• The Supreme Court Reaffirms and Clarifies the Mobile-Sierra Doctrine
  • July 30, 2008 | Author: Nicholas A. Giannasca
  • Law Firm: Blank Rome LLP - New York Office
  • On June 26, 2008, the U.S. Supreme Court issued its long- awaited decision in Morgan Stanley Capital Group Inc. v. Public Utility Group No. 1 of Snohomish County.1 The decision reaffirms and clarifies the Mobile-Sierra doctrine, that freely negotiated contracts for the sale of electricity or natural gas under the Federal Power Act (“FPA”) and the Natural Gas Act are presumptively “just and reasonable,” unless the presumption is rebutted by a showing that the rates impair the public interest.

    The Mobile-Sierra doctrine was formulated after two U.S. Supreme Court decisions2 in 1956 which held that freely negotiated contracts are presumed to be just and reasonable, unless the public interest warrants a modification or abrogation of the contract. The “public interest” standard is extremely difficult to satisfy. In the Court’s view, a contract is inconsistent with the public interest if continued enforcement will “impair the financial ability of the public utility to continue its service, cast upon other consumers an excess burden, or be unduly discriminating”.3 If the standard is met, the contract may be modified in order to prevent an excess financial burden on consumers or the deterioration of a public utility’s financial health.

    The facts of Morgan Stanley Capital Group Inc. v. Public Utility Group No. 1 of Snohomish County entail the California legislature’s decision to deregulate the power industry in 1996 and establish a “spot market” in which utilities can purchase electricity at real-time prices. California experienced an exceptionally hot summer in 2000 and this, among other factors, led to significant increases in the spot market price for energy. In response to inflated spot market prices, certain buyers negotiated power purchase contracts with below market rates fixed for a longer term. These contracts were not individually reviewed by the Federal Energy Regulatory Commission (“FERC”). Once the energy crisis ended, prices retreated but the purchasers under these long-term contracts remained subject to above market rates. They brought an action before FERC seeking to void or renegotiate these contracts on the basis that the market was “dysfunctional” at the time these contracts were negotiated. Following the Mobile-Sierra doctrine, FERC presumed the rates under those contracts to be just and reasonable, and found that the public interest standard had not been satisfied to support a modification.

    The Ninth Circuit set aside FERC’s refusal to modify the contracts as arbitrary and contrary to the FPA. Among its rulings, the Ninth Circuit held that:

    • the Mobile-Sierra doctrine only applies when FERC has a meaningful opportunity to review the underlying contract (which FERC did not do with the contracts in question),
    • the Mobile-Sierra doctrine does not apply to contracts formed in an atmosphere of market dysfunction, and
    • the public interest standard for evaluating buyer complaints that a jurisdictional rate is too high differs from the standard applicable to a seller’s claim that the rate is too low.

    The Ninth Circuit established a “zone of reasonableness” test for determining whether a rate imposes an undue burden on customers, which is one of the public interest considerations under the Mobile-Sierra doctrine. However, the Supreme Court rejected the Ninth Circuit’s ruling that the Mobile-Sierra presumption applies only where there has been an opportunity for FERC to review the rates before the contract’s effective date. Also rejected were the Ninth Circuit’s rulings that the presumption does not apply to contracts formed in an atmosphere of “market dysfunction,” and that challenges by buyers satisfy the “excessive burden” element of the public interest standard if the rates exceed the seller’s marginal cost (i.e., the zone of reasonableness).

    In a 5–2 decision, the Supreme Court reaffirmed the Mobile-Sierra doctrine by stating that only when the mutually agreed upon contract rate for energy seriously harms the public interest may FERC declare the contract to be unjust and unreasonable. The Court also clarified that setting aside a contract rate for energy requires a finding of unequivocal public necessity or extraordinary circumstances, and ruled that FERC failed to determine whether the contracts imposed excessive burden on the consuming public relative to the rates they could have obtained but for the long-term contracts. In an additional clarification, the Court instructed FERC to address the purchasers’ claim that there was a manipulation of the market and its effect on the rate because any illegal market manipulation would be grounds for a modification of the contract in the interest of the public. Therefore, the Court remanded the case back to FERC to reexamine these issues in accordance with the opinion.

    The implications of this case for the wholesale energy market are significant. The Supreme Court’s ruling to remand the case back to FERC could potentially result in a FERC directive to the involved sellers to issue refunds or accept modified contract terms. As a general matter, however, the decision should restore stability to the marketplace and contracts because it reaffirms the presumption of “just and reasonable” rates in negotiated contracts and sets the bar at a high level for contract modification in requiring a showing of serious harm to the public interest or that the rates were the subject of market manipulation.

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    1. Morgan Stanley Capital Group Inc. v. Public Utility Group No. 1 of Snohomish County, (U.S. June 26, 2008) (No. 06-1457).
    2. United Gas Pipe Line Co. v. Mobile Gas Services Corp., 350 U.S. 332 (1956) (“Mobile”); FPC v. Sierra Pacific Power Co., 350 U.S. 348 (1956) (“Sierra”).
    3. Sierra, 350 U.S. at 355.