Bankruptcy Judge Now Has the Power

Federal Bankruptcy Judge Dennis Montali of San Francisco was handed the biggest case of his career Friday--the largest utility bankruptcy in U.S. history.

The case may determine the fate of one of California’s largest companies and have a dramatic impact on the utility bills paid by 13 million Pacific Gas & Electric Co. customers.

The company will continue to operate as its creditors form committees to prepare for the first major hearing in Montali’s courtroom May 8. Between now and then, the UC Berkeley law school graduate is expected to approve the payment of routine bills and salaries that will enable PG&E; to get by.

Over the long run, Montali will have the ultimate power to approve or reject any plan of how PG&E; reorganizes its financial house and arranges to repay billions in debt.

As part of the plan, the judge could authorize the auction of PG&E;’s sizable assets, including 140,000 acres of land, long-term power contracts, a nuclear power plant and 68 powerhouses on Sierra rivers.

The sheer scale of the case is unprecedented, legal experts said.

“This is unique, particularly because of the meshing of political and economic issues,” said Loyola Law School professor Daniel Schechter.

Given the magnitude of the case, there are many tough questions that Montali will have to resolve. Among them:

* Whether he can override the California Public Utilities Commission and impose a larger rate increase.

* Whether he can compel PG&E;’s parent company to return funds that the utility transferred to it over the past year.

* Whether he can compel PG&E;’s suppliers to provide power to the company at lower rates than currently agreed to.

The case could drag on for years and it is likely to be “a painful process,” said Robert Gee, who was the chairman of the Texas Public Utilities Commission when El Paso Electric Co. filed for protection under Chapter 11 of the U.S. Bankruptcy Code in 1992. “It took just shy of four years for that company to come out of bankruptcy,” Gee said, noting that the case involved much less money.

PG&E; is temporarily shielded from creditors’ legal claims because of filing under Chapter 11. But that does not mean “a magic wand is waved and all the company’s problems are solved,” Schechter said.

In filing for bankruptcy, the utility giant surrenders information and control in order to win a financial reprieve.

After PG&E; files a schedule listing what it owns and what it owes, its representatives must face its creditors--from state agencies to the tiniest company that provided it with copier toner--at a hearing. Under oath.

“It can be freewheeling, even contentious and ugly at times,” said Chicago bankruptcy attorney Christopher Combest, of the so-called 341 hearing. “People can ask anything.”

But before that happens, the first decisions Montali is expected to make are likely to concern the minutiae hashed out at smaller sessions called first-day hearings.

In a series of baby steps, the judge will establish how PG&E;’s battery of bankruptcy lawyers and other professionals will be paid and how the utility will handle day-to-day operating costs as the case grinds on.

The company may well receive permission to pay employee-related expenses that are among its list of debts to prevent morale problems, attorneys said.

Creditors will be represented by several separate committees. The seven largest unsecured creditors would typically form one panel represented by a trustee appointed by the U.S. trustee’s office. Stockholders may form a separate committee to press their interests.

The role consumers will play is in question. On Friday, Nettie Hoge, executive director of the Utility Reform Network, a consumer advocacy group, said that the organization will seek a formal role in the proceedings and that she expects California Atty. Gen. Bill Lockyer to support such a role for consumers.

However, several legal experts, including UCLA law professor Lynn LoPucki, said it would probably be difficult for consumers to play such a role role because they have no legal standing under federal bankruptcy law. Still, LoPucki said, he has seen cases in which judges have listened to consumers affected by bankruptcies, even though they had no formal standing.

Other legal experts said the PUC, as the agency that has controlled rates, is likely to play a crucial role in giving consumers a voice.

Petitions by state regulators in Louisiana, for example, helped ensure that the bidder offering the lowest rates, not the highest price, won the assets of defunct utility Cajun Electric, said attorney Combest, who worked on that case in the mid-1990s.

“The Bankruptcy Court may well allow [the PUC] to be heard and to be a player on rates and on the transfer of assets,” Combest said.

Experts Disagree on Judge’s Powers

Bankruptcy experts were split Friday on some of the major legal issues.

Charles Tatelbaum, a bankruptcy attorney in Naples, Fla., said federal law gives Judge Montali broad authority to set rates and to compel suppliers to continue to do business with PG&E; until a reorganization plan is confirmed.

“We’re in somewhat uncharted water here, but he has the power to increase the rates temporarily so they are not operating at a loss,” he said.

But several legal experts, including Loyola’s Schechter, said they did not think Montali’s power will prove that sweeping. “I know of no grounds for a judge to override the Public Utilities Commission and command higher rates,” he said.

On the other hand, Schechter said, during the course of the bankruptcy proceedings the PUC might, as a practical matter, have to order another rate increase.

In the bankruptcy of the Public Service Co. of New Hampshire in the late 1980s, a judge prepared to increase rates by 7.5% for seven years, but the increases were never implemented because parties reached a settlement. In the El Paso case, Gee said, the parties ultimately agreed to a 10% rate hike--an increase the state’s PUC agreed to because it feared the judge might raise rates more.

There is likely to be considerable focus in Bankruptcy Court on PG&E;’s transfer of $4.5 billion to its parent company since deregulation was enacted, said Schechter and Los Angeles bankruptcy lawyer Kenneth Klee, who was the co-author of the 1978 federal bankruptcy law.

“The bankruptcy law enables the judge to use certain powers to reverse transactions and create equitable distributions” of funds, Klee said. “Recapturing that money is not a farfetched idea,” he said.

In order for that to happen, LoPucki said, the creditors would have to show that PG&E; “upstreamed” the money to its parent company under circumstances where it knew or should have known that it was going to need the money. The legal term of art is a “fraudulent conveyance,” and several legal experts said they were sure the issue would be raised.

Tatelbaum said the bankruptcy process could offer all parties--from the utility to the state to consumers--the advantage of consistency, minus political pressure.

Tatelbaum said the fact that Montali is not subject to political pressure like an elected judge--he was appointed to a 14-year term by the U.S. 9th Circuit Court of Appeals in 1993--is likely to give all parties “a more objective forum and a judge used to dealing with distressed companies.”

On the other hand, Gee, the former Texas regulator, said he believes “public policy and public utility law do not mesh well with the Bankruptcy Code.”

“The bankruptcy process puts the ratepayer at a decided disadvantage,” said Gee, now an energy consultant in Washington. “The process is heavily weighted toward increasing cash flow for the utility,” rather than being concerned with the interests of ratepayers, he said.

Similar sentiments were expressed by UCLA’s LoPucki. “If you’re asking does a bankruptcy judge have the nerve to double or triple rates in California, the answer may be yes,” LoPucki said. “Bankruptcy judges are somewhat isolated. They see their function as preservation of the [corporate] estate. A bankruptcy judge could do something that would appall the public and the ratepayers.”

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Steps of the Chapter 11 Process

Filing for Chapter 11 bankruptcy protection will give Pacific Gas & Electric Co., a subsidiary of PG&E; Corp., some breathing room to reorganize and devise a plan to pay its debts.

* Chapter 11 will temporarily shield the company from creditors’ legal claims. They cannot sue, seek to foreclose or take other actions to collect their debts.

* To keep the business running smoothly, a bankruptcy judge will issue “first-day” orders covering matters such as honoring employees’ sick time and vacation days.

* Current management is allowed to stay in place to run the business, but the bankruptcy judge must approve any non-ordinary transactions, such as the sale of a substantial asset like the company’s transmission lines.

* The court will appoint a creditors’ committee or committees to closely monitor what the company proposes to do.

* Ultimately, the firm must come up with a plan to pay its debts, creditors must approve the plan and, finally, the court gives its OK. The company then comes out of bankruptcy, a process that could take several years.

* Debts can be paid off in cash, promissory notes, stocks or other ways. In some cases the firm’s stock is canceled and new shares are issued to creditors to pay off debts.

WHO GETS PAID

Federal bankruptcy law spells out the order in which creditors get paid. Post-petition creditors, those who lend money or supply goods or services after the company files for bankruptcy, are generally paid before pre-petition creditors. Shareholders are at the bottom of the list. Creditors are paid as follows:

* Secured creditors, such as banks that lent money for plants or equipment and mortgage or revenue bondholders, but only to the extent of their secured collateral. Any amount over that falls into the unsecured creditor category.

* Any firms that lend money to keep the company running during the bankruptcy period.

* Providers of other goods and services associated with keeping the company running during the bankruptcy period, such as employees, attorneys, vendors and suppliers.

* Other so-called priority debt, such as taxes.

* Unsecured creditors such as vendors, suppliers and tradespeople who supplied goods and services before the bankruptcy and who are still owed money. Unsecured bondholders are considered unsecured creditors.

* The holding company.

* Shareholders.

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Researched by NONA YATES / Los Angeles Times

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