Request By:
Mike Miller, County Judge/Executive Marshall CountyD.M. Butler, II, County Judge/Executive Metcalfe County
Opinion
Opinion By: Albert B. Chandler III, Attorney General; Janet M. Graham, Assistant Attorney General
Opinion of the Attorney General
Preface
The Fiscal Courts of Marshall and Metcalfe Counties may lawfully issue industrial revenue bonds to finance the construction of electric generating stations. Pursuant to KRS 103.200, electric generating stations constitute "industrial buildings" as defined by the statute. The generating stations satisfy the statutory definition of "industrial buildings" because they are used to "manufacture" electricity, and electricity constitutes a "commercial product."
Factual Summary
The Marshall and Metcalfe County Fiscal Courts request an opinion regarding whether they may issue industrial revenue bonds to finance the construction of two electric generating stations. Their request stems from a preliminary proposal by Duke Energy North America, LLC ("Duke Energy") a Fortune 100 company that is one of the top 10 electric generators in the United States. Duke Energy is examining sites in Metcalfe and Marshall County due to their proximity to interstate gas transmission pipelines and electrical distribution systems. Duke Energy seeks to build and operate two natural gas-fired electric generating stations in Kentucky. Each plant would consist of eight combustion turbine units that would generate approximately 640 megawatts of electric power.
Duke Energy has requested and received a ruling from the Public Service Commission ("PSC") that (with respect to the proposed Marshall County site) it is not a utility subject to the PSC's regulatory jurisdiction. [PSC Order, Case No. 99-514, March 13, 2000]. The PSC ruled that Duke Energy is not a utility because all electricity generated by the proposed station will be sold on the wholesale electricity market - not directly to public retail consumers.
Statement of the Issues
The Fiscal courts request an opinion on the following two issues:
1. Whether with respect to a wholesale electric generating station which is not a utility subject to regulation under KRS Chapter 278, any land and building(s), any facility or other improvement thereon, and all real and personal properties, including operating equipment and machinery deemed necessary in connection therewith suitable for generating electricity constitute "industrial buildings" as defined in KRS 103.200;
and
2. Whether the County or the Kentucky Economic Development Finance Authority may lawfully issue industrial revenue bonds pursuant to KRS Chapter 103 to finance the acquisition and construction of the electric generating station referenced in Issue I.
Statutory Framework
Pursuant to KRS 103.210, a county may issue industrial revenue bonds to finance construction of an "industrial building. " KRS 103.200 defines "industrial building" as follows:
Any land and building or buildings (including office space related and subordinate to any of the facilities enumerated below), any facility or other improvement thereon, and all real and personal properties, including operating equipment and machinery deemed necessary in connection therewith, whether or not now in existence, which shall be suitable for the following or any combination thereof:
(emphasis added). In order for the counties to properly issue these bonds, generating electricity must constitute manufacturing, and electricity must be legally classified as a commercial product. In the context of industrial revenue bonds, these are issues of first impression in Kentucky.
The Generation of Electric Power is Manufacturing
Kentucky cases clearly hold that the generation of electricity constitutes manufacturing. In Kentucky Electric Co. v. Buechel, 146 Ky. 660, 143 S.W.58 (1912), Kentucky's highest court addressed this issue in the context of a tax dispute regarding industrial property. The Court held that the Kentucky Electric Company was engaged in the business of manufacturing when it produced electricity, stating: "The fact that courts generally have held that a plant engaged in the production of artificial gas is a manufacturing plant is persuasive that a similar plant engaged in the production of electricity is likewise a manufacturing plant. " Id. at 60. See City of Louisville v. Howard, 306 Ky. 687, 208 S.W.2d 522 (1947) ("The generation of electricity is manufacturing. ") Id. at 526, citing Buechel; See also Department of Revenue ex rel. Luckett v. Allied Drum Service, Inc., Ky. App., 550 S.W.2d 564 (1977), aff'd 561 S.W.2d 323 (1978). Although Buechel is an older case, its holding was recently reaffirmed in Revenue Cabinet v. Kentucky-American Water Company, Ky., 997 S.W.2d 2 (1999).
