A BRIGHT ENDING FOR PG&E AND THE CALIFORNIA POWER CRISIS

by

Gary M. Kaplan

The California energy crisis of late 2000 and early 2001 led to the April 2001 Chapter 11 bankruptcy filing of San Francisco-based Pacific Gas and Electric Company, the largest utility bankruptcy in U.S. history. In addition to the sheer magnitude of the bankruptcy case (the company listed assets of more than $21 billion in its bankruptcy filing), the case raised enormous public policy issues, as the energy crisis jeopardized the long-term financial health of California, threatened millions of customers with substantially higher energy costs, and pushed the company, its regulators and certain creditors into costly litigation that could have lasted for years. ILN member Howard, Rice, Nemerovski, Canady, Falk & Rabkin, acting as PG&E’s bankruptcy counsel, guided PG&E through one of the most complex and interesting bankruptcy cases in recent memory, resulting in a successful ending—a reorganization plan paying all creditors with interest, and reductions in customer’s electric rates.

Beginning in mid-2000, wholesale energy prices skyrocketed ten-fold or more in California, due in large part to market manipulation and other misconduct by Enron and several other energy sellers. (In proceedings that remain ongoing, federal regulators determined that such wholesale prices were illegal, and ordered energy sellers to refund billions of dollars to PG&E and other California energy purchasers.) PG&E was unable to pass these spiraling energy costs on to its customers, because retail electric rates were “frozen” under a 1996 partial deregulation of the power industry in California. PG&E eventually ran up billions of dollars of debt to power sellers, and in early 2001 the State of California was forced to step in to purchase power on behalf of its customers as a result of PG&E’s deteriorating financial condition. With little progress having been made toward a resolution of the crisis, in early April 2001, PG&E filed a Chapter 11 bankruptcy petition.

During the early stages of PG&E’s bankruptcy case, Howard, Rice helped stabilize the company by, among other things, reaching agreement to use some $3 billion of cash that PG&E had pledged as collateral to its primary secured lender, obtaining authority to make $1.5 billion of capital expenditures through 2001, continuing to honor all of its employee and customer related obligations, and implementing a program for retention of key executives. PG&E was thus able to provide uninterrupted service to its four million customers. The company then turned to developing a plan to exit bankruptcy.

PG&E’s initial plan, submitted in September 2001 and supported by the official committee of unsecured creditors in the bankruptcy case, proposed to split the company into four entities, with one under state regulation, and the other three regulated by the federal government. Due to the haphazard nature of California energy regulation, which had exacerbated the energy crisis, the company expected that being under federal control would give it a better credit rating and a more viable future. PG&E took the position that it had a constitutional right to restructure the company this way because the federal bankruptcy code preempted state and local laws prohibiting such a reorganization. The state of California and the California Public Utilities Commission, as well as several other governmental creditors, resisted this switch in control, and the matter become embroiled in extensive litigation. The bankruptcy court initially ruled that it would not allow blanket preemption of state and local laws, but left the door open for more limited preemption upon a showing that it was necessary for PG&E to reorganize. This ruling was reversed on appeal to the United States District Court, but was reinstated on further appeal to the Ninth Circuit Court of Appeals. PG&E’s petition for certiorari to the United States Supreme Court is currently pending. Howard, Rice teamed with renowned Harvard Law School Professor Laurence Tribe in litigating these complex and arcane issues of constitutional law through four levels of courts.

Meanwhile, in mid-2002 the CPUC proposed an alternative reorganization plan for PG&E that would keep the company entirely under state regulation. The creditors’ committee eventually became a co-sponsor of this plan, while still maintaining support for PG&E’s plan. Creditors voted overwhelmingly in favor of PG&E’s plan, although the CPUC’s alternative plan remained viable under relevant bankruptcy code provisions, notwithstanding the expressed preference of creditors. After commencing a lengthy confirmation hearing on the competing plans in late 2002, the bankruptcy judge directed the parties to mediation before another bankruptcy judge. After several months of intense negotiations, PG&E reached a settlement with the CPUC in June 2003, and obtained the bankruptcy court’s approval of the resulting settlement plan (over the objection of a handful of creditors) in December 2003, allowing it to emerge from bankruptcy in April 2004 with an investment-grade credit rating, and paving the way far for it to raise some $8 billion in funds to pay all creditors in full. The company’s restored creditworthiness has enabled it to resume purchasing energy for its millions of customers. In addition, its equity value has more than quadrupled from its low point.

The 125-lawyer Howard, Rice firm, utilizing a team comprising not only a half-dozen attorneys from its well-regarded bankruptcy practice, but also more than two dozen of the firm’s litigators and transactional lawyers, guided PG&E through the bankruptcy case, which raised myriad novel and complex issues of both state and federal law. For example, in response to anti-trust and other claims of up to $50 billion asserted by the City of Palo Alto, which threatened the viability of PG&E’s reorganization, Howard, Rice assembled a team that engaged in intense discovery and trial preparation on an expedited schedule in the midst of the plan confirmation hearings. Following a three-day trial, PG&E prevailed, with the bankruptcy court estimating the value of Palo Alto’s claims at zero, thereby paving the way for continued pursuit of PG&E’s reorganization. Howard, Rice also worked closely with the company in analyzing and resolving over 13,000 creditor claims aggregating more than $50 billion. Through extensive negotiations and litigation, they were able to reduce these claims to approximately $12 billion, thereby eliminating another potential obstacle to PG&E’s emergence from bankruptcy.

In the end, PG&E, with the able assistance of Howard, Rice and countless other professionals, was able to overcome a crisis that threatened not only the company, but California’s energy-dependent economy as well, with an outcome that was beneficial to the company, its creditors, and its millions of customers.