Chapter 11: Life After Death

It is a fundamental tenet of economics that life in a competitive marketplace
comes with both risks and rewards. Partial deregulation of the utility industries
has proven no exception. Utilities are now facing, in some cases for the first
time, the reality that bad things sometimes happen even to good companies.

In particular, utilities operating in competitive energy markets have found
themselves vulnerable to the possibility of purchasing commodities at higher
prices than they are allowed to pass on to consumers, as the California energy
crisis dramatically illustrated.

When a utility finds itself in a bad situation, where can it turn for help?
One important option is Chapter 11 protection under the United States Bankruptcy
Code. Although bankruptcy is always risky, a Chapter 11 reorganization can,
and often does, bring troubled companies back from the brink of extinction.

Chapter 11, however, is not a panacea for every ill. Some situations, including
some commonly encountered by struggling utility companies, are not easily remedied
even with the strong medicine that reorganization can provide.

Chapter 11 provides a process whereby a business may attempt to reorganize
itself by restructuring its debt, business, and assets or by liquidating its
assets in an orderly fashion. It also provides debtors with powerful tools to
cure the underlying causes of its financial problems.

Of course, these benefits come with certain drawbacks, even apart from the
stigma that bankruptcy bears. For instance, Chapter 11 fundamentally changes
the dynamics of operating a company.

Public Process

Bankruptcy is a very public process. It can be very distressing for a company’s
officers to know that a small army of creditors, attorneys, and other interested
parties will publicly debate the company’s past decisions, present proposed
actions and future viability.

Even more disturbing is the realization that the company’s future is almost
entirely dependent on the approval of its creditors. In fact, a company that
has filed for Chapter 11 protection is normally operated by its officers as
a “debtor-in-possession,” which has the primary duty not of maximizing profits
for shareholders, but of maximizing the company’s assets for the benefit of
its creditors — and only then for the benefit of its shareholders if any
value remains.

As an additional challenge to this often-daunting process, industries that
operate under public scrutiny, most notably the utility industries, may find
their attempts to take full advantage of the benefits of Chapter 11 frustrated
by the actions of regulators, state legislatures, and other public actors. On
the other hand, bankruptcy can provide a fresh forum to work out a utility’s
tensions with the public actors who may have become intractable in traditional
regulatory environments.

With all of this in mind, it is useful to review the major lessons learned
from several of the leading utility bankruptcies of the last few years. Recent
utility bankruptcies provide a valuable backdrop against which to evaluate bankruptcy’s
usefulness in new situations. Of course, bankruptcy (like most forms of litigation)
can be unpredictable. As in the stock market, past performance does not necessarily
predict future results. Nonetheless, the questions and answers below provide
utility companies with valuable insight into life after death.

Will state and federal regulatory bodies be allowed to intervene in the
bankruptcy proceeding?
Generally, bankruptcy courts have allowed state public utility commissions
or similar regulatory bodies to participate in utility bankruptcy proceedings.
This means that regulatory agencies will generally be allowed to be heard on
issues that arise during the bankruptcy, as would any other party in interest.

They may even propose a plan of reorganization, as the California Public Utilities
Commission (CPUC) has in the Pacific Gas and Electric (PG&E) bankruptcy, if
the court in its discretion allows. The regulators will generally not, however,
be allowed to vote on a plan of reorganization since they usually are not creditors.

In addition to PG&E, state agencies have been granted party in interest status
in In re Public Service Company of New Hampshire (PSNH), In re Cajun Electric
Power Cooperative Inc. (Cajun), and In re Columbia Gas Systems, Inc (Columbia).

The rationale for including the regulatory entities in the proceedings is well-summarized
by the bankruptcy court in PSNH, which stated that “rather than burdening the
reorganization process of a regulated electric utility, the granting of such
status and rights to the State of New Hampshire should expedite the progress
of this reorganization process.”

Thus, it is very likely that interested regulatory bodies will be heard in
utility bankruptcy cases. By contrast, a utility’s ratepayers themselves will
likely not be allowed to participate directly in the bankruptcy proceedings.
For example, the bankruptcy court overseeing the PG&E bankruptcy ruled early
in that proceeding that adequate representation of creditors did not require
the formation of a ratepayer committee. The court noted that “ratepayers have
other means and other fora to protect their interests,” namely the state regulators.

Can a regulatory body change rates during the pendency of bankruptcy?
Regulators who have power to set utility rates can be expected to continue
“normal rate-making activities” involving the utility, even after the utility
has filed for Chapter 11 protection. The bankruptcy “automatic stay” that generally
stays all actions against a debtor to recover on pre-petition financial obligations
does not generally apply to regulatory rate-making actions. Thus, filing for
bankruptcy most likely does not prevent a regulator from increasing or decreasing
the debtor utility’s rates based on the effects of normal external forces.

On the other hand, bankruptcy courts have been known to enjoin regulators as
in Cajun Electric, where rate cases were seen as oppressive and disruptive to
the reorganization. However, recent United States Supreme Court opinions, which
have expanded traditional notions of state sovereign immunity under the 11th
Amendment, suggest that such injunctions, unless very carefully crafted, may
be beyond the power of the federal courts.

Who will make daily business decisions during the pendency of the bankruptcy?
The Bankruptcy Code generally allows a company operating under Chapter
11 to make so-called “ordinary course of business” operational decisions without
court approval.

In contrast, decisions not in the ordinary course of business (such as the
sale of major assets, re-financing and substantial changes in operations) cannot
be taken without court approval unless no party in interest objects to the proposed
action.

