The D.C. Circuit Court of Appeals last week remanded a FERCorder denying Iroquois Gas Transmission the recovery of legal costsstemming from criminal and civil investigations into environmentalviolations associated with the construction of pipeline facilitiesin the early 1990s.

In 1996, the Commission reversed the decision of anadministrative law judge (ALJ) and refused to allow the recovery ofthe pipeline’s legal expenses – more than $15 million – on thebasis that Iroquois Gas had failed to demonstrate any economic ornon-economic benefits to ratepayers as a result of its activities.The fact that the legal costs grew out of civil and criminalviolations, FERC argued then, cast doubt on their prudence. Thecourt, however, said FERC failed to adequately justify the reasonfor its decision in the case.

The Commission “has not made clear which types of legal defensecosts are presumed recoverable for ratemaking purposes and which[are] not, or why the costs here belong on the nonrecoverable sideof the line,” wrote Circuit Judge Stephen Williams in the July 21stopinion [[No. 97-1276, 97-1533].

The order in Iroquois, according to Williams, fell short of thecourt’s opinion in Mountain States I, which held that the illegalbehavior of AT&ampT “[did] not inexorably compel or warrant eitherrejection or stigmatization of the [legal] expenses as a factor inrate calculations.” The FERC order also was in conflict with thecourt’s Mountain States II ruling, which essentially found thatlegal expenses arising from a company’s violation of federalstatutes could be recoverable if the activities of the companyeconomically ‘benefited’ the ratepayers.

The court cited a case where customers/ratepayers could benefitfrom a company’s illegal behavior. In its example, a “carrier” isforced to decide between instituting a strict pollution-monitoringpolicy or a lax policy that would cost $50,000 less. If it choosesthe latter, the company will be sued under a federal statute andfaces a 10% chance of losing. In the event that happens, itestimates the plaintiff would recover $100,000, making the expectedcost of the lawsuit ($100,000 x 10%) about $10,000. “Thus thecarrier reasonably determines that adopting the lax policy willproduce a net benefit of $40,000 to the ratepayers, who wouldotherwise have to pay the cost of the strict monitoring policy. Itwould be misleading to say that requiring ratepayers to bear thecost of the resulting judgment, if any, causes them to subsidizethe carrier’s illegal activity.”

In Iroquois, the Commission did not specifically addresswhether the pipeline’s illegal activities had any economic benefitfor ratepayers. Instead, it raised the issue of non-economic harmarising from the pipeline’s violation of federal environmental andsafety laws. It argued that ratepayers had a “general interest” inIroquois complying with those laws, and thus were harmed when thepipeline violated them. The court called FERC’s argument too”generic.”

“Because all citizens share an interest in widespreadcompliance, not just with environmental or safety laws but withlaws of any kind, the Commission’s approach would result in thepresumptive disallowance of all litigation expenses leading toanything short of outright triumph for the regulated entity,” theappellate court opined.

Moreover, FERC’s approach “utterly fails to respond to theproblem of [economic] incentives posed in Mountain States II,” itnoted. “Iroquois’s ratepayers…undoubtedly share an interest inmaintaining the purity of the region’s creeks and streams. But thesame ratepayers have a unique and concentrated interest in timelyand efficient pipeline construction.” And as a result, “a firmincurring optimal environmental compliance costs will on occasiontake measures that are ultimately found illegal.” With this inmind, “the Commission must do a better job of explaining why allactivities that turn out to violate environmental laws should bepresumed unlikely ‘to benefit ratepayers,” the court majority said.

In a separate concurring opinion, Circuit Judge Patricia Waldsaid both economic and non-economic benefits should be factored inwhen deciding the recoverability of legal costs.

Susan Parker

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