Opinion Recap: Morgan Stanley v. Public Utility 1

Rachel Lee is a summer associate at Stoel Rives, which represents a petitioner in 06-1454, a related petition that was GVR’d after the Morgan Stanley decision. She is a rising 3L at Stanford Law School.

On Thursday, the Supreme Court disappointed public utilities seeking to reduce the electricity rates of long-term contracts they entered into during the California energy crisis. The Court embraced the importance of enforceable long-term contracts and concluded that Congress “intended to reserve the Commission’s contract-abrogation power for those extraordinary circumstances where the public will be severely harmed.” Nevertheless, the Court did not entirely close the door on the claims. Rather, it directed FERC to determine on remand whether the contracts imposed an excessive burden on consumers “down the line,” and whether the energy sellers had “engaged in such extensive unlawful market manipulation as to alter the playing field for contract negotiation.”

Justice Scalia, writing for a four-member majority, vacated the Ninth Circuit’s decisions in Morgan-Stanley and its companion case, American Electric Power Service Corp. v. Public Utility District No. 1 of Snohomish County. The Court agreed with the energy sellers and held that the Ninth Circuit had misinterpreted the Mobile-Sierra doctrine in two ways when reviewing FERC’s decisions. First, the Mobile-Sierra presumption that a negotiated rate is “just and reasonable” applies to all contract rates, even if FERC passively allowed a rate to go into effect without an initial review of its reasonableness. Second, the Mobile-Sierra standard applies symmetrically, both to rates challenged as too low and those challenged as too high. The presumption of validity does not depend on whether the rate is above or below the marginal cost for the electricity—otherwise it would be a return to the cost-based regulation that contract-based rates are intended to avoid. Thus, under Mobile-Sierra, a contract rate can be modified by FERC “only if it harms the public interest” by, for example, impairing the continued financial viability of a public utility, laying an excessive burden on consumers, or being unduly discriminatory. In endorsing Mobile-Sierra, the Court stressed that “contract stability ultimately benefits consumers, even if short-term rates for a subset of the public might be high by historical standards.”

However, although it rejected the Ninth Circuit’s analysis, the Court affirmed the results—the cases are to be remanded to FERC for further consideration—based on two serious flaws that it identified in FERC’s prior review of the contracts. First, FERC appears to have evaluated the contracts’ burden on consumers by comparing contract rates over the life of the contract with the rates in effect immediately before the contract—the high rates of the dysfunctional spot market in 2000 and 2001. The Court directed FERC to also consider the difference between the contract rates and the prices that consumers would now be paying on the open market. Second, the Court held that a contract should be abrogated by FERC if a party to the contract engaged in market manipulation that affected the contract rate. Because FERC’s earlier order concluded that market manipulation in the spot market was irrelevant unless the forward market rates also harmed the public interest under Mobile-Sierra, FERC did not conclusively determine whether the energy sellers’ alleged market manipulation had affected the contracts at issue. Although FERC has no duty to inquire into whether a contract was formed in a “dysfunctional” market—and to suggest otherwise would have the perverse effect of discouraging stabilizing long-term contracts in highly volatile energy markets—FERC should not apply Mobile-Sierra when it finds “a causal connection between unlawful activity and the contract rate.”

Justice Ginsburg wrote a one-paragraph concurrence noting that she would have preferred to deny the interlocutory petition while awaiting further developments.

Justice Stevens wrote a dissent, joined by Justice Souter, in which he argued that the Court has hobbled FERC by mandating the Mobile-Sierra presumption, the circumstances for its nonapplication, and the role of marginal cost in reviewing a contract rate. By using “general” language in the Federal Power Act, Congress intended to delegate the details of rate review to FERC, and it is improper to “bind[] the Commission to a rigid formula of the Court’s own making.” The statute itself does not contain the Mobile-Sierra presumption, nor do the eponymous cases compel it: Mobile did not involve the standard of review for contract rates, and Sierra determined the standard of review for low contractual rates, not for high ones. Moreover, the responsibility for balancing the short-term financial interests of consumers with their interests in stable energy markets belongs properly not to the courts but to FERC, underscoring FERC’s need for discretionary authority rather than a court-mandated presumption. Thus, Justice Stevens agreed with the majority that the Ninth Circuit erred and the cases belong back in front of FERC, but he differed on what sort of marching orders should go with them.

The Chief Justice and Justice Breyer took no part in the consideration or decision of these cases.

On remand, FERC will need to make the findings of fact as directed by the Court. In addition, two associated petitions (06-1454, 06-1468) were GVR’d on Friday. In these cases, the Ninth Circuit will need to consider the standard set in Morgan Stanley and take appropriate action, which may result in more remands to FERC. Finally, the Court has explicitly left open the possibility of future challenges to the lawfulness of FERC’s entire market-based-tariff system.