Docket OST-97-2329 (Docket 50176) / Docket OST-95-474 / May 27, 1997

In its brief, the City argues as if this remand proceeding were an academic exercise in economic theory. As a result, in urging approval of its alleged "opportunity costs," the City: (1) never addresses whether recovery of such costs would be reasonable under the policies of the governing statutes; (2) ignores or mischaracterizes the facts of record which show why recovery of these alleged costs would be unreasonable in this case: and (3) claims it is constitutionally entitled to these costs in order to earn a "fair rate of return" when the purpose of such a fair rate has already been fully satisfied by the costs the Secretary has allowed. Accordingly, the Secretary should find the claimed "opportunity costs" to be unreasonable. 1/

As we explained in our opening brief, and as DOT has recognized, Congress did not intend for airports to use their landing fees as a means of accumulating surpluses that are not needed to cover actual capital costs or operating expenses or to meet contingency or reserve requirements. See 61 Fed. Reg. 32010. Further, airports that are allowed to recover all these cost requirements should be deemed fully "self-sustaining" within the meaning of the statute.

1/ Both the City and ACI make much of the "burden of proof" issue. This is a red herring. The Court has directed the Secretary to consider the City's arguments in favor of opportunity costs. The Secretary, in turn, has indicated that he will entertain whatever arguments the parties want to make concerning the reasonableness of allowing such costs. The Secretary's resolution of that reasonableness question involves a policy judgment, not a determination of who had the burden of proof. And in any case. even if the Airlines had some burden, they have clearly met it by showing that recovery of the claimed opportunity costs would be completely unreasonable.

Accordingly, the purported "opportunity costs" the City now seeks to recover—which the City measures by the profits it says it could have received if LAX were not an airport—would simply add to the airport's ever-increasing surpluses, a result expressly prohibited by federal policy. See 49 U.S.C. § 47101(a)(13). The City ignores all these statutory underpinnings that should govern the Secretary's policy choice in this case and instead makes several claims that are either completely irrelevant or factually incorrect.

First, the City says it should be permitted to earn rental profits on its land because those profits would be "reinvest[ed]"in "airport system development projects." City Br. at 9. This is beside the point. When the City wishes to make capital improvements to aeronautical facilities, it can—and does—charge the airlines directly for those projects. Its desire to prefund future, undefined projects cannot justify increased fees under its compensatory methodology. Indeed, the record shows that the City is already earning an enormous 40% operating margin on its overall activities, demonstrating that it far overreaches with this argument. 2/ The City cannot escape the fact that the proposed land rental charges would serve no purpose other than to add to the City's mounting "surpluses"—a result directly contrary to the policies of the statute. Thus, it is not the Airlines who are seeking an improper "subsidy" here (see City Br. at 14-15); rather, it is the City that is seeking to be compensated for costs it does not incur in order to build surpluses it does not need.

The City also argues that if it cannot impose "fair rental-value" charges for the land, the airfield will be "underpriced and overused." City Br. at 12. But there is no evidence whatever that limiting the City to recovery of its historic costs has led to any "overuse" of resources. See infra at S-6. Moreover, the City's argument again ignores the governing statutory

2/ In fact, as the Secretary knows, the City—in furtherance of longstanding policy, see PFF 23-35—has recently attempted to divert nearly $90,000,000 in surplus airport revenues to non-airport uses (approximately $59,000,000 in condemnation proceeds, and approximately $30,000,000 that was recently returned to the airport in response to an FAA order), further showing that it does not now need additional revenues for airport development.

policies. The AHTA was designed to prevent airports from using their inherent monopoly power to levy excessive charges on airlines, passengers, and shippers. See Airline Br. at 6. At the same time, massive federal funding was provided to airports to reduce costs to airport users so that more of them—not fewer—could avail themselves of the national transportation system. It would be unreasonable—indeed, it would be absurd—for the Secretary to turn these purposes on their head and adopt a policy designed to price marginal travelers out of the market.

