Opinion
Case No. 01-30923-SFM, Chapter 11.
May 16, 2001
TENTATIVE RULING AND ORDER TO MEET AND CONFER FOLLOWING HEARING ON EMERGENCY MOTION OF MID-SET COGENERATION CO., ET AL.
I. Introduction
On May 10, 2001, the court heard the Emergency Motion For Relief From Stay ("Motion") filed by Mid-Set Cogeneration Co., Coalinga Cogeneration Co., Salinas River Cogeneration Co. and Sargent Canyon Cogeneration Co. (collectively "Mid-Set"), each of which is commonly referred to as a "QF" or "Qualifying Facility." The appearances of counsel are noted in the record. Presently on the court's calendar are similar motions by other QFs (the "Other Moving QFs") which supply energy to Pacific Gas Electric Company ("PGE" or "Debtor"). By this Tentative Ruling, the court is setting forth certain findings of fact and conclusions of law it is prepared to enter regarding Mid-Set's Motion and PGE's opposition. Rule 7052(a). It is also directing that the parties explore interim remedies as described below.
The term "qualifying facility" is shorthand for various cogeneration, solar and similar facilities. See 18 C.F.R. § 292.101(b)(1) and 292.201-292.207 and 16 U.S.C. § 796(17) and (18), part of the Public Utilities Regulatory Policies Act of 1978, as amended, 16 U.S.C. § 824 et seq. ("PURPA").
At a hearing on May 10, 2001, the court heard argument on Mid-Set's Motion, PGE's opposition, and comments of counsel for the Official Committee of Unsecured Creditors ("OCC") and others. The court acknowledges that it also told counsel for Mid-Set that at the continued hearing on May 24, 2001, he would be permitted to present his final closing argument. That offer remains open, and counsel for Mid-Set, PGE, and the OCC will be allowed to address not only the matters presented via testimony at the May 24 hearing, but all matters covered in this Tentative Ruling.
Unless otherwise indicated, all chapter and section references are to the Bankruptcy Code, 11 U.S.C. § 101-1330, and all rule references are to the Federal Rules of Bankruptcy Procedure.
II. Discussion
A. Nature of Relief Sought Mid-Set seeks various forms of relief, including:
1. Relief from the automatic stay imposed by section 362 to permit Mid-Set to suspend performance under its Power Purchase Agreements ("PPAs") with PGE and sell power in the open market;
2. Adjustment of the price to be paid for energy and capacity above those presently being tendered by PGE under California Public Utilities Commission ("CPUC") Decision No. 01-03-067 ("Wood Decision");
3. Acceleration of payments under its PPAs; and
4. Imposition of an immediate deadline for PGE to assume or reject the PPAs under section 365.
Several Other Moving QFs go one step further and contend that forcing them to deliver power to PGE is an impermissible involuntary extension of credit under Bankruptcy Code section 364. It appears that any QF would be obligated to perform if it is given adequate assurance of performance. Cf. Continental Energy Assocs. Ltd. P'ship v. Hazleton Fuel Mgmt. Co. (In re Continental Energy Assocs. Ltd. P'ship), 178 B.R. 405, 409 (Bankr. M.D. Pa. 1995) (debtor can enforce terms of contract prior to assumption or rejection). Mid-Set agreed to such performance in the PPAs.
Several Other Moving QFs go one step further and contend that forcing them to deliver power to PGE is an impermissible involuntary extension of credit under Bankruptcy Code section 364. It appears that any QF would be obligated to perform if it is given adequate assurance of performance. Cf. Continental Energy Assocs. Ltd. P'ship v. Hazleton Fuel Mgmt. Co. (In re Continental Energy Assocs. Ltd. P'ship), 178 B.R. 405, 409 (Bankr. M.D. Pa. 1995) (debtor can enforce terms of contract prior to assumption or rejection). Mid-Set agreed to such performance in the PPAs.
B. Broader Issues
In deciding whether Mid-Set and the Other Moving QFs should be granted relief, the court cannot and will not ignore other considerations, including:
The interests of creditors and parties in interest in this Chapter 11 estate;
The current California energy crisis and the need to keep QFs on-line, producing power for California;
PGE's right to reorganize and to make deliberate, reasonable and reasoned business decisions whether to assume or reject its executory contracts;
Several specific factors articulated by counsel for the OCC, including: efforts by the members of the OCC to bring about a consensus on the issues pertaining to the QFs, who produce approximately 22% of PGE's energy needs; the ramifications of any decision pertaining to Mid-Set's motion; the need to enhance the potential for power generation in California; and, if relief is granted, a determination of how much power will be generated and sold for use in California rather than elsewhere.
C. Imponderables
The court has heard and read much about a number of other factors that bear upon the problems confronting PGE, Mid-Set, the QFs, creditors and parties in interest. The court has not been asked, nor does it presently determine that it is even able to attempt to resolve those complex matters, but they include the following:
The future of the Wood Decision at the CPUC and the Federal Energy Regulation Commission ("FERC");
PGE's pending or anticipated litigation over its rates in other courts;
The possibility of regulatory or legislative solutions to these major problems;
The future of natural gas prices and the impact of those prices on the cost of power and capacity produced by QFs that use natural gas.
