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.

The Legal Framework

The Bankruptcy Code does not pre-empt ongoing state regulation. A chapter 11 debtor must operate its business in compliance with state law. See 28 U.S.C. §959(b).¹ 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."

The PSNH and Cajun Cases

In the PSNH case, Judge Yacos took the extraordinary step of enjoining an involuntary rate case commenced by the New Hampshire PUC. Public 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). 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)² 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 Louisiana Pub. Serv. Comm'n. v. Mabey (In re Cajun Elec. Power Co-op. Inc.), 185 F.3d 446 (5th Cir. 1999). 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 28 U.S.C. §959(b), 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.

Sovereign Immunity

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. Seminole Tribe of Florida v. Florida, 517 U.S. 44 (1996). 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.

The PG&E Decision

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.³ 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 28 U.S.C. §959(b) 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. Pacific Gas & Elec. Co. v. California Pub. Utils. Comm'n. (In re Pacific Gas & Elec. Co.), 263 B.R. 306 (Bankr. N.D. Cal. 2001), 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 Ex parte Young, 209 U.S. 123 (1908) (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.

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.

Id. at 322. 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.

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.

Id. at 323.

Conclusion

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.

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Footnotes

¹ 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." Return to article

² 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." Return to article

³ 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. Return to article