V. Lawfulness of the PSA

A. The Purpose of the Commission v. The Purpose of the Bankruptcy Court

Before reviewing the specific legal issues, it is important to recognize the fundamental differences between the Commission and the Bankruptcy Court. The Commission regulates the relationship between public utilities and their ratepayers whereas the Bankruptcy Court is concerned with the relationship between the debtor and its creditors.

As the California Supreme Court recently explained in Southern California Edison Company v. Peevey (2003) 31 Cal. 4th 781, 792, the Commission's "authority derives not only from statute but from the California Constitution, which creates the agency and expressly gives it the power to fix rates for public utilities." The Supreme Court, in a prior decision, had declared that: The Commission was created by the Constitution in 1911 in order to "protect the people of the state from the consequences of destructive competition and monopoly in the public service industries . . . [The Commission] is an active instrument of government charged with the duty of supervising and regulating public utility services and rates. "(Sale v. Railroad Commission (1940) 15 Cal. 2d 612, 617.) The Commission has legislative and judicial powers. (People v Western Air Lines (1954) 42 Cal. 2d 621, 630.) The fixing of rates is quasi-legislative in character. (Clam v. PUC (1979) 25 Cal. 3rd 891, 909; Southern Pacific Co. v. Railroad Com. (1924) 194 Cal. 734, 739.) In addition, the California Legislature has provided that "all charges by a public utility for commodities or services rendered shall be just and reasonable (§ 451) and has given the commission the power and obligation to determine not only that any rate or increase in a rate is just and reasonable (§§ 454, 728), but also authority to `supervise and regulate every public utility in the State . . . '" (Camp Meeker Water System, Inc. v. Public Utilities Com. (1990) 51 Cal. 3d 845, 861-862.)

In contrast, the Bankruptcy Court operates under the authority of the Bankruptcy Code, and a central purpose of the Bankruptcy Code is to "provide a procedure by which certain insolvent debtors can reorder their affairs, make peace with their creditors, and enjoy `a new opportunity in life . . . '" (Grogan v. Garner (1991) 498 U.S. 279, 286.) Put another way, the two overarching purposes of the Bankruptcy Code are: "(1) providing protection for the creditors of the insolvent debtor and (2) permitting the debtor to carry on and ... make a ` fresh start.'" (In re Andrews (4th Cir. 1996) 80 F.3d 906, 909.) (We note that PG&E is a solvent debtor.) PG&E's disclosure statement (Ex. 101b, p. 2) seconds this: "Under chapter 11, a debtor is authorized to reorganize its business for the benefit of itself, its creditors, and its equity interest holders." Significantly, no mention is made of the ratepayers who are expected to shoulder 100 percent of PG&E's burden.

The Bankruptcy Code, 11 U.S.C. § 1129 (a) (6), explicitly recognizes that utility ratemaking is the province of governmental regulatory commissions, such as the Commission, rather than the Bankruptcy Court. As stated in In re Cajun Elec. Power Co-op., Inc. (5th Cir. 1999) 185 F.3d 446, 453, "[s}ection 1129 (a) (6) of the Bankruptcy Code further provides that any rate change in a reorganization plan must be approved by governmental regulatory commissions with proper jurisdiction." The Court found no support for a narrow reading of § 1129 (a) (6), because "such an argument ` ignores the reasons which mandate [public utility commission] regulation in the first instance. The [commission] is entrusted to safeguard the compelling public interest in the availability of electric service at reasonable rates. That public interest is no less compelling during the pendency of a bankruptcy than at other times.' ("Id., at 453, n. 11, quoting with approval Flaschen & Reilly, Bankruptcy Analysis of a Financially-Troubled Electric Utility, (1985) 59 Am.Bankr.L.J. 135, 144.)

Indeed, in an earlier phase of PG&E's bankruptcy proceeding, it sought from the Bankruptcy Court a stay of the Commission's D.01-03-082 (the Accounting Decision). In finding that the public interest will not be served by issuing an injunction, the Bankruptcy Court declared that issuing a stay "would create jurisdictional chaos. 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. PG&E has all the usual avenues for relief from the Accounting Decision, including appellate review and reconsideration by CPUC. These alternatives may be particularly apropos in the constantly-changing factual and regulatory environment." (In re Pacific Gas and Electric Company (2001) 263 B.R. 306, 323; 2001 Bankr. LEXIS 629 **38, appeal pending sub nom., Pacific Gas and Electric Company v. California Public Utilities Commission, et al., United States District Court for the Northern District of California No. C-01-2490 VRW.)

