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The Constellation Experience

Ring-fencing after the subprime meltdown.

Fortnightly Magazine - August 2010

the financial crisis that enveloped Wall Street in the Fall of 2008. Lehman Brothers Holdings filed a voluntary bankruptcy petition on Sept. 15, 2008. Within days following the Lehman bankruptcy, Federal Reserve Chairman Ben Bernanke warned Congress that the economy of the world would collapse unless Congress provided $700 billion in discretionary funds. 8

On the morning of Sept. 16, 2008, Constellation faced its own crisis arising, at least in part, from rumors concerning the company’s alleged exposure to the Lehman bankruptcy. While owning BGE, a regulated utility, much of Constellation’s revenues were in fact a result of energy trading and related contracting. These trading activities, combined with threatened, and ultimately implemented, credit-rating downgrades, exposed Constellation to potential collateral needs that—in light of the credit crisis—the company simply could not meet. The Constellation “management team was concerned that a further erosion of confidence in Constellation Energy’s ability to support its business… could lead to demand for additional collateral that would require more liquidity than Constellation Energy had or could access in a short time.” 9 In short, Constellation faced bankruptcy: 10

Based on statements made by the ratings agencies to Constellation Energy, absent a significant, immediate equity investment, one or more of the ratings agencies were likely to downgrade Constellation Energy’s credit rating ( i.e., possibly by two notches to below investment grade), which would trigger an obligation for Constellation Energy to post additional collateral under existing counterparty contracts and further exacerbate the crisis of confidence with its business counterparties, thereby seriously impairing Constellation Energy’s ability to operate its business and likely forcing the company to file for bankruptcy protection.

Constellation avoided bankruptcy by agreeing to an offer from Warren Buffet’s MidAmerican Energy Holdings Co. to acquire the entire company for $4.7 billion. Electricité de France (EDF) subsequently displaced Buffet’s takeover bid by making an offer adjudged by the Constellation board of directors to be superior: the acquisition of a 49.99-percent share of Constellation’s nuclear generating subsidiary for roughly $4.5 billion.

One year later, testifying in support of the EDF acquisition before the Maryland Public Service Commission (MDPSC), Constellation executives acknowledged that what was true in September 2008 was still the case in September 2009. Constellation had insufficient ring-fencing measures surrounding BGE to mitigate against the likelihood that a court would involuntarily consolidate BGE into a Constellation bankruptcy. 11 In addition, Constellation controlled a majority of the seats on the board of directors of BGE, as noted, a wholly-owned subsidiary, and could direct BGE to file a voluntary petition for bankruptcy together with a Constellation filing. 12

The MDPSC responded to this state of affairs by conditioning its approval of the EDF acquisition upon Constellation’s implementation of significant ring-fencing measures. In an order issued in October 2009, 13 the commission imposed specific conditions, including: 1) creation of a special purpose entity (SPE) intermediate holding company that would hold all shares of BGE stock, and have two separate “golden votes” that must be voted in favor of any voluntary petition of bankruptcy; 14 2) Constellation, BGE and the SPE obtain a non-consolidation