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Borough v. Middletown Water Joint Venture LLC

United States District Court, M.D. Pennsylvania

July 19, 2018

MIDDLETOWN BOROUGH, Plaintiff
v.
MIDDLETOWN WATER JOINT VENTURE LLC, Defendant

          MEMORANDUM

          Christopher C. Conner, Chief Judge

         Plaintiff Middletown Borough (“the Borough”) commenced this action seeking reformation of its water and sewer services contract with defendant Middletown Water Joint Venture LLC (“Middletown Water”). The Borough moves the court to preliminarily enjoin imposition of a service charge on its residents pending the outcome of this litigation and a related arbitration proceeding.

         I. Background

         The Borough commenced this action with the filing of a verified complaint in the Court of Common Pleas for Dauphin County, Pennsylvania. In its complaint, the Borough seeks reformation of the parties' lease agreement governing operation of the Borough's water and sewer system. It asserts that the lease agreement's water sales shortfall provisions do not accurately reflect the intent of the parties at the time of contracting. The Borough seeks preliminary injunctive relief pending resolution of its contract reformation claim and the parties' related arbitration proceeding. Middletown Water timely removed the case to federal court.

         The court convened a preliminary injunction hearing on May 22, 2018, taking evidence in the form of documentary exhibits and witness testimony. The parties filed proposed findings of fact and conclusions of law in support of their respective positions subsequent to the hearing. With briefing concluded and the record closed, the Borough's motion for preliminary injunction is ripe for disposition. Following the close of the preliminary injunction record, Middletown Water moved to dismiss the Borough's complaint pursuant to Federal Rule of Civil Procedure 12(b)(6). The Borough then filed an amended complaint.

         II. Findings of Fact[1]

         Middletown Water is a joint venture comprising SUEZ Water Environmental Services Inc. (“SUEZ”) and Argo Infrastructure Partners.[2] (Correll Aff. ¶ 9). SUEZ serves as operator of the wastewater utility system and water plant and distribution system for the Middletown Water project.[3] (Id.; see M.W. Ex. 1 at 49). The Borough and Middletown Water executed a Municipal Water and Wastewater Utility System Concession and Lease Agreement (“lease agreement”) naming Middletown Water as concessionaire on September 30, 2014. (M.W. Ex. 1). Article 7 of the lease agreement governs imposition of service charges for water and sewer services. (Id. at 76-79).

         The lease agreement prohibits Middletown Water from increasing water and sewer rates prior to January 2019, absent Borough approval, and establishes caps on rate increases permitted thereafter. (Id. at 76-77). Section 7.1(l ) sets forth one of several exceptions to this prohibition on rate increases and reads as follows:

(1) Demand Shortfall Recovery. [Middletown Water] may also impose upon all Retail Water Customers and Retail Sewer Customers a Service Charge in any Demand Shortfall Recovery Year to recover the Annual Shortfall Recovery Amount that may be recovered in that Demand Shortfall Recovery Year, which Service Charge shall be in addition to the Service Charges otherwise imposed under Section 7.1.

(Id. at 76, 78). A demand shortfall recovery year is any of the three years following the final year of a three-year rolling test period-beginning with calendar years 2015-2017-in which there is a water sales shortfall. (Id. at 11, 29). A water sales shortfall occurs when the sum in gallons of (1) “the actual average daily volume of metered water sales to all Retail Water Customers” over a three-year test period, and (2) the bulk sales surplus over the three-year test period, is less than 639, 340 gallons per day. (Id.) A bulk sales surplus is the amount in gallons per day that the “actual average daily volume of metered water sales to all [Middletown bulk customers]” over a three-year test period exceeds 62, 970 gallons. (Id. at 6).

         When a water sales shortfall occurs, Middletown Water may impose a service charge to recover the annual shortfall recovery amount. (Id. at 25, 78). The annual shortfall recovery amount is one-third of the shortfall recovery amount for a three-year period. (Id. at 4). The water sales shortfall, expressed in gallons per day, is used to calculate the three-year shortfall recovery amount. (Id. at 25). The instant litigation arises out of Middletown Water's invocation of the demand shortfall recovery exception to the lease agreement's restrictions on rate increases.

         A. Bidding and Contract Negotiations

         The Borough participated in Pennsylvania's Early Intervention Program in 2013, which “assist[s] municipalities in addressing long-term financial, operational and economic development issues.” (M.W. Ex. 8 at 1; M.W. Ex. 14 at 4). At the time, the Borough grappled with, inter alia, a budget deficit of $3.3 million in its general fund and tens of millions of dollars in unfunded pension liabilities. (M.W. Ex. 8 at 1-2; M.W. Ex. 14 at 13; Tr. 34:3-16, 66:20-67:18). Susquehanna Group Advisors, Inc. (“Susquehanna”) financially advised the Borough during its participation in the Early Intervention Program. (See M.W. Exs. 8, 14). Susquehanna recommended leasing the Borough's water and sewer system as part of a multi-year plan to address these fiscal issues. (Kapenstein Aff. ¶ 4; see M.W. Ex. 8 at 1; M.W. Ex. 14 at 33; Tr. 34:7-16, 67:19-68:4). The Borough agreed and town councilman Benjamin Kapenstein (“Councilman Kapenstein”) supported exploration of leasing the system. (M.W. Ex. 8 at 1).

