Both Pacific Gas & Electric Co. and the California Public Utilities Commission (CPUC) were claiming victory Friday, after a federal judge presiding over the utility’s Chapter 11 bankruptcy proceeding rejected a blanket federal legal preemption of state laws as they relate to the company’s reorganization plan. While the CPUC sees the decision as sinking the plan, PG&E reads it as simply requiring it to get more specific about what state laws should be preempted by federal jurisdiction in order to put its plan into effect.

The utility’s plan would spin off all of its nondistribution assets into three non-state-regulated affiliates, coming under the PG&E Corp. holding company. Judge Dennis Montali has given the utility the options of filing a revised plan and/or re-working its arguments. He also called on the CPUC to file an outline of its own reorganization plan by Feb. 13.

While conceding that the judge has “left a crack in the door” for PG&E, but has left such a “heavy burden” on the utility to show that preemption of state law is necessary for it to reorganize, that the company will not be able to do it in the long run, according to the state regulators’ chief attorney. “It is so high as to be insurmountable.”

In the short term before the bankruptcy judge rules further, a key question is what the PG&E bankruptcy creditors’ committee thinks of the ruling, and whether the committee would force it to turn to the state for a solution. Part of the CPUC’s broadcast of its victory claims is aimed at bringing the creditors over to its side.

“This decision is a defeat for their (the utility’s) plan and a victory for our right to file a plan,” said Gary Cohen, CPUC general counsel. The CPUC has led a multi-state agency effort to opposed the utility bankruptcy proposal. The judge has “rejected each and every one of PG&E’s arguments as to why federal bankruptcy law should preempt state law,” Cohen said.

“In addition, (the judge) found that PG&E’s plan offends the state’s sovereign immunity by seeking to prevent the state from requiring its statutory obligation to serve its customers, seeking an order to prevent the commission from applying its rules to require the utility to share any gains on the sale of assets.”

In a prepared statement, PG&E’s utility indicated it would move forward with a modified version of its reorganization plan.

“The court concluded the state law may be preempted based on a showing of the need for preemption in order to implement the (reorganization) plan,” the utility said in a written statement. “Therefore, the court’s decision allows PG&E to proceed with its plan of reorganization, with preemption issues ultimately being addressed to the confirmation process.

“Thus, while the court did not accept the utility’s argument that federal law automatically preempts state law, the ruling does provide that preemption is possible, if necessary to confirm the utility’s plan of reorganization. The court also rejected arguments made by the CPUC and the (state) Attorney General that PG&E’s plan inappropriately seeks to escape from state regulation.”

In responding to a reporter’s question in a conference call the CPUC had arranged to declare a victory of sorts, Cohen, the regulators’ chief attorney, said he is “not surprised, but disappointed” at the utility’s reaction, adding that he expected that “PG&E would look very carefully through the decision’s 49 pages to find something to be gratified about.”

As the result of the ruling, which is centered on the so-called “Disclosure Statement,” a sort of “prospectus” accompanying a Chapter 11 proposed reorganization plan, the CPUC by Wednesday (Feb. 13) will file a “term sheet” outlining the elements of its proposed alternative to the PG&E proposal, and then give PG&E a week and a 20-page limit to respond to the regulators’ proposal. Then, Judge Montali has scheduled an additional hearing for Feb. 27.

At this point, Cohen said he would hope that PG&E would “stop the blame game” and begin talking with the regulators about a mutually agreed-to plan — similar to the court settlement with Southern California Edison Co. — to “craft a regulatory solution that will enable it to emerge from bankruptcy, repay its creditors and resume traditional service to its customers.”

“We urge PG&E to reaffirm that it is a corporate citizen of this state, and join us in restoring the California energy market to normality,” Cohen said. PG&E’s reorganization plan was spawned and supported by creditors in part because of the belief that the state government through various politically-motivated rulings exacerbated the energy crisis last year which resulted in the PG&E bankruptcy.

In response to questions about the distinct difference in the interpretation of the judge’s ruling between the CPUC and PG&E, Cohen said the creditors committee, which is on record as supporting the utility’s proposed reorganization, will come “flocking” to the regulators because that is where the quickest solution lies for them to get paid and that is — after all — the chief concern they all have in common.

“PG&E doesn’t need to break itself apart into all of these different businesses,” Cohen said. “We can craft a solution that is similar to the solution that will find Southern California Edison creditworthy very soon.” With the judge’s ruling on the preemption issue as it applies to the PG&E Disclosure Statement, Cohen said PG&E “needs to get serious about getting out of bankruptcy, as opposed to getting out from under state regulation.”

Veteran California bankruptcy attorney John Hansen, of the firm Nossaman, Guthner, Knox & Elliott LLP in San Francisco, interpreted the judge’s ruling as presenting “fairly significant hurdles” that will make it much more difficult for PG&E to prevail, since it will have to prove “it is absolutely necessary” for certain state regulations to be preempted in order for it to reorganize. It also will have to prove that the regulations that would have to be bypassed “are not regulations that are there to protect the public health, welfare or safety.”

Just proving that disaggregation is a good business strategy that will result in a better credit rating may not be enough, Hansen said. The judge has previously cited a precedent decision “that determined that just because state regulation may make reorganization more difficult, is not a reason to preempt it. You have to show pretty strong evidence that you really have to do this in order to get money to pay the creditors.” In that case, Moody’s citing specifically of the uncertainty prevailing under CPUC regulation as the reason it awarded a lower credit rating to Southern California Edison debt Friday would not be enough of an argument (see related story).

In other, but unrelated, legal proceedings, PG&E on Friday filed a motion to transfer the lawsuit filed against it by the state attorney general from a state Superior Court to the federal bankruptcy court in San Francisco. The transfer is effective immediately, according to the utility. The state’s suit alleges the utility has inappropriately tried to use bankruptcy court to avoid state regulatory oversight.

“The attorney general’s complaint is without merit, and clearly appears to be part of his ongoing efforts to obstruct our utility’s plans for emerging from bankruptcy,” said Bruce Worthington, senior vice president and general counsel at PG&E Corp. “It makes sense for the complaint to be moved to bankruptcy court, which has the original and exclusive jurisdiction of claims involved in the bankruptcy process.”

Separately Cohen said the state regulatory panel asked a federal court Thursday to dismiss PG&E’s still-active “filed rate doctrine” case against the CPUC. It was a similar case being pushed by Southern California Edison Co. that led to a massive court settlement between that financially strapped utility and the CPUC. Cohen on Friday held it up as a model that PG&E ought to follow in resolving its issues with the regulatory commission.

Finally, as expected, two major consumer organizations in California, along with Gov. Gray Davis, all hailed the bankruptcy judge’s ruling as a victory for the state and its consumers against PG&E. The Utility Reform Network called the bankruptcy ruling “a severe setback for PG&E’s overreaching reorganization plan,” and the CPUC’s independent Office of Ratepayer Advocates expressed gratification that the bankruptcy judge apparently recognizes “that federal bankruptcy law does not categorically permit PG&E to sweep aside California consumer protection laws.”

Davis issued a prepared statement in which he was glad the judge “rejects PG&E’s plan” and its ongoing efforts “to preempt California’s regulatory and environmental protection laws wholesale.

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