would incur a tax on the gain under Section 311(b) of the Internal Revenue Code, just as if the Corporation had sold the systems to the City for full, fair market value. If the City purchases all of the stock in the Corporation and the Corporation continues in existence with its facilities, only the former shareholders incur a tax. As a result, the difference in the sales prices accounts for the additional tax liability incurred by the Corporation, if the City elects to purchase the Corporation’s assets, rather than its stock. Under either approach, the net proceeds of the transaction in the hands of the shareholders remain the same.

The City desires to acquire effective control over the Corporation’s water and sewer systems in the most economical manner within the limits of its authority. Funds for the stock purchase would come from revenues from water and sewer operation and not from bonds or other debt.

In order to preserve the economic benefit from purchasing the Corporation’s stock, the City would not cause the Corporation to transfer its water and sewer systems to the City but would continue the Corporation under strictly limited conditions. City employees who discharge duties that are generally similar to their counterparts in the corporate world would be given the responsibility, as City employees, to perform limited duties for the Corporation as directors or officers. The duty of a director or officer of the Corporation would be to approve and execute an agreement with the City under which the City would: connect the Corporation’s water and sewer systems to the City’s own water and sewer system; maintain and operate the Corporation’s water and sewer systems under the same policies as apply to the City’s own water and sewer system; bill all persons receiving water and sewer service from the Corporation’s water and sewer systems according to the same rates that apply to the City’s own water and sewer system; and collect and retain all revenue received from such persons in consideration for the City’s services to the Corporation under the agreement. The only other duty of a director or officer would be to prepare and maintain such records, reports, tax returns, etc., as may be necessary for the Corporation to satisfy applicable law and maintain its corporate existence. Necessary changes to the Corporation’s Charter, bylaws or any other corporate documents would be made to insure that the Corporation would not undertake any activity which the City is not authorized to undertake.

The contract by which the City would acquire the stock of the Corporation is being negotiated. That contract will assure that the transaction is undertaken in a prudent and business-like manner. Binding and enforceable representations will be made by the shareholders concerning the absence of adverse claims against the Corporation, e.g., litigation, tax liability, governmental investigation, etc. The shareholders will indemnify the City against any loss arising from a breach of such representation. A substantial portion of the purchase price will not be paid immediately to the shareholders but will be retained or otherwise escrowed for a reasonable time to serve as a source of funds to stand behind the indemnification responsibilities of the shareholders.

II. DISCUSSION.

Water and sewer systems are public enterprises which the General Assembly has authorized a city to acquire, construct, establish, enlarge, improve, maintain, own, operate and contract for and which the Supreme Court has held to be public purposes. N.C.G.S. §§ 160A-311, 312; Madison Cablevision v. City of Morganton 325 N.C. 634, 386 S.E.2d 200 (1989). While the statutes do not specifically authorize the purchase of stock of a private corporation owning a water and sewer system, the authority of a city generally to acquire and hold personal property under the provisions of N.C.G.S. § 160A-11 should be sufficient to authorize the purchase of all of the stock of a corporation where the corporation’s sole asset is a water and sewer system.

However, there are two problems with that part of the plan that calls for the City to continue the existence of the Corporation. The first problem is the lack of any express or implied authority for a city to own or operate a private for-profit corporation which was created under the provisions of Chapter 55 of the General Statutes. It is the opinion of this office that the authority to "hold" property granted by N.C.G.S. 160A-11 should not be interpreted to authorize a city to act as a shareholder of such a corporation, and to appoint city officials and employees as corporate directors or officers.

The language of N.C.G.S. 160A-4 requires that the provisions of Chapter 160A "be broadly construed". While River Birch Associates v. City of Raleigh, 326 NC 100, 388 S.E.2d 538 (1990), reaffirms the broad construction to be given to statutory grants of power, there must be language granting the power. The language of N.C.G.S. § 160A-11 granting in very general terms the authority to own property does not address the issue at hand, i.e., the operation of a for-profit corporation by a city. The operating of a private for-profit corporation does not appear to be either necessary or expedient to the general power to hold or own property. To determine that the authority to "hold" property is a grant of authority to operate a for-profit corporation would not be merely a broad interpretation of the statutory language, but, rather, it would constitute the addition of a power. A review of Part 1 of Article 16 of Chapter 160A of the General Statutes reveals a legislative intent that a city either operate a public enterprise itself or that it grant a franchise to one or more private entities to operate the enterprise. The proposed plan for operating the Corporation set out in the request for an opinion does not fall within either category contemplated by that legislation.