Finally, having nothing in the policies of the statutes to support its claim, the City disingenuously says on several occasions that the Secretary "now recognizes [fair market valuation] as a reasonable alternative." City Br. at 2. See also id. at 5. The City bases this on the statement in the revised Policy that "the FMV technique has been sustained in judicial decisions as meeting the standard of reasonableness." 61 Fed. Reg. 32010 (1996). But as shown in our opening brief, none of the judicial decisions approving FMV or opportunity costs are remotely like this case—which involves a highly subsidized, regulated public entity that has been allowed to meet all its out-of-pocket requirements and has been instructed not to set fees that earn surpluses. Indeed' the Secretary has made it quite clear that the economic rationale behind the City s claim for profits measured by opportunity costs is wholly inapplicable to federal regulation of public, municipally-owned airports. See id. at 32010-32011.

The City not only ignores the statutory policies applicable to the present opportunity cost issue. 3/ It also ignores (or misstates) the key facts of record that govern this issue. The remand order and the parties' briefs identify seven such key facts: (1) the City s inability to

3/ It is worth noting that the opportunity cost issue presented here is not whether, in the abstract, a fair market value methodology would be reasonable at LAX. After all, this is not the methodology LAX has adopted. It has adopted a compensatory or cost-of-service methodology. The question is whether charging an alleged FMV rent for the land is reasonable under such a methodology. And it can be reasonable only if, as the Court of Appeals said, the City bears an "actual" opportunity cost in maintaining the land as an airport. 103 F.3d at 1034.

use the land for any other "opportunity"; (2) the current allocation of the land to its best use, (3) the City's ability to recover all its actual costs, including all its actual opportunity costs; (4) the fact that only LAX claims the need for further opportunity costs; (5) the fact that the City is already earning a reasonable "rate of return"; (6) the total benefits to the City from using the land as an airport; and (7) the difficulties and uncertainties affecting the City's FMV appraisal.

1. The City Has No Other Opportunities. The key fact demonstrating that the City has no real opportunity cost is that it has no real opportunity; i.e., as the City concedes, its federal grant assurances prohibit it, at least for the 20-year duration of the restrictions. from using its airfield land for any other purposes. See City Br. at 8 n.7. The City accepted such grants as recently as September 30, 1993, see Ex. ATA-71 (LAXI), and it is bound by those restrictions at least until 2013. Id. at 20. When it accepted these subsidies—totaling more than $303 million from 1973-1993, see Recommended Decision at 4 (LAXI) LADOA voluntarily gave up any opportunity it may have had to devote its land to some other use. We do not contend, as the City claims we do, that by accepting these restrictions the City "waived" a purported ' right" to recover real opportunity costs (see City Br. at 9); rather, the City's agreement that it would not use its land in any other manner demonstrates that the City's claimed "opportunity costs', are simply not real. 4/

Nevertheless, the City asserts without explanation or analysis that it incurs opportunity costs even though it "may be legally or even practically committed to using its assets in a particular manner." Id. at 8. This is not only illogical, but it is contradicted by the City's own

4/ At the recent May 15, 1997 oral argument before the Court of Appeals, the City implied that it might be relieved of its restrictions in five to eight years. The City, however, did not make that claim in its opening brief, most likely because it is belied by the record evidence showing that the City accepted grants as recently as 1993. But in any event, the fact that the City will not be relieved of its grant restrictions until some point in the distant future shows that it has no current opportunity costs, for the discounted value of those future opportunities (which the City has never calculated and is therefore not in the record) would obviously be close to zero.

