Wood Alternate Comment Decision. Opinion Modifying the Proposed Settlement Agreement of Pacific Gas & Electric Company, PG&E Corporation and the Commission Staff and Approving the Settlement Agreement as Modified.

Lawfulness of the Settlement Agreeement

J. 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 mostly concerned with the relationship between the debtor and its creditors.

As the California Supreme Court recently explained in Southern California Edison Co. v. Peevey, supra, 31 Cal. 4th at 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. 3d 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."

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, PG&E 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.)

K. The Commission's Ability to Bind Future Commissions

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.

There cannot be any doubt that under certain circumstances, the Commission can legally enter into contracts which would bind future Commissions when authorized by statute.²¹ In Southern California Edison Co. v. Peevey, supra, 31 Cal. 4^th at 792, the California Supreme Court relied upon the Commission's broad authority under Article XII of the California Constitution, sections 701 and 728 of the Public Utilities Code, and prior precedent to conclude that the Commission is a "state agency of constitutional origin with far-reaching duties, functions and powers whose `power to fix rates [and] establish rules' has been `liberally construed.'" Because the Commission had not acted contrary to state law and in light of the Commission's inherent authority, the California Supreme Court upheld the Commission entering into a binding settlement with SCE in its federal district court case against the Commission. Id. at 805.²²

It is true that in Diablo Canyon, D.88-12-083, 30 CPUC 2d 189, 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.)

The proponents of the PSA 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 by itself may not bind future Commissions, but the Commission may execute a settlement agreement or a contract to bind future Commissions.

We agree with the proponents that a court-approved settlement, consistent with state law, would bind the Commission. There is an important difference between the Commission's authority within the scope of its own proceedings, and the Commission's efforts to resolve litigation in courts. The Commission must abide by court orders and a subsequent Commission does not have the authority to ignore a court order approving a settlement to which the Commission is a party. The Commission must have the ability to exercise its regulatory and police powers to resolve the Bankruptcy Court litigation through a settlement which it legally bound to honor. When entering into settlement agreements or contracts the Commission may not act inconsistent with state law. As the Court declared in Southern California Edison Co. v. Peevey, supra, 31 Cal. 4^that 792: "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."

We therefore must determine that a settlement is consistent with state law before we can enter into the settlement. While Paragraphs 21 and 32 of the PSA provide that the Parties agree that the settlement agreement, the settlement plan and any court orders are intended to be binding and enforceable under federal law, "notwithstanding any contrary state law," this is general language that does not specify the purportedly contrary state laws. More significantly, this is irrelevant language to the extent that the settlement agreement, as modified by this decision, is not contrary to state law. To avoid any confusion, we are striking these phrases from the settlement, because we can enter into a settlement only if it is consistent with state law. However, as discussed below, the settlement agreement, as modified and clarified by this decision (the "MSA"), is not contrary to state law and we can bind the Commission by entering into it.

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), the Commission must retain its authority to set just and reasonable rates during the term of the settlement and thereafter.

"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 Commission cannot be powerless to protect PG&E's ratepayers from unjust and unreasonable rates or practices during the 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).)

Whether or not the Commission could enter into a settlement agreement without violating state law turns on whether the settlement agreement would surrender or suspend the Commission's exercise of its police powers or whether the settlement agreement is consistent with the Commission exercising its regulatory powers. In Santa Margarita Area Residents Together v. San Louis Obispo County Bd. of Supervisors (2000) 84 Cal. App.4th 221, 233, the Court found that notwithstanding a zoning freeze, the County's agreement had not surrendered its police powers, because under the agreement, the project had to be developed in accordance with the County's general plan, the agreement did not permit construction until the County had approved detailed building plans, and the agreement retained the County's discretionary authority in the future.

The Santa Margarita court approved the development agreement at issue there as an appropriate exercise of a county's powers under the Development Agreement Statute, Gov. Code sections 65684 et seq. In rejecting the argument that the development agreement was an unconstitutional restraint on the county's police powers, the court focused on two factors: (1) the conclusion that the county had reasonably interpreted an express statutory authorization, Santa Margarita, 84 Cal. App. 4^th 221, 227-232 and (2) the limited duration of the contract - not more than five (5) years. Id. at 233.

There is no express statutory authorization for the type of agreement that is proposed in the PSA. However, in the Edison settlement, the Commission expressly limited the duration of its obligation for four (4) years and in fact accomplished the objectives in 21 months. While the Santa Margarita concept of a limited waiver of police power authority may be applicable here, the absence of an express statutory authorization makes compliance with the other factor - limited duration - even more important.

We hold that notwithstanding the lack of an express statutory authorization, we may bind ourselves to this settlement agreement that has the effect of circumscribing certain of our regulatory powers, but only for a limited period of time, not to exceed four (4) years. The amortization of the regulatory asset should be limited in time by the duration of the waiver. This enables us to limit the scope and intrusiveness of federal court oversight to enforce the terms of the MSA to the same period.

