ARTICLE
24 January 2006

Court of Appeals Holds That State Court Should Hear Claims Relating To Alleged Transfer of $4 Billion From PG & E Bankruptcy Estate to Parent Corporation

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In a 2-1 decision, the Ninth Circuit recently held that claims arising out of the alleged transfer of $4 billion from PG & E’s bankruptcy estate to the parent corporation must be heard in state court instead of federal district court. City & County of San Francisco v. PG & E Corporation, --- F.3d ---, 2006 WL 44315 (9th Cir. Jan. 10, 2006).
United States Energy and Natural Resources
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In a 2-1 decision, the Ninth Circuit recently held that claims arising out of the alleged transfer of $4 billion from PG & E’s bankruptcy estate to the parent corporation must be heard in state court instead of federal district court. City & County of San Francisco v. PG & E Corporation, --- F.3d ---, 2006 WL 44315 (9th Cir. Jan. 10, 2006).

The controversy arose when PG & E Corporation ("PG & E Corp."), the parent of PG & E Company ("Utility"), allegedly transferred over $4 billion to itself in order to shield the money from creditors during the period leading up to the Utlitity’s bankruptcy proceedings. Id. at *1. The City and County of San Francisco and the California Attorney General ("plaintiffs") filed suit in state court under California Business and Professions Code § 17200 seeking injunctive relief, civil penalties, and restitution. Id. PG & E Corp. removed the lawsuit to federal district court, prompting the plaintiffs to move to remand the case to state court. Id. at *2.

The legal question was whether the claims were exempt from removal because they were "police or regulatory" actions within the meaning of 28 U.S.C. § 1452 (a). Id. This provision allows a party to remove a claim related to a bankruptcy case to federal district court unless it is "a civil action by a governmental unit to enforce such governmental unit’s police or regulatory power." 28 U.S.C. § 1452 (a). The bankruptcy court held that all three claims were "police or regulatory" and thus could not be removed. Id. However, on a preliminary appeal, the federal district court reversed in part, holding that the restitution claim was not "police or regulatory" and therefore could be removed. Id.

On a subsequent appeal, the Ninth Circuit Court of Appeals reversed, holding that the restitution claim constitutes a "police or regulatory" action that cannot be removed to federal court. Id. at *1. The Court sent the restitution claim back to state court to be heard with the other two. Id.

The Court applied two alternative tests to determine whether the restitution claim is "police or regulatory" in nature: the "pecuniary interest" test and the "public purpose" test. Id. at *5. Under controlling precedent, satisfying either test would suffice and the Court was not required to apply both tests. However, the Court applied both nonetheless, reasoning that "there are sound analytical reasons for considering both tests in conjunction." Id. This approach would be more consistent with the legislative intent to allow the government to bring suit to protect the public health and safety but not to protect its own pecuniary interests in the bankruptcy estate. Id. at n.11.

Under the "pecuniary interest" test, the Court asks whether the claim relates primarily to protecting the government’s "pecuniary interest" in the debtor’s property, or instead to matters of public safety and welfare. Id. at *6. If the claim is pecuniary in nature, it is not "police or regulatory" and can be removed to federal district court. Id. Under the facts of this case, the Court reasoned that the claim for restitution did not relate primarily to the government’s "pecuniary interest" because the money "may flow directly to the [Utility], and not to the state, county, or city governments." Id. The claim also benefits the public welfare by penalizing past unlawful conduct and deterring future wrongdoing. Id. at *7. It is therefore "police or regulatory" in nature and cannot be removed to federal district court. Id.

Next, the court applied the "public purpose" test. According to this test, if the primary purpose of the claim is to "effectuate public policy," then it is "police or regulatory" in nature and cannot be removed to federal district court. Id. However, if the claim seeks to "adjudicate private rights" for the advantage of private parties, it is not "police or regulatory" and can be removed to federal district court. Id.

The Court held that the restititution claim had a "public purpose" and could not be removed. Id. The Court relied on a California Supreme Court case which held that a civil action under § 17200, including a claim for restitution, is "fundamentally a law enforcement action designed to protect the public and not to benefit private parties." See People v. Pacific Land Research Co., 141 Cal.Rptr. 20, 24 (Cal. 1977). The Ninth Circuit reasoned that any case involving restitution may result in damages flowing to private parties, but that is not the fundamental purpose of the claim in this case. City & County of San Francisco, 2006 WL 44315 at *7. Therefore, the "public purpose" test is met and the claim should be remanded to state court. Id.

Judge Callahan dissented from the majority opinion. With respect to the "pecuniary interest" test, Judge Callahan argued that it makes no difference whether the restitution claim benefits the public because it is still primarily pecuniary in nature. Id. at *9. The Judge pointed out that the parties dispute exactly who will receive the restitution award, meaning that it may flow partially to the government afterall. Id. at n.1. Turning to the "public purpose" test, Judge Callahan noted that the public’s interest in punishing and deterring unlawful behavior is addressed by the state’s claims for injunctive relief and civil penalties. Id. at *10. Therefore, the restitution claim meets neither the "pecuniary interest" test nor the "public purpose" test and was properly removed to federal district court. Id.

According to a recent filing with the Securities and Exchange Commission, "PG & E Corporation disagrees with the Ninth Circuit’s decision and intends to file a petition for rehearing en banc." Furthermore, "PG&E Corporation believes these allegations have no merit, and that the ultimate outcome of this matter would not result in a material adverse effect on its financial condition or results of operations." Assuming the holding is affirmed by the en banc review, the plaintiffs will likely pursue their claims in San Francisco Superior Court.

Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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