D. Bankruptcy Considerations
Within the province of this court is the need to apply bankruptcy principles in order to decide Mid-Set's Motion. The court envisions its role as devising a legal and equitable remedy to maintain a balance while parties in interest in this case are given an opportunity to make crucial decisions that affect their rights, duties and obligations, and while parties outside of this case work as they are charged, either to leave in place or to alter the Wood Decision and otherwise to attend to the problems of the California energy crisis.
Those bankruptcy considerations and the court's treatment of them follows.
1. Suspension of performance
Mid-Set argues that it should be allowed to suspend performance pending PGE's assumption or rejection of its PPAs. Presumably this concept is rooted in Uniform Commercial Code section 2609, which protects the non-debtor's expectation of receiving due performance. Outside bankruptcy, when reasonable grounds for insecurity arise with respect to performance and absent adequate assurance of due performance, a party may — if commercially reasonable — suspend any performance for which it has not received its agreed return. See Cal. Comm. Code § 2609.
In the context of a bankruptcy case, non-debtor parties may not unilaterally terminate existing contracts. Computer Communications, Inc. v. Codex Corp. (In re Computer Communications, Inc.), 824 F.2d 725, 728-29 (9th Cir. 1987) (creditor violated automatic stay by unilaterally terminating contract; "[e]ven if [creditor] had a valid reason for terminating the Agreement, it was still required to petition the court for relief from the automatic stay under § 362"); Carroll v. Tri-Growth Centre City, Ltd (In re Carroll), 903 F.2d 1266, 1271 (9th Cir. 1991) (an "executory contract that is property of the estate can only be terminated after a grant of relief from the stay"). Nonetheless, they are entitled to ask the court to require the debtor to provide assurances of performance or adequate protection. If the court is satisfied that post-petition performance of an unassumed executory contract cannot reasonably be assured, then relief from stay based upon that finding is appropriate.
PGE has demonstrated that it is able to perform its post-petition obligations under the PPAs between it and Mid-Set at the present time, based upon its substantial cash reserves of approximately $2.5 billion. PGE projects that through the coming months those reserves will not be materially reduced unless intervening events at FERC or the CPUC (or otherwise) alter the short term course of its financial affairs.
In that regard PGE suggests it can provide adequate protection to Mid-Set by tendering payments at the Wood Decision level on a going-forward basis, and that the "disconnect" between this amount and the cost of generating the power is a problem of Mid-Set's (and other QFs') own making. PGE essentially argues that Mid-Set should be held to the bargain it struck in the PPAs, namely being paid what has been determined to be the agreed price. In each instance Mid-Set elected to receive what are described in the respective PPA as PGE's "full short-run avoided operating costs," which in turn are defined to be CPUC "approved costs which are the basis of PGE's published energy prices" ("Avoided Cost").
The court notes that in the Wood Decision, when discussing whether or not a price ceiling should be adopted, the CPUC made the following observation about the plight of QFs who complain that the avoided cost recovery formula may not allow them to recover operating costs:
QFs have never been absolutely entitled to a payment to cover their operating costs under any and all circumstances, only to a payment consistent with the utility's avoided cost. As we have seen recently in both the gas and electricity markets, over-reliance on spot market purchases can lead to significant volatility in prices. The Commission has never directed QFs to enter into gas purchase arrangements based on California border indices; this decision is left to QFs. The fact that a QF may not have protected itself from pricing volatility is not a reason not to establish a cap on QF payments at utility avoided costs.
Wood Decision, pp. 23-24.
Mid-Set suggests that it could sell electricity on the open market and share some of the extra revenue with PGE. The court is not inclined to authorize PGE to release Mid-Set from its obligations so it can sell power at potentially extreme prices to California. Not only is this harmful to California, but PGE states that the CPUC could view this as a violation of PGE's duties to its ratepayers, and would likely penalize PGE and reduce its rates to compensate for the increased prices. In other words, the cure may be worse than the disease. Moreover, a debtor in bankruptcy generally has to comply with valid state laws governing the operation and management of property. See 28 U.S.C. s 959(b).
For the foregoing reasons the court at this time is not inclined to grant Mid-Set its requested relief from the automatic stay to suspend performance under the PPAs. As discussed below, the court reserves the issue whether to grant Mid-Set any other form of relief from the automatic stay until after conclusion of the May 24, 2001 hearing.
2. Reasonable rate
"During the period prior to assumption or rejection of an executory contract or unexpired lease, the estate must pay the reasonable value of any contractual benefits the estate receives during that period, as an administrative expense." In re Resource Technology Corp., 254 B.R. 215, 221 (Bankr. N.D. Ill. 2000), citing Continental Energy, 178 B.R. at 408. As noted by the Supreme Court in National Labor Relations Board v. Bildisco and Bildisco, 465 U.S. 513, 533 (1984):
If the debtor-in-possession elects to continue to receive benefits from the other party to an executory contract pending a decision to reject or assume the contract, the debtor-in-possession is obligated to pay for the reasonable value of those services [citation omitted], which, depending on the circumstances of a particular contract, may be what is specified in the contract.
The court notes that counsel for one set of the Other Moving QFs seeking relief quoted this sentence, but chose to end the quote at "services" by placing a period at that point in the sentence. The quote was therefore misleading, because it omitted (without even an ellipsis to indicate deleted text) a clause from the sentence that was somewhat detrimental to the QFs' position. The court cautions counsel that such editing of quoted text is inappropriate and will not be tolerated in the future.