A shortened amortization period has additional economic, financial and policy benefits. It reduces the risk of nonrecovery. It accelerates meaningful, progressive rate reductions and a speedy return to cost-based rates. It also eliminates the possibility that the personnel of the Commission will change and that a different group may adopt a different policy. Whether or not we can bind future commissioners as an institutional matter, c.f., Denio v. City of Huntington Beach,(1943), 22 Cal. 2d 80, we can certainly bind ourselves and bring about amortization during a period when a majority of the voting Commissioners remain on the Commission.

Paramount in this connection is our concern that PG&E management not undermine our efforts to assure investment grade credit ratings. Many parties have expressed their opposition to Paragraph 2.g. of the PSA, which would require the Commission "to act to facilitate and maintain Investment Grade Company Credit Ratings for PG&E" as compounding the problems associated with circumscribing our regulatory authority for a limited period. The statutory requirements under sections 454 and 728 of the Public Utilities Code are that the rates must be just and reasonable (see Camp Meeker Water System, Inc. v. Public Utilities Com., 51 Cal. 3d at 862), and opponents argue that the investment grade requirement would supplant the just and reasonable standard. We disagree. As discussed below, however, we believe that this commitment as we proposed to clarify it is consistent with our statutory responsibility to ensure that PG&E's rates are just and reasonable.

The Commission's commitment will remain, as provided in Paragraph 2.g., to act to facilitate and maintain the investment grade credit ratings. However, we do not interpret Paragraph 2.g. to require the Commission to guarantee such a credit rating when there are other causes, besides the Commission's actions (e.g., PG&E's imprudent conduct resulting in a disallowance), which are responsible for any threats to PG&E's investment grade credit rating. Further, we recognize that there are inherent risks in a holding company structure that warrant greater vigilance, which we provide for in revised Paragraphs 2g and 3.b. Therefore, under the MSA, PG&E's ratepayers will still be protected from unjust and unreasonable rates.

In setting just and reasonable rates, in addition to protecting the consumers, we also must consider the financial health of the public utility. Indeed, we view this commitment to act to facilitate and maintain investment grade credit ratings as essentially doing what we have always done under cost-of-service regulation: provide just and reasonable rates and authorize a reasonable capital structure that maintains the fiscal integrity of the utility. As already discussed, our traditional regulation resulted in high investment grade ratings of our energy utilities.

In the balancing of interests of the utility and its ratepayers that we undertake in setting rates, a major factor is the utility's financial integrity. There should be enough revenue for all of the utility's prudently incurred costs or operating expenses, investments and costs of debt. See Duquesne Light Co. v. Barasch (1989) 488 U.S. 299, 310; FPC v. Hope Natural Gas Co., supra, 320 U.S. at 603. We are therefore exercising our regulatory authority in agreeing with this commitment in Paragraph 2g., as clarified above, because we find as part of our regulatory responsibilities, that it is in the public interest to get PG&E out of bankruptcy and restore its investment grade credit ratings.

In Southern California Edison Company v. Peevey, supra, 31 Cal.4^th at 791, the California Supreme Court explicitly recognized that the Commission's settlement with SCE was intended to "restore SCE's creditworthiness and avoid further instability and uncertainty for the company and consumers." The Court not only upheld the Commission's authority to enter into the settlement, it also confirmed the Commission's "duty and authority to guarantee that the electric utilities would have the capacity and financial viability to provide power to California consumers." Id. at 793.

Just as the Court found in Santa Margarita Area Residents Together v. San Louis Obispo County Bd. of Supervisors, supra, 84 Cal. App.4^th at 233, that the County had not completely surrendered its police powers, because in entering the agreement, the County had exercised its regulatory powers and retained the County's discretionary authority in the future, the Commission would not be surrendering or suspending its police powers, because the present settlement, as modified and clarified by this decision, is consistent with exercise of those police powers based upon the record in this proceeding because the Commission has retained its discretionary authority over PG&E's overall retail electric rates. After considering all of the evidence and positions of the parties in this proceeding, we find that the provisions concerning the regulatory asset as modified are just and reasonable.

As Southern California Edison Co. v. Peevey, supra, 31 Cal.4th at 792 makes clear, we have the inherent authority to enter into binding settlements where we are not limited by state law. The Commission's settlement with SCE was approved by a federal district court's stipulated judgment, and the California Supreme Court upheld our right to enter into and be bound by the settlement even without hearings, a written decision with findings, and a vote in a public meeting. Id. at 805.²³

In the present case, the settlement, as modified and clarified by this decision, is consistent with state law. We have held a hearing, issued a written decision with findings, voted in a public meeting and modified and clarified provisions in the PSA to make the settlement, as modified, fair, just and reasonable and in the public interest. Accordingly, we find that we can enter into the MSA and bind future Commissions.