Moreover, the Buechel holding aligns with other Kentucky cases that broadly define the term "manufacturing. " Kentucky's highest court has espoused a lenient definition of this term, stating: Manufacturing consists in the application of labor or skill by hand or machinery to material so that as a result thereof, a new, different, and useful article of commerce is produced." Hughes & Co. v. City of Lexington, 211 Ky. 596, 277 S.W. 981, 982 (1925). This definition of manufacturing certainly encompasses the method of electricity production used by these generating stations: Natural gas from the earth's crust is drawn from wells and transported by pipeline to the site. At the generating station, the natural gas is moved through a combustion chamber where it is burned. As the hot gas burns, it expands through the blades on the turbine rotor and causes them to move. Then the turbine spins the generator to "manufacture" electricity. Thus, according to the Hughes definition, the heat energy expended in combustion is manufactured into a new, different and useful product - electricity.
Although Kentucky cases are fairly uniform in the treatment of electricity generation as manufacturing, there is a split amongst other states on this issue. However, several states follow Kentucky's position that the generation of electricity constitutes manufacturing. See Department of Revenue v. Puget Sound Power & Light Company, 587 P.2d 1282 (Mont. 1978) ("This Court has long recognized that the generation of electricity is a manufacturing process. "); Curry v. Alabama Power Co., 243 Ala. 53, 8 So.2d 521 (1942); Peoples' Gas & Electric Co. v. State Tax Comm'n, 28 N.W.2d 799 (Iowa 1947); Commonwealth ex rel. McCormick v. Keystone Light, Heat & Power Co., 193 Pa. 245, 251, 44 A.326 (1899) ("Electric light, heat, and power companies are manufacturing corporations. . ."); But see United Illuminating Co. v. Groppo, 601 A.2d 1005 (Conn. 1992).
Electricity is a Commercial Product
In order to qualify as an industrial building under KRS 103.200, not only must the generation of electricity constitute manufacturing, but also, electricity must be classified as a "commercial product." In older taxation cases, the court axiomatically holds that electricity is a "manufactured" product and a "commercial product." Kentucky Electric Co. v. Buechel, 146 Ky. 660, Ky., 143 S.W. 58 (1912); City of Princeton v. Princeton Electric Light & Power Co., 166 Ky. 730, 179 S.W. 1074, 1077 (1915). These holdings comport with other Kentucky cases holding that the definition of manufacturing necessarily involves the production of a commercial product. However, in two recent federal court decisions involving tort law, the courts struggled with whether electricity is a product or a service.
As previously noted, the older Kentucky cases classify electricity as a manufactured product. In Buechel , not only did the Court hold that the generation of electricity was a manufacturing process, it also held that electricity was the "product" that was manufactured. The Court stated, "As a manufacturing plant, it generates electricity. As a public service corporation, it sells the product of its factory to the public in the city of Louisville. Its product-the electricity -is delivered to its patrons through wires, either run beneath the ground in conduits or above the ground on poles." Id. at 61. (Emphasis added). See City of Princeton v. Princeton Electric Light & Power Co., 166 Ky. 730, 179 S.W. 1074, 1077 (1915) ("The right to produce and sell electricity as a commercial product is not a prerogative of the government, but is a business which is open to all. . ."); See also City of Florence v. Owen Electric Cooperative, Inc., Ky., 832 S.W.2d 876, 879 (1992);Commonwealth ex rel. Luckett v. WLEX TV, Inc., Ky., 438 S.W.2d 520, 521 (1968) ("In Buechel there was involved the use of coal, water, and heat to produce an entirely new, though invisible, product - electricity. ")
The labels "commercial product" and "manufactured product" appear to be substantially identical in Kentucky case law. The definition of "manufacturing" employed by the courts implicitly holds that the manufactured product will have value and will be placed in the stream of commerce. In Shelby County Board of Assessment Appeals v. Gro-Green Chemical Co., Ky., 602 S.W.2d 155 (1980), the Court incorporated a commercial element into the definition of manufacturing, stating, "This court defined manufacturing 'process' as 'material having no commercial value for its intended use before processing has appreciable commercial value for its intended use after processing by the machinery. " Id. at 156, quoting Department of Revenue ex rel. Luckett v. Allied Drum Service, Inc., Ky., 561 S.W.2d 323, 325-26 (1978). Therefore, by naming something a manufactured product, Kentucky courts have imported a commercial element into this definition, leaving the phrases "commercial product" and "manufactured product" substantially identical.
