Stanford Law’s Marcus Cole on PG&E Bankruptcy: No Free Lunches

On January 29 of this year, PG&E filed for bankruptcy, citing billions of dollars in liabilities stemming from wildfires in both 2017 and 2018—some of California’s most deadly. In the discussion that follows, Professor G. Marcus Cole, a leading scholar of bankruptcy law, discusses what this means to PG&E and ratepayers in California.

Why did PG&E file for bankruptcy?

PG&E filed what we bankruptcy geeks refer to as a “defensive bankruptcy” filing. The purpose of a defensive bankruptcy is to achieve, for a defendant facing mass tort litigation, an aggregation of cases and claims. This can be viewed as a “reverse class action” because it forces similarly situated plaintiffs into one forum, to be considered in context with each other rather than independently. Chapter 11 of the Bankruptcy Code enables a debtor confronting many claims and claimants to gain some order and predictability by using bankruptcy in this way. A defensive bankruptcy filing allows the defendant to hire one team of lawyers who can mount an orchestrated and consistent defense strategy for all cases. This avoids the risks of attenuated cases, and most importantly, exposure to collateral estoppel. Collateral estoppel is the doctrine that treats common issues of fact across cases involving the same defendant as conclusively determined for all other cases for that same defendant. By aggregating cases in bankruptcy, one team of defense lawyers can avoid the possibility of errors by lawyers litigating far-flung cases in different venues.

PG&E is a public utility. What does that mean?  

As a “public utility,” PG&E is essentially a private company operating in what we call a “regulated industry.” This means that, in exchange for certain legal protections and exclusivity, PG&E must embrace a loss of control over much of its operations that other companies can take for granted. So, for example, PG&E cannot decide on its own what prices (rates) to charge for its services, or where and how it provides those services. In return, PG&E enjoys a “natural monopoly” existence, protected from competition, in part by the capital-intensive nature of its business, and in part by the regulatory structure imposed by the State of California and the U.S. Department of Energy.

Will PG&E’s bankruptcy lead to increased rates for consumers?

PG&E’s bankruptcy will undoubtedly mean higher rates for ratepayers. Tort liability like that associated with the fires will mean safety improvements are likely to be required. It also means that the succeeding electric power provider – whether that is a reorganized PG&E, an acquirer, or the “broken-up,” smaller utilities that might emerge from this process, will all push for higher rates to cover the costs associated with safety improvements and expansive liability exposure.

How extensive are PG&E’s liabilities?

Although PG&E is not insolvent (the company has assets estimated at around $69 billion, and the tort claims are estimated to amount to around $35 billion), there is no “insolvency requirement” contained in the bankruptcy code. In fact, bankruptcy is often employed by solvent companies to achieve certain purposes, including the aggregation and capping of claims. Bankruptcy is an effective device for this, and has been used by similarly situated companies facing mass tort litigation.

PG&E’s exposure is thought to be reduced because CalFire cleared the company of responsibility in the 2017 Tubbs Fire, but total tort claims are still expected to rise, by some reports, as high as $35 billion.

Are taxpayers in California ultimately responsible for PG&E’s liabilities?

Strictly speaking, taxpayers are not directly responsible for the PG&E’s liabilities, but the economics of the situation ultimately cost everyone in California in some way. First, it will be more expensive for ratepayers to receive electric power in California, because, as customers of the utility, they are the source of revenue necessary to cover these expenses associated with PG&E’s operations. Furthermore, even Californians who are not PG&E customers are likely to pay indirectly, in the form of lower real estate values, higher insurance rates, and even higher electric power rates from other, similarly situated providers who must account for the risks exposed by PG&E’s fires.

Did PG&E have sufficient insurance to cover its liabilities? Or were the wildfires unpredictable?

It is not clear that any insurer could possibly have underwritten the extensive liability that PG&E faces here. Although I am no expert on wildfires or their predictability, there are likely risks associated with operating a public utility that are generally uninsurable.

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Professor G. Marcus Cole

What happens next in the bankruptcy process?

The case may remain in bankruptcy, or it may be dismissed from bankruptcy jurisdiction under Section 305 of the Bankruptcy Code as an improper filing. The court – whether a Bankruptcy Court or the U.S. District Court “sitting in bankruptcy” – is likely to retain bankruptcy jurisdiction over this case rather than dismiss it. This case bears the characteristics of a case contemplated by the drafters of the code, namely, multiple claims on a limited pool of assets, even if those assets exceed the claims.

But will the PG&E Chapter 11 plan of reorganization be confirmed? This is a much more complex question, because it depends entirely upon the contents of the plan. The Bankruptcy Code has several requirements that a plan must meet in order to be confirmed. Technically, if the plan satisfies those requirements, the court must confirm the plan. Nevertheless, the court has broad discretion in a number of areas that affect whether a plan can or will satisfy the requirements of Chapter 11. It remains to be seen what plan of reorganization might be proposed by the Debtor-in-Possession (PG&E’s management), and how much support the plan will receive from the companies creditors, including the “fire” tort creditors.

You’ve researched PG&E and bankruptcy. What do you make of this latest episode? What do you think is the best way forward for the state and PG&E customers?

