Canada: Who Can Do What for LDCs and Their Affiliates?

On July 10, 2006, the Chief Compliance Officer (the "CCO") of the Ontario Energy Board issued two Compliance Bulletins¹ with respect to what activities could and could not be done by electricity distributors and their affiliates. The CCO has interpreted the Affiliate Relationships Code (the "Code") and s.71(1) of the Ontario Energy Board Act, 1998, in a manner which, if enforced, will have an important structural and operational impact on municipally-owned electric distributors ("LDCs"), their affiliates and their municipalities. Below we summarize the CCO’s positions and give our views.

Some of the activities sought to be prohibited by the CCO are:

• Contracting out of LDC employees (even if contracting out would reduce excess human resource capacity)
• LDCs providing engineering and construction services for privately-owned electrical infrastructure (even if that would make efficient use of excess human resource capacity with a resultant cost recovery)
• LDCs providing billing and collection charges for services such as water heaters (LDC affiliates may provide such services, but only using different employees than the LDC)
• LDCs providing street lighting and sentinel services (LDC affiliates may provide such services, but only using different employees than the LDC)
• The provision by an LDC of its services outside its licensed service area
• In most cases, affiliate employees that provide services to an LDC must be different individuals than the affiliate employees that provide non-LDC services and must be physically separated from each other (this is inefficient for the LDC that must pay the full cost of each employee even if he or she has excess capacity).

In addition, in correspondence with certain LDCs, the CCO has taken the position that an LDC must have at least one employee who has responsibility and authority for managing its operations and for ensuring that its distribution system is operated in accordance with all legal and regulatory requirements, and who is not shared with any affiliate.

In arriving at his conclusions, the CCO has blurred the line between affiliates that are energy service providers and those that are not. This has resulted in a very wide set of prohibitions. Most if not all of these prohibitions will lead to significant inefficiencies in LDCs’ operations.

In our view, the CCO’s interpretation of the Code focuses on the protection of confidential information and does not deal with the reality and efficiency of LDC/affiliate operations in the municipal context. It does not give proper weight to the fact that LDCs have obligations to protect the personal information of their customers under a comprehensive statutory scheme, and that only activities giving rise to a demonstrable abuse of market power by monopoly LDCs should be prohibited. Activities and corporate structures that are efficient and do not give rise to such abuse should be available to LDCs and their affiliates. Properly interpreted, the Code focuses on ensuring that licensed LDCs do not subsidize or inappropriately favour their own unregulated affiliates to the prejudice of consumers.

The Code is designed to enhance the development of a competitive market while saving ratepayers harmless from the actions of distributors with respect to dealings with their affiliates. In particular, "the standards established in the Code are intended to:

1. minimize the potential for a utility to cross-subsidize competitive or non-monopoly activities;
2. protect the confidentiality of consumer information collected by a transmitter or distributor in the course of provision of utility services; and
3. ensure there is no preferential access to regulated utility services."

LDC licences and the Code should be interpreted in light of this intention. The CCO has failed to properly balance these three objectives, focusing unduly on the second.

Section 71(1) of the Ontario Energy Board Act, 1998, provides that LDCs may only distribute electricity and not engage in other business activities. The CCO has interpreted that provision narrowly. He has confined the meaning of "distribution" to functions that operationally provide for the distribution of electricity and excluded matters related to the efficiency and financial viability of the distributor. This is not consistent with the Board’s statutory objectives,

Activities that are ancillary to electricity distribution operations and make an LDC more efficient should be interpreted as falling within LDCs’ mandate. This includes finding ways to cover the costs of LDC resources that are not being used for the LDC’s own purposes, that is, use of excess capacity by LDC affiliates. The public interest in protecting against the abuse of market power is addressed by fair and transparent transfer pricing agreements — not the blanket prohibition put forward by the CCO.

There Is No Requirement That an LDC Have At Least One Employee

The CCO has incorrectly concluded that the electricity distribution licenses and the Code require that an LDC have at least one employee who has responsibility and authority for managing its operations and for ensuring that its distribution system is operated in accordance with all legal and regulatory requirements.

There is no explicit authority supporting this conclusion in the Electricity Act, the Ontario Energy Board Act, corporate law or the Code, nor any supporting policy goal. The CCO appears to derive the one employee requirement from the simple fact that an LDC’s distribution license gives it sole authority to own and operate a distribution system within its distribution territory.

The CCO’s conclusion is premised on the incorrect assumption that employees are ultimately responsible for a corporation and that without an employee a corporation has no one to run it.

In reality, an LDC is governed by its directors — not its employees. As long as the appropriate corporate mechanisms are in place, an LDC can be operated without employees, and the Board can be confident that particular individuals identified in the LDCs corporate records are ultimately responsible for the actions of the LDC.

