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Key Middletown borough officials testify in federal court over surcharge in Suez water, sewer lease

By Dan Miller

danmiller@pressandjournal.com

717-944-4628
Posted 5/23/18

Former Middletown council member Ben Kapenstein testified Tuesday that up until recently he considered the 50-year lease of the borough’s water and sewer system his “proudest …

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Key Middletown borough officials testify in federal court over surcharge in Suez water, sewer lease

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Former Middletown council member Ben Kapenstein testified May 22 that up until recently he considered the 50-year lease of the borough’s water and sewer system his “proudest accomplishment” while in office.

Kapenstein, Mayor James H. Curry III and borough manager Ken Klinepeter all testified during a hearing in federal court in Harrisburg to consider Middletown’s April request for an injunction to block a 11.5 percent surcharge that has been added to water and sewer bills.

Suez is the private company that runs Middletown’s water and sewer systems under the lease that council and the former borough authority approved on Sept. 29, 2014. The lease went into effect on Jan. 1, 2015.

Suez says the surcharge is required under the lease to make up for lost revenue to Middletown Water Joint Venture LLC resulting from a water sales shortfall in the first three years of the lease, from January 2015 through December 2017.

Kapenstein testified May 22 that had he known the lease would result in a “double digit” increase in water and sewer rates in 2018, he never would have voted for the deal. He was re-elected to a two-year term in 2017, but resigned from council on May 1.

A decision on the injunction request is up to federal Chief Judge Christopher C. Conner, who is assigned the case and who presided over the hearing.

Conner did not say how soon he will decide on the borough’s challenge.

The borough contends the lease formula used to calculate a shortfall is such that the borough cannot avoid a shortfall, thereby guaranteeing what lawyers for the borough say is a financial “windfall” for the joint venture, which consists of Suez and private equity investors backing the Middletown lease deal.

Besides seeking the injunction to block the 11.5 percent surcharge now in effect, the borough lawsuit seeks to change the water sales shortfall formula to make it fairer to the borough.

Did borough know of potential problems?

The hearing revolved around issues that lawyers for both sides already brought out in papers filed in the case.

Lawyers for the joint venture and Suez say that council and the authority knew of, or should have known of, the economic ramifications of the water sales shortfall when council and the authority voted to approve the lease in September 2014.

During the hearing, lawyers for the joint venture also referred to monthly meetings Suez had with the borough starting in 2015, in which the existence of a water sales shortfall was made clear to the borough by Suez.

The borough officials who testified, Curry and Kapenstein in particular, said that the potential consequences of the shortfall provision were not evident to them when the lease agreement was before council and the authority to approve in September 2014.

Kapenstein said his understanding of the shortfall at that time was as a “risk provision” to protect Suez and the joint venture from an extraordinary loss in water sales, such as the 2011 flooding that occurred in Middletown from Tropical Storm Lee.

“If a flood and 100 houses are demolished, this would allow Suez to raise rates” to make up for the loss, Kapenstein said.

Kapenstein was among seven councilors voting for the lease in 2014.

Lease: Lesser of two evils?

The recommendation the borough consider leasing its water and sewer systems first surfaced in a March 2013 report done for the borough by its financial advisers as part of Middletown entering the state’s Early Intervention Program, Kapenstein testified. The EIP exists to assist financially troubled municipalities in Pennsylvania.

A financial adviser first elected to council in November 2013, Kapenstein acknowledged “leading the charge” for council to consider leasing the systems in 2014.

Kapenstein was chosen by the council in 2014 to lead a committee formed to explore the possibility of leasing the water and sewer systems.

Curry testified he could have vetoed council approving the lease in September 2014, but did not because he saw the lease as the lesser of evils compared to the other options Kapenstein was proposing for the borough to dig itself out of its financial hole, such as raising electric rates or increasing the property tax by 37 percent.

“The lease was attractive to me at the time based on what I knew,” Curry said, adding it was his impression that the lease would provide “stability” to borough residents and businesses regarding future water and sewer rate increases.

The only “potential negative” he saw regarding the lease was the borough giving up control, Curry testified.

Curry described the surcharge as potentially “devastating” for the borough, not just regarding the present 11.5 percent surcharge but future surcharges Suez could put in place over the 50-year lease if the provision for calculating a water sales shortfall is not changed.

“Unaccounted-for water”

Klinepeter testified regarding his earlier deposition submitted in court papers concerning alleged problems with some of the water meters used by Suez.

The amount of “unaccounted-for water” in the borough water and sewer systems has increased since Suez took over operations in January 2015, said Klinepeter, who started as borough manager in May 2016.

Klinepeter worked for Middletown in various public works capacities from October 1979 until retiring in August 2014.

He then worked for Steelton borough until taking a job with Suez in Middletown in September 2015, a position he held until council hired him as borough manager.

Klinepeter said in his deposition and repeated in testimony during the hearing that he played no role in crafting the lease agreement between the borough and the joint venture, as he had left the borough and was working for Steelton at the time.

Conner during the hearing noted that the borough and the joint venture are involved in a separate arbitration proceeding regarding the borough’s claim that issues with the water meters call into question the data Suez relied on in calculating the shortfall.

The borough according to court papers also sought to arbitrate the shortfall itself, but contends that the joint venture has refused to submit the shortfall to arbitration.

At the end of the hearing, Conner pondered if a “stay” is possible to block continued imposition of the surcharge, pending the outcome of the arbitration regarding the water meters.

But a lawyer for the joint venture said a stay is not warranted, as the amount of lost water at issue in the arbitration over the meters is less than 5 percent of the total shortage Suez claims occurred in the first three years of the lease.

Testimony not allowed

Also at the urging of lawyers for the joint venture, Conner refused to allow testimony from someone the borough sought to call as an expert witness regarding the water sales shortfall.

Daniel E. Koplish worked for the city of Allentown’s water and sewer systems for 28 years before becoming a consultant. The borough hired him as an expert witness to testify on the shortfall provision as the lease between Middletown and the joint venture was modeled on Allentown’s lease of its water and sewer systems to the Lehigh County Authority.

However, Conner agreed with a lawyer from the joint venture who while acknowledging Koplish as expert in the operation of water and sewer systems, is not qualified to provide expert testimony on the water sales shortfall which is the focus of the borough injunction request.

Koplish in a report borough lawyers filed with the court May 18 said that the shortfall as written is “not designed to limit risk” to the joint venture but had “the effect of producing a windfall” to the joint venture in the form of the surcharge that went into effect in 2018.

Suez didn’t suffer a loss

Among those testifying for the joint venture was Dan Sugarman, managing director of Water Capital Partners LLC, the company representing private equity investors backing the Middletown lease.

Sugarman testified that the Middletown lease was not profitable for the joint venture during the first three years from 2015 through the end of 2017.

He said Suez itself did not suffer a loss during this time, as the company’s compensation from the joint venture is not dependent upon whether the lease is profitable or not.

Sugarman said that the joint venture would not have bid on the lease had the shortfall provisions not been written as they are.

Asked by a lawyer for the borough if the shortfall provision means that “the less water sold, the more profit” going to the joint venture, Sugarman responded: “I’m going to say no to that.”

“There are too many other factors” that are “unpredictable” regarding whether the lease deal is profitable for the joint venture, such as inflation, Sugarman said.