Power Plays When Bankruptcy and Utility Law Collide

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Oct 2001

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The comprehensive restructuring of the electric utility industry begun in the
mid-1990s has led, among other things, to financial crises for some major electric
utilities. The most notable business failure has been that of Pacific Gas and
Electric Co. (PG&E) in Northern California. PG&E's chapter 11 filing has,
in turn, seriously threatened the viability of companies selling power to PG&E.
Other California utilities may follow PG&E into chapter 11 unless state bailout
plans succeed in averting another catastrophe.

In a bankruptcy reorganization of an electric utility, there are tensions between
the bankruptcy court and the utility's regulators as the court attempts to arbitrate the
company's desire to rehabilitate itself through the chapter 11 process and as the
regulators need to set and implement regulatory policy. When regulatory action threatens
the viability of the reorganization process, courts have struggled to find ways to
protect the utilities without unduly interfering with ongoing public utility regulation.
However, bankruptcy courts have never taken over the rate-setting process, and the
best that debtors have been able to accomplish has been a temporary injunction against
regulatory action.

These tensions were addressed in many of the electric utility bankruptcies of the
late 1980s through the mid-1990s, including such notable cases as Public Service
Co. of New Hampshire (PSNH), Wabash Valley Power Association and Cajun Electric
Power Cooperative. In PG&E's pending chapter 11, this conflict has thus far been
the central issue in the case. However, changes in the law since the PSNH and
Cajun cases have altered the legal framework for resolving the conflict in the
post-restructuring era.

<h3>The Legal Framework</h3>

The Bankruptcy Code does not pre-empt ongoing state regulation. A chapter 11
debtor must operate its business in compliance with state law. See <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… U.S.C.
§959(b)</a>.<a href="#1" name="1a">1</a> In the case of a regulated electric utility, this means that its
rates for electric service will be subject to ongoing state regulation. The exercise
of state police or regulatory power is also exempted from the automatic stay by
§362(b)(4) of the Bankruptcy Code, which provides, in part, that the filing
of a petition "does not operate as a stay...of the commencement or continuation of
an action or proceeding by a governmental unit...to enforce such governmental
unit's...police or regulatory power."

<h3>The PSNH and Cajun Cases</h3>

In the PSNH case, Judge Yacos took the extraordinary step of enjoining an
involuntary rate case commenced by the New Hampshire PUC. <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… Serv. Co. of New
Hampshire v. New Hampshire (In re Public Serv. Co. of New Hampshire), 98
B.R. 120 (Bankr. D. N.H. 1989)</a>. The state claimed that PSNH was
overcharging its rate-payers and began a rate proceeding to lower rates or compel
refunds. The bankruptcy court found that the rate proceeding would involve a review
of PSNH's entire rate base and annual rate of return. The court also found that the
proceedings could take several months and would divert the attention of PSNH's
management and staff from crucial actions and hearings in the bankruptcy court. Faced
with the prospect of a severe disruption of the chapter 11 process, the court
enjoined the proceeding for up to six months. The PSNH court based its authority to
enjoin the rate case on Bankruptcy Code §105(a)<a href="#2" name="2a">2</a> and did not reach alternate
theories based on violation of the automatic stay or regulatory bad faith.

The PSNH court applied the standards applicable to the granting of preliminary
injunctive relief to the §105(a) request and considered whether PSNH would suffer
irreparable harm, whether the harm to PSNH in the absence of an injunction would
outweigh the harm to the state, the likelihood of success on the merits and whether
the public interest would be adversely affected by the order. In balancing the harms
to the parties, Judge Yacos gave weight to the federal interest in maximizing value
for all parties in the reorganization proceeding by enhancing the prospects for a
consensual plan through issuance of the requested injunction.

