John J. Rapisardi and Daniel Shamah

PG&E Corporation (“Holdco”) and its subsidiary, Pacific Gas & Electric Company (the “Utility” and together with Holdco, “PG&E”) announced on Jan. 13, 2019 that it expects to file for Chapter 11 bankruptcy protection on or around Jan. 29, 2019, right around the conclusion of a mandatory 15-day notice requirement under California law. See Form 8-K of PG&E Corp. and Pacific Gas & Electric Co. (Jan. 13, 2019). Such a filing would represent the second time PG&E resorted to protection under the U.S. Bankruptcy Code. PG&E filed for bankruptcy on April 6, 2001 and emerged three years later, on April 12, 2004. See Case No. 01-30923-DM (Bankr. N.D. Cal.). The challenges PG&E has faced since wildfires began consuming large swaths of California are well-known and has fueled speculation about a bankruptcy filing. But less well-understood and appreciated are the legal and regulatory issues confronting PG&E and other similarly-situated California utilities. As we’ll see, those legal and regulatory issues present critical complications in a potential second PG&E bankruptcy.

Background on PG&E

PG&E, incorporated in California in 1905, is one of the largest combined natural gas and electrical energy companies in the United States. Based in San Francisco, it employs nearly 20,000 people. Its primary business is the transmission and delivery of energy—both natural gas and electricity—to nearly 16 million customers in Northern and Central California. The rates PG&E charges its customers are predominantly set by its principal regulator, the California Public Utility Commission (“CPUC”).

As noted above, PG&E has previously been through Chapter 11. In 2001, PG&E filed for bankruptcy after it piled on too much debt acquiring electricity as a result of a deregulation initiative under which PG&E was forced to buy more electricity, no matter the cost. As the market for natural gas drove electricity prices up, PG&E (and other California utilities) were placed under enormous financial strain. PG&E was ultimately forced into bankruptcy amid rolling blackouts and accusations of market manipulation. PG&E emerged from bankruptcy in 2004, but ratepayers saw higher electric bills for years after PG&E’s emergence from Chapter 11.

Fast-forward to 2017, and PG&E’s balance sheet has ballooned again. It currently has about $18.4 billion of debt, through a combination of bonds, fully-drawn revolvers, and term loan debt. The bulk of that debt—approximately $17.8 billion of it—was issued by the Utility, not the publicly-owned Holdco. All of the debt is unsecured and none of it is guaranteed. According to PG&E’s January 13 Form 8-K, PG&E has approximately $400 million and $1.1 billion of cash and cash equivalents on hand.

How Did PG&E Come to Be Distressed?

PG&E’s recent issues largely stem from a California judicial doctrine known as “inverse condemnation,” which imposes on utilities such as PG&E a form of strict liability for damages caused by any fires that may be traceable to utility-owned equipment. Inverse condemnation is derived from the California Constitution, which provides that “[p]rivate property may be taken or damaged for a public use … only when just compensation … has first been paid to … the owner.” Cal. Const., art. I, §19, subd. (a). A private property owner can seek compensation for damages caused to property by “public use” through an inverse-condemnation action, which, unlike ordinary negligence claims, generally requires no showing of fault on behalf of the public entity. See, e.g., Holtz v. Superior Court, 3 Cal. 3d 296, 302-304 (1970) (noting that, with limited exceptions, inverse condemnation is a strict liability cause of action). The doctrine is premised on the notion that the costs of public improvements—including the damages caused by them—should be “distribute[d] throughout the community” rather than “inflicted on the individual.” Id. at 303 (internal quotation marks omitted). California courts have held that inverse condemnation applies not only to government entities and publicly-owned utilities, but also to privately-owned public utilities like PG&E. Pacific Bell Tel. Co. v. S. Cal. Edison Co., 208 Cal. App. 4th 1400 (2011); Barham v. S. Cal. Edison Co., 74 Cal. App. 4th 744 (1999).

Inverse condemnation poses a particular problem for PG&E given California’s regulatory regime. Unlike a government entity, private utilities like PG&E lack the power to tax or the ability to set their own rates to recoup any losses from an inverse-condemnation action. Pacific Bell Tel. Co., 208 Cal. App. 4th at 1407. PG&E can increase rates only with the approval of the CPUC. See id. When doing so, the CPUC employs a “prudent manager” standard to determine whether the utility may apply a rate increase to recover fire-related costs.

Problematically for PG&E, the CPUC has concluded that a utility’s inverse-condemnation liability is irrelevant to this determination and thus cannot be a basis to increase rates to cover their inverse-condemnation liabilities. CPUC Decision 17-11-033 at 65 (Nov. 30, 2017). Because PG&E can be held strictly liable for wildfire damages under inverse condemnation and cannot necessarily increase rates to cover those losses, it may be vulnerable to tens of billions of dollars in liability for Northern California’s wildfires without the ability to increase revenues.

 How Has PG&E Tried to Deal With the Bind It’s In?

In an attempt to avoid potentially significant liability in an inverse-condemnation action, PG&E has largely taken a two-prong approach, looking to (1) the courts to narrow or overturn the inverse condemnation doctrine and (2) the legislature to resolve the CPUC standards versus inverse condemnation conundrum.