definition of opportunity costs—the profits that the City claims the land could currently earn in its best alternative use. See City Br. at 5. Under this definition. the City obviously can incur no such costs if there are in fact no current alternative uses. As one Airlines' expert stated, while in some contexts "the opportunity is obvious, to sell the land and move elsewhere," in other contexts "the opportunity is virtually nil, in which case there is no opportunity cost." Tr. at 429 (Horngren). Similarly, due to the federal grant restrictions the land simply cannot be valued in a hypothetical "free transaction." Ex. ATA-E2 at 119 (LAXI) (Kasper). Or, as the Secretary succinctly put it in his Policy, "Los Angeles' claim for opportunity costs assumes that airport proprietors are free to disinvest in the airfield and put their capital to other uses. Most airport proprietors subject to this policy, including Los Angeles, are not." 61 Fed. Reg. at 32011. The record in this case supports the Secretary's conclusion.

Even so, says the City, airports can and do move to new locations. City Br. at 7. In the first place, they can do so only with express FAA approval. See FAA Order No. 5190.6A 7-20 at 53. But more importantly, no such move is possible at Los Angeles. As the City's own appraisers concluded, "the relocation of the Los Angeles International Airport is practically impossible" because "[t]here are no urban sites in Los Angeles that can provide an alternative airport development site" and because "the costs to acquire such a site would be prohibitive." Ex. LAX-14 at 20 (LAXI) (emphasis supplied). It would therefore be patently unreasonable to "compensate" the City for not exercising its non-existent opportunity to relocate LAX.

2. The Land is Already Allocated to its Best Use.

The City nevertheless claims that it should be entitled to earn opportunity costs because otherwise "tilt . . . may result in misallocation of resources ...." City Br. at 12. But again the City is ignoring the facts of record. Not only is the City unable to use the land in an alternative use, completely negating any opportunity costs; but, in fact, there is no need whatsoever to permit the City to charge opportunity costs to ensure the most efficient use of resources, because the City's own appraisers found in fact that airport use is the highest, best use of the land. See Ex. LAX- 14 at 13 (LAX I). Hence, the claimed "misallocation" is completely without foundation and cannot justify the claimed opportunity costs. See Ex. ATA-E2 at 16 (Kasper)

3. The City's Costs Are Fully Recovered. Also without foundation is the City s claim that the Secretary embraced its opportunity cost rationale by allowing imputed interest on non-airfield funds used for airfield investments. City Br. at 6. But in allowing imputed interest on the investment of actual surplus funds the Secretary determined that airports have real alternatives for the investment of such real funds and therefore real opportunity costs. Surplus revenues can be invested either in non-aeronautical or aeronautical facilities, and the Secretary has asserted that imputed interest will encourage aeronautical investments. 5/ The record demonstrates, however, that the City has no similar alternative uses for its airfield land. It is therefore unreasonable to compensate the City for opportunity costs it does not incur, particularly when the Secretary's policy fully compensates the City for all the costs it does incur, affords it considerable subsidies, and allows it to earn unlimited profits on non-aeronautical activities. It is unreasonable to allow airports fictional "opportunity costs" on top of this.

4. All Other Airports Value Airfield Land at Historic Cost. Contrary to the City's contentions, it is plainly relevant that LAX is the only airport in the Nation that has ever contended that it needs to rent out its airfield land at "fair market" rates in order to capture purported opportunity costs. City Br. at 20. As the Secretary has noted (see Remand Order at 8) and as the City does not dispute, hundreds of airports operate under compensatory methodologies that limit recovery to historic costs of airfield land, and yet none of these other airports contend that they are suffering uncompensated opportunity costs as a result. And not one has contended that such costs are needed to make it "self-sustaining." In his role of determining federal transportation policy in this area, the Secretary is plainly entitled to take account of this universal

5/ ATA has sought review of this aspect of the Policy. But regardless of the outcome of that challenge, the Secretary's policy on imputed interest has no application here.

practice. That no other airport in the country has seen a need to levy such charges in order to maintain and improve its facilities is relevant and compelling evidence that (l) the City's charges are not intended to compensate it for any true cost; (2) such charges are not needed to make LAX self-sustaining; and (3) the charges are merely a way to accumulate unnecessary surpluses. 6/