The court notes that counsel for one set of the Other Moving QFs seeking relief quoted this sentence, but chose to end the quote at "services" by placing a period at that point in the sentence. The quote was therefore misleading, because it omitted (without even an ellipsis to indicate deleted text) a clause from the sentence that was somewhat detrimental to the QFs' position. The court cautions counsel that such editing of quoted text is inappropriate and will not be tolerated in the future.
Id. at 533. See also Peoples Gas System, Inc. v. Thatcher Glass Corp. (In re Thatcher Glass Corp.), 59 B.R. 797, 799 (Bankr. D. Conn. 1986) (pending assumption or rejection, a non-debtor is entitled to the reasonable value of post-petition goods, although "the contract rate is presumed to be reasonable"); cf. Thompson v. IFG Leasing Co. (In re Thompson), 788 F.2d 560, 563 (9th Cir. 1986) (in case involving rejected lease, Ninth Circuit held that rejection damages are "fair and reasonable value" of lease; lease rental rate is "presumptive evidence of fair and reasonable value," but if presumption was rebutted then the open market value would provide "fairest measure of compensation for all concerned").
The statute had changed since Thompson as to leases, but not other executory contracts. The provisions of section 365(d)(3) regarding payment of post-petition pre-assumption or rejection amounts to be paid on non-residential leases were interpreted in Towers v. Chickering and Gregory (In re Pacific-Atlantic Trading Co.), 27 F.3d 401, 403-405 (9th Cir. 1994), to require the contract rate of rent to be paid as a post-petition administrative expense claim. The 1994 amendments to the Code made similar changes as to non-consumer personal property leases beginning 60 days after the petition date. See section 365(d)(10). As to other post-petition pre-assumption or rejection contractual obligations, the "reasonable" rate would still apply.
As noted above, PGE is tendering to Mid-Set, and has represented that it is tendering to the other QFs, the avoided cost amounts required in the respective PPAs and as determined by the CPUC in the Wood Decision. Mid-Set correctly argues that pending assumption or rejection, it is entitled to a "reasonable" rice for the energy and/or capacity it provides PGE. Mid-Set's counsel specifically concedes — and the court deems correct as a matter of law — that "reasonable" is not the same as "market" price. In this contested matter, Mid-Set has not shown that any price other than that set by the PPAs and the Wood Decision is "reasonable."
First, the existing power markets are not functioning competitively. The FERC has already found that, under certain conditions, short-term wholesale power rates in the California market were "unjust and unreasonable" within the meaning of § 206(a) of the Federal Power Act, as amended, 16 U.S.C. § 824e(a). 93 FERC 6 61,121, at, e.g., text accompanying n. 50.
Second, even if the existing markets were reliable, Mid-Set has offered no basis for this court to determine which "market" is relevant. If the court looks to the market in "comparable" long-term PPAs executed by other parties, would the court look at PPAs executed in the last year, the last month, or the last week — given the wild fluctuations in prices, the differences could be enormous? Would the court only consider PPAs executed by parties in comparable geographic locations, of similar duration, type of facility, and other characteristics? As the Wood Decision illustrates, seemingly minor differences can have large consequences. The court questions whether any decisions it might make on all these variables would result in a more "reasonable" rate than that determined in the Wood Decision.
Third, the statutory and regulatory scheme itself provides one way to measure the reasonable "market" price — namely, the avoided cost. See 18 C.F.R. § 292.303 and 292.304(b)(2) (1982) (utilities' obligation to purchase from QFs at "avoided cost"); 18 C.F.R. § 292.101(b)(6) (1982) (defining "avoided costs"); 16 U.S.C. § 824a-3. The federal and state legislatures have established regulatory bodies with specialized expertise to figure out the geographic and other measures of that market. In adopting the then-current regulatory/market rate as the "reasonable" rate, the Thatcher court observed:
The contractual arrangement between these parties must not be viewed in a vacuum. Rather, this court must recognize that the public served by the regulatory agency has an interest in rates charged for natural gas and that the lower [contract] rate is contrary to the guidelines of the public authority.
Thatcher Glass, 59 B.R. at 800. See also Sharon Steel Corp. v. Nat'l Fuel Gas Distrib. Corp., 872 F.2d 36 (3d Cir. 1989) (contract required debtor to take a minimum amount of gas each month and provided a minimum demand charge, but the regulated rate for other customers did not; the court held that the regulated rate was reasonable).
For all the above reasons, assuming without deciding that Mid-Set could overcome the presumptive reasonableness of its contract rate, it has made no argument or offer of proof that would establish a more satisfactory measure of what is "reasonable" than the elaborate statutory and regulatory structure for determining avoided costs. Therefore, the court will adopt the rate established by the Wood Decision as the "reasonable" rate to compensate Mid-Set for performance under its PPAs.
3. Accelerated payments.
The court will not require PGE to make payments more frequently or earlier than ordered by the CPUC (see Wood Decision, conclusion of law 21 and ordering paragraphs 10-12). The court is satisfied that there is ample — more than adequate — assurance that PGE will be able to perform under the PPAs, pending its assumption or rejection of those PPAs.
