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The Constellation Experience

Ring-fencing after the subprime meltdown.

Fortnightly Magazine - August 2010

opinion that a bankruptcy court would not consolidate the assets of BGE with Constellation in the event of a Constellation bankruptcy; 15 3) the SPE and BGE implement sundry specific measures to maintain requisite legal separateness between and among themselves and Constellation; and 4) BGE’s charter and by-laws be amended to require the unanimous vote of the board of directors, including the BGE independent directors, in order for BGE to file a voluntary petition of bankruptcy. The MDPSC also conditioned its approval of the acquisition on BGE’s not paying dividends to Constellation if, after the dividend payment, BGE’s equity level would fall below 48 percent.

With the repeal of the 1935 Act, state regulators looking to safeguard regulated utilities and protect consumer interests face the significant challenge of insulating utilities in holding companies from the risks flowing from unregulated enterprises. The credit, collateral and market risk associated with derivatives and trading activities is only one example—albeit a compelling one—of the risks associated with unregulated entities. 16

Given the difficulty of policing and monitoring the riskiness in public utility holding company structures and dealings, ring-fencing measures offer a potential structural safeguard. However, ring-fencing does not offer fool-proof protection and can give rise to its own regulatory trade-offs.

Bankruptcy Remoteness, Not Prevention

Courts have found that it might be “sound business practice for [the parent] to seek Chapter 11 protection for its wholly-owned subsidiaries when those subsidiaries [are] crucial to its own reorganization plan.” 17 A parent holding company typically can order a wholly-owned utility subsidiary to file a voluntary petition for bankruptcy together with the parent’s own filing. While the utility articles of incorporation or by-laws likely would require board of director approval for such action, the parent company likely would control the board of directors of a utility subsidiary. Consistent with the concept of owner-control, the utility vote to file is thus a foregone conclusion.

The creation of a golden vote and/or golden share is a measure for addressing this issue, and was one of the MDPSC’s required ring-fencing measures for BGE. The utility’s governing documents are modified to provide for at least one independent board member, and the arrangements are such that the decision to file for bankruptcy must be by unanimous vote of the board. 18 Alternatively, or additionally, the decision to file can be conditioned upon the vote of a special voting share that resides in the hands of an independent entity. In the case of Enron and PGE, the suite of ring-fencing protections included a golden share requirement.

The golden vote mechanism is not a guarantee that the subsidiary utility will choose to forego filing a petition for bankruptcy. There does not appear to be a recognized requirement that an independent director or golden shareholder must vote against the utility’s filing a voluntary petition for bankruptcy. The Bankruptcy Court for the Southern District of New York was very clear on this point in the recent General Growth Properties proceeding. The “belie[f] that an ‘independent’ manager can serve on a board solely for the purpose of voting ‘no’ to