In an attempt to show that airfield land is not universally valued at historic costs, the City wrongly relies on statements from the Airlines, accounting expert that airports use various rate-setting methodologies. See City Br. at 21. The expert was referring to differing methodologies, not allowable costs under a compensatory methodology. That airports have employed different ways of calculating reasonable fees does not alter the undisputed fact that all airports except LAX have valued airfield land at historic cost. See Tr. at 409 (Barker). 7/ It is likewise not true, as the City claims (see City Br. at 22), that airports were waiting until the Kent County litigation was decided before they attempted to use fair market methodologies. The City, in fact, imposed its land rental charges before the Supreme Court decided Kent County? and other airports still have not followed suit. Finally, it is irrelevant that the City has imposed its fees by ordinance rather than agreement. See City Br. at 22-23 n.20. Obviously? when airports desire to implement reasonable compensatory methodologies that permit airports to recover only their true costs of serving airline users, airlines are willing to agree to such systems. The fact that no other

6/ The City says that "DOT has recognized that an airport that charges based only on the historic costs of assets such as land cannot comply with the self-sustaining requirement." City Br. at 18. This is a complete falsehood, as the City's supporting citation shows. That citation concerns the FAA's approval of escalation clauses in long-term leases designed to compensate airports for increased out-of-pocket costs they may face during the life of the leases. Obviously, this approval has no application here.

7/ The City also distorts statements from ATA's brief in the Policy appeal. See City Br. at 21. The quoted passages merely noted the reasons why residual systems were becoming less common. ATA did not imply that compensatory methodologies were unusual or that historic costs was not the universal methodology for valuing airfield land at such airports. Furthermore, even an airport operating under a residual methodology could attempt to include purported opportunity costs" in its fee calculations.

airport has elected to use its power to impose land rental charges by ordinance, far from supporting the City's charges here, is in fact evidence that such charges do not compensate airports for any real cost and are therefore unreasonable.

As a fallback, the City contends that if it is limited to historic costs on its land, it must at least be allowed an additional "fair rate of return." See City Br. at 13-14. But as the Secretary has already concluded in rejecting the City's "taking" argument (see infix), such an additional return would be unreasonable. That is because the function of a rate of return in traditional ratemaking is to compensate a private, profit-making entity for its actual costs of capital, both debt and equity. 8/ Thus, the Secretary has provided that an airport with private equity investors would be entitled to a reasonable rate of return to compensate those investors. See 61 Fed. Reg. 32019. Here. however, the Secretary's prior ruling already allows the City to recover all of its actual costs of debt and it has no costs of equity because it has no equity investors. As a result, it has already been paid the full "rate of return" it needs to meet its actual costs of capital. To pay it more—for costs it does not actually have—would be unreasonable.

Even if the City had shown that it incurs compensable opportunity costs by devoting its land to an airport rather than to some actual' alternative use—which it has not—it plainly has not shown that it incurs any net cost from that decision. It is rational and reasonable for the Secretary to take this into consideration here. As explained in our opening brief and as our record cites show' the City benefits significantly from the fact that LAX is an airport rather than something else, both because the City

8/ See AT&T v. FCC, 836 F.2d 1386, 1389-90 (D.C. Cir. 1988) ("The rate of return . . . must be sufficient to cover the cost of capital the carrier must raise to do business"); United States v. FCC, 707 F.2d 610, 612 (D.C. Cir. 1983) ("rate of return" allowed in utility regulation is "a composite of the return on the two major components of the company's capital—debt and stockholder's equity. . ."); MCI v. FCC, 675 F.2d 408, 410 n.3 (D.C. Cir. 1982) (just and reasonable rates "should be set to allow recovery of costs, including the cost of capital").

