Banks May Face Unwanted Regulation If They Foreclose
The owner or operator of a power plant or power contract is considered a utility under certain federal laws. As long as the owner is a passive lender, it is not likely to be regulated, but once a lender takes active possession of a power plant or power contract, then utility status may result.
In addition, if a lender forecloses on voting stock of a project company that is considered a utility after a default, then the lender could become a “holding company” subject to even broader utility holding company regulation.
Finally, a federal regulator has recently determined that a company designating itself as a “financial adviser” to a power marketer that owns only electric power (and other) contracts, but no physical plant, is nonetheless an “operator” of such power marketer contracts, and therefore a public utility.
What’s the big deal if a bank becomes a public utility? Arguably, a bank or other lender should not care if it is deemed a public utility as long as the relevant regulators employ “lightened” regulation as is the current federal trend. However, as discussed below, the Bank of America and UBS, both of which have chosen to become public utilities in order to trade in wholesale electric contracts, have found that even lightened regulation may be too burdensome for their purposes. In addition, a change in the political climate against deregulation could trigger a return to much “heavier” regulation of electric traders.
The potential regulatory consequences of foreclosure on an electric utility or stock are explained below.
Holding Company Act: SEC
Traditionally, the federal utility regulation most feared by non-utilities has been under the “Public Utility Holding Company Act,” or “PUHCA,” administered by the US Securities and Exchange Commission, which regulates the parent companies of utilities.
PUHCA regulation is to be avoided. Among other things, a parent company required to register with the SEC must divest its non-utility businesses – like banking! – unless they are “functionally related” to the utility business. It must also limit its utility holdings to a single integrated system, thus precluding geographically widespread utility holdings. PUHCA also provides a comprehensive scheme under which the SEC regulates the corporate organization and financial activities, including acquisitions or sales, of utility parent companies that have to register with the SEC.
If a bank acquires 10% or more of the voting stock of a company considered a utility in the course of exercising remedies upon default of a loan agreement, then the bank will technically become a “holding company” subject to the PUHCA requirements to register and divest its non-utility businesses.
A bank can escape this consequence of foreclosure if the owner of the power plant has been declared to be an exempt wholesale generator, or “EWG.” This exemption is found in section 32 of PUHCA. To qualify, the power company must be exclusively in the business of owning or operating a power plant that sells electricity exclusively at wholesale. EWGs are exempted from PUHCA, and the owners of EWGs do not become utility holding companies solely on account of such ownership.
Foreclosure on stock of most power plants considered “qualifying facilities,” or “QFs,” under PURPA also results in no PUHCA status, as long as the project remains a QF after the bank forecloses. No more than 50% of a QF can be owned by “electric utilities,” “electric utility holding companies” or their subsidiaries, as defined in Federal Energy Regulatory Commission rules. Since banks are typically not “electric utilities,” they can generally meet this requirement and own or operate QFs without becoming a “public utility” or “public utility company.” (However, see the discussion below about the Bank of America and UBS as “public utilities” for Federal Power Act purposes and, presumably, “electric utilities” for PURPA purposes.)
If a power plant owner whose voting stock is being acquired by a bank or other lender cannot qualify as an EWG (because the plant also sells electricity at retail or for some other reason) or as a QF, then PUHCA provides a temporary exemption from holding company status to a bank for purposes of liquidation or distribution in connection with a previously contracted bona fide debt. This PUHCA exemption – called a section 3(a)(4) exemption by lawyers – can be obtained by a bank for a period of two years by a simple filing with the SEC. Non-bank lenders, such as insurance companies, cannot use the same filing procedure as banks, but they can apply to the SEC for a temporary exemption for purposes of liquidation or distribution. Banks can also apply for a longer exemption extending past two years. In such a case, the filing of a “good faith” application would exempt the bank or lender until the SEC acts on its merits. (A “good faith” application has traditionally been considered one in which the PUHCA staff at the SEC has acquiesced, but be alert to any new SEC decisions on this question as the issue of what qualifies as “good faith” has been raised in a pending Enron-related PUHCA proceeding.)
