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After 18 months of intermittent hearings, $64 million in professional fees and some 11,000 documents on the docket, the Chapter 11 bankruptcy case of the Pacific Gas & Electric Co. is about to enter one of its most crucial, and dramatic, stages. This morning in San Francisco, confirmation hearings begin for two competing plans to lift PG&E out of bankruptcy and restructure its $13 billion in debt. U.S. Bankruptcy Judge Dennis Montali has blocked off much of the next three months on his calendar to allow PG&E and the California Public Utilities Commission to prove that their respective reorganization plans meet the requirements for confirmation laid out in U.S. bankruptcy code — and to demonstrate that the other party’s plan does not. In a bankruptcy case that’s grown in complexity, significance and unpredictability with every turn, the trial to confirm a reorganization plan promises to be anything but routine. Instead of the typical, often-formulaic exercise to ratify a reorganization plan, the PG&E hearings will provide a forum for various parties to try to torpedo the two proposed plans. “In these large cases it is almost entirely consensual — either the parties agree or one side doesn’t put up a fight,” said Lynn LoPucki, a bankruptcy professor at UCLA School of Law. “The cases where the parties actually go to court and battle over the plan are very rare.” Dozens of witnesses are slated for live, in-court testimony and cross-examination, and top-shelf litigators have been enlisted to provide firepower. While San Francisco’s Howard, Rice, Nemerovski, Canady, Falk & Rabkin has served as PG&E’s chief bankruptcy counsel throughout the case, Palo Alto, Calif.’s Cooley Godward’s go-to litigator Stephen Neal will step in as the utility’s chief trial lawyer during the confirmation hearings. New York-based Paul, Weiss, Rifkind, Wharton & Garrison, which is the CPUC’s main bankruptcy counsel, will tap its own in-house litigation talent. “In certain ways this is more like a typical litigation where you have one side against the other. That typically doesn’t happen in bankruptcy the same way,” said Roberta Kaplan, a litigator at Paul, Weiss. The CPUC team will also be backed by lawyers from another New York-based firm, Milbank, Tweed, Hadley & McCloy, which represents the official committee of unsecured creditors. Earlier this year, the committee signed on as co-proponents of the CPUC’s reorganization plan. Montali has divided the trial into two distinct phases, providing each proposed plan with its own, separate confirmation hearing. The CPUC’s reorganization plan is up first, beginning today, with hearings for PG&E’s plan tentatively scheduled to get under way Dec. 16. The two-stage nature of the trial means that attorneys for PG&E and the CPUC will have to alternate between playing defendant and plaintiff. And as the two groups clash with each other, they’ll also have to contend with a number of creditors who for various financial, environmental and regulatory reasons object to one plan or the other. “There’s not just two sides to this fight,” said one attorney representing a significant creditor in the case. “There are probably a dozen different sides to this contest.” In July, 35 objections were filed against confirmation of the CPUC plan and almost 50 objections were filed against the PG&E plan. According to Howard Rice’s James Lopes, the lead bankruptcy attorney for PG&E, the utility has resolved many of these objections in the past few months. Objecting creditors have the right to not only produce their own witnesses at trial, but to cross-examine anyone else’s witnesses. Some of the most ardent objectors, including the state of California and the city of Palo Alto, have signaled their intention to take an active role in the trial by submitting witness lists to the court. And it’s unclear to what extent other objectors will jump in during the trial to cross-examine the numerous witnesses. “These are complicated plans and complicated cases with lots of interested parties,” said Michael Lubic, a bankruptcy and restructuring partner at Sonnenschein Nath & Rosenthal. “Unlike a trial where it’s very structured, this may be a little more of a free-for-all in terms of the numbers of people who are entitled to be heard.” Bankruptcy attorneys expect Montali to manage the trial in a way that allows everyone to express their views. It’s something Montali has gotten some practice at during the 1 1/2 years that the PG&E case has been going on. PG&E filed for voluntary Chapter 11 bankruptcy protection in April 2001 in the wake of California’s energy crisis. At the time, it was the third largest corporate bankruptcy case in history. Nearly a year after filing for Chapter 11, the utility lost its exclusive right to author a reorganization plan and the CPUC began drafting its own plan to reorganize PG&E. Both plans promise to repay all of PG&E’s creditors in full. But they rely on decidedly different means to achieve that goal. PG&E’s plan would split the utility into four companies, moving some assets outside of state regulation. The gas and retail division would remain under the CPUC’s jurisdiction, while the energy generating and transmission assets would be overseen by the Federal Energy Regulatory Commission. The CPUC’s rival plan keeps PG&E intact and under state regulation. It proposes to pay the utility’s creditors through an $8.3 billion, investment-grade debt offering and a $500 million preferred stock offering. It also gives the CPUC the right to set PG&E’s retail electricity rates for up to 30 years. As with any Chapter 11 plan confirmation hearing, the trial centers around the plan’s proponent proving to the court that its plan conforms with 13 specific requirements catalogued in the bankruptcy code. While some of these requirements are less contentious, like the obligation to continue retiree benefits, others can prove to be major sources of factual disputes. Key among these is the “feasibility” requirement, which is expected to be one of the main battlegrounds. “The CPUC Plan is not financially feasible: The debt and equity financings required by the plan simply cannot be successfully marketed and sold,” reads PG&E’s trial brief in opposition to the CPUC plan. According to PG&E, the uncertainty of the California regulatory environment will doom the bonds to a sub-investment, or junk, rating. And the sorry state of the junk-bond market, as well as the massive size of the offering envisioned by the CPUC, mean that the bonds will not sell, PG&E says. PG&E also argues that the CPUC plan is unlawful, in that it binds future incarnations of the commission to its ratemaking decisions — something prohibited by the state’s Public Utilities code. The briefs arguing in favor and against the confirmation of PG&E’s competing reorganization plan had not been filed by press time. But it’s clear that one of the prime areas of dispute will be the so-called pre-emption issue. While PG&E acknowledges that its plan to transfer assets out of state regulation violates numerous state laws, it contends that federal bankruptcy law pre-empts these laws. Montali has taken the position that bankruptcy law does not “expressly” pre-empt the state laws at issue, but a federal court reversed him in August. That decision, by U.S. District Judge Vaughn Walker, is now pending appeal by the CPUC with the 9th U.S. Circuit Court of Appeal. And since neither plan won the unanimous backing of every creditor class during this summer’s vote, the plans must both meet the bankruptcy code’s “cramdown” provisions, which allow a plan to be confirmed without complete creditor class endorsement. Even if both plans survive the trial and are deemed confirmable by the bankruptcy court, they would face a final hurdle when Montali would have to choose which plan to confirm. While the bankruptcy code provides a few guidelines for the judge to follow in this scenario, the situation is so rare that it’s a largely untested area of law. “I don’t know of another major case that ever got to that state,” said UCLA’s LoPucki. In a bankruptcy as unusual as the PG&E case, though, it’s a state that no one is ruling out.

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