Litigation Strategy: In the Northern California wildfire cases, PG&E has attempted to challenge the application of inverse condemnation to private utilities. Among other things, it has argued that the loss-spreading rationale of inverse condemnation is inapplicable to private utilities because they cannot pass on costs through rate increases as can government entities, and that applying inverse condemnation to private utilities is an unconstitutional taking and violates their due process rights. But these efforts have proved unsuccessful, as trial courts have consistently interpreted California Court of Appeal opinions to permit the application of inverse-condemnation liability to private utilities, finding that those appellate rulings are binding on the lower courts. See, e.g., California North Bay Fire Cases, Case No. JCCP 4955, Order Overruling PG&E’s Demurrers at 3-8 (Cal. Super. Ct. May 21, 2018). Although PG&E has challenged these decisions in the California appellate courts through writ proceedings, both the Court of Appeal and Supreme Court have denied the writ petitions. See, e.g., Pacific Gas & Elec. Co. v. Superior Court, Case No. A154847, Order denying petition filed (Cal. Ct. App. Sept. 17, 2018); Pacific Gas & Elec. Co. v. Superior Court, Case No. S251585, petition for review denied (Cal. Nov. 14, 2018).

Legislative Strategy: Separately, PG&E has been working furiously both publicly and behind the scenes to see if there can be a legislative fix to the legal challenges it faces. This past summer, the California legislature adopted SB 901, which was signed into by law by then-Governor Brown. While SB 901 did not modify or eliminate inverse condemnation, it did loosen the reins on the CPUC for wildfires occurring after Dec. 31, 2018, thereby allowing the CPUC to consider twelve “reasonableness” factors in determining whether to allow rate increases. SB 901 also authorized electric utilities to finance the cost of wildfire liabilities through recovery bonds; although, again it only applies to wildfires occurring after Dec. 31, 2018.

What Would a PG&E Bankruptcy Filing Look Like?

So now that we understand the conundrum PG&E is facing, it’s worth asking: what does a PG&E bankruptcy look like?

Reasons to File: There are four principal reasons why PG&E would likely consider a bankruptcy filing. First, and most obviously, a filing would trigger the automatic stay to halt the wave of litigation that has engulfed PG&E over the past 18 months. See 11 U.S.C. §362(a). The Bankruptcy Code authorizes courts to lift the stay “for cause.” Id. at §362(d)(1). Courts have largely adopted a multi-factor test to determine whether “cause” exists to lift the stay. See, e.g., In re Sonnax Indus., Inc., 907 F.2d 1280 (2d Cir. 1990) (identifying twelve relevant factors). As we’ll discuss below, there are significant limits on how a bankruptcy could help PG&E address its inverse-condemnation liabilities, but the “breathing spell” afforded by the automatic stay would likely be a key cornerstone to any bankruptcy strategy.

Second, PG&E’s liquidity position is apparently rapidly diminishing as a result of their inability to recover inverse-condemnation liabilities under the pre-SB 901 regulations. PG&E’s Jan. 13, 2019 bankruptcy announcement included a disclosure that they were currently negotiating $5.5 billion of debtor-in-possession financing. Under Bankruptcy Code §364, DIP financing offers debtors an attractive way of raising secured financing in bankruptcy by “priming” existing indebtedness. See 11 U.S.C. §364(d)(1).

Third, a filing could put more pressure on stakeholders—the legislature, the governor, and other interested groups and associations—to join in finding a legislative solution to inverse condemnation and CPUC regulations once and for all. As noted, the uncertainty associated with a major utility bankruptcy may not be politically palatable to elected officials. However, PG&E could be betting that having a federal judge oversee the course California’s largest electric utility takes may be just the motivation elected officials need to come to a solution.

Fourth, there remains the possibility that PG&E in its bankruptcy case could challenge inverse condemnation as a violation of PGE’s Fifth Amendment property rights under the federal Constitution. PG&E has unsuccessfully raised this argument in state court and it’s uncertain whether a federal bankruptcy judge would take the step to invalidate a California judicial doctrine. But even the threat of such a challenge—particularly in the cauldron of what would surely be a hotly-contested bankruptcy—could be enough to bring parties to the table.

Significant Drawback to a Filing: There is one significant obstacle to any PG&E bankruptcy: the likely inability to discharge liabilities associated with wildfires that have not yet occurred. There have been numerous mass tort bankruptcies in the past that have been resolved through the formation of a litigation trust and channeling injunction, forcing litigants into a single forum where claims are satisfied through trust assets. See, e.g., 11 U.S.C. §524(g) (channeling injunction for asbestos debtors); In re TK Holdings, Doc. No. 2120, Case No. 17-11375 (Bankr D. Del.) (confirmation order with channeling injunction for debtor that manufactured airbags with defective components). But that structure only works for claims based on prior conduct or acts. PG&E, in contrast, faces perennial liability associated with wildfires and inverse condemnation. It may be challenging to discharge the inverse-condemnation liabilities associated with a post-petition wildfire. See 28 U.S.C. §959(a) (debtors-in-possession may be sued “with respect to any of their acts or transactions in carrying on business connected with such property.”).

Conclusion

PG&E must navigate through a challenging legal and regulatory environment to move its business forward. Whether its likely bankruptcy filing at the end of January would resolve PG&E’s needs to solve the recurring problems caused by wildfires remains an open question. Parties with an interest in PG&E will have to carefully monitor and assess events as they continue to unfold in the near future.

John J. Rapisardi is the global chair of the restructuring group at O’Melveny & Myers. Daniel Shamah is a partner in the group. Associate Kyle Grossman, a member of the firm’s litigation department, assisted in the preparation of this article.