         The Borough engaged the law firm McNees Wallace & Nurick LLC (“McNees”) to administer a competitive procurement process. (Tr. 30:11-14, 34:21-23, 43:23-44:12; Kapenstein Aff. ¶ 5). McNees solicited proposals and made a preliminary draft lease agreement available to prospective bidders in an online data room on June 13, 2014. (Tr. 38:12-20; Correll Aff. ¶ 13; Kapenstein Aff. ¶¶ 5, 14; M.W. Ex. 7 at 5). It modeled the draft lease agreement on a similar contract executed by the City of Allentown, Pennsylvania, a transaction in which McNees was “heavily involved.” (Tr. 60:10-14; Correll Aff. ¶ 12; Kapenstein Aff. ¶ 5). Over the summer months, three qualified prospective bidders submitted comments to the Borough on multiple iterations of the draft lease agreement. (Correll Aff. ¶ 14; Kapenstein Aff. ¶ 6; M.W. Ex. 7 at 5).

         Early draft language set the water sales shortfall threshold at 480, 000 gallons per day, or approximately 75% of 2013 average daily volume sales to all consumers. (Kapenstein ¶ 15; M.W. Ex. 2 at 6). On August 27, 2014, SUEZ asked the Borough to increase the threshold to 608, 000 gallons per day, or approximately 95% of the 2013 total sales. (Kapenstein ¶ 16). The following day, a second prospective bidder sought to increase the threshold to 577, 225 gallons per day. (Id. ¶ 17). SUEZ submitted redlined edits to the lease agreement to McNees by email dated September 3, 2014. (M.W. Ex. 2). Therein, SUEZ edited the shortfall recovery amount to include retail sewer customers and altered the water sales shortfall formula to measure the “actual average daily volume of metered water sales to all Retail Water Customers, ” plus any bulk sales surplus, against “100[]% of 2013 Average Daily Volume sales to all Customers.”[4] (Id. at 5-6).

         McNees attorney Michael Jarman (“Attorney Jarman”) responded that “2013 was an abnormal year.” (Id. at 2). SUEZ stated that it “[could not] accept undue risk on volume” and encouraged Attorney Jarman to “explain the issue to [his] client.” (Id. at 1; see also Tr. 94:3-7). On September 3, 2014, the Borough incorporated SUEZ's proposed changes, sent earlier that same day, and circulated a “Final Draft” lease agreement and accompanying memorandum. (Tr. 44:13-24; Correll Aff. ¶¶ 16-17; Kapenstein Aff. ¶ 21; see also M.W. Ex. 2 at 1). The memorandum described alterations to the shortfall recovery amount and water sales shortfall provisions as “substantial changes to the economic terms of the [lease agreement].” (M.W. Ex. 3 at 2-3). Middletown Water submitted the sole bid on the final draft lease agreement in late September 2014.[5] (See Correll Aff. ¶ 18; Kapenstein Aff. ¶ 25).

         At a town council meeting on September 29, 2014, Councilman Kapenstein made a comprehensive presentation on contract negotiations, the bid process, and the final draft lease agreement. (M.W. Ex. 8 at 2-3). He poignantly noted that the Borough could execute the lease agreement with Middletown Water or raise electric rates or taxes as much as 37% to address the Borough's financial challenges. (Id. at 2; Tr. 42:21-43:4, 68:5-69:2, 73:8-17). In supporting execution of the lease agreement, Councilman Kapenstein represented that he had done “the necessary due diligence.” (M.W. Ex. 8 at 3). Mayor James Curry (“Mayor Curry”) described the decision facing the Borough as a choice between “the lesser of two evils” and noted that leasing the system is the “best [solution] at this time.” (Id. at 6; Tr. 69:14-21). Neither Mayor Curry nor Councilman Kapenstein participated in negotiations of the lease agreement that predated the September 29, 2014 meeting. (Tr. 43:16-22, 70:20-22, 73:20-74:1). The Borough awarded the lease agreement to Middletown Water in exchange for an upfront payment of $43 million and annual payments totaling $45 million over the 50-year term. (See Correll Aff. ¶ 8; Kapenstein Aff. ¶ 25; see also M.W. Ex. 1 at 33).

         B. Water Sales Shortfall

         Middletown Water assumed control of the water and sewer system effective January 1, 2015. (M.W. Ex. 8 at 2). The parties convened monthly operations committee meetings and Middletown Water provided monthly operations reports. (See M.W. Exs. 24-30, 33-43; Tr. 26:18-24, 78:20-79:10, 82:7-12). Borough manager Kenneth Klinepeter (“Klinepeter”), accompanied by counsel, represented the Borough at these meetings. (Tr. 79:14-21). Each monthly operations report included Middletown Water's calculation of the water sales shortfall and an explanation of said calculation. (See M.W. Ex. 24 at 15; M.W. Ex. 25 at 14; M.W. Ex. 26 at 14; M.W. Ex. 27 at 14; M.W. Ex. 28 at 15; M.W. Ex. 29 at 15; M.W. Ex. 30 at 16; Tr. 26:25-27:2, 28:21-29:3; 82:7-12; 84:17-85:6). Through late 2017, the Borough expressed no concerns regarding these monthly reports or the lease agreement's water sales shortfall provisions. (Tr. 29:10-24, 49:3-50:15, 85:7-10).

         Middletown Water notified the Borough in late 2017 that a water sales shortfall occurred during the three-year test period of 2015 through 2017. (M.W. Ex. 31). The shortfall recovery amount for this three-year period was approximately $1.9 million which resulted in an annual shortfall recovery amount of approximately $640, 000. (M.W. Ex. 31 at 5). On March 28, 2018, Middletown Water notified Borough consumers that an 11.5% ...


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