However, notwithstanding the above discussion, a momentary detour into tort law reveals that electricity is treated differently in the context of strict liability in tort. In fact, two federal courts have taken different positions regarding how electricity should be classified with respect to strict liability issues. In G & K Dairy v. Princeton Electric Plant Board, 781 F.Supp. 485 (W.D. Ky. 1991), a dairy farmer brought an action against a distributor of electricity for injuries to his cattle herd caused by stray voltage. Stray voltage is unintended low-level voltage generally caused by faulty electric wiring in livestock areas. When an animal touches two contact points, an electric current flows through the animal, causing damage. The Court held that under Kentucky law, the defendant did not manufacture a product, but instead provided a service. Id. at 489. Additionally, the Court noted that a "good" had to be sold for strict liability to apply, and stray voltage was merely an undesirable byproduct of electric transmission rather than a valuable article of commerce.
However, another federal district court in Kentucky has reached the opposite conclusion. In C.G. Bryant v. Tri-County Electric Membership Corporation, 844 F.Supp. 347 (W.D. Ky. 1994), the plaintiff brought an action against its local utility company for damages from a fire sustained at its sawmill. The defendants alleged that it could not be held strictly liable for these injuries. However, the Court disagreed. The Court stated, "The majority of the state courts considering this issue have encountered little difficulty deciding that electricity is a product." Id. at 349. The Court in C.G. Bryant distinguished the previous case by noting that it dealt with stray voltage that is not a useful product, rather than useable, commercial electricity.
Although Buechel and its progeny were decided in the context of taxation issues (not with respect to the issuance of industrial bonds), these cases are more persuasive precedent than the distinct line of cases involving strict liability in tort. Additionally, the federal district courts noted above were merely predicting how the Kentucky courts would rule if confronted with these issues in a strict liability context. Buechel and its progeny indicate that Kentucky courts would follow the view that electricity is a commercial product.
The view that electricity is a commercial product is strengthened by the recent changes caused by deregulation of the market for electricity. Because of the creation of a new wholesale market for electricity, electricity is essentially treated as a commodity. As one court has noted,
Electricity is a commodity which like other goods, can be manufactured, transported and sold . . . Electricity is a form of energy that can be made or produced by man, confined, controlled, transmitted and distributed as an energy source for heat, power and light.
Bailey v. Gulf States Utilities Company, 27 S.W.3d 713, 718 (Texas App. 2000).
Although there is a split amongst other states regarding whether electricity is a product, the weight of authority holds that it is a manufactured product. See Northern States Power Company v. Commissioner of Revenue, 571 N.W.2d 573, 575 (Minn. 1997) ("This court has determined that electricity is a manufactured product. " [Citations omitted]; Hetherington v. Camp Bird Mining, Leasing & Power Co., 70 Colo. 531, 202 P. 1087 (1921); Ransome v. Wisconsin Electric Power Company, 275 N.W. 2d 641 (Wis. 1979); But see Otte v. Dayton Power & Light Company, 523 N.E.2d 835 (Ohio 1988); Omaha Public Power District v. Nebraska Department of Revenue, 537 N.W.2d 312, 317 (1995) (holding that the generation of electricity is a service, not the manufacture of tangible, personal property).
Electric Generating Stations are Industrial Buildings
As explained in the previous analysis, the generating stations constitute "industrial buildings" pursuant to KRS 103.200.
Conclusion
The Fiscal Courts of Marshall County and Metcalfe County may lawfully issue industrial revenue bonds to finance the construction of electric generating stations because the generation of electricity constitutes manufacturing, and electricity is a commercial product.