All LDCs in Ontario have been incorporated under the Ontario Business Corporations Act (the "OBCA"). All OBCA corporations must have at least one director and can have one or more officers, none of whom must be employees. The OBCA vests in directors and officers the fiduciary obligation to manage the business and affairs of the corporation in its best interests. Thus, all LDCs have one or more individuals who are "on the hook" and whose identities are readily ascertainable. Employees only have the authority assigned to them by the officers and directors.

The goal of ensuring that one or more individuals have ultimate authority and responsibility for an LDC is not furthered by reading into a distribution license or the Code a requirement that the responsible individual or individuals be employees. If the directors, acting prudently and in the best interest of the corporation, determine that the traditional employee functions should be outsourced, subject at all times to the overall supervision of the directors, there is no reason to interfere with that determination, and indeed there is no intention to so interfere reflected in the relevant statutory provisions or codes.

The CCO has incorrectly concluded that LDC affiliates which provide services such as electricity engineering, maintenance and billing activities to an LDC are energy service providers ("ESPs") and, therefore, must adhere to the provisions of the Code that address the relationship between a distributor and an ESP affiliate (for example, an LDC may not share with an ESP affiliate employees that carry out the day-to-day operation of the LDCs transmission or distribution network). In the CCO’s view, ESPs are involved in "the provision of services related to the production or use of electricity" [emphasis added]. This very wide definition has no basis in the Code or legislation.

The Code defines an ESP as:

In our view, the word "involved" must be read harmoniously with the examples within this definition. The examples provide guidance as to the types of services encompassed by the ESP definition. All of the examples given in the ESP definition are electricity commodity related products or services. They are not core distribution services.

The ESP definition’s focus on electricity commodity related services is consistent with the Code’s use of the word "supply" in defining an ESP. Throughout the Electricity Act and the Ontario Energy Board Act, the use of the word "supply" addresses the electricity commodity. For example, section 25.30(1) of the Ontario Energy Board Act deals with "electricity supply from alternative energy sources and renewable energy sources" [emphasis added]. Similarly, in dealing with the electricity commodity, as distinct from electricity distribution, the Board created the Standard Supply Service Code to address the default supply of the electricity commodity by distributors.

The ESP definition’s focus on electricity commodity related services is also consistent with the objectives of the Code, as set out in s.1. Electricity commodity related services are most vulnerable to anti-competitive practices by LDCs and the Code provides an elevated level of protection commensurate with that risk. Core distribution services do not carry with them the same level of risk and the Board has not subjected them to the elevated level of protection.

The focus of the ESP definition on electricity commodity related services is also apparent from s. 2.2.4 of the Code. Read with the interpretation of the ESP definition proposed by the CCO, s.2.2.4 would constitute a complete prohibition on personnel providing services with respect to the "day-today operation of the utility’s transmission or distribution network" by any entity except the LDC itself. Had this been the Board’s intention, it would have made such a major prohibition explicit — which it did not do.

Core electricity distribution services are part of an LDC’s monopoly and should be provided in the most efficient manner possible so as minimize electricity distribution rates — which are based in part on those costs. As noted above, this is an explicit objective of the Ontario Energy Board Act.

The time of LDC personnel is most efficiently used if their excess capacity is used, and paid for, by affiliates doing nonelectricity work (such as street lighting, water and sewage). As long as core distribution personnel are not also engaged in providing electricity commodity related services (with the associated elevated risks described above), it is to everyone’s advantage to allow such efficient use of personnel.

The CCO has advised certain LDCs that even with respect to billing, an LDC and its affiliates may not share resources. Effectively this would preclude an affiliate from engaging in billing services for an LDC (which always involves confidential information) — an outcome inconsistent with the Code3.

Section 2.6.2 of the Code expressly allows the disclosure of confidential information for billing purposes:

Therefore, affiliate employees are expressly allowed to provide billing services for an LDC. This is an express exception to the general prohibition on the disclosure of confidential information and sharing of employees. Similarly, s.2.6.2 allows confidential information to be disclosed to an affiliate if that disclosure is required for "market operation purposes".

We disagree with many of the CCO’s interpretations of the Code and Section 71 of the Ontario Energy Board Act. We also believe that if the CCO’s views are implemented, the results will be the imposition of very real costs and burdens, particularly on small to mid-size LDCs. The contracting out programs of the larger LDCs to provide electricity servicing materials and services to land developers and builders could also require restructuring.

The Compliance Bulletins were issued after the CCO wrote to LDCs with respect to compliance with the Code and requested responses from them. Acting for a number of LDCs, Goodmans LLP has already provided comments to the Electricity Distributor Association and CCO concerning the CCO’s view of the Code. We would be pleased to assist other LDCs with their unique circumstances.

The content of this article does not constitute legal advice and should not be relied on in that way. Specific advice should be sought about your specific circumstances.