B. The Commission's ability to Bind Future Commissions

"The regulation of utilities is one of the most important of the functions traditionally associated with the police power of the states." (Arkansas Electric Coop. v. Arkansas Pub. Serv. Comm'n (1983) 461 U.S. 375, 377.) This Commission's authority to regulate public utilities in the State of California is pursuant to the State's police power. (See, Motor Transit Company v. Railroad Commission of the State of California (1922) 189 Cal. 573, 581.) The California Supreme Court has held that "it is settled that the government may not contract away its right to exercise the police power in the future." (Avco Community Developers, Inc. v. South Coast Regional Com. (1976) 17 Cal. 3d 785, 800.) The argument that the Commission would not be surrendering the State's police powers because the proposed settlement would only bind the Commission for nine years has no merit. The Commission cannot be powerless to protect PG&E's ratepayers from unjust and unreasonable rates or practices during the nine-year term of the proposed settlement. "The police power being in its nature a continuous one, must ever be reposed somewhere, and cannot be barred or suspended by contract or irrepealable law. It cannot be bartered away even by express contract." (Mott v. Cline (1927) 200 Cal. 434, 446 (emphasis added).)¹²

In Re Pacific Gas and Electric Company (1988) D.88-12-083, 30 CPUC 2d 189 ("Diablo Canyon"), we held that we lack the power to approve settlements that bind future Commissions. We relied upon cases which hold that a legislative body cannot restrict its own power or that of subsequent legislative bodies, as well as §§ 728 and 1708, which provide that, after a hearing, the Commission may rescind, alter or amend previous decisions, or may declare rates are unjust and unreasonable and fix the just and reasonable rates to be thereafter observed and in force. (Id. at 223-225.)

An excerpt from Diablo Canyon sets forth the rationale and a solution.

"A major concern in this case is whether a future Commission will adhere to the terms of a settlement agreement which fixes the price to be paid for Diablo Canyon electricity for the next 28 years. The parties agree that we cannot bind future Commissions. PG&E: "Since ratemaking is quasi-legislative in nature, it is a general principle that a commission cannot bind the actions of a future commission" (Brief. p. 71); AG: "As a legal matter, the Commission cannot bind its successors as to policy matters" (Brief, p. 5); the DRA: "No order of the Commission is binding on future Commissions" (Brief, p. 7); TURN: "It is well-established that a decision made by the current Commission cannot bind a future Commission" (Brief, p. 15). And we have specifically held that we cannot bind the actions of a future Commission. (Re PG&E (1981) 6 CPUC 2d 739 (abstract), D.93497 in A.59537.)

* * *

The CPUC is both a court and an administrative tribunal. It exercises both judicial and legislative powers. (Re L. A. Metro. Transit Auth. (1962) 60 CPUC 125, 127.) The fixing of rates of public utilities is an example of its legislative powers. (People v. Western Air lines, Inc. (1954) 42 Cal. 2d 621, 630.)

* * *

The Public Utilities Code strengthens the proposition that we cannot bind future Commissions. Section 1708 provides: "The commission may at any time . . . rescind, alter, or amend any order or decision made by it." Section 457 permits utilities to enter into an agreement for a fixed period for the automatic adjustment of charges for electricity with the caveat "Nothing in this section shall prevent the commission from revoking its approval at any time and fixing other rates and charges . . . ." Finally, Section 451 provides that "All charges demanded or received by any public utility . . . shall be just and reasonable" and Section 728 provides that if the Commission finds rates are unreasonable, "the commission shall . . . fix . . . the just, reasonable . . . rates . . . to be thereafter observed and in force." We have reviewed these statutes, which are familiar to all practitioners of public utility law in California, to impress upon the proponents of the settlement the limitations under which we act today. (Cf. FPC v. Sierra Pac. Power Co. (1956) 350 US 348, 100 L. Ed. 388.) And we deliberately refrain from commenting on the consequences of a future Commission's changing of the terms of the settlement. We believe the settlement is a fair compromise of a difficult, costly controversy and we intend that the terms and conditions of the Settlement Agreement and the Implementing Agreement shall be effective on the dates specified in the agreements. The proponents have prepared the following language to propitiate future Commissions, which we adopt.

To the extent permitted by law, the Commission intends that this decision be binding upon future Commissions. In approving this settlement, based on our determination that taken as a whole its terms produce a just and reasonable result, this Commission intends that all future Commissions should recognize and give all possible consideration and weight to the fact that this settlement has been approved based upon the expectations and reasonable reliance of the parties and this Commission that all of its terms and conditions will remain in effect for the full term of the agreement and be implemented by future Commissions."

Conclusion of Law 4 in Diablo Canyon held: "This Commission cannot bind future Commission in fixing just and reasonable rates for PG&E." We reaffirm that holding and will adopt the mitigating language set forth above, expecting future Commissions to abide by our approval of a settlement extending for a period of years.