PG&E has now taken the very unusual step of acknowledging likely responsibility for triggering the Camp Fire. This means that the bankruptcy case is likely to proceed in a more expedited fashion. It also opens up the possibility of a more efficient, streamlined “claims resolution facility” (a “CRF”) to process claims and award damages, in much the way that asbestos claims have been paid in the Johns-Manville bankruptcy and in similar cases. It is not clear, however, that the tort plaintiffs will agree to such a process. There is also a possibility that the court may appoint a representative for “future demands,” pursuant to Sections 524(g) & (h) of the Bankruptcy Code, to make allowances for the possibility that “latent” injuries or claims might arise later on. This might include respiratory illnesses arising from exposure to smoke from the fires.

The best way forward, at this point, is to allow PG&E to use its “exclusivity period” to craft and negotiate a plan of reorganization. This will allow all parties with standing, including the state legislature and regulators, to have input on measures to protect present and future interests. This will also allow for consideration of safety improvements, while keeping a reign on the costs of those improvements as they impact the asset pool and consumer rates.

A recent report in Barron’s said that the PG&E’s outlook had improved from sell to hold, noting that the state may now work with PG&E to manage its liabilities. What does that mean?

The Barron’s report is merely recognition of the special circumstances associated with financial distress of a public utility. Electric power must be provided. Someone must provide it. The equipment and transmission lines are already in place to provide it, and those assets have little value other than to provide electric power. So the state, and everyone involved, must recognize that either PG&E will provide that power, or a successor to PG&E will do so. The liability is a cost of power supply, and no company will take on that exposure without an assurance that it can do so profitably. Even if the state were to take over the public provision of electric power (as many municipalities already have), it still must do so while accounting for liability and losses. There is no free lunch. Taxpayers may wind up defraying some of these costs for PG&E directly, since they will probably pay indirectly for these losses anyway.

Can you explain the state’s “inverse condemnation” laws and how it relates to this filing?

Inverse condemnation is actually a misnomer. Condemnation is the precursor to eminent domain, the process by which government (at any level) takes property from a private owner. The Fifth Amendment to the Constitution of the United States and Article One, Section 19 of the California Constitution both require that, when a governmental entity takes private property, it must provide the owner with “just compensation.” This usually means that the government will first condemn the property, and then initiate judicial proceedings to take the condemned property from the owner.

Inverse condemnation occurs when the government simply takes the property, requiring the owner to initiate judicial proceedings to either stop the taking, or to receive just compensation for it. It is called “inverse” because it reverses the ordinary procedure used to have an effect on a taking.

In the context of a public utility, the California Supreme Court ruled back in 1885 that a deprivation of private property by a governmental entity constitutes “inverse condemnation.” In 1999, the Court ruled that Southern California Edison, a private, investor-owned public utility, was like a governmental agency when it destroyed private property, since California law also gives public utilities the power of eminent domain. In short, when a public utility destroys private property, it is the equivalent of a taking of property for purposes of the California Takings Clause. As a result, this liability may not be dischargeable in bankruptcy because it is, in essence, a Constitutional tort, and not a private one.

PG&E challenged this doctrine as recently as last year, but to no avail.

The result is that PG&E may not be able to put together a confirmable plan of reorganization if the court sitting in bankruptcy determines that the inability to cap and close this liability renders the company unattractive to potential acquirers, or impossible to value accurately for current creditors.

PG&E went through bankruptcy before, didn’t it? What were the circumstances? What triggered it?

The last time that PG&E went through bankruptcy was in 2001. That bankruptcy filing, however, was not triggered by disasters – unless you think of the California State Legislature as a “disaster.”

The 2001 PG&E bankruptcy filing was caused by California’s unrealistic “de-regulation” structure. California tried to implement the type of electric utility deregulation that proved wildly successful in Great Britain under Prime Minister Margaret Thatcher. Unfortunately, California’s version of deregulation did not trust market forces. While utilities like PG&E were encouraged to purchase electric power on the open market at market rates, they were required to turn around and sell that power at set, regulated rates. This structure worked fine, while wholesale power prices were below the regulated retail rates. However, when the wholesale price rose above the regulated rates set by the Public Utilities Commission, PG&E lost money on each and every transaction with its customers. Over time, if the wholesale price of power remained higher than the retail rates, PG&E would run out of money, which it eventually did.

One key difference between the 2019 PG&E bankruptcy and the 2001 PG&E bankruptcy is that, prior to the 2001 filing, PG&E could see in advance what was happening, and had the ability to plan. As part of its “bankruptcy estate planning” process, PG&E “pushed” extensive cash holdings into subsidiaries for distribution to shareholders, effectively “ring-fencing” those profits to “protect” them from creditors. That type of planning could not take place in association with the company’s 2019 filing, since there was no way the company could predict the outbreak of the fires, or the extent of the liability associated with them.

G. Marcus Cole is a leading scholar of the empirical law and economics of commerce and finance, and teaches courses in the areas of Bankruptcy, Banking, Contracts, and Venture Capital. He is the William F. Baxter-Visa International Professor of Law at Stanford.