4. Assumption or rejection of executory contracts
Bankruptcy Code section 365 entitles a debtor in possession to assume or reject executory contracts and unexpired leases. In general the decision to assume or reject is left to the business judgment of the debtor in possession. Robertson v. Pierce (In re Chi-Feng Huang), 23 B.R. 798, 800-802 (9th Cir. BAP 1982) (adopting and explaining nature of business judgment test). This is a very complex case and the decision to assume or reject any particular PPA (with Mid-Set or any other QF) may itself involve a very complex analysis. Moreover, numerous other executory contracts and many other urgent matters demand the attention of legal and business professionals for PGE, the OCC, and other parties in interest. In addition PGE and the OCC argue that forcing an early assumption of its PPAs could result in PGE having to use its available cash to pay pre-petition breaches that may be close to $1 billion, which could have an adverse effect on the reorganization. For all of these reasons the court is reluctant to force an early decision whether to assume or reject PPAs or any other executory contracts.
Although there is no specific evidence as to the aggregate prepetition defaults to QFs, various counsel have represented that those defaults are approximately $1 billion. Counsel for PGE and the OCC have not challenged that assertion.
On the other hand, delaying the decision whether to assume or reject may cause serious harm to Mid-Set and others. Until PGE assumes or rejects the PPAs, Mid-Set may be unable to operate except at a loss and unable to enter into PPAs with anyone other than PGE. This may leave Mid-Set unable to pay its employees or creditors, particularly because, based upon the evidence presented, Mid-Set is owed approximately $58 million on account of PGE's prepetition defaults. The upshot is that Mid-Set may have to go off-line, file its own bankruptcy petition, or even shut down completely.
Numerous third parties may be harmed. For example, Mid-Set may have to lay off its employees and breach its agreements with third parties. California would suffer, according to Mid-Set, because of the ripple effect to the economy, less power in the grid, rolling blackouts, and skyrocketing electricity prices. Such effects would be dangerous and probably irreparable: as PGE has stated, "public health and safety depend upon a steady supply of electricity. . . ." Memorandum of Points and Authorities In Support of Debtor's Emergency Motion for Authority to Pay Pre-Petition Compensation and Benefits, p. 34:17.
Mid-Set's counsel argued that in recent days rolling blackouts were only narrowly averted and the crucial margin of power supply preventing blackouts was largely due to Mid-Set and other QFs temporarily coming back on-line. Mid-Set's counsel claimed this reprieve was due to the "fluke" that gas prices were temporarily low enough for QFs to operate profitably under the Wood Decision.
Moreover, for the following three reasons the court is concerned that if Mid-Set's predictions have any validity then, ironically, PGE and its other creditors could be seriously harmed:
The doomsday scenarios may repeat themselves for other QF's; still others may have the economic resources to weather this storm.
First, if Mid-Set is correct that QFs will have to go off-line, and if this causes power losses and/or price spikes, then PGE could suffer considerable losses. In fact, PGE has blamed price spikes for pushing it into bankruptcy, because of the "disconnect" between buying electricity at peak wholesale prices and selling it at frozen retail prices.
Second, if PGE eventually assumes the PPAs it will have to "cure" all defaults and, in addition, compensate Mid-Set for its "actual pecuniary loss" resulting from PGE's defaults.
11 U.S.C. s 365(b)(1)(A) and (B).
Although section 365(b)(2)(D) appears to excuse PGE from having to satisfy any "penalty rate or provision," PGE will likely have to pay any other "pecuniary loss" recoverable under applicable state law, which generally includes consequential damages and interest. See Bildisco, 465 U.S. at 531-532 (debtor who elects to assume contract does so "cum onere"); In re Eagle Bus Mfg., Inc., 148 B.R. 481 (Bankr. S.D. Tex. 1992) (interest on unpaid rent allowed as pecuniary loss). See also Lacey v. Westside Print Works, Inc. (In re Westside Print Works, Inc.), 180 B.R. 557 (9th Cir. BAP 1995) (following Eagle Bus Mfg., but affirming denials of claim for attorneys' fees, increased taxes and insurance and other alleged costs, because not adequately proven).
This is not just a technical issue. If PGE's default to the QF's is close to $1 billion, as various counsel have claimed, then the interest alone will be very substantial. Consequential damages under state law could include not only damage to Mid-Set but also, if PGE's non-payment under the PPAs forces Mid-Set to breach its own contracts with third parties, any damages from those breaches. See 1 Witkin, Sum. of Cal. Law, Contracts §§ 825 (future profits), 842 (attorneys' fees, including fees incurred in bringing or defending action against third person), 848 (consequential damages) (9th ed. Supp. 2000).
Third, if PGE eventually rejects the PPAs, PGE might nevertheless still have to pay 100% of any consequential damages and interest. The Bankruptcy Code treats rejection of executory contracts as a pre-petition breach. 11 U.S.C. § 502(g). In general, the effect is that post-petition consequential damages are treated as unsecured, non-priority pre-petition claims. See Abercrombie v. Hayden Corp. (In re Abercrombie), 139 F.3d 755, 758-759 (9th Cir. 1998) (attorneys' fees incurred litigating post-petition bankruptcy issues treated as part of pre-petition unsecured claim). If PGE were insolvent, those claims would be paid something less than their face value, without post-petition interest. 11 U.S.C. §§ 502(b)(2), 726(a)(5) and 1129(a)(7)(A)(ii).
