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SCIENTECH IssueAlert, October 26, 2000
TXU Sued By 23 Texas Cities Over Franchise Fees
By: Will McNamara, Director, Electric Industry Analysis
===============================================================

The City of Denton, Texas, has filed a lawsuit against TXU Electric & Gas,
claiming that the utility intentionally underpaid Denton its franchise
fees by not accurately reporting its gross revenues, on which franchise
fees are based. To date, 23 cities have signed resolutions to join Denton
in the lawsuit and more are expected. An initial audit by Denton claims
that the amount that TXU owes could potentially exceed $240 million.

ANALYSIS: Over this last year, several utilities in Texas have come under
fire for allegedly not paying the full amount of franchise fees for which
various cities claim they are obligated. This suit against TXU is just
the latest, but it follows a judgment against Reliant Energy earlier this
spring and a pending suit against CPL (a subsidiary of AEP/CSW).

Franchise fees are essentially rental payments that a city has the right
to charge a utility for use of the city's public streets and grounds for
the placement of pipelines, poles and utility cables. Texas state law allows
cities to charge utilities 2 percent of their gross revenues for the right
to franchises within a city's limits. Some utilities such as Reliant entered
into agreements*stretching back to the 1950s*that obligate them to pay
4 percent of gross revenues earned in a city in exchange for 50-year 
franchises.
In any case, the cities are arguing that franchise fees should be based
on gross revenue, not net revenue, that the utilities have earned from
providing service within the city limits.

Herein lies the core of the litigation as, in this case, the City of Denton
is claiming that TXU intentionally reported lower gross revenue, thereby
reducing the amount it was required to pay to Denton and the other cities
involved in the lawsuit. The cities involved in the suit claim they are
entitled to not only unpaid franchise fees from TXU, but punitive damages
as well.

The prognosis may not be very good for TXU, if a similar case against Reliant
Energy is any indication. In May, a Houston jury ruled that Reliant-HL&P
"acted with malice by intentionally underpaying cities for decades for
the exclusive right to sell electricity in those cities." The state district
court ordered HL&P to pay $34.2 million to the cities of Pasadena, Galveston
and Wharton. The award consisted of $30 million in punitive damages, another
$3 million because it was determined that HL&P had defrauded the cities,
and $1.2 million in actual damages. That seemed to be just the start of
Reliant's problems, as following that case 47 additional cities, including
Houston, came together and launched a class-action suit against Reliant
HL&P, again claiming that the utility intentionally underpaid franchise
fees for the sole right to provide power in the cities. This lawsuit is
claiming $113 million in damages, the bulk of which ($77 million) is allotted
for the City of Houston.

However, illustrating how polarized this issue is, just last week a state
district judge overturned the $34.2 million ruling for the first three
cities, and reduced the damages down to $1.2 million. In addition, the
same judge overturned the separate ruling that had given the green light
for the 47 cities to proceed with the class-action suit. Both rulings are
still being appealed by the cities in hopes to reinstate the award for
fraud and punitive damages. In addition, the 47 cities involved in the
new lawsuit against Reliant are proceeding*just with 47 individual cases
instead of one. Sound confusing? It certainly is, and it will no doubt
amount to one big mess if the cities are not permitted to band together
in one class-action suit.

Here's Reliant's position in the litigation, which is presently supported
by the Texas State District Court. Reliant claims that transactions that
do not generate profits or represent the selling of power in a city*such
as reconnection fees, renting pole space to other utilities and sending
electricity to other markets*should not be considered part of gross revenue
and, therefore, not subject to franchise fees. Thus, the figure Reliant
reported as gross revenue may indeed be lower than the cities expected
it to be*but it is an accurate number, based on Reliant's interpretation.

As noted, CPL is also involved in a pending lawsuit with the City of San
Juan, Texas, and a group of about 30 other cities. These cities claim that
CPL underpaid franchise fees and seek damages of up to $300 million plus
attorney's fees. CPL has filed a counterclaim for overpayment of franchise
fees and intends to defend itself against the cities' claims.

How all of this will impact the case against TXU is unclear, but certainly
the momentum is growing against the utilities in Texas. TXU, like Reliant
and CPL, maintains that it has done nothing wrong and that it has paid
in full all of the fees owed to the over 330 Texas cities and towns to
which it provides electric service. Again, the center of the dispute lies
in how to calculate gross revenues. TXU contends that gross revenue includes
only the direct proceeds it has received from the sale of electricity and
natural gas. The City of Denton, on the other hand, argues that gross revenue
also should include other income such as taxes and fees collected for bad
checks, which conceivably could result in a much higher figure, especially
when calculated over a 40-year period.

TXU had 1999 operating revenues of approximately $17.1 billion so, like
Reliant, a settlement in the $1.2 million range would not wield much financial
impact. However, more important to these utilities may be the fact that
this could be just the beginning of a string of similar lawsuits, brought
forward by cities across Texas. Consider the class action suit against
Reliant, to the tune of $113 million. If that suit is allowed to proceed,
we're talking about big money, especially when attorney fees are added
to the equation. In addition, the reputation of these utilities is at stake.
The cities initiating the lawsuits are using such terms as "unlawful business
practices" and claiming that every dollar utilities like TXU and Reliant
have not paid to the cities means a dollar increase in taxes for citizens.
As deregulation continues to unfold, a utility's reputation will be one
of the foundations on which it attracts new customers and retains current
ones.

It's also important to note that under Texas' restructuring law, once 
competition
begins in the state (January 2002) the formula to determine franchise fees
in the state will switch from a revenue formula to a consumption formula.
In other words, the amount that utilities collected as gross revenue in
1998 will be divided by the amount of total kilowatt hours consumed within
the city limits during the same year, and that will be the amount of the
franchise fee owed by utilities to cities. The franchise fee shall be equal
to the charge per kilowatt hour determined for 1998, multiplied times the
number of kilowatt hours delivered within the city limits. Of course, all
of these pending lawsuits are bringing into question the amount of gross
revenue that was collected during 1998, which might make this formula 
difficult
to calculate. In any case, I don't see these issues subsiding any time
soon as they are based on a fundamentally different interpretation of how
to define gross revenue. The real winners in these lawsuits may be the
attorneys themselves, as undoubtedly these cases will remain in litigation
for several years.
===============================================================
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===============================================================

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Sincerely,

Will McNamara
Director, Electric Industry Analysis
wmcnamara@scientech.com
===============================================================
Feedback regarding SCIENTECH's IssueAlert should be sent to 
wmcnamara@scientech.com
===============================================================

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