In the Cajun Electric Power Cooperative case, the courts also struggled with
the extent to which the bankruptcy court could enjoin regulatory action. See <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…
Pub. Serv. Comm'n. v. Mabey (In re Cajun Elec. Power Co-op. Inc.),
185 F.3d 446 (5th Cir. 1999)</a>. In Cajun, the bankruptcy court had
enjoined the Louisiana PUC from considering a decrease in Cajun's rates based on the
suspension of Cajun's obligation to pay interest during the bankruptcy proceedings, and
the district court had affirmed. The PUC argued that the court exceeded its authority
under §105(a) and that Congress had preserved state rate-making authority during
the bankruptcy case by excepting governmental police and regulatory actions from the
automatic stay in §362(b)(4) of the Bankruptcy Code. The Fifth Circuit
ultimately ruled that the bankruptcy court's order was an abuse of discretion and did
not need to decide the difficult issue of the scope of the bankruptcy court's authority
under §105(a). As to the requirement to operate in compliance with state law
under <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… U.S.C. §959(b)</a>, the Fifth Circuit concurred with the prevailing
view that the general bankruptcy policy of fostering rehabilitation will not serve to
pre-empt otherwise applicable state laws dealing with public safety and welfare. The
court observed that it was not presented with a situation where the PUC's actions were
likely to result in administrative insolvency or prevent the utility from successfully
reorganizing, so it did not need to fully define the scope of its powers under
§105(a) to enjoin regulatory action. Its comments suggest, however, that the
threshold for exercising injunctive powers under §105(a) should be higher than that
used in PSNH.

<h3>Sovereign Immunity</h3>

At around the same time that the Federal Energy Regulatory Commission (FERC)
was mandating the restructuring of the electric utility industry, the Supreme Court was
declaring that the abrogation of sovereign immunity in §106(a) of the Bankruptcy
Code was unconstitutional. <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… Tribe of Florida v. Florida, 517 U.S. 44
(1996)</a>. This restriction on a debtor's ability to sue states or their agencies
in the federal courts has significantly altered the leverage available to utilities
reorganizing under chapter 11. The sovereign-immunity issue has added another layer
to the already complex balancing analysis where state regulatory action threatens the
viability of an electric utility's reorganization. In an area already deeply imbued
with considerations of comity and public policy, the courts now must address the
constitutional limits on their power to provide even temporary relief to debtors.

<h3>The PG&E Decision</h3>

In the PG&E chapter 11 case, PG&E immediately took on the California
Public Utilities Commission (CPUC) and its commissioners by filing an adversary
proceeding against them to enjoin the application of an accounting decision issued by
the CPUC just prior to the filing of the petition. The CPUC's decision required
PG&E to aggregate or "true up" its monthly revenue surpluses and shortfalls since
Jan. 1, 1998, in its Transition Cost Balancing Account. The effect of this
true-up was that PG&E had not fully recovered the approximately $7 billion in
stranded costs identified in its cost recovery plan under California's electric utility
restructuring statute. Since the costs had not been fully recovered, PG&E was
required to continue the statutory freeze on retail electric rates at 10 percent below
their levels as of June 1996. PG&E contended that the CPUC's decision would
irrevocably cause it to lose $4 billion as a result of the continuation of the rate
freeze through March 31, 2002, in a market environment in which its costs far
exceeded the frozen revenues.

PG&E claimed that the CPUC's threatened enforcement of the accounting decision
violated the automatic stay and that, even if there was no violation of the stay,
the CPUC's action should be enjoined in the exercise of the court's extraordinary
equitable powers under §105(a). The CPUC responded with multiple defenses. Not
surprisingly, its first defense was that the doctrine of sovereign immunity prevented
PG&E from suing the CPUC or its commissioners in the federal courts.<a href="#3" name="3a">3</a> The CPUC
argued that the automatic stay did not apply because the accounting decision was entered
several days before the chapter 11 filing. According to the CPUC, any
determination on the application of the automatic stay to hypothetical post-petition
enforcement actions was premature. Furthermore, the CPUC contended that even if the
CPUC's actions came within the scope of the stay, its actions were exempted by
§362(b)(4) as the exercise of police or regulatory power. Finally, the CPUC
claimed that <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… U.S.C. §959(b)</a> required PG&E to comply with state regulatory
orders and that PG&E was not entitled to an injunction under §105(a).

