California Wildfire Liability Legal Update: Why Inverse Condemnation is Unlikely to be Overturned by the Courts

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Eric Selmon Hugh Wynne

Office: +1-646-843-7200 Office: +1-917-999-8556

Email: eselmon@ssrllc.com Email: hwynne@ssrllc.com

SEE LAST PAGE OF THIS REPORT FOR IMPORTANT DISCLOSURES

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April 30, 2018

California Wildfire Liability Legal Update:

Why Inverse Condemnation is Unlikely to be Overturned by the Courts

  • Last week, the trial court in the Butte wildfire lawsuits against PG&E (PCG) ruled against the utility in holding that higher court precedent applying inverse condemnation to investor owned utilities is still binding, regardless of the CPUC’s 2017 decision not to allow San Diego Gas & Electric (SDG&E) to recover the damages it paid out to plaintiffs in inverse condemnation lawsuits stemming from the Witch and Rice wildfires in 2007.
    • Rejection of inverse condemnation reduces the risk to utilities of strict liability for damages to plaintiffs in wildfire cases. In the absence of inverse condemnation, plaintiffs seeking damages must prove the utility was negligent in causing the fire.
    • Rejection of inverse condemnation in the SDG&E case would have raised the possibility of rejection of inverse condemnation for the much bigger October 2017 wildfires, as well as for the Thomas fire in December 2017, materially benefiting PCG and EIX, respectively, although the lawsuits for negligence would remain.
  • The primary reason to deny PCG’s motion was that facts were not different enough from the facts in the previous appeals court decisions applying inverse condemnation to investor owned utilities for the higher court decisions to no longer apply.
    • The court adopted this position despite the fact that the CPUC’s 2017 decision in the SDG&E case was the first decision by the CPUC denying recovery of damages paid out under an inverse condemnation claim, raising the real possibility that an investor owned utility held liable under inverse condemnation may be denied the ability to recover the costs from ratepayers.
    • This “socialization” of damages suffered by a private entity (the plaintiff) caused by something which benefits the public (in this case, the electric grid) is an important economic principle underlying the doctrine of inverse condemnation.
  • While the decision is tentative, once it is finalized, PCG will be able to appeal to a higher court. We doubt, however, that the lower court’s decision will be overturned.
  • Although the appeals court has the authority to reverse or limit its own prior decisions, we see two reasons why it would not in this case:
    • The facts of the SDG&E case; and
    • The language of the California Constitution and the precedents set by previous decisions applying inverse condemnation.

The Facts of the SDG&E Case

  • Critically, in the Witch/Rice fires cases, SDG&E settled all of the claims against it and did not fully litigate any of them. As the CPUC noted in its decision, “We are not aware of any Superior Court determination that SDG&E was in fact strictly liable for the costs requested in its application.”
    • Rather, SDG&E settled the inverse condemnation claims that had been brought against it and persuaded plaintiffs to drop their tort liability claims.
    • SDG&E’s failure fully to litigate the tort liability claims against left it open to the suspicion that it had settled these claims out of fear that it would be found liable due to negligence. By settling under the principle of inverse condemnation, SDG&E may have hoped to pass the cost of its liability for damages on to ratepayers.
    • The CPUC subsequently found in its own proceeding that SDG&E had been negligent, and denied recovery of the damages from ratepayers.
  • Given this fact pattern, the denial of recovery by the CPUC in the SDG&E case does not contravene the basic principles of inverse condemnation. An appeals court reviewing the SDG&E case would recognize that, in the absence of utility negligence, there is still a possibility of recovery, upholding the economic theory of socialization that underpins inverse condemnation.
    • In the absence of negligence, the utility would be able to recover from its ratepayers, the beneficiaries of its equipment, any damages it pays to property owners damaged by that equipment, and thus to socialize the cost of property losses borne by those individuals.
    • If the CPUC finds the utility to have been negligent (i.e., not prudent in the operation or maintenance of its assets), a decision by the CPUC to deny the utility recovery of damages paid is consistent with regulatory principles and the CPUC’s responsibilities under law.
    • Thus, if a utility settles claims for damages under the principle of inverse condemnation, and is subsequently denied recovery because the CPUC found it to be negligent (not prudent) in causing those damages, the legal basis for inverse condemnation is unaffected.
  • It is worth noting that the law does not endow utilities with the right of recovery simply because they pay out damages under the principle of inverse condemnation. To do so would create a perverse incentive for utilities to settle damage claims against them in hope of securing recovery.
  • A very different fact pattern would arise if (i) a utility fully litigates claims of inverse condemnation or tort liability and is not found by the court to be negligent, but (ii) is held liable for these claims under the strict liability principle of inverse condemnation and is denied recovery from ratepayers by the CPUC.
    • In this case, we would still expect inverse condemnation to stand, but the CPUC’s denial of recovery would be reversed in court as an unconstitutional taking of the utility’s property.