In addition to regulating the upstream “owners” of a power plant or power contract, PUHCA also regulates the upstream “operators” of power plants. There is a difference between a typical operating and maintenance contract and status as an “operator” under the statute. If the “operator” carries out day-to-day plant decisions, but is ultimately responsible to someone else, receives a fixed fee or one with appropriate incentive payments rather than profits tied directly to electricity revenues and has no ownership interest in the utility, then the O&M contract will be considered simply a “service contract” that will not subject the contractor’s parent company to holding company regulation.
To our knowledge, the SEC has never ruled that a power contract or other utility contract by itself is a “facility” under PUHCA, and its staff has issued numerous “no action” letters to the effect that a contract alone is not a statutory “facility.” Thus, banks should be able to foreclose on and acquire the voting stock of electric power marketers that own only electric contracts, not power plants, without concern about becoming “holding companies” under PUHCA.
Federal Power Act: FERC
Financial entities, including banks, that have passive, lender-type interests in wholesale electric contracts (or transmission contracts) are not typically deemed “public utilities” under the Federal Power Act as long as they remain passive lenders. Lenders often obtain declaratory orders from the Federal Energy Regulatory Commission to confirm their non-utility status. The two-part test is that passive lenders must take no part in the ultimate control of the power company that is the borrower, and they must be primarily in a business other than the utility business (such as banking).
Once a lender forecloses and takes control of a power plant or power contract, the lender loses its passive status.
A power plant is not considered a “facility” for purposes of the Federal Power Act (because power plants are regulated by state commissions). However, unlike PUHCA, the Federal Power Act has been interpreted to provide for FERC regulation of entities owning power contracts that are on file at FERC. Thus, foreclosure that results in a bank acquiring only electric wholesale contracts of a power marketer or EWG will subject the bank to FERC jurisdiction. Transmission contracts, as well as transmission facilities, are also FERC-regulated facilities.
Unlike PUHCA, the Federal Power Act has no specific provisions to exempt banks that foreclose on utility facilities, and EWGs are not exempted from FERC regulation, although that regulation is usually “lightened.” Banks that have had to foreclose on utility plants or contracts can set up special-purpose subsidiaries to be regulated as “public utilities” that will hold the utility assets until the bank can sell them.
Public utility status under the Federal Power Act is far less onerous for a bank than “holding company” status under PUHCA because the former does not result in direct upstream regulation of parent companies. Indeed, the Bank of America and UBS have recently become “public utilities” under the Federal Power Act as power marketers because of their ownership of power contracts. As a general rule, FERC waives its regulations or grants “pre-approvals” wherever possible for power marketers and others selling electricity at wholesale at market rates.
However, these banks have been required to make public, quarterly reports to FERC regarding their marketing activities. Moreover, FERC refused to pre-approve acquisitions by the banks of more than 1% of the securities of other companies considered public utilities without the banks applying to FERC for approval. Thus, these two banks have another step they must go through before foreclosing on borrowers in the power industry.
Also, FERC has in recent years extended its regulation to the upstream owners of public utilities to require FERC prior approval for sales or purchases that result in a change in control over assets that are subject to FERC regulation, such as power contracts. Although FERC approval is generally given for such sales or acquisitions, banks may not want to have to get prior FERC approval for their decisions.
The Bank of America and UBS have asked FERC to reconsider its refusal to grant them certain waivers and pre-approvals, indicating that without those, the banks would not find it worthwhile to enter the power trading business. FERC has indicated that it will act on the banks’ request for a rehearing by April 14, 2003.
Just like the SEC does under PUHCA, FERC draws a distinction under the Federal Power Act between a statutory “operator” of assets that it regulates, and one who conducts operations as an agent pursuant to a “service contract,” usually an operations and maintenance agreement. However, FERC recently found that a company that purported to be a “financial adviser” to a power marketer that owned power contracts was in fact the “operator” of those contracts. The problem was the entity was more than a mere financial adviser. It had sole discretion to enter into power contracts and to sell electric services on its own. It also owned computer programs to help it determine which contracts to enter. FERC concluded that this indicated the company was the “operator” of the power marketer’s contracts and, thus, a public utility in its own right. (The power marketer was also considered a public utility for purposes of FERC regulation.)
There may be state law consequences to becoming an active owner or operator of a public utility, particularly one that sells electricity at retail. However, these consequences vary state to state and are outside the scope of this article.