Will regulatory approval be required for the company to exercise powers
granted under the bankruptcy code, such as rejecting contracts?
The Bankruptcy Code grants significant powers to debtor companies that
have filed for protection under Chapter 11 of the Bankruptcy Code. These powers
include the power to avoid and recover “preferential” or “fraudulent” transfers,
as well as the power to assume or reject executory contracts entered into before
bankruptcy. These powers allow companies in Chapter 11 to revisit previous decisions,
effectively allowing them a second chance to make certain critical decisions.
Before exercising these powers bankruptcy court approval is required. But regulatory
approval is not normally required before exercising rights arising under the
Bankruptcy Code.

This issue arose during the course of the Cajun proceedings. An open administrative
docket was sought by the state public service commission to consider whether
Cajun had prudently exercised its contract rejection right, one of the Company’s
core bankruptcy powers, in refusing, for the time being, to reject Cajun’s fuel
supply and fuel transportation contracts. In response, the bankruptcy court
ruled that the commission was enjoined from making such an inquiry. The approval
of the bankruptcy court would be required before the utility could exercise
such a right; however, the approval of the regulatory agency, to its consternation,
would not be required.

Will regulatory approval be required to confirm a plan of reorganization?
Confirmation and consummation of a plan of reorganization are the principal
objectives of a Chapter 11 reorganization case. A plan of reorganization restructures
the company and sets forth the means for satisfying claims against the company.

Confirmation of a plan of reorganization by the bankruptcy court makes the
plan binding, so far as possible, on the world. A requirement of regulatory
approval of part of the plan gives substantial power over the debtor utility’s
future to a regulatory agency.

Here the law differentiates between decisions regarding rate-making itself
and decisions regarding the restructuring of the utility under Chapter 11. The
law requires that any rate changes proposed in a plan of reorganization be approved
by the regulator before they can be implemented.

On the other hand, the law and court decisions suggest that, even though regulatory
agencies will be allowed to participate and be heard in the bankruptcy process,
their authority to approve the restructuring (aside from rate changes) proposed
in a plan is severely limited.

It appears that core bankruptcy restructuring actions (such as transfers of
assets, merger, disaggregation of component entities, and the like), may be
approved by the bankruptcy court irrespective of non-bankruptcy law. At least
this is the current teaching from PG&E. (Nonetheless, PG&E has agreed to comply
with federal, but not state, regulatory approval requirements.)

In December 2001, PG&E presented a plan of reorganization that would disaggregate
the current company into three limited liability companies pursuing four lines
of business: retail gas and electric distribution, electric transmission, interstate
gas transmission, and electric generation. State law prohibited key aspects
of this disaggregation and required the approval of the CPUC prior to any sale,
lease, or spin-off of any of the company’s utility facilities. Based on these
state law requirements, CPUC objected to the proposed reorganization.

In early 2002, the bankruptcy court overseeing the PG&E case issued a decision
rejecting PG&E’s claim that federal bankruptcy law preempts non-bankruptcy laws
otherwise applicable to the proposed restructuring transactions. This decision
was reversed by an order of U.S. District Court for the Northern District of
California, which held:

“The preemption issues raised by reorganization are particularly acute
in the case of a public utility in bankruptcy, as perhaps no other debtor
is subject to as much state regulation as the public utility. But the removal
of the statutory right of approval by state commissions of the restructuring
of public utilities by the 1978 Bankruptcy Reform Act is powerful evidence
that Congress concluded that public utilities should no longer be subject
to the costs, delays and uncertainty accompanying such a requirement.

“The bankruptcy code at one time permitted state regulatory commissions
to wield considerable power over the reorganization of public utilities. But
now — with the exception of the right to approve rate changes —
it does not. Non-bankruptcy laws otherwise applicable to the ‘restructuring
transactions necessary to an effective and feasible reorganization’ are expressly
preempted by the bankruptcy code.”

After the District Court issued its decision, CPUC requested that the decision
be stayed pending an appeal of the decision to the 9th U.S. Circuit Court of
Appeals. The District Court denied CPUC’s request.

As of the date of this article, the decision has not been appealed, although
because the decision is interlocutory, it may be appealed later.

Is Chapter 11 available to help restructure foreign power projects?
Chapter 11 is powerful medicine for the restructuring of financially
troubled power projects. As a result, both lenders and energy companies have
looked toward U.S. bankruptcy law for assistance with the restructuring of troubled
foreign power projects.

The doors of the U.S. Bankruptcy Court are open for the filing of Chapter 11
by companies which have any assets in the United States (even if simply a bank
account), some operations in the United States, or were incorporated in the
United States. Moreover, projects which are in bankruptcy, receivership, or
liquidation overseas, and which do not seek to file Chapter 11, may still obtain
the assistance of the U.S. Bankruptcy Courts in support of the foreign proceeding
— such as by enjoining creditors in the United States from going after
assets within the United States.

While the theoretical possibilities for restructuring foreign power projects
under Chapter 11 are broad, there are many practical impediments. Chief among
these is the difficulty of a United States court effectively protecting or otherwise
asserting jurisdiction over those assets not located here.

Conclusion

At the writing of this article, the bankruptcy court presiding over the PG&E
case had not ruled as to whether the company’s or the CPUC’s plan of reorganization
would be confirmed. This ruling, together with decisions that will be made on
appeal, will cast substantially more light on a Chapter 11 utility’s life after
death. In the meantime, except for rate-making, creditors and courts have the
upper hand over a Chapter 11 utility’s life support. n