The proponents of the PSA attempt to distinguish Diablo Canyon, because that case involved a settlement pending before the Commission, whereas the PSA would be entered into by the Commission itself to settle litigation in federal courts. The proponents claim that a decision of the Commission may not bind future Commissions, but the Commission may execute a settlement agreement or a contract to bind future Commissions. This distinction is absurd.

We do not doubt that under certain circumstances, the Commission can legally enter into settlements or contracts which would bind future Commissions.¹³ However, when entering into the settlement agreements or contracts, the Commission may not act inconsistently with state law. In Southern California Edison Co. v. Peevey, (2003) 31 Cal. 4th at 792, the Court declared: "If PUC lacked substantive authority to propose and enter into the rate settlement agreement at issue here, it was not for lack of inherent authority, but because this rate agreement was barred by some specific statutory limit on PUC's power to set rates." Similarly, in Southern California Edison Co. v. Lynch (9th Cir. 2002) 307 F.3d 794, 809, the Ninth Circuit held that if the Commission's settlement agreement violated state law, "then the Commission lacked capacity to consent to the Stipulated Judgment, and [the Ninth Circuit] would be required to vacate it as void. State officials cannot enter into a federally-sanctioned consent decree beyond their authority under state law."

The PSA purports to bind the Commission for nine years. In light of the constitutional requirement that the Commission actively supervise and regulate public utility rates (Sale v. Railroad Commission (1940) 15 Cal. 2d 607 at 617) and the statutory requirements under the §§451, 454, 728 that the Commission ensure that the public utilities' rates are just and reasonable (Camp Meeker Water System, Inc. v. Public Utilities Com. (1990) 51 Cal. 3d 850 at 861-862), we hold that the Commission has the authority to enter into settlements but does not have authority to limit or prevent future Commissions from determining whether or not PG&E's rates are just and reasonable.

The clause of the PSA requiring future Commissions to be bound is paragraph 21.

21. Validity and Binding Effect. The Parties agree not to contest the validity and enforceability of this Agreement, the Settlement Plan or any order entered by the Court contemplated by or required to implement this Agreement and the Settlement Plan. This Agreement, the Settlement Plan and any such orders are intended to be enforceable under federal law, notwithstanding any contrary state law. This Agreement and the Settlement Plan, upon becoming effective, and the orders to be entered by the Court as contemplated hereby and under the Settlement Plan, shall be irrevocable and binding upon the Parties and their successors and assigns, notwithstanding any future decisions and orders of the Commission.

Because we cannot bind future Commissions we strike the third sentence of the paragraph. And because of the view we take regarding consenting to Bankruptcy Court jurisdiction and choice of laws (discussed below) we have rewritten paragraph 21 to read as follows:

The Parties agree not to contest the validity and enforceability of this Agreement or the Settlement Plan.

1. Jurisdiction of the Bankruptcy Court

The clause of the PSA regarding the jurisdiction of the Bankruptcy Court is paragraph 22.

22. Enforcement. The Parties agree that the Court shall retain jurisdiction over the Parties for all purposes relating to enforcement of this Agreement, the Settlement Plan and the Confirmation Order.

This paragraph is deleted in its entirety.

Under the PSA the Bankruptcy Court will be asked to determine such matters as a) whether the Commission discriminated against PG&E, see ¶ 2j; b) whether the Commission failed to act to maintain PG&E's investment grade company credit ratings, see ¶ 2g; or c) whether the Commission restricted the ability of PG&E to declare dividends or repurchase common stock, see ¶ 6; the PSA includes other provisions of a more general nature under which PG&E could request intervention by the Bankruptcy Court. Among many scenarios which might reasonably arise, we note three:

1. PG&E files an application for a 3% attrition increase. The Commission grants only 1% and places the entire increase on the large industrial customers. PG&E claims a violation of the PSA and seeks relief in Bankruptcy Court. Meanwhile, the industrial customers seek relief by appealing the Commission decision to the California appellate courts. The result would be a conflict of jurisdictions leading to conflicting decisions, delay, and increased expense.

2. On the facts above, the Bankruptcy Court orders PG&E to increase its rates by 2%, which it does without CPUC authorization; or the Bankruptcy Court orders the CPUC to raise PG&E's rates by 2% under threat of a contempt action.

3. The CPUC opens an investigation of PG&E seeking to reduce rates by a specific (or unspecific) amount. PG&E immediately moves the Bankruptcy Court for an injunction preventing the CPUC from proceeding with the investigation.

Appellate procedure to challenge the decisions of the Commission is clear. § 1759 states:

1759. (a) No court of this state, except the Supreme Court and the court of appeal, to the extent specified in this article, shall have jurisdiction to review, reverse, correct, or annul any order or decision of the commission or to suspend or delay the execution or operation thereof, or to enjoin, restrain, or interfere with the commission in the performance of its official duties, as provided by law and the rules of court.

