In a decision released on April 20, 2010, the Ontario Court of Appeal reinstated an Ontario Energy Board (OEB) decision that required Toronto Hydro-Electric System Limited (THESL) to obtain the approval of a majority of its independent directors before declaring a dividend. The decision is notable because it reinforces the unique obligations that distinguish regulated monopolies from private corporations and indicates that regulators have considerable latitude to intervene where a regulated company fails to meet those obligations.
The appeal concerned the dividend policies of THESL, an electricity distributor licensed and regulated by the OEB. THESL is a wholly owned subsidiary of the Toronto Hydro Corporation (THC) and all of the shares of THC are owned by the City of Toronto. In 2004-2005, THC paid over $166 million to the City in dividends and interest payments, which were funded from substantial increases in dividends from THESL and by charging THESL an above-market rate of interest on an inter-company loan.
When THESL applied to the OEB for approval of its 2006 distribution rates, the OEB was concerned that THESL was making substantial payments to the City while insufficient amounts were being re-invested in THESL's aging infrastructure. The OEB disallowed collection of any interest charges above market rates from THESL's customers and imposed a condition requiring a majority of THESL's independent directors to approve any future dividend payments. THESL successfully appealed the OEB's restriction on the issuance of dividends to the Divisional Court by arguing that the condition exceeded the OEB's jurisdiction and was an unlawful restriction on the authority of the board of directors to declare a dividend.
A three-judge panel of the Court of Appeal set aside the Divisional Court's order and reinstated the requirement for THESL to obtain approval from its independent directors before issuing a dividend. In doing so, the Court stated that deference is owed to the decisions of regulatory tribunals with specialized expertise and held that the OEB has very broad rate-setting authority that allows it to "impose such conditions as it considers proper" when making rate orders. In this respect, the Court distinguished the case from the Supreme Court of Canada's decision in ATCO Gas & Pipeline Ltd. v. Alberta (Energy & Utilities Board),  1 S.C.R. 140 (ATCO). In the Court's opinion, the facts of ATCO were different from the present case because the condition set by the OEB was guided by specific objectives set out in its enabling statute (which require the OEB to consider the interests of both customers and distributors) in contrast to the "vague, elastic, and open-ended" provision at issue in ATCO.
The key issue in the appeal was the clash between the principles of regulatory law and of corporate law. THESL argued that the OEB's remedy was inconsistent with the principles that govern THESL as a company incorporated under the Business Corporations Act (Ontario). This argument was strongly rejected by the Court. The Court noted that the principles governing a regulated utility that operates as a monopoly are different from those that apply to private sector companies operating in a competitive market. Whereas the directors of private-sector corporations must act in the best interest of the company (which is often taken to mean the best interests of the shareholders), the Court stated that a regulated public utility must operate in a manner that balances the interests of the utility's shareholders against those of its ratepayers. The panel noted that "[i]f a utility fails to operate in this way, it is incumbent on the OEB to intervene in order to strike this balance and protect the interests of the ratepayers."
With respect to the specific condition imposed on THESL, the Court reviewed the OEB's reasons in making the order and concluded that it was "within a range of possible, acceptable outcomes which are defensible in respect of the fact and law." The OEB had a legitimate concern that THESL would either have to ignore its aging infrastructure or borrow funds in order to maintain it, which would negatively impact THESL's credit rating and lead to higher borrowing costs. As THESL admitted it was making large dividend payouts at the request of the City, the Court determined that it was reasonable for the OEB to require approval from THESL's independent directors before any future dividends could be paid.