derives huge external benefits from its airport and because the City is earning huge overall profits by using the land for an airport. Contrary to the City's contentions, the Airlines do not contend that the benefits and profits accruing to the City from LAX must be "cross-credited" against the Airlines' fees, or that the Secretary must determine whether the City is responsible for the success of the airport or vice versa. See City Br. at 9-10. It is therefore completely beside the point that "[i]f an airport were located in the middle of an ocean, few passengers would fly there." Id. at 10. This airport is not in the middle of the ocean; and whether it is the City that attracts traffic into and out of LAX, or the mere existence of LAX that attracts this traffic, or a combination of the two, either way it is undisputed that the City and its economy benefit enormously from that traffic. And it is patently unreasonable for the City to claim a net opportunity cost from using the land as an airport when it has taken no account of the -huge benefits to it from that use.

While the foregoing is more than sufficient to demonstrate the unreasonableness of the claimed opportunity costs, the administrative difficulties posed by the City's appraisal methodology plainly add to that unreasonableness. First, the City's methodology will necessarily require repeated reappraisals so that the "rental" rates represent current market value. The City attempts to sidestep this issue by asserting that "DOT need not confront the issue of whether airfield land may be revalued on a periodic basis, because the issue is not presented in this case." City Br. at 20 n. 18. Yet both the Court of Appeals and the Secretary specifically identified this issue as important to the remand inquiry, because the necessity of periodic reappraisals will contribute significantly to the administrative burden on the Airlines and DOT. Alternatively, the City contends that ' periodic reappraisal of the LAX airfield land does not necessarily follow from the economic rationale for valuing airfield assets at market value at least at the time of establishment of the compensatory methodology." Id. (emphasis in original). The City provides no support for this contention, because it is simply untrue. As the City's own expert explained when devising the land rental charges, see Ex. ATA-74 at I (LAXI), the fair market value" concept necessarily requires an appraisal of current "market value" whenever the charges are sought to be imposed. 9/

The City is also wrong to argue that its appraisal methodology is reasonable merely because the Airlines have agreed to cargo and maintenance leases at fair market value' and because FAA requires appraisals for various purchases of airport property. See City Br. at 17-19. Even if the evidence regarding the Airlines' leases were in the record—which it is not—it would not help the City. 10/ As Chief Judge Mathias concluded, such evidence is irrelevant because, to the extent those agreements were made while LAX was under a residual system, the Airlines would receive a year-end credit through their landing fees. Nor do FAA and DOT appraisal requirements demonstrate the ease of appraising the entire LAX airfield. These requirements apply to specific parcels of land being purchased for airport use or leased for non-aeronautical use, and therefore say nothing about the administrative ease of periodically reappraising an entire airfield occupying nearly 1800 acres of Los Angeles real estate based on the assumption that this huge expanse of real estate would be redeveloped as something else and rented out to other users.

For these reasons—both those based on statutory policy considerations and those based on the particular facts of this case—the claimed "opportunity costs" are unreasonable.

9/ The Secretary should likewise reject the City's assertions that the administrative reasonableness of the FMV technique is shown by the Airlines' purported failure to challenge it. The Airlines did in fact challenge the City's appraisal as circular. And as pointed out in our opening brief, the appraisal on its face contains numerous flaws that render its conclusions questionable at best. In any event, the fact that the Airlines challenged the concept of any appraisal based on fair market value—which violated the Secretary's Policy—does not amount to a waiver of other arguments that would be relevant if that Policy is changed here.

10/ As the City concedes, Chief Judge Mathias excluded evidence of these other leases. In the prior proceedings, the City renewed its objections to this exclusion both before the Secretary and the Court of Appeals. Neither the Secretary nor the Court reversed the Chief Judge's ruling, however, and the City therefore cannot challenge that ruling on remand.

Even though the issue is not before the Secretary on this remand, the City argues again that preventing it from earning a profit on its airfield land would be an unconstitutional taking of its property. See City Br. at 23-25. 11/ As explained more fully in our previous submissions, 12/ for several reasons the City has not come close to carrying its "heavy burden" of making a "convincing showing" that limiting it to recovery of its historic costs violates the Fifth Amendment. Federal Power Comm 'n v. Hope Natural Gas Co.. 320 U.S. 591, 602 (1944).