PGE claims, however, that it is solvent. PGE's counsel has made numerous representations to the court to the effect that PGE intends this case to be conducted on a "business as usual" basis and that all creditors will be paid in full. In addition, the information that accompanied the voluntary petition, while not conclusive, leads the court to believe at this point that PGE is solvent in a balance sheet sense. If PGE is correct that it is solvent, pre-petition claims should receive payment in full with interest. 11 U.S.C. §§ 726(a)(5) and 1129(a)(7)(A)(ii). Indeed, this has led some courts to refuse to approve solvent debtors' motions to reject executory contracts, because the net effect would be worse for the bankruptcy estate than assuming the contracts. See Chi-Feng Huang, supra, 23 B.R. at 803 (if estate is solvent, rejection would "accomplish nothing for the general unsecured creditors" and "might only impose unwarranted administrative expenses or delay"); Bregman v. Meehan (In re Meehan), 59 B.R. 380 (E.D.N.Y. 1986) (bankruptcy court may decline to authorize rejection of contract in solvent estate because it will not benefit unsecured creditors).
Given the above analysis it might seem that it makes economic sense for PGE to assume all its executory contracts. Moreover, it seems likely that PGE will want to assume Mid-Set's PPAs, both because they appear to be below-market at present and because if PGE rejects the PPAs it might be required by the Federal Power Act to enter into a new PPA with Mid-Set (possibly at a higher rate). See generally 16 U.S.C. § 824i and 824k and 18 C.F.R. § 292.303 and 292.304 (1982) (utilities' obligation to purchase from QFs). See also American Paper Institute, Inc. v. American Elec. Power Service Corp., 461 U.S. 402 (1983) (upholding validity of rules). The court notes that a delay in assuming or rejecting an executory contract can be at least temporarily beneficial to debtors but might ultimately be detrimental to the bankruptcy estate. See R and O Elevator Co., Inc. v. Harmon, 93 B.R. 667 (D. Minn. 1988) (debtor did not move to assume or reject executory contract with former president until plan confirmation, thereby benefitting from non-competition agreement without having to assume contract and pay cure, but president was therefore under no duty to mitigate damages). Nonetheless, the court recognizes that there may be many valid business reasons for PGE to defer the decision whether to assume or reject its executory contracts, not least of which are shifting regulatory and economic circumstances.
In other words, the longer PGE takes to decide whether to assume or reject the PPAs the greater the damage might be to PGE and its creditors. As already noted, there may also be substantial harm to Mid-Set, third parties and California.
PGE, however, disputes Mid-Set's dire predictions. PGE claims that most QFs are able and willing to live up to their bargains in the PPAs. From the evidence presently before the court, there is scant showing of harm to anyone other than Mid-Set. The court notes that Mid-Set's alleged damages may be subject to set-off if PGE can establish that Mid-Set violated duties it may have under the PPAs and applicable law to stay on-line, help avoid price increases and rolling blackouts, and mitigate damages. Resolution of those matters is for another day. At present the factual record simply is not sufficiently developed for this court to determine whether it is appropriate to set any deadline, let alone an immediate deadline, for PGE to assume or reject the Mid-Set PPAs.
The court notes that it has not read the Second Supplemental Declaration of Kelly Lucas, submitted by Mid-Set under seal, for reasons explained at the May 10, 2001 hearing. The court is not inclined, however, to expand discovery beyond the scope of what is already alleged in Mid-Set's declarations (including the declaration under seal, if that is admitted in evidence). Nor is the court inclined to continue the May 24, 2001 hearing or hold further hearings on Mid-Set's motion unless, of course, the parties reach an interim resolution of their current differences. See 6 D.6, infra.
At the May 10, 2001 hearing the OCC joined with PGE in asking for more time. The court established procedures for expedited discovery and an evidentiary hearing on May 24, 2001 to consider the harm alleged in Mid-Set's declarations. Based on that harm, and the foregoing discussion, the court will decide at that time whether to set a deadline for PGE to assume or reject Mid-Set's PPAs.
5. The need for interim relief
Other than expedited procedures the court has so far indicated that it will deny Mid-Set any relief. The court is concerned, however, that from the evidence Mid-Set has already presented there may be irreparable harm to Mid-Set (and other QFs) if it is not afforded some form of immediate relief. Of more concern to the bankruptcy estate, and ultimately to California and all parties in interest, the court has been informed that without some form of relief Mid-Set may be unable to produce power in accordance with its PPAs when needed. Therefore the court suggests the following as a template for interim relief to Mid-Set (and perhaps to Other Moving QF's).
6. Interim relief a. An extraordinary case calling for extraordinary remedies.
Mid-Set alleges that the threat to its continued ability to perform under the PPAs comes from a combination of (a) having to operate at a loss under the Wood Decision and (b) not being paid anything on account of the $58 million allegedly owed to Mid-Set by PGE. The court has already declined to impose a rate at variance with the Wood Decision. The court has also declined to require PGE to make an immediate decision whether to assume or reject — which would involve "prompt" payment of the entire $58 million if PGE assumed the PPAs — because that decision may be too complex to be rushed. 11 U.S.C. § 365(b)(1)(A). Despite that complexity, the economic analysis seems very simple: unless there are compelling reasons to the contrary, under the standards set forth below, a portion of Mid-Set's $58 million claims should be paid sooner rather than later.