L. 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.

The present case is not the usual case where the Commission issues its decisions involving public utilities' rates. We are in an extraordinary situation involving PG&E's bankruptcy. Under sections of the United States Code and the Bankruptcy Code, 28 U.S.C. §§ 157(b), 1334, and 11 U.S.C. § 1129, the Bankruptcy Court has jurisdiction over the plan of reorganization, which must be confirmed in order to get PG&E out of bankruptcy. By agreeing to this settlement, as modified, it is our intent to present the Bankruptcy Court with a plan that is lawful under state law and that the Court will be able to confirm.

We also recognize that the Bankruptcy Court must have jurisdiction over the parties to enforce the agreement, the settlement plan and the Court's own confirmation order. Under sections of the United States Code and Bankruptcy Code, 28 U.S.C. §§ 157(b), 1334, and 11 U.S.C. § 1142, the Bankruptcy Court has jurisdiction over the implementation of the bankruptcy plan. As discussed above, we have required modifications to the PSA in order for it to be consistent with state law and to be just and reasonable. Having done so, we may bind the Commission to an agreement that is part of the settlement plan before the Bankruptcy Court. Just as the Commission was bound by the settlement with SCE and the federal district court can enforce the stipulated judgment (which adopted the settlement), the Bankruptcy Court can enforce the modified settlement agreement to the extent that it becomes part of the settlement plan approved by the Bankruptcy Court's confirmation order.

Contrary to the views of opponents of the PSA, the Bankruptcy Court's potential enforcement of the agreement (as modified), the settlement plan incorporating the modified agreement and the Court's confirmation order, in no way means that the Bankruptcy Court will decide PG&E's rates or services or supplant the California appellate courts from their judicial review of Commission orders involving PG&E. As discussed above, the modifications we have required to the PSA will result in the Commission retaining the authority over PG&E's rates and services subject to judicial review in the California appellate courts. Except for its enforcing the specific provisions in the settlement as modified for a limited period of time, the Bankruptcy Court will not be supervising the Commission's determinations as to PG&E's rates and services.

For the most part, after the Bankruptcy Court confirms the plan of reorganization, the Bankruptcy Court no longer supervises or protects the debtor. See Southwest Marine Inc. v. Danzig (9th Cir. 2000) 217 F.3d 1128, 1140. As the Bankruptcy Court stated with regard to the Commission's plan of reorganization, the Bankruptcy Court "is being asked to enforce the reorganization agreement. Nothing more... I see this Court's role as more limited than PG&E's counsel predicts." The Bankruptcy Court gave limited examples where it could find the Commission would be in breach of the reorganization agreement, but the Court recognized the Commission's " historic practice for [authorizing the] recovery of prudently incurred costs," and stated that only a departure from this practice for the "recoverable costs in the agreement" could be a breach. (Exhibit No. 122, Exhibit C, pp. 6-10-6-11.)

PG&E concedes that the PSA would not result in the Bankruptcy Court sitting as a super appellate court over the Commission decisions affecting PG&E. Moreover, the modification to the PSA which strikes Paragraph 6 from the requires PG&E to omit from the bankruptcy settlement plan Paragraph 6's restrictions on the Commission's authority over dividends or stock repurchase practices. Therefore, for the Commission to enter into a settlement with PG&E in the bankruptcy proceeding, those restrictions would not be part of the plan that the Bankruptcy Court would have the authority to approve, implement and enforce. Under these circumstances, it is justifiable for the Commission to agree to the enforcement provisions in paragraph 22, and for the Bankruptcy Court to have jurisdiction to enforce the MSA, the settlement plan incorporating the MSA, and the Court's confirmation order for a period of four (4) years.

M. 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 Co. v. Peevey, supra, 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 eliminated AB 1890's market valuation requirement for the utilities' retained generation assets and AB 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 "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 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 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 Co. v Peevey, supra, 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.)

²¹ For example, the Commission may enter into contracts to rent offices § 306(a); may procure books, stationery, furniture, etc., (§ 306(d)); may hire consultants and advisory services (§§ 631, 1094); may contract with state agencies (§ 274); may award grants (§ 276.5(c)); and may hire experts to prepare EIRs and Negative Declarations (Rule 17). Water Code § 80110 grants the Commission express authority to enter into an agreement with the Department of Water Resources with respect to charges under § 451. (D.02-03-053, at p. 8.) ²² During the energy crisis, the skyrocketing wholesale power costs and AB 1890's rate freeze had caused both SCE and PG&E to face mounting debts and lose their creditworthiness. Both utilities sued the Commission in federal district courts. The California Supreme Court upheld the Commission's settlement with SCE, which provided for SCE's recovery of its costs, which were incurred but unrecovered during the AB 1890 rate freeze. Id. at 791. ²³ In Southern California Edison Co., 31 Cal.4^th at 802-805, the Supreme Court found that a hearing, decision with findings and vote in a public meeting were not statutorily required, because the Commission had "maintained" and not "changed" SCE's rates. That case had a very unique factual situation. The Commission frequently has proceedings, issues written decisions with findings, and votes in public meetings, because the far more typical situation addressing a public utility's recovery of costs, such as the present case, involves changes to the public utility's rates.