First, because the City has no private equity investors and no equity cost of capital, the standards applicable to private utility companies, Duquesne Light Co. v. Barasch, 488 U.S. 299, 307 (1989), are irrelevant here. The Constitution requires only that LAX's fees be "sufficient to assure confidence in the financial integrity of the enterprise, so as to maintain its credit and to attract capital," which occurs when there is "enough revenue not only for operating expenses but also for the capital costs of the business. These include service on the debt and dividends on the stock." Hope, 320 U.S. at 603. This requirement is plainly satisfied here, for the City will be able to recover all of its capital and operating costs. Second, the City has not shown that it had any "reasonable investment-backed expectations.' Ruckelshaus v. Monsanto, 467 U.S. 986, 1006-07 (1984); Connolly v. Pension Benefit Guaranty Corp., 475 U.S. 211, 224-225 (1986), that it would earn a profit on its land. And finally, the City has, in any event, failed to demonstrate that the "net effects" of invalidating its land rental charges would cause it

11/ Of course, the entire premise of this claim is wrong. A regulated public entity such as LAX is not constitutionally entitled to earn a profit. Jersey Central Power & Light Co. v. FERC, 810 F.2d 1168, 1180-81 (D.C. Cir. 1987) (en bane).

12/ See Brief for Intervenor ATA at 20-31, City of Los Angeles v. DOT, No. 95- 1188 (filed Feb. 2, 1996); Brief for Intervenors ATA et al. 8- 16, Nos. 95- 1344 et al. (filed July 1, 1996); Brief for Intervenor ATA at 22-32, Nos. 96- 1253 & 96- 1269 (filed Apr. 15, 1997). ATA hereby incorporates by reference the arguments in those briefs (which were served on both the Secretary and the City) as well the arguments in ATA's brief to the Secretary filed June 2, 1995.

to suffer "deep financial hardship." 13/ Nor could it. given that the City is in fact earning enormous profits on the overall activities of LAX. 14/

For all these reasons and those set forth in our opening brief, the Secretary should limit the City to recovery of its historic costs of airport land.

Respectfully submitted,

Allen R. Snyder

Walter A. Smith, Jr.

Jonathan L. Abram

Jonathan S. Franklin

HOGAN & HARTSON L.L.P.

555 13th Street, NW

Washington, DC 20004

202/637-5741

Attorneys for Original Complainant Airlines

Dated: May27, 1997  

13/ See Jersey Central, 810 F.2d at 1181 n.3; Rural Tel. Coalition v. FCC, 838 F.2d 1307, 1313 (D.C. Cir. 1988); Illinois Bell Tel. Co. v. FCC, 988 F.2d 1254, 1263 (D.C. Cir. 1993); Memorandum Opinion at 2, City of Los Angeles v. DOT, No. 95- 1188 (D.C. Cir. July 1, 1996).

14/ Because the Constitution does not require that LAX earn a profit above its actual costs, the Secretary properly found unnecessary a separate hearing to determine an appropriate "rate of return." This is especially so since the City is already receiving the full rate of return to which it is entitled, i. e., its actual costs of capital. However, in the unlikely event that the Secretary were to reverse his position on this question, the City is wrong to suggest that its land rental charges must be upheld without further hearing. If the Secretary were to conclude that the land rental charges are unreasonable as a matter of federal policy, but that the Constitution nevertheless requires that the City earn a rate of return on its land, then the level of that rate must be determined after a hearing. The City's own brief demonstrates that its land rental charges would produce profits far in excess of a return that a private business would reasonably need to cover its capital costs. See City Br. at 6 n.6 (imputed interest charge of 7% per year on airfield land would be a "mere pittance" compared to City's land rental charges).