(b) The writ of mandamus shall lie from the Supreme Court and from the court of appeal to the commission in all proper cases as prescribed in Section 1085 of the Code of Civil Procedure.

For this Commission to consent to a dilution of the power of the Supreme Court of California and the appellate courts to review our orders and decisions is a step we are not prepared to take. We recognize that the Bankruptcy Court has the power to enforce its orders and nothing we say here should be construed to deny that power.

2. Conflict of Laws

The PSA exposition of controlling law is confusing. Paragraph 21 (set forth above) states, in part: "This Agreement, the Settlement Plan and any such orders [entered by the Bankruptcy Court] are intended to be enforceable under federal law, notwithstanding any contrary state law."

Paragraph 32 states:

32. California Law. This Agreement shall be governed by, and shall be construed and enforced in accordance with, the laws of the State of California, without giving effect to the conflict of law principles thereof, except that this Agreement, the Settlement Plan and any orders of the Court (including the Confirmation Order) are intended to be enforceable under federal law, notwithstanding any contrary state law.

As discussed above, we cannot lawfully enter into a settlement that may be contrary to state law (See, Southern California Edison co. v. Peevey (2003) 31 Cal. 4^th at 792; Southern California Edison Co. v. Lynch (9^th Cir. 2002) 307 F.3d 794, 809), and we cannot limit the future decisions and orders of the Commission such that the Commission could no longer protect PG&E's ratepayers from unjust and unreasonable rates. Perhaps we are being unduly cautious, but under the PSA we foresee the intricacies of Erie v. Tompkins (1938) 304 US 64, 114 ALR 1487, lurking in the details of determining just what California laws are to be enforced under which federal law, and more to the point, a reiteration of SCE v Lynch (9^th Cir. 2002) 307 F.3d 794, 812 with the federal court of appeals certifying questions of California law to the California Supreme Court. We have rewritten paragraph 32 to read as follows:

California Law. This Agreement shall be governed by, and shall be construed and enforced in accordance with, the laws of the State of California.

3. Consistency with Assembly Bill 1890 and § 368(a)

At one time there was uncertainty as to whether AB 1890 had limited the Commission's authority to allow PG&E to recover all of the wholesale power costs it had booked into its Transition Revenue Account (TRA), or all of its uneconomic generation-related costs in its TCBA. The uncertainty was due to the AB 1890 provision (i.e. § 368(a)) putting the utilities at risk for those costs not recovered by the time that the AB 1890 rate freeze ended (i.e., no later than March 31, 2002).

All parties recognize that there no longer is any uncertainty about the Commission's authority to allow PG&E's recovery of its TCBA balance because AB 6X restored the Commission's ratemaking authority over generation-related facilities owned by the public utilities under our jurisdiction. As the California Supreme Court held in Southern California Edison Company v. Peevey, 31 Cal.4^th at 793, "after the enactment of AB 6X in 2001,...PUC was authorized to approve rates allowing SCE to recover the costs...." Referring to AB 6X as a "major retrenchment from the competitive price-reduction approach of AB 1890," the Court found that AB 6X reemphasized "PUC's duty and authority to guarantee that the electric utilities would have the capacity and financial viability to provide power to California consumers."

The Commission has the authority to allow the utilities to recover their prudently incurred generation-related costs, because AB 6X had eliminated AB 1890's market valuation requirement for the utilities' retained generation assets and Assembly Bill 6X "allowed PUC to regulate the rates for power so generated pursuant to ordinary `cost-of-service' ratemaking." (Id. at 795.) Due to the restoration of the Commission's ratemaking authority over these assets, AB 6X had "largely eliminated the category of `uneconomic' generating asset costs," and, therefore the limit in § 368(a) "no longer applies to the generation-related costs of the utilities." Id.

In view of the California Supreme Court's recent decision finding that AB 6X had made § 368(a) inapplicable to the utilities' unrecovered costs, it is clear that the Commission's authority to allow PG&E to recover the balance in its TCBA is not limited by AB 1890.

TURN argues that under basic principles of utility ratesetting, ratepayers cannot be forced to contribute capital to a utility and that utilities are not entitled to earn a return on their expenses. (TURN Op. Br. p. 11-13.) We do not agree that that principle applies to this settlement. In Diablo Canyon, (1988) 30 CPUC 2d 189, and subsequent decisions for the nuclear powerplants owned by PG&E, SCE, and SDG&E, the Commission approved incremental cost incentive pricing that allowed the utility to recover its operating expenses on the basis of operating performance rather than actual cost, thus allowing the utility to recover more than its actual operating expenses if performance exceeded benchmarks. As we discussed above, in Southern California Edison v Peevey 31 Cal. 4^th at 793, the Court reemphasized the Commission's duty and authority to guarantee that the electric utilities would have the capacity and "financial viability to provide power to California customers." (Emphasis added.)