In a decision issued on June 1, 2001, Judge Montali denied PG&E's request
for an injunction on the merits and ordered the adversary proceeding dismissed. <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…
Gas & Elec. Co. v. California Pub. Utils. Comm'n. (In re Pacific Gas
& Elec. Co.), 263 B.R. 306 (Bankr. N.D. Cal. 2001)</a>, appeal
docketed, No. 01-02490 (N.D. Cal. June 28, 2001). The
sovereign-immunity issues were the first to be considered by the court. Although the
CPUC was named in the complaint, PG&E did not contest that the CPUC was
entitled to assert a sovereign immunity defense. Thus, PG&E was only entitled a
proceed against the individual commissioners, and then only if it could come within
the Ex parte Young exception to sovereign immunity. See <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… parte Young, 209
U.S. 123 (1908)</a> (allowing relief against state officials to enjoin violations
of federal law). In an aspect of the ruling currently under appeal by the state,
the bankruptcy court found that PG&E had established a prima facie case for
application of the Ex parte Young doctrine. The court reasoned that the ordering
paragraphs of the accounting decision presented a sufficient threat that the CPUC would
implement or enforce the decision. The court also stated that PG&E was entitled to
obtain a ruling on the merits of the automatic stay and injunction issues.

The court ruled that CPUC's actions did not violate the automatic stay and fell
squarely within the exception for police and regulatory action under §362(b)(4).
Its denial of PG&E's §105(a) injunction request followed its ruling on the
automatic stay. The court recognized that its powers under §105(a) were not limited
by the delineated exceptions to the automatic stay, but held that exercise of §105
powers must be linked to a violation of some other provision of the Bankruptcy Code.
Simply making reorganization more difficult does not rise to the level of improperly
frustrating the Code's purposes and objectives.

The PG&E court's discussion of the discretionary standards for §105(a) injunctions
sets the bar high for establishing irreparable harm and obtaining injunctive relief. As
a preliminary matter, the court acknowledged a line of cases, including the PSNH
decision, holding that a threat to a debtor's ability to reorganize can, in appropriate
circumstances, establish or substitute for the various elements in the traditional analysis
for granting injunctive relief. The court found, though, that no such threat or
interference was present in the PG&E case. Despite the massive continuing losses that
PG&E would incur as a result of the accounting decision, the court found no
irreparable harm.

<blockquote>
PG&E predicts that between now and March 31, 2002, when it will be
entitled under AB 1890 to raise rates, it may lose as much as $4
billion. That is an enormous sum of money for any entity to lose, but PG&E
has not shown that even in the face of such losses, reorganization would be
threatened.
</blockquote>

<a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; at 322</a>. The court also took the view that the public interest would not be
served by the jurisdictional chaos that would ensue if the court were to issue the
requested injunction.

<blockquote>
The public interest is better served by deference to the regulatory scheme and
leaving the entire regulatory function to the regulator, rather than selectively
enjoining the specific aspects of one regulatory decision that PG&E disputes.
</blockquote>

<a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; at 323</a>.

<h3>Conclusion</h3>

In the high-stakes arena of electric utility reorganization, there frequently will
be a need for temporary relief from state regulatory action under §105(a). In
one respect, the PG&E decision preserves this option by allowing a debtor to sue
state public utility commissioners under the Ex parte Young doctrine even though a suit
against the state is impossible after Seminole. In another respect, the decision
limits the availability of relief to situations where failure to enjoin regulatory action
will destroy the debtor or prevent reorganization. As courts face these issues in
future cases, they will need to strike the appropriate balance among the interests of
the states, the debtors and the creditors.

<hr>
<h3>Footnotes</h3>

<a name="1">1</a> This section provides, in pertinent part: "[A] trustee, receiver or manager appointed in any cause pending in any court of the
United States, including a debtor-in-possession, shall manage and operate the property in his possession as such trustee, receiver or manager
according to the requirements of the valid laws of the state in which such property is situated, in the same manner that the owner or
possessor thereof would be bound to do if in possession thereof." <a href="#1a">Return to article</a>

<a name="2">2</a> Section 105(a) provides in part that "the court may issue any order, process or judgment that is necessary or appropriate to
carry out the provisions of this title." <a href="#2a">Return to article</a>

<a name="3">3</a> In the PG&E case, the state of California was careful not to enter an appearance for fear that it would be deemed to have
waived its constitutionally guaranteed immunity from suit. <a href="#3a">Return to article</a>

Journal Authors

Daniel J. Carragher

Journal Date

Monday, October 1, 2001 - 12:00

Bankruptcy Rule

2001