In the first hours of the case (as with most other Chapter 11 cases involving operating businesses) the court was asked, and without objection, authorized PGE to pay certain prepetition obligations. These included wages, customer deposits and other "ordinary course of business" type expenses. Paying selected critical pre-petition debts is not only the accepted practice in many Chapter 11 cases, as set forth below it is authorized under controlling Ninth Circuit authority.
Here Mid-Set and the Other Moving QFs, not unlike PGE's own employees, are providing a valuable service to PGE, its customers, and ultimately the citizens of California. That valuable service is the provision of desperately needed electrical energy. No purpose would be served by forcing Mid-Set to reduce or cease production or substitute its performance with that of less efficient power generators. Certainly that would reduce the total amount of energy available, not to mention the domino effect it would have on parties who could assert damages against Mid-Set, thus exacerbating the situation for PGE by an almost inestimable breach of contract claim. But because Mid-Set will be entitled to be paid either way, the court will set in motion a procedure that might get Mid-Set paid sooner rather than later in order to avoid exponential increases of damage claims and perhaps increasing the energy havoc already rolling through California.
b. Authority to pay critical pre-petition obligations
Numerous courts have authorized early payment of some pre-petition obligations where those payments are essential to the debtor's attempts to reorganize. As already noted the most common example is wages and benefits to key employees, who would otherwise leave and cripple the debtor. See, e.g., Pension Benefit Guar. Corp. v. Sharon Steel Corp. (In re Sharon Steel Corp.), 159 B.R. 730, 736-737 (Bankr. W.D. Pa. 1993) (allowing $1.5 million payment of pre-petition wages over objection, where alternative would "far exceed" that cost); In re Eagle-Picher Industries, Inc., 124 B.R. 1021, 1023 (Bankr. S.D. Ohio 1991) (payment of $931,000 on account of prepetition general unsecured debts to certain customers, because debtor "show[ed] that the payment is necessary to avert a serious threat to the chapter 11 process"); In re Gulf Air, Inc., 112 B.R. 152 (Bankr. W.D. La. 1989) (granting motion to pay employee-related expenses); In re Ionosphere Clubs, Inc., 98 B.R. 174 (Bankr. S.D.N.Y. 1989) (reaffirming court's prior authorization to pay some pre-petition wages, but denying union's motion for payment of non-working employees); Michigan Bureau of Workers' Disability Comp. v. Chateaugay Corp. (In re Chateaugay Corp.), 80 B.R. 279, 287 and n. 17 (S.D.N.Y. 1987) (payment of workers' compensation claims allowed, to permit "greatest likelihood of survival of the debtor and payment of creditors" even though "it is not clear [that employees] are entitled to priority under § 507"); In re Jewish Memorial Hospital, 13 B.R. 417 (S.D.N.Y. 1981) (hospital permitted to pay a portion of pre-petition employee benefits, emphasizing public health and welfare concerns). See also Craft Precision Indus., Inc. v. U.S. Healthcare, Inc. (In re Crafts Precision Indus., Inc.), 244 B.R. 178, 180 and 183 (1st Cir. BAP 2000) (noting that, by allowing debtor to pay pre-petition vacation benefits that "did not comply with § 507's priority scheme," bankruptcy court "preserved [debtor's] potential for rehabilitation"); Cohen v. KDC Fin. Serv., Inc. (In re Miller Mining, Inc.), 219 B.R. 219, 223 (Bankr. N.D. Ohio 1998) (court noted that it has permitted payment of pre-petition wages so debtor-in-possession can maintain "effective work force").
A minority view refuses to authorize requested payments of pre-petition obligations, but cases adopting that view almost invariably lack adequate showings of any benefit to the estate from the proposed payments. See, e.g., Official Comm. of Equity Security Holders v. Mabey, 832 F.2d 299, 302 (4th Cir. 1987), cert. denied, 485 U.S. 962 (1988) (payments could not be made for reconstructive surgery or in vitro fertilization for women injured by the Dalkon Shield); In re FCX, Inc., 60 B.R. 405, 411-412 (E.D. N.C. 1986) (inadequate showing of "public interest" to support payment of employees and grain producers, and it is "simply inequitable" to pay some pre-petition debts because "such action may be detrimental to the remaining unsecured creditors if the reorganization fails and the estate has to be liquidated").
The Ninth Circuit has issued no decision directly on point, but two cases are particularly useful. In the earlier case, the Ninth Circuit rejected wholesale incorporation of the so-called "necessity of payment" rule traditionally applied in railroad reorganizations, but left open the possibility of paying pre-petition obligations upon a proper showing of sufficient justification:
Because the Necessity of Payment Rule does not concern priorities of creditor claims, it is not included by reference in § 1171(b). Therefore, the limitation to railroad cases imposed by § 103(g) is not applicable. Nevertheless, we decline to extend the rule to the facts of this case. The Necessity of Payment Rule was created for and has been applied only to railroad cases. Absent compelling reasons, we deem it unwise to tamper with the statutory priority scheme devised by Congress in the 1978 Act. See 11 U.S.C. § 507. Even if we were convinced that the Necessity of Payment Rule survived the 1978 Act, appellants have not presented to this court sufficient justification for extending the Necessity of Payment Rule to trucking reorganizations.