The Language of the California Constitution

  • A second argument as to why the SDG&E case does not merit reconsideration by the higher courts of prior decisions on inverse condemnation can be based on the language of the California Constitution.
  • The clause of the California Constitution that is the basis of inverse condemnation states: “Private property may be taken or damaged for a public use only when just compensation has first been paid to, or into court for, the owner.”
    • This clause makes no mention of the idea of socialization of costs, only requiring compensation for damage caused to private property by a public use.
  • In previous decisions applying inverse condemnation to investor owned utilities, the courts have clearly determined that the operation of the electric grid benefits the public and is a public use, and that therefore the principle of inverse condemnation applies.
    • Indeed, a California Supreme Court decision regarding the applicability of other legal principles to investor owned utilities, which was cited by the appeals court in a key inverse condemnation case, made clear that the quasi-monopoly franchise granted by the state to the utility infuses the utility with quasi-governmental characteristics.
    • In these decisions, however, no investigation was ever made into whether the CPUC would allow recovery of the damages from ratepayers.
  • Thus, the refusal of the CPUC to allow SDG&E to recover damages paid under inverse condemnation in no way contradicts the language of the California Constitution or prior court precedent.

Does Strict Liability Under Inverse Condemnation Really Make a Difference?

  • Despite the likelihood, in our view, of the survival of inverse condemnation for utilities, absent any legislative decision to change, we do not believe the risk from inverse condemnation warrants a significant discount, for the reasons set out below. (See also our note from December 6, “EIX, PCG, SRE: The Five Things You Need to Know About the Exposure of California’s Utilities to Wildfires Under Inverse Condemnation and Tort Liability”).
    • All of the lawsuits brought against PCG for the Northern California fires from October and against EIX for the Thomas Fire and Montecito mudslides include claims for both inverse condemnation and negligence.
    • As long as EIX and PCG fully litigate some of the claims and are not found to have been negligent, but rather are liable only under the strict liability standard of inverse condemnation, they should be able to recover all damages from ratepayers.
    • If the utilities are found to have been negligent, they would have been liable regardless of inverse condemnation.
    • And, despite claims to the contrary, we do not believe there would have been any fewer lawsuits in the absence of inverse condemnation – when there are billions of dollars of damages, the potential payouts are large enough for lawyers to file lawsuits even if negligence is the only theory available.
  • The primary risk for utilities from wildfires remains the application of the standard of negligence in determining tort liability under California law, as opposed to a higher hurdle of gross negligence as applied in most other states, for damages caused by natural disasters that have multiple causes in addition to the actions of the utility.
    • The damages caused by the California wildfires reflect, among other things, the choice by people to live in fire-prone regions with minimal zoning and construction requirements, the long term impact of climate change, and the vagaries of the weather; in this context, any action of the utility action may have been a minor contributor even though it could be the proximate cause.
  • A second important risk is the ability of the CPUC and the courts to second guess the reasonableness of the utility’s actions when reviewed after the tragic outcome is known.

Our Thoughts on Legislative Action

  • Over the past several weeks there has also been a lot of legislative activity to address the wildfires, including bills that address the liabilities of utilities.
  • For the reasons discussed above, we do not see the removal of inverse condemnation liability, alone, as having a major impact on the risk for utilities from wildfires.
  • The best bill we have seen, both from the perspective of public policy and for the utilities, is Senate Bill 1088, which requires the establishment and continued review of a “safety, reliability and resilience plan,” with annual reviews by the commission on compliance. If found to be in compliance with the plan, its performance and operations covered by the plan would be deemed to be prudent “for all purposes.”
    • The bill has been amended and the latest text is not available, but if the language referenced above remains, this bill would offer significant protection for utilities, while encouraging more careful behavior.
    • This law does not prevent lawsuits, nor would its language regarding prudency “for all purposes” be binding in a negligence lawsuit, but the finding by the CPUC would be evidence in favor of the utility in court and, more importantly, should mandate recovery from ratepayers should the utility lose on inverse condemnation or settle with plaintiffs.
  • We believe, even if no legislation is passed, the CPUC has the authority to put in place a program similar to what SB1088 requires and to make that the basis of its prudency review in allowing recovery from ratepayers for wildfires.

The Investment Case for EIX and PCG

Exhibit 1: Heat Map: Preferences Among Utilities, IPP and Clean Technology

Source: SSR analysis

©2018, SSR LLC, 225 High Ridge Road, Stamford, CT 06905. All rights reserved. The information contained in this report has been obtained from sources believed to be reliable, and its accuracy and completeness is not guaranteed. No representation or warranty, express or implied, is made as to the fairness, accuracy, completeness or correctness of the information and opinions contained herein.  The views and other information provided are subject to change without notice.  This report is issued without regard to the specific investment objectives, financial situation or particular needs of any specific recipient and is not construed as a solicitation or an offer to buy or sell any securities or related financial instruments. Past performance is not necessarily a guide to future results.

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