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Friday’s U.S. District Court decision allowing bankrupt Pacific Gas & Electric Co. to slip out from under state regulation opens up new fronts and shifts the balance of power in the protracted Chapter 11 case. PG&E and the California Public Utilities Commission, which have each drafted competing plans for reorganizing the utility, are poised to square off in bankruptcy court confirmation hearings this November. Now, with PG&E’s hand strengthened by the district court decision, the CPUC may have to rethink its strategy. The Friday decision by the U.S. District Court for the Northern District of California essentially says federal bankruptcy law trumps state laws that might interfere with a reorganization plan. The ruling gives PG&E the green light to proceed with its plan to transfer its assets to federal oversight. According to bankruptcy experts, the CPUC might now consider anything from settling with PG&E to asking the bankruptcy court to delay confirmation hearings. “The burden going forward now is on the PUC,” said Kenneth Klee, a bankruptcy attorney and professor at UCLA School of Law. The PUC has stated that it will appeal the decision to the 9th U.S. Circuit Court of Appeals, but other than that it won’t alter its strategy. “We were surprised and very disappointed” with the decision, said Alan Kornberg, an attorney with New York-based Paul, Weiss, Rifkind, Wharton & Garrison who represents the commission. But he said he was confident in the commission’s own plan, which was recently endorsed by the official committee of unsecured creditors. PG&E, which filed for Chapter 11 bankruptcy protection in April 2001, wants to split itself apart into four separate companies. Under its proposed plan of reorganization, PG&E’s electricity and gas retail division would remain under state control, while its energy generating and transmission assets would be overseen by the Federal Energy Regulatory Commission. While PG&E has acknowledged that this plan circumvents numerous state laws, it argues that federal bankruptcy law automatically pre-empts those laws and allows it to do so. Earlier this year, U.S. Bankruptcy Judge Dennis Montali of the Northern District of California disagreed with PG&E’s express pre-emption argument. On Friday, U.S. District Judge Vaughn Walker overturned Montali’s decision, finding that “Congress intended expressly to preempt nonbankruptcy laws that would otherwise apply to bar, among other things, transactions necessary to implement the reorganization plan.” Walker also wrote that the PUC does not have veto power over PG&E’s reorganization plan, other than what concerns rate changes. By taking away this veto power, say some bankruptcy experts, the court has altered the dynamics of the case and increased the incentive to settle. “The settlement dynamic has changed,” said Isaac Pachulski, an attorney at Los Angeles’ Stutman, Treister & Glatt who handled Public Service Co. of New Hampshire v. New Hampshire, 108 BR 854 (D NH 1989), one of the few bankruptcy cases to deal with the pre-emption issue. “If the PUC has a veto over the debtor’s plan, there isn’t that much to negotiate. If now there’s a serious question over their veto power, it means that [PG&E's] got more leverage to try and negotiate,” Pachulski said. Kornberg said that the commission never contended that it had veto power. He stressed that the PUC welcomed a consensual plan with PG&E but was unaware of any settlement talks between the two parties. PG&E and PUC were ordered into mediation by Judge Montali earlier this year, but failed to reach an accord. And while the PUC has stated its intention to appeal Friday’s decision, it’s likely that the 9th Circuit might not rule in time to affect this November’s confirmation hearings. “My guess is that if anybody wants this to be reviewed they’re going to have to put off confirmation for at least six months,” says Oakland, Calif.-based Crosby, Heafey, Roach & May bankruptcy attorney Mike Buckley.

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