B W Enterprises, Inc. v. Goodman Oil Co. (Matter of B W Enterprises, Inc.), 713 F.2d 534, 537 (9th Cir. 1983) (emphasis added).
A later Ninth Circuit case, Burchinal v. Central Washington Bank (In re Adams Apple, Inc.), 829 F.2d 1484, 1490 (9th Cir. 1987), squarely favors payment of pre-petition obligations where necessary. The court's comments are dicta, but the Ninth Circuit pointed out that rehabilitation of debtors is a "fundamental tenet" of bankruptcy law, and this tenet can "supersede the policy of equal treatment":
[A]ppellants claim that the cross-collateralization clause violates a fundamental tenet of bankruptcy law that like creditors must be treated alike. This argument is simply a restatement of their general assertion that cross-collateralization clauses are illegal per se. It is flawed because the "fundamental tenet" conflicts with another "fundamental tenet" — rehabilitation of debtors, which may supersede the policy of equal treatment. Cases have permitted unequal treatment of pre-petition debts when necessary for rehabilitation, in such contexts as (i) pre-petition wages to key employees; (ii) hospital malpractice premiums incurred prior to filing; (iii) debts to providers of unique and irreplaceable supplies; and (iv) peripheral benefits under labor contracts. See Ordin, Case Comment, In re Texlon Corporation, 596 F.2d 1092 (2d Cir. 1979): Finality of Order of Bankruptcy Court, 54 Amer. Bankr. L.J. 173, 177 (1980). In addition, Congress provided in section 364(d) that pre-petition debts, even secured interests, may be subordinated by post-petition obligations. Although this more traditional application of section 364(d) does not involve disparate treatment of creditors, it illustrates a Congressional willingness to subordinate the interests of pre-petition creditors to the goal of rehabilitation.
Cross-collateralization means granting a post-petition lender a security interest in assets of the estate to secure pre-petition debts to that lender, as part of the consideration for the post-petition financing. That practice is generally frowned upon. See this court's Guidelines for Cash Collateral and Financing Stipulations. In the Adams Apple case, however, the court held that it was not bad faith for the post-petition lender to seek and obtain an order from the bankruptcy court approving cross-collateralization and therefore section 364(e) protected the lender even if the bankruptcy court had acted beyond its authority.
Cross-collateralization means granting a post-petition lender a security interest in assets of the estate to secure pre-petition debts to that lender, as part of the consideration for the post-petition financing. That practice is generally frowned upon. See this court's Guidelines for Cash Collateral and Financing Stipulations. In the Adams Apple case, however, the court held that it was not bad faith for the post-petition lender to seek and obtain an order from the bankruptcy court approving cross-collateralization and therefore section 364(e) protected the lender even if the bankruptcy court had acted beyond its authority.
Cross-collateralization clauses may provide the only means for saving a failing company. As noted above, a lender may be willing to take the risk of advancing funds to a debtor only if the gain derived from cross-collateralization is available. If the lender is the sole lender willing to finance the debtor, a cross-collateralization clause may mean the difference between an ongoing enterprise and a company in liquidation.
Adams Apple, 829 F.2d at 1490 (emphasis added).
Since Adams Apple the Ninth Circuit has emphasized that the above-quoted comments were dicta, and has suggested that to "pay certain pre-petition unsecured claims in full while others remain unpaid" would "impermissibly violate the priority scheme of the Bankruptcy Code." Transamerica Comm. Fin. Corp. v. Citibank, N.A. (In re Sun Runner Marine, Inc.), 945 F.2d 1089, 1094-1095 (9th Cir. 1991) (rejecting cross-collateralization as justification for bankruptcy court's order authorizing payment in full to pre-petition flooring financier).
This broad comment in Sun Runner is also dicta, as the court acknowledged. See id. at 1094-1094 and n. 8 (declining to rule on "hypothetical" question whether bankruptcy court would have justified its ruling by allowing cross-collateralization, or whether it is "ever permissible"). Moreover, whereas Sun Runner speaks of payment "in full" and in violation of section 507, this court is concerned with partial payments that, given PGE's apparent solvency, are more a matter of timing than priority.
Of course, cross collateralization is not the same as partial payment on account of certain pre-petition debts, but the economic effect is much the same.