The cases from other jurisdictions cited by the City in its memorandum of law are relevant on the issue of the purchase of all of the stock of the private corporation, but they do not address the issue of the continued operation or existence of the corporation. In fact, the judicially approved plans for purchase of stock in those cases called for the dissolution of the corporations shortly after purchase by the municipalities.

[T]he agreement of sale and purchase provides that the companies shall be delivered to the County free and clear of all encumbrances and provides for indemnity by Pawley for any undisclosed obligations of the companies prior to the hour of sale. It is further conceded and the agreement provides that the purchase of all of the common stock of these companies by the County is made for the purpose of acquiring said companies in their entirety including all of assets, and that promptly upon the closing of the transaction the companies will be dissolved. The County will then become the owner of the transportation system and all of its physical properties. (Emphasis added)

State v. Dade County, 142 So2d 79, 88 (Fla. 1962).

Respondents further contend that the City cannot purchase the common stock of Gas & Electric, citing Section 6, Article 9, of the Constitution, prohibiting a city from becoming a subscriber to the capital stock of any corporation. However, it is clear that the City is not subscribing to the stock of Gas & Electric and becoming a part owner therein, but has contracted with Federal to buy all of its stock in order to become the owner of its physical utility properties and is purchasing this stock solely to acquire them. The ordinance provides for the immediate dissolution of Gas & Electric and is using this means of acquiring its properties because it can do so at much less cost in this way. (Emphasis added)

Springfield v. Monday, 353 Mo. 981, , 185 S.W.2d 788, 792 (1945).

Therefore, while there may be authority for the City to purchase all of the stock of the Corporation, there is no authority to operate a private for-profit corporation which is outside of the traditional functions of a municipality and for which there is no judicial or legislative approval.

A second and independent problem is that the proposed plan of operation of the Corporation by the City eliminates the "corporate separateness" necessary for the Corporation’s continued existence. An integral part of the proposed operation has municipal officials and employees in corporate offices and positions. Chapter 55 of the General Statutes lists statutory duties and responsibilities of directors, officers and agents of a for-profit corporation; however, under the proposed plan of operation municipal officers and employees could act only on behalf of the City and there could be no thought of acting on behalf of the private for-profit Corporation. In other words the proposed plan of operation would result in the merger of the corporate entity into the municipal entity and the dissolution of the Corporation. The concept of corporate separateness usually arises in attempts to "pierce the corporate veil" so that assets of the corporate shareholder may be made available for payment to a creditor. Generally speaking, the courts will look to find fraud before allowing such a recovery. Robinson, North Carolina Corporation Law §§ 2.8 through 2.10. While the fact situation under consideration clearly has no fraud involved, the complete dominance of the public purpose, and complete lack of a separate private corporate purpose, leads to the conclusion that the Corporation would become an instrumentality of the City and there would no longer be a separate corporate existence. Under such circumstances there would not be any independent identity of the private for-profit Corporation and, if challenged, it is the opinion of this office that the existence of the Corporation would be declared to have ceased.

However, on the other hand, if after purchasing all of the shares of the Corporation, the City is able to transform the Corporation into a nonprofit corporation there is clear authority for the City to contract with and operate the Corporation. N.C.G.S. § 160A-312; Publishing Co. v. Hospital Systems, Inc., 55 N.C. App. 1, 284 S.E.2d 542, rev. denied 305 N.C. 302, 291 S.E.2d 151, cert. denied, appeal dismissed 103 S. Ct. 26, 459 U.S. 803, 74 L. Ed. 2d 42 (1981); Sides v. Cabarrus Memorial Hospital, Inc., 287 N.C. 14, 213 S.E.2d 297 (1975). Whether the transformation of the Corporation to a nonprofit corporation under Chapter 55A can be accomplished with the beneficial tax consequences is not addressed in this opinion.

III. CONCLUSION.

In light of the above, it is concluded that the City does not have the authority to continue the existence of the private for-profit Corporation.

LACY H. THORNBURG, Attorney General Charles J. Murray Special Deputy Attorney General