Contemporary American History, 1877-1913

by Charles A. Beard

The absence of any dissent from this opinion, in spite of the fact that Judge Gray, who had concurred in Justice Bradley's vigorous dissenting opinion in the Chicago-Minnesota case four years before, was still on the bench, indicates that the last lingering opposition to the doctrine of judicial review in the minds of any of the Court had been dissolved. Henceforth it was but the emphatic affirmation and consistent development of that doctrine that was to be expected.

If we leave out of account Mr. Justice Brewer's dicta and consider the Court to have decided merely the issues squarely presented, the Reagan case left much to be done before the doctrine of judicial review could be regarded as established beyond all possibility of limitation and serious qualification. Other cases on the point followed quickly, but it was not until the celebrated case of Smyth v. Ames, decided in 1898, that the two leading issues were fairly presented and settled. In this case the rate attacked was not fixed by a commission, but by a state legislature itself; and the rate was not admitted by the counsel for the state to be unreasonable, but was strongly defended as wholly reasonable and just. The Court had to meet the issues.

The original action in the case of Smyth v. Ames was a bill in equity brought against the attorney-general and the Nebraska state board of transportation, in the Federal circuit court, by certain bondholders of the railroads affected, to restrain the enforcement of the statute of that state providing a comprehensive schedule of freight rates. The bills alleged, and attempted to demonstrate by elaborate calculations, that the rates fixed were confiscatory, inasmuch as a proportionate reduction on all the rates of the railroads affected by them would so reduce the income of the companies as to make it impossible for them to pay any dividends; and in the case of some of them, even to meet all their bonded obligations. On behalf of the state, it was urged that the reduction in rates would increase business, and, therefore, increase net earnings, and that some at least of the companies were bonded far in excess of their actual value. Supreme Court Justice Brewer, sitting in circuit, on the basis of the evidence submitted to him, consisting mainly of statements of operating expenses, gross receipts, and inter- and intra-state tonnage, found the contention of the railroads well taken, and issued the injunctions applied for.

The opinion of the Supreme Court, affirming the decree of Judge Brewer, was, in the essential part of it—that asserting the principle of judicial review in its broadest terms—singularly brief. Contenting himself with citing a few short dicta from previous decisions, Justice Harlan, speaking for the Court, declared that the principle "must be regarded as settled" that the reasonableness of a rate could not be so conclusively determined by a legislature as to escape review by the judiciary. Equally well settled, it was declared, was the principle that property affected with a public interest was entitled to a "fair return" on its "fair" valuation. These principles regarded as established, the Court proceeded to examine the evidence, although it admitted that it lacked the technical knowledge necessary to a completely equitable decision; and sustained the finding of the lower court in favor of the railroads. There was no dissent.

With Smyth v. Ames the doctrine of judicial review may be regarded as fully established. No portion of the judicial prerogative could now be surrendered without not merely "distinguishing" but flatly overruling a unanimous decision of the Court.

The significance of Smyth v. Ames was soon observable in the activities of the lower Federal courts. Within the nine months of 1898 that followed that decision, there were at least four applications for injunctions against alleged unreasonable rates, and in three of these cases the applications were granted. During the years that followed Smyth v. Ames, Federal courts all over the country were tying the hands of state officers who attempted to put into effect legislative measures regulating railway concerns. In Arkansas, Florida, Alabama, Minnesota, Missouri, Illinois, North Carolina, Louisiana, and Oregon, rates fixed by statute, commission, or ordinance were attacked by the railways in the Federal courts and their enforcement blocked. In several instances the injunctions of the lower courts were made permanent, and no appeal was taken to the Supreme Court of the United States. With Smyth v. Ames staring them in the face, state attorneys accepted the inevitable.

The decision in Smyth v. Ames left still one matter in doubt. The allegation of the railroads in that case had been that the rates fixed were actually confiscatory—that is, so low as to make dividends impossible. In the course of his opinion, Justice Harlan had stated, however, that the railroads were entitled to a "fair return," an opinion that had been expressed also in the Reagan case, where indeed it had been necessary to the decision, and still earlier, but with little relevancy, in the Chicago-Minnesota case. In none of these cases, however, had any precise definition of the terms "reasonable" or "fair" return been necessary, and none had been made.

The first direct suggestion of the development of the judicial reasoning on this point that was to take place is found in the Milwaukee Electric Railway case, also decided in 1898. In that case Judge Seaman, of the Federal circuit court, found from the evidence that the dividends of the street railway company for several years past had been from 3.3 to 4.5 per cent, while its bonds bore interest at 5 per cent. Anything less than these returns, the judge declared, would be unreasonable, inasmuch as money loaned on real estate, secured by a first mortgage, was at that time commanding 6 per cent in Milwaukee.

Eleven years later, in 1909, the Supreme Court sustained virtually the same rule in the New York Consolidated Gas case, holding, with the lower court, that the company was entitled to six per cent return on a fair value of its property (including franchises and the high values of the real estate used by it in the business), because six per cent was the "customary" rate of interest at that time in New York City. On the same day the court decided that a return of six per cent on waterworks property in Knoxville, Tennessee, was also not unreasonable. In neither of these cases, however, did the Court attempt any examination or explanation of the evidence on which it rested its determination that six per cent was the "customary" rate in the places named; nor did it attempt to explain the principle on which such "customary" rate could be determined for other times and places. Plainly there is still room for a great deal of "distinguishing" on this point. The extreme vagueness of the rule was exemplified by the decision of Federal circuit Judge Sanborn in the Shephard case (1912), in which he decided that, for a railroad running through Minnesota, seven per cent was no more than a "fair" return, and that any reduction in rates which would diminish the profits of the road below that figure was unreasonable.

Equally important and of as great difficulty are the questions entering into the determination of a "fair" valuation. This point is both too unsettled and too technical to render any discussion of it profitable here. Attention may, however, be called to two of the holdings in the Consolidated Gas case. In arriving at a "fair" valuation of the gas company's property, the Court allowed a large valuation to be placed upon the franchises of the company—none of which had been paid for by the companies to which they had originally been issued, and which had not been paid for by the Consolidated Company when it took them over, except in the sense that a large amount of stock, more than one sixth of the total stock issued by the company, had been issued against them, when the consolidation was formed. The particular facts surrounding this case are such as to make it very easy for the Court to "distinguish" this case from the usual one, for the consolidation was formed, and its stock issued, under a statute that authorized the formation of consolidations, and forbade such consolidations to issue stock in excess of the fair value of the "property, franchises, and rights" of the constituent companies. This last prohibition the Court construed as indicative of the legislative intention that the franchises should be capitalized. Equally plain is it, however, that this particular circumstance of the Consolidated Gas case is so irrelevant that it will offer no obstacle whatever to the Court's quoting that case as a precedent for the valuation of franchises obtained gratis, should it so desire.