PGE's fortunes depend in part, on an adequate supply of power from all available sources. Mid-Set has presented proof that it generates approximately 148 MGw of power when it performs under the PPAs, and Mid-Set has also presented proof that it may be unable to continue generating such power if it must continue selling at a loss under the Wood Decision, and if it cannot receive some relief to the negative cash flow it is presently experiencing. Payment of some amount on account of the $58 million allegedly owed by PGE will enhance cash flow and help Mid-Set solve its immediate problems. Although, as discussed above, the court does not yet have much evidence of harm other than to Mid-Set itself, the court can take judicial notice that electric power is scarce enough in California that the availability of those 148 MGw when needed is likely to make a difference. Therefore, the court believes that a necessary cost of preserving the estate is for PGE to pay Mid-Set, on account of the $58 million default, sufficient amounts to enable it to perform when needed under the PPAs.
c. Role of the OCC and PGE's cash
The OCC is charged with a duty to perform such services as are in the interest of those represented. 11 U.S.C. § 1103(c)(5). The OCC's counsel expressed the conviction and desire of the members of the OCC to work on a coordinated "global solution." The court can think of no better place to start such a solution than to draw upon the skills and interest of the OCC and its professionals to work with PGE and its professionals to allocate some portion of PGE's $2.5 billion cash reserve to mitigate the inevitable damages being suffered by Mid-Set and which will inevitably be visited upon this estate.
d. Meet and Confer
1. Counsel for PGE, the OCC, and Mid-Set, accompanied by representatives of their clients authorized to act on behalf of PGE, the OCC and Mid-Set, respectively, are hereby ordered to meet and confer as soon as possible with a goal of reaching an agreement as to an amount of money to be paid by PGE to Mid-Set as partial payment(s) on account of PGE's prepetition defaults under the PPAs. Meeting in this fashion will permit those parties to attempt to arrive first at a consensual confidentiality agreement whereby sensitive financial information which Mid-Set desires to keep from the public eye can be shared as appropriate to assist the parties in reaching an agreement.
The court is mindful of the shortness of time available before the May 24, 2001 hearing. If the meeting ordered by the court cannot take place by then, at the May 24 hearing the parties should advise the court when such a meeting will occur.
2. The court has in mind that Mid-Set would be entitled to no less than the economic equivalent of the difference between the Wood Decision rates being paid for energy since the petition date, and what would be received by Mid-Set were it to be permitted to sell power on the open market. The court cannot readily determine that amount (or any other appropriate terms and safeguards for all concerned) but the parties can bring their expertise and experience to bear and do so. The parties should note, however, that the court is not departing from the "reasonable" rate tentatively ordered herein. Rather, it is trying to suggest a formula whereby Mid-Set will receive at least sufficient monies to eliminate the "disconnect" on a going-forward basis while at the same time bringing down its rejection (breach) or assumption (cure) claim.
3. The actual terms of any such agreement, including the amount and timing of payments, are for the parties to explore. If an agreement is reached, the court expects that PGE and the OCC will bring before the court on an expedited basis a Rule 9019(a) motion for approval of this partial compromise with Mid-Set.
The court is not ordering the parties to reach agreement, only to meet to consider the possibility of doing so. If no agreement is reached the court need only be advised of that fact.
4. In the event there is no agreement among PGE, the OCC and Mid-Set, and if Mid-Set convinces the court on May 24 that it should be granted relief from stay to suspend performance or that the court should set a deadline for PGE to assume or reject the Mid-Set PPAs, it will be required to produce satisfactory evidence to assure PGE, the OCC and the court that it will be available to perform under its PPAs with PGE if motions to assume are brought within a reasonable time and granted. Mid-set must further demonstrate that during any such period of suspended performance, its power generation will be dedicated to the needs of the citizens of California. PGE and the OCC will be given an opportunity to take exception to Mid-Set's showing as to the foregoing items. Before the court makes any order granting relief from stay it will consider as an alternative form of adequate protection, payments from PGE's cash reserves to be applied on account of Mid-Set's prepetition default claim.
Further, if the meeting directed in paragraph 1 has not taken place by May 24, 2001, the court will defer ruling on the Motion until that meeting has occurred and the court is advised of the outcome.
IV. Conclusion
In summary, the court's tentative ruling on this matter is:
1. Suspension of contract/performance.
The court is denying Mid-Set's request for relief from stay to be allowed to suspend performance under its PPAs and deliver power elsewhere. Whether any other relief is ultimately granted depends upon the facts to be developed at the May 24, 2001 hearing, although the court is likely to direct PGE to pay Mid-Set, as a necessary cost of preserving the estate, a portion of the $58 million pre-petition obligation, to enable Mid-Set to perform when needed under the Mid-Set PPAs. Such relief will be conditioned on Mid-Set agreeing to perform under the PPAs, provide power only to California, and any other appropriate limitations.
2. Reasonable rate
Mid-Set is entitled to be paid under its PPAs at a reasonable rate, which the court concludes is PGE's avoided cost as determined by the Wood Decision. Obviously any modification, reversal, or vacation of the Wood Decision will necessarily alter the amount of payments to be made under the PPAs, as so established by controlling law and authorities.
3. Accelerated payments
The court will not presently require PGE to make payments more frequently or earlier than ordered by the CPUC.
4. Assumption or rejection of executory contracts
At this time the court will not set a deadline for PGE to assume or reject the Mid-Set PPAs.
The court's order is that PGE, the OCC and Mid-Set proceed as outlined in 6 III.6.(d).
Nothing in this Tentative Ruling should be construed to be, nor is it intended to be a determination of anything beyond exactly what it states. In particular, the court has not predetermined PGE's right to assume or reject any PPA; it has not predetermined the damage claims of Mid-Set; it has not fixed a deadline for PGE to move to assume or reject any PPA; it has not decided to grant relief to Mid-Set; and it has not decided to order payments